10-Q/A 1 v038463_10-qa.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------- AMENDMENT NO.1 TO FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to _________ Commission File Number: 0-23511 -------------------- Integrated Healthcare Holdings, Inc. (Exact name of small business issuer as specified in its charter) Nevada 87-0412182 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1301 N. Tustin Ave. 92705 Santa Ana, California (Zip Code) (Address of principal executive offices) (714) 953-3503 (Registrant's telephone number, including area code) 695 Town Center Drive, Suite 260, Costa Mesa, California 92626 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| Explanatory Note On March 28, 2006, the Company's Audit Committee, acting on a recommendation from the Company's management and following accounting questions reviewed with the Securities and Exchange Commission determined that the Company's unaudited condensed consolidated quarterly financial statements for the periods ended March 31, 2005, June 30, 2005, and September 30, 2005, should be restated to revise the accounting and related disclosures for the expense of warrants issued on January 27, 2005. In addition, the Company's Audit Committee, acting on recommendation from the Company's management has concluded that the quarterly provision for income taxes for the periods ended March 31, 2005, June 30, 2005 and September 30, 2005 should be restated to correct an error in the calculation of the taxable gain on the sale of assets to PCHI. The restatements impact each of the three months and the respective year to date periods ended March 31, 2005, June 30, 2005, and September 30, 2005 presented herein and is further discussed in Note 12 to the unaudited condensed consolidated financial statements included herein. This amendment to the Company's Quarterly Report on Form 10-Q/A is being filed for the purpose of amending and restating Items 1, 2 and 4 of Part I and Item 6 of Part II of the Form 10-Q originally filed solely to the extent necessary (i) to reflect the restatement of the Company's unaudited condensed consolidated financial statements as of and for the periods ended March 31, 2005, June 30, 2005, and September 30, 2005 as described in Note 12 to the unaudited condensed consolidated financial statements and (ii) to make revisions to "Management's Discussion and Analysis of Financial Condition and Results of Operations" as warranted by the restatement, (iii) to make revisions to Item 4 of Part I to reflect our evaluation of controls and procedures as of the date of filing this amended Quarterly Report on Form 10-Q/A, (iv) to include the certifications required by the Sarbanes-Oxley Act of 2002 and (v) to update the exhibits. This amended Quarterly Report on Form 10-Q/A is as of the date the Quarterly Report on Form 10-Q was originally filed except for material subsequent events more fully described in Note 13 to the unaudited condensed consolidated financial statements and supplemental information provided to enhance managements discussion of critical accounting estimates. Integrated Healthcare Holdings, Inc. Form 10-Q Table of Contents
--------------------------------------------------------------------------------------------------------------------------- Page Number PART I FINANCIAL INFORMATION Item 1. Financial Statements: Unaudited Condensed Consolidated Balance Sheet as of June 30, 2005 and December 31, 2004 2 Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 3 30, 2005 and June 30, 2004 Unaudited Condensed Consolidated Statement of Stockholders' Equity as of June 30, 2005 and 4 December 31, 2004 Unaudited Condensed Consolidated Statement of Cash Flows for the three and six months ended June 5 30, 2005 and June 30, 2004 Condensed Notes to Unaudited Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 3. Quantitative and Qualitative Disclosures About Market Risk 31 Item 4. Controls and Procedures 31 PART II OTHER INFORMATION Item 1. Legal Proceedings 31 Item 3. Defaults Upon Senior Securities 32 Item 6. Exhibits 32 SIGNATURES 33 ---------------------------------------------------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION Item 1. Financial Statements. The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements INTEGRATED HEALTHCARE HOLDINGS, INC. Unaudited Condensed Consolidated Balance Sheet ASSETS
June 30, December 31, 2005 2004 ------------------------------ (Unaudited) (Restated) Current assets: Cash and cash equivalents $ 7,396,828 $ 69,454 Accounts receivable, net of allowance for doubtful accounts of $14,445,000 at June 30, 2005 40,441,658 -- Inventories of supplies, at cost 5,856,321 -- Prepaid expenses and other assets 6,866,733 63,489 ------------------------------ 60,561,540 132,943 Property and equipment, net 58,689,233 57,423 Investment in hospital asset purchase -- 11,142,145 Deferred loan fees, net of accumulated amortization of $268,238 1,625,790 -- ------------------------------ Total assets $ 120,876,563 $ 11,332,511 ============================== LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current liabilities Notes payable $ 84,604,113 $ 11,264,013 Accounts payable 11,631,374 156,142 Accrued compensation and benefits 12,999,220 800,313 Income taxes payable 810,000 -- Other current liabilities 6,654,573 -- ------------------------------ Total current liabilities 116,699,280 12,220,468 Capital lease obligations, net of current of $204,141 3,384,256 -- Commitments and contingencies -- -- Minority interest in variable interest entity 4,795,578 -- Stockholders' deficiency: Common stock, $0.001 par value; 250,000,000 shares authorized; 124,559,000 and 20,780,000 shares issued and outstanding, respectively 124,559 20,780 Common stock warrants; 74,700,000 outstanding 17,215,000 -- Additional paid in capital 12,040,487 1,189,621 Accumulated deficit (33,382,597) (2,098,358) ------------------------------ Total stockholders' deficiency (4,002,551) (887,957) ------------------------------ Total liabilities and stockholders' deficiency $ 120,876,563 $ 11,332,511 ==============================
The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements 2 INTEGRATED HEALTHCARE HOLDINGS, INC. Unaudited Condensed Consolidated Statement of Operations
Three Months Ended Six Months Ended ------------------------------ ------------------------------ June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004 ------------- ------------- ------------- ------------- (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Restated) (Restated) Net operating revenues $ 83,190,537 $ -- $ 104,937,566 $ -- Operating expenses: Salaries and benefits 48,439,345 306,317 60,889,949 603,146 Supplies 11,521,967 -- 14,555,782 -- Provision for doubtful accounts 11,331,354 -- 14,472,760 -- Other operating expenses 17,283,135 108,763 21,183,354 288,887 Depreciation and amortization 902,845 15,528 1,165,057 30,707 Common stock warrant expense -- -- 17,215,000 -- ------------- ------------- ------------- ------------- 89,478,646 430,608 129,481,902 922,740 Operating loss (6,288,109) (430,608) (24,544,336) (922,740) Interest expense 4,069,029 -- 4,734,325 -- ------------- ------------- ------------- ------------- Loss including minority interest and before provision for income taxes (10,357,138) (430,608) (29,278,661) (922,740) Provision for income taxes 1,266,000 -- 2,210,000 -- Minority interest in variable interest entity (195,517) -- (204,422) -- ------------- ------------- ------------- ------------- Net loss $ (11,427,621) $ (430,608) $ (31,284,239) $ (922,740) ============= ============= ============= ============= Per Share Data: Basic and fully diluted Loss per common share ($0.09) ($0.02) ($0.29) ($0.05) Weighted average shares outstanding 124,539,000 19,590,000 106,518,528 19,510,778
The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements 3 INTEGRATED HEALTHCARE HOLDINGS, INC. Unaudited Condensed Consolidated Statement of Shareholders' Deficiency
Common Stock Common Stock Warrants Additional ------------------------- ----------------------- Paid-in Accumulated Shares Amount Shares Amount Capital Deficit Total ----------- ------------ ---------- ----------- ----------- ------------ ------------ (Restated) (Restated) (Restated) Balance, December 31, 2003 19,380,000 $ 19,380 -- $ -- $ 551,021 $ (217,781) $ 352,620 Issuance of debt for the acquisition of MMG, Inc. -- -- -- -- -- (40,386) (40,386) Issuance of common stock for cash at $0.25 per share 200,000 200 -- -- 49,800 -- 50,000 Issuance of common stock for cash at $0.50 per share 1,200,000 1,200 -- -- 588,800 -- 590,000 Net loss -- -- -- -- -- (1,840,191) (1,840,191) ----------- ------------ ---------- ----------- ----------- ------------ ------------ Balance, December 31, 2004 20,780,000 $ 20,780 -- $ -- $ 1,189,621 $ (2,098,358) $ (887,957) =========== ============ ========== =========== =========== ============ ============ Issuance of common stock for cash at $0.50 per share 1,179,000 1,179 -- -- 598,322 -- 599,501 Issuance of common stock for cash to OCPIN 102,600,000 102,600 -- -- 9,997,400 -- 10,100,000 Issuance of common stock options -- -- -- -- 255,144 -- 255,144 Issuance of common stock warrants -- -- 74,700,000 17,215,000 -- -- 17,215,000 Net loss -- -- -- -- -- (31,284,239) (31,284,239) ----------- ------------ ---------- ----------- ----------- ------------ ------------ Balance, June 30, 2005 124,559,000 $ 124,559 74,700,000 $17,215,000 $12,040,487 $(33,382,597) $ (4,002,551) =========== ============ ========== =========== =========== ============ ============
The accompanying condensed notes are an integral part of these unaudited condensed consolidated financial statements 4 INTEGRATED HEALTHCARE HOLDINGS, INC. Unaudited Condensed Consolidated Statement of Cash Flows
Six Months Ended Six Months Ended June 30, 2005 Junes 30, 2004 ------------ ------------ (Unaudited) (Unaudited) (Restated) Cash flows from operating activities: Net loss $(31,284,239) $ (922,740) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization expense 1,194,450 30,707 Common stock warrant and option expense 17,470,144 -- Minority interest in variable interest entity (204,422) -- Increase in prepaid expense and other assets (4,490,087) -- Increase in net accounts receivable (40,441,658) -- Increase (decrease) in accounts payable 11,475,232 (5,601) Increase in accrued compensation and benefits 12,320,927 438,080 Increase in income taxes payable 810,000 -- Increase in other accrued liabilities 6,450,432 -- Decrease in inventories of supplies 162,674 -- ------------ ------------ Net cash used in operating activities (26,536,547) (459,554) ------------ ------------ Cash flows from investing activities: Acquisition of hospital assets, net of lease obligations (63,171,676) -- Purchase of property and equipment -- (19,260) Acquisition of MMG, Inc., net of cash acquired -- 8,534 ------------ ------------ Net cash used in investing activities (63,171,676) (10,726) Cash flows from financing activities: Issuance of secured promissory notes, net of costs 48,067,000 -- Proceeds from lines of credit 34,604,113 -- Proceeds from issuance of stock 10,699,501 250,000 Proceeds from the sale of partnership interests in variable interest entity used for the Acqusition 5,000,000 -- Repayment of secured notes (1,335,017) (100,000) Advances from shareholders -- 73,285 ------------ ------------ Net cash provided by financing activities 97,035,597 223,285 ------------ ------------ Net increase (decrease) in cash 7,327,374 (246,995) ------------ ------------ Cash and cash equivalents, beginning of period 69,454 265,000 ------------ ------------ Cash and cash equivalents, end of period $ 7,396,828 $ 18,005 ============ ============ Supplemmental disclosure of noncash transactions: Issuance of promissory notes for Acquisition $ 53,000,000 $ 60,000 Consolidation of variable interest entity $ 54,758,312 $ -- Expense of common stock warrants and options $ 17,470,144 $ -- Rescinded secured promissory note for the return of initial deposit on hospital assets $ 10,000,000 $ -- Interest paid $ 2,511,411 $ -- Income taxes paid $ 1,400,000 $ --
