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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

 

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
   
  For the quarterly period ended September 30, 2012; 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 REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

NEVADA 87-0573331
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)  

 

1301 NORTH TUSTIN AVENUE  
SANTA ANA, CALIFORNIA 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

 

(714) 953-3503 (Registrant's telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes[X] No [_]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  [_] Accelerated filer [_]
Non-accelerated filer  [_] Smaller reporting company  [X]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [_] No [X]

 

There were 255,307,262 shares outstanding of the registrant's common stock as of November 5, 2012.

 

 

 
 

 

INTEGRATED HEALTHCARE HOLDINGS, INC.

FORM 10-Q

 

TABLE OF CONTENTS

 

 

 

 

      Page
     
   PART I - FINANCIAL INFORMATION  
     
Item 1. Financial Statements: 3
     
  Condensed Consolidated Balance Sheets as of September 30 and March 31, 2012 – (unaudited) 3
     
  Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2012 and 2011 – (unaudited) 4
     
  Condensed Consolidated Statement of Stockholders’ Deficiency for the six months ended September 30, 2012 – (unaudited) 5
     
  Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2012 and 2011 – (unaudited) 6
     
  Notes to Condensed Consolidated Financial Statements – (unaudited) 7
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 21
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
     
Item 4. Controls and Procedures 31
     
PART II - OTHER INFORMATION
     
Item 1. Legal Proceedings 32
     
Item 1A. Risk Factors 33
     
Item 6. Exhibits 33
     
  Signatures 33

 

 

 

 

2
 

PART I - FINANCIAL INFORMATION

Item 1.  Financial statements 

 

INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in 000's, except par value)

(unaudited)

 

   September 30,   March 31, 
   2012   2012 
ASSETS    
Current assets:          
Cash and cash equivalents  $10,120   $11,829 
Restricted cash   8    10 
Accounts receivable, net of allowance for doubtful accounts of $20,257 and $18,201, respectively   54,423    53,599 
Inventories of supplies, at cost   6,686    6,855 
Due from governmental payers   7,848    5,183 
Hospital quality assurance fees receivable   23,264    2,436 
Prepaid expenses - hospital quality assurance fees   9,174     
Prepaid insurance   1,368    366 
Prepaid income taxes   2,149    892 
Other prepaid expenses and current assets   11,956    8,339 
Total current assets   126,996    89,509 
           
Property and equipment, net   60,291    55,529 
Debt issuance costs, net       64 
Total assets  $187,287   $145,102 
           
LIABILITIES AND STOCKHOLDERS' DEFICIENCY     
Current liabilities:          
Revolving line of credit  $25,268   $14,000 
Debt, current   46,350     
Accounts payable   55,048    52,700 
Accrued compensation and benefits   18,138    19,847 
Accrued insurance retentions   13,296    14,377 
Hospital quality assurance fees payable   28,519     
Warrant liability, current   2,036     
Other current liabilities   4,950    3,242 
Total current liabilities   193,605    104,166 
           
Debt, noncurrent       45,000 
Warrant liability, noncurrent       1,641 
Capital lease obligations, net of current portion of $1,059 and $891, respectively   7,113    5,944 
Total liabilities   200,718    156,751 
           
Commitments and contingencies          
           
Stockholders' deficiency:          
Integrated Healthcare Holdings, Inc. stockholders' deficiency:          
Common stock, $0.001 par value; 800,000 shares authorized; 255,307 shares issued and outstanding   255    255 
Additional paid in capital   62,911    62,911 
Accumulated deficit   (72,720)   (71,828)
Total Integrated Healthcare Holdings, Inc. stockholders' deficiency   (9,554)   (8,662)
Noncontrolling interests   (3,877)   (2,987)
Total stockholders' deficiency   (13,431)   (11,649)
           
Total liabilities and stockholders' deficiency  $187,287   $145,102 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.  

3
 

    

INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in 000's, except per share amounts)

(unaudited)

 

   Three months ended
September 30,
   Six months ended
September 30,
 
   2012   2011   2012   2011 
                 
Patient service revenues (net of contractual allowances and discounts)  $139,371   $93,702    230,963    183,364 
Provision for bad debts   (13,509)   (7,119)   (23,436)   (16,816)
Net patient service revenues   125,862    86,583    207,527    166,548 
                     
Operating expenses:                    
Salaries and benefits   53,287    53,160    106,278    106,398 
Supplies   13,978    13,230    28,029    26,213 
Other operating expenses   53,062    14,699    68,105    29,176 
Depreciation and amortization   960    1,077    1,918    2,167 
    121,287    82,166    204,330    163,954 
                     
Operating income   4,575    4,417    3,197    2,594 
                     
Other expense:                    
Interest expense, net   (3,018)   (2,480)   (5,450)   (5,322)
Gain (loss) on warrants   (1,125)   3,053    (395)   (217)
    (4,143)   573    (5,845)   (5,539)
                     
Income (loss) before income tax provision (benefit)   432    4,990    (2,648)   (2,945)
Income tax provision (benefit)   (1,922)   4,400    (1,878)   (800)
Net income (loss)   2,354    590    (770)   (2,145)
Net (income) loss attributable to noncontrolling interests (Note 9)   228    (84)   (122)   (219)
                     
Net income (loss) attributable to Integrated Healthcare Holdings, Inc.  $2,582   $506   $(892)  $(2,364)
                     
Per Share Data (Note 8):                    
Earnings (loss) per common share attributable to Integrated Healthcare Holdings, Inc. stockholders               
Basic  $0.01   $0.00   $(0.00)  $(0.01)
Diluted  $0.01   $0.00   $(0.00)  $(0.01)
Weighted average shares outstanding                    
Basic   255,307    255,307    255,307    255,307 
Diluted   256,987    256,972    255,307    255,307 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

   

4
 

 

INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY

(amounts in 000's)

(unaudited)

 

   Integrated Healthcare Holdings, Inc. Stockholders         
    Common Stock    Additional Paid-in     Accumulated    Noncontrolling      
    Shares    Amount    Capital    Deficit    Interests    Total 
                               
Balance, March 31, 2012   255,307   $255   $62,911   $(71,828)  $(2,987)  $(11,649)
                               
Net income (loss)               (892)   122    (770)
                               
Noncontrolling interests distributions                   (1,012)   (1,012)
                               
Balance, September 30, 2012   255,307   $255   $62,911   $(72,720)  $(3,877)  $(13,431)

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

     

 

 

 

 

5
 

   

INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in 000's)

(unaudited)

 

   Six months ended September 30, 
   2012   2011 
Cash flows from operating activities:          
Net loss  $(770)  $(2,145)
Adjustments to reconcile net loss to net cash used in operating activities:          
Depreciation and amortization of property and equipment   1,918    2,167 
Provision for doubtful accounts   23,436    16,816 
Amortization of debt issuance costs   530    449 
Loss on warrants   395    217 
Changes in operating assets and liabilities:          
Accounts receivable   (24,260)   (13,275)
Inventories of supplies   169    (250)
Due from governmental payers   (2,665)   (1,494)
Prepaid income taxes   (1,257)   (1,223)
Prepaid expenses - hospital quality assurance fees   (9,174)   (15,247)
Hospital quality assurance fees receivable   (20,828)   1,815 
Prepaid insurance, other prepaid expenses and current assets, and other assets   (3,125)   (760)
Accounts payable   (1,209)   (3,724)
Accrued compensation and benefits   (1,709)   (1,595)
Unearned revenues - hospital quality assurance fees       18,386 
Hospital quality assurance fees payable   28,519     
Income taxes payable       (12,800)
Accrued insurance retentions and other current liabilities   459    (3,851)
Net cash used in operating activities   (9,571)   (16,514)
           
Cash flows from investing activities:          
Decrease in restricted cash   2    13 
Additions to property and equipment   (1,242)   (752)
Net cash used in investing activities   (1,240)   (739)
           
Cash flows from financing activities:          
Proceeds from revolving line of credit, net   11,268    919 
Debt issuance costs, net   (610)    
Noncontrolling interests distributions   (1,012)   (883)
Payments on capital lease obligations   (544)   (521)
Payment received - receivable from stockholders       132 
Net cash provided by (used in) financing activities   9,102    (353)
           
Net decrease in cash and cash equivalents   (1,709)   (17,606)
Cash and cash equivalents, beginning of period   11,829    20,539 
Cash and cash equivalents, end of period  $10,120   $2,933 
           
Supplemental information:          
Cash paid for interest  $4,590   $4,587 
Cash paid for income taxes  $   $13,095 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.   

 

6
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

BASIS OF PRESENTATION - The accompanying unaudited condensed consolidated financial statements of Integrated Healthcare Holdings, Inc. and its wholly owned subsidiaries (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and the rules and regulations of the Securities and Exchange Commission ("SEC") for interim financial reporting. Accordingly, the accompanying unaudited condensed consolidated statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, these statements include all adjustments that are of a normal and recurring nature necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows. The results of operations for the three and six months ended September 30, 2012 are not necessarily indicative of the results for the entire 2013 fiscal year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2012 filed with the SEC on June 22, 2012.

 

The Company has determined that Pacific Coast Holdings Investment, LLC ("PCHI") (Note 9), is a variable interest entity as defined by GAAP and the Company is the primary beneficiary and, accordingly, the financial statements of PCHI are included in the accompanying unaudited condensed consolidated financial statements.

 

All significant intercompany accounts and transactions have been eliminated in consolidation. Unless otherwise indicated, all amounts included in these notes to the condensed consolidated financial statements are expressed in thousands (except per share amounts, percentages and stock option prices and values). 

 

LIQUIDITY - As of September 30, 2012, the Company had a total stockholders’ deficiency of $13.4 million and a working capital deficit of $66.6 million.  For the three and six months ended September 30, 2012, the Company had net income (loss) of $2.6 million and $(0.9) million, respectively. At September 30, 2012, the Company had $4.7 million in additional availability under its revolving credit facility (Note 3). The stated maturity date of our $46.35 million term loan with Silver Point Finance, LLC and its affiliates SPCP Group IV, LLC and SPCP Group, LLC (collectively, “Silver Point”) is April 13, 2013.  If we are unable to refinance, restructure or extend our obligation to repay the principal amount by the maturity date, such failure would constitute a default under the credit agreement with Silver Point and our other loan facilities, which would permit Silver Point and our other lenders to seize our assets and those of our variable interest entity, PCHI. Any actions by Silver Point or our other lenders to enforce their rights by seizing our assets could force us into bankruptcy or liquidation, which would have a material adverse effect on our liquidity and financial position and the value of our common stock.

 

DESCRIPTION OF BUSINESS - Effective March 8, 2005, the Company acquired four hospitals (the "Hospitals") from subsidiaries of Tenet Healthcare Corporation (the "Acquisition"). The Company owns and operates the four community-based hospitals located in southern California, which are:

  

  282-bed Western Medical Center in Santa Ana
  188-bed Western Medical Center in Anaheim
  178-bed Coastal Communities Hospital in Santa Ana
  114-bed Chapman Medical Center in Orange

  

RECLASSIFICATION FOR PRESENTATION - Certain amounts previously reported have been reclassified to conform to the current period's presentation with no impact on the reported net income (loss) of the Company.

 

CONCENTRATION OF RISK - The Hospitals are subject to licensure by the State of California and accreditation by the Joint Commission. Loss of either licensure or accreditation would impact the ability to participate in various governmental and managed care programs, which provide the majority of the Company's revenues.

 

Substantially all patient service revenues come from external customers. The largest payers are Medicare and Medicaid (including Medicare and Medicaid managed care plans), which combined accounted for 65% and 55% of the patient service revenues for the three months ended September 30, 2012 and 2011, respectively, and 62% and 55% for the six months ended September 30, 2012 and 2011, respectively. No other payers represent a significant concentration of the Company's patient service revenues.

    

The Company receives all of its inpatient service revenues from operations in Orange County, California. The economic conditions of this market could affect the ability of patients and third-party payers to reimburse the Company for services, through its effect on disposable household income and the tax base used to generate state funding for Medicaid programs.

