UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)



|[X] | Quarterly Report Pursuant to Section 13 or 15(d)
    of the Securities Exchange Act of 1934                               
|--- | --------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                           
|    | For the quarterly period ended June 30, 2012; or                                                                          
|    |                                                                                                                           
|[_] | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to



Commission File Number 0-23511












INTEGRATED HEALTHCARE HOLDINGS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN
ITS CHARTER)



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



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



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





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










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



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



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



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



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



There were 255,307,262 shares outstanding of the registrant's
common stock as of August 6, 2012.












INTEGRATED HEALTHCARE HOLDINGS, INC.

FORM 10-Q



TABLE OF CONTENTS



|         |                                                                                                                     | Page
|-------- | ------------------------------------------------------------------------------------------------------------------- | ----
|         |                                                                                                                     |     
|         | PART I - FINANCIAL INFORMATION                                                                                      |     
|         |                                                                                                                     |     
|Item 1.  | Financial Statements:                                                                                               | 3   
|         |                                                                                                                     |     
|         | Condensed Consolidated Balance Sheets as of June 30 and March 31, 2012 – (unaudited)                                | 3   
|         |                                                                                                                     |     
|         | Condensed Consolidated Statements of Operations for the three months ended June 30, 2012 and 2011 – (unaudited)     | 4   
|         |                                                                                                                     |     
|         | Condensed Consolidated Statement of Stockholders’ Deficiency for the three months ended June 30, 2012 – (unaudited) | 5   
|         |                                                                                                                     |     
|         | Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2012 and 2011 – (unaudited)     | 6   
|         |                                                                                                                     |     
|         | Notes to Condensed Consolidated Financial Statements – (unaudited)                                                  | 7   
|         |                                                                                                                     |     
|Item 2.  | Management's Discussion and Analysis of Financial Condition and Results of Operations                               | 23  
|         |                                                                                                                     |     
|Item 3.  | Quantitative and Qualitative Disclosures About Market Risk                                                          | 33  
|         |                                                                                                                     |     
|Item 4.  | Controls and Procedures                                                                                             | 33  
|         |                                                                                                                     |     
|         | PART II - OTHER INFORMATION                                                                                         |     
|         |                                                                                                                     |     
|Item 1.  | Legal Proceedings                                                                                                   | 34  
|         |                                                                                                                     |     
|Item 1A. | Risk Factors                                                                                                        | 34  
|         |                                                                                                                     |     
|Item 6.  | Exhibits                                                                                                            | 35  
|         |                                                                                                                     |     
|         | Signatures                                                                                                          | 36  







2





PART I - FINANCIAL INFORMATION

Item 1.  Financial statements



INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in 000's, except par value)

(unaudited)



|                                                                                                 |  | June 30, |         |   | March 31, |  
|------------------------------------------------------------------------------------------------ |  | -------- | ------- | - | --------- | -
|                                                                                                 |  | 2012     |         |   | 2012      |  
|ASSETS                                                                                           |  |          |         |   |           |  
|Current assets:                                                                                  |  |          |         |   |           |  
|Cash and cash equivalents                                                                        |  | $        | 8,913   |   |           | $
|Restricted cash                                                                                  |  |          | 27      |   |           |  
|Accounts receivable, net of allowance for doubtful accounts of $17,106 and $18,201, respectively |  |          | 52,607  |   |           |  
|Inventories of supplies, at cost                                                                 |  |          | 6,971   |   |           |  
|Due from governmental payers                                                                     |  |          | 2,097   |   |           |  
|Prepaid insurance                                                                                |  |          | 1,995   |   |           |  
|Prepaid income taxes                                                                             |  |          | 227     |   |           |  
|Hospital quality assurance fee receivable                                                        |  |          | –       |   |           |  
|Other prepaid expenses and current assets                                                        |  |          | 9,314   |   |           |  
|Total current assets                                                                             |  |          | 82,151  |   |           |  
|                                                                                                 |  |          |         |   |           |  
|Property and equipment, net                                                                      |  |          | 55,171  |   |           |  
|Debt issuance costs, net                                                                         |  |          | 26      |   |           |  
|Total assets                                                                                     |  | $        | 137,348 |   |           | $
|                                                                                                 |  |          |         |   |           |  
|LIABILITIES AND STOCKHOLDERS' DEFICIENCY                                                         |  |          |         |   |           |  
|Current liabilities:                                                                             |  |          |         |   |           |  
|Revolving line of credit                                                                         |  | $        | 14,000  |   |           | $
|Debt, current                                                                                    |  |          | 45,000  |   |           |  
|Accounts payable                                                                                 |  |          | 50,289  |   |           |  
|Accrued compensation and benefits                                                                |  |          | 18,138  |   |           |  
|Accrued insurance retentions                                                                     |  |          | 14,193  |   |           |  
|Warrant liability, current                                                                       |  |          | 910     |   |           |  
|Due to governmental payers                                                                       |  |          | 72      |   |           |  
|Other current liabilities                                                                        |  |          | 4,034   |   |           |  
|Total current liabilities                                                                        |  |          | 146,636 |   |           |  
|                                                                                                 |  |          |         |   |           |  
|Debt, noncurrent                                                                                 |  |          | –       |   |           |  
|Warrant liability, noncurrent                                                                    |  |          | –       |   |           |  
|Capital lease obligations, net of current portion of $762 and $891, respectively                 |  |          | 5,786   |   |           |  
|Total liabilities                                                                                |  |          | 152,422 |   |           |  
|                                                                                                 |  |          |         |   |           |  
|Commitments, contingencies and subsequent events                                                 |  |          |         |   |           |  
|                                                                                                 |  |          |         |   |           |  
|Stockholders' deficiency:                                                                        |  |          |         |   |           |  
|Integrated Healthcare Holdings, Inc. stockholders' deficiency:                                   |  |          |         |   |           |  
|Common stock, $0.001 par value; 800,000 shares authorized; 255,307 shares issued and outstanding |  |          | 255     |   |           |  
|Additional paid in capital                                                                       |  |          | 62,911  |   |           |  
|Accumulated deficit                                                                              |  |          | (75,302 | ) |           |  
|Total Integrated Healthcare Holdings, Inc. stockholders' deficiency                              |  |          | (12,136 | ) |           |  
|Noncontrolling interests                                                                         |  |          | (2,938  | ) |           |  
|Total stockholders' deficiency                                                                   |  |          | (15,074 | ) |           |  
|                                                                                                 |  |          |         |   |           |  
|Total liabilities and stockholders' deficiency                                                   |  | $        | 137,348 |   |           | $



