-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ua4JTo/DTmEogYo7q3ZjyoHsTVcvd/cuZE+KyOiy5IIgjtzOt/dx4tXURKf1sD6V 0fEqH2r2EcFO+sGXhMbvEg== 0001144204-05-025633.txt : 20050815 0001144204-05-025633.hdr.sgml : 20050815 20050815172900 ACCESSION NUMBER: 0001144204-05-025633 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20050815 DATE AS OF CHANGE: 20050815 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Integrated Healthcare Holdings Inc CENTRAL INDEX KEY: 0001051488 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HOSPITALS [8060] IRS NUMBER: 870412182 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-23511 FILM NUMBER: 051028250 BUSINESS ADDRESS: STREET 1: 695 TOWN CENTER DRIVE STREET 2: SUITE 260 CITY: COSTA MESA STATE: CA ZIP: 92626 BUSINESS PHONE: 714-434-9191 MAIL ADDRESS: STREET 1: 695 TOWN CENTER DRIVE STREET 2: SUITE 260 CITY: COSTA MESA STATE: CA ZIP: 92626 FORMER COMPANY: FORMER CONFORMED NAME: Integrated Healthcare Holdings DATE OF NAME CHANGE: 20040816 FORMER COMPANY: FORMER CONFORMED NAME: FIRST DELTAVISION INC DATE OF NAME CHANGE: 19971216 10-Q 1 v023871_10q.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------- FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to _________ Commission File Number: 0-23511 -------------------- Integrated Healthcare Holdings, Inc. (Exact name of small business issuer as specified in its charter) Nevada 87-0412182 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1301 N. Tustin Ave. 92705 Santa Ana, California (Zip Code) (Address of principal executive offices) (714) 953-3503 (Registrant's telephone number, including area code) 695 Town Center Drive, Suite 260, Costa Mesa, California 92626 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| Integrated Healthcare Holdings, Inc. Form 10-Q Table of Contents
- --------------------------------------------------------------------------------------------------------------------------- Page Number PART I FINANCIAL INFORMATION Item 1. Financial Statements: Unaudited Condensed Consolidated Balance Sheet as of June 30, 2005 and December 31, 2004 2 Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 3 30, 2005 and June 30, 2004 Unaudited Condensed Consolidated Statement of Stockholders' Equity as of June 30, 2005 and 4 December 31, 2004 Unaudited Condensed Consolidated Statement of Cash Flows for the three and six months ended June 5 30, 2005 and June 30, 2004 Condensed Notes to Unaudited Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 3. Quantitative and Qualitative Disclosures About Market Risk 30 Item 4. Controls and Procedures 30 PART II OTHER INFORMATION Item 1. Legal Proceedings 31 Item 3. Defaults Upon Senior Securities 31 Item 6. Exhibits 32 SIGNATURES 33 - ---------------------------------------------------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION Item 1. Financial Statements. The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Consolidated Balance Sheet (Unaudited) ASSETS
June 30, December 31, 2005 2004 ------------------------------ Current assets: Cash and cash equivalents $ 7,396,828 $ 69,454 Accounts receivable, net of allowance for doubtful accounts of $14,445,000 at June 30, 2005 40,441,658 -- Inventories of supplies, at cost 5,856,321 -- Prepaid expenses and other assets 6,866,733 63,489 ------------------------------ 60,561,540 132,943 Property and equipment, net 58,689,233 57,423 Investment in hospital asset purchase -- 11,142,145 Deferred loan fees, net of accumulated amortization of $268,238 1,625,790 -- ------------------------------ Total assets $ 120,876,563 $ 11,332,511 ============================== LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current liabilities Notes payable $ 84,604,113 $ 11,264,013 Accounts payable 11,631,374 156,142 Accrued compensation and benefits 12,999,220 800,313 Income taxes payable 1,834,000 -- Other current liabilities 6,654,573 -- ------------------------------ Total current liabilities 117,723,280 12,220,468 Capital lease obligations, net of current of $204,141 3,384,256 -- Commitments and contingencies -- -- Minority interest in variable interest entity 4,795,578 -- Stockholders' equity (deficiency): Common stock, $0.001 par value; 250,000,000 shares authorized; 124,559,000 and 20,780,000 shares issued and outstanding, respectively 124,559 20,780 Common stock warrants; 74,700,000 outstanding (41,292,892 exercisable at June 30, 2005) 27,987,100 -- Additional paid in capital 12,040,487 1,189,621 Deferred warrant expense (11,552,927) -- Accumulated deficit (33,625,770) (2,098,358) ------------------------------ Total stockholders' deficiency (5,026,551) (887,957) ------------------------------ Total liabilities and stockholders' deficiency $ 120,876,563 $ 11,332,511 ==============================
The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements 2 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Consolidated Statement of Operations (Unaudited)
Three Months Ended Six Months Ended ------------------------------ ------------------------------ June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (Unaudited) (Unaudited) (Unaudited) (Unaudited) Net operating revenues $ 83,190,537 $ -- $ 104,937,566 $ -- Operating expenses: Salaries and benefits 48,439,345 306,317 60,889,949 603,146 Supplies 11,521,967 -- 14,555,782 -- Provision for doubtful accounts 11,331,354 -- 14,472,760 -- Other operating expenses 17,283,135 108,763 21,183,354 288,887 Depreciation and amortization 902,845 15,528 1,165,057 30,707 Common stock warrant expense -- -- 16,434,173 -- ------------- ------------- ------------- ------------- 89,478,646 430,608 128,701,075 922,740 Operating loss (6,288,109) (430,608) (23,763,509) (922,740) Interest expense 4,069,029 -- 4,734,325 -- ------------- ------------- ------------- ------------- Loss including minority interest and before provision for income taxes (10,357,138) (430,608) (28,497,834) (922,740) Provision for income taxes 1,762,000 -- 3,234,000 -- Minority interest in variable interest entity (195,517) -- (204,422) -- ------------- ------------- ------------- ------------- Net loss $ (11,923,621) $ (430,608) $ (31,527,412) $ (922,740) ============= ============= ============= ============= Per Share Data: Basic and fully diluted Loss per common share ($0.10) ($0.02) ($0.30) ($0.05) Weighted average shares outstanding 124,539,000 19,590,000 106,518,528 19,510,778
The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements 3 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Consolidated Statement of Shareholders' Deficiency (Unaudited)
Common Stock Common Stock Warrants Additional Deferred ------------------------- ----------------------- Paid-in Warrant Accumulated Shares Amount Shares Amount Capital Expense Deficit Total ----------- ------------ ---------- ----------- ----------- ------------ ------------ ------------ Balance, December 31, 2003 19,380,000 $ 19,380 -- $ -- $ 551,021 $ -- $ (217,781) $ 352,620 Issuance of debt for the acquisition of MMG, Inc. -- -- -- -- -- -- (40,386) (40,386) Issuance of common stock for cash at $0.25 per share 200,000 200 -- -- 49,800 -- -- 50,000 Issuance of common stock for cash at $0.50 per share 1,200,000 1,200 -- -- 588,800 -- -- 590,000 Net loss -- -- -- -- -- -- (1,840,191) (1,840,191) ----------- ------------ ---------- ----------- ----------- ------------ ------------ ------------ Balance, December 31, 2004 20,780,000 $ 20,780 -- $ -- $ 1,189,621 $ -- $ (2,098,358) $ (887,957) =========== ============ ========== =========== =========== ============ ============ ============ Issuance of common stock for cash at $0.50 per share 1,179,000 1,179 -- -- 598,322 -- -- 599,501 Issuance of common stock for cash to OCPIN 102,600,000 102,600 -- -- 9,997,400 -- -- 10,100,000 Issuance of common stock options -- -- -- -- 255,144 -- -- 255,144 Issuance of common stock warrants -- -- 74,700,000 27,987,100 -- (27,987,100) -- -- Common stock warrants expensed at June 30, 2005 -- -- -- -- -- 16,434,173 -- 16,434,173 Net loss -- -- -- -- -- -- (31,527,412) (31,527,412) ----------- ------------ ---------- ----------- ----------- ------------ ------------ ------------ Balance, June 30, 2005 124,559,000 $ 124,559 74,700,000 $27,987,100 $12,040,487 $(11,552,927) $(33,625,770) $ (5,026,551) =========== ============ ========== =========== =========== ============ ============ ============
The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements 4 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Consolidated Statement of Cash Flows (Unaudited)
Six Months Ended Six Months Ended June 30, 2005 Junes 30, 2004 ------------ ------------ Cash flows from operating activities: Net loss $(31,527,412) $ (922,740) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization expense 1,194,450 30,707 Common stock warrant and option expense 16,689,317 -- Minority interest in variable interest entity (204,422) -- Increase in prepaid expense and other assets (4,490,087) -- Increase in net accounts receivable (40,441,658) -- Increase (decrease) in accounts payable 11,475,232 (5,601) Increase in accrued compensation and benefits 12,320,927 438,080 Increase in income taxes payable 1,834,000 -- Increase in other accrued liabilities 6,450,432 -- Decrease in inventories of supplies 162,674 -- ------------ ------------ Net cash used in operating activities (26,536,547) (459,554) ------------ ------------ Cash flows from investing activities: Acquisition of hospital assets, net of lease obligations (62,967,535) -- Proceeds from sale of property 5,000,000 -- Purchase of property and equipment -- (19,260) Acquisition of MMG, Inc., net of cash acquired -- 8,534 ------------ ------------ Net cash used in investing activities (57,967,535) (10,726) Cash flows from financing activities: Issuance of secured promissory notes, net of costs 48,067,000 -- Proceeds from lines of credit 34,604,113 -- Proceeds from issuance of stock 10,699,501 250,000 Repayment of secured notes (1,264,013) (100,000) Payments on capital leases (275,145) Advances from shareholders -- 73,285 ------------ ------------ Net cash provided by financing activities 91,831,456 223,285 ------------ ------------ Net increase (decrease) in cash 7,327,374 (246,995) ------------ ------------ Cash and cash equivalents, beginning of period 69,454 265,000 ------------ ------------ Cash and cash equivalents, end of period $ 7,396,828 $ 18,005 ============ ============ Supplemmental disclosure of noncash transactions: Issuance of promissory notes for Acquisition $ 53,000,000 $ 60,000 Consolidation of variable interest entity $ 54,758,312 $ -- Expense of common stock warrants and options $ 16,689,317 $ -- Rescinded secured promissory note for the return of initial deposit on hospital assets $ 10,000,000 $ -- Interest paid $ 2,511,411 $ -- Income taxes paid $ 1,400,000 $ --