7
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

USE OF ESTIMATES - The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Principal areas requiring the use of estimates include third-party cost report settlements, income taxes, accrued insurance retentions, self-insurance reserves, and net patient receivables. Management regularly evaluates the accounting policies and estimates that are used. In general, management bases the estimates on historical experience and on assumptions that it believes to be reasonable given the particular circumstances in which its Hospitals operate. Although management believes that all adjustments considered necessary for fair presentation have been included, actual results may materially vary from those estimates.

 

PATIENT SERVICE REVENUES – Patient service revenues are recognized in the period in which services are performed and are recorded based on established billing rates (gross charges) less contractual allowances and discounts, principally for patients covered by Medicare, Medicaid, managed care, and other health plans. Gross charges are retail charges. They are not the same as actual pricing, and they generally do not reflect what a hospital is ultimately paid and therefore are not displayed in the consolidated statements of operations. Hospitals are typically paid amounts that are negotiated with insurance companies or are set by the government. Gross charges are used to calculate Medicare outlier payments and to determine certain elements of payment under managed care contracts (such as stop-loss payments). Since Medicare requires that a hospital's gross charges be the same for all patients (regardless of payer category), gross charges are also what the Hospitals charge all other patients prior to the application of discounts and allowances.

 

The following is a summary of sources of patient service revenues (net of contractual allowances and discounts) before provision for bad debts:

 

   Three months ended   Six months ended 
   September 30,   September 30, 
   2012   2011   2012   2011 
                 
Medicare  $11,830   $15,146   $26,592   $30,597 
Medicaid   52,916    12,447    61,701    24,167 
Managed care   52,730    50,185    104,430    99,240 
Indemnity, self-pay and other   21,015    15,209    36,515    27,806 
Miscellaneous   880    715    1,725    1,554 
   $139,371   $93,702   $230,963   $183,364 

 

 Revenues under the traditional fee-for-service Medicare and Medicaid programs are based primarily on prospective payment systems. Discounts for retrospectively cost based revenues and certain other payments, which are based on the Hospitals' cost reports, are estimated using historical trends and current factors. Cost report settlements for retrospectively cost-based revenues under these programs are subject to audit and administrative and judicial review, which can take several years until final settlement of such matters are determined and completely resolved. Estimates of settlement receivables or payables related to a specific year are updated periodically and at year end and at the time the cost report is filed with the fiscal intermediary. Typically no further updates are made to the estimates until the final Notice of Program Reimbursement is received, at which time the cost report for that year has been audited by the fiscal intermediary. There could be a time lag of several years between the submission of a cost report and receipt of the Final Notice of Program Reimbursement. Since the laws, regulations, instructions and rule interpretations governing Medicare and Medicaid reimbursement are complex and change frequently, the estimates recorded by the Hospitals could change by material amounts. The Company has established settlement receivables of $46 and $190 as of September 30 and March 31, 2012, respectively.

 

The Hospitals receive supplemental payments from the State of California to support indigent care (Medi-Cal Disproportionate Share Hospital payments or "DSH") and from the California Medical Assistance Commission ("CMAC") under the SB 1100 and SB 1255 programs. The Hospitals received (repaid) supplemental payments of $(600) and $1.1 million during the three months ended September 30, 2012 and 2011, respectively, and $4.1 million and $5.9 million, during the six months ended September 30, 2012 and 2011, respectively. The related revenue recorded for the three months ended September 30, 2012 and 2011, was $5.1 million and $4.0 million, respectively, and $6.9 million and $7.4 million for the six months ended September 30, 2012 and 2011, respectively. As of September 30 and March 31, 2012, estimated DSH receivables were $7.8 million and $5.0 million, respectively, which are included as due from government payers in the accompanying unaudited condensed consolidated balance sheets.

 

8
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

Revenues under managed care plans, including Medicare and Medicaid managed care plans (with patient service revenues of $19.7 million and $18.2 million for the three months ended September 30, 2012 and 2011, respectively, and $43.3 million and $38.0 million for the six months ended September 30, 2012 and 2011, respectively), 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. Management believes the estimation and review process allows for timely identification of instances where such estimates need to be revised. The Company does not believe there were any adjustments to estimates of individual patient bills that were material to patient service revenues.

 

The Hospitals provide charity care to patients whose income level is below 300% of the Federal Poverty Level. Patients with income levels between 300% and 350% of the Federal Poverty Level qualify to pay a discounted rate under AB 774 based on various government program reimbursement levels. Patients without insurance are offered assistance in applying for Medicaid and other programs they may be eligible for, such as state disability, Victims of Crime, or county indigent programs. Patient advocates from the Hospitals' Medical Eligibility Program ("MEP") screen patients in the hospital and determine potential linkage to financial assistance programs. They also expedite the process of applying for these government programs. The estimated costs of charity care (based on direct and indirect costs as a ratio of gross uncompensated charges associated with providing care to charity patients) for the three months ended September 30, 2012 and 2011 were approximately $2.5 million and $2.5 million, respectively, and $4.6 million and $3.8 million for the six months ended September 30, 2012 and 2011, respectively.

 

The Company is not aware of any material claims, disputes, or unsettled matters with any payers that would affect revenues that have not been adequately provided for in the accompanying unaudited condensed consolidated financial statements.

.

PROVISION FOR BAD DEBTS - The Company provides for accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. The Hospitals estimate this allowance based on the aging of their accounts receivable, historical collections experience for each type of payer and other relevant factors. There are various factors that can impact the collection trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of uninsured and underinsured patients, volume of patients through the emergency department, the increased burden of copayments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the estimation process.

 

The Company's policy is to attempt to collect amounts due from patients, including copayments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act ("EMTALA"). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In nonemergency circumstances or for elective procedures and services, it is the Hospitals' policy, when appropriate, to verify insurance prior to a patient being treated.

 

Effective March 31, 2012, the Company adopted Accounting Standards Update (“ASU”) 2011-07, “Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities,” which requires health care entities to present the provision for bad debts relating to patient service revenues as a deduction from patient service revenues in the statement of operations rather than as an operating expense. All periods presented have been reclassified in accordance with the provisions of ASU 2011-07.

 

CASH AND CASH EQUIVALENTS - The Company considers all highly liquid debt investments purchased with a maturity of three months or less to be cash equivalents.

 

Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. The Company has never experienced any losses related to these balances. All of the non-interest bearing cash balances were fully insured at September 30, 2012 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts. Beginning 2013, insurance coverage will revert to $250 per depositor at each financial institution, and the Company’s non-interest bearing cash balances may again exceed federally insured limits.

 

9
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

RECEIVABLES AND ALLOWANCE FOR DOUBTFUL ACCOUNTS – The following is a summary of the principal components of accounts receivable and due from government payers as of September 30 and March 31, 2012:

 

   September 30,   March 31, 
   2012   2012 
Accounts receivable:          
Patient accounts receivable  $74,680   $71,800 
Allowance for doubtful accounts   (20,257)   (18,201)
Accounts receivable, net  $54,423   $53,599 
           
Due from government payers:          
Settlement receivables  $46   $190 
DSH   7,802    4,993 
   $7,848   $5,183 

 

The Company’s self-pay collection rate, which is the blended collection rate for uninsured and balance after insurance accounts receivable, was approximately 5.0% and 11.3% as of September 30 and March 31, 2012, respectively. These self-pay collection rates include payments made by patients, including co-payments and deductibles paid by patients with insurance. As of September 30 and March 31, 2012, the allowance for doubtful accounts for self-pay uninsured was 96.1% and 90.3%, respectively, of self-pay uninsured patient accounts receivable. As of September 30 and March 31, 2012, the allowance for doubtful accounts for self-pay balance after insurance was 76.4% and 77.4%, respectively, of self-pay balance after insurance patient accounts receivable, consisting primarily of co-pays and deductibles owed by patients with insurance. As of September 30 and March 31, 2012, the allowance for doubtful accounts for managed care was 16.5% and 16.1%, respectively, of managed care patient accounts receivable.

 

Receivables from patients who are potentially eligible for Medicaid are classified as Medicaid pending under the MEP, with appropriate contractual allowances recorded. If the patient does not qualify for Medicaid, the receivables are reclassified to charity care and written off, or they are reclassified to self-pay and adjusted to their net realizable value through the provision for bad debts. Reclassifications of pending Medicaid 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 bad debts accounts recorded when the accounts are reclassified. All accounts classified as pending Medicaid, as well as certain other governmental receivables, over the age of 90 days were reserved in contractual allowances as of September 30 and March 31, 2012 based on historical collections experience.

 

INVENTORIES OF SUPPLIES - Inventories of supplies are valued at the lower of weighted average cost or market.

 

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 property and equipment and a corresponding lease liability is recognized. The value of the property and equipment under capital lease is recorded at 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 the lease term or their estimated useful life, where applicable.

 

The Company uses the straight-line method of depreciation for buildings and improvements, and equipment over their estimated useful lives of 25 years, and 3 to 15 years, respectively.

 

LONG-LIVED ASSETS - 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. Fair value estimates are derived from established market values of comparable assets or internal calculations of estimated undiscounted future net cash flows. The estimates of future net cash flows are based on assumptions and projections believed by the Company 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.

 

DEBT ISSUANCE COSTS - Debt issuance costs are amortized over the related credit facility’s life using the straight-line method. On August 1, 2012, the Company amended its debt and incurred an aggregate of $1.96 million in origination, consent, and amendment fees which are being amortized over the remaining lives of the respective credit facilities (Note 3). Debt issuance costs of $486 and $38 were amortized during the three months ended September 30, 2012 and 2011, respectively, and $530 and $449 during the six months ended September 30, 2012 and 2011, respectively.  At September 30 and March 31, 2012, prepaid expenses and other current assets in the accompanying unaudited condensed consolidated balance sheets included $1.65 million and $153, respectively, as the current portion of debt issuance costs.

 

10
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

FAIR VALUE MEASUREMENTS - The Company's financial assets and liabilities recorded in the unaudited condensed consolidated balance sheets include cash and cash equivalents, restricted cash, receivables, debt, accounts payable, and other liabilities, all of which are recorded at book value which approximates fair value.

 

GAAP has established a hierarchy for ranking the quality and reliability of the information used to determine fair values and requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

 

  Level 1: Unadjusted quoted market prices in active markets for identical assets or liabilities.
     
  Level 2: Unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
     
  Level 3: Unobservable inputs for the asset or liability.

 

The Company utilizes the best available information in measuring fair value.  Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company currently has no financial or nonfinancial assets or liabilities subject to fair value measurement on a recurring basis except for warrants issued in April 2010 (Note 4).

 

The following table sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis and where they are classified within the hierarchy:

 

  Total   Level 1   Level 2    Level 3 
                     
Warrant liability at September 30, 2012  $2,036           $2,036 
Warrant liability at March 31, 2012  $1,641           $1,641 

 

 

Warrant liability - fair value measurements using significant unobservable inputs (Level 3)     
      
Balance at March 31, 2012  $1,641 
Change in fair value of warrant liability included in earnings   (730)
Balance at June 30, 2012   911 
Change in fair value of warrant liability included in earnings   1,125 
Balance at September 30, 2012  $2,036 

 

WARRANTS - The Company has entered into complex transactions that contain warrants (Notes 3 and 4). If an instrument (or an embedded feature) that has the characteristics of a derivative instrument is indexed to an entity’s own stock, it is still necessary to evaluate whether it is classified in stockholders’ equity (or would be classified in stockholders’ equity if it were a freestanding instrument). The Company has concluded that the warrants should be classified as liabilities as the settlement of the warrants are not deemed to be in the control of the Company.

 

INCOME (LOSS) PER COMMON SHARE – Income (loss) per share is calculated under two different methods, basic and diluted. Basic income (loss) per share is calculated by dividing the net income (loss) by the weighted average shares of common stock outstanding during the period. Diluted income (loss) per share is calculated by dividing the net income (loss) by the weighted average shares of common stock outstanding during the period and dilutive potential shares of common stock. Dilutive potential shares of common stock, as determined under the treasury stock method, consist of shares of common stock issuable upon exercise of stock warrants or options, net of shares of common stock assumed to be repurchased by the Company from the exercise proceeds (Note 8).

