FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements, as that
term is defined in the Private Securities Litigation Reform Act of 1995. These
statements relate to future events or our future financial performance. In some
cases, you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential," "continue," or the negative of these terms or other
comparable terminology. These statements are only predictions and involve known
and unknown risks, uncertainties and other factors, including the risks
discussed under the caption "Risk Factors" in our Annual Report on Form 10-K
filed on June 22, 2012 that may cause our Company's or our industry's actual
results, levels of activity, performance, or achievements to be materially
different from those expressed or implied by these forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements. Except as may be required by applicable
law, we do not intend to update any of the forward-looking statements to conform
these statements to actual results.
As used in this report, the terms "we," "us," "our," "the Company," "Integrated
Healthcare Holdings" or "IHHI" mean Integrated Healthcare Holdings, Inc., a
Nevada corporation, unless otherwise indicated.
Unless otherwise indicated, all amounts included in this Item 2 are expressed in
thousands (except percentages and per share amounts).
OVERVIEW
On March 8, 2005, we completed our acquisition (the "Acquisition") of four
Orange County, California hospitals and associated real estate, including: (i)
282-bed Western Medical Center - Santa Ana, CA; (ii) 188-bed Western Medical
Center - Anaheim, CA; (iii) 178-bed Coastal Communities Hospital in Santa Ana,
CA; and (iv) 114-bed Chapman Medical Center in Orange, CA (collectively, the
"Hospitals") from Tenet Healthcare Corporation. The Hospitals were assigned to
four of our wholly owned subsidiaries formed for the purpose of completing the
Acquisition. We also acquired the following real estate, leases and assets
associated with the Hospitals: (i) a fee interest in the Western Medical Center
at 1001 North Tustin Avenue, Santa Ana, CA, a fee interest in the administration
building at 1301 North Tustin Avenue, Santa Ana, CA, certain rights to acquire
condominium suites located in the medical office building at 999 North Tustin
Avenue, Santa Ana, CA; (ii) a fee interest in the Western Medical Center at 1025
South Anaheim Blvd., Anaheim, CA; (iii) a fee interest in the Coastal
Communities Hospital at 2701 South Bristol Street, Santa Ana, CA, and a fee
interest in the medical office building at 1901 North College Avenue, Santa Ana,
CA; (iv) a lease for the Chapman Medical Center at 2601 East Chapman Avenue,
Orange, CA, and a fee interest in the medical office building at 2617 East
Chapman Avenue, Orange, CA; and (v) equipment and contract rights. At the
closing of the Acquisition, we transferred all of the fee interests in the
acquired real estate to Pacific Coast Holdings Investment, LLC ("PCHI"), a
company owned 51% by various physician investors and 49% by our largest
shareholder.
SIGNIFICANT CHALLENGES
COMPANY - Our Acquisition involved significant cash expenditures, debt
incurrence and integration expenses that has seriously strained our consolidated
financial condition. If we are required to issue equity securities to raise
additional capital or for any other reasons, existing stockholders will likely
be substantially diluted, which could affect the market price of our stock. In
April 2010 we issued equity securities to an existing shareholder and a lender
(see "WARRANTS").
INDUSTRY - Our Hospitals receive a substantial portion of their revenues from
Medicare and Medicaid. The healthcare industry is experiencing a strong trend
toward cost containment as the government seeks to impose lower reimbursement
and resource utilization group rates, limit the scope of covered services and
negotiate reduced payment schedules with providers. These cost containment
measures generally have resulted in a reduced rate of growth in the
reimbursement for the services that we provide relative to the increase in our
cost to provide such services.
Changes to Medicare and Medicaid reimbursement programs have limited, and are
expected to continue to have limited, payment increases. Also, the timing of
payments made under the Medicare and Medicaid programs is subject to regulatory
action and governmental budgetary constraints resulting in a risk that the time
period between submission of claims and payment could increase. Further, within
the statutory framework of the Medicare and Medicaid programs, a substantial
number of areas are subject to administrative rulings and interpretations which
may further affect payments.
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Our business is subject to extensive federal, state and, in some cases, local
regulation with respect to, among other things, participation in the Medicare
and Medicaid programs, licensure and certification of facilities, and
reimbursement. These regulations relate to the adequacy of physical property and
equipment, qualifications of personnel, standards of care, government
reimbursement, operational requirements and the like. Compliance with these
regulatory requirements, as interpreted and amended from time to time, can
increase operating costs and thereby adversely affect the financial viability of
our business. Since these regulations are amended from time to time and are
subject to interpretation, we cannot predict when and to what extent liability
may arise. Failure to comply with current or future regulatory requirements
could also result in the imposition of various remedies including (with respect
to inpatient care) fines, restrictions on admission, denial of payment for all
or new admissions, the revocation of licensure, decertification, imposition of
temporary management or the closure of a facility or site of service.
We are subject to periodic audits by the Medicare and Medicaid programs, which
have various rights and remedies against us if they assert that we have
overcharged the programs or failed to comply with program requirements. Rights
and remedies available to these programs include repayment of any amounts
alleged to be overpayments or in violation of program requirements, or making
deductions from future amounts due to us. These programs may also impose fines,
criminal penalties or program exclusions. Other third-party payer sources also
reserve rights to conduct audits and make monetary adjustments in connection
with or exclusive of audit activities.