5 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Acquisition - On March 8, 2005, the Company completed its acquisition (the "Acquisition") of four Orange County, California hospitals and associated real estate, including: (i) 282-bed Western Medical Center--Santa Ana, CA; (ii) 188-bed Western Medical Center--Anaheim, CA; (iii) 178-bed Coastal Communities Hospital in Santa Ana, CA; and (iv) 114-bed Chapman Medical Center in Orange, CA (collectively, the "Hospitals") from Tenet Healthcare Corporation ("Tenet"). The Hospitals were assigned to four wholly-owned subsidiaries of the Company (the "Subsidiaries") formed for the purpose of completing the Hospital Acquisition. The Company also acquired the following real estate, leases and assets associated with the Hospitals: (i) a fee interest in the Western Medical Center at 1001 North Tustin Avenue, Santa Ana, CA 92705, a fee interest in the administration building at 1301 North Tustin Avenue, Santa Ana, CA 92705, certain rights to acquire condominium suites located in the medical office building at 999 North Tustin Avenue, Santa Ana, CA, and the business known as the West Coast Breast Cancer Center; (ii) a fee interest in the Western Medical Center at 1025 South Anaheim Blvd., Anaheim, CA 92805; (iii) a fee interest in the Coastal Communities Hospital at 2701 South Bristol Street, Santa Ana, CA 92704, and a fee interest in the medical office building at 1901 North College Avenue, Santa Ana, CA; (iv) a lease for the Chapman Medical Center at 2601 East Chapman Avenue, Orange, CA 92869, and a fee interest in the medical office building at 2617 East Chapman Avenue, Orange, CA; and (v) the furniture, fixtures and contract rights associated with the Hospitals. The results of operations of the acquired assets from the acquisition date (March 8, 2005) have been included in the Company's consolidated statement of operations for the three and six months ended June 30, 2005.As a result of the Acquisition, the Company has commenced its planned principal operations and accordingly is no longer considered a development stage enterprise. As discussed further in Note 7, concurrent with the close of the Acquisition, the Company entered into a sale-leaseback transaction with a Pacific Coast Holdings Investment, LLC ("PCHI"), a then wholly owned subsidiary, involving all the real property acquired in the Acquisition, except for the fee interest in the medical office building at 2617 East Chapman Avenue. PCHI was then immediately sold to certain major equity holders in the Company. In this transaction the Company received consideration of $5 million in cash plus PCHI's guarantee of $50 million in debt issued by the Company in the Acquisition. Because, among other reasons, the Company remains primarily liable under the $50 million debt, this transaction does not qualify for sale-leaseback accounting and the $50 million in debt has not been removed from the Company's consolidated balance sheet at June 30, 2005. However, because PCHI now holds title to the real property, the Company's interest in the real estate was converted to a lease interest pursuant to the lease entered into between PCHI, as lessor, and the Company, as lessee as part of the sale-leaseback transaction. Additionally, as further discussed under Consolidation below, Company management has determined that generally accepted accounting principles require that the financial statements of PCHI must be included in the consolidated financial statements of the Company under generally accepted accounting principles. Consolidation - The consolidated financial statements include the accounts of Integrated Healthcare Holdings, Inc. ("the Company") and its wholly owned subsidiaries, Mogel Management Group, Inc. ("MMG") and its four hospital subsidiaries located in Orange County, California (collectively, the "Hospitals"): Western Medical Center - Anaheim Anaheim, CA 188 beds Western Medical Center - Santa Ana Santa Ana, CA 282 beds Coastal Communities Hospital Santa Ana, CA 178 beds Chapman Medical Center Orange, CA 114 beds 6 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Additionally, generally accepted accounting principles require that a company consolidate the financial statements of any entity that cannot finance its activities without additional subordinated financial support, and for which one company provides the majority of that support through means other than ownership. As discussed further in Note 9, the Company has determined that it provides to the entity that purchased the Hospitals' real estate, PCHI, the majority of its financial support through various sources including lease payments, remaining primarily liable under the $50 million debt, and cross-collateralization of the Company's non real property assets to secure the $50 million debt. Accordingly, the accompanying consolidated financial statements include the accounts of PCHI from the date of the real estate sale, March 8, 2005. All significant intercompany accounts and transactions have been eliminated in combination. Company Operations - The Company, through the Hospitals, operates in a single industry segment, the operation of general hospitals and related healthcare facilities. The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated losses from continuing operations of $11,427,621 and $31,284,239 (inclusive of a warrant issuance expense of $17,215,000 incurred in connection with the Acquisition during the three months and six months ended June 30, 2005, respectively and has negative working capital of $(56,137,740) at June 30, 2005. In addition, on or around May 9, 2005, the Company received a notice of default from Medical Provider Financial Corporation II ("Medical Provider"), which is the lender under the $50 million acquisition loan and under a working capital line of credit that has an outstanding balance of $13.2 million as of June 30, 2005. The default has caused the acquisition loan to be classified as a current liability as of June 30, 2005. These factors, among others, indicate a need for the Company to take action to resolve its financing issues and operate its business on a profitable basis. Management is working to restructure the debt with Medical Provider and believes that the Company's existing cash flow from operations and the Company's ability to raise additional capital will be sufficient to meet its continuing obligations for the foreseeable future. The Company and PCHI have agreed to permit the Company and PCHI to use the assets of PCHI and the Hospitals as collateral for the purposes of joint financing of Company's business operation and PCHI's acquisition of real properties for an initial period of time. Condensed Consolidated Financial Statements - The accompanying financial statements have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly its consolidated financial position at June 30, 2005, and its consolidated results of operations for the three months and six months ended June 30, 2005 and 2004, respectively and the statement of changes in cash flows for the six months ended June 30, 2005 and 2004 have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 2004 audited consolidated financial statements. The results of operations for the periods ended June 30, 2005 and 2004 are not necessarily indicative of the operating results for the full year. Organization - Integrated Healthcare Holdings, Inc., ("the Company") was organized under the laws of the State of Utah on July 31, 1984 under the name of Aquachlor Marketing. The Company never engaged in business activities and was suspended for failure to file annual reports and tax returns. In December 1988, all required reports and tax returns were filed and the Company was reinstated by the State of Utah. In December 1988, the Company merged with Aquachlor, Inc., a Nevada corporation incorporated on December 20, 1988. The Nevada corporation became the surviving entity and changed its name to Deltavision, Inc. In March 1997, the Company received a Certificate of Revival from the State of Nevada using the name First Deltavision, Inc. In March 2004, the Company changed its name to Integrated Healthcare Holdings, Inc. 7 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Use of Estimates - The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United State of American and prevailing practices for investor-owned entities within the healthcare industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of American requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management regularly evaluates the accounting policies and estimates that are used. In general, management bases the estimates on historical experience and on assumptions that it believes to be reasonable given the particular circumstances in which the Hospitals operate. Although management believes that adjustments considered necessary for fair presentation have been included, actual results may vary from those estimates. Net Patient Service Revenue - Net patient service revenue is recognized in the period in which services are performed and is recorded based on established billing rates (gross charges) less estimated discounts for contractual allowances, principally for patients covered by Medicare, Medicaid, managed care and other health plans. Gross charges are retail charges. They are not the same as actual pricing, and they generally do not reflect what a hospital is ultimately paid and therefore are not displayed in the condensed consolidated statements of operations. Hospitals are typically paid amounts that are negotiated with insurance companies or are set by the government. Gross charges are used to calculate Medicare outlier payments and to determine certain elements of payment under managed care contracts (such as stop-loss payments). Because Medicare requires that a hospital's gross charges be the same for all patients (regardless of payer category), gross charges are also what hospitals charge all other patients prior to the application of discounts and allowances. Percentages of net patient service revenue, by payer type, for the Hospitals for the six months ended June 30, 2005 were as follows: Six months ended June 30, 2005 Medicare 22% Medicaid 16% Managed care 42% Indemnity, self-pay and other 20% Revenues under the traditional fee-for-service Medicare and Medicaid programs are based primarily on prospective payment systems. Discounts for retrospectively cost-based revenues and certain other payments, which are based on the hospitals' cost reports, are estimated based on relationships of costs to charges subject to regulatory adjustments. For the six months ended June 30, 2005 retrospective revenues were $3.0 million. Cost report settlements for retrospectively cost-based revenues under these programs will be subject to audit and administrative and judicial review, which can take several years until final settlement of such matters are determined and completely resolved. Because the laws, regulations, instructions and rule interpretations governing Medicare and Medicaid reimbursement are complex and change frequently, the estimates recorded by the Hospitals could change by material amounts. 8 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Outlier payments, which were established by Congress as part of the diagnosis-related groups (DRG) prospective payment system, are additional payments made to hospitals for treating Medicare patients who are costlier to treat than the average patient in the same DRG. To qualify as a cost outlier, a hospital's billed (or gross) charges, adjusted to cost, must exceed the payment rate for the DRG by a fixed threshold established annually by the Centers for Medicare and Medicaid Services of the United State Department of Health and Human Services (CMS). The Medicare fiscal intermediary calculates the cost of a claim by multiplying the billed charges by the cost-to-charge ratio from the hospital's most recent filed cost report. If the computed cost exceeds the sum of the DRG payment plus the fixed threshold, the hospital receives 80% of the difference as an outlier payment. Medicare has reserved the option of adjusting outlier payments, through the cost report, to the hospital's actual cost-to charge ratio. Upon receipt of the current payment cost-to-charge ratios from the fiscal intermediary, any variance between current payments and the estimated final outlier settlement will be reported. Under Sections 1886(d) and 1886(g) of the Social Security Act, CMS must project aggregate annual outlier payments to all prospective payment system hospitals to be not less than 5% or more than 6% of total DRG payments (Outlier Percentage). The Outlier Percentage is determined by dividing total outlier payments by the sum of DRG and outlier payments. CMS annually adjusts the fixed threshold to bring expected outlier payments within the mandated limit. A change to the fixed threshold affects total outlier payments by changing (1) the number of cases that qualify for outlier payments, and (2) the dollar amount hospitals receive for those cases that still qualify. The most recent change to the cost outlier threshold that became effective on October 1, 2004 was a decrease from $31,000 to $25,800, which CMS projects will result in an Outlier Percentage of 5.1%. Revenues under managed care plans are based primarily on payment terms involving predetermined rates per diagnosis, per-diem rates, discounted fee-for-service rates and/or other similar contractual arrangements. These revenues are also subject to review and possible audit by the payers. The payers are billed for patient services on an individual patient basis. An individual patient's bill is subject to adjustment on a patient-by-patient basis in the ordinary course of business by the payers following their review and adjudication of each particular bill. The Hospitals estimate the discounts for contractual allowances utilizing billing data on an individual patient basis. At the end of the month, the Hospitals estimate expected reimbursement for patient of managed care plans based on the applicable contract terms. These estimates are continuously reviewed for accuracy by taking into consideration known contract terms as well as payment history. Although the Hospitals do not separately accumulate and disclose the aggregate amount of adjustments to the estimated reimbursements for every patient bill, management believes the estimation and review process allows for timely identification of instances where such estimates need to be revised. Management does not believe there were any adjustments to estimates of individual patient bills that were material to its net patient service revenue. Management is not aware of any material claims, disputes, or unsettled matters with any payers that would affect revenues that have not been adequately provided for in the accompanying combined financial statements. The Hospitals provide charity care to patients whose income level is below 200% of the Federal Poverty Level with only a co-payment charged to the patient. The Hospitals' policy is to not pursue collection of amounts determined to qualify as charity care; and accordingly, the Hospitals do not report the amounts in net patient service revenue or in the provision for doubtful accounts. Patients whose income level is between 200% and 300% of the Federal Poverty Level may also be considered under a catastrophic provision of the charity care policy. Patients without insurance who do not meet the Federal Poverty Level guidelines are offered assistance in applying for Medicaid and other programs they may be eligible for, such as state disability, Victims of Crime, or county indigent programs. Patient advocates from the Hospitals' Medical Eligibility Program (MEP) screen patients in the hospital and determine potential linkage to financial assistance programs. They also expedite the process of applying for these government programs. The amount of gross charges foregone under the charity policy, including indigent care accounts, for the three months and six months ended June 30, 2005 were approximately $3,638,933 and $4,646,811 respectively. 