 

11
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

 INCOME TAXES - Deferred income tax assets and liabilities are determined based on the differences between the book and tax basis of assets and liabilities and are measured using the currently enacted tax rates and laws using the asset and liability method. The Company assesses the realization of deferred tax assets to determine whether an income tax valuation allowance is required. The Company has recorded a 100% valuation allowance on its deferred tax assets.

 

There is a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and California. Certain tax attributes carried over from prior years continue to be subject to adjustment by taxing authorities. Any penalties or interest arising from federal or state taxes are recorded as a component of the Company’s income tax provision.

 

SEGMENT REPORTING - The Company operates in one line of business, the provision of healthcare services through the operation of general hospitals and related healthcare facilities. The Company's Hospitals generate substantially all of its net patient service revenues.

 

The Company's four Hospitals and related healthcare facilities operate in one geographic region in Orange County, California. There are similarities in the region's economic characteristics and the nature of the Hospitals' operations, the regulatory environment in which they operate and the manner in which they are managed. This region is an operating segment, as defined by GAAP. In addition, the Company's Hospitals and related healthcare facilities share certain resources and benefit from many common clinical and management practices. Accordingly, the Company aggregates the facilities into a single reportable operating segment.

 

NOTE 2 - PROPERTY AND EQUIPMENT

 

Property and equipment consists of the following:

 

   September 30,   March 31, 
   2012   2012 
           
Buildings  $36,536   $35,376 
Land and improvements   13,523    13,523 
Equipment   23,021    18,268 
Construction in progress       1,160 
Assets under capital leases   13,099    11,218 
    86,179    79,545 
Less accumulated depreciation   (25,888)   (24,016)
           
Property and equipment, net  $60,291   $55,529 

 

Equipment at September 30 and March 31, 2012 includes $10.7 million and $4.6 million, respectively, relating to the Company’s ongoing development of its new electronic health record technology, which has not been placed into service (Note 12).

 

The Hospitals are located in an area near active and substantial earthquake faults. The Hospitals carry earthquake insurance with a policy limit of $50.0 million. A significant earthquake could result in material damage and temporary or permanent cessation of operations at one or more of the Hospitals.

 

The State of California has imposed hospital seismic safety requirements. Under these requirements, the Hospitals must meet stringent seismic safety criteria in the future. In addition, there could be other remediation costs pursuant to this seismic retrofit.

         

The State of California has a seismic review methodology known as HAZUS. The HAZUS methodology may preclude the need for some structural modifications. All four Hospitals requested HAZUS review and received a favorable notice pertaining to structural reclassification. All Hospital buildings, with the exception of one (an administrative building), have been deemed compliant until January 1, 2030 for both structural and nonstructural retrofit. The Company does not have an estimate of the cost to remediate the seismic requirements for the administrative building as of September 30, 2012.

 

12
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

There are additional requirements that must be complied with by 2030. The costs of meeting these requirements have not yet been determined. Compliance with seismic ordinances will be costly and could have a material adverse effect on the Company's cash flow.  In addition, remediation could possibly result in certain environmental liabilities, such as asbestos abatement.

 

NOTE 3 - DEBT

 

On August 1, 2012, the Company entered into Amendment No. 4 to Credit Agreement and Consent (the “Credit Agreement Amendment”), which amends the Term Loan Credit Agreement.  Under the Credit Agreement Amendment, Silver Point consented to and waived certain provisions under the Term Loan Credit Agreement in connection with the Company’s execution of the Revolving Loan Amendment. In addition, the provisions in the Term Loan Credit Agreement that provide for mandatory prepayment of the Company’s outstanding “A/R Financing,” as defined, upon receipt of certain federal matching funds under the QAF program were amended to replace 65% with 80%. In connection with the Credit Agreement Amendment, the Company agreed to pay Silver Point a one-time consent and amendment fee in an aggregate amount equal to $1.8 million, of which $450 was paid upon execution of the Credit Agreement Amendment and the balance was added to the principal amount of the Term Loan Credit Agreement.

 

Also on August 1, 2012, the Company entered into Amendment No. 3 to Credit and Security Agreement (the “Revolving Loan Amendment”), which amends the Revolving Loan Agreement. Under the Revolving Loan Amendment, the minimum Revolving Loan Commitment Amount under the Revolving Loan Agreement was increased from $14.0 million to $30.0 million, and the Company agreed to pay to MidCap Funding IV, LLC, as assigned to it from MidCap Financial, LLC, as administrative agent and a lender, and Silicon Valley Bank, as a lender (collectively, the “Lenders”) an origination fee of 1.0% of the Lenders’ increased commitment under the Revolving Loan Amendment, or $160.

 

In addition, under the Revolving Loan Amendment, the lockbox requirements under the Revolving Loan Agreement were amended to provide that in the event the Revolving Loan Commitment Amounts are $30.0 million or less during any period prior to March 31, 2013, or $20.0 million or less thereafter (and assuming there is no Event of Default at the time), the Company would be permitted to transfer funds that are deposited into any Lockbox Account, as defined, to a different bank account designated by the Company, subject to the other terms and conditions contained in the Revolving Loan Agreement.

 

As of September 30, 2012, the Company had the following credit facilities:

     

  $46.35 million term loan under the Credit Agreement, dated as of October 9, 2007, as amended (the “Term Loan Credit Agreement”), by and among the Company, Silver Point, and PCHI and Ganesha Realty LLC (“Ganesha”), as Credit Parties, bearing a fixed interest rate of 14.5% per year ($46.35 million outstanding balance at September 30, 2012). If any event of default occurs and continues, the lender can increase the interest rate to 19.5% per year.  The stated maturity date for this Credit Agreement is April 13, 2013 and, accordingly, the term loan is reflected in the accompanying unaudited condensed consolidated balance sheet as current debt.
     
  $30.0 million revolving line of credit under the Credit and Security Agreement, dated as of August 30, 2010, as amended (the “Revolving Loan Agreement”), by and among the Company, MidCap Funding IV, LLC, as assigned to it from the Lenders, bearing an interest rate of 5.0% plus LIBOR, with a 2.5% floor, per year (7.5% at September 30, 2012) and an unused commitment fee of 0.625% per year ($25.3 million outstanding balance at September 30, 2012).  For purposes of calculating interest, all payments the Company makes on the revolving line of credit are subject to a six business day clearance period.  The stated maturity date for this Revolving Loan Agreement is August 30, 2013. At September 30, 2012, the Company had $4.7 million in additional availability under its revolving credit facility.

 

The Company’s credit facilities contain various affirmative and negative covenants and customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to similar obligations, events of bankruptcy and insolvency, judgment defaults, the invalidity of liens on collateral, and the occurrence of events which have a material adverse effect on the Company. As of September 30, 2012, the Company was in compliance with all financial covenants.

 

13
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

The Company's outstanding debt consists of the following:

 

   September 30,   March 31, 
   2012   2012 
         
Current:          
Revolving line of credit  $25,268   $14,000 
Term loan   46,350     
   $71,618   $14,000 
           
Noncurrent:          
Term loan  $   $45,000 

 

NOTE 4 - COMMON STOCK WARRANTS

 

On April 13, 2010, the Company issued warrants (the “Omnibus Warrants”) to purchase its common stock for a period of three years at an exercise price of $0.07 per share in the following denominations: 139.0 million shares to KPC Resolution Company (a company owned and controlled by Kali P. Chaudhuri, M.D., the Company’s majority shareholder) or its designees and 96.0 million shares to the $46.35 million term loan lender or its designees. The Omnibus Warrants also provide the holders with certain pre-emptive, information and registration rights. On April 13, 2010, the Company recorded warrant expense and the related warrant liability of $2.9 million, representing fair value.  As of September 30, 2012, the fair value of the Omnibus Warrants was $1.181 million.

 

In addition, on April 13, 2010, the Company issued a three-year warrant (the “Release Warrant”) to acquire up to 170.0 million shares of its common stock at $0.07 per share to Dr. Chaudhuri who facilitated a release enabling the Company to recover amounts due from the Company’s prior lender and a $1.0 million reduction in principal of its outstanding debt, among other benefits to the Company. As a result, the Company recorded the fair value of the Release Warrant ($2.1 million) as an offsetting cost of the recovery of amounts due from the Company’s prior lender. The Release Warrant also provides the holder with certain pre-emptive, information and registration rights. As of September 30, 2012, the fair value of the Release Warrant was $855.

 

The Omnibus Warrants and the Release Warrant are collectively referred to as the “April Warrants.” The net gain (loss) recorded related to the April Warrants for the three months ended September 30, 2012 and 2011 was $(1.126) million and $3.1 million, respectively, and $(395) and $(217) for the six months ended September 30, 2012 and 2011, respectively.

 

The fair value of warrants issued by the Company is estimated using the Black-Scholes valuation model, which the Company believes is the appropriate valuation method under the circumstances. Since the Company’s stock is thinly traded, the expected volatility is based on an analysis of the Company's stock and the stock of eight other publicly traded companies that own hospitals.

 

The risk-free interest rate is based on the average yield on U.S. Treasury notes with maturity commensurate with the terms of the warrants. The dividend yield reflects that the Company has not paid any cash dividends since inception and does not anticipate paying cash dividends in the foreseeable future.  The assumptions used in the Black-Scholes valuation model are as follows.

 

   September 30,
2012
   March 31,
2012
 
           
Expected dividend yield   0.0%    0.0% 
Risk-free interest rate   0.1%    0.2% 
Expected volatility   31.4%    57.3% 
Expected term (in years)   0.53    1.04 

  

14
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

NOTE 5 - INCOME TAXES

 

The utilization of net operating loss (“NOL”) and credit carryforwards is limited under the provisions of the Internal Revenue Code (“IRC”) Section 382 and similar state provisions. Section 382 of the IRC of 1986 generally imposes an annual limitation on the amount of NOL carryforwards that may be used to offset taxable income where a corporation has undergone significant changes in stock ownership. In fiscal year 2009, the Company entered into the amended purchase agreement which resulted in a change in control. The Company conducted an analysis and determined that it is subject to significant IRC Section 382 limitations. For both Federal and State tax purposes, the Company's utilization of NOL and credit carryforwards is subject to significant IRC Section 382 limitations. The Company evaluates its ability to utilize the net operating losses each period with regard to the limitations imposed under IRC 382 and also considering the continuing expiration of statutes of limitation for prior years; and in the prior year determined that a portion of the federal and state net operating losses were no longer realizable, and removed from the schedule of deferreds those net operating losses in excess of the IRC 382 limitation and also considering prior years statutes now closed.

 

The difference between the reported income tax provision (benefit) and the amount computed by multiplying income before income tax provision (benefit) in the accompanying unaudited condensed consolidated statements of operations for the three and six months ended September 30, 2012 and 2011 by the statutory federal income tax rate primarily relates to the impact of a full valuation allowance reserving the net deferred assets, permanently nondeductible expenses, state and local income taxes, and variable interest entity.

 

The application of FASB Interpretation Number 18 requires the Company to compute the interim period income tax provision (benefit) by applying the estimated annual effective tax rate to the income (loss) from continuing operations for the three and six months ended September 30, 2012, which resulted in the recognition of a tax benefit for the three and six months ended September 30, 2012.

 

The Company evaluated its historical and projected sources of income to determine the extent to which the net deferred tax assets projected at September 30, 2012 could be realized and, based on this analysis, the Company concluded that there was not sufficient positive evidence to support the realization of the net deferred tax assets, and therefore will continue to maintain a full valuation allowance against its net deferred assets as of September 30, 2012.

 

The Company’s California Enterprise Zone credits were recently examined by the California taxing authority, which issued a Notice of Proposed Adjusted Carryover Amount.  The Company has filed a Protest requesting an oral hearing with the taxing authority. The Protest is currently pending review by the taxing authority. As a result of the examination, during the year ended March 31, 2011, the Company recorded a liability of approximately $18.9 million for unrecognized tax benefits.  The Company's utilization of these credits is also subject to significant IRC Section 383 limitations, and these limitations have been incorporated into the tax provision calculation.