The healthcare industry is highly competitive. We compete with a variety of
other organizations in providing medical services, many of which have greater
financial and other resources and may be more established in their respective
communities than we are. Competing companies may offer newer or different
centers or services than we do and may thereby attract patients or customers who
are presently our patients or customers or are otherwise receiving our services.
An increasing trend in malpractice litigation claims, rising costs of
malpractice litigation, losses associated with these malpractice lawsuits and a
constriction of insurers have caused many insurance carriers to raise the cost
of insurance premiums or refuse to write insurance policies for hospital
facilities. Also, a tightening of the reinsurance market has affected property,
vehicle, and excess liability insurance carriers.
We receive all of our inpatient service revenues from operations in Orange
County, California. The economic condition of this market could affect the
ability of our patients and third-party payers to reimburse us for our services,
through its effect on disposable household income and the tax base used to
generate state funding for Medicaid programs. An economic downturn, or changes
in the laws affecting our business in our market and in surrounding markets,
could have a material adverse effect on our financial position, results of
operations, and cash flows.
LIQUIDITY AND CAPITAL RESOURCES
The accompanying unaudited condensed consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and settlement of obligations in the normal course of business. As of December
31, 2012, the Company had a total stockholders' deficiency of $28 million and a
working capital deficit of $33 million. For the three and nine months ended
December 31, 2012, the Company had net loss of $13 million and $14 million,
respectively.
Key items for the nine months ended December 31, 2012 included:
1. Net patient service revenues (patient service revenues, net of contractual
allowances and discounts, less provision for bad debts) for the nine months
ended December 31, 2012 and 2011 were $296.5 million and $280.5 million,
respectively, representing an increase of $16.0 million, or 5.7%. The Hospitals
serve a disproportionate number of indigent patients and receive governmental
revenues and subsidies in support of care for these patients. Governmental
revenues include payments from Medicaid, Medicaid DSH, and Orange County, CA
(CalOptima). Governmental net revenues increased $19.2 million for the nine
months ended December 31, 2012 compared to the nine months ended December 31,
2011. The increase was primarily related to QAF revenues of $46.5 million
recognized during the nine months ended December 31, 2012 compared to $31.9
million during the same period in fiscal 2012 (see "HOSPITAL QUALITY ASSURANCE
FEES").
Inpatient admissions decreased by 3.5% to 15.3 for the nine months ended
December 31, 2012 compared to 15.9 for the nine months ended December 31, 2011.
The decline in admissions is primarily related to reductions in managed care,
shifts from inpatient to outpatient observation, and obstetrics admissions.
Uninsured patients, as a percentage of gross charges (retail charges), were 5.8%
for the nine months ended December 31, 2012 compared to 5.3% for the nine months
ended December 31, 2011.
2. Operating expenses: Management is working aggressively to reduce costs
without reduction in service levels. These efforts have in large part been
offset by inflationary pressures. Operating expenses before interest and warrant
loss for the nine months ended December 31, 2012 were $302.7 million,
representing an increase of $35.6 million, or 13.3%, compared to the nine months
ended December 31, 2011. The increase is primarily related to QAF expenses of
$45.3 million incurred during the nine months ended December 31, 2012 compared
to $15.9 million during the same period in fiscal year 2012.
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DEBT - On August 1, 2012, we entered into Amendment No. 4 to Credit Agreement
and Consent (the "Credit Agreement Amendment"), which amends the Term Loan
Credit Agreement. Under the Credit Agreement Amendment, Silver Point consented
to and waived certain provisions under the Term Loan Credit Agreement in
connection with our execution of the Revolving Loan Amendment. In addition, the
provisions in the Term Loan Credit Agreement that provide for mandatory
prepayment of our outstanding "A/R Financing," as defined, upon receipt of
certain federal matching funds under the QAF program were amended to replace 65%
with 80%. In connection with the Credit Agreement Amendment, we agreed to pay
Silver Point a one-time consent and amendment fee in an aggregate amount equal
to $1.8 million, of which $450 was paid upon execution of the Credit Agreement
Amendment and the balance was added to the principal amount of the Term Loan
Credit Agreement.
Also on August 1, 2012, we entered into Amendment No. 3 to Credit and Security
Agreement (the "Revolving Loan Amendment"), which amends the Revolving Loan
Agreement. Under the Revolving Loan Amendment, the minimum Revolving Loan
Commitment Amount under the Revolving Loan Agreement was increased from $14.0
million to $30.0 million, and we agreed to pay to MidCap Funding IV, LLC, as
assigned to it from MidCap Financial, LLC, as administrative agent and a lender,
and Silicon Valley Bank, as a lender (collectively, the "Lenders") an
origination fee of 1.0% of the Lenders' increased commitment under the Revolving
Loan Amendment, or $160.
In addition, pursuant to the Revolving Loan Amendment, the lockbox requirements
under the Revolving Loan Agreement were amended to provide that in the event the
Revolving Loan Commitment Amounts are $30.0 million or less during any period
prior to March 31, 2013, or $20.0 million or less thereafter (and assuming there
is no Event of Default at the time), we would be permitted to transfer funds
that are deposited into any Lockbox Account, as defined, to a different bank
account designated by us, subject to the other terms and conditions contained in
the Revolving Loan Agreement.
As of December 31, 2012, we had the following credit facilities:
? $46.35 million term loan under the Credit Agreement, dated as of October 9, 2007, as amended (the "Term Loan Credit Agreement"), by and among us,
Silver Point, and PCHI and Ganesha Realty LLC ("Ganesha"), as Credit
Parties, bearing a fixed interest rate of 14.5% per year ($46.35 million
outstanding balance at December 31, 2012).