5 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Acquisition - On March 8, 2005, the Company completed its acquisition (the "Acquisition") of four Orange County, California hospitals and associated real estate, including: (i) 282-bed Western Medical Center--Santa Ana, CA; (ii) 188-bed Western Medical Center--Anaheim, CA; (iii) 178-bed Coastal Communities Hospital in Santa Ana, CA; and (iv) 114-bed Chapman Medical Center in Orange, CA (collectively, the "Hospitals") from Tenet Healthcare Corporation ("Tenet"). The Hospitals were assigned to four wholly-owned subsidiaries of the Company (the "Subsidiaries") formed for the purpose of completing the Hospital Acquisition. The Company also acquired the following real estate, leases and assets associated with the Hospitals: (i) a fee interest in the Western Medical Center at 1001 North Tustin Avenue, Santa Ana, CA 92705, a fee interest in the administration building at 1301 North Tustin Avenue, Santa Ana, CA 92705, certain rights to acquire condominium suites located in the medical office building at 999 North Tustin Avenue, Santa Ana, CA, and the business known as the West Coast Breast Cancer Center; (ii) a fee interest in the Western Medical Center at 1025 South Anaheim Blvd., Anaheim, CA 92805; (iii) a fee interest in the Coastal Communities Hospital at 2701 South Bristol Street, Santa Ana, CA 92704, and a fee interest in the medical office building at 1901 North College Avenue, Santa Ana, CA; (iv) a lease for the Chapman Medical Center at 2601 East Chapman Avenue, Orange, CA 92869, and a fee interest in the medical office building at 2617 East Chapman Avenue, Orange, CA; and (v) the furniture, fixtures and contract rights associated with the Hospitals. The results of operations of the acquired assets from the acquisition date (March 8, 2005) have been included in the Company's consolidated statement of operations for the three and six months ended June 30, 2005.As a result of the Acquisition, the Company has commenced its planned principal operations and accordingly is no longer considered a development stage enterprise. As discussed further in Note 7, concurrent with the close of the Acquisition, the Company entered into a sale-leaseback transaction with a Pacific Coast Holdings Investment, LLC ("PCHI"), a then wholly owned subsidiary, involving all the real property acquired in the Acquisition, except for the fee interest in the medical office building at 2617 East Chapman Avenue. PCHI was then immediately sold to certain major equity holders in the Company. In this transaction the Company received consideration of $5 million in cash plus PCHI's guarantee of $50 million in debt issued by the Company in the Acquisition. Because, among other reasons, the Company remains primarily liable under the $50 million debt, this transaction does not qualify for sale-leaseback accounting and the $50 million in debt has not been removed from the Company's consolidated balance sheet at June 30, 2005. However, because PCHI now holds title to the real property, the Company's interest in the real estate was converted to a lease interest pursuant to the lease entered into between PCHI, as lessor, and the Company, as lessee as part of the sale-leaseback transaction. Additionally, as further discussed under Consolidation below, Company management has determined that generally accepted accounting principles require that the financial statements of PCHI must be included in the consolidated financial statements of the Company under generally accepted accounting principles. Consolidation - The consolidated financial statements include the accounts of Integrated Healthcare Holdings, Inc. ("the Company") and its wholly owned subsidiaries, Mogel Management Group, Inc. ("MMG") and its four hospital subsidiaries located in Orange County, California (collectively, the "Hospitals"): Western Medical Center - Anaheim Anaheim, CA 188 beds Western Medical Center - Santa Ana Santa Ana, CA 282 beds Coastal Communities Hospital Santa Ana, CA 178 beds Chapman Medical Center Orange, CA 114 beds 6 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Additionally, generally accepted accounting principles require that a company consolidate the financial statements of any entity that cannot finance its activities without additional subordinated financial support, and for which one company provides the majority of that support through means other than ownership. As discussed further in Note 9, the Company has determined that it provides to the entity that purchased the Hospitals' real estate, PCHI, the majority of its financial support through various sources including lease payments, remaining primarily liable under the $50 million debt, and cross-collateralization of the Company's non real property assets to secure the $50 million debt. Accordingly, the accompanying consolidated financial statements include the accounts of PCHI from the date of the real estate sale, March 8, 2005. All significant intercompany accounts and transactions have been eliminated in combination. Company Operations - The Company, through the Hospitals, operates in a single industry segment, the operation of general hospitals and related healthcare facilities. The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated losses from continuing operations of $11,923,621 and $31,527,412 (inclusive of a warrant issuance expense incurred in connection with the Hospital acquisitions of $16,434,173) during the three months and six months ended June 30, 2005, respectively and has negative working capital of $(57,161,740) at June 30, 2005. In addition, on or around May 9, 2005, the Company received a notice of default from Medical Provider Financial Corporation II ("Medical Provider"), which is the lender under the $50 million acquisition loan and under a working capital line of credit that has an outstanding balance of $13.2 million as of June 30, 2005. The default has caused the acquisition loan to be classified as a current liability as of June 30, 2005. These factors, among others, indicate a need for the Company to take action to resolve its financing issues and operate its business on a profitable basis. Management is working to restructure the debt with Medical Provider and believes that the Company's existing cash flow from operations and the Company's ability to raise additional capital will be sufficient to meet its continuing obligations for the foreseeable future. The Company and PCHI have agreed to permit the Company and PCHI to use the assets of PCHI and the Hospitals as collateral for the purposes of joint financing of Company's business operation and PCHI's acquisition of real properties for an initial period of time. Condensed Consolidated Financial Statements - The accompanying financial statements have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly its consolidated financial position at June 30, 2005, and its consolidated results of operations for the three months and six months ended June 30, 2005 and 2004, respectively and the statement of changes in cash flows for the six months ended June 30, 2005 and 2004 have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 2004 audited consolidated financial statements. The results of operations for the periods ended June 30, 2005 and 2004 are not necessarily indicative of the operating results for the full year. Organization - Integrated Healthcare Holdings, Inc., ("the Company") was organized under the laws of the State of Utah on July 31, 1984 under the name of Aquachlor Marketing. The Company never engaged in business activities and was suspended for failure to file annual reports and tax returns. In December 1988, all required reports and tax returns were filed and the Company was reinstated by the State of Utah. In December 1988, the Company merged with Aquachlor, Inc., a Nevada corporation incorporated on December 20, 1988. The Nevada corporation became the surviving entity and changed its name to Deltavision, Inc. In March 1997, the Company received a Certificate of Revival from the State of Nevada using the name First Deltavision, Inc. In March 2004, the Company changed its name to Integrated Healthcare Holdings, Inc. 7 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Use of Estimates - The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United State of American and prevailing practices for investor-owned entities within the healthcare industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of American requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management regularly evaluates the accounting policies and estimates that are used. In general, management bases the estimates on historical experience and on assumptions that it believes to be reasonable given the particular circumstances in which the Hospitals operate. Although management believes that adjustments considered necessary for fair presentation have been included, actual results may vary from those estimates. Net Patient Service Revenue - Net patient service revenue is recognized in the period in which services are performed and is recorded based on established billing rates (gross charges) less estimated discounts for contractual allowances, principally for patients covered by Medicate, Medicaid, managed care and other health plans. Gross charges are retail charges. They are not the same as actual pricing, and they generally do not reflect what a hospital is ultimately paid and therefore are not displayed in the condensed consolidated statements of operations. Hospitals are typically paid amounts that are negotiated with insurance companies or are set by the government. Gross charges are used to calculate Medicare outlier payments and to determine certain elements of payment under managed care contracts (such as stop-loss payments). Because Medicare requires that a hospital's gross charges be the same for all patients (regardless of payer category), gross charges are also what hospitals charge all other patients prior to the application of discounts and allowances. Percentages of net patient service revenue, by payer type, for the Hospitals for the six months ended June 30, 2005 were as follows: Six months ended June 30, 2005 ---------------- Medicare 22% Medicaid 16% Managed care 42% Indemnity, self-pay and other 20% Revenues under the traditional fee-for-service Medicare and Medicaid programs are based primarily on prospective payment systems. Discounts for retrospectively cost-based revenues, which were more prevalent in earlier periods, and certain other payments, which are based on the hospitals' cost reports, are estimated using historical trends and current factors. Cost report settlements for retrospectively cost-based revenues under these programs are subject to audit and administrative and judicial review, which can take several years until final settlement of such matters are determined and completely resolved. Because the laws, regulations, instructions and rule interpretations governing Medicare and Medicaid reimbursement are complex and change frequently, the estimates recorded by the Hospitals could change by material amounts. 8 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Outlier payments, which were established by Congress as part of the diagnosis-related groups (DRG) prospective payment system, are additional payments made to hospitals for treating Medicare patients who are costlier to treat than the average patient in the same DRG. To qualify as a cost outlier, a hospital's billed (or gross) charges, adjusted to cost, must exceed the payment rate for the DRG by a fixed threshold established annually by the Centers for Medicare and Medicaid Services of the United State Department of Health and Human Services (CMS). The Medicare fiscal intermediary calculates the cost of a claim by multiplying the billed charges by the cost-to-charge ratio from the hospital's most recent filed cost report. If the computed cost exceeds the sum of the DRG payment plus the fixed threshold, the hospital receives 80% of the difference as an outlier payment. Under Sections 1886(d) and 1886(g) of the Social Security Act, CMS must project aggregate annual outlier payments to all prospective payment system hospitals to be not less than 5% or more than 6% of total DRG payments (Outlier Percentage). The Outlier Percentage is determined by dividing total outlier payments by the sum of DRG and outlier payments. CMS annually adjusts the fixed threshold to bring expected outlier payments within the mandated limit. A change to the fixed threshold affects total outlier payments by changing (1) the number of cases that qualify for outlier payments, and (2) the dollar amount hospitals receive for those cases that still qualify. The most recent change to the cost outlier threshold that became effective on October 1, 2004 was a decrease from $31,000 to $25,800, which CMS projects will result in an Outlier Percentage of 5.1%. Revenues under managed care plans are based primarily on payment terms involving predetermined rates per diagnosis, per-diem rates, discounted fee-for-service rates and/or other similar contractual arrangements. These revenues are also subject to review and possible audit by the payers. The payers are billed for patient services on an individual patient basis. An individual patient's bill is subject to adjustment on a patient-by-patient basis in the ordinary course of business by the payers following their review and adjudication of each particular bill. The Hospitals estimate the discounts for contractual allowances utilizing billing data on an individual patient basis. At the end of the month, the Hospitals estimate expected reimbursement for patient of managed care plans based on the applicable contract terms. These estimates are continuously reviewed for accuracy by taking into consideration known contract terms as well as payment