9 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Receivables from patients who are potentially eligible for Medicaid are classified as Medicaid pending, under the MEP, with appropriate contractual allowances recorded. If the patient does not quality for Medicaid, the receivables are reclassified to charity care and written off, or they are reclassified to self-pay and adjusted to their net realizable value through the provision of doubtful accounts. Reclassifications of Medicaid pending accounts to self-pay do not typically have a material impact on the results of operations as the estimated Medicaid contractual allowances initially recorded are not materially different than the estimated provision for doubtful accounts recorded when the accounts are reclassified. All accounts classified as pending Medicaid are fully reserved when they reach 180 days old. Provision for Doubtful Accounts - The Company provide for accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. The Hospitals estimate this allowance based on the aging of their accounts receivable, historical collections experience for each type of payer and other relevant factors. There are various factors that can impact the collection trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of uninsured and underinsured patients, volume of patients through the emergency department, the increased burden of co-payments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the estimation process. The Company's policy is to attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act (EMTALA). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In non-emergency circumstances or for elective procedures and services, it is the Hospitals' policy, when appropriate, to verify insurance prior to a patient being treated. During the three months and six months ended June 30, 2005, the Company recorded provisions for doubtful accounts of $11,331,354 and $14,472,760 respectively. Cash and Cash Equivalents - The Company considers all highly liquid debt investments purchased with a maturity of three months or less to be cash equivalents. Property and Equipment - Property and equipment are stated at cost, less accumulated depreciation and any impairment write-downs related to assets held and used. Additions and improvements to property and equipment are capitalized at cost. Expenditures for maintenance and repairs are charged to expense as incurred. Capital leases are recorded at the beginning of the lease term as assets and liabilities. The value recorded is the lower of either the present value of the minimum lease payments or the fair value of the asset. Such assets, including improvements, are amortized over the shorter of either the lease term or their estimated useful life. 10 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 The Company uses the straight-line method of depreciation for buildings, building improvements, and equipment over their estimated useful lives as follows: Buildings and improvements 4 to 25 years Equipment 3 to 15 years The Company evaluates its long-lived assets for possible impairment whenever circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future cash flows. However, there is an evaluation performed at least annually. Fair value estimates are derived from independent appraisals, established market values of comparable assets or internal calculations of estimated future net cash flows. The estimates of future net cash flows are based on assumptions and projections believed by management to be reasonable and supportable. These assumptions take into account patient volumes, changes in payer mix, revenue, and expense growth rates and changes in legislation and other payer payment patterns. The Company believes there has been no impairment in the carrying value of its property and equipment at June 30, 2005. Medical Claims Incurred but not Reported - The Company is contracted with CalOptima, which is a county sponsored entity that operates similar to a HMO, to provide health care services to indigent patients at a fixed amount per enrolled member per month. The Company receives payments from CalOptima based on a fixed fee and the number of enrolled members to the Company's specific hospitals. The Company recognizes these capitation fees as revenues on a monthly basis for providing comprehensive health care services for the period. The Company does not have contractual obligations with HMO's. In certain circumstances, members will receive health care services from hospitals not owned by the Company. In these cases, the Company records estimates of patient member claims incurred but not reported (IBNR) for services provided by other health care institutions. The claims incurred but not reported are estimated using historical claims patterns, current enrollment trends, hospital pre-authorizations, member utilization patterns, timeliness of claims submissions, and other factors. There can be no assurance that the ultimate liability will not exceed our estimates. Adjustments to the estimated IBNR reserves are recorded in our results of operations in the periods when such amounts are determined. Per guidance under SFAS NO. 5, the Company accures for IBNR reserves when it is probable that expected future health care costs and maintenance costs under an existing contract have been incurred and the amount can be reasonably estimable. The Company records these IBNR claim reserves against its net operating revenues. During the six months ended June 30, 2005, the Company recorded net revenues from CalOptima of approximately $1.5 million, net of IBNR reserves of $2.1 million. The Company's direct cost of providing services to patient members in IHHI facilities is recorded as an operating expense. Stock-Based Compensation - Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to account for stock-based compensation using the intrinsic value method prescribed in previously issued standards. Accordingly, compensation cost for stock options issued to employees is measured as the excess, if any, of the fair market value of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. Compensation is charged to expense over the shorter of the service or vesting period. Stock options issued to non-employees are recorded at the fair value of the services received or the fair value of the options issued, whichever is more reliably measurable, and charged to expense over the service period. During the three and six months ended June 30, 2005, the Company recognized $255,144 of other operating expense from the granting of 500,000 stock options to its public relations consultant. Fair Value of Financial Instruments - The Company considers all liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. Short-term investments generally mature between three months and six months from the purchase date. All cash and short-term investments are classified as available for sale and are recorded at market using the specific identification method; unrealized gains and losses are reflected in other comprehensive income. Cost approximates market for all classifications of cash and short-term investments. Net Loss per Common Share - Net loss per share is calculated in accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that options and warrants are included in the calculation of diluted earnings per share, except when their effect would be anti-dilutive. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. 11 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Impairment of Long-Lived Assets - The Company continually monitors events or changes in circumstances that could indicate that the carrying amount of long-lived assets to be held and used, including intangible assets, may not be recoverable. The determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. When impairment is indicated for a long-lived asset, the amount of impairment loss is the excess of net book value over fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. As of June 30, 2005, the Company has determined that no impairment of its long-lived assets exists. Goodwill and Intangible Assets - On July 20, 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards ("SFAS") 141, Business Combinations, and SFAS 142, Goodwill and Intangible Assets. Under these new standards, all acquisitions subsequent to June 30, 2001 must be accounted for using the purchase method of accounting. The cost of intangible assets with indefinite lives and goodwill are no longer amortized, but are subject to an annual impairment test based upon its fair value. Goodwill and intangible assets principally result from business acquisitions. The Company accounts for business acquisitions by assigning the purchase price to tangible and intangible assets and liabilities. Assets acquired and liabilities assumed are recorded at their fair values; the excess of the purchase price over the net assets acquired is recorded as goodwill. As of June 30, 2005 no goodwill had been recorded on acquisitions. Segment Reporting - The Company operates in one line of business, the provision of health care services through the operation of general hospitals and related health care facilities. Our general hospitals generated substantially all of our net operating revenues during the six months ended June 30, 2005. Recently Enacted Accounting Standards - On October 13, 2004, the Financial Accounting Standards Board issued Statement 123R, Share-Based Payment, which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value. The statement is effective for the Company as of the fiscal year commencing January 1, 2006. The statement generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in the consolidated statements of operations. This standard also requires that the modified prospective transition method be used, under which the Company will recognize compensation cost for (1) the fair value of new awards granted, modified or settled after the effective date of the SFAS 123R; and (2) a portion of the fair value of each option and stock grant made to employees or directors prior to the implementation date that represents the unvested portion of these share-based awards as of such date. The measurement of compensation cost for awards that are not fully vested as of the effective date of the SFAS 123R would be based on the same estimate that the Company used to previously value its grants under SFAS 123. As a result of SFAS 123R, the Company will be required to expense the fair value of its stock option grants rather than disclose the impact on its consolidated statement of operations within the Company's footnotes, as is current practice. Additionally, if it chooses to do so, SFAS 123(R) permits the Company to adopt the new share-based award accounting by retrospectively restating results for all periods presented to facilitate period-to-period comparison. In January 2003, the Financial Accounting Standards Board issued FIN 46, "Consolidation of Variable Interest Entities," which requires consolidation of certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Paragraph 1 of ARB 51 states that consolidated financial statements are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies. Paragraph 2 states that "the usual condition for a controlling financial interest is ownership of a majority voting interest..." However, application of the majority voting interest requirement in ARB 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. Application of Interpretation 46 or Interpretation 46(R) is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. See Note 7 regarding the Company's implementation of FIN 46 (R). 12 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 2 - ACQUISITION The purchase price, after all purchase price adjustments, of the Acquisition amounted to $66,246,821. The fair value of the tangible assets acquired and liabilities assumed consisted of the following: Property and equipment $ 59,493,353 Inventories of supplies 6,018,995 Prepaid expenses and other current assets 2,460,874 Deferred loan fees 1,933,000 Capital lease obligations (3,659,401) ------------ $ 66,246,821 ============ The Company financed the asset purchase and related financing costs (Note 6) by obtaining a $50 million acquisition debt, drawing $3 million on a working capital line of credit, the sale of the Company's common stock for $10.1 Million, and $5 million in proceeds from the sale of the real property of the acquired Hospitals. The Company recorded its initial deposit of $10 million on the Acquisition and direct acquisition costs of $1,142,145, consisting primarily of legal fees, as an Investment in hospital asset purchase in the accompanying consolidated balance sheet as of December 31, 2004. The following unaudited supplemental pro forma information represents the Company's consolidated results of operations as if the Acquisition had occurred on January 1, 2004 and after giving effect to certain adjustments including interest expense, depreciation expense, and related tax effects. In addition, the following unaudited pro forma information includes the nonrecurring items related to the issuance of 74,700,000 common stock warrants (Note 5), which resulted in an expense of $17,250,000 that the Company recorded during the three months ended March 31, 2005 and restructuring charges of $3,147,000 incurred by Tenet during the three months ended March 31, 2005. Such pro forma information does not purport to be indicative of operating results that would have been reported had the Acquisition occurred on January 1, 2004 or future operating results.