? $30.0 million revolving line of credit under the Credit and Security
Agreement, dated as of August 30, 2010, as amended (the "Revolving Loan
Agreement"), by and among us, and the Lenders, bearing an interest rate
of 5.0% plus LIBOR, with a 2.5% floor, per year (7.5% at December 31,
2012) and an unused commitment fee of 0.625% per year ($28.8 million
outstanding balance at December 31, 2012). For purposes of calculating
interest, all payments we make on the revolving line of credit are
subject to a six business day clearance period. At December 31, 2012, we
had $1.2 million in additional availability under our revolving credit
facility.
The Company's credit facilities contain various affirmative and negative
covenants and customary events of default, including payment defaults, breaches
of representations and warranties, covenant defaults, cross-defaults to similar
obligations, events of bankruptcy and insolvency, judgment defaults, the
invalidity of liens on collateral, and the occurrence of events which have a
material adverse effect on the Company.
The Company entered into an Amendment on February 7, 2013, which changed the
measurement period for the term loan facility. The next assessment date for
which the Company is required to comply with the term loan financial covenants
will be for the period ended June 30, 2013.
The Company did not meet the financial covenants for its revolving line of
credit for the period ended December 31, 2012. Although the Company is not
required to report compliance with the financial covenant for its revolving line
of credit until 50 days after the fiscal quarter end, the Company is seeking the
lenders' consent to a potential non-compliance with this financial covenant.
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Our outstanding debt consists of the following:
December 31, March 31,
2012 2012
Current:
Revolving line of credit $ 28,806 $ 14,000
Noncurrent:
Term loan $ 46,350 $ 45,000
On February 7, 2013, the Company amended its $46.35 million term loan which
included, among other changes, an extension of the maturity date to April 16,
2016.
WARRANTS - On April 13, 2010, the Company issued warrants (the "Omnibus
Warrants") to purchase its common stock for a period of three years at an
exercise price of $0.07 per share in the following denominations: 139.0 million
shares to KPC Resolution Company (a company owned and controlled by Kali P.
Chaudhuri, M.D., the Company's majority shareholder) or its designees and 96.0
million shares to the $46.35 million term loan lender or its designees. The
Omnibus Warrants also provide the holders with certain pre-emptive, information
and registration rights. On April 13, 2010, the Company recorded warrant expense
and the related warrant liability of $2.9 million, representing fair value. As
of December 31, 2012, the fair value of the Omnibus Warrants was $1.9 million.
In addition, on April 13, 2010, the Company issued a three-year warrant (the
"Release Warrant") to acquire up to 170.0 million shares of its common stock at
$0.07 per share to Dr. Chaudhuri who facilitated a release enabling the Company
to recover amounts due from the Company's prior lender and a $1.0 million
reduction in principal of its outstanding debt, among other benefits to the
Company. As a result, the Company recorded the fair value of the Release Warrant
($2.1 million) as an offsetting cost of the recovery of amounts due from the
Company's prior lender. The Release Warrant also provides the holder with
certain pre-emptive, information and registration rights. As of December 31,
2012, the fair value of the Release Warrant was $1.3 million.
The Omnibus Warrants and the Release Warrant are collectively referred to as the
"April Warrants." The net gain (loss) recorded related to the April Warrants for
the three months ended December 31, 2012 and 2011 was $(1,182) and $256,
respectively, and $(1,577) and $39 for the nine months ended December 31, 2012
and 2011, respectively.
In connection with the change in maturity of the term loan discussed above, the
April Warrants maturity date was revised to April 13, 2016.
HOSPITAL QUALITY ASSURANCE FEES - In October 2009, the Governor of California
signed legislation supported by the hospital industry to impose a provider fee
on general acute care hospitals that, combined with federal matching funds,
would be used to provide supplemental Medi-Cal payments to hospitals. The state
submitted the plan to the Centers for Medicare and Medicaid Services ("CMS") for
a required review and approval process, and certain changes in the plan were
required by CMS. Legislation amending the fee program to reflect the required
changes was passed by the legislature and signed by the Governor on September 8,
2010. Among other changes, the legislation leaves distribution of "pass-through"
payments received by Medi-Cal managed care plans that will be paid to hospitals
under the program to the discretion of the plans. The hospital quality assurance
fee program ("QAF") created by this legislation initially provided payments for
up to 21 months retroactive to April 2009 and expiring on December 31, 2010
("2010 QAF"). In February 2011, CMS gave final approval for the 2010
QAF. During fiscal year 2011, we recognized $87.2 million in revenue and
recorded expenses of $47.8 million relating to the 2010 QAF.
In December 2011, CMS gave final approval for the extension of the QAF for the
nine month period from January 1 through June 30, 2011 ("2011 QAF").
Accordingly, for the three and nine months ended December 31, 2011 the Company
recognized $31.9 million in revenue and recorded expenses of $15.9 million
relating to the 2011 QAF.