history. Although the Hospitals do not separately accumulate and disclose the aggregate amount of adjustments to the estimated reimbursements for every patient bill, management believes the estimation and review process allows for timely identification of instances where such estimates need to be revised. Management does not believe there were any adjustments to estimates of individual patient bills that were material to its net patient service revenue. Management is not aware of any material claims, disputes, or unsettled matters with any payers that would affect revenues that have not been adequately provided for in the accompanying combined financial statements. The Hospitals provide charity care to patients whose income level is below 200% of the Federal Poverty Level with only a co-payment charged to the patient. The Hospitals' policy is to not pursue collection of amounts determined to qualify as charity care; and accordingly, the Hospitals do not report the amounts in net patient service revenue or in the provision for doubtful accounts. Patients whose income level is between 200% and 300% of the Federal Poverty Level may also be considered under a catastrophic provision of the charity care policy. Patients without insurance who do not meet the Federal Poverty Level guidelines are offered assistance in applying for Medicaid and other programs they may be eligible for, such as state disability, Victims of Crime, or county indigent programs. Patient advocates from the Hospitals' Medical Eligibility Program (MEP) screen patients in the hospital and determine potential linkage to financial assistance programs. They also expedite the process of applying for these government programs. The amount of gross charges foregone under the charity policy, including indigent care accounts, for the three months and six months ended June 30, 2005 were approximately $3,638,933 and $4,646,811 respectively. 9 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Receivables from patients who are potentially eligible for Medicaid are classified as Medicaid pending, under the MEP, with appropriate contractual allowances recorded. If the patient does not quality for Medicaid, the receivables are reclassified to charity care and written off, or they are reclassified to self-pay and adjusted to their net realizable value through the provision of doubtful accounts. Reclassifications of Medicaid pending accounts to self-pay do not typically have a material impact on the results of operations as the estimated Medicaid contractual allowances initially recorded are not materially different than the estimated provision for doubtful accounts recorded when the accounts are reclassified. All accounts classified as pending Medicaid are fully reserved when they reach 180 days old. Provision for Doubtful Accounts - The Company provide for accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. The Hospitals estimate this allowance based on the aging of their accounts receivable, historical collections experience for each type of payer and other relevant factors. There are various factors that can impact the collection trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of uninsured and underinsured patients, volume of patients through the emergency department, the increased burden of co-payments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the estimation process. The Company's policy is to attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act (EMTALA). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In non-emergency circumstances or for elective procedures and services, it is the Hospitals' policy, when appropriate, to verify insurance prior to a patient being treated. During the three months and six months ended June 30, 2005, the Company recorded provisions for doubtful accounts of $11,331,354 and $14,472,760 respectively. Cash and Cash Equivalents - The Company considers all highly liquid debt investments purchased with a maturity of three months or less to be cash equivalents. Property and Equipment - Property and equipment are stated at cost, less accumulated depreciation and any impairment write-downs related to assets held and used. Additions and improvements to property and equipment are capitalized at cost. Expenditures for maintenance and repairs are charged to expense as incurred. Capital leases are recorded at the beginning of the lease term as assets and liabilities. The value recorded is the lower of either the present value of the minimum lease payments or the fair value of the asset. Such assets, including improvements, are amortized over the shorter of either the lease term or their estimated useful life. 10 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 The Company uses the straight-line method of depreciation for buildings, building improvements, and equipment over their estimated useful lives as follows: Buildings and improvements 4 to 25 years Equipment 3 to 15 years The Company evaluates its long-lived assets for possible impairment whenever circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future cash flows. However, there is an evaluation performed at least annually. Fair value estimates are derived from independent appraisals, established market values of comparable assets or internal calculations of estimated future net cash flows. The estimates of future net cash flows are based on assumptions and projections believed by management to be reasonable and supportable. These assumptions take into account patient volumes, changes in payer mix, revenue, and expense growth rates and changes in legislation and other payer payment patterns. The Company believes there has been no impairment in the carrying value of its property and equipment at June 30, 2005. Medical Claims Incurred but not Reported - The Company record estimates of claims incurred but not reported (IBNR) to the Hospitals for its obligations under agreements with various HMOs. Claims incurred but not reported are estimated using historical claims patterns, current enrollment trends, hospital pre-authorizations, member utilization patterns, timeliness of claims submissions, and other factors. These estimates are periodically reviewed and any adjustments are reflected prospectively in operations. The Company believes that IBNR claims reserves are adequate to satisfy ultimate claims liabilities; however, establishment of IBNR claims estimates is an inherently uncertain process and actual experience could result in prospective revisions to these estimated reserves. Stock-Based Compensation - Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to account for stock-based compensation using the intrinsic value method prescribed in previously issued standards. Accordingly, compensation cost for stock options issued to employees is measured as the excess, if any, of the fair market value of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. Compensation is charged to expense over the shorter of the service or vesting period. Stock options issued to non-employees are recorded at the fair value of the services received or the fair value of the options issued, whichever is more reliably measurable, and charged to expense over the service period. During the three and six months ended June 30, 2005, the Company recognized $255,144 of other operating expense from the granting of 500,000 stock options to its public relations consultant. Fair Value of Financial Instruments - The Company considers all liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. Short-term investments generally mature between three months and six months from the purchase date. All cash and short-term investments are classified as available for sale and are recorded at market using the specific identification method; unrealized gains and losses are reflected in other comprehensive income. Cost approximates market for all classifications of cash and short-term investments. Net Loss per Common Share - Net loss per share is calculated in accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that options and warrants are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 11 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Impairment of Long-Lived Assets - The Company continually monitors events or changes in circumstances that could indicate that the carrying amount of long-lived assets to be held and used, including intangible assets, may not be recoverable. The determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. When impairment is indicated for a long-lived asset, the amount of impairment loss is the excess of net book value over fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. As of June 30, 2005, the Company has determined that no impairment of its long-lived assets exists. Goodwill and Intangible Assets - On July 20, 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards ("SFAS") 141, Business Combinations, and SFAS 142, Goodwill and Intangible Assets. Under these new standards, all acquisitions subsequent to June 30, 2001 must be accounted for using the purchase method of accounting. The cost of intangible assets with indefinite lives and goodwill are no longer amortized, but are subject to an annual impairment test based upon its fair value. Goodwill and intangible assets principally result from business acquisitions. The Company accounts for business acquisitions by assigning the purchase price to tangible and intangible assets and liabilities. Assets acquired and liabilities assumed are recorded at their fair values; the excess of the purchase price over the net assets acquired is recorded as goodwill. As of June 30, 2005 no goodwill had been recorded on acquisitions. Recently Enacted Accounting Standards - On October 13, 2004, the Financial Accounting Standards Board issued Statement 123R, Share-Based Payment, which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value. The statement is effective for the Company as of the fiscal year commencing January 1, 2006. The statement generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in the consolidated statements of operations. This standard also requires that the modified prospective transition method be used, under which the Company will recognize compensation cost for (1) the fair value of new awards granted, modified or settled after the effective date of the SFAS 123R; and (2) a portion of the fair value of each option and stock grant made to employees or directors prior to the implementation date that represents the unvested portion of these share-based awards as of such date. The measurement of compensation cost for awards that are not fully vested as of the effective date of the SFAS 123R would be based on the same estimate that the Company used to previously value its grants under SFAS 123. As a result of SFAS 123R, the Company will be required to expense the fair value of its stock option grants rather than disclose the impact on its consolidated statement of operations within the Company's footnotes, as is current practice. Additionally, if it chooses to do so, SFAS 123(R) permits the Company to adopt the new share-based award accounting by retrospectively restating results for all periods presented to facilitate period-to-period comparison. In January 2003, the Financial Accounting Standards Board issued FIN 46, "Consolidation of Variable Interest Entities," which requires consolidation of certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Paragraph 1 of ARB 51 states that consolidated financial statements are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies. Paragraph 2 states that "the usual condition for a controlling financial interest is ownership of a majority voting interest..." However, application of the majority voting interest requirement in ARB 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. Application of Interpretation 46 or Interpretation 46(R) is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. See Note 7 regarding the Company's implementation of FIN 46 (R). 