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



3





INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

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

(unaudited)



|                                                                       |  | Three months ended June 30, |        
|---------------------------------------------------------------------- |  | --------------------------- | -------
|                                                                       |  | 2012                        |        
|                                                                       |  |                             |        
|Patient service revenues (net of contractual allowances and discounts) |  | $                           | 91,592 
|Provision for bad debts                                                |  |                             | (9,927 
|Net patient service revenues                                           |  |                             | 81,665 
|                                                                       |  |                             |        
|Operating expenses:                                                    |  |                             |        
|Salaries and benefits                                                  |  |                             | 52,991 
|Supplies                                                               |  |                             | 14,051 
|Other operating expenses                                               |  |                             | 15,043 
|Depreciation and amortization                                          |  |                             | 959    
|                                                                       |  |                             | 83,044 
|                                                                       |  |                             |        
|Operating loss                                                         |  |                             | (1,379 
|                                                                       |  |                             |        
|Other expense:                                                         |  |                             |        
|Interest expense, net                                                  |  |                             | (2,433 
|Gain (loss) on warrants                                                |  |                             | 731    
|                                                                       |  |                             | (1,702 
|                                                                       |  |                             |        
|Loss before income tax provision (benefit)                             |  |                             | (3,081 
|Income tax provision (benefit)                                         |  |                             | 44     
|Net loss                                                               |  |                             | (3,125 
|Net income attributable to noncontrolling interests
    (Note 9)       |  |                             | (349   
|                                                                       |  |                             |        
|Net loss attributable to                                               |  |                             |        
|Integrated Healthcare Holdings, Inc.                                   |  | $                           | (3,474 
|                                                                       |  |                             |        
|Per Share Data (Note 8):                                               |  |                             |        
|Earnings (loss) per common share attributable to                       |  |                             |        
|Integrated Healthcare Holdings, Inc. stockholders                      |  |                             |        
|Basic                                                                  |  | $                           | (0.01  
|Diluted                                                                |  | $                           | (0.01  
|Weighted average shares outstanding                                    |  |                             |        
|Basic                                                                  |  |                             | 255,307
|Diluted                                                                |  |                             | 255,307



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



4







INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' DEFICIENCY

(amounts in 000's)

(unaudited)



|                                       |  | Integrated Healthcare Holdings, Inc. Stockholders |              |  |  |   |                    |  | 
|-------------------------------------- |  | ------------------------------------------------- | ------------ |  |  | - | ------------------ |  | 
|                                       |  |                                                   | Common Stock |  |  |   | Additional Paid-in |  | 
|                                       |  |                                                   | Shares       |  |  |   | Amount             |  | 
|                                       |  |                                                   |              |  |  |   |                    |  | 
|Balance, March 31, 2012                |  |                                                   | 255,307      |  |  | $ | 255                |  | 
|                                       |  |                                                   |              |  |  |   |                    |  | 
|Net income (loss)                      |  |                                                   | –            |  |  |   | –                  |  | 
|                                       |  |                                                   |              |  |  |   |                    |  | 
|Noncontrolling interests distributions |  |                                                   | –            |  |  |   | –                  |  | 
|                                       |  |                                                   |              |  |  |   |                    |  | 
|Balance, June 30, 2012                 |  |                                                   | 255,307      |  |  | $ | 255                |  | 







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





5







INTEGRATED HEALTHCARE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS

(amounts in 000's)

(unaudited)



|                                                                                          |  | Three months ended June 30, |       
|----------------------------------------------------------------------------------------- |  | --------------------------- | ------
|                                                                                          |  | 2012                        |       
|Cash flows from operating activities:                                                     |  |                             |       
|Net loss                                                                                  |  | $                           | (3,125
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                             |       
|Depreciation and amortization of property and equipment                                   |  |                             | 959   
|Provision for doubtful accounts                                                           |  |                             | 9,927 
|Amortization of debt issuance costs                                                       |  |                             | 38    
|Loss (gain) on warrants                                                                   |  |                             | (731  
|Changes in operating assets and liabilities:                                              |  |                             |       
|Accounts receivable                                                                       |  |                             | (8,935
|Inventories of supplies                                                                   |  |                             | (116  
|Due from governmental payers                                                              |  |                             | 3,086 
|Prepaid income taxes                                                                      |  |                             | 665   
|Prepaid expenses - hospital quality assurance fees                                        |  |                             | –     
|Hospital quality assurance fee receivable                                                 |  |                             | 2,436 
|Prepaid insurance, other prepaid expenses and current assets, and other assets            |  |                             | (2,604
|Accounts payable                                                                          |  |                             | (2,411
|Accrued compensation and benefits                                                         |  |                             | (1,709
|Due to governmental payers                                                                |  |                             | 72    
|Unearned revenues - hospital quality assurance fees                                       |  |                             | –     
|Income taxes payable                                                                      |  |                             | –     
|Accrued insurance retentions and other current liabilities                                |  |                             | 608   
|Net cash used in operating activities                                                     |  |                             | (1,840
|                                                                                          |  |                             |       
|Cash flows from investing activities:                                                     |  |                             |       
|Decrease in restricted cash                                                               |  |                             | (17   
|Additions to property and equipment                                                       |  |                             | (601  
|Net cash used in investing activities                                                     |  |                             | (618  
|                                                                                          |  |                             |       
|Cash flows from financing activities:                                                     |  |                             |       
|Proceeds from revolving line of credit, net                                               |  |                             | –     
|Noncontrolling interests distributions                                                    |  |                             | (300  
|Payments on capital lease obligations                                                     |  |                             | (158  
|Net cash provided by (used in) financing activities                                       |  |                             | (458  
|                                                                                          |  |                             |       
|Net decrease in cash and cash equivalents                                                 |  |                             | (2,916
|Cash and cash equivalents, beginning of period                                            |  |                             | 11,829
|Cash and cash equivalents, end of period                                                  |  | $                           | 8,913 
|                                                                                          |  |                             |       
|Supplemental information:                                                                 |  |                             |       
|Cash paid for interest                                                                    |  | $                           | 2,282 
|Cash paid for income taxes                                                                |  | $                           | –     



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



6





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



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



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



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



LIQUIDITY - As of June
30, 2012, the Company had a total stockholders’ deficiency of $15.1 million and a working capital deficit of $64.5 million.  For
the three months ended June 30, 2012, the Company had a net loss of $3.5 million. At June 30, 2012, the Company had no additional
availability under its revolving credit facility (Notes 3 and 14).



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



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



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



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



Substantially all patient
service revenues come from external customers. The largest payers are Medicare and Medicaid (including Medicare and Medicaid managed
care plans), which combined accounted for 57% and 55% of the patient service revenues for the three months ended June 30, 2012
and 2011, respectively. No other payers represent a significant concentration of the Company's patient service revenues.