 

PCHI tax status – PCHI is a limited liability company. PCHI's taxable income or loss will flow through to its owners and be their separate responsibility. Accordingly, the accompanying unaudited condensed consolidated financial statements do not include any amounts for the income tax expense or benefit, or liabilities related to PCHI's income or loss.

 

NOTE 6 - STOCK INCENTIVE PLAN

 

The Company's 2006 Stock Incentive Plan (the "Plan"), which is shareholder-approved, permits the grant of share options to its employees and board members for up to a maximum aggregate of 12.0 million shares of common stock. In addition, as of the first business day of each calendar year in the period 2007 through 2015, the maximum aggregate number of shares shall be increased by a number equal to one percent of the number of shares of common stock of the Company outstanding on December 31 of the immediately preceding calendar year. Accordingly, as of September 30, 2012, the maximum aggregate number of shares under the Plan was 23.5 million. The Company believes that such awards better align the interests of its employees with those of its shareholders. In accordance with the Plan, incentive stock options, nonqualified stock options, and performance based compensation awards may not be granted at less than 100 percent of the estimated fair market value of the common stock on the date of grant. Incentive stock options granted to a person owning more than 10 percent of the voting power of all classes of stock of the Company may not be issued at less than 110 percent of the fair market value of the stock on the date of grant. Option awards generally vest based on 3 years of continuous service (1/3 of the shares vest on the twelve month anniversary of the grant date, and an additional 1/12 of the shares vest on each subsequent fiscal quarter-end of the Company following such twelve month anniversary). Certain option awards provide for accelerated vesting if there is a change of control, as defined. The option awards have 7-year contractual terms.

  

15
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

When the measurement date is certain, the fair value of each option grant is estimated on the date of grant using the Black-Scholes valuation model. Since there is limited historical data with respect to both pre-vesting forfeiture and post-vesting termination, the expected life of the options was determined utilizing the simplified method, whereby the expected term is calculated by taking the sum of the vesting term plus the original contractual term and dividing that quantity by two.

 

No options were granted or exercised during the three and six months ended September 30, 2012 and 2011. All outstanding options were fully vested as of September 30 and March 31, 2012.

 

A summary of stock option activity for the six months ended September 30, 2012 is presented as follows.

 

   Shares   Weighted-
average exercise
price
   Weighted-
average
grant date
fair value
   Weighted-
average
remaining
contractual term (years)
   Aggregate intrinsic value 
Outstanding, March 31, 2012   8,235   $0.18                
Granted      $   $           
Exercised      $                
Forfeited or expired   (150)  $0.26                
Outstanding, September 30, 2012   8,085   $0.18         2.2   $ 
Exercisable at September 30, 2012   8,085   $0.18        2.2   $ 

 

 

NOTE 7 - RETIREMENT PLAN

 

The Company has a 401(k) plan for its employees. All employees with 90 days of service are eligible to participate, unless they are covered by a collective bargaining agreement which precludes coverage. The Company matches employee contributions up to 3% of the employee's compensation, subject to IRS limits. During the three months ended September 30, 2012 and 2011, the Company incurred expenses of $833 and $808, respectively, and $1.6 million and $1.6 million for the six months ended September 30, 2012 and 2011, respectively. These costs are included in salaries and benefits in the accompanying unaudited condensed consolidated statements of operations.  At September 30 and March 31, 2012, accrued compensation and benefits in the accompanying unaudited condensed consolidated balance sheets included $2.4 million and $3.9 million, respectively, in accrued employer contributions.

 

NOTE 8 - INCOME (LOSS) PER SHARE

 

Income (loss) per share is calculated under two different methods, basic and diluted. Basic income per share is calculated by dividing the net income by the weighted average shares of common stock outstanding during the period. Diluted income per share is calculated by dividing the net income by the weighted average shares of common stock outstanding during the period and dilutive potential shares of common stock. Dilutive potential shares of common stock, as determined under the treasury stock method, consist of shares of common stock issuable upon exercise of stock warrants or options, net of shares of common stock assumed to be repurchased by the Company from the exercise proceeds.

 

Income per share for the three months ended September 30, 2012 and 2011 was computed as shown below. Stock options and warrants aggregating approximately 411 and 412 million shares were not included in the diluted calculations since they were anti-dilutive during the three months ended September 30, 2012 and 2011, respectively.

 

   Three months ended   Three months ended 
   September 30, 2012   September 30, 2011 
Numerator:          
Net income attributable to          
 Integrated Healthcare Holdings, Inc.  $2,582   $506 
           
Denominator:          
Weighted average common shares   255,307    255,307 
Dilutive options   1,680    1,665 
Denominator for diluted calculation   256,987    256,972 
           
Income per share - basic  $0.01   $0.00 
Income per share - diluted  $0.01   $0.00 

 

16
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

Since the Company incurred a loss for the six months ended September 30, 2012 and 2011, the potential shares of common stock consisting of approximately 413 and 414 million shares, respectively, issuable under warrants and stock options were not included in the diluted calculations since they were anti-dilutive.

 

NOTE 9 - VARIABLE INTEREST ENTITY

 

Concurrent with the close of the Acquisition, PCHI simultaneously acquired title to substantially all of the real property acquired by the Company in the Acquisition. The Company received $5.0 million and PCHI guaranteed the Company's $46.35 million term loan. The Company remains primarily liable as the borrower under the $46.35 million term loan notwithstanding its guarantee by PCHI. The $46.35 million term loan 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, which is a related party entity that is affiliated with the Company through common ownership and control. As of September 30, 2012, PCHI was owned 51% by various physician investors and 49% by Ganesha, which is managed by Dr. Chaudhuri.

 

The Company entered into a lease agreement dated March 7, 2005 (amended and restated as of April 13, 2010) under which it leased back from PCHI all of the real estate that it transferred to PCHI (Note 13). The amended lease terminates on the 25-year anniversary of the original lease (March 7, 2005), grants the Company the right to renew for one additional 25-year period, and requires combined annual base rental payments of $8.3 million for all the properties. However, until PCHI refinances the related $46.35 million term loan, the annual base rental payments are reduced to $7.3 million. In addition, the Company offsets, against its rental payments owed to PCHI, interest payments that it makes on the related $46.35 million term loan. Lease payments to PCHI and offsetting interest payments are eliminated in consolidation.

 

GAAP defines variable interest entities (“VIE”) as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a stand-alone basis, or whose equity holders lack certain characteristics of a controlling financial interest. Then, for entities identified as a VIE, the guidance sets forth a model to a primary beneficiary based on an assessment of which party to a VIE, if any, bears a majority of the exposure to expected losses, or stands to gain from a majority of its expected returns and has the power to direct activities of the VIE that impacts economic performance. The primary beneficiary of a VIE should consolidate the VIE.

 

The Company determined that it provides the majority of financial support to PCHI through various sources including lease payments, remaining primarily liable under the $46.35 million term loan, and cross-collateralization of the Company's non-real estate assets to secure the $46.35 million term loan. The Company concluded that PCHI is a VIE and it is the primary beneficiary. Accordingly, the financial statements of PCHI are included in the accompanying unaudited condensed consolidated financial statements.

 

PCHI's assets, liabilities, and deficiency are set forth below.

 

   September 30,
2012
   March 31,
2012
 
Cash  $101   $68 
Property, net   40,340    40,984 
Other   1,671    207 
Total assets  $42,112   $41,259 
           
           
Debt (as guarantor)  $46,350   $45,000 
Other   640    641 
Total liabilities   46,990    45,641 
           
Deficiency   (4,878)   (4,382)
Total liabilities and accumulated deficit  $42,112   $41,259 

   

As noted above, PCHI is a guarantor on the $46.35 million term loan should the Company not be able to perform.  PCHI's total liabilities represent the Company's maximum exposure to loss.

 

PCHI rental income and the Company’s related rental expense of $1.9 million and $1.9 million were eliminated upon consolidation for the three months ended September 30, 2012 and 2011, respectively, and $3.9 and $3.8 million for the six months ended September 30, 2012 and 2011, respectively.

 

17
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

The Company has a lease commitment to PCHI (Note 13). Additionally, the Company is responsible for seismic remediation under the terms of the lease agreement (Note 2).

 

NOTE 10 - RELATED PARTY TRANSACTIONS

 

The Company leases substantially all of the real property of the acquired Hospitals from PCHI which is owned by various physician investors and Ganesha, which is managed by Dr. Chaudhuri. As of September 30 and March 31, 2012, Dr. Chaudhuri and Mr. William E. Thomas are the beneficial holders of an aggregate of 447.5 million shares of the outstanding stock of the Company. As described in Note 9, PCHI is a variable interest entity and the Company is the primary beneficiary, accordingly, the Company has consolidated the financial statements of PCHI in the accompanying unaudited condensed consolidated financial statements.

 

NOTE 11 - HOSPITAL QUALITY ASSURANCE FEES (“QAF”)

 

In October 2009, the Governor of California signed legislation supported by the hospital industry to impose a provider fee on general acute care hospitals that, combined with federal matching funds, would be used to provide supplemental Medi-Cal payments to hospitals. The state submitted the plan to the Centers for Medicare and Medicaid Services (“CMS”) for a required review and approval process, and certain changes in the plan were required by CMS. Legislation amending the fee program to reflect the required changes was passed by the legislature and signed by the Governor on September 8, 2010. Among other changes, the legislation leaves distribution of “pass-through” payments received by Medi-Cal managed care plans that will be paid to hospitals under the program to the discretion of the plans.  The hospital quality assurance fee program (“QAF”) created by this legislation initially provided payments for up to 21 months retroactive to April 2009 and expiring on December 31, 2010 (“2010 QAF”).  In February 2011, CMS gave final approval for the 2010 QAF. 

 

In December 2011, CMS gave final approval for the extension of the QAF for the six month period from January 1 through June 30, 2011 (“2011 QAF”).  During fiscal year 2012, the Company recognized $31.9 million in revenue and recorded expenses of $15.9 million relating to the 2011 QAF. 

 

In June 2012, CMS conditionally approved the extension of the QAF for the thirty month period from July 1, 2011 through December 31, 2013 (“2013 QAF”).  In June 2012, the California State Legislature amended the hospital fee statute to recognize separate CMS approval of the fee-for-service portion and managed care portion of the 2013 QAF, which was further clarified in legislation approved by the governor of California in September 2012.  As a result, during the three months ended September 30, 2012, the Company recognized revenue of $38.7 million and expenses of $38.4 million relating to the fee-for-service portion of the 2013 QAF for the period from July 1, 2011 through September 30, 2012.

 

Based on the most recent modeling prepared by the California Hospital Association, the Company anticipates making payments for provider fees and other expenses relating to the 2013 QAF of approximately $105.8 million and receiving approximately $235.5 million in revenues from the State ($79.4 million from the fee-for-service portion and $156.1 million from the managed care portion). 

 

The Company cannot provide any assurances or estimates in connection with CMS’s final approval of the 2013 QAF or a possible continuation of the QAF program beyond December 31, 2013.

 

NOTE 12 – ELECTRONIC HEALTH RECORDS INCENTIVE PROGRAM

 

Provisions of the American Recovery and Reinvestment Act of 2009 provide incentive payments for the adoption and meaningful use of certified electronic health record (EHR) technology. The Medicare EHR incentive program provides incentive payments to eligible hospitals (and certain other providers) that are meaningful users of certified EHRs. The Medicaid EHR incentive program provides incentive payments to eligible hospitals (and certain other providers) for efforts to adopt, implement, upgrade, or meaningfully use of certified EHR technology.