12 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 2 - ACQUISITION The purchase price, after all purchase price adjustments, of the Acquisition amounted to $66,042,680. The fair value of the tangible assets acquired and liabilities assumed consisted of the following: Property and equipment $ 59,493,353 Inventories of supplies 6,018,995 Prepaid expenses and other current assets 2,338,854 Debt issuance costs 1,933,000 Capital lease obligations (3,659,401) Other assumed liabilities (82,121) ------------ $ 66,042,680 ============ The Company financed the asset purchase and related financing costs (Note 6) by obtaining a $50 million acquisition debt, drawing $3 million on a working capital line of credit, the sale of the Company's common stock for $10.1 Million, and $5 million in proceeds from the sale of the real property of the acquired Hospitals. The Company recorded its initial deposit of $10 million on the Acquisition and direct acquisition costs of $1,142,145, consisting primarily of legal fees, as an Investment in hospital asset purchase in the accompanying consolidated balance sheet as of December 31, 2004. The following unaudited pro forma information represents the Company's consolidated results of operations as if the Acquisition had occurred on January 1, 2005 and after giving effect to certain adjustments including the elimination of investment losses not attributable to on-going operations, interest expense, depreciation expense, and related tax effects. Such pro forma information does not purport to be indicative of operating results that would have been reported had the Acquisition occurred on January 1, 2005 or future operating results. Supplemental pro forma information disclosing the results of operations for the comparative periods in 2004 was not available to the Company. 13 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Pro Foma -------------------------------- Three Months Six Months Ended Ended June 30, 2005 June 30, 2005 -------------------------------- Net operating revenues $ 83,190,537 $ 160,203,857 Net loss (11,923,621) (42,456,022) Loss per common share (basic and fully diluted) $ (0.10) $ (0.34) Weighted average shares outstanding 124,539,000 124,308,528 NOTE 3 - PROPERTY AND EQUIPMENT Property and equipment consist of the following as of June 30, 2005: Buildings and improvements $ 32,844,916 Land 15,264,266 Equipment 7,915,164 Leasehold 3,659,401 -------------- 59,683,747 Less accumulated depreciation (994,514) -------------- Property and equipment, net $ 58,689,233 ============== The Hospitals are affected by State of California Senate Bill 1953 (SB 1953), which requires certain seismic safety building standards for acute care hospital facilities. The Hospitals are currently reviewing the SB 1953 compliance requirements and developing multiple plans of action to achieve such compliance, the estimated time frame for complying with such requirements, and the cost of performing necessary remediation of certain of the properties. The Hospitals cannot currently estimate with reasonable accuracy the remediation costs that will need to be incurred in order to make the facilities SB 1953-compliant, but such remediation costs could be significant. NOTE 4 - COMMON STOCK Stock Purchase Agreement with OC-PIN - On January 28, 2005, the Company entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with Orange County Physicians Investment Network, LLC ("OC-PIN"), a company founded by Dr. Anil V. Shah and owned by a number of physicians practicing at the acquired hospitals, pursuant to which OC-PIN committed to invest $30,000,000 in the Company for an aggregate of 108,000,000 shares of the Company's common stock. In addition, a prior Purchase Option Agreement, dated November 16, 2004, between the Company and Dr. Anil V. Shah, was terminated. During the six months ended June 30, 2005, the Company issued a total of 102,600,000 shares of its common stock in consideration of $10.1 million from OC-PIN under the Stock Purchase Agreement. The Company used the proceeds from this stock sale as part of the consideration paid to Tenet for the acquisition of the Hospitals. 14 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Under the Stock Purchase Agreement, no later than six calendar days before the closing of Acquisition, OC-PIN was to deliver to the Company additional financing totaling $20,000,000. Upon receipt of the $20,000,000, the Company was to issue an additional 5.4 million shares of its common stock to OC-PIN. The Company extended OC-PIN's additional financing commitment to June 16, 2005, when the Company entered into the following new agreements: o First Amendment to the Stock Purchase Agreement, dated as of June 1, 2005 (the "First Amendment"); and o Escrow Agreement, dated as of June 1, 2005, by and among IHHI, OC-PIN and City National Bank (the "Escrow Amendment"). The following material terms, which were contained in the First Amendment and the Escrow Agreement, are currently in process: o A total of 57,250,000 shares of Company common stock previously issued to OC-PIN were placed in an escrow account with City National Bank. OC-PIN will have until September 1, 2005 to make aggregate payments of up to approximately $15,000,000 in monthly installments into the escrow account. Such portion of the escrowed shares which are fully paid will be returned to OC-PIN and the balance will be transferred back to the Company. If there is a shortfall, the Company will use its reasonable best efforts to sell equity to new investors to cover the shortfall; o OC-PIN will reimburse the Company for certain of its additional debt financing costs incurred since March 8, 2005; o The Company will work to complete a new borrowing transaction with Capital Source Finance LLC; and o Upon receipt of at least $5,000,000 of new capital under the First Amendment, the Company will call a shareholders meeting to re-elect directors. The nominees for the Board will consist of two current directors, two members of OC-PIN, two independent directors unaffiliated with IHHI or OC-PIN, and Anil V. Shah, M.D. NOTE 5 - COMMON STOCK WARRANTS The Company entered into a Rescission, Restructuring and Assignment Agreement with Dr. Chaudhuri and William Thomas on January 27, 2005 (the "Restructuring Agreement"). Previously, the Company had obtained financing from Dr. Chaudhuri and Mr. Thomas and had issued to them a $500,000 secured convertible promissory note that was convertible into approximately 88.8% of the Company's issued and outstanding common stock on a fully-diluted basis, a $10 million secured promissory note, and a stock option agreement, all of which together with related accrued interest payable pursuant to the terms of the notes were rescinded and cancelled. Pursuant to the Restructuring Agreement, the Company released its initial deposit of $10 million plus accrued interest on the Tenet Hospital Acquisition back to Dr. Chaudhuri and issued non-convertible secured promissory notes totaling $1,264,014 and warrants to purchase up to 74,700,000 shares of the Company's Common Stock (but not to exceed 24.9% of the Company's Fully-Diluted capital stock) (the "Warrants") to Dr. Chaudhuri and Mr. Thomas. 15 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 The Warrants are exercisable beginning January 27, 2007 and expire in 3.5 years from the date of the issuance. The exercise price for the first 43 million shares purchased under the Warrants is $0.003125 per share, and the exercise or purchase price for the remaining 31.7 million shares is $0.078 per share if exercised between January 27, 2007 and July 26, 2007, $0.11 per share if exercised between July 27, 2007 and January 26, 2008, and $0.15 thereafter. Based upon a valuation obtained by the Company from an independent valuation firm, the Company has assigned a value to the 74,700,000 warrants of $27,987,100 at the date of grant. As of June 30, 2005, the Company has recognized an expense of $16,434,173 related to the issuance of the common stock warrants. The Company computed the expense of the warrants based on the fair value of the warrants at the date of grant and the maximum number of shares exercisable as of June 30, 2005 of 41,298,523 (which constitutes 24.9% of the fully diluted stock that would have been outstanding as of June 30, 2005 assuming maximum possible exercise of the Warrants). The Company has recorded the fair value of the remaining unexercisable Warrants as of June 30, 2005 of $11,552,927 as deferred warrant expense in the accompanying consolidated balance sheet as of June 30, 2005. The Company will recognize additional warrant expense in subsequent quarters over the term of the Warrants of 3.5 years, based on any future increase in the number of warrants that become exercisable. The fair value of the Warrants was determined based on the Black-Scholes option pricing model with the following assumptions: Low, High --------- Risk-free interest rate 3.2%, 3.33% Expected volatility 33.6%, 35.7% Dividend yield - Expected life (years) 2, 2.5 Fair value of Warrants (fully diluted) $0.343, $0.398 Due to the Company emerging from the development stage during the six months ended June 30, 2005, the Company computed the volatility of its stock based on an average of comparable public companies that own hospitals. NOTE 6 - DEBT The current portion of the Company's debt consists of the following notes as of June 30, 2005: Secured acquisition note payable $50,000,000 Secured line of credit note payable 13,200,000 Advances from accounts receivable purchase agreement 21,404,113 ----------- $84,604,113 =========== Acquisition Loan and Line of Credit - In connection with the Tenet Hospital Acquisition, the Company obtained borrowings to complete the Hospital Acquisition from affiliates of Medical Capital Corporation of Anaheim, CA. Effective March 3, 2005, the Company and its Subsidiaries collectively entered into a Credit Agreement (the "Credit Agreement") with Medical Provider Financial Corporation II ("the Lender"), whereby the Company has obtained initial financing in the form of a loan with interest at the rate of 14% per annum in the amount of $80,000,000 of which $30,000,000 will be in the form of a non-revolving Line of Credit (the "Line of Credit") and $50,000,000 will be in the form of a real estate loan (the "Acquisition Loan") (collectively, the "Obligations"). The Company used the proceeds from the $50 million Acquisition Loan and $3 million from the Line of Credit to complete the Acquisition (See Notes 1 and 3). The Line of Credit is to be used for the purpose of providing (a) working capital financing for the Company and its Subsidiaries, (b) funds for other general corporate purposes of the Company and its Subsidiaries, and (c) other permitted purposes. 16 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Interest payments are due on the Obligations on the first business day of each calendar month to occur while any Obligation is outstanding at the interest rate of 14% per annum. The Obligations mature at the first to occur of (i) the Commitment Termination Date for the Line of Credit Loan, (ii) March 2, 2007, or (iii) the occurrence or existence of a continuing Event of Default under any of the Obligations. The Commitment Termination Date means the earliest of (a) thirty calendar days prior to March 2, 2007; (b) the date of termination of Lender's obligations to make Advances under the Line of Credit Note or permit existing Obligations to remain outstanding pursuant to Section 8.2(b), (c) the date of prepayment in full by the Company and its Subsidiaries of the Obligations and the permanent reduction of all Commitments to zero dollars; (d) March 2, 2007. Per the Credit Agreement, all future capital contributions to the Company by OC-PIN shall be used by the Company as mandatory prepayments of the Line of Credit. The Acquisition Loan and Line of Credit are secured by a lien on substantially all of the assets of the Company and its Subsidiaries, including without limitation, a pledge of the capital stock by the Company in its wholly owned subsidiary Hospitals. In addition, (i) PCHI (see Note 1) has agreed to guaranty the payment and performance of the Obligations, (ii) West Coast and Ganesha (see Note 7) have each agreed to pledge their membership interests in PCHI as security for repayment of the Obligations, (iii) the members of West Coast have agreed to pledge their membership interests in PCHI as security for repayment of the Obligations, and (iv) OC-PIN (see Note 5) has agreed to guaranty the payment and performance of all the Obligations. Credit Agreement Fees - Concurrently with the execution and delivery of the Credit Agreement and as a condition to the funding of the Acquisition Loan, Company and its Subsidiaries agreed to pay to the Lender an origination fee in an amount equal to 2% of the Credit Line Commitment or $600,000, and 2% of the Acquisition Loan or $1,000,000, to be payable out of Company and its Subsidiaries own funds, which fee shall be deemed earned in full upon receipt by Lender. Upon the completion of the Acquisition on March 8, 2005, the Company paid the Lender a total of $1,600,000 in origination fees and paid the Lender's legal fees of approximately $333,000. The Company is amortizing the deferred loan fees of $1,933,000 over the two year term of the Obligations. During the six months ended June 30, 2005, the Company recognized $307,210 of amortization expense and has unamortized deferred loan fees of $1,625,790 as of June 30, 2005. Accounts Receivable Purchase Agreement - In March 2005, the Hospitals entered into an Accounts Purchase Agreement that allows the sale of their accounts receivable to Medical Provider Financial Corp., an affiliate of the Lender, as they become billable to third parties. The Company will continue to provide billing and collection services and the proceeds collected from the accounts receivable are applied to reduce amounts advanced under this agreement. As of June 30, 2005, advances made under this agreement were $21,404,113. This agreement has a term of two years. 