Pro Forma (Unaudited) -------------------------------------------------------------------------- Three Months Ended Six Months Ended -------------------------------------------------------------------------- June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004 -------------------------------------------------------------------------- Net operating revenues $ 83,190,537 $ 78,581,594 $ 160,203,857 $ 165,327,579 Net loss $ (11,427,621) $ (9,136,708) $ (42,212,849) $ (32,853,926) Loss per common share (basic and fully diluted) $ (0.09) $ (0.08) $ (0.34) $ (0.27) Weighted average shares outstanding 124,539,000 122,190,000 124,308,528 122,110,778 ============== ============== ============== ==============
13 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 3 - PROPERTY AND EQUIPMENT Property and equipment consist of the following as of June 30, 2005: Buildings and improvements $ 32,844,916 Land 15,264,266 Equipment 7,915,164 Leasehold 3,659,401 -------------- 59,683,747 Less accumulated depreciation (994,514) -------------- Property and equipment, net $ 58,689,233 ============== The Hospitals are affected by State of California Senate Bill 1953 (SB 1953), which requires certain seismic safety building standards for acute care hospital facilities. The Hospitals are currently reviewing the SB 1953 compliance requirements and developing multiple plans of action to achieve such compliance, the estimated time frame for complying with such requirements, and the cost of performing necessary remediation of certain of the properties. The Hospitals cannot currently estimate with reasonable accuracy the remediation costs that will need to be incurred in order to make the facilities SB 1953-compliant, but such remediation costs could be significant. NOTE 4 - COMMON STOCK Stock Purchase Agreement with OC-PIN - On January 28, 2005, the Company entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with Orange County Physicians Investment Network, LLC ("OC-PIN"), a company founded by Dr. Anil V. Shah and owned by a number of physicians practicing at the acquired hospitals, pursuant to which OC-PIN committed to invest $30,000,000 in the Company for an aggregate of 108,000,000 shares of the Company's common stock. In addition, a prior Purchase Option Agreement, dated November 16, 2004, between the Company and Dr. Anil V. Shah, was terminated. During the six months ended June 30, 2005, the Company issued a total of 102,600,000 shares of its common stock in consideration of $10.1 million from OC-PIN under the Stock Purchase Agreement. The Company used the proceeds from this stock sale as part of the consideration paid to Tenet for the acquisition of the Hospitals. 14 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Under the Stock Purchase Agreement, no later than six calendar days before the closing of Acquisition, OC-PIN was to deliver to the Company additional financing totaling $20,000,000. Upon receipt of the $20,000,000, the Company was to issue an additional 5.4 million shares of its common stock to OC-PIN. The Company extended OC-PIN's additional financing commitment to June 16, 2005, when the Company entered into the following new agreements: o First Amendment to the Stock Purchase Agreement, dated as of June 1, 2005 (the "First Amendment"); and o Escrow Agreement, dated as of June 1, 2005, by and among IHHI, OC-PIN and City National Bank (the "Escrow Amendment"). The following material terms, which were contained in the First Amendment and the Escrow Agreement, are currently in process: o OC-PIN's total stock purchase commitment under the Stock Purchase Agreement was reduced from $30 million to $25 million. o A total of 57,250,000 shares of Company common stock previously issued to OC-PIN were placed in an escrow account with City National Bank in July 2005. OC-PIN will have until September 1, 2005 to make aggregate payments of up to approximately $15,000,000 in monthly installments into the escrow account. Such portion of the escrowed shares which are fully paid will be returned to OC-PIN and the balance will be transferred back to the Company. If there is a shortfall, the Company will use its reasonable best efforts to sell equity to new investors to cover the shortfall. See the financial impact of the shares placed into escrow at Note 10 - loss per share; o OC-PIN will reimburse the Company for certain of its additional debt financing costs incurred since March 8, 2005; o The Company will work to complete a new borrowing transaction with Capital Source Finance LLC; and o Upon receipt of at least $5,000,000 of new capital under the First Amendment, the Company will call a shareholders meeting to re-elect directors. The nominees for the Board will consist of two current directors, two members of OC-PIN, two independent directors unaffiliated with IHHI or OC-PIN, and Anil V. Shah, M.D. NOTE 5 - COMMON STOCK WARRANTS The Company entered into a Rescission, Restructuring and Assignment Agreement with Dr. Chaudhuri and William Thomas on January 27, 2005 (the "Restructuring Agreement"). Previously, the Company had obtained financing from Dr. Chaudhuri and Mr. Thomas and had issued to them a $500,000 secured convertible promissory note that was convertible into approximately 88.8% of the Company's issued and outstanding common stock on a fully-diluted basis, a $10 million secured promissory note, and a Real Estate Purchase Option agreement originally dated September 28, 2004 to purchase 100% of substantially all of the real property in the Acquisition for $5 million (the "Real Estate Option"), all of which together with related accrued interest payable pursuant to the terms of the notes were rescinded and cancelled. Pursuant to the Restructuring Agreement, the Company released its initial deposit of $10 million plus accrued interest on the Tenet Hospital Acquisition back to Dr. Chaudhuri and issued non-convertible secured promissory notes totaling $1,264,014 and warrants to purchase up to 74,700,000 shares of the Company's Common Stock (but not to exceed 24.9% of the Company's Fully-Diluted capital stock) (the "Warrants") to Dr. Chaudhuri and Mr. Thomas. In addition, the Company amended the Real Estate Option to provide that Dr. Chaudhuri's option shall be to purchase 49% of substantially all of the real property in the Acquisition for $2,450,000. Concurrent with the close of the Acquisition, IHHI repaid the non-convertible secured promissory notes of $1,264,014 to Dr. Chaudhuri and Mr. Thomas. 15 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 The Warrants are exercisable beginning January 27, 2007 and expire in 3.5 years from the date of the issuance. The exercise price for the first 43 million shares purchased under the Warrants is $0.003125 per share, and the exercise or purchase price for the remaining 31.7 million shares is $0.078 per share if exercised between January 27, 2007 and July 26, 2007, $0.11 per share if exercised between July 27, 2007 and January 26, 2008, and $0.15 thereafter. Based upon a valuation obtained by the Company from an independent valuation firm, the Company has recognized an expense of $17,215,000 related to the issuance of the common stock warrants. The Company computed the expense of the warrants based on the fair value of the warrants at the date of grant and the estimated maximum number of shares exercisable of 43,254,715. The fair value of the Warrants was determined based on the Black-Scholes option pricing model with the following assumptions: Risk-free interest rate 3.2% Expected volatility 33.6% Dividend yield -- Expected life (years) 3.5 Fair value of Warrants (fully diluted) $0.398 Due to the Company emerging from the development stage during the six months ended June 30, 2005, the Company computed the volatility of its stock based on an average of comparable public companies that own hospitals. Based on the market for the Company's stock not being reasonably efficient, the market not expecting the significant warrant grant, and the Company not commensurately benefiting from an exercise of the warrant, the Company determined that the dilutive effect of the warrant should be reflected in estimating its fair value. The Company calculated the dilutive effect by dividing the non-dilutive fair value by 1.249, based on the maximum number of shares to be issued under the warrant of 24.9% of total outstanding shares. NOTE 6 - DEBT The current portion of the Company's debt consists of the following notes as of June 30, 2005: Secured acquisition note payable $50,000,000 Secured line of credit note payable 13,200,000 Advances from accounts receivable purchase agreement 21,404,113 ----------- $84,604,113 =========== Acquisition Loan and Line of Credit - In connection with the Tenet Hospital Acquisition, the Company obtained borrowings to complete the Hospital Acquisition from affiliates of Medical Capital Corporation of Anaheim, CA. Effective March 3, 2005, the Company and its Subsidiaries collectively entered into a Credit Agreement (the "Credit Agreement") with Medical Provider Financial Corporation II ("the Lender"), whereby the Company has obtained initial financing in the form of a loan with interest at the rate of 14% per annum in the amount of $80,000,000 of which $30,000,000 will be in the form of a non-revolving Line of Credit (the "Line of Credit") and $50,000,000 will be in the form of a real estate loan (the "Acquisition Loan") (collectively, the "Obligations"). The Company used the proceeds from the $50 million Acquisition Loan and $3 million from the Line of Credit to complete the Acquisition (See Notes 1 and 3). The Line of Credit is to be used for the purpose of providing (a) working capital financing for the Company and its Subsidiaries, (b) funds for other general corporate purposes of the Company and its Subsidiaries, and (c) other permitted purposes. 16 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Interest payments are due on the Obligations on the first business day of each calendar month to occur while any Obligation is outstanding at the interest rate of 14% per annum. The Obligations mature at the first to occur of (i) the Commitment Termination Date for the Line of Credit Loan, (ii) March 2, 2007, or (iii) the occurrence or existence of a continuing Event of Default under any of the Obligations. The Commitment Termination Date means the earliest of (a) thirty calendar days prior to March 2, 2007; (b) the date of termination of Lender's obligations to make Advances under the Line of Credit Note or permit existing Obligations to remain outstanding pursuant to Section 8.2(b), (c) the date of prepayment in full by the Company and its Subsidiaries of the Obligations and the permanent reduction of all Commitments to zero dollars; (d) March 2, 2007. Per the Credit Agreement, all future capital contributions to the Company by OC-PIN shall be used by the Company as mandatory prepayments of the Line of Credit. The Acquisition Loan and Line of Credit are secured by a lien on substantially all of the assets of the Company and its Subsidiaries, including without limitation, a pledge of the capital stock by the Company in its wholly owned subsidiary Hospitals. In addition, (i) PCHI (see Note 1) has agreed to guaranty the payment and performance of the Obligations, (ii) West Coast and Ganesha (see Note 7) have each agreed to pledge their membership interests in PCHI as security for repayment of the Obligations, (iii) the members of West Coast have agreed to pledge their membership interests in PCHI as security for repayment of the Obligations, and (iv) OC-PIN (see Note 5) has agreed to guaranty the payment and performance of all the Obligations. Credit Agreement Fees - Concurrently with the execution and delivery of the Credit Agreement and as a condition to the funding of the Acquisition Loan, Company and its Subsidiaries agreed to pay to the Lender an origination fee in an amount equal to 2% of the Credit Line Commitment or $600,000, and 2% of the Acquisition Loan or $1,000,000, to be payable out of Company and its Subsidiaries own funds, which fee shall be deemed earned in full upon receipt by Lender. Upon the completion of the Acquisition on March 8, 2005, the Company paid the Lender a total of $1,600,000 in origination fees and paid the Lender's legal fees of approximately $333,000. The Company is amortizing the deferred loan fees of $1,933,000 over the two year term of the Obligations. During the six months ended June 30, 2005, the Company recognized $307,210 of amortization expense and has unamortized deferred loan fees of $1,625,790 as of June 30, 2005. Accounts Receivable Purchase Agreement - In March 2005, the Hospitals entered into an Accounts Purchase Agreement that allows the sale of their accounts receivable to Medical Provider Financial Corp., an affiliate of the Lender, as they become billable to third parties. The Company will continue to provide billing and collection services and the proceeds collected from the accounts receivable are applied to reduce amounts advanced under this agreement. As of June 30, 2005, advances made under this agreement were $21,404,113. This agreement has a term of two years. 