 

CMS has established the final rule which requires eligible providers in their first year of participation in the Medicaid incentive payment program to demonstrate that they have adopted (acquired, purchased, or secured access to), or implemented, or upgraded to certified EHR technology in order to qualify for an incentive payment. During the second and subsequent years of the program, eligible providers are required to meet other criteria, including meaningful use, to receive additional funds. The Company has been awarded a total amount of $13.6 million under the Medicaid EHR incentive program, which will be earned and received over a four year period. The Company adopted certified EHR technology and it recognized other income of $6.8 million relative to the first year under the Medicaid EHR incentive program during fiscal year 2012.

 

18
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

NOTE 13 - COMMITMENTS AND CONTINGENCIES

 

INFORMATION TECHNOLOGY SYSTEMS – On July 1, 2011, the Company entered into software and services agreements with McKesson Technologies Inc. (“McKesson”) to upgrade the Company’s information technology systems.

 

Under the agreements, McKesson will provide the Company with a variety of services, including new software implementation and education/training services for the Company’s personnel, software maintenance services and professional services related to movement and migration of data from legacy systems.  McKesson will also furnish to the Company and maintain new hardware to accommodate the upgraded software and systems.  The new hardware will include computers and servers, among other things, and will include installation, testing, and ongoing maintenance.  The Company has entered into the arrangement to enhance its clinical information systems and upgrade its billing and revenue management information systems.

 

The agreements will initially run for a period of five years, and the recurring services may be renewed by the Company for successive periods.  The agreements do not provide that they may be terminated by the Company prior to the initial expiration date.  The agreements provide for one-time fees and recurring fees which aggregate a total of $22.0 million.  Approximately 60% of the fees are for one-time charges, while the balance is for recurring services.

 

LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY – On April 13, 2010, the Company and PCHI entered into a Second Amendment to Amended and Restated Triple Net Hospital Building Lease (the “2010 Lease Amendment”).  Under the 2010 Lease Amendment, the annual base rent to be paid by the Company to PCHI was increased from $5.4 million to $7.3 million. The base rent is subject to an annual Consumer Price Index increase on January 1 of each year; such increase shall not be less than 2% or more than 6% per year. As a result, the annual base rent as of January 1, 2012 is $7.7 million. If PCHI refinances the $46.35 million term loan, the annual base rent will increase to $8.3 million. This lease commitment with PCHI is eliminated in consolidation.

 

CAPITAL LEASES - In connection with the Acquisition, the Company also assumed the leases for the Chapman facility, which include buildings and land with terms that were extended concurrently with the assignment of the leases to December 31, 2023. The Company leases equipment under capital leases expiring at various dates through December 2015. Assets under capital leases with a net book value of $7.6 million and $6.2 million are included in the accompanying unaudited condensed consolidated balance sheets as of September 30 and March 31, 2012, respectively. Interest rates used in computing the net present value of the lease payments are based on the interest rates implicit in the leases.

 

INSURANCE – The Company accrues for estimated general and professional liability claims, to the extent not covered by insurance, when they are probable and reasonably estimable. The Company has purchased as primary coverage a claims-made form insurance policy for general and professional liability risks. Estimated losses within general and professional liability retentions from claims incurred and reported, along with incurred but not reported (“IBNR”) claims, are accrued based upon projections and are discounted to their net present value using a weighted average risk-free discount rate of 5%. To the extent that subsequent claims information varies from estimates, the liability is adjusted in the period such information becomes available. As of September 30 and March 31, 2012, the Company had accrued $10.7 million and $11.5 million, respectively, which is comprised of $4.6 million and $4.5 million, respectively, in incurred and reported claims, along with $6.1 million and $7.0 million, respectively, in estimated IBNR. Estimated insurance recoveries of $2.7 million and $3.0 million are included in other prepaid expenses and current assets as of September 30 and March 31, 2012, respectively.

 

The Company has also purchased occurrence coverage insurance to fund its obligations under its workers compensation program. The Company has a "paid loss plan" policy, under which the carrier pays all workers compensation claims, with no deductible or reimbursement required of the Company. The Company accrues for estimated workers compensation claims, to the extent not covered by insurance, when they are probable and reasonably estimable. The ultimate costs related to this program include expenses for deductible amounts associated with claims incurred and reported in addition to an accrual for the estimated expenses incurred in connection with IBNR claims. Claims are accrued based upon projections and are discounted to their net present value using a weighted average risk-free discount rate of 5%. To the extent that subsequent claims information varies from estimates, the liability is adjusted in the period such information becomes available. As of September 30 and March 31, 2012, the Company had accrued $649 and $673, respectively, comprised of $342 and $338, respectively, in incurred and reported claims, along with $307 and $335, respectively, in estimated IBNR.

  

19
 

INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2012

(UNAUDITED)

 

In addition, the Company has a self-insured health benefits plan for its employees. As a result, the Company has established and maintains an accrual for IBNR claims arising from self-insured health benefits provided to employees. The Company's IBNR accruals at September 30 and March 31, 2012 were based upon projections. The Company determines the adequacy of this accrual by evaluating its limited historical experience and trends related to both health insurance claims and payments, information provided by its insurance broker and third party administrator, and industry experience and trends. The accrual is an estimate and is subject to change. Such change could be material to the Company's unaudited condensed consolidated financial statements. As of September 30 and March 31, 2012, the Company had accrued $1.9 million and $2.2 million, respectively, in estimated IBNR.

 

The Company has also purchased umbrella liability policies with aggregate limits of $25 million. The umbrella policies provide coverage in excess of the primary layer and applicable retentions for insured liability risks such as general and professional liability, auto liability, and workers compensation (employers liability).

 

As of September 30, 2012, the Company finances various insurance policies at an interest rate of 4.39% per annum. The Company incurred finance charges relating to such policies of $13 and $13 for the three months ended September 30, 2012 and 2011, respectively, and $25 and $25 for the six months ended September 30, 2012 and 2011, respectively. As of September 30 and March 31, 2012, the accompanying unaudited condensed consolidated balance sheets include the following balances relating to the financed insurance policies.

 

   September 30,
2012
   March 31,
2012
 
         
Prepaid insurance  $1,368   $366 
           
Accrued insurance premiums  $785   $- 
(Included in other current liabilities)          

 

CLAIMS AND LAWSUITS – The Company and the Hospitals are subject to various legal proceedings, most of which relate to routine matters incidental to operations. The results of these claims cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on the Company's business (both in the near and long term), financial position, results of operations, or cash flows. Although the Company defends itself vigorously against claims and lawsuits and cooperates with investigations, these matters (1) could require payment of substantial damages or amounts in judgments or settlements, which individually or in the aggregate could exceed amounts, if any, that may be recovered under insurance policies where coverage applies and is available, (2) cause substantial expenses to be incurred, (3) require significant time and attention from the Company's management, and (4) could cause the Company to close or sell the Hospitals or otherwise modify the way its business is conducted. The Company accrues for claims and lawsuits when an unfavorable outcome is probable and the amount is reasonably estimable.

 

There have been no material developments in the matters identified in the Company’s Form 10-K filed with the SEC on June 22, 2012.

 

 

20
 

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,” “continue,” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks discussed under the caption “Risk Factors” in our Annual Report on Form 10-K filed on June 22, 2012 that may cause our Company's or our industry's actual results, levels of activity, performance, or achievements to be materially different from those expressed or implied by these forward-looking statements.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except as may be required by applicable law, we do not intend to update any of the forward-looking statements to conform these statements to actual results.

 

As used in this report, the terms “we,” “us,” “our,” “the Company,” “Integrated Healthcare Holdings” or “IHHI” mean Integrated Healthcare Holdings, Inc., a Nevada corporation, unless otherwise indicated.

 

Unless otherwise indicated, all amounts included in this Item 2 are expressed in thousands (except percentages and per share amounts).

 

OVERVIEW

 

On March 8, 2005, we completed our acquisition (the "Acquisition") of four Orange County, California hospitals and associated real estate, including: (i) 282-bed Western Medical Center - Santa Ana, CA; (ii) 188-bed Western Medical Center - Anaheim, CA; (iii) 178-bed Coastal Communities Hospital in Santa Ana, CA; and (iv) 114-bed Chapman Medical Center in Orange, CA (collectively, the "Hospitals") from Tenet Healthcare Corporation. The Hospitals were assigned to four of our wholly owned subsidiaries formed for the purpose of completing the Acquisition. We also acquired the following real estate, leases and assets associated with the Hospitals: (i) a fee interest in the Western Medical Center at 1001 North Tustin Avenue, Santa Ana, CA, a fee interest in the administration building at 1301 North Tustin Avenue, Santa Ana, CA, certain rights to acquire condominium suites located in the medical office building at 999 North Tustin Avenue, Santa Ana, CA; (ii) a fee interest in the Western Medical Center at 1025 South Anaheim Blvd., Anaheim, CA; (iii) a fee interest in the Coastal Communities Hospital at 2701 South Bristol Street, Santa Ana, CA, and a fee interest in the medical office building at 1901 North College Avenue, Santa Ana, CA; (iv) a lease for the Chapman Medical Center at 2601 East Chapman Avenue, Orange, CA, and a fee interest in the medical office building at 2617 East Chapman Avenue, Orange, CA; and (v) equipment and contract rights. At the closing of the Acquisition, we transferred all of the fee interests in the acquired real estate (the "Hospital Properties") to Pacific Coast Holdings Investment, LLC ("PCHI"), a company owned 51% by various physician investors and 49% by our largest shareholder.

 

SIGNIFICANT CHALLENGES

 

COMPANY - Our Acquisition involved significant cash expenditures, debt incurrence and integration expenses that has seriously strained our consolidated financial condition. If we are required to issue equity securities to raise additional capital or for any other reasons, existing stockholders will likely be substantially diluted, which could affect the market price of our stock. In April 2010 we issued equity securities to an existing shareholder and a new lender (see “WARRANTS”).

 

INDUSTRY - Our Hospitals receive a substantial portion of their revenues from Medicare and Medicaid. The healthcare industry is experiencing a strong trend toward cost containment, as the government seeks to impose lower reimbursement and resource utilization group rates, limit the scope of covered services and negotiate reduced payment schedules with providers. These cost containment measures generally have resulted in a reduced rate of growth in the reimbursement for the services that we provide relative to the increase in our cost to provide such services.

  

Changes to Medicare and Medicaid reimbursement programs have limited, and are expected to continue to have limited, payment increases. Also, the timing of payments made under the Medicare and Medicaid programs is subject to regulatory action and governmental budgetary constraints resulting in a risk that the time period between submission of claims and payment could increase. Further, within the statutory framework of the Medicare and Medicaid programs, a substantial number of areas are subject to administrative rulings and interpretations which may further affect payments.

 

21
 

Our business is subject to extensive federal, state and, in some cases, local regulation with respect to, among other things, participation in the Medicare and Medicaid programs, licensure and certification of facilities, and reimbursement. These regulations relate, among other things, to the adequacy of physical property and equipment, qualifications of personnel, standards of care, government reimbursement and operational requirements. Compliance with these regulatory requirements, as interpreted and amended from time to time, can increase operating costs and thereby adversely affect the financial viability of our business. Since these regulations are amended from time to time and are subject to interpretation, we cannot predict when and to what extent liability may arise. Failure to comply with current or future regulatory requirements could also result in the imposition of various remedies including (with respect to inpatient care) fines, restrictions on admission, denial of payment for all or new admissions, the revocation of licensure, decertification, imposition of temporary management or the closure of a facility or site of service.

 

We are subject to periodic audits by the Medicare and Medicaid programs, which have various rights and remedies against us if they assert that we have overcharged the programs or failed to comply with program requirements. Rights and remedies available to these programs include repayment of any amounts alleged to be overpayments or in violation of program requirements, or making deductions from future amounts due to us. These programs may also impose fines, criminal penalties or program exclusions. Other third-party payer sources also reserve rights to conduct audits and make monetary adjustments in connection with or exclusive of audit activities.

 

The healthcare industry is highly competitive. We compete with a variety of other organizations in providing medical services, many of which have greater financial and other resources and may be more established in their respective communities than we are. Competing companies may offer newer or different centers or services than we do and may thereby attract patients or customers who are presently our patients or customers or are otherwise receiving our services.