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



7





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



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



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



|                              |  | Three months ended June 30, |       
|----------------------------- |  | --------------------------- | ------
|                              |  | 2012                        |       
|                              |  |                             |       
|Medicare                      |  | $                           | 14,762
|Medicaid                      |  |                             | 8,784 
|Managed care                  |  |                             | 51,726
|Indemnity, self-pay and other |  |                             | 15,475
|Miscellaneous                 |  |                             | 845   
|                              |  | $                           | 91,592



Revenues under the
traditional fee-for-service Medicare and Medicaid programs are based primarily on prospective payment systems. Discounts for retrospectively
cost based revenues and certain other payments, which are based on the Hospitals' cost reports, are estimated using historical
trends and current factors. Cost report settlements for retrospectively cost-based revenues under these programs are subject to
audit and administrative and judicial review, which can take several years until final settlement of such matters are determined
and completely resolved. Estimates of settlement receivables or payables related to a specific year are updated periodically and
at year end and at the time the cost report is filed with the fiscal intermediary. Typically no further updates are made to the
estimates until the final Notice of Program Reimbursement is received, at which time the cost report for that year has been audited
by the fiscal intermediary. There could be a time lag of several years between the submission of a cost report and receipt of the
Final Notice of Program Reimbursement. Since the laws, regulations, instructions and rule interpretations governing Medicare and
Medicaid reimbursement are complex and change frequently, the estimates recorded by the Hospitals could change by material amounts.
The Company has established settlement receivables (payables) of $(72) and $190 as of June 30 and March 31, 2012, respectively.



8





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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 $4.7 million and $4.9 million during the three months ended June 30, 2012 and 2011,
respectively. The related revenue recorded for the three months ended June 30, 2012 and 2011, was $1.8 million and $3.4 million,
respectively. As of June 30 and March 31, 2012, estimated DSH receivables were $2.1 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 $23.6 million and $19.8 million
for the three months ended June 30, 2012 and 2011, respectively), are based primarily on payment terms involving predetermined
rates per diagnosis, per-diem rates, discounted fee-for-service rates and/or other similar contractual arrangements. These revenues
are also subject to review and possible audit by the payers. The payers are billed for patient services on an individual patient
basis. An individual patient's bill is subject to adjustment on a patient-by-patient basis in the ordinary course of business by
the payers following their review and adjudication of each particular bill. The Hospitals estimate the discounts for contractual
allowances utilizing billing data on an individual patient basis. Management believes the estimation and review process allows
for timely identification of instances where such estimates need to be revised. The Company does not believe there were any adjustments
to estimates of individual patient bills that were material to patient service revenues.



The Hospitals provide
charity care to patients whose income level is below 300% of the Federal Poverty Level. Patients with income levels between 300%
and 350% of the Federal Poverty Level qualify to pay a discounted rate under AB 774 based on various government program reimbursement
levels. Patients without insurance are offered assistance in applying for Medicaid and other programs they may be eligible for,
such as state disability, Victims of Crime, or county indigent programs. Patient advocates from the Hospitals' Medical Eligibility
Program ("MEP") screen patients in the hospital and determine potential linkage to financial assistance programs. They
also expedite the process of applying for these government programs. The estimated costs of charity care (based on direct and indirect
costs as a ratio of gross uncompensated charges associated with providing care to charity patients) for the three months ended
June 30, 2012 and 2011 were approximately $2.5 million and $1.3 million, 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 DOUBTFUL
ACCOUNTS - 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.



9





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



The provision for doubtful
accounts for the three months ended June 30, 2012 was $9.9 million compared to $9.7 million for the three months ended June 30,
2011, representing a 2.1% increase.



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 doubtful accounts relating to patient service
revenue as a deduction from patient service revenue in the statement of operations rather than as an operating expense. All periods
presented have been reclassified in accordance with the provisions of ASU 2011-07.



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



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



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



|                                |  | June 30,
2012 |         |   | March 31,
2012 |  
|------------------------------- |  | ------------- | ------- | - | -------------- | -
|Accounts receivable:            |  |               |         |   |                |  
|Patient accounts receivable     |  | $             | 69,713  |   |                | $
|Allowance for doubtful accounts |  |               | (17,106 | ) |                |  
|Accounts receivable, net        |  | $             | 52,607  |   |                | $
|                                |  |               |         |   |                |  
|Due from government payers:     |  |               |         |   |                |  
|Settlement receivables          |  | $             | –       |   |                | $
|DSH                             |  |               | 2,097   |   |                |  
|                                |  | $             | 2,097   |   |                | $



The Company’s
self-pay collection rate, which is the blended collection rate for uninsured and balance after insurance accounts receivable, was
approximately 5.0% and 11.3% as of June 30 and March 31, 2012, respectively. These self-pay collection rates include payments
made by patients, including co-payments and deductibles paid by patients with insurance. As of June 30 and March 31, 2012,
the allowance for doubtful accounts for self-pay uninsured was 96.1% and 90.3%, respectively, of self-pay uninsured patient accounts
receivable. As of June 30 and March 31, 2012, the allowance for doubtful accounts for self-pay balance after insurance
was 76.8% and 77.4%, respectively, of self-pay balance after insurance patient accounts receivable, consisting primarily of co-pays
and deductibles owed by patients with insurance. As of June 30 and March 31, 2012, the allowance for doubtful accounts for managed
care was 16.1% and 16.1%, respectively, of managed care patient accounts receivable.



10





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



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



PROPERTY AND EQUIPMENT
- Property and equipment are stated at cost, less accumulated depreciation and any impairment write-downs related to assets held
and used. Additions and improvements to property and equipment are capitalized at cost. Expenditures for maintenance and repairs
are charged to expense as incurred. Capital leases are recorded at the beginning of the lease term as property and equipment and
a corresponding lease liability is recognized. The value of the property and equipment under capital lease is recorded at the lower
of either the present value of the minimum lease payments or the fair value of the asset. Such assets, including improvements,
are amortized over the shorter of the lease term or their estimated useful life, where applicable.



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



LONG-LIVED ASSETS -
The Company evaluates its long-lived assets for possible impairment whenever circumstances indicate that the carrying amount of
the asset, or related group of assets, may not be recoverable from estimated future cash flows. Fair value estimates are derived
from established market values of comparable assets or internal calculations of estimated undiscounted future net cash flows. The
estimates of future net cash flows are based on assumptions and projections believed by the Company to be reasonable and supportable.
These assumptions take into account patient volumes, changes in payer mix, revenue, and expense growth rates and changes in legislation
and other payer payment patterns.



DEBT ISSUANCE COSTS
- Debt issuance costs are amortized over the related credit facility’s life using the straight-line method. Debt issuance
costs of $38 and $410 were amortized during the three months ended June 30, 2012 and 2011, respectively.  At June 30
and March 31, 2012, prepaid expenses and other current assets in the accompanying unaudited condensed consolidated balance sheets
included $153 and $153, respectively, as the current portion of debt issuance costs.