In June 2012, CMS conditionally approved the extension of the QAF for the thirty
month period from July 1, 2011 through December 31, 2013 ("2013 QAF"). In June
2012, the California State Legislature amended the hospital fee statute to
recognize separate CMS approval of the fee-for-service portion and managed care
portion of the 2013 QAF, which was further clarified in legislation approved by
the governor of California in September 2012. As a result, during the three and
nine months ended December 31, 2012, the Company recognized revenue of $7.8
million and $46.5 million and expenses of $6.9 million and $45.3 million
relating to the fee-for-service portion of the 2013 QAF for the periods from
October 1, 2012 through December 31, 2012 and July 1, 2011 through December
31,
2012, respectively.
Based on the most recent modeling prepared by the California Hospital
Association, we anticipate making payments for provider fees and other expenses
relating to the 2013 QAF of approximately $105.8 million and receiving
approximately $235.5 million in revenues from the State ($79.4 million from the
fee-for-service portion and $156.1 million from the managed care portion).
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We cannot provide any assurances or estimates in connection with CMS's final
approval of the 2013 QAF or a possible continuation of the QAF program beyond
December 31, 2013.
ELECTRONIC HEALTH RECORDS INCENTIVE PROGRAM - Provisions of the American
Recovery and Reinvestment Act of 2009 provide incentive payments for the
adoption and meaningful use of certified electronic health record (EHR)
technology. The Medicare EHR incentive program provides incentive payments to
eligible hospitals (and certain other providers) that are meaningful users of
certified EHRs. The Medicaid EHR incentive program provides incentive payments
to eligible hospitals (and certain other providers) for efforts to adopt,
implement, upgrade, or meaningfully use of certified EHR technology.
CMS has established the final rule which requires eligible providers in their
first year of participation in the Medicaid incentive payment program to
demonstrate that they have adopted (acquired, purchased, or secured access to),
or implemented, or upgraded to certified EHR technology in order to qualify for
an incentive payment. During the second and subsequent years of the program,
eligible providers are required to meet other criteria, including meaningful
use, to receive additional funds. We have been awarded a total amount of $13.6
million under the Medicaid EHR incentive program, which will be earned and
received over a four year period. We adopted certified EHR technology and
recognized other income of $6.8 million relative to the first year under the
Medicaid EHR incentive program during fiscal year 2012.
LONG TERM LEASE COMMITMENT WITH VARIABLE INTEREST ENTITY - On April 13, 2010, we
and PCHI entered into a Second Amendment to Amended and Restated Triple Net
Hospital Building Lease (the "2010 Lease Amendment"). Under the 2010 Lease
Amendment, the annual base rent to be paid by us to PCHI was increased from $5.4
million to $7.3 million. The base rent is subject to an annual Consumer Price
Index increase on January 1 of each year; such increase shall not be less than
2% or more than 6% per year. As a result, the annual base rent as of January 1,
2012 is $7.7 million. If PCHI refinances the $46.35 million term loan, the
annual base rent will increase to $8.3 million. This lease commitment with PCHI
is eliminated in consolidation.
COMMITMENTS AND CONTINGENCIES - The State of California has imposed hospital
seismic safety requirements. Under these requirements, the Hospitals must meet
stringent seismic safety criteria in the future. In addition, there could be
other remediation costs pursuant to this seismic retrofit.
The State of California has a seismic review methodology known as HAZUS. The
HAZUS methodology may preclude the need for some structural modifications. All
four Hospitals requested HAZUS review and received a favorable notice pertaining
to structural reclassification. All Hospital buildings, with the exception of
one (an administrative building), have been deemed compliant until January 1,
2030 for both structural and nonstructural retrofit. We do not have an estimate
of the cost to remediate the seismic requirements for the administrative
building as of December 31, 2012.
There are additional requirements that must be complied with by 2030. The costs
of meeting these requirements have not yet been determined. Compliance with
seismic ordinances will be costly and could have a material adverse effect on
our cash flow. In addition, remediation could possibly result in certain
environmental liabilities, such as asbestos abatement.
On July 1, 2011, we entered into software and services agreements with McKesson
Technologies Inc. ("McKesson") to upgrade our information technology systems.
Under the agreements, McKesson will provide us with a variety of services,
including new software implementation and education/training services for our
personnel, software maintenance services and professional services related to
movement and migration of data from legacy systems. McKesson will also furnish
to us and maintain new hardware to accommodate the upgraded software and
systems. The new hardware will include computers and servers, among other
things, and will include installation, testing, and ongoing maintenance. We have
entered into the arrangement to enhance our clinical information systems and
upgrade our billing and revenue management information systems.
The agreements will initially run for a period of five years, and the recurring
services may be renewed by us for successive periods. The agreements do not
provide that they may be terminated by us prior to the initial expiration
date. The agreements provide for one-time fees and recurring fees which
aggregate a total of $22.0 million. Approximately 60% of the fees are for
one-time charges, while the balance is for recurring services. During the three
months ended December 31, 2012 the Company commenced conversion of one of its
facilities to the McKesson system and is concurrently completing testing and
developing system applications where necessary.
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CASH FLOW - Net cash used by operating activities for the nine months ended
December 31, 2012 and 2011 was $6.2 million and $13.8 million, respectively. Net
income (loss), adjusted for depreciation and other non-cash items, excluding the
provision for bad debts and net income from non-controlling interests (not a
measurement under accounting principles generally accepted in the United States
of America ("GAAP")), totaled ($8.8) million and $14.1 million for the nine
months ended December 31, 2012 and 2011, respectively. Cash provided (used) was
$2.7million and ($27.6) million (including $10.8 million for income taxes) in
working capital for the nine months ended December 31, 2012 and 2011,
respectively. Net cash provided (used) in payment of accounts payable, accrued
compensation and benefits and other current liabilities was $8.5 million and
($3.1) million for the nine months ended December 31, 2012 and 2011,
respectively. Cash provided (used) by accounts receivable, net of provision for
bad debts, was ($5.4) million and $2.3 million for the nine months ended
December 31, 2012 and 2011, respectively.