 

An increasing trend in malpractice litigation claims, rising costs of malpractice litigation, losses associated with these malpractice lawsuits and a constriction of insurers have caused many insurance carriers to raise the cost of insurance premiums or refuse to write insurance policies for hospital facilities. Also, a tightening of the reinsurance market has affected property, vehicle, and excess liability insurance carriers.

 

We receive all of our inpatient service revenues from operations in Orange County, California. The economic condition of this market could affect the ability of our patients and third-party payers to reimburse us for our services, through its effect on disposable household income and the tax base used to generate state funding for Medicaid programs. An economic downturn, or changes in the laws affecting our business in our market and in surrounding markets, could have a material adverse effect on our financial position, results of operations, and cash flows.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. We had a total stockholders’ deficiency of $13.4 million and a working capital deficit of $66.6 million at September 30, 2012.  For the three and six months ended September 30, 2012, we had net income (loss) of $2.6 million and $(0.9) million, respectively. As discussed below, the stated maturity date of our $46.35 million term loan with Silver Point Finance, LLC and its affiliates SPCP Group IV, LLC and SPCP Group, LLC (collectively, “Silver Point”) is April 13, 2013.  If we are unable to refinance, restructure or extend our obligation to repay the principal amount by the maturity date, such failure would constitute a default under the credit agreement with Silver Point and our other loan facilities, which would permit Silver Point and our other lenders to seize our assets and those of our variable interest entity, PCHI. Any actions by Silver Point or our other lenders to enforce their rights by seizing our assets could force us into bankruptcy or liquidation, which would have a material adverse effect on our liquidity and financial position and the value of our common stock.

 

Key items for the six months ended September 30, 2012 included:

 

1.   Net patient service revenues (patient service revenues, net of contractual allowances and discounts, less provision for bad debts) for the six months ended September 30, 2012 and 2011 were $207.5 million and $166.5 million, respectively, representing an increase of $41.0 million, or 24.6%. The Hospitals serve a disproportionate number of indigent patients and receive governmental revenues and subsidies in support of care for these patients. Governmental revenues include payments from Medicaid, Medicaid DSH, and Orange County, CA (CalOptima). Governmental net revenues increased $42.7 million for the six months ended September 30, 2012 compared to the six months ended September 30, 2011. The increase was primarily related to QAF revenues of $38.7 million recognized during the six months ended September 30, 2012 compared to $0 during the same period in fiscal 2012 (see “HOSPITAL QUALITY ASSURANCE FEES”). 

  

Inpatient admissions decreased by 2.8% to 10.3 for the six months ended September 30, 2012 compared to 10.6 for the six months ended September 30, 2011. The decline in admissions is primarily related to reductions in managed care, shifts from inpatient to outpatient observation, and obstetrics admissions.

 

Uninsured patients, as a percentage of gross charges (retail charges), were 6.0% for the six months ended September 30, 2012 compared to 5.3% for the six months ended September 30, 2011.

 

22
 

2.   Operating expenses: Management is working aggressively to reduce costs without reduction in service levels. These efforts have in large part been offset by inflationary pressures. Operating expenses before interest for the six months ended September 30, 2012 were $204.3 million, representing an increase of $40.4 million, or 24.6%, compared to the six months ended September 30, 2011. The increase is primarily related to QAF expenses of $38.3 million incurred during the six months ended September 30, 2012 compared to $0 during the same period in fiscal year 2012.

 

DEBT – On August 1, 2012, we entered into Amendment No. 4 to Credit Agreement and Consent (the “Credit Agreement Amendment”), which amends the Term Loan Credit Agreement.  Under the Credit Agreement Amendment, Silver Point consented to and waived certain provisions under the Term Loan Credit Agreement in connection with our execution of the Revolving Loan Amendment. In addition, the provisions in the Term Loan Credit Agreement that provide for mandatory prepayment of our outstanding “A/R Financing,” as defined, upon receipt of certain federal matching funds under the QAF program were amended to replace 65% with 80%. In connection with the Credit Agreement Amendment, we agreed to pay Silver Point a one-time consent and amendment fee in an aggregate amount equal to $1.8 million, of which $450 was paid upon execution of the Credit Agreement Amendment and the balance was added to the principal amount of the Term Loan Credit Agreement.

 

Also on August 1, 2012, we entered into Amendment No. 3 to Credit and Security Agreement (the “Revolving Loan Amendment”), which amends the Revolving Loan Agreement. Under the Revolving Loan Amendment, the minimum Revolving Loan Commitment Amount under the Revolving Loan Agreement was increased from $14.0 million to $30.0 million, and we agreed to pay to MidCap Funding IV, LLC, as assigned to it from MidCap Financial, LLC, as administrative agent and a lender, and Silicon Valley Bank, as a lender (collectively, the “Lenders”) an origination fee of 1.0% of the Lenders’ increased commitment under the Revolving Loan Amendment, or $160.

 

In addition, under the Revolving Loan Amendment, the lockbox requirements under the Revolving Loan Agreement were amended to provide that in the event the Revolving Loan Commitment Amounts are $30.0 million or less during any period prior to March 31, 2013, or $20.0 million or less thereafter (and assuming there is no Event of Default at the time), we would be permitted to transfer funds that are deposited into any Lockbox Account, as defined, to a different bank account designated by us, subject to the other terms and conditions contained in the Revolving Loan Agreement.

 

As of September 30, 2012, we had the following credit facilities:

 

  $46.35 million term loan under the Credit Agreement, dated as of October 9, 2007, as amended (the “Term Loan Credit Agreement”), by and among us, Silver Point, and PCHI and Ganesha Realty LLC (“Ganesha”), as Credit Parties, bearing a fixed interest rate of 14.5% per year ($46.35 million outstanding balance at September 30, 2012). If any event of default occurs and continues, the lender can increase the interest rate to 19.5% per year.  
       
  $30.0 million revolving line of credit under the Credit and Security Agreement, dated as of August 30, 2010, as amended (the “Revolving Loan Agreement”), by and among us, and the Lenders, bearing an interest rate of 5.0% plus LIBOR, with a 2.5% floor, per year (7.5% at September 30, 2012) and an unused commitment fee of 0.625% per year ($25.3 million outstanding balance at September 30, 2012).  For purposes of calculating interest, all payments we make on the revolving line of credit are subject to a six business day clearance period.  At September 30, 2012, we had $4.7 million in additional availability under our revolving credit facility.  

 

Our credit facilities contain various affirmative and negative covenants and customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to similar obligations, events of bankruptcy and insolvency, judgment defaults, the invalidity of liens on collateral, and the occurrence of events which have a material adverse effect on us. As of September 30, 2012, we were in compliance with all financial covenants.

 

Our outstanding debt consists of the following:

 

   September 30,   March 31, 
   2012   2012 
           
Current:          
Revolving line of credit  $25,268   $14,000 
Term loan   46,350     
   $71,618   $14,000 
           
Noncurrent:          
Term loan  $   $45,000 

 

23
 

WARRANTS – On April 13, 2010, we issued warrants (the “Omnibus Warrants”) to purchase our common stock for a period of three years at an exercise price of $0.07 per share in the following denominations: 139.0 million shares to KPC Resolution Company (a company owned and controlled by Kali P. Chaudhuri, M.D., our majority shareholder) or its designees and 96.0 million shares to the $46.35 million term loan lender or its designees. The Omnibus Warrants also provide the holders with certain pre-emptive, information and registration rights. As of April 13, 2010, we recorded warrant expense and the related warrant liability of $2.9 million, representing fair value.  As of September 30, 2012, the fair value of the Omnibus Warrants was $1.181 million.

 

In addition, on April 13, 2010, we issued a three-year warrant (the “Release Warrant”) to acquire up to 170.0 million shares of our common stock at $0.07 per share to Dr. Chaudhuri who facilitated a release enabling us to recover amounts due from our prior lender and a $1.0 million reduction in principal of our outstanding debt, among other benefits to us. As a result, we recorded the fair value of the Release Warrant ($2.1 million) as an offsetting cost of the recovery of amounts due from our prior lender. The Release Warrant also provides the holder with certain pre-emptive, information and registration rights. As of September 30, 2012, the fair value of the Release Warrant was $855.

 

The Omnibus Warrants and the Release Warrant are collectively referred to as the “April Warrants.” The net gain (loss) recorded related to the April Warrants for the three months ended September 30, 2012 and 2011 was $(1.126) million and $3.1 million, respectively, and $(395) and $(217) for the six months ended September 30, 2012 and 2011, respectively.

 

HOSPITAL QUALITY ASSURANCE FEES - In October 2009, the Governor of California signed legislation supported by the hospital industry to impose a provider fee on general acute care hospitals that, combined with federal matching funds, would be used to provide supplemental Medi-Cal payments to hospitals. The state submitted the plan to the Centers for Medicare and Medicaid Services (“CMS”) for a required review and approval process, and certain changes in the plan were required by CMS. Legislation amending the fee program to reflect the required changes was passed by the legislature and signed by the Governor on September 8, 2010. Among other changes, the legislation leaves distribution of “pass-through” payments received by Medi-Cal managed care plans that will be paid to hospitals under the program to the discretion of the plans.  The hospital quality assurance fee program (“QAF”) created by this legislation initially provided payments for up to 21 months retroactive to April 2009 and expiring on December 31, 2010 (“2010 QAF”).  In February 2011, CMS gave final approval for the 2010 QAF. During fiscal year 2011, we recognized $87.2 million in revenue and recorded expenses of $47.8 million relating to the 2010 QAF.

 

In December 2011, CMS gave final approval for the extension of the QAF for the six month period from January 1 through June 30, 2011 (“2011 QAF”).  During fiscal year 2012, we recognized $31.9 million in revenue and recorded expenses of $15.9 million relating to the 2011 QAF. 

 

In June 2012, CMS conditionally approved the extension of the QAF for the thirty month period from July 1, 2011 through December 31, 2013 (“2013 QAF”).  In June 2012, the California State Legislature amended the hospital fee statute to recognize separate CMS approval of the fee-for-service portion and managed care portion of the 2013 QAF, which was further clarified in legislation approved by the governor of California in September 2012.  As a result, during the three months ended September 30, 2012, we recognized revenue of $38.7 million and expenses of $38.4 million relating to the fee-for-service portion of the 2013 QAF for the period from July 1, 2011 through September 30, 2012.

 

Based on the most recent modeling prepared by the California Hospital Association, we anticipate making payments for provider fees and other expenses relating to the 2013 QAF of approximately $105.8 million and receiving approximately $235.5 million in revenues from the State ($79.4 million from the fee-for-service portion and $156.1 million from the managed care portion). 

 

We cannot provide any assurances or estimates in connection with CMS’s final approval of the 2013 QAF or a possible continuation of the QAF program beyond December 31, 2013.

 

ELECTRONIC HEALTH RECORDS INCENTIVE PROGRAM – Provisions of the American Recovery and Reinvestment Act of 2009 provide incentive payments for the adoption and meaningful use of certified electronic health record (EHR) technology. The Medicare EHR incentive program provides incentive payments to eligible hospitals (and certain other providers) that are meaningful users of certified EHRs. The Medicaid EHR incentive program provides incentive payments to eligible hospitals (and certain other providers) for efforts to adopt, implement, upgrade, or meaningfully use of certified EHR technology.

 

CMS has established the final rule which requires eligible providers in their first year of participation in the Medicaid incentive payment program to demonstrate that they have adopted (acquired, purchased, or secured access to), or implemented, or upgraded to certified EHR technology in order to qualify for an incentive payment. During the second and subsequent years of the program, eligible providers are required to meet other criteria, including meaningful use, to receive additional funds. We have been awarded a total amount of $13.6 million under the Medicaid EHR incentive program, which will be earned and received over a four year period. We adopted certified EHR technology and recognized other income of $6.8 million relative to the first year under the Medicaid EHR incentive program during fiscal year 2012.