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



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



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



11





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



The following table
sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis and where they are
classified within the hierarchy as of June 30, 2012:



|                  |  | Total |     |  | Level 1 |  |   | Level 2 |  |  | Level 3 | 
|----------------- |  | ----- | --- |  | ------- |  | - | ------- |  |  | ------- | 
|                  |  |       |     |  |         |  |   |         |  |  |         | 
|Warrant liability |  | $     | 910 |  |         |  | – |         |  |  | –       | 



|Warrant liability - fair value measurements using significant unobservable inputs (Level 3)
|-------------------------------------------------------------------------------------------
|                                                                                           
|Balance at March 31, 2012                                                                  
|Change in fair value of warrant liability included in earnings                             
|Balance at June 30, 2012                                                                   



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



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



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



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



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



12





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



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



NOTE 2 - PROPERTY AND EQUIPMENT



Property and equipment
consists of the following:



|                              |  | June 30, |         |   | March 31, |  
|----------------------------- |  | -------- | ------- | - | --------- | -
|                              |  | 2012     |         |   | 2012      |  
|                              |  |          |         |   |           |  
|Buildings                     |  | $        | 36,536  |   |           | $
|Land and improvements         |  |          | 13,523  |   |           |  
|Equipment                     |  |          | 18,856  |   |           |  
|Construction in progress      |  |          | –       |   |           |  
|Assets under capital leases   |  |          | 11,218  |   |           |  
|                              |  |          | 80,133  |   |           |  
|Less accumulated depreciation |  |          | (24,962 | ) |           |  
|                              |  |          |         |   |           |  
|Property and equipment, net   |  | $        | 55,171  |   |           | $



Equipment at June 30
and March 31, 2012 includes $5.1 million and $4.6 million, respectively, relating to the Company’s ongoing development of
its new electronic health record technology, which has not been placed into service (Note 12).



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



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



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



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



13





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



NOTE 3 - DEBT



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



| | ● | $45.0 million term loan under the Credit Agreement, dated as of October 9, 2007, as amended (the “Term Loan Credit Agreement”), by and among the Company, Silver Point Finance, LLC and its affiliates SPCP Group IV, LLC and SPCP Group, LLC (together with Silver Point Finance, LLC, “Silver Point”), and PCHI and Ganesha, as Credit Parties, bearing a fixed interest rate of 14.5% per year ($45.0 million outstanding balance at June 30, 2012). If any event of default occurs and continues, the lender can increase the interest rate to 19.5% per year.  The stated maturity date for this Credit Agreement is April 13, 2013 and, accordingly, the term loan is reflected in the accompanying unaudited condensed consolidated balance sheet as current debt.                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ● | $14.0 million revolving line of credit under the Credit and Security Agreement, dated as of August 30, 2010, as amended (the “Revolving Loan Agreement”), by and among the Company, MidCap Funding IV, LLC, as assigned to it from MidCap Financial, LLC, as administrative agent and a lender, and Silicon Valley Bank, as a lender (collectively, the “Lenders”), bearing an interest rate of 5.0% plus LIBOR, with a 2.5% floor, per year (7.5% at June 30, 2012) and an unused commitment fee of 0.625% per year ($14.0 million outstanding balance at June 30, 2012).  For purposes of calculating interest, all payments the Company makes on the revolving line of credit are subject to a six business day clearance period.  The stated maturity date for this Revolving Loan Agreement is August 30, 2013.



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



The Company's outstanding
debt consists of the following:



|                         |  | June 30, |        |  | March 31, |  
|------------------------ |  | -------- | ------ |  | --------- | -
|                         |  | 2012     |        |  | 2012      |  
|                         |  |          |        |  |           |  
|Current:                 |  |          |        |  |           |  
|Revolving line of credit |  | $        | 14,000 |  |           | $
|Term loan                |  |          | 45,000 |  |           |  
|                         |  | $        | 59,000 |  |           | $
|                         |  |          |        |  |           |  
|Noncurrent:              |  |          |        |  |           |  
|Term loan                |  | $        | –      |  |           | $



On August 1,
2012, the Company amended its Revolving Loan Agreement andTerm Loan Credit Agreement(Note 14).



14







INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



NOTE 4 - COMMON STOCK WARRANTS



On April 13, 2010,
the Company issued warrants (the “Omnibus Warrants”) to purchase its common stock for a period of three years at an
exercise price of $0.07 per share in the following denominations: 139.0 million shares to KPC Resolution Company (a company owned
and controlled by Kali P. Chaudhuri, M.D., the Company’s majority shareholder) or its designees and 96.0 million shares to
the $45.0 million term loan lender or its designees. The Omnibus Warrants also provide the holders with certain pre-emptive, information
and registration rights. As of April 13, 2010, the Company recorded warrant expense and the related warrant liability of $2.9 million,
representing fair value.  As of June 30, 2012, the fair value of the Omnibus Warrants was $528.



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 June 30, 2012, the fair value of the Release Warrant was $382.



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 June 30, 2012 and 2011 was $731 and $(3.3) million, respectively.



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



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



|                         |  | June 30, 2012 |       |  | March 31, 2012 | 
|------------------------ |  | ------------- | ----- |  | -------------- | 
|                         |  |               |       |  |                | 
|Expected dividend yield  |  |               | 0.0%  |  |                | 
|Risk-free interest rate  |  |               | 0.2%  |  |                | 
|Expected volatility      |  |               | 65.1% |  |                | 
|Expected term (in years) |  |               | 0.79  |  |                | 



NOTE 5 - INCOME TAXES



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



15





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



The
application ofFASB Interpretation Number18 requires the Company to compute the interim period
income tax provision (benefit) by applying the estimated annual effective tax rate to the loss from continuing operations for the
three months ended June 30, 2012, which resulted in the recognition of a tax expense for the three months ended June 30, 2012.



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



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



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



NOTE 6 - STOCK INCENTIVE PLAN



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



16





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



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



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







|                             |  | Shares |       |   | Weighted-
        average
        exercise
        price |   |      | Weighted-
        average
        grant date
        fair value |  |   | Weighted-
        average
        remaining
        contractual
        term
        (years) |  |  | Aggregate
        intrinsic
        value |    
|---------------------------- |  | ------ | ----- | - | -------------------------------------------------------- | - | ---- | --------------------------------------------------------------- |  | - | -------------------------------------------------------------------------------------------- |  |  | ----------------------------------------- | ---
|                             |  |        |       |   |                                                          |   |      |                                                                 |  |   |                                                                                              |  |  |                                           |    
|Outstanding, March 31, 2012  |  |        | 8,235 |   |                                                          | $ | 0.18 |                                                                 |  |   |                                                                                              |  |  |                                           |    
|Granted                      |  |        | –     |   |                                                          | $ | –    |                                                                 |  | $ | –                                                                                            |  |  |                                           |    
|Exercised                    |  |        | –     |   |                                                          | $ | –    |                                                                 |  |   |                                                                                              |  |  |                                           |    
|Forfeited or expired         |  |        | (100  | ) |                                                          | $ | 0.26 |                                                                 |  |   |                                                                                              |  |  |                                           |    
|Outstanding, June 30, 2012   |  |        | 8,135 |   |                                                          | $ | 0.18 |                                                                 |  |   |                                                                                              |  |  |                                           | 2.4
|Exercisable at June 30, 2012 |  |        | 8,135 |   |                                                          | $ | 0.18 |                                                                 |  |   |                                                                                              |  |  |                                           | 2.4





NOTE 7 - RETIREMENT PLAN



The Company has a 401(k)
plan for its employees. All employees with 90 days of service are eligible to participate, unless they are covered by a collective
bargaining agreement which precludes coverage. The Company matches employee contributions up to 3% of the employee's compensation,
subject to IRS limits. During the three months ended June 30, 2012 and 2011, the Company incurred expenses of $804 and $774, respectively.
These costs are included in salaries and benefits in the accompanying unaudited condensed consolidated statements of operations.  At
June 30 and March 31, 2012, accrued compensation and benefits in the accompanying unaudited condensed consolidated balance sheets
included $1.7 million and $3.9 million, respectively, in accrued employer contributions.