17 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Default Notice - On or about May 9, 2005, the Company received a notice of default from the Lender. In addition, each of OC-PIN, PCHI, Ganesha Realty, LLC, and West Coast Holdings, LLC, which are parties to the Credit Agreement, has received a notice of default under the Credit Agreement. The Company has recorded the acquisition note of $50 million and outstanding draws on the line of credit of $13.2 million as current liabilities in the accompanying consolidated financial statements. The notice of default asserts that (i) the Company failed to provide satisfactory evidence that the Company has received capital contributions of not less than $15,000,000, as required under the Credit Agreement, (ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as required under the Credit Agreement, and (iii) a Material Adverse Effect has occurred under the Credit Agreement for reasons relating primarily to OC-PIN's failure to fully fund its obligations under its Stock Purchase Agreement with the Company dated January 28, 2005. Forbearance Agreement - In connection with the Company's First Amendment (see Note 4), the Company entered into an Agreement to Forbear as of June 1, 2005 by and among the Company, OC-PIN, West Coast Holdings, LLC and the Lender (the "Forbearance Agreement"). Without another default, the Lender agrees for 100 days to forbear from (i) recording Notices of Default, (ii) filing a judicial foreclosure lawsuit against the Company, OC-PIN and West Coast Holdings, LLC, and (iii) filing lawsuits against the Company, OC-PIN and West Coast Holdings, LLC. The interest rate on the notes will be increased to the Default Rate of 19%, as defined in the Credit Agreement, and all Obligations (as defined in the Credit Agreement), will be forthwith due and payable, as long as the events of default remain uncured. The Company's Line of Credit facility is suspended to additional advances. During the forbearance period of 100 days, OC-PIN and other investors will invest not less than $15 million in new equity capital in the Company. NOTE 7 - VARIABLE INTEREST ENTITY Concurrent with the close on the acquisition of the Hospitals, Dr. Chaudhuri and Dr. Shah exercised their option to purchase all of the real property of the Hospitals pursuant to an Option agreement dated September 28, 2004, as amended and restated on November 16, 2004 ("LLC Option Agreement"). The option was exercised by the option holders purchasing from the Company all of the equity interests in PCHI, which holds title to the real property. The Company received $5 million and PCHI guaranteed the Company's acquisition debt of $50 million. The Company remains primarily liable under the $50 million acquisition note notwithstanding its guarantee by PCHI, and this note is cross-collateralized by substantially all of the Company's assets and all of the real property of the Hospitals. All of the Company's operating activities are directly affected by the real property that was sold to PCHI. Given these factors, it appears that the Company has indirectly guaranteed the indebtedness of PCHI. The Company is standing ready to perform on the acquisition debt should PCHI not be able to perform and has undertaken a contingent obligation to make future payments if those triggering events or conditions occur. In connection with the sale of all of the real property of the Hospitals, the Company entered into a triple net lease with PCHI to leaseback this real property for an initial term of 25 years. Per the triple net lease, PCHI will receive rent that covers the cost of the underlying debt, plus a guaranteed spread up to 2.5%. Additionally, the Company has a right to renew the leases for periods up to an additional 25 years. PCHI is a related party entity that is affiliated with the Company through common ownership and control. It is owned 51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha Realty, LLC (Dr. Chaudhuri and William Thomas). Generally accepted accounting principles require that a company consolidate the financial statements of any entity that cannot finance its activities without additional subordinated financial support, and for which one company provides the majority of that support through means other than ownership. Effective March 8, 2005, the Company determined that it provided the majority of financial support to PCHI through various sources including lease payments, remaining primarily liable under the $50 million debt, and cross-collateralization of the Company's non-real estate assets to secure the $50 million debt. Accordingly, during the six months ended June 30, 2005, the Company included in its consolidated financial statements, the net assets of PCHI, net of consolidation adjustments. 18 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 Selected information of PCHI's balance sheet as of June 30, 2005, and its results of operations for the period March 8, 2005 to June 30, 2005 are as follows: Total assets $ 55,362,360 Total liabilities 50,566,782 Member's equity 4,795,578 Net revenues 3,353,508 Net loss 204,422 Consolidation adjustments to reflect the effects of the following matters are included in the accompanying consolidated financial statements: o The Company's lease interest in the hospitals has been eliminated leaving PCHI's ownership of the land and buildings being presented in the accompanying consolidated financial statements. Additionally, a deferred gain of $12,157,808 arising from the Company's sale of the real property of the Hospitals to PCHI has been eliminated to state the land and buildings at the Company's cost. o Because the Company remains primarily liable under the $50 million debt notwithstanding its guarantee by PCHI, generally accepted accounting principles do not allow the Company to remove this liability from its balance sheet. Therefore, it is necessary to eliminate the same item from PCHI's balance sheet in consolidation. o PCHI's equity accounts have been classified as minority interest variable interest entity in the accompanying consolidated balance sheet. o The Company's rent expense has been eliminated against PCHI's rental income. Additionally, amounts assigned to buildings are being depreciated and amortized over the 25 year initial term of the lease with PCHI. NOTE 8 - INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" which requires the liability approach for the effect of income taxes. The provision for income taxes consists of provisions for federal and state income taxes. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amount of tax-related assets and liabilities and income tax provisions. The Company assesses the recoverability of the deferred tax assets on an ongoing basis. In making this assessment the Company is required to consider all available positive and negative evidence to determine whether, based on such evidence, it is more likely than not that some portion or all of our net deferred assets will be realized in future periods. This assessment requires significant judgment. In addition, the Company has made significant estimates involving current and deferred income taxes, tax attributes relating to the interpretation of various tax laws, historical bases of tax attributes associated with certain tangible and intangible assets and limitations surrounding the realizability of our deferred tax assets. The Company does not recognize current and future tax benefits until it is deemed probable that certain tax positions will be sustained. 19 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 The provision for income taxes consisted of the following for the six months ended June 30,: 2005 2004 ---------- ---------- Current income tax expense: U.S. Federal and State $2,210,000 $ -- Deferred income taxes: U.S. Federal and State -- -- ---------- ---------- Total $2,210,000 $ -- ========== ========== A reconciliation between the amount of reported income tax expense (benefit) and the amount computed by multiplying income (loss) from continuing operations before income taxes by the statutory federal income tax rate is shown below for the six months ended June 30, 2005: Estimated tax benefit at federal and state statutory rates on an annualized basis $(8,434,000) Common stock warrant expense 3,774,000 Gain on sale of real estate 1,292,000 Change in valuation allowance 6,363,000 State credits (817,000) Other 32,000 ----------- $ 2,210,000 =========== Deferred income taxes reflect the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. The following table discloses those significant components of our deferred tax assets and liabilities, including any valuation allowance: June 30, 2005 June 30, 2004 ------------ ------------ Current deferred tax assets: Allowance for doubtful accounts $ 5,911,500 $ -- Accrued vacation 2,429,490 -- Other accruals 1,886,369 -- Net operating losses 576,984 444,000 ------------ ------------ Deferred tax assets 10,804,343 444,000 Valuation allowance (10,804,343) (444,000) ------------ ------------ Net deferred tax assets $ -- $ -- ============ ============ 20 A valuation allowance of $10.8 million was recorded as of June 30, 2005 based on an assessment of the realization of our deferred tax assets as described below. We assess the realization of our deferred tax assets to determine whether an income tax valuation allowance is required. Based on all available evidence, both positive and negative, and the weight of that evidence to the extent such evidence can be objectively verified, Company management determines whether it is more likely than not that all or a portion of the deferred tax assets will be realized. The main factors taken into consideration include: o cumulative losses in recent years; o income/losses expected in future years; o unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels; o the availability, or lack there, of taxable income in prior carryback periods that would limit realization of tax benefits; o the carryforward period associated with the deferred tax assets and liabilities; and o prudent and feasible tax-planning strategies. Through the second quarter of 2005, we concluded that it was more likely than not that the deferred tax assets were not realizable. Therefore, we determined that it was appropriate to record a valuation allowance after considering and weighing all evidence in the second quarter of 2005. Tenet Hospital Acquisition - The Acquisition was an asset purchase transaction and the Company will not benefit from the net operating losses of the acquired Hospitals. In connection with the Company's completion of the Tenet Hospital Acquisition in March 2005, the Company sold all of the real estate of the acquired hospitals to its majority shareholders. For income tax purposes, the sale of the real estate of the acquired hospitals could require the Company to report dividend and/or interest income. If the Company is required to report dividend and/or interest income in connection with this transaction, the Company would be required to withhold 28% on any deemed dividend or interest income. The Company's sale of its 100% membership interest in PCHI on March 8, 2005, to West Coast Holdings LLC and Ganesha Realty LLC in consideration of $5 million plus the assumption of the $50 million Acquisition Loan on the real property debt is a taxable event to the Company. PCHI Tax Status - PCHI is a limited liability corporation. PCHI's owners plan to make tax elections for it be treated as a disregarded entity for tax reporting whereby similar to a partnership PCHI's taxable income or loss will flow through to its owners and be their separate responsibility. Accordingly, the accompanying consolidated financial statements do not include any amounts for the income tax expense or benefit of PCHI's income or loss. 21 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 9 - RELATED PARTY TRANSACTIONS PCHI - The Company leases all of the real property of the acquired Tenet Hospitals from PCHI. PCHI is owned by two LLC's, which are owned and co-managed by Dr. Shah, Dr. Chaudhuri, and Mr. William Thomas. Dr. Shah is the chairman of the Company and is also the co-manager an investor in OC-PIN, which is the majority shareholder of the Company. Dr. Chaudhuri and Mr. Thomas are the holders of the Warrants to purchase up to 24.9% of the Company's fully diluted capital stock. The Company has consolidated the financial statements of PCHI for the period March 8, 2005 through June 30, 2005 in accordance with FIN 46(R) (see Note 7). During the six month period ended June 30, 2005, the Company incurred a liability for rent expense payable to PCHI of $3,353,508, which was eliminated upon consolidation at June 30, 2005. Management Agreements - In December 2004, February 2005, and March 2005, the Company entered into seven employment agreements with its executive officers. Among other terms, the three year employment agreements in aggregate provide for annual salaries totaling $2,290,000, total stock option grants to purchase 6,650,000 shares of the Company's common stock at an exercise price equal to the mean average per share for the ten days following the date of issuance with vesting at 33% per year, and an annual bonus to be determined by the Board of Directors. As of June 30, 2005, the Company has not issued any stock options pursuant to the employment agreements. NOTE 10 - LOSS PER SHARE The following data show the amounts used in computing loss per share for the periods presented:
Three Months Ended June 30, Six Months Ended June 30, ----------------------------- ----------------------------- 2005 2004 2005 2004 ------------- ------------- ------------- ------------- Loss from continuing operations available to common shareholders (numerator) $ (11,427,621) $ (430,608) $ (31,284,239) $ (922,740) Weighted average number of common shares used in loss per share during the period (denominator) 124,539,000 19,590,000 106,518,528 19,510,778
The Company's weighted average common stock equivalents related to the Warrants (Note 6) were 41,291,892 for the six months ended June 30, 2005. These common stock equivalents have been excluded from the Company's weighted average number of common shares outstanding due to their anti-dilutive effect for the three months ended June 30, 2005. If the First Amendment to the Stock Purchase Agreement and the Escrow Agreement were entered into as of the date of the original Stock Purchase Agreement dated January 28, 2005, the Company's future loss per share would be greater than reported and the Company's loss per share would have been $(0.17) and $(0.54) for the three and six months ended June 30, 2005, respectively. 