 

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LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY – On April 13, 2010, we and PCHI entered into a Second Amendment to Amended and Restated Triple Net Hospital Building Lease (the “2010 Lease Amendment”).  Under the 2010 Lease Amendment, the annual base rent to be paid by us to PCHI was increased from $5.4 million to $7.3 million. The base rent is subject to an annual Consumer Price Index increase on January 1 of each year; such increase shall not be less than 2% or more than 6% per year. As a result, the annual base rent as of January 1, 2012 is $7.7 million. If PCHI refinances the $46.35 million term loan, the annual base rent will increase to $8.3 million. This lease commitment with PCHI is eliminated in consolidation.

 

COMMITMENTS AND CONTINGENCIES – The State of California has imposed hospital seismic safety requirements. Under these requirements, the Hospitals must meet stringent seismic safety criteria in the future. In addition, there could be other remediation costs pursuant to this seismic retrofit.

         

The State of California has a seismic review methodology known as HAZUS. The HAZUS methodology may preclude the need for some structural modifications. All four Hospitals requested HAZUS review and received a favorable notice pertaining to structural reclassification. All Hospital buildings, with the exception of one (an administrative building), have been deemed compliant until January 1, 2030 for both structural and nonstructural retrofit. We do not have an estimate of the cost to remediate the seismic requirements for the administrative building as of September 30, 2012.

 

There are additional requirements that must be complied with by 2030. The costs of meeting these requirements have not yet been determined. Compliance with seismic ordinances will be costly and could have a material adverse effect on our cash flow.  In addition, remediation could possibly result in certain environmental liabilities, such as asbestos abatement.

 

On July 1, 2011, we entered into software and services agreements with McKesson Technologies Inc. (“McKesson”) to upgrade our information technology systems.

 

Under the agreements, McKesson will provide us with a variety of services, including new software implementation and education/training services for our personnel, software maintenance services and professional services related to movement and migration of data from legacy systems.  McKesson will also furnish to us and maintain new hardware to accommodate the upgraded software and systems.  The new hardware will include computers and servers, among other things, and will include installation, testing, and ongoing maintenance.  We have entered into the arrangement to enhance our clinical information systems and upgrade our billing and revenue management information systems.

 

The agreements will initially run for a period of five years, and the recurring services may be renewed by us for successive periods.  The agreements do not provide that they may be terminated by us prior to the initial expiration date.  The agreements provide for one-time fees and recurring fees which aggregate a total of $22.0 million.  Approximately 60% of the fees are for one-time charges, while the balance is for recurring services.

 

CASH FLOW – Net cash used by operating activities for the six months ended September 30, 2012 and 2011 was $9.6 million and $16.5 million, respectively. Net income (loss), adjusted for depreciation and other non-cash items, excluding the provision for bad debts and net income from non-controlling interests (not a measurement under accounting principles generally accepted in the United States of America (“GAAP”)), totaled $2.1 million and $0.7 million for the six months ended September 30, 2012 and 2011, respectively. We used $11.6 million and $17.2 million (including $12.8 million for income taxes) in working capital for the six months ended September 30, 2012 and 2011, respectively. Net cash used in payment of accounts payable, accrued compensation and benefits and other current liabilities was $2.5 million and $9.2 million for the six months ended September 30, 2012 and 2011, respectively. Cash provided (used) by accounts receivable, net of provision for bad debts, was $(0.8) million and $3.5 million for the six months ended September 30, 2012 and 2011, respectively.

 

Net cash used in investing activities during the six months ended September 30, 2012 and 2011 was $1.2 million and $0.7 million, respectively. In the six months ended September 30, 2012 and 2011, we invested $1.2 million and $0.8 million in cash, respectively, in new property and equipment.

 

Net cash provided by (used in) financing activities for the six months ended September 30, 2012 and 2011 was $9.1 million and $(0.4) million, respectively.    

 

RESULTS OF OPERATIONS AND FINANCIAL CONDITION

 

The following table sets forth, for the three and six months ended September 30, 2012 and 2011 our unaudited condensed consolidated statements of operations expressed as a percentage of net patient service revenues.

 

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   Three months ended September 30,   Six months ended September 30, 
   2012   2011   2012   2011 
                     
Net patient service revenues   100.0%    100.0%    100.0%    100.0% 
                     
Operating expenses:                    
Salaries and benefits   42.3%    61.4%    51.2%    63.9% 
Supplies   11.1%    15.3%    13.5%    15.7% 
Other operating expenses   42.2%    17.0%    32.9%    17.5% 
Depreciation and amortization   0.8%    1.2%    0.9%    1.3% 
    96.4%    94.9%    98.5%    98.4% 
                     
Operating income   3.6%    5.1%    1.5%    1.6% 
                     
Other expense:                    
Interest expense, net   (2.4%)   (2.9%)   (2.6%)   (3.2%)
Income (loss) on warrants   (0.9%)   3.5%    (0.2%)   (0.1%)
    (3.3%)   0.6%    (2.8%)   (3.3%)
                     
Income (loss) before income tax provision (benefit)   0.3%    5.7%    (1.3%)   (1.7%)
Income tax provision (benefit)   (1.5%)   5.1%    (0.9%)   (0.5%)
Net income (loss)   1.8%    0.6%    (0.4%)   (1.2%)
Net (income) loss attributable to noncontrolling interests   0.2%    (0.1%)   (0.1%)   (0.1%)
Net income (loss) attributable to Integrated Healthcare Holdings, Inc.   2.0%    0.5%    (0.5%)   (1.3%)

 

 

THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2011

 

NET PATIENT SERVICE REVENUES – Net patient service revenues for the three months ended September 30, 2012 increased 45.4% compared to fiscal year 2012, from $86.6 million to $125.9 million. The increase was primarily related to QAF revenues of $38.7 million recognized during the three months ended September 30, 2012 compared to $0 during the same period in fiscal 2012. The provision for bad debts for the three months ended September 30, 2012 was $13.5 million compared to $7.1 million for the three months ended September 30, 2011, representing a 90.1% increase.  The primary reason for the increase in the provision for bad debts relates to the termination of Section 1011 of the Medicare Modernization Act of 2003 program in January 2012. Section 1011 provided federal funding of emergency health services for “eligible aliens.” During the three months ended September 30, 2011, patient service revenues recorded under Section 1011 were reduced by contractual allowances and discounts whereas patient service revenues related to the same type of services provided after the termination of Section 1011 are adjusted to net patient service revenues through the provision for bad debts.

 

Admissions for the three months ended September 30, 2012 decreased 0.9% compared to the same period in fiscal year 2012. The decline in admissions is the combined result of lower obstetrical deliveries, and psychiatric admissions. Net patient service revenues per admission increased 46.6% during the three months ended September 30, 2012. This increase was primarily due to an increase orthopedic surgeries and shifts from inpatient to outpatient observation.

 

Essentially all patient service revenues come from external customers. The largest payers are the Medicare and Medicaid (including Medicare and Medicaid managed care plans) programs accounting for 65% and 55% of the patient service revenues for the three months ended September 30, 2012 and 2011, respectively.

 

Uninsured patients, as a percentage of gross charges, increased to 6.6% from 5.8% for the three months ended September 30, 2012 compared to the three months ended September 30, 2011.

 

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The Hospitals serve a disproportionate number of indigent patients and receive governmental revenues and subsidies in support of care for these patients. Governmental revenues include payments from Medicaid, Medicaid DSH, and Orange County, CA (CalOptima). Governmental net revenues increased $39.8 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011.  

 

OPERATING EXPENSES – Operating expenses for the three months ended September 30, 2012 increased to $121.3 million from $82.2 million, an increase of $39.1 million, or 47.6%, compared to the same period in fiscal year 2012. Operating expenses expressed as a percentage of net patient services revenues for the three months ended September 30, 2012 and 2011 were 96.4% and 94.9%, respectively. On a per admission basis, operating expenses increased 48.9%. The increase is primarily related to QAF expenses of $38.3 million incurred during the three months ended September 30, 2012 compared to $0 during the same period in fiscal year 2012.

 

Salaries and benefits increased $127 (0.2%) for the three months ended September 30, 2012 compared to the same period in fiscal year 2012.

 

Supplies increased $748 (5.7%) for the three months ended September 30, 2012 compared to the same period in fiscal year 2012. The increase primarily related to increases in orthopedic supplies and pacemakers.

 

Other operating expenses during the three months ended September 30, 2012 increased to $53.1 million from $14.7 million, an increase of $38.4 million, or 261.2%, compared to the same period in fiscal year 2012. The increase is primarily related to QAF expenses of $38.3 million incurred during the three months ended September 30, 2012 compared to $0 during the same period in fiscal year 2012.

 

OPERATING INCOME – The operating income for the three months ended September 30, 2012 and 2011 was $4.6 million and $4.4 million, respectively.

 

OTHER INCOME (EXPENSE) – Interest expense for the three months ended September 30, 2012 was $3.0 million compared to $2.5 million for the same period in fiscal year 2012. The increase primarily related to increased drawdowns on our revolving line of credit.

 

As of September 30, 2012, the fair value of our April Warrants aggregated $2.0 million.  A gain (loss) relating to the change in fair value of the April Warrants of $(1.1) million and $3.1 million was recorded during the three months ended September 30, 2012 and 2011, respectively. See “WARRANTS.”

   

NET INCOME – Net income for the three months ended September 30, 2012 and 2011 was $2.6 million and $0.5 million, respectively.

 

SIX MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO SIX MONTHS ENDED SEPTEMBER 30, 2011

 

NET PATIENT SERVICE REVENUES – Net patient service revenues for the six months ended September 30, 2012 increased 24.6% compared to fiscal year 2012, from $166.5 million to $207.5 million. The increase was primarily related to QAF revenues of $38.7 million recognized during the six months ended September 30, 2012 compared to $0 during the same period in fiscal 2012. The provision for bad debts for the six months ended September 30, 2012 was $23.4 million compared to $16.8 million for the six months ended September 30, 2011, representing a 39.3% increase. The primary reason for the increase in the provision for bad debts relates to the termination of Section 1011 of the Medicare Modernization Act of 2003 program in January 2012. Section 1011 provided federal funding of emergency health services for “eligible aliens.” During the six months ended September 30, 2011, patient service revenues recorded under Section 1011 were reduced by contractual allowances and discounts whereas patient service revenues related to the same type of services provided after the termination of Section 1011 are adjusted to net patient service revenues through the provision for bad debts.

 

Admissions for the six months ended September 30, 2012 decreased 2.8% compared to the same period in fiscal year 2012. The decline in admissions is the combined result of lower obstetrical deliveries, and psychiatric admissions. Net patient service revenues per admission increased 27.2% during the six months ended September 30, 2012. This increase was primarily due to an increase orthopedic surgeries and shifts from inpatient to outpatient observation.

 

Essentially all patient service revenues come from external customers. The largest payers are the Medicare and Medicaid (including Medicare and Medicaid managed care plans) programs accounting for 62% and 55% of the patient service revenues for the six months ended September 30, 2012 and 2011, respectively.

 

Uninsured patients, as a percentage of gross charges, increased to 6.0% from 5.3% for the six months ended September 30, 2012 compared to the six months ended September 30, 2011.

 

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The Hospitals serve a disproportionate number of indigent patients and receive governmental revenues and subsidies in support of care for these patients. Governmental revenues include payments from Medicaid, Medicaid DSH, and Orange County, CA (CalOptima). Governmental net revenues increased $42.7 million for the six months ended September 30, 2012 compared to the six months ended September 30, 2011.  

 

OPERATING EXPENSES – Operating expenses for the six months ended September 30, 2012 increased to $204.3 million from $164.0 million, an increase of $40.3 million, or 24.6%, compared to the same period in fiscal year 2012. Operating expenses expressed as a percentage of net patient services revenues for the six months ended September 30, 2012 and 2011 were 98.5% and 98.4%, respectively. On a per admission basis, operating expenses increased 27.2%. The increase is primarily related to QAF expenses of $38.3 million incurred during the six months ended September 30, 2012 compared to $0 during the same period in fiscal year 2012.

 

Salaries and benefits decreased $120 (0.1%) for the six months ended September 30, 2012 compared to the same period in fiscal year 2012.