NOTE 8 - INCOME (LOSS) PER SHARE



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



Since the Company incurred losses for the
three months ended June 30, 2012 and 2011, the potential shares of common stock, consisting of approximately 411 million and 412
million shares, respectively, issuable under warrants and stock options, have been excluded from the calculations of diluted loss
per share for those periods.



17





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



NOTE 9 - VARIABLE INTEREST ENTITY



Concurrent with the
close of the Acquisition, PCHI simultaneously acquired title to substantially all of the real property acquired by the Company
in the Acquisition. The Company received $5.0 million and PCHI guaranteed the Company's $45.0 million Loan. The Company remains
primarily liable as the borrower under the $45.0 million Loan notwithstanding its guarantee by PCHI. The $45.0 million term loan
is cross-collateralized by substantially all of the Company's assets and all of the real property of the Hospitals. All of the
Company's operating activities are directly affected by the real property that was sold to PCHI, which is a related party entity
that is affiliated with the Company through common ownership and control. As of June 30, 2012, PCHI was owned 51% by various physician
investors and 49% by Ganesha Realty LLC (“Ganesha”), which is managed by Dr. Chaudhuri.



The Company entered
into a lease agreement dated March 7, 2005 (amended and restated as of April 13, 2010) under which it leased back from PCHI all
of the real estate that it transferred to PCHI (Note 13). The amended lease terminates on the 25-year anniversary of the original
lease (March 7, 2005), grants the Company the right to renew for one additional 25-year period, and requires combined annual base
rental payments of $8.3 million for all the properties. However, until PCHI refinances the related $45.0 million term loan, the
annual base rental payments are reduced to $7.3 million. In addition, the Company offsets, against its rental payments owed to
PCHI, interest payments that it makes on the related $45.0 million term loan. Lease payments to PCHI and offsetting interest payments
are eliminated in consolidation.



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



The Company determined
that it provides the majority of financial support to PCHI through various sources including lease payments, remaining primarily
liable under the $45.0 million term loan, and cross-collateralization of the Company's non-real estate assets to secure the $45.0
million term loan. The Company concluded that PCHI is a VIE and it is the primary beneficiary. Accordingly, the financial statements
of PCHI are included in the accompanying unaudited condensed consolidated financial statements.



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



|                                          |  | June 30, 2012 |        |   | March 31, 2012 |  
|----------------------------------------- |  | ------------- | ------ | - | -------------- | -
|                                          |  |               |        |   |                |  
|Cash                                      |  | $             | 266    |   |                | $
|Property, net                             |  |               | 40,662 |   |                |  
|Other                                     |  |               | 283    |   |                |  
|Total assets                              |  | $             | 41,211 |   |                | $
|                                          |  |               |        |   |                |  
|Debt (as guarantor)                       |  | $             | 45,000 |   |                | $
|Other                                     |  |               | 544    |   |                |  
|Total liabilities                         |  |               | 45,544 |   |                |  
|                                          |  |               |        |   |                |  
|Deficiency                                |  |               | (4,333 | ) |                |  
|Total liabilities and accumulated deficit |  | $             | 41,211 |   |                | $



18





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



As noted above, PCHI
is a guarantor on the $45.0 million term loan should the Company not be able to perform.  PCHI's total liabilities represent
the Company's maximum exposure to loss.



PCHI rental income
and the Company’s related rental expense of $2.0 million and $1.9 million were eliminated upon consolidation for the three
months ended June 30, 2012 and 2011, respectively.



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



NOTE 10 - RELATED PARTY TRANSACTIONS



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



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



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



The hospital quality
assurance fee program (“QAF”) created by this legislation initially provided payments for up to 21 months retroactive
to April 2009 and expiring on December 31, 2010 (“2010 QAF”). In February 2011, CMS gave final approval for the
2010 QAF. In December 2011, CMS gave final approval for the extension of the QAF for the six month period from January 1 through
June 30, 2011 (“2011 QAF”).



During fiscal year
2012, the Company recognized $31.9 million in revenue and recorded expenses of $15.9 million relating to the 2011 QAF.  During
fiscal year 2011, the Company recognized $87.2 million in revenue and recorded expenses of $47.8 million relating to the 2010 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”). Based on the most recent modeling prepared by the California Hospital Association, the Company
anticipates making payments for provider fees and other expenses relating to the 2013 QAF of approximately $105.8 million and
receiving approximately $235.5 million in revenues from the state ($79.4 million from the fee-for-service portion and $156.1
million from the managed care portion). No amounts have been recognized relating to the 2013 QAF pending resolution
of CMS conditions of approval.





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



19





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



NOTE 12 – ELECTRONIC HEALTH RECORDS INCENTIVE PROGRAM



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



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



NOTE 13 - COMMITMENTS AND CONTINGENCIES



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



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



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



GUARANTEE – At
June 30, 2012, the Company continues to maintain an accrual for $1.8 million for a guarantee extended to UC Irvine Healthcare,
a state supported teaching institution, to accept the transfer of an uninsured patient for a necessary higher level of care. The
Company is contesting UC Irvine Healthcare’s position.



LONG TERM LEASE COMMITMENT
WITH VARIABLE INTEREST ENTITY – On April 13, 2010, the Company and PCHI entered into a Second Amendment to Amended and Restated
Triple Net Hospital Building Lease (the “2010 Lease Amendment”).  Under the 2010 Lease Amendment, the annual
base rent to be paid by the Company to PCHI was increased from $5.4 million to $7.3 million. The base rent is subject to an annual
Consumer Price Index increase on January 1 of each year; such increase shall not be less than 2% or more than 6% per year. As a
result, the annual base rent as of January 1, 2012 is $7.7 million. If PCHI refinances the $45.0 million term loan, the annual
base rent will increase to $8.3 million. This lease commitment with PCHI is eliminated in consolidation.



20





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



CAPITAL LEASES - In
connection with the Acquisition, the Company also assumed the leases for the Chapman facility, which include buildings and land
with terms that were extended concurrently with the assignment of the leases to December 31, 2023. The Company leases equipment
under capital leases expiring at various dates through December 2015. Assets under capital leases with a net book value of $6.0
million and $6.2 million are included in the accompanying unaudited condensed consolidated balance sheets as of June 30 March 31,
2012, respectively. Interest rates used in computing the net present value of the lease payments are based on the interest rates
implicit in the leases.