Net cash used in investing activities during the nine months ended December 31,
2012 and 2011 was $7.4 million and $1.7 million, respectively were for new
property and equipment.
Net cash provided (used) in financing activities for the nine months ended
December 31, 2012 and 2011 was $11.9 million and ($1.1) million,
respectively. The increase was incurred primarily to fund payment of the QAF
fees to the State of California.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following table sets forth, for the three and nine months ended December 31,
2012 and 2011 our unaudited condensed consolidated statements of operations
expressed as a percentage of net patient service revenues.
Three months ended December 31, Nine months ended December 31,
2012 2011 2012 2011
Net patient service
revenues 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Salaries and benefits 61.1% 49.2% 54.2% 57.9%
Supplies 15.7% 12.3% 14.2% 14.3%Other operating expenses 32.5% 28.1%
32.7% 21.8%
Depreciation and
amortization 1.2% 0.9% 1.0% 1.1%
110.5% 90.5% 102.1% 95.2%
Operating income (loss) (10.5%) 9.5% (2.1%) 4.8%
Other expense:
Interest expense, net (3.8%) (2.1%) (3.0%) (2.8%)
Income from electronic
health records incentive
program 0.0% 6.0% 0.0% 2.4%
Income (loss) on warrants (1.3%) 0.2% (0.5%) 0.0%
(5.1%) 4.0% (3.5%) (0.3%)
Income (loss) before
income tax provision
(benefit) (15.6%) 13.6% (5.6%) 4.5%
Income tax provision
(benefit) (0.1%) 2.5% (0.7%) 0.7%
Net income (loss) (15.5%) 11.1% (4.9%) 3.7%
Net (income) loss
attributable tononcontrolling interests 0.5% (0.1%) )
0.1% (0.1%)
Net income (loss)
attributable to
Integrated Healthcare
Holdings, Inc. (15.0%) 11.0% (4.8%) 3.6%
THREE MONTHS ENDED DECEMBER 31, 2012 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2011
NET PATIENT SERVICE REVENUES - Net patient service revenues for the three months
ended December 31, 2012 decreased 21.9% compared to fiscal year 2012, from
$114.0 million to $89.0 million. The decrease was primarily related to QAF
revenues of $7.8 million recognized during the three months ended December 31,
2012 compared to $31.9 million during the same period in fiscal 2012. The
provision for bad debts for the three months ended December 31, 2012 was $12.0
million compared to $9.0 million for the three months ended December 31, 2011,
representing a 32.8% increase. The primary reason for the increase in the
provision for bad debts relates to the termination of Section 1011 of the
Medicare Modernization Act of 2003 program in January 2012. Section 1011
provided federal funding of emergency health services for "eligible aliens."
During the three months ended December 31, 2011, patient service revenues
recorded under Section 1011 were reduced by contractual allowances and discounts
whereas patient service revenues related to the same type of services provided
after the termination of Section 1011 are adjusted to net patient service
revenues through the provision for bad debts.
Admissions for the three months ended December 31, 2012 decreased 6.4% compared
to the same period in fiscal year 2012. The decline in admissions is the
combined result of lower obstetrical deliveries, and psychiatric admissions. Net
patient service revenues per admission decreased 16.6% during the three months
ended December 31, 2012. This decrease was primarily due to the decrease in QAF
revenues recognized during the three months ended December 31, 2012 compared to
the same period in fiscal 2012.
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Essentially all patient service revenues come from external customers. The
largest payers are the Medicare and Medicaid (including Medicare and Medicaid
managed care plans) programs accounting for 59% and 64% of the patient service
revenues for the three months ended December 31, 2012 and 2011, respectively.
Uninsured patients, as a percentage of gross charges, decreased to 5.2% from
5.3% for the three months ended December 31, 2012 compared to the three months
ended December 31, 2011.
The Hospitals serve a disproportionate number of indigent patients and receive
governmental revenues and subsidies in support of care for these patients.
Governmental revenues include payments from Medicaid, Medicaid DSH, and Orange
County, CA (CalOptima). Governmental net revenues, including QAF funds,
decreased $23.6 million for the three months ended December 31, 2012 compared to
the three months ended December 31, 2011. $24.1 million of the decline in
governmental revenue is the decrease in QAF revenues from the three months
ended
December 31, 2011.
OPERATING EXPENSES - Operating expenses for the three months ended December 31,
2012 decreased to $98.4 million from $103.2 million, a decrease of $4.8 million,
or 4.6%, compared to the same period in fiscal year 2012. Operating expenses
expressed as a percentage of net patient services revenues for the three months
ended December 31, 2012 and 2011 were 110.5% and 90.5%, respectively. On a per
admission basis, operating expenses increased 1.9%. The increase is the net
result of QAF expenses of $6.9 million incurred during the three months ended
December 31, 2012 compared to $15.9 million during the same period in fiscal
year 2012 offset by loss reserves for potential legal settlements.
Salaries and benefits decreased $1.7 million (3.1%) for the three months ended
December 31, 2012 compared to the same period in fiscal year 2012 due to lower
admissions partially offset by wage increases.