17 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Default Notice - On or about May 9, 2005, the Company received a notice of default from the Lender. In addition, each of OC-PIN, PCHI, Ganesha Realty, LLC, and West Coast Holdings, LLC, which are parties to the Credit Agreement, has received a notice of default under the Credit Agreement. The Company has recorded the acquisition note of $50 million and outstanding draws on the line of credit of $13.2 million as current liabilities in the accompanying consolidated financial statements. The notice of default asserts that (i) the Company failed to provide satisfactory evidence that the Company has received capital contributions of not less than $15,000,000, as required under the Credit Agreement, (ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as required under the Credit Agreement, and (iii) a Material Adverse Effect has occurred under the Credit Agreement for reasons relating primarily to OC-PIN's failure to fully fund its obligations under its Stock Purchase Agreement with the Company dated January 28, 2005. Forbearance Agreement - In connection with the Company's First Amendment (see Note 4), the Company entered into an Agreement to Forbear as of June 1, 2005 by and among the Company, OC-PIN, West Coast Holdings, LLC and the Lender (the "Forbearance Agreement"). Without another default, the Lender agrees for 100 days to forbear from (i) recording Notices of Default, (ii) filing a judicial foreclosure lawsuit against the Company, OC-PIN and West Coast Holdings, LLC, and (iii) filing lawsuits against the Company, OC-PIN and West Coast Holdings, LLC. The interest rate on the notes will be increased to the Default Rate of 19%, as defined in the Credit Agreement, and all Obligations (as defined in the Credit Agreement), will be forthwith due and payable, as long as the events of default remain uncured. The Company's Line of Credit facility is suspended to additional advances. During the forbearance period of 100 days, OC-PIN and other investors will invest not less than $15 million in new equity capital in the Company. NOTE 7 - SALE OF REAL ESTATE AND VARIABLE INTEREST ENTITY Concurrent with the close on the acquisition of the Hospitals, Dr. Chaudhuri and Dr. Shah exercised their option to purchase all of the real property of the Hospitals pursuant to an Option agreement dated September 28, 2004, as amended and restated on November 16, 2004 ("LLC Option Agreement"). The option was exercised by the option holders purchasing from the Company all of the equity interests in PCHI, which holds title to the real property. The Company received $5 million and PCHI guaranteed the Company's acquisition debt of $50 million. The Company remains primarily liable under the $50 million acquisition note notwithstanding its guarantee by PCHI, and this note is cross-collateralized by substantially all of the Company's assets and all of the real property of the Hospitals. All of the Company's operating activities are directly affected by the real property that was sold to PCHI. Given these factors, it appears that the Company has indirectly guaranteed the indebtedness of PCHI. The Company is standing ready to perform on the acquisition debt should PCHI not be able to perform and has undertaken a contingent obligation to make future payments if those triggering events or conditions occur. In connection with the sale of all of the real property of the Hospitals, the Company entered into a triple net lease with PCHI to leaseback this real property for an initial term of 25 years. Per the triple net lease, PCHI will receive rent that covers the cost of the underlying debt, plus a guaranteed spread up to 2.5%. Additionally, the Company has a right to renew the leases for periods up to an additional 25 years. PCHI is a related party entity that is affiliated with the Company through common ownership and control. It is owned 51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha Realty, LLC (Dr. Chaudhuri and William Thomas). Generally accepted accounting principles require that a company consolidate the financial statements of any entity that cannot finance its activities without additional subordinated financial support, and for which one company provides the majority of that support through means other than ownership. Effective March 8, 2005, the Company determined that it provided the majority of financial support to PCHI through various sources including lease payments, remaining primarily liable under the $50 million debt, and cross-collateralization of the Company's non-real estate assets to secure the $50 million debt. Accordingly, during the six months ended June 30, 2005, the Company included in its consolidated financial statements, the net assets of PCHI, net of consolidation adjustments. 18 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Selected information of PCHI's balance sheet as of June 30, 2005, and its results of operations for the period March 8, 2005 to June 30, 2005 are as follows: Total assets $ 55,362,360 Total liabilities 50,566,782 Member's equity 4,795,578 Net revenues 3,353,508 Net loss 204,422 Consolidation adjustments to reflect the effects of the following matters are included in the accompanying consolidated financial statements: o The Company's lease interest in the hospitals has been eliminated leaving PCHI's ownership of the land and buildings being presented in the accompanying consolidated financial statements. Additionally, a deferred gain of $12,157,808 arising from the Company's sale of the real property of the Hospitals to PCHI has been eliminated to state the land and buildings at the Company's cost. o Because the Company remains primarily liable under the $50 million debt notwithstanding its guarantee by PCHI, generally accepted accounting principles do not allow the Company to remove this liability from its balance sheet. Therefore, it is necessary to eliminate the same item from PCHI's balance sheet in consolidation. o PCHI's equity accounts have been classified as minority interest variable interest entity in the accompanying consolidated balance sheet. o The Company's rent expense has been eliminated against PCHI's rental income. Additionally, amounts assigned to land and buildings are being depreciated and amortized over the 25 year initial term of the lease with PCHI. NOTE 8 - INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" which requires the liability approach for the effect of income taxes. The provision for income taxes consists of provisions for federal and state income taxes. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amount of tax-related assets and liabilities and income tax provisions. The Company assesses the recoverability of the deferred tax assets on an ongoing basis. In making this assessment the Company is required to consider all available positive and negative evidence to determine whether, based on such evidence, it is more likely than not that some portion or all of our net deferred assets will be realized in future periods. This assessment requires significant judgment. In addition, the Company has made significant estimates involving current and deferred income taxes, tax attributes relating to the interpretation of various tax laws, historical bases of tax attributes associated with certain tangible and intangible assets and limitations surrounding the realizability of our deferred tax assets. The Company does not recognize current and future tax benefits until it is deemed probable that certain tax positions will be sustained. 19 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 The Company recorded a provision for income taxes of $1,762,000 and $0 for the three months ended June 30, 2005 and 2004, respectively. The Company recorded a provision for income taxes of $3,234,000 and $0 for the six months ended June 30, 2005 and 2004, respectively. The effective tax rate differs from the statutory U.S. federal income tax rate of 35% primarily due to the nondeductible common stock warrant expense, the taxable gain on sale of real property to PCHI, and the change in allowance for doubtful accounts for the six months ended June 30, 2005. The Company has provided a valuation allowance of $10,804,000 and $800,000 as of June 30, 2005 and December 31, 2004, respectively, on 100% of its net deferred tax assets. The Company assesses the realization of its deferred tax assets to determine whether an income tax valuation allowance is required. Based on all available evidence, both positive and negative, and the weight of that evidence to the extent such evidence can be objectively verified, Company management has determined that it was more likely than not that the deferred tax assets were not realizable. Tenet Hospital Acquisition - The Acquisition was an asset purchase transaction and the Company will not benefit from the net operating losses of the acquired Hospitals. In connection with the Company's completion of the Tenet Hospital Acquisition in March 2005, the Company sold all of the real estate of the acquired hospitals to its majority shareholders. For income tax purposes, the sale of the real estate of the acquired hospitals could require the Company to report dividend and/or interest income. If the Company is required to report dividend and/or interest income in connection with this transaction, the Company would be required to withhold 28% on any deemed dividend or interest income. The March 8, 2005 contribution of the real estate acquired in the Tenant Hospital Acquisition to Pacific Coast Holdings Investment LLC ("PCHI"), a 100% owned subsidiary of the Company, was intended to be a non-taxable event. The Company's sale of 100% of the membership interest in PCHI on March 8, 2005, to West Coast Holdings LLC and Ganesha Realty LLC in consideration of $5 million plus the assumption of the $50 million Acquisition Loan on the real property debt is a taxable event to the Company. The Company is currently assessing the potential impact of this taxable event in 2005. PCHI Tax Status - PCHI is a limited liability corporation. PCHI's owners plan to make tax elections for it be treated as a disregarded entity for tax reporting whereby similar to a partnership PCHI's taxable income or loss will flow through to its owners and be their separate responsibility. Accordingly, the accompanying consolidated financial statements do not include any amounts for the income tax expense or benefit of PCHI's income or loss. 20 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 9 - RELATED PARTY TRANSACTIONS PCHI - The Company leases all of the real property of the acquired Tenet Hospitals from PCHI. PCHI is owned by two LLC's, which are owned and co-managed by Dr. Shah, Dr. Chaudhuri, and Mr. William Thomas. Dr. Shah is the chairman of the Company and is also the co-manager an investor in OC-PIN, which is the majority shareholder of the Company. Dr. Chaudhuri and Mr. Thomas are the holders of the Warrants to purchase up to 24.9% of the Company's fully diluted capital stock. The Company has consolidated the financial statements of PCHI for the period March 8, 2005 through June 30, 2005 in accordance with FIN 46(R) (see Note 7). During the six month period ended June 30, 2005, the Company incurred a liability for rent expense payable to PCHI of $3,353,508, which was eliminated upon consolidation at June 30, 2005. Management Agreements - In December 2004, February 2005, and March 2005, the Company entered into seven employment agreements with its executive officers. Among other terms, the three year employment agreements in aggregate provide for annual salaries totaling $2,290,000, total stock option grants to purchase 6,650,000 shares of the Company's common stock at an exercise price equal to the mean average per share for the ten days following the date of issuance with vesting at 33% per year, and an annual bonus to be determined by the Board of Directors. As of June 30, 2005, the Company has not issued any stock options pursuant to the employment agreements. NOTE 10 - LOSS PER SHARE The following data show the amounts used in computing loss per share for the periods presented:
Three Months Ended June 30, Six Months Ended June 30, ----------------------------- ----------------------------- 2005 2004 2005 2004 ------------- ------------- ------------- ------------- Loss from continuing operations available to common shareholders (numerator) $ (11,923,621) $ (430,608) $ (31,527,412) $ (922,740) Weighted average number of common shares used in loss per share during the period (denominator) 124,539,000 19,590,000 106,518,528 19,510,778
The Company's weighted average common stock equivalents related to the Warrants (Note 6) were 41,291,892 for the six months ended June 30, 2005. These common stock equivalents have been excluded from the Company's weighted average number of common shares outstanding due to their anti-dilutive effect for the three months ended June 30, 2005. 21 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 11 - COMMITMENTS AND CONTINGENCIES Operating Leases - Concurrent with the closing of the Tenet Hospital Acquisition as of March 7, 2005, the Company entered into a sale leaseback type agreement with a related party entity, PCHI (the "Related Party Lease"). The Company leases all of the real estate of the acquired Hospitals properties (the "Hospital Properties") and medical office buildings and a long term acute care facility (collectively the "MOB Properties") from PCHI. The term of the Lease for the Hospital Properties is approximately 25 years, commencing March 8, 2005 and terminating on February 28, 2030. The Company has the option to extend the term of this triple net lease for an additional term of twenty-five years. Additionally, in connection with the acquisition of the Hospitals, the Company also assumed the operating leases for the Chapman facility, which include buildings, land, and other equipment. The Related Party Lease has been eliminated in the consolidation of PCHI in the accompanying consolidated financial statements. Claims and Lawsuits - The Company and the Hospitals are subject to a significant number of claims and lawsuits. The results of these claims, lawsuits and investigations cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on the Company's business (both in the near and long term), financial position, results of operations or cash flows. Although the Company defends itself vigorously against claims and lawsuits and cooperate with investigations, these matters (1) could require payment of substantial damages or amounts in judgments or settlements, which individually or in the aggregate could exceed amounts, if any, that may be recovered under insurance policies where coverage applies and is available, (2) cause substantial expenses to be incurred, (3) require significant time and attention from management and (4) could cause the Company to close or sell the Hospitals or otherwise modify the way its business is conducted. Reserves for claims and lawsuits are recorded when they are probable and reasonably estimable. NOTE 12 - SUBSEQUENT EVENT On August 1, 2005, Larry Anderson resigned as a director of the Company, and the Board of Directors appointed the following four individuals to serve as directors to fill current vacancies on the Board: Maurice J. DeWald, Fernando Niebla, Syed J. Naqvi and Jaime Ludmir. 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Information This Quarterly Report on Form 10-Q contains forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expects", "plans", "anticipates", "believes", "estimates", "predicts", "potential" or "continue" or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks discussed under the caption "Risk Factors" in our Annual Report on Form 10-KSB filed on March 31, 2005, that may cause our company's or our industry's actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as may be required by applicable law, we do not intend to update any of the forward-looking statements to conform these statements to actual results. As used in this report, the terms "we", "us", "our", "the Company", "Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings, Inc., a Nevada corporation, unless otherwise indicated. Overview Prior to March 8, 2005, we were primarily a development stage company with no material operations and no revenues from operations. On September 29, 2004, the Company entered into a definitive agreement to acquire four hospitals from subsidiaries of Tenet Healthcare Corporation ("Tenet"), and completed the transaction on March 8, 2005. Effective March 8, 2005, we acquired and began operating the following four hospital facilities in Orange County, California (referred to in this report as our "Hospitals"): o 282-bed Western Medical Center in Santa Ana; o 188-bed Western Medical Center in Anaheim; o 178-bed Coastal Communities Hospital in Santa Ana; and o 114-bed Chapman Medical Center in Orange. Our results of operations discussed in this report reflect Hospital operations for the full quarter ended June 30, 2005 and the 24 days of the quarter ended March 31, 2005. We entered into agreements with third-party payers, including government programs and managed care health plans, under which rates are based upon established charges, the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from established charges. During the 24 days ended March 31, 2005, substantially all of Tenet's negotiated rate agreements were assigned to our Hospitals. Our own Medicare provider numbers were received in April 2005. California State Medicaid Program provider numbers were received in June 2005. 23 Critical Accounting Policies and Estimates Provisions For Doubtful Accounts Our policy is to attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act ("EMTALA"). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In non-emergency circumstances or for elective procedures and services, it is our policy, when appropriate, to verify insurance prior to a patient being treated. We provide for an allowance against accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance based on the aging of certain of our accounts receivables by hospital, our historical collection experience by hospital and for each type of payer, and other relevant factors. Our practice is to write-down self-pay accounts receivable, including accounts related to the co-payments and deductibles due from patients with insurance, to their estimated net realizable value at the time of billing. Generally, uncollected balances are assigned to collection agency between 90 to 120 days, once patient responsibility has been identified. When accounts are assigned for collections by the hospitals, the accounts are completely written off through provision for doubtful accounts. Any recoveries from collection agencies thereafter are credited to the provision as received. Common Stock Warrants The Company entered into a Rescission, Restructuring and Assignment Agreement with Dr. Chaudhuri and William Thomas on January 27, 2005 (the "Restructuring Agreement"). Previously, the Company had obtained financing from Dr. Chaudhuri and Mr. Thomas and had issued to them a $500,000 secured convertible promissory note that was convertible into approximately 88.8% of the Company's issued and outstanding common stock on a fully-diluted basis, a $10 million secured promissory note, and a stock option agreement, all of which together with related accrued interest payable pursuant to the terms of the notes were rescinded and cancelled. Pursuant to the Restructuring Agreement, the Company released its initial deposit of $10 million plus accrued interest on the Tenet Hospital Acquisition back to Dr. Chaudhuri and issued non-convertible secured promissory notes totaling $1,264,014 and warrants to purchase up to 74,700,000 shares of the Company's Common Stock (but not to exceed 24.9% of the Company's Fully-Diluted capital stock) (the "Warrants") to Dr. Chaudhuri and Mr. Thomas. The Warrants are exercisable beginning January 27, 2007 and expire 3.5 years from the date of issuance. The exercise price for the first 43 million shares purchasable under the Warrants is $0.003125 per share, and the exercise price for the remaining 31.7 million shares is $0.078 per share if exercised between January 27, 2007 and July 26, 2007, $0.11 per share if exercised between July 27, 2007 and January 26, 2008, and $0.15 thereafter. As of June 30, 2005, the Company recognized an expense of $16.4 million related to the issuance of the Warrants. The Company computed the expense of the Warrants based on the fair value of the Warrants at the date of grant and the maximum number of shares exercisable as of June 30, 2005 of 41,298,523(24.9% of the fully diluted stock outstanding as of June 30, 2005). The Company recorded the fair value of the remaining unexercisable Warrants as of June 30, 2005 of $11.6 million as deferred warrant expense in the accompanying consolidated balance sheet. The Company will amortize the deferred compensation in subsequent quarters over the term of the Warrants of 3.5 years based on any future increases in the number of outstanding shares of the Company's fully diluted common stock. 24 The Company computed the fair value of the Warrants based on the Black-Scholes option pricing model with the following assumptions: Low, High --------- Risk-free interest rate 3.2%, 3.33% Expected volatility 33.6%, 35.7% Dividend yield - Expected life (years) 2, 2.5 Fair value of Warrants (fully diluted) $0.343, $0.398 Due to fact that the Company emerged from the development stage during the six months ended June 30, 2005, the Company computed the volatility of its stock based on an average of comparable public companies that own hospitals. Sale of Real Estate and Variable Interest Entity Concurrent with the close of the Company's acquisition of the Hospitals, Dr. Chaudhuri and Dr. Anil Shah exercised their options to purchase the Company's interest in a limited liability company holding the real property underlying the Hospitals pursuant to an option agreement dated September 28, 2004, as amended and restated on November 16, 2004 (the "LLC Option Agreement"). The option holders purchased all of the Company's interests in Pacific Coast Holdings Investment LLC ("PCHI"), which acquired title to the real property. The Company received $5 million and PCHI guaranteed the Company's acquisition debt of $50 million. The Company remains primarily liable under the $50 million acquisition note notwithstanding its guarantee by PCHI, and this note is cross-collateralized by substantially all of the Company's assets and all of the real property of the Hospitals. All of the Company's operating activities are directly affected by the real property that was sold to PCHI. Given these factors, it appears that the Company has indirectly guaranteed the indebtedness of PCHI. The Company is standing ready to perform on the acquisition debt should PCHI not be able to perform and has undertaken a contingent obligation to make future payments if those triggering events or conditions occur. In connection with the sale of all of the real property of the Hospitals, the Company entered into a triple net lease with PCHI to leaseback this real property for an initial term of 25 years. Per the triple net lease, PCHI will receive rent that covers the cost of the underlying debt, plus a guaranteed spread up to 2.5%. Additionally, the Company has a right to renew the leases for periods up to an additional 25 years. PCHI is a related party entity that is affiliated with the Company through common ownership and control. It is owned 51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha Realty, LLC (Dr. Chaudhuri and William Thomas). Generally accepted accounting principles require that a company consolidate the financial statements of any entity that cannot finance its activities without additional subordinated financial support, and for which one company provides the majority of that support through means other than ownership. Effective March 8, 2005, the Company determined that it provided the majority of financial support to PCHI through various sources including lease payments, remaining primarily liable under the $50 million debt, and cross-collateralization of the Company's non-real estate assets to secure the $50 million debt. Accordingly, during the three and six months ended June 30, 2005, the Company included in its consolidated financial statements, the net assets of PCHI, net of consolidation adjustments. 