 

Supplies increased $1.8 million (6.9%) for the six months ended September 30, 2012 compared to the same period in fiscal year 2012. The increase primarily related to increases in orthopedic supplies and pacemakers.

 

Other operating expenses during the six months ended September 30, 2012 increased to $68.1 million from $29.2 million, an increase of $38.9 million, or 133.2%, compared to the same period in fiscal year 2012. The increase is primarily related to QAF expenses of $38.3 million incurred during the six months ended September 30, 2012 compared to $0 during the same period in fiscal year 2012.

 

OPERATING INCOME – The operating income for the six months ended September 30, 2012 and 2011 was $3.2 million and $2.6 million, respectively.

 

OTHER INCOME (EXPENSE) – Interest expense for the six months ended September 30, 2012 was $5.5 million compared to $5.3 million for the same period in fiscal year 2012. The increase primarily related to increased drawdowns on our revolving line of credit. 

 

As of September 30, 2012, the fair value of our April Warrants aggregated $2.0 million.  A loss relating to the change in fair value of the April Warrants of $395 and $217 was recorded during the six months ended September 30, 2012 and 2011, respectively. See “WARRANTS.”

   

NET LOSS - Net loss for the six months ended September 30, 2012 and 2011 was $0.9 million and $2.4 million, respectively.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

PATIENT SERVICE REVENUES – Patient service revenues are recognized in the period in which services are performed and are recorded based on established billing rates (gross charges) less contractual allowances and discounts, principally for patients covered by Medicare, Medicaid, managed care, and other health plans. Gross charges are retail charges. They are not the same as actual pricing, and they generally do not reflect what a hospital is ultimately paid and therefore are not displayed in the consolidated statements of operations. Hospitals are typically paid amounts that are negotiated with insurance companies or are set by the government. Gross charges are used to calculate Medicare outlier payments and to determine certain elements of payment under managed care contracts (such as stop-loss payments). Since Medicare requires that a hospital's gross charges be the same for all patients (regardless of payer category), gross charges are also what the Hospitals charge all other patients prior to the application of discounts and allowances.

 

Revenues under the traditional fee-for-service Medicare and Medicaid programs are based primarily on prospective payment systems. Discounts for retrospectively cost based revenues and certain other payments, which are based on the Hospitals' cost reports, are estimated using historical trends and current factors. Cost report settlements for retrospectively cost-based revenues under these programs are subject to audit and administrative and judicial review, which can take several years until final settlement of such matters are determined and completely resolved. Estimates of settlement receivables or payables related to a specific year are updated periodically and at year end and at the time the cost report is filed with the fiscal intermediary. Typically no further updates are made to the estimates until the final Notice of Program Reimbursement is received, at which time the cost report for that year has been audited by the fiscal intermediary. There could be a time lag of several years between the submission of a cost report and receipt of the Final Notice of Program Reimbursement. Since the laws, regulations, instructions and rule interpretations governing Medicare and Medicaid reimbursement are complex and change frequently, the estimates recorded by the Hospitals could change by material amounts. We have established settlement receivables of $46 and $190 as of September 30 and March 31, 2012, respectively.

 

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The Hospitals receive supplemental payments from the State of California to support indigent care (Medi-Cal Disproportionate Share Hospital payments or "DSH") and from the California Medical Assistance Commission ("CMAC") under the SB 1100 and SB 1255 programs. The Hospitals received (repaid) supplemental payments of $(600) and $1.1 million during the three months ended September 30, 2012 and 2011, respectively, and $4.1 million and $5.9 million during the six months ended September 30, 2012 and 2011, respectively. The related revenue recorded for the three months ended September 30, 2012 and 2011, was $5.1 million and $4.0 million, respectively, and $6.9 million and $7.4 million for the six months ended September 30, 2012 and 2011, respectively. As of September 30 and March 31, 2012, estimated DSH receivables were $7.8 million and $5.0 million, respectively.

 

Revenues under managed care plans, including Medicare and Medicaid managed care plans (with patient service revenues of $19.7 million and $18.2 million for the three months ended September 30, 2012 and 2011, respectively, and $43.3 million and $38.0 million for the six months ended September 30, 2012 and 2011, respectively), 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. We believe the estimation and review process allows for timely identification of instances where such estimates need to be revised. We do not believe there were any adjustments to estimates of individual patient bills that were material to our patient service revenues.

 

The Hospitals provide charity care to patients whose income level is below 300% of the Federal Poverty Level. Patients with income levels between 300% and 350% of the Federal Poverty Level qualify to pay a discounted rate under AB 774 based on various government program reimbursement levels. Patients without insurance are offered assistance in applying for Medicaid and other programs they may be eligible for, such as state disability, Victims of Crime, or county indigent programs. Patient advocates from the Hospitals' Medical Eligibility Program ("MEP") screen patients in the hospital and determine potential linkage to financial assistance programs. They also expedite the process of applying for these government programs. The estimated costs of charity care (based on direct and indirect costs as a ratio of gross uncompensated charges associated with providing care to charity patients) for the three months ended September 30, 2012 and 2011 were approximately $2.5 million and $2.5 million, respectively, and $4.6 million and $3.8 million for the six months ended September 30, 2012 and 2011, respectively.

  

We are 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 our consolidated financial statements.

 

PROVISION FOR BAD DEBTS - We provide for accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. The Hospitals estimate this allowance based on the aging of their accounts receivable, historical collections experience for each type of payer and other relevant factors. There are various factors that can impact the collection trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of uninsured and underinsured patients, volume of patients through the emergency department, the increased burden of copayments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the estimation process.

 

Our policy is to attempt to collect amounts due from patients, including copayments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act ("EMTALA"). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In nonemergency circumstances or for elective procedures and services, it is the Hospitals' policy, when appropriate, to verify insurance prior to a patient being treated.

 

Effective March 31, 2012, we adopted Accounting Standards Update (“ASU”) 2011-07, “Health Care Entities (Topic 954): Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities,” which requires health care entities to present the provision for bad debts relating to patient service revenue as a deduction from patient service revenue in the statement of operations rather than as an operating expense.

 

INCOME TAXES - Deferred income tax assets and liabilities are determined based on the differences between the book and tax basis of assets and liabilities and are measured using the currently enacted tax rates and laws using the asset and liability method. We assess the realization of deferred tax assets to determine whether an income tax valuation allowance is required. We have recorded a 100% valuation allowance on its deferred tax assets.

 

There is a recognition threshold and measurement attribute for recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 

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We and our subsidiaries file income tax returns in the U.S. federal jurisdiction and California. Certain tax attributes carried over from prior years continue to be subject to adjustment by taxing authorities. Any penalties or interest arising from federal or state taxes are recorded as a component of our income tax provision.

 

INSURANCE - We accrue for estimated general and professional liability claims, to the extent not covered by insurance, when they are probable and reasonably estimable. We have purchased as primary coverage a claims-made form insurance policy for general and professional liability risks. Estimated losses within general and professional liability retentions from claims incurred and reported, along with incurred but not reported (“IBNR”) claims, are accrued based upon projections and are discounted to their net present value using a weighted average risk-free discount rate of 5%. To the extent that subsequent claims information varies from estimates, the liability is adjusted in the period such information becomes available. As of September 30 and March 31, 2012, we had accrued $10.7 million and $11.5 million, respectively, which is comprised of $4.6 million and $4.5 million, respectively, in incurred and reported claims, along with $6.1 million and $7.0 million, respectively, in estimated IBNR. Estimated insurance recoveries of $2.7 million and $3.0 million are included in other prepaid expenses and current assets as of September 30 and March 31, 2012, respectively.

 

We have also purchased occurrence coverage insurance to fund our obligations under our workers compensation program. We have a "paid loss plan" policy, under which the carrier pays all workers compensation claims, with no deductible or reimbursement required of us. We accrue for estimated workers compensation claims, to the extent not covered by insurance, when they are probable and reasonably estimable. The ultimate costs related to this program include expenses for deductible amounts associated with claims incurred and reported in addition to an accrual for the estimated expenses incurred in connection with IBNR claims. Claims are accrued based upon projections and are discounted to their net present value using a weighted average risk-free discount rate of 5%. To the extent that subsequent claims information varies from estimates, the liability is adjusted in the period such information becomes available. As of September 30 and March 31, 2012, we had accrued $649 and $673, respectively, comprised of $342 and $338, respectively, in incurred and reported claims, along with $307 and $335, respectively, in estimated IBNR.

  

In addition, we have a self-insured health benefits plan for our employees. As a result, we have established and maintain an accrual for IBNR claims arising from self-insured health benefits provided to employees. Our IBNR accruals at September 30 and March 31, 2012 were based upon projections. We determine the adequacy of this accrual by evaluating our historical experience and trends related to both health insurance claims and payments, information provided by our insurance broker and third party administrator and industry experience and trends. The accrual is an estimate and is subject to change. Such change could be material to our unaudited condensed consolidated financial statements. As of September 30 and March 31, 2012, we had accrued $1.9 million and $2.2 million, respectively, in estimated IBNR.

 

We have also purchased umbrella liability policies with aggregate limits of $25 million. The umbrella policies provide coverage in excess of the primary layer and applicable retentions for insured liability risks such as general and professional liability, auto liability, and workers compensation (employer’s liability).

 

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

As of September 30, 2012, the Company did not have any investment in, or outstanding liabilities under, market rate sensitive instruments. The Company does not enter into hedging instrument arrangements.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 15d-15(e) under the Exchange Act. The Company's disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching the Company's desired disclosure control objectives. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As of September 30, 2012, the end of the period of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2012 the Company's disclosure controls and procedures were effective to ensure that the information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

During the three months ended September 30, 2012, there were no changes in the Company's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

 

 

 

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

The Company and the Hospitals are subject to various legal proceedings, most of which relate to routine matters incidental to operations. The results of these claims cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on the Company's business (both in the near and long term), financial position, results of operations, or cash flows. Although the Company defends itself vigorously against claims and lawsuits and cooperates with investigations, these matters (1) could require payment of substantial damages or amounts in judgments or settlements, which individually or in the aggregate could exceed amounts, if any, that may be recovered under insurance policies where coverage applies and is available, (2) cause substantial expenses to be incurred, (3) require significant time and attention from the Company's management, and (4) could cause the Company to close or sell the Hospitals or otherwise modify the way its business is conducted. The Company accrues for claims and lawsuits when an unfavorable outcome is probable and the amount is reasonably estimable.

 

There have been no material developments in the matters identified in the Company’s Form 10-K filed with the SEC on June 22, 2012.

 

 

 

 

 

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ITEM 1A. RISK FACTORS

 

There are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

 

ITEM 6. EXHIBITS

 

Exhibit Number   Description
     
10.10   Amendment No. 3 to Credit and Security Agreement, dated August 1, 2012, by and among the Company, MidCap Funding IV, LLC, as Agent and lender, and Silicon Valley Bank, as lender (incorporated by reference to Exhibit 99.1 to the Registrant's Report on Form 8-K filed on August 6, 2012).
     
10.11   Amendment No. 4 to Credit Agreement and Consent, dated August 1, 2012, by and among the Company, Pacific Coast Holdings Investment, LLC, Ganesha Realty, LLC, SPCP Group IV, LLC, SPCP Group, LLC and Silver Point Finance, LLC (incorporated by reference to Exhibit 99.2 to the Registrant's Report on Form 8-K filed on August 6, 2012).
     
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.

 

101.INS   XBRL Instance Document
     
101.SCH   XBRL Schema Document
     
101.CAL   XBRL Calculation Linkbase Document
     
101.DEF   XBRL Definition Linkbase Document
     
101.LAB   XBRL Label Linkbase Document
     
101.PRE   XBRL Presentation Linkbase Document

 

 

 

 

 

 

SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

  INTEGRATED HEALTHCARE HOLDINGS, INC.  
       
Dated: November 13, 2012 By:     /s/ Steven R. Blake  
    Steven R. Blake  
    Chief Financial Officer (Principal Financial Officer)  
       

 

 

 

 

 

 

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