Supplies decreased $35 (0.3%) for the three months ended December 31, 2012
compared to the same period in fiscal year 2012. The decrease primarily related
to the decline in admissions.
Other operating expenses during the three months ended December 31, 2012
decreased to $29.0 million from $32.0 million, a decrease of $3.0 million, or
9.6%, compared to the same period in fiscal year 2012. The decrease is primarily
related to QAF expenses of $6.9 million incurred during the three months ended
December 31, 2012 compared to $15.9 million during the same period in fiscal
year 2012 offset by loss reserves for potential legal settlements.
OPERATING INCOME - The operating income (loss) for the three months ended
December 31, 2012 and 2011 was ($9.3) million and $10.9 million, respectively.
OTHER INCOME (EXPENSE) - We adopted certified EHR technology and recognized
other income of $0 and $6.8 million under the Medicaid EHR incentive program
during the three months ended December 31, 2012 and 2011.
Interest expense for the three months ended December 31, 2012 was $3.4 million
compared to $2.4 million for the same period in fiscal year 2012. The increase
primarily related to increased drawdowns on our revolving line of credit.
As of December 31, 2012, the fair value of our April Warrants aggregated $3.2
million. A gain (loss) relating to the change in fair value of the April
Warrants of ($1.2) million and $0.3 million was recorded during the three months
ended December 31, 2012 and 2011, respectively. See "WARRANTS."
NET INCOME - Net income (loss) for the three months ended December 31, 2012 and
2011 was ($13.4) million and $12.5 million, respectively.
NINE MONTHS ENDED DECEMBER 31, 2012 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
2011
NET PATIENT SERVICE REVENUES - Net patient service revenues for the nine months
ended December 31, 2012 increased 5.7% compared to fiscal year 2012, from $280.5
million to $296.6 million. The increase was primarily related to QAF revenues of
$46.5 million recognized during the nine months ended December 31, 2012 compared
to $31.9 million during the same period in fiscal 2012. The provision for bad
debts for the nine months ended December 31, 2012 was $35.4 million compared to
$25.9 million for the nine months ended December 31, 2011, representing a 37.1%
increase. The primary reason for the increase in the provision for bad debts
relates to the termination of Section 1011 of the Medicare Modernization Act of
2003 program in January 2012. Section 1011 provided federal funding of emergency
health services for "eligible aliens." During the nine months ended December 31,
2011, patient service revenues recorded under Section 1011 were reduced by
contractual allowances and discounts whereas patient service revenues related to
the same type of services provided after the termination of Section 1011 are
adjusted to net patient service revenues through the provision for bad debts.
Admissions for the nine months ended December 31, 2012 decreased 3.5% compared
to the same period in fiscal year 2012. The decline in admissions is the
combined result of lower obstetrical deliveries, and psychiatric admissions. Net
patient service revenues per admission increased 9.5% during the nine months
ended December 31, 2012. This increase was primarily due to an increase
orthopedic surgeries and an increase in QAF revenue.
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Substantially all patient service revenues come from external customers. The
largest payers are Medicare and Medicaid (including Medicare and Medicaid
managed care plans), which combined accounted for 61% and 59% for the nine
months ended December 31, 2012 and 2011, respectively.
Uninsured patients, as a percentage of gross charges, increased to 5.8% from
5.3% for the nine months ended December 31, 2012 compared to the nine months
ended December 31, 2011.
The Hospitals serve a disproportionate number of indigent patients and receive
governmental revenues and subsidies in support of care for these patients.
Governmental revenues include payments from Medicaid, Medicaid DSH, and Orange
County, CA (CalOptima). Governmental net revenues, including QAF funds,
increased $19.2 million for the nine months ended December 31, 2012 compared to
the nine months ended December 31, 2011.
OPERATING EXPENSES - Operating expenses for the nine months ended December 31,
2012 increased to $302.7 million from $267.1 million, an increase of $35.6
million, or 13.3%, compared to the same period in fiscal year 2012. Operating
expenses expressed as a percentage of net patient services revenues for the nine
months ended December 31, 2012 and 2011 were 102.1% and 95.2%, respectively. On
a per admission basis, operating expenses increased 17.4%. The increase is
primarily related to QAF expenses of $45.3 million incurred during the nine
months ended December 31, 2012 compared to $15.9 million during the same period
in fiscal year 2012.
Salaries and benefits decreased $1.8 million (1.1%) for the nine months ended
December 31, 2012 compared to the same period in fiscal year 2012 due to lower
admissions partially offset by wage increases.
Supplies increased $1.8 million (4.4%) for the nine months ended December 31,
2012 compared to the same period in fiscal year 2012. The increase primarily
related to increases in orthopedic supplies and pacemakers.
Other operating expenses during the nine months ended December 31, 2012
increased to $97.1 million from $61.2 million, an increase of $35.9 million, or
58.6%, compared to the same period in fiscal year 2012. The increase is
primarily related to QAF expenses of $45.3 million incurred during the nine
months ended December 31, 2012 compared to $15.9 million during the same period
in fiscal year 2012 and loss reserves for potential legal settlements.
OPERATING INCOME - The operating income (loss) for the nine months ended
December 31, 2012 and 2011 was ($6.1) million and $13.5 million, respectively.