25 Results of Operations The following table summarizes our results of operations from continuing operations for the three months ended June 30, 2005 and 2004. The 2004 period reflects our results prior to ownership of the Hospitals, which began in March 2005. Three Months Ended ------------- ------------- June 30, 2005 June 30, 2004 ------------- ------------- (Unaudited) (Unaudited) ------------- ------------- Net operating revenues $ 83,190,537 $ -- Operating expenses: Salaries and benefits 48,439,345 306,317 Supplies 11,521,967 -- Provision for doubtful accounts 11,331,354 -- Other operating expenses 17,283,135 108,763 Depreciation and amortization 902,845 15,528 Common stock warrant expense -- -- ------------- ------------- 89,478,646 430,608 Operating loss (6,288,109) (430,608) Interest expense 4,069,029 -- ------------- ------------- Loss including minority interest and before provision for income taxes (10,357,138) (430,608) Provision for income taxes 1,762,000 -- Minority interest in variable interest entity (195,517) -- ------------- ------------- Net loss $ (11,923,621) $ (430,608) ============= ============= Per Share Data: Basic and fully diluted Loss per common share ($ 0.10) ($ 0.02) Weighted average shares outstanding 124,539,000 19,590,000 Three and Six Months Ended June 30, 2005 and 2004 Losses from continuing operations, before interest, taxes and common stock warrant expense, increased to $6.0 million for the three months ended June 30, 2005 from $0.4 million for the three months ended June 30, 2004. Substantially all of the losses from continuing operations during the three and six months ended June 30, 2005 reflects the operational losses from our Hospitals, which were acquired on March 8, 2005. For the three months ended March 31, 2005 and the six months ended June 30, 2005, we recognized an expense of $16.4 million relating to the issuance of common stock Warrants to Dr. Chaudhuri and Mr. Thomas. We computed the expense of the Warrants based on their fair value at the date of grant and the maximum number of shares exercisable as of March 31, 2005 of 41,292,892 (24.9% of fully diluted shares outstanding as of June 30, 2005). We recorded the fair value of the remaining unexercisable Warrants at June 30, 2005 of $11.6 million as deferred compensation in the accompanying condensed consolidated balance sheet. We will amortize the deferred warrant expense in subsequent quarters over the term of the Warrants of 3.5 years, based on any future increases in the number of outstanding shares of our fully diluted common stock. 26 The income tax provision was $1.8 million for the three months ended June 30, 2005 and $3.2 million for the six months ended June 30, 2005, and consisted primarily of a taxable gain on the sale of the real property of the Hospitals to PCHI, the non-deductible Warrant expense and allowances for doubtful accounts, offset with losses from operations. As of June 30, 2005, we had net deferred tax assets of approximately $10.8 million for which a full valuation allowance has been provided. Managed care contracting The prior owners the hospitals adopted a state wide managed care contracting strategy that was designed to improve consolidated results with less regard for the individual facilities financial needs. Those contracts have been substantially all assigned to IHHI preserving the existing revenue base. Management is committed to negotiating terms more closely aligned with the services provided and the financial resources required to achieve that level of service. Although management believes that substantial opportunity exists for improving contracted reimbursement, there can be no assurance that this will be achieved and failure to do so could have a material adverse impact on future performance. Salaries and benefits We have experienced and expect to continue to experience significant wage and benefit pressures created by the nursing shortages throughout the region. In addition, approximately 24% of our employees were represented by labor unions as of June 30, 2005. If union activity increases at our hospitals, our salaries and benefits expense may increase more rapidly than our net operating revenues. Labor costs remain a significant cost pressure facing us as well as the health care industry in general. The nursing shortage continues and remains more serious in key specialties. This has increased labor costs for nursing personnel. In addition, state-mandated nurse-staffing ratios in California have not only increased our labor costs, but may also adversely affect net operating revenues due to volume limitations if the required number of nurses are unavailable. In March 2005, increases to California's state-mandated nurse-staffing ratios went into effect as provided by the original statute. The vast majority of hospitals in California, including our hospitals, are not at all times meeting these ratios. We have, however, gradually improved our monthly compliance and expect that our compliance levels will continue to improve throughout our hospitals in 2005. Provision for doubtful accounts We provide for accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance based on the aging of accounts receivable, historical collections experience for each type of payer and other relevant factors. Various factors that can impact our collection trends, including changes in the economy, which in turn have an impact on unemployment rates and the number of uninsured and underinsured patients, volume of patients through the emergency department, the increased burden of co-payments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the estimation process. Our Hospitals' policy is to attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act (EMTALA). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In non-emergency circumstances or for elective procedures and services, it is our Hospitals' policy, when appropriate, to verify insurance prior to a patient being treated. 27 During the three months and six months ended June 30, 2005, we recorded provisions for doubtful accounts of $11.3 million and $14.5 million, respectively. The breakdown of our billed hospital receivables (which is a component of total receivables) at June 30, 2005 is summarized in the table below. June 30, 2005 ------------- Insured receivables 78.3% Uninsured receivables 21.7% ------------- Total 100.0% ============= Our allowance for doubtful accounts and the approximate percentages of allowance for doubtful accounts to accounts receivable at June 30, 2005 are summarized as follows (dollars in thousands): June 30, 2005 Allowance for doubtful accounts $14,445 Percentage of accounts receivables 26.2% Our reported accounts receivable as of June 30, 2005 were all under 115 days outstanding, due to the fact that our acquisition of Hospital assets from Tenet on March 8, 2005 did not include patient accounts. Net days in AR outstanding as of June 30, 2005 were 44.2 days. Liquidity and Capital Resources Cash used by operating activities was $26.5 million in the six months ended June 30, 2005. Net accounts receivable increased to $40.4 million after a full quarter of hospital operations. Accounts payable increased by $11.5 million and payroll related accruals increased by $12.3 million. Estimated taxes payable increased by $1.8 million. Other current liabilities increased by $6.5 million and consist primarily of accrued interest, workers' compensation insurance, and other miscellaneous accruals. Cash used in investing activities of $58.0 million in the six months ended June 30, 2005 was used to complete the Hospital acquisition and is net of proceeds of $5 million from the sale of the real property of the Hospitals to PCHI, a related party entity. Cash provided by financing activities was $91.8 million in the six months ended June 30, 2005. At June 30, 2005, our indebtedness consisted of a $50 million term loan for the purchase of our Hospitals, a $13.2 million drawn-down from a $30 million line of credit. In addition, in March 2005, our Hospitals entered into a 2-year Accounts Purchase Agreement to sell Accounts Receivable to a lending institution as they become billable to third parties. We continue to provide billing and collection services and the proceeds collected thereby are applied to reduce amounts advanced under this agreement. As of June 30, 2005 $21.4 million had been advanced under this agreement. On or about May 9, 2005, the Company received a notice of default from its lender, Medical Provider Financial Corporation II ("Medical Provider"). Medical Provider is the lender for the secured acquisition note of $50 million, and the Company's secured line of credit note of up to $30 million. The Company has recorded the acquisition note of $50 million and outstanding draws on the line of credit of $13.2 million as current liabilities in the accompanying consolidated financial statements. The notice of default asserts that (i) the Company failed to provide satisfactory evidence that the Company has received capital contributions of not less than $15,000,000, as required under the Credit Agreement, (ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as required under the Credit Agreement, and (iii) a Material Adverse Effect has occurred under the Credit Agreement for reasons relating primarily to OC-PIN's failure to fully fund its obligations under its Stock Purchase Agreement with the Company dated January 28, 2005. 28 As of June 1, 2005, the Company entered into an Agreement to Forbear with Medical Provider. Without another default, Medical Provider agrees for 100 days to forbear from (i) recording Notices of Default, (ii) filing a judicial foreclosure lawsuit against the Company, OC-PIN and West Coast Holdings, LLC, and (iii) filing lawsuits against the Company, OC-PIN and West Coast Holdings, LLC. The interest rate on the notes will be increased from 14% to the Default Rate of 19%, as defined in the Credit Agreement, and all Obligations (as defined in the Credit Agreement), will be forthwith due and payable, as long as the events of default remain uncured. The Company's Line of Credit facility is suspended to additional advances. During the forbearance period of 100 days, OC-PIN and other investors will invest not less than $15 million in new equity capital in the Company. In June 2005, in connection with the First Amendment to Stock Purchase Agreement, dated as of June 1, 2005, by and among the Company, OC-PIN, PCHI, West Coast Holdings, LLC, and Ganesha Realty LLC, OC-PIN placed into an escrow account 57,250,000 shares of the Company's common stock. As of the date of this Report, an aggregate of $12.5 million in cash has been deposited in the escrow account. Recent Accounting Pronouncements On October 13, 2004, the Financial Accounting Standards Board issued Statement 123R, Share-Based Payment, which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value. The statement is effective for all public companies for interim or annual periods after June 15, 2005. The statement eliminates the ability to account for share-based compensation transactions using APB No. 25, and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in our consolidated statements of operations. The standard also requires that the modified prospective transition method be used, which would necessitate the Company to recognize compensation cost for the fair value of new awards granted, modified or settled after the effective date of the SFAS 123R. In addition, the measurement of compensation cost for awards that are not fully vested as of the effective date of the SFAS 123R would be based on the same estimate that the Company used to previously value its grants under SFAS 123. As a result of SFAS 123R, the Company will be required to expense the fair value of any stock option grants that it may make in the future, rather than disclose the impact on its consolidated statement of operations within the Company's footnotes. In January 2003, the Financial Accounting Standards Board issued FIN 46, "Consolidation of Variable Interest Entities," which requires consolidation of certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Paragraph 1 of ARB 51 states that consolidated financial statements are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies. Paragraph 2 states that "the usual condition for a controlling financial interest is ownership of a majority voting interest..." However, application of the majority voting interest requirement in ARB 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. Application of Interpretation 46 or Interpretation 46(R) is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. See Note to the financial statements regarding the Company's implementation of FIN 46 (R). 