INSURANCE – The
Company accrues for estimated general and professional liability claims, to the extent not covered by insurance, when they are
probable and reasonably estimable. The Company has purchased as primary coverage a claims-made form insurance policy for general
and professional liability risks. Estimated losses within general and professional liability retentions from claims incurred and
reported, along with incurred but not reported (“IBNR”) claims, are accrued based upon projections and are discounted
to their net present value using a weighted average risk-free discount rate of 5%. To the extent that subsequent claims information
varies from estimates, the liability is adjusted in the period such information becomes available. As of June 30 and March 31,
2012, the Company had accrued $12.0 million and $11.5 million, respectively, which is comprised of $5.4 million and $4.5 million,
respectively, in incurred and reported claims, along with $6.6 million and $7.0 million, respectively, in estimated IBNR. Estimated
insurance recoveries of $3.6 million and $3.0 million are included in other prepaid expenses and current assets as of June 30 and
March 31, 2012, respectively.



The Company has also
purchased occurrence coverage insurance to fund its obligations under its workers compensation program. The Company has a "guaranteed
cost" 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 June 30 and March 31, 2012, the Company had accrued $643 and $673, respectively, comprised
of $318 and $338, respectively, in incurred and reported claims, along with $325 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 June 30 and March 31,
2012 were based upon projections. The Company determines the adequacy of this accrual by evaluating its limited historical experience
and trends related to both health insurance claims and payments, information provided by its insurance broker and third party administrator,
and industry experience and trends. The accrual is an estimate and is subject to change. Such change could be material to the Company's
unaudited condensed consolidated financial statements. As of June 30 and March 31, 2012, the Company had accrued $1.6 million and
$2.2 million, respectively, in estimated IBNR.



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



As of June 30, 2012,
the Company finances various insurance policies at an interest rate of 4.39% per annum. The Company incurred finance charges relating
to such policies of $17 and $12 for the three months ended June 30, 2012 and 2011, respectively. As of June 30 and March 31, 2012,
the accompanying unaudited condensed consolidated balance sheets include the following balances relating to the financed insurance
policies.



|                                        |  | June 30, 2012 |       |  | March 31, 2012 |  
|--------------------------------------- |  | ------------- | ----- |  | -------------- | -
|                                        |  |               |       |  |                |  
|Prepaid insurance                       |  | $             | 1,995 |  |                | $
|                                        |  |               |       |  |                |  
|Accrued insurance premiums              |  | $             | 69    |  |                | $
|(Included in other current liabilities) |  |               |       |  |                |  



21





INTEGRATED HEALTHCARE HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

JUNE 30, 2012

(UNAUDITED)



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



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



NOTE 14 – SUBSEQUENT EVENTS



On August 1, 2012,
the Company entered into Amendment No. 3 to Credit and Security Agreement (the “Revolving Loan Amendment”), which amends
the Revolving Loan Agreement.



Under the Revolving
Loan Amendment, the minimum Revolving Loan Commitment Amount under the Revolving Loan Agreement was increased from $14.0 million
to $30.0 million, and the Company agreed to pay to the Lenders an origination fee of 1.0% of the Lenders’ increased commitment
under the Revolving Loan Amendment, or $160.



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



Also on August 1, 2012,
the Company entered into Amendment No. 4 to Credit Agreement and Consent (the “Credit Agreement Amendment”), which
amends the Term Loan Credit Agreement.



Under the Credit Agreement
Amendment, Silver Point consented to and waived certain provisions under the Term Loan Credit Agreement in connection with the
Company’s execution of the Revolving Loan Amendment. In addition, the provisions in the Term Loan Credit Agreement that provide
for mandatory prepayment of the Company’s outstanding “A/R Financing,” as defined, upon receipt of certain federal
matching funds under the QAF program were amended to replace 65% with 80%. In connection with the Credit Agreement Amendment, the
Company agreed to pay Silver Point a one-time consent and amendment fee in an aggregate amount equal to $1.8 million, of which
$450 was paid upon execution of the Credit Agreement Amendment and the balance was added to the principal amount of the Term Loan
Credit Agreement.



On August 1, 2012, the Company borrowed
$9.5 million under its amended Revolving Loan Agreement and used the funds to pay the first installment fee of $9.5 million under
the 2013 QAF.



22





ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.



FORWARD-LOOKING INFORMATION



This Quarterly Report
on Form 10-Q contains forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995.
These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements
by terminology such as “may,” “will,” “should,” “expects,” “plans,”
“anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,”
or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown
risks, uncertainties and other factors, including the risks discussed under the caption “Risk Factors” in our Annual
Report on Form 10-K filed on June 22, 2012 that may cause our Company's or our industry's actual results, levels of activity, performance,
or achievements to be materially different from those expressed or implied by these forward-looking statements.





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



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



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



OVERVIEW



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



SIGNIFICANT CHALLENGES



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



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



23





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.



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



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



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



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



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



LIQUIDITY AND CAPITAL RESOURCES



The
accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates
the realization of assets and settlement of obligations in the normal course of business. We had a total stockholders’ deficiency
of $15.1 million and a working capital deficit of $64.5 million at June 30, 2012.  For the three months ended June 30,
2012, we had a net loss of $3.5 million. As discussed below, the stated maturity date of our $45.0 million term loan with Silver
Point is April 13, 2013.  If we are unable to refinance, restructure or extend our obligation to repay the principal
amount by the maturity date, such failure would constitute a default under the credit agreement with Silver Point and our other
loan facilities, which would permit Silver Point and our other lenders to seize our assets and those of our variable interest
entity, PCHI. Any actions by Silver Point or our other lenders to enforce their rights by seizing our assets could force us into
bankruptcy or liquidation, which would have a material adverse effect on our liquidity and financial position and the value of
our common stock.



24











| | Key items for the three months ended June 30, 2012 included:       
| | -------------------------------------------------------------------
| |                                                                    
| | 1.                                                                 
| |                                                                    
| |                                                                    
| |                                                                    
| |                                                                    
| |                                                                    
| | 2.                                                                 
| |                                                                    
| | DEBT – As of June 30, 2012, we had the following credit facilities:



| | ● | $45.0 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 Finance, LLC and its affiliates SPCP Group IV, LLC and SPCP Group, LLC (together with Silver Point Finance, LLC, “Silver Point”), and PCHI and Ganesha, as Credit Parties, bearing a fixed interest rate of 14.5% per year ($45.0 million outstanding balance at June 30, 2012). If any event of default occurs and continues, the lender can increase the interest rate to 19.5% per year.                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | ● | $14.0 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, 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”), bearing an interest rate of 5.0% plus LIBOR, with a 2.5% floor, per year (7.5% at June 30, 2012) and an unused commitment fee of 0.625% per year ($14.0 million outstanding balance at June 30, 2012).  For purposes of calculating interest, all payments we make on the revolving line of credit are subject to a six business day clearance period.