OTHER INCOME (EXPENSE) - We adopted certified EHR technology and recognized
other income of $0 and $6.8 million under the Medicaid EHR incentive program
during the nine months ended December 31, 2012 and 2011.
Interest expense for the nine months ended December 31, 2012 was $8.8 million
compared to $7.8 million for the same period in fiscal year 2012. The increase
primarily related to increased drawdowns on our revolving line of credit.
As of December 31, 2012, the fair value of our April Warrants aggregated $3.2
million. A gain (loss) relating to the change in fair value of the April
Warrants of ($1,577) and $39 was recorded during the nine months ended December
31, 2012 and 2011, respectively. See "WARRANTS."
NET INCOME (LOSS) - Net income (loss) for the nine months ended December 31,
2012 and 2011 was ($14.3) million and $10.2 million, respectively.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
PATIENT SERVICE REVENUES - Patient service revenues are recognized in the period
in which services are performed and are recorded based on established billing
rates (gross charges) less contractual allowances and discounts, principally for
patients covered by Medicare, Medicaid, managed care, and other health plans.
Gross charges are retail charges. They are not the same as actual pricing, and
they generally do not reflect what a hospital is ultimately paid and therefore
are not displayed in the consolidated statements of operations. Hospitals are
typically paid amounts that are negotiated with insurance companies or are set
by the government. Gross charges are used to calculate Medicare outlier payments
and to determine certain elements of payment under managed care contracts (such
as stop-loss payments). Since Medicare requires that a hospital's gross charges
be the same for all patients (regardless of payer category), gross charges are
also what the Hospitals charge all other patients prior to the application
of
discounts and allowances.
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Revenues under the traditional fee-for-service Medicare and Medicaid programs
are based primarily on prospective payment systems. Discounts for
retrospectively cost based revenues and certain other payments, which are based
on the Hospitals' cost reports, are estimated using historical trends and
current factors. Cost report settlements for retrospectively cost-based revenues
under these programs are subject to audit and administrative and judicial
review, which can take several years until final settlement of such matters are
determined and completely resolved. Estimates of settlement receivables or
payables related to a specific year are updated periodically and at year end and
at the time the cost report is filed with the fiscal intermediary. Typically no
further updates are made to the estimates until the final Notice of Program
Reimbursement is received, at which time the cost report for that year has been
audited by the fiscal intermediary. There could be a time lag of several years
between the submission of a cost report and receipt of the Final Notice of
Program Reimbursement. Since the laws, regulations, instructions and rule
interpretations governing Medicare and Medicaid reimbursement are complex and
change frequently, the estimates recorded by the Hospitals could change by
material amounts. The Company has established settlement (payables) receivables
of ($414) and $190 as of December 31 and March 31, 2012, respectively.
The Hospitals receive supplemental payments from the State of California to
support indigent care (Medi-Cal Disproportionate Share Hospital payments or
"DSH") and from the California Medical Assistance Commission ("CMAC") under the
SB 1100 and SB 1255 programs. The Hospitals received supplemental payments of
$5.5 million and $4.0 million during the three months ended December 31, 2012
and 2011, respectively, and $9.6 million and $9.9 million during the nine months
ended December 31, 2012 and 2011, respectively. The related revenue recorded for
the three months ended December 31, 2012 and 2011, was $4.4 million and $3.1
million, respectively, and $11.3 million and $10.5 million for the nine months
ended December 31, 2012 and 2011, respectively. As of December 31 and March 31,
2012, estimated DSH receivables were $6.7 million and $5.0 million,
respectively, which are included as due from government payers in the
accompanying unaudited condensed consolidated balance sheets.
Revenues under managed care plans, including Medicare and Medicaid managed care
plans (with patient service revenues of $24.4 million and $26.2 million for the
three months ended December 31, 2012 and 2011, respectively, and $79.8 million
and $72.3 million for the nine months ended December 31, 2012 and 2011,
respectively), are based primarily on payment terms involving predetermined
rates per diagnosis, per-diem rates, discounted fee-for-service rates and/or
other similar contractual arrangements. These revenues are also subject to
review and possible audit by the payers. The payers are billed for patient
services on an individual patient basis. An individual patient's bill is subject
to adjustment on a patient-by-patient basis in the ordinary course of business
by the payers following their review and adjudication of each particular bill.
The Hospitals estimate the discounts for contractual allowances utilizing
billing data on an individual patient basis. Management believes the estimation
and review process allows for timely identification of instances where such
estimates need to be revised. The Company does not believe there were any
adjustments to estimates of individual patient bills that were material to
patient service revenues.
The Hospitals provide charity care to patients whose income level is below 300%
of the Federal Poverty Level. Patients with income levels between 300% and 350%
of the Federal Poverty Level qualify to pay a discounted rate under AB 774 based
on various government program reimbursement levels. Patients without insurance
are offered assistance in applying for Medicaid and other programs they may be
eligible for, such as state disability, Victims of Crime, or county indigent
programs. Patient advocates from the Hospitals' Medical Eligibility Program
("MEP") screen patients in the hospital and determine potential linkage to
financial assistance programs. They also expedite the process of applying for
these government programs. The estimated costs of charity care (based on direct
and indirect costs as a ratio of gross uncompensated charges associated with
providing care to charity patients) for the three months ended December 31, 2012
and 2011 were approximately $1.9 million and $2.5 million, respectively, and
$6.5 million and $6.3 million for the nine months ended December 31, 2012 and
2011, respectively.