22 INTEGRATED HEALTHCARE HOLDINGS, INC. Condensed Notes to Unaudited Consolidated Financial Statements June 30, 2005 NOTE 11 - COMMITMENTS AND CONTINGENCIES Operating Leases - Concurrent with the closing of the Tenet Hospital Acquisition as of March 7, 2005, the Company entered into a sale leaseback type agreement with a related party entity, PCHI (the "Related Party Lease"). The Company leases all of the real estate of the acquired Hospitals properties (the "Hospital Properties") and medical office buildings and a long term acute care facility (collectively the "MOB Properties") from PCHI. The term of the Lease for the Hospital Properties is approximately 25 years, commencing March 8, 2005 and terminating on February 28, 2030. The Company has the option to extend the term of this triple net lease for an additional term of twenty-five years. Additionally, in connection with the acquisition of the Hospitals, the Company also assumed the operating leases for the Chapman facility, which include buildings, land, and other equipment. The Related Party Lease has been eliminated in the consolidation of PCHI in the accompanying consolidated financial statements. The following is a schedule of the Company's future minimum operating lease payments that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2004: Unrelated Third Related Year Ended December 31, Parties Party (PCHI) Total ----------------------- ---------------------------------------------- 2005 $ 2,038,365 $ 10,642,672 12,681,037 2006 2,008,102 13,153,611 15,161,713 2007 1,660,807 13,233,219 14,894,026 2008 1,162,675 13,315,216 14,477,891 2009 844,267 13,315,216 14,159,483 Thereafter 8,569,793 278,706,133 287,275,926 ---------------------------------------------- $ 16,284,009 $342,366,067 $358,650,076 ============================================== Capital Leases - The Hospitals have long-term lease obligations for certain equipment. For financial reporting purposes, the leases have been classified as capital leases; accordingly, assets with a net book value of approximately $3,529,109 are included in property and equipment in the accompanying consolidated balance sheet. The following is a schedule of future minimum lease payments under capitalized equipment leases together with the present value of the net minimum lease payments as of June 30, 2005: Year ending June 30, -------------------- 2005 $ 686,292 2006 686,292 2007 686,292 2008 686,292 2009 686,292 Thereafter 2,573,595 ---------- Total minimum lease payments $6,005,055 Less amount representing interest 2,416,658 ---------- Present value of net minimum lease payments 3,588,397 Less current portion 204,141 ---------- Long-term portion $3,384,256 ========== Agreement for Compensation - In connection with the close of the Hospital Acquisition, the Company entered into an Agreement for Compensation Related to the 999 Medical Office Building (the "Compensation Agreement with PCHI, a related party (see Note 7). In the amended Asset Sale Agreement with Tenet, certain medical office condominium units (the "Condo Units") were excluded from the Company's Hospital Acquisition due to the tenants of the Condo Units having a first right of refusal to purchase such real property. The Company's purchase price of the Hospitals from Tenet was reduced by $5 million. Pursuant to the amended Asset Sale Agreement upon the expiration of the tenant's right of first refusal, Tenet will transfer title to the Condo Units to the Company in exchange for consideration of $5 million, pro rated if less than all of the Condo Units are transferred. Pursuant to the Compensation Agreement, the Company shall acquire title to the Condo Units upon expiration of the tenant's right of first refusal and then transfer such title to the Condo Units to PCHI. If some of the Condo Units are acquired by the tenants, the Company shall provided compensation to PCHI and the Company shall pay down its Acquisition Note (see Note 6) by $5 million or such pro rata portion. In the event of the Company's failure to obtain title to the Condo Units, the Company shall pay to PCHI a sum to be agreed upon between the Company, PCHI, and the owners of PCHI, but not less than the product of $2,500,000 multiplied by a fraction, the numerator of which shall be the number of Condo Units not acquired the Company and transferred to PCHI, and the denominator equal to the total Condo Units of twenty-two. The tenants are currently in ligitation with Tenet related to the purchase price of the Condo Units offered by Tenet to the tenants. As the financial statements of the related party entity, PCHI (see Note 7), are included in the Company's accompanying consolidated financial statements, management has determined that any future payment to PCHI under the Compensation Agreement would reduce the Company's gain on sale of assets to PCHI (see Note 7.) Although the gain on sale of assets is eliminated upon the consolidation of the financial statements of PCHI, the Company's income tax provision related to such gain would be reduced. Claims and Lawsuits - The Company and the Hospitals are subject to various legal proceedings, most of which relate to routine matters incidental to our business. The results of these claims cannot be predicted, and it is possible that the ultimate resolution of these matters, individually or in the aggregate, may have a material adverse effect on the Company's business (both in the near and long term), financial position, results of operations or cash flows. Although the Company defends itself vigorously against claims and lawsuits and cooperate with investigations, these matters (1) could require payment of substantial damages or amounts in judgements or settlements, which individually or in the aggregate could exceed amounts, if any, that may be recovered under insurance policies where coverage applies and is available. (2) cause substantial expenses to be incurred, (3) require significant time and attention from management and (f) could cause the Company to close or sell the Hospitals or otherwise modify the way its business is conducted. Reserves for claims and lawsuits are recorded when they are probable and reasonably estimable. NOTE 12 - RESTATEMENT OF PRIOR PERIODS In March 2006, the Company restated its 2005 quarterly financial statements due to the following adjustments: o The Company revised its calculation of the Warrant expense incurred during the six months ended June 30, 2005. The total adjustment required to increase the Warrant expense to its proper balance was $780,827 pre-tax. The adjustment was a result of the Company recognizing the warrant expense as a nonrecurring settlement charge during the three months ended March 31, 2005 using a probability analysis to estimate the maximum number of warrants exercisable at the date of issuance of 43,254,715 shares. o The Company revised its provision for income taxes due to an error in the calculation of the taxable gain on the sale of real property to PCHI (see Note 7 Variable Interest Entity.) The total adjustment required to reduce the provision for income taxes was $496,000 and $1,024,000 for the three and six months ended June 30, 2005, respectively. The effects of the restatement were as follows:
Three Months Ended Six Months Ended ------------------------------------ ------------------------------------ June 30, 2005 June 30, 2005 ------------------------------------ ------------------------------------ As Previously As As Previously As Reported Restated Reported Restated ---------------- ---------------- ---------------- ---------------- Net loss $ (11,923,621) $ (11,427,621) $ (31,527,412) $ (31,284,239) Basic and fully diluted: Net loss per common share $ (0.10) $ (0.09) $ (0.30) $ (0.29)
NOTE 13 - SUBSEQUENT EVENTS On December 14, 2005, the Company and its subsidiaries collectively entered into Amendment No. 1 to Credit Agreement dated as of December 12, 2005 (the "Amendment"), that amends that certain credit agreement dated as of March 3, 2005 (the "March Credit Agreement"), with PCHI, OC-PIN, Ganesha Realty, LLC, West Coast Holdings, LLC (the "Credit Parties") and Medical Provider Financial Corporation II (the "Lender"). The Amendment (i) declares cured those certain events of default set forth in the notices of default received on or about May 9, 2005, from the Lender, (ii) requires the Company to pay $5,000,000 to the Lender for mandatory prepayment required under the March Credit Agreement, (iii) requires the Company to obtain $10,700,000 in additional new capital contributions to pay in full and retire all amounts due and owing under the new Note evidenced by the Credit Agreement (as defined below) and (iv) includes certain indemnities and releases in favor of the Lender. On December 14, 2005, the Company also entered into a credit agreement (the "Credit Agreement"), dated as of December 12, 2005, with the Credit Parties and the Lender. Under the Credit Agreement, the Lender loaned a total of $10,700,000 to the Company as evidenced by that certain promissory note in favor of the Lender (the "New Note") with a total principal balance of $10,700,000. The Company will use the proceeds to operate the Hospital facilities. Interest is payable monthly at the rate of 12% per annum and the New Note is due on December 12, 2006. The Company may not prepay the New Note in whole or in part. The New Note is secured by substantially all of the Company's assets. In addition, the Company issued a common stock warrant to the Lender as collateral under the New Note. The warrant is exercisable by the Lender only in the event of that a default has occurred and is continuing on the New Note. The warrant provides the Lender to purchase the number of shares of the Company's common stock equal in value to the amount of the New Note not repaid at maturity, plus accrued interest and lender fees for an aggregate exercise price of $1.00, regardless of the amount of shares acquired. The Warrant is exercisable from and after December 12, 2005 until the occurrence of either a termination of the Credit Agreement by the Lender or the Company's payment in full of all obligations under the Credit Agreement. The Company is obligated to register the estimated number of shares of common stock issuable upon exercise of the warrant by filing a registration statement under the Securities Act of 1933, as amended (the "Securities Act"), no later than ninety days prior to the maturity date of the New Note. If the Company proposes to file a registration statement under the Securities Act on or before the expiration date of the warrant, then the Company must offer to the holder of the warrant the opportunity to include the number of shares of common stock as the holder may request. The Company has determined it appropriate to classify the warrant as a liability at the date of issuance in accordance with EITF No. 00-19 "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock," FAS 133 "Accounting for Derivative Instruments and Hedging Activities," and FAS 150 "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." In addition, the Company will re-measure the warrants subsequent to the initial measurement date at fair value with changes in fair value recognized in earnings. As a result of the Company not being able to determine the maximum number of shares that could be required to be issued under the warrants issued on December 12, 2005, the Company has also determined that share settlement of the Warrants issued on January 27, 2005 is not within its control and will reclassify the Warrants as a liability as of December 12, 2005. PCHI and OC-PIN have each agreed to guaranty payment of the New Note. In addition, West Coast Holdings, LLC and Ganesha Realty, LLC have each agreed to pledge their membership interests in PCHI as security for payment of the New Note. On or about October 31, 2005, the Company and OC-PIN entered into the Second Amendment to Stock Purchase Agreement (see Note 4). Contingency - The Company is a defendant in a claim brought by Andrew Weiss, a former consultant to the Company, filed with Judicial Arbitration and Mediation Service in Orange County, California, alleging breach of contract, wrongful discharge, failure to pay wages, fraud, and other related claims relating to his services to the Company in 2004 and 2005. Mr. Weiss alleges that he was an employee of the Company and was covered by a purported written employment agreement dated March 3, 2005. Mr. Weiss is seeking unspecified damages, including lost earnings and benefits, loss of future earnings, penalties, punitive damages and attorneys fees and costs. The Company intends to defend itself vigorously against these claims. Although the Company does not believe it is probable that it will lose this case, it is possible that resolution of this case could result in a loss. Management is not able to estimate the amount of such loss as of September 30, 2005. On August 1, 2005, Larry Anderson resigned as a director of the Company, and the Board of Directors appointed the following four individuals to serve as directors to fill current vacancies on the Board: Maurice J. DeWald, Fernando Niebla, Syed J. Naqvi and Jaime Ludmir. 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Information This Quarterly Report on Form 10-Q contains forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expects", "plans", "anticipates", "believes", "estimates", "predicts", "potential" or "continue" or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks discussed under the caption "Risk Factors" in our Annual Report on Form 10-KSB filed on March 31, 2005, that may cause our company's or our industry's actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as may be required by applicable law, we do not intend to update any of the forward-looking statements to conform these statements to actual results. As used in this report, the terms "we", "us", "our", "the Company", "Integrated Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings, Inc., a Nevada corporation, unless otherwise indicated. Overview Prior to March 8, 2005, we were primarily a development stage company with no material operations and no revenues from operations. On September 29, 2004, the Company entered into a definitive agreement to acquire four hospitals from subsidiaries of Tenet Healthcare Corporation ("Tenet"), and completed the transaction on March 8, 2005. Effective March 8, 2005, we acquired and began operating the following four hospital facilities in Orange County, California (referred to in this report as our "Hospitals"): o 282-bed Western Medical Center in Santa Ana; o 188-bed Western Medical Center in Anaheim; o 178-bed Coastal Communities Hospital in Santa Ana; and o 114-bed Chapman Medical Center in Orange. Our results of operations discussed in this report reflect Hospital operations for the full quarter ended June 30, 2005 and the 24 days of the quarter ended March 31, 2005. We entered into agreements with third-party payers, including government programs and managed care health plans, under which rates are based upon established charges, the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from established charges. During the 24 days ended March 31, 2005, substantially all of Tenet's negotiated rate agreements were assigned to our Hospitals. Our own Medicare provider numbers were received in April 2005. California State Medicaid Program provider numbers were received in June 2005. 24 Provision for Doubtful Accounts Accounts receivable primarily consist of amounts due from third-party payors and patients. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. We provide for an allowance against accounts receivable that could become uncollectible by establishing an allowance to reduce the carrying value of such receivables to their estimated net realizable value. Our allowance is based on the aging of certain of our accounts receivables by hospital, the historical collection experience by hospital and for each type of payer and other relevant factors. The percentages applied in the calculation of the allowance are consistent with those used by Tenet. The primary uncertainty lies with uninsured patient receivables and deductibles, co-payments or other amounts due from individual patients, which collectively represent the largest component of bad debts. Our practice is to write-down self-pay accounts receivable, including accounts related to the co-payments and deductibles due from patients with insurance, to their estimated net realizable value at the time of billing. We attempt to collect amounts due from patients, including co-payments and deductibles due from patients with insurance, at the time of service while complying with all federal and state laws and regulations, including, but not limited to, the Emergency Medical Treatment and Labor Act ("EMTALA"). Generally, as required by EMTALA, patients may not be denied emergency treatment due to inability to pay. Therefore, until the legally required medical screening examination is complete and stabilization of the patient has begun, services are performed prior to the verification of the patient's insurance, if any. In non-emergency circumstances or for elective procedures and services, it is our policy, when appropriate, to verify insurance prior to a patient being treated. Generally, uncollected balances are expected to be assigned to a collection agency between 90 to 120 days past due, once patient responsibility has been identified. As we did not acquire Tenet's accounts receivable in our Acquisition on March 8, 2005, our accounts have been current up to the third quarter. Accordingly, in September 2005 we engaged a collection agency and bad debt assignments commenced. When accounts are assigned for collections by the Hospitals, the accounts are completely written off through provision for doubtful accounts. Any recoveries from collection agencies thereafter are credited to the provision as received. The process of determining the allowance requires us to estimate uncollectible patient accounts that are highly uncertain and requires a high degree of judgment. It is impacted by changes in regional economic conditions, business office operations, payor mix and trends in federal or state governmental healthcare coverage. Due to our limited historical information as a result of our Acquisition occurring on March 8, 2005, the following represents our significant categories of gross patient accounts receivable as of December 31, 2005 (in thousands and unaudited): Governmental $ 16,809 Insured Patient Accounts, net of discounts 33,222 Uninsured and Self Pay Accounts 16,927 --------- $ 66,958 Also as of December 31, 2005, $20 million in accounts had been written off and assigned for collection. Of the combined uninsured and self pay balances (both active accounts and bad debt write-offs) 4.4% had been collected as of December 31, 2005. The uninsured accounts category represented 78% of the allowance for uncollectible accounts and net of this portion of the allowance represented an estimated receivable of $1.4 million. Uninsured accounts are reserved at 93.2% of the balance for all aging categories. Based on collection experience through December 31, 2005, we expect to collect 65% or $0.9 million of this prior to assignment. The remainder represents the expected recovery by the outside collection agency after the active balances are assigned. Until we obtain additional historical experience, this recovery is not assured. Approximately $17 million of our accounts at December 31, 2005 are governmental accounts reserved at 100% for potential denials after 180 days. Insured patient accounts represent 22% of the allowance for doubtful accounts as of December 31, 2005 calculated on a scale based on the age of the accounts from date of service starting at 3.3% for current accounts and progressing to 63% for accounts over 180 days. Our commercial insured accounts of $22 million have an allowance of $4 million as of December 31, 2005. The average age of these accounts from date of service to collection is 52 days. In management's opinion this is reasonable as long as the accounts continue to be current. A significant increase in our provision for doubtful accounts (as a percentage of revenues) would have a significant increase to our operating losses. This would adversely affect our results of operations, financial condition, liquidity and future access to capital. Common Stock Warrants As indicated in the notes to the financial statements, the Company entered into a Rescission, Restructuring and Assignment Agreement with Dr. Chaudhuri and William Thomas on January 27, 2005 (the "Restructuring Agreement"). Pursuant to the Restructuring Agreement, the Company released its initial deposit of $10 million plus accrued interest on the Tenet Hospital Acquisition back to Dr. Chaudhuri and issued non-convertible secured promissory notes totaling $1,264,014 and warrants to purchase up to 74,700,000 shares of the Company's Common Stock. The warrants were limited not to exceed 24.9% of the Company's Fully-Diluted capital stock. The Company recognized an expense of $17.2 million related to the issuance of the Warrants during the three months ended March 31, 2005. The Company computed the expense of the Warrants based on the fair value of the Warrants at the date of grant and the estimated maximum number of shares exercisable of 43,254,715. The Company computed the fair value of the Warrants based on the Black-Scholes option pricing model with the following assumptions: Risk-free interest rate 3.2% Expected volatility 33.6% Dividend yield -- Expected life (years) 3.5 Fair value of Warrants (fully diluted) $0.398 Due to fact that the Company emerged from the development stage during the three months ended March 31, 2005, the Company computed the volatility of its stock based on an average of the following comparable public companies that own hospitals: Amsurg Inc (AMSG) Community Health Systems (CYH) Healhcare Company (HCA) Health Management Associates Inc. (HMA) Lifepoint (LPNT) Tenet Healthcare Corp. (THC) Triad Hospitals Corp. (TRI) Universal (UHS) Although management believes this is most reasonable and accurate methodology to determine the Company's volatility, the circumstances affecting volatility of the comparable companies selected may not be an accurate predictor of the Company's volatility. 25 Due to fact that the Company emerged from the development stage during the six months ended June 30, 2005, the Company computed the volatility of its stock based on an average of comparable public companies that own hospitals. Variable Interest Entity Concurrent with the close of the Company's acquisition of the Hospitals, Dr. Chaudhuri and Dr. Anil Shah exercised their options to purchase the Company's interest in a limited liability company holding the real property underlying the Hospitals pursuant to an option agreement dated September 28, 2004, as amended and restated on November 16, 2004 (the "LLC Option Agreement"). The option holders purchased all of the Company's interests in Pacific Coast Holdings Investment LLC ("PCHI"), which acquired title to the real property. The Company received $5 million and PCHI guaranteed the Company's acquisition debt of $50 million. The Company remains primarily liable under the $50 million acquisition note notwithstanding its guarantee by PCHI, and this note is cross-collateralized by substantially all of the Company's assets and all of the real property of the Hospitals. All of the Company's operating activities are directly affected by the real property that was sold to PCHI. Given these factors, it appears that the Company has indirectly guaranteed the indebtedness of PCHI. The Company is standing ready to perform on the acquisition debt should PCHI not be able to perform and has undertaken a contingent obligation to make future payments if those triggering events or conditions occur. In connection with the sale of all of the real property of the Hospitals, the Company entered into a triple net lease with PCHI to leaseback this real property for an initial term of 25 years. Per the triple net lease, PCHI will receive rent that covers the cost of the underlying debt, plus a guaranteed spread up to 2.5%. Additionally, the Company has a right to renew the leases for periods up to an additional 25 years. PCHI is a related party entity that is affiliated with the Company through common ownership and control. It is owned 51% by West Coast Holdings, LLC (Dr. Shah and investors) and 49% by Ganesha Realty, LLC (Dr. Chaudhuri and William Thomas). Generally accepted accounting principles require that a company consolidate the financial statements of any entity that cannot finance its activities without additional subordinated financial support, and for which one company provides the majority of that support through means other than ownership. Effective March 8, 2005, the Company determined that it provided the majority of financial support to PCHI through various sources including lease payments, remaining primarily liable under the $50 million debt, and cross-collateralization of the Company's non-real estate assets to secure the $50 million debt. Accordingly, during the three and six months ended June 30, 2005, the Company included in its consolidated financial statements, the net assets of PCHI, net of consolidation adjustments. 26 Results of Operations The following table summarizes our results of operations from continuing operations for the three months ended June 30, 2005 and 2004. The 2004 period reflects our results prior to ownership of the Hospitals, which began in March 2005. Three Months Ended ------------- ------------- June 30, 2005 June 30, 2004 ------------- ------------- (Unaudited) (Unaudited) (Restated) ------------- ------------- Net operating revenues $ 83,190,537 $ -- Operating expenses: Salaries and benefits 48,439,345 306,317 Supplies 11,521,967 -- Provision for doubtful accounts 11,331,354 -- Other operating expenses 17,283,135 108,763 Depreciation and amortization 902,845 15,528 ------------- ------------- 89,478,646 430,608 Operating loss (6,288,109) (430,608) Interest expense 4,069,029 -- ------------- ------------- Loss including minority interest and before provision for income taxes (10,357,138) (430,608) Provision for income taxes 1,266,000 -- Minority interest in variable interest entity (195,517) -- ------------- ------------- Net loss $ (11,427,621) $ (430,608) ============= ============= Per Share Data: Basic and fully diluted Loss per common share ($ 0.09) ($ 0.02) Weighted average shares outstanding 124,539,000 19,590,000 Three and Six Months Ended June 30, 2005 and 2004 Losses from continuing operations, before interest, taxes and common stock warrant expense, increased to $6.3 million for the three months ended June 30, 2005 from $0.4 million for the three months ended June 30, 2004. Substantially all of the losses from continuing operations during the three and six months ended June 30, 2005 reflects the operational losses from our Hospitals, which were acquired on March 8, 2005. For the three months ended March 31, 2005 and the six months ended June 30, 2005, we recognized an expense of $17.2 million relating to the issuance of common stock Warrants to Dr. Chaudhuri and Mr. Thomas. We computed the expense of the Warrants based on their fair value at the date of grant and the estimated maximum number of shares exercisable of 43,254,715. 27 The income tax provision was $1.3 million for the three months ended June 30, 2005 and $2.2 million for the six months ended June 30, 2005, and consisted primarily of a taxable gain on the sale of the real property of the Hospitals to PCHI, the non-deductible Warrant expense and allowances for doubtful accounts, offset with losses from operations. As of June 30, 2005, we had net deferred tax assets of approximately $10.8 million for which a full valuation allowance has been provided. Managed care contracting The prior owners the hospitals adopted a state wide managed care contracting strategy that was designed to improve consolidated results with less regard for the individual facilities financial needs. Those contracts have been substantially all assigned to IHHI preserving the existing revenue base. Management is committed to negotiating terms more closely aligned with the services provided and the financial resources required to achieve that level of service. Although management believes that substantial opportunity exists for improving contracted reimbursement, there can be no assurance that this will be achieved and failure to do so could have a material adverse impact on future performance. Salaries and benefits We have experienced and expect to continue to experience significant wage and benefit pressures created by the nursing shortages throughout the region. In addition, approximately 24% of our employees were represented by labor unions as of June 30, 2005. If union activity increases at our hospitals, our salaries and benefits expense may increase more rapidly than our net operating revenues. Labor costs remain a significant cost pressure facing us as well as the health care industry in general. The nursing shortage continues and remains more serious in key specialties. This has increased labor costs for nursing personnel. In addition, state-mandated nurse-staffing ratios in California have not only increased our labor costs, but may also adversely affect net operating revenues due to volume limitations if the required number of nurses are unavailable. In March 2005, increases to California's state-mandated nurse-staffing ratios went into effect as provided by the original statute. The vast majority of hospitals in California, including our hospitals, are not at all times meeting these ratios. We have, however, gradually improved our monthly compliance and expect that our compliance levels will continue to improve throughout our hospitals in 2005. 