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



25





Our outstanding debt
consists of the following:



|                         |  | June 30,
2012 |        |  | March 31,
2012 |  
|------------------------ |  | ------------- | ------ |  | -------------- | -
|Current:                 |  |               |        |  |                |  
|Revolving line of credit |  | $             | 14,000 |  |                | $
|Term loan                |  |               | 45,000 |  |                |  
|                         |  | $             | 59,000 |  |                | $
|                         |  |               |        |  |                |  
|Noncurrent:              |  |               |        |  |                |  
|Term loan                |  | $             | –      |  |                | $



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 the Lenders an origination fee of 1.0% of the Lenders’ increased commitment under
the Revolving Loan Amendment, or $160.



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



Also 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.



On August 1, 2012, we borrowed $9.5 million
under the amended Revolving Loan Agreement and used the funds to pay the first installment fee of $9.5 million under the 2013 QAF
(see “HOSPITAL QUALITY ASSURANCE FEES”).



WARRANTS – On
April 13, 2010, we issued warrants (the “Omnibus Warrants”) to purchase our common stock for a period of three years
at an exercise price of $0.07 per share in the following denominations: 139.0 million shares to KPC Resolution Company (a company
owned and controlled by Kali P. Chaudhuri, M.D., our majority shareholder) or its designees and 96.0 million shares to the $45.0
million Term Loan lender or its designees. The Omnibus Warrants also provide the holders with certain pre-emptive, information
and registration rights. As of April 13, 2010, we recorded warrant expense and the related warrant liability of $2.9 million, representing
fair value.  As of June 30, 2012, the fair value of the Omnibus Warrants was $528.



26





In addition, on April
13, 2010, we issued a three-year warrant (the “Release Warrant”) to acquire up to 170.0 million shares of our common
stock at $0.07 per share to Dr. Chaudhuri who facilitated a release enabling us to recover amounts due from our prior lender and
a $1.0 million reduction in principal of our outstanding debt, among other benefits to us. As a result, we recorded the fair
value of the Release Warrant ($2.1 million) as an offsetting cost of the recovery of amounts due from our prior lender. The Release
Warrant also provides the holder with certain pre-emptive, information and registration rights. As of June 30, 2012, the fair value
of the Release Warrant was $382.



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 June 30, 2012 and 2011 was $731 and $(3.3) million, respectively.



HOSPITAL QUALITY ASSURANCE
FEES - In October 2009, the Governor of California signed legislation supported by the hospital industry to impose a provider fee
on general acute care hospitals that, combined with federal matching funds, would be used to provide supplemental Medi-Cal payments
to hospitals. The state submitted the plan to the Centers for Medicare and Medicaid Services (“CMS”) for a required
review and approval process, and certain changes in the plan were required by CMS. Legislation amending the fee program to reflect
the required changes was passed by the legislature and signed by the Governor on September 8, 2010. Among other changes, the
legislation leaves distribution of “pass-through” payments received by Medi-Cal managed care plans that will be paid
to hospitals under the program to the discretion of the plans.



The hospital quality
assurance fee program (“QAF”) created by this legislation initially provided payments for up to 21 months retroactive
to April 2009 and expiring on December 31, 2010 (“2010 QAF”). In February 2011, CMS gave final approval for the
2010 QAF. In December 2011, CMS gave final approval for the extension of the QAF for the six month period from January 1 through
June 30, 2011 (“2011 QAF”).



During fiscal year
2012, we recognized $31.9 million in revenue and recorded expenses of $15.9 million relating to the 2011 QAF.  During fiscal
year 2011, we recognized $87.2 million in revenue and recorded expenses of $47.8 million relating to the 2010 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”). 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). No amounts have been recognized relating to the 2013 QAF pending resolution of
CMS conditions of approval. On August 1, 2012, we paid the first installment fee of $9.5 million under the 2013 QAF (see
“DEBT”).



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.



27





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 $45.0 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 June 30, 2012.



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



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



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



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



CASH FLOW – Net
cash used by operating activities for the three months ended June 30, 2012 and 2011 was $1.8 million and $5.4 million, respectively.
Net income (loss), adjusted for depreciation and other non-cash items, excluding the provision for doubtful accounts and net income
from non-controlling interests (not a measurement under accounting principles generally accepted in the United States of America
(“GAAP”), totaled $(2.9) million and $2.0 million for the three months ended June 30, 2012 and 2011, respectively.
We provided (used) $1.0 million and $(7.5) million in working capital for the three months ended June 30, 2012 and 2011, respectively.
Net used in payment of accounts payable, accrued compensation and benefits and other current liabilities was $3.5 million and $5.1
million for the three months ended June 30, 2012 and 2011, respectively. Cash provided by accounts receivable, net of provision
for doubtful accounts, was $1.0 million and $6.2 million for the three months ended June 30, 2012 and 2011, respectively.



28





Net cash used in investing
activities during the three months ended June 30, 2012 and 2011 was $0.6 million and $0.4 million, respectively. In the three months
ended June 30, 2012 and 2011, we invested $0.6 million and $0.4 million in cash, respectively, in new property and equipment.



Net cash provided by
(used in) financing activities for the three months ended June 30, 2012 and 2011 was $(0.5) million and $0.1 million, respectively.



RESULTS OF OPERATIONS AND FINANCIAL CONDITION



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



|                                                        |  | Three months ended June 30, |       
|------------------------------------------------------- |  | --------------------------- | ------
|                                                        |  | 2012                        |       
|                                                        |  |                             |       
|Net patient service revenues                            |  |                             | 100.0%
|                                                        |  |                             |       
|Operating expenses:                                     |  |                             |       
|Salaries and benefits                                   |  |                             | 64.9% 
|Supplies                                                |  |                             | 17.2% 
|Other operating expenses                                |  |                             | 18.4% 
|Depreciation and amortization                           |  |                             | 1.2%  
|                                                        |  |                             | 101.7%
|                                                        |  |                             |       
|Operating loss                                          |  |                             | (1.7% 
|                                                        |  |                             |       
|Other income (expense):                                 |  |                             |       
|Interest expense, net                                   |  |                             | (3.0% 
|Gain (loss) on warrants                                 |  |                             | 0.9%  
|                                                        |  |                             | (2.1% 
|                                                        |  |                             |       
|Loss before income tax provision (benefit)              |  |                             | (3.8% 
|Income tax provision (benefit)                          |  |                             | 0.1%  
|Net loss                                                |  |                             | (3.9% 
|Net income attributable to noncontrolling
    interests |  |                             | (0.4% 
|Net loss attributable to                                |  |                             |       
|Integrated Healthcare Holdings, Inc.                    |  |                             | (4.3% 



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



NET PATIENT SERVICE
REVENUES – Net patient service revenues for the three months ended June 30, 2012 increased 2.1% compared to fiscal year 2012,
from $80.0 million to $81.7 million. The provision for doubtful accounts for the three months ended June 30, 2012 was $9.9 million
compared to $9.7 million for the three months ended June 30, 2011, representing a 2.1% increase.



Admissions for the
three months ended June 30, 2012 decreased 3.8% compared to the same period in fiscal year 2012. The decline in admissions is the
combined result of lower obstetrical deliveries, and psychiatric admissions. Net patient service revenues per admission increased
5.5% during the three months ended June 30, 2012. This increase was primarily due to an increase orthopedic surgeries and shifts
from inpatient to outpatient observation.