The Company is not aware of any material claims, disputes, or unsettled matters
with any payers that would affect revenues that have not been adequately
provided for in the accompanying unaudited condensed consolidated financial
statements.
PROVISION FOR BAD DEBTS - The Company provides for accounts receivable that
could become uncollectible by establishing an allowance to reduce the carrying
value of such receivables to their estimated net realizable value. The Hospitals
estimate this allowance based on the aging of their accounts receivable,
historical collections experience for each type of payer and other relevant
factors. There are various factors that can impact the collection trends, such
as changes in the economy, which in turn have an impact on unemployment rates
and the number of uninsured and underinsured patients, volume of patients
through the emergency department, the increased burden of copayments to be made
by patients with insurance and business practices related to collection efforts.
These factors continuously change and can have an impact on collection trends
and the estimation process.
The Company's policy is to attempt to collect amounts due from patients,
including copayments and deductibles due from patients with insurance, at the
time of service while complying with all federal and state laws and regulations,
including, but not limited to, the Emergency Medical Treatment and Labor Act
("EMTALA"). Generally, as required by EMTALA, patients may not be denied
emergency treatment due to inability to pay. Therefore, until the legally
required medical screening examination is complete and stabilization of the
patient has begun, services are performed prior to the verification of the
patient's insurance, if any. In nonemergency circumstances or for elective
procedures and services, it is the Hospitals' policy, when appropriate, to
verify insurance prior to a patient being treated.
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Effective March 31, 2012, the Company adopted Accounting Standards Update
("ASU") 2011-07, "Health Care Entities (Topic 954): Presentation and Disclosure
of Patient Service Revenue, Provision for Bad Debts, and the Allowance for
Doubtful Accounts for Certain Health Care Entities," which requires health care
entities to present the provision for bad debts relating to patient service
revenues as a deduction from patient service revenues in the statement of
operations rather than as an operating expense. All periods presented have been
reclassified in accordance with the provisions of ASU 2011-07.
INCOME TAXES - Deferred income tax assets and liabilities are determined based
on the differences between the book and tax basis of assets and liabilities and
are measured using the currently enacted tax rates and laws using the asset and
liability method. We assess the realization of deferred tax assets to determine
whether an income tax valuation allowance is required. We have recorded a 100%
valuation allowance on its deferred tax assets.
There is a recognition threshold and measurement attribute for recognition and
measurement of a tax position taken or expected to be taken in a tax return. It
also provides guidance on de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition.
We and our subsidiaries file income tax returns in the U.S. federal jurisdiction
and California. Certain tax attributes carried over from prior years continue to
be subject to adjustment by taxing authorities. Any penalties or interest
arising from federal or state taxes are recorded as a component of our income
tax provision.
INSURANCE - The Company accrues for estimated general and professional liability
claims, to the extent not covered by insurance, when they are probable and
reasonably estimable. The Company has purchased as primary coverage a
claims-made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from
claims incurred and reported, along with incurred but not reported ("IBNR")
claims, are accrued based upon projections and are discounted to their net
present value using a weighted average risk-free discount rate of 5%. To the
extent that subsequent claims information varies from estimates, the liability
is adjusted in the period such information becomes available.
As of December 31 and March 31, 2012, the Company had accrued $9.3 million and
$11.5 million, respectively, which is comprised of $4.2 million and $4.5
million, respectively, in incurred and reported claims, along with $5.1 million
and $7.0 million, respectively, in estimated IBNR. Estimated insurance
recoveries of $2.7 million and $3.0 million are included in other prepaid
expenses and current assets as of December 31 and March 31, 2012, respectively.
The Company has also purchased occurrence coverage insurance to fund its
obligations under its workers compensation program. The Company has a "paid loss
plan" policy, under which the carrier pays all workers compensation claims, with
no deductible or reimbursement required of the Company. The Company accrues for
estimated workers compensation claims, to the extent not covered by insurance,
when they are probable and reasonably estimable. The ultimate costs related to
this program include expenses for deductible amounts associated with claims
incurred and reported in addition to an accrual for the estimated expenses
incurred in connection with IBNR claims. Claims are accrued based upon
projections and are discounted to their net present value using a weighted
average risk-free discount rate of 5%. To the extent that subsequent claims
information varies from estimates, the liability is adjusted in the period such
information becomes available. As of December 31 and March 31, 2012, the Company
had accrued $593 and $673, respectively, comprised of $282 and $338,
respectively, in incurred and reported claims, along with $311 and $335,
respectively, in estimated IBNR.
In addition, the Company has a self-insured health benefits plan for its
employees. As a result, the Company has established and maintains an accrual for
IBNR claims arising from self-insured health benefits provided to employees. The
Company's IBNR accruals at December 31 and March 31, 2012 were based upon
projections. The Company determines the adequacy of this accrual by evaluating
its limited historical experience and trends related to both health insurance
claims and payments, information provided by its insurance broker and third
party administrator, and industry experience and trends. The accrual is an
estimate and is subject to change. Such change could be material to the
Company's unaudited condensed consolidated financial statements. As of December
31 and March 31, 2012, the Company had accrued $2.0 million and $2.2 million,
respectively, in estimated IBNR.
The Company has also purchased umbrella liability policies with aggregate limits
of $25 million. The umbrella policies provide coverage in excess of the primary
layer and applicable retentions for insured liability risks such as general and
professional liability, auto liability, and workers compensation (employersliability).
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