28 During the three months and six months ended June 30, 2005, we recorded provisions for doubtful accounts of $11.3 million and $14.5 million, respectively. The breakdown of our billed hospital receivables (which is a component of total receivables) at June 30, 2005 is summarized in the table below. June 30, 2005 ------------- Insured receivables 78.3% Uninsured receivables 21.7% ------------- Total 100.0% ============= Our allowance for doubtful accounts and the approximate percentages of allowance for doubtful accounts to accounts receivable at June 30, 2005 are summarized as follows (dollars in thousands): June 30, 2005 Allowance for doubtful accounts $14,445 Percentage of accounts receivables 26.2% Our reported accounts receivable as of June 30, 2005 were all under 115 days outstanding, due to the fact that our acquisition of Hospital assets from Tenet on March 8, 2005 did not include patient accounts. Net days in AR outstanding as of June 30, 2005 were 44.2 days. Liquidity and Capital Resources Cash used by operating activities was $26.5 million in the six months ended June 30, 2005. Net accounts receivable increased to $40.4 million after a full quarter of hospital operations. Accounts payable increased by $11.5 million and payroll related accruals increased by $12.3 million. Estimated taxes payable increased by $0.8 million. Other current liabilities increased by $6.5 million and consist primarily of accrued interest, workers' compensation insurance, and other miscellaneous accruals. Cash used in investing activities of $63.2 million in the six months ended June 30, 2005 was used to complete the Hospital acquisition on March 8, 2005. Cash provided by financing activities was $97 million in the six months ended June 30, 2005. At June 30, 2005, our indebtedness consisted of a $50 million term loan for the purchase of our Hospitals, a $13.2 million drawn-down from a $30 million line of credit. We received $5 million in net proceeds from the sale of the real property of the Hospitals to PCHI, a related party entity. In addition, in March 2005, our Hospitals entered into a 2-year Accounts Purchase Agreement to sell Accounts Receivable to a lending institution as they become billable to third parties. We continue to provide billing and collection services and the proceeds collected thereby are applied to reduce amounts advanced under this agreement. As of June 30, 2005 $21.4 million had been advanced under this agreement. On or about May 9, 2005, the Company received a notice of default from its lender, Medical Provider Financial Corporation II ("Medical Provider"). Medical Provider is the lender for the secured acquisition note of $50 million, and the Company's secured line of credit note of up to $30 million. The Company has recorded the acquisition note of $50 million and outstanding draws on the line of credit of $13.2 million as current liabilities in the accompanying consolidated financial statements. The notice of default asserts that (i) the Company failed to provide satisfactory evidence that the Company has received capital contributions of not less than $15,000,000, as required under the Credit Agreement, (ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as required under the Credit Agreement, and (iii) a Material Adverse Effect has occurred under the Credit Agreement for reasons relating primarily to OC-PIN's failure to fully fund its obligations under its Stock Purchase Agreement with the Company dated January 28, 2005. 29 As of June 1, 2005, the Company entered into an Agreement to Forbear with Medical Provider. Without another default, Medical Provider agrees for 100 days to forbear from (i) recording Notices of Default, (ii) filing a judicial foreclosure lawsuit against the Company, OC-PIN and West Coast Holdings, LLC, and (iii) filing lawsuits against the Company, OC-PIN and West Coast Holdings, LLC. The interest rate on the notes will be increased from 14% to the Default Rate of 19%, as defined in the Credit Agreement, and all Obligations (as defined in the Credit Agreement), will be forthwith due and payable, as long as the events of default remain uncured. The Company's Line of Credit facility is suspended to additional advances. During the forbearance period of 100 days, OC-PIN and other investors will invest not less than $15 million in new equity capital in the Company. In June 2005, in connection with the First Amendment to Stock Purchase Agreement, dated as of June 1, 2005, by and among the Company, OC-PIN, PCHI, West Coast Holdings, LLC, and Ganesha Realty LLC, OC-PIN placed into an escrow account 57,250,000 shares of the Company's common stock. As of the date of this Report, an aggregate of $12.5 million in cash has been deposited in the escrow account. Recent Accounting Pronouncements On October 13, 2004, the Financial Accounting Standards Board issued Statement 123R, Share-Based Payment, which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value. The statement is effective for all public companies for interim or annual periods after June 15, 2005. The statement eliminates the ability to account for share-based compensation transactions using APB No. 25, and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in our consolidated statements of operations. The standard also requires that the modified prospective transition method be used, which would necessitate the Company to recognize compensation cost for the fair value of new awards granted, modified or settled after the effective date of the SFAS 123R. In addition, the measurement of compensation cost for awards that are not fully vested as of the effective date of the SFAS 123R would be based on the same estimate that the Company used to previously value its grants under SFAS 123. As a result of SFAS 123R, the Company will be required to expense the fair value of any stock option grants that it may make in the future, rather than disclose the impact on its consolidated statement of operations within the Company's footnotes. In January 2003, the Financial Accounting Standards Board issued FIN 46, "Consolidation of Variable Interest Entities," which requires consolidation of certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Paragraph 1 of ARB 51 states that consolidated financial statements are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies. Paragraph 2 states that "the usual condition for a controlling financial interest is ownership of a majority voting interest..." However, application of the majority voting interest requirement in ARB 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. Application of Interpretation 46 or Interpretation 46(R) is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. See Note to the financial statements regarding the Company's implementation of FIN 46 (R). 30 Item 3. Quantitative and Qualitative Disclosures About Market Risk. At June 30, 2005, we did not have any investment in or outstanding liabilities under market rate sensitive instruments. We do not enter into hedging or derivative instrument arrangements. We have no off-balance sheet arrangements. Item 4. Controls and Procedures. The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's periodic reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 15d-15(e). The Company's disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching the Company's desired disclosure control objectives. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005. During previous quarters we conducted evaluations of the effectiveness of our disclosure controls and procedures as of March 31, June 30 and September 30, 2005 and found them to be effective as of such dates. However, we have subsequently conducted a re-evaluation of the effectiveness of our disclosure controls and procedures as of March 31, June 30 and September 30, 2005, and identified certain material weaknesses, discussed further below. With the participation of the Company's Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our system of internal control over financial reporting as of December 31, 2005, based on the framework in Internal Control-Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission. Based on these evaluations and re-evaluations, management determined that the Company's system of disclosure controls and procedures was not effective as of March 31, June 30, September 30 and December 31, 2005, and the Company's systems of internal control over financial reporting was not effective as of December 31, 2005, due to the presence of certain material weaknesses. These weaknesses contributed to the need for restatements of our financial statements for the quarterly periods ending March 31, June 30 and September 30, 2005 as follows. 1. As described in the notes to the accompanying restated financial statements, the Company revised its calculation of Warrant expense incurred during the three months ended March 31, 2005 after review of its accounting treatment following receipt of comments from the Staff of the Securities and Exchange Commission. The total adjustment required to increase the Warrant expense to its proper balance was $780,827 pre-tax for such period. This adjustment was necessary because the Company recognized the Warrant expense as a nonrecurring settlement charge during the three months ended March 31, 2005 using a probability analysis to estimate the maximum number of warrants exercisable at the date of issuance of 43,254,715 shares. 2. As described in the notes to the accompanying restated financial statements, the Company revised its provision for income taxes due to an error in the calculation of the taxable gain on the sale of real property to PCHI (see Note 7 Variable Interest Entity). The total adjustment required to reduce the provision for income taxes was $528,000 for the three months ended March 31, 2005, $496,000 for the three months ended June 30, 2005, $799,000 for the three months ended September 30, 2005 and $1,823,000 for the nine months ended September 30, 2005. Management has identified, as a material weakness contributing to these restatements, that the Company's research and analysis of complex accounting issues was inadequate. Although the type of complex transactions giving rise to the restatements are expected to occur very infrequently, management believes that its process of analyzing and accounting for complex financial transactions requires improvement. In addition to inadequate expertise, due to business exigencies there was a lack of complete accounting analysis of these transactions until after they were completed, which contributed to an incomplete accounting analysis. Under the direction of the Audit Committee, management intends in the future to engage experts with sufficient expertise to advise on accounting and financial reporting of complex financial transactions, and to do so prior to or concurrently with the Company's commitment to these transactions. PART II - OTHER INFORMATION Item 1. Legal Proceedings From time to time, we are a party to claims and legal proceedings arising in the ordinary course of our business. With the exception of a potentially adverse outcome in the litigation described in the next paragraph, after taking into consideration information furnished by our counsel as to the current status of these claims and proceedings, we do not believe that the aggregate potential liability resulting from such proceedings would have a material adverse effect on our financial condition or results of operation. On or about May 27, 2005, the Company, along with other defendants, was served with a petition to compel arbitration with Judicial Arbitration and Mediation Service (JAMS) by Andrew Weiss, a former consultant to the Company. Mr. Weiss is claiming, among other things, that he was an employee of the Company and was wrongfully terminated, and is requesting unspecified compensatory, statutory and punitive damages relating to his claimed lost earnings and benefits, stock options, and other special and general damages. The Company is vigorously contesting this matter. The Company has filed a stay in the arbitration proceedings and is requesting to move the claim to Los Angeles County Superior Court. This matter is in an early stage and it is not possible to assess the likely outcome of this litigation or the amount of damages that we would be required to pay if this litigation is decided adverse to the Company. 31 Item 3. Defaults Upon Senior Securities. On or about May 9, 2005, the Company received a notice of default from Medical Provider Financial Corporation II ("Medical Provider"). Medical Provider is the lender to the Company under a $50 million acquisition loan, and a working capital non-revolving line of credit of up to $30 million, each of which has been issued pursuant to a Credit Agreement, dated as of March 3, 2005, to which the Company and Medical Provider are parties (the "Credit Agreement"). In addition, each of Orange County Physicians Investment Network, LLC ("OC-PIN"), Pacific Coast Holdings Investment, LLC, Ganesha Realty, LLC, and West Coast Holdings, LLC, which are parties to the Credit Agreement, has received a notice of default under the Credit Agreement. The notice of default asserts that (i) the Company failed to provide satisfactory evidence that the Company has received capital contributions of not less than $15,000,000, as required by Section 2.1(s) of the Credit Agreement, (ii) the Company failed to prepay $5,000,000 by the Mandatory Prepay Date as required under Section 1.2(b)(ii) of the Credit Agreement, and (iii) a Material Adverse Effect has occurred under the Credit Agreement for reasons relating primarily to OC-PIN's failure to fully fund its obligations under its Stock Purchase Agreement with the Company dated January 28, 2005 (as discussed further below in Item 8.01). Medical Provider has indicated that, as a consequence of the alleged events of default and for so long as such events are continuing, the interest rates applicable to the outstanding loans under the Credit Agreement will be increased to the Default Rate (as defined in the Credit Agreement), the line of credit facility is suspended as to additional advances (with any additional advances made at its discretion at the Default Rate), and all Obligations (as defined in the Credit Agreement), will be forthwith due and payable. The total principal and interest due and payable under the loans made under the Credit Agreement currently amount to approximately $64.2 million, which does not include possible additional amounts claimed by Medical Provider for unpaid interest at the Default Rate, attorneys' fees and costs, costs of collection, trustee's fees and costs, and other fees, charges and expenses paid or incurred by Medical Provider. Item 6. Exhibits. Exhibit Number Description ------ ----------- 10.1 First Amendment to Stock Purchase Agreement, dated as of June 1, 2005, by and among the Registrant, Orange County Physicians Investment Network, LLC, Pacific Coast Holdings Investment, LLC, West Coast Holdings, LLC, and Ganesha Realty LLC (incorporated herein by reference from Exhibit 99.1 to the Registrant's Current Report on Form 8-K filed with the Commission on June 22, 2005).* 10.2 Escrow Agreement, dated as of June 1, 2005, by and among the Registrant, Orange County Physicians Investment Network, LLC and City National Bank (incorporated herein by reference from Exhibit 99.2 to the Registrant's Current Report on Form 8-K filed with the Commission on June 22, 2005).* 32 10.3 Agreement to Forbear, dated as of June 1, 2005, by and among the Registrant, certain of its subsidiaries, Orange County Physicians Investment Network, LLC, West Coast Holdings, LLC, and Medical Provider Financial Corporation II (incorporated herein by reference from Exhibit 99.3 to the Registrant's Current Report on Form 8-K filed with the Commission on June 22, 2005).* 10.4 Letter agreement, dated June 6, 2005, amending employment agreements of Messrs. Anderson, Mogel and Ligon.* 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Previously filed. SIGNATURE In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INTEGRATED HEALTHCARE HOLDINGS, INC. Dated: April 6, 2006 By: /s/ Steven R. Blake ------------------------------------- Steven R. Blake Chief Financial Officer (Principal Financial Officer) 33