29





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 57% and 55% of the patient service revenues for the three months ended June 30, 2012
and 2011, respectively.



Uninsured patients,
as a percentage of gross charges, increased to 5.4% from 4.8% for the three months ended June 30, 2012 compared to the three months
ended June 30, 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
increased $2.9 million for the three months ended June 30, 2012 compared to the three months ended June 30, 2011.



OPERATING EXPENSES
– Operating expenses for the three months ended June 30, 2012 increased to $83.0 million from $81.8 million, an increase
of $1.2 million, or 1.5%, 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 June 30, 2012 and 2011 were 101.7% and 102.3%, respectively. On a per admission
basis, operating expenses increased 4.9%.



Salaries and benefits
decreased $247 (0.5%) for the three months ended June 30, 2012 compared to the same period in fiscal year 2012.



Supplies increased
$1.1 million (8.5%) for the three months ended June 30, 2012 compared to the same period in fiscal year 2012. The increase primarily
related to increases in orthopedic supplies ($0.7 million) and pacemakers ($0.6 million).



Other operating expenses
during the three months ended June 30, 2012 increased to $15.0 million from $14.5 million, an increase of $0.5 million, or 3.4%,
compared to the same period in fiscal year 2012.



OPERATING LOSS –
The operating loss for the three months ended June 30, 2012 and 2011 was $1.4 million and $1.8 million, respectively.



OTHER INCOME (EXPENSE)
– Interest expense for the three months ended June 30, 2012 was $2.4 million compared to $2.8 million for the same period
in fiscal year 2012. The decrease primarily related to the paydown of our revolving line of credit.



As of June 30, 2012,
the fair value of our April Warrants aggregated $910.  A gain (loss) relating to the change in fair value of the April
Warrants of $731 and $(3.3) million was recorded during the three months ended June 30, 2012 and 2011, respectively. See “WARRANTS.”



NET LOSS - Net loss
for the three months ended June 30, 2012 and 2011 was $3.5 million and $2.9 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.



30





Revenues under the
traditional fee-for-service Medicare and Medicaid programs are based primarily on prospective payment systems. Discounts for retrospectively
cost based revenues and certain other payments, which are based on the Hospitals' cost reports, are estimated using historical
trends and current factors. Cost report settlements for retrospectively cost-based revenues under these programs are subject to
audit and administrative and judicial review, which can take several years until final settlement of such matters are determined
and completely resolved. Estimates of settlement receivables or payables related to a specific year are updated periodically and
at year end and at the time the cost report is filed with the fiscal intermediary. Typically no further updates are made to the
estimates until the final Notice of Program Reimbursement is received, at which time the cost report for that year has been audited
by the fiscal intermediary. There could be a time lag of several years between the submission of a cost report and receipt of the
Final Notice of Program Reimbursement. Since the laws, regulations, instructions and rule interpretations governing Medicare and
Medicaid reimbursement are complex and change frequently, the estimates recorded by the Hospitals could change by material amounts.
We have established settlement receivables (payables) of $(72) and $190 as of June 30 and March 31, 2012, respectively.



The Hospitals receive
supplemental payments from the State of California to support indigent care (Medi-Cal Disproportionate Share Hospital payments
or "DSH") and from the California Medical Assistance Commission ("CMAC") under the SB 1100 and SB 1255 programs.
The Hospitals received supplemental payments of $4.7 million and $4.9 million during the three months ended June 30, 2012 and 2011,
respectively. The related revenue recorded for the three months ended June 30, 2012 and 2011, was $1.8 million and $3.4 million,
respectively. As of June 30 and March 31, 2012, estimated DSH receivables were $2.1 million and $5.0 million, respectively.



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. Management believes the estimation and review process allows for timely identification of instances where such estimates
need to be revised. We do not believe there were any adjustments to estimates of individual patient bills that were material to
our patient service revenues.



The Hospitals provide
charity care to patients whose income level is below 300% of the Federal Poverty Level. Patients with income levels between 300%
and 350% of the Federal Poverty Level qualify to pay a discounted rate under AB 774 based on various government program reimbursement
levels. Patients without insurance are offered assistance in applying for Medicaid and other programs they may be eligible for,
such as state disability, Victims of Crime, or county indigent programs. Patient advocates from the Hospitals' Medical Eligibility
Program ("MEP") screen patients in the hospital and determine potential linkage to financial assistance programs. They
also expedite the process of applying for these government programs. The estimated costs (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 June 30, 2012
and 2011 were approximately $2.5 million and $1.3 million, respectively.



We are not aware of
any material claims, disputes, or unsettled matters with any payers that would affect revenues that have not been adequately provided
for in our consolidated financial statements.



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



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



31





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



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



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



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



INSURANCE - We accrue
for estimated general and professional liability claims, to the extent not covered by insurance, when they are probable and reasonably
estimable. We have purchased as primary coverage a claims-made form insurance policy for general and professional liability risks.
Estimated losses within general and professional liability retentions from claims incurred and reported, along with incurred but
not reported (“IBNR”) claims, are accrued based upon projections and are discounted to their net present value using
a weighted average risk-free discount rate of 5%. To the extent that subsequent claims information varies from estimates, the liability
is adjusted in the period such information becomes available. As of June 30 and March 31, 2012, we had accrued $12.0 million and
$11.5 million, respectively, which is comprised of $5.4 million and $4.5 million, respectively, in incurred and reported claims,
along with $6.6 million and $7.0 million, respectively, in estimated IBNR. Estimated insurance recoveries of $3.6 million and $3.0
million are included in other prepaid expenses and current assets as of June 30 and March 31, 2012, respectively.



We have also purchased
occurrence coverage insurance to fund our obligations under our workers compensation program. We have a "guaranteed cost"
policy, under which the carrier pays all workers compensation claims, with no deductible or reimbursement required of us. We accrue
for estimated workers compensation claims, to the extent not covered by insurance, when they are probable and reasonably estimable.
The ultimate costs related to this program include expenses for deductible amounts associated with claims incurred and reported
in addition to an accrual for the estimated expenses incurred in connection with IBNR claims. Claims are accrued based upon projections
and are discounted to their net present value using a weighted average risk-free discount rate of 5%. To the extent that subsequent
claims information varies from estimates, the liability is adjusted in the period such information becomes available. As of June
30 and March 31, 2012, we had accrued $643 and $673, respectively, comprised of $318 and $338, respectively, in incurred and reported
claims, along with $325 and $335, respectively, in estimated IBNR.



In addition, we have
a self-insured health benefits plan for our employees. As a result, we have established and maintain an accrual for IBNR claims
arising from self-insured health benefits provided to employees. Our IBNR accruals at June 30 and March 31, 2012 were based upon
projections. We determine the adequacy of this accrual by evaluating our historical experience and trends related to both health
insurance claims and payments, information provided by our insurance broker and third party administrator and industry experience
and trends. The accrual is an estimate and is subject to