29 Item 3. Quantitative and Qualitative Disclosures About Market Risk. At June 30, 2005, we did not have any investment in or outstanding liabilities under market rate sensitive instruments. We do not enter into hedging or derivative instrument arrangements. We have no off-balance sheet arrangements. Item 4. Controls and Procedures. The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 15d-15(e). The Company's disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching the Company's desired disclosure control objectives. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Company's certifying officers have concluded that the Company's disclosure controls and procedures are effective in reaching that level of assurance. As of the end of the period of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Company completed its evaluation. PART II - OTHER INFORMATION Item 1. Legal Proceedings From time to time, we are a party to claims and legal proceedings arising in the ordinary course of our business. With the exception of a potentially adverse outcome in the litigation described in the next paragraph, after taking into consideration information furnished by our counsel as to the current status of these claims and proceedings, we do not believe that the aggregate potential liability resulting from such proceedings would have a material adverse effect on our financial condition or results of operation. On or about May 27, 2005, the Company, along with other defendants, was served with a petition to compel arbitration with Judicial Arbitration and Mediation Service (JAMS) by Andrew Weiss, a former consultant to the Company. Mr. Weiss is claiming, among other things, that he was an employee of the Company and was wrongfully terminated, and is requesting unspecified compensatory, statutory and punitive damages relating to his claimed lost earnings and benefits, stock options, and other special and general damages. The Company is vigorously contesting this matter. The Company has filed a stay in the arbitration proceedings and is requesting to move the claim to Los Angeles County Superior Court. This matter is in an early stage and it is not possible to assess the likely outcome of this litigation or the amount of damages that we would be required to pay if this litigation is decided adverse to the Company. 30 Item 3. Defaults Upon Senior Securities. On or about May 9, 2005, the Company received a notice of default from Medical Provider Financial Corporation II ("Medical Provider"). Medical Provider is the lender to the Company under a $50 million acquisition loan, and a working capital non-revolving line of credit of up to $30 million, each of which has been issued pursuant to a Credit Agreement, dated as of March 3, 2005, to which the Company and Medical Provider are parties (the "Credit Agreement"). In addition, each of Orange County Physicians Investment Network, LLC ("OC-PIN"), Pacific Coast Holdings Investment, LLC, Ganesha Realty, LLC, and West Coast Holdings, LLC, which are parties to the Credit Agreement, has received a notice of default under the Credit Agreement. The notice of default asserts that (i) the Company failed to provide satisfactory evidence that the Company has received capital contributions of not less than $15,000,000, as required by Section 2.1(s) of the Credit Agreement, (ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as required under Section 1.2(b)(ii) of the Credit Agreement, and (iii) a Material Adverse Effect has occurred under the Credit Agreement for reasons relating primarily to OC-PIN's failure to fully fund its obligations under its Stock Purchase Agreement with the Company dated January 28, 2005 (as discussed further below in Item 8.01). Medical Provider has indicated that, as a consequence of the alleged events of default and for so long as such events are continuing, the interest rates applicable to the outstanding loans under the Credit Agreement will be increased to the Default Rate (as defined in the Credit Agreement), the line of credit facility is suspended as to additional advances (with any additional advances made at its discretion at the Default Rate), and all Obligations (as defined in the Credit Agreement), will be forthwith due and payable. The total principal and interest due and payable under the loans made under the Credit Agreement currently amount to approximately $64.2 million, which does not include possible additional amounts claimed by Medical Provider for unpaid interest at the Default Rate, attorneys' fees and costs, costs of collection, trustee's fees and costs, and other fees, charges and expenses paid or incurred by Medical Provider. Item 6. Exhibits. Exhibit Number Description - ------ ----------- 10.1 First Amendment to Stock Purchase Agreement, dated as of June 1, 2005, by and among the Registrant, Orange County Physicians Investment Network, LLC, Pacific Coast Holdings Investment, LLC, West Coast Holdings, LLC, and Ganesha Realty LLC (incorporated herein by reference from Exhibit 99.1 to the Registrant's Current Report on Form 8-K filed with the Commission on June 22, 2005). 10.2 Escrow Agreement, dated as of June 1, 2005, by and among the Registrant, Orange County Physicians Investment Network, LLC and City National Bank (incorporated herein by reference from Exhibit 99.2 to the Registrant's Current Report on Form 8-K filed with the Commission on June 22, 2005). 31 10.3 Agreement to Forbear, dated as of June 1, 2005, by and among the Registrant, certain of its subsidiaries, Orange County Physicians Investment Network, LLC, West Coast Holdings, LLC, and Medical Provider Financial Corporation II (incorporated herein by reference from Exhibit 99.3 to the Registrant's Current Report on Form 8-K filed with the Commission on June 22, 2005). 10.4 Letter agreement, dated June 6, 2005, amending employment agreements of Messrs. Anderson, Mogel and Ligon. 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32 SIGNATURE In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INTEGRATED HEALTHCARE HOLDINGS, INC. Dated: August 15, 2005 By: /s/ Steven R. Blake ------------------------------------- Steven R. Blake Chief Financial Officer (Principal Financial Officer) 33 EX-10.4 2 v023871_ex10-4.txt EXHIBIT 10.4 June 6, 2005 Messrs: Larry B. Anderson Bruce Mogel James T. Ligon Re: Letter of Amendment to Employment Agreements Dear Sirs: This is to confirm the amendment to your respective Employment Agreements, dated February 22, 2005, as a result of the June 1, 2005, Amended Stock Purchase Agreement between Integrated Healthcare Holdings, Inc. (IHHI) and the Orange County Physicians Investment Network (OC-PIN). (A complete and executed copy of that Agreement is attached hereto as Exhibit A.) By virtue of that Agreement your Employment Agreements are amended in sections 5.2 and 5.3, to provide that, There shall be a 3-year severance payment (instead of 1-year currently provided for), payable in a lump sum at employees request, if any of the three of you are terminated without cause or if any of the three of you resign for good cause. The severance amount shall be three years' compensation beginning from the date of this Agreement, (June 1, 2005) and shall be reduced by one month for each month employed thereafter. However, the severance shall not be reduced to less than 12 months. For the purposes of this Amendment, "good cause" shall mean that OC-PIN has requested an executive to engage in an illegal act or violation of any law, rule, regulation or accounting principle applicable to IHHI (each, a "Violation"), that IHHI's counsel or auditors has confirmed that such request is a Violation and OC-PIN persists in making the request following receipt of notice of the improper nature of the request. Additionally, the Form of Severance Agreement applicable to your Employment Agreement is hereby modified to the Form included herewith and made a part hereof as Exhibit B. June 9, 2005 /s/ Anil V. Shah - ---------------------------------- ------------------------------------ Date Anil V. Shah Chairman of the Board of IHHI EX-31.1 3 v023871_ex31-1.txt EXHIBIT 31.1 CERTIFICATION PURSUANT TO RULE 13a-14 AND 15d-14 UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED I, Bruce Mogel, Chief Executive Officer of Integrated Healthcare Holdings, Inc., certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Integrated Healthcare Holdings, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated, or caused such disclosure controls and procedure to be designed under our supervision, subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Dated: August 15, 2005 By: /s/ Bruce Mogel ------------------------------------- Bruce Mogel Chief Executive Officer EX-31.2 4 v023871_ex31-2.txt EXHIBIT 31.2 CERTIFICATION PURSUANT TO RULE 13a-14 AND 15d-14 UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED I, Steven R. Blake, Chief Financial Officer of Integrated Healthcare Holdings, Inc., certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Integrated Healthcare Holdings, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated, or caused such disclosure controls and procedure to be designed under our supervision, subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Dated: August 15, 2005 /s/ Steven R. Blake ----------------------------------------- Steven R. Blake Chief Financial Officer EX-32.1 5 v023871_ex32-1.txt EXHIBIT 32.1 CERTIFICATE PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Integrated Healthcare Holdings, Inc. (the "Company") on Form 10-Q for the quarter ended June 30, 2005, as filed with the Securities and Exchange Commission (the "Report"), the undersigned, in the capacity and on the dates indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the dates and for the period indicated. This Certificate has not been, and shall not be deemed, "filed" with the Securities and Exchange Commission. Dated: August 15, 2005 By: /s/ Bruce Mogel ----------------------------------------- Bruce Mogel Chief Executive Officer EX-32.2 6 v023871_ex32-2.txt EXHIBIT 32.2 CERTIFICATE PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Integrated Healthcare Holdings, Inc. (the "Company") on Form 10-Q for the quarter ended June 30, 2005, as filed with the Securities and Exchange Commission (the "Report"), the undersigned, in the capacity and on the dates indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company at the dates and for the period indicated. This Certificate has not been, and shall not be deemed, "filed" with the Securities and Exchange Commission. Dated: August 15, 2005 By: /s/ Steven R. Blake ----------------------------------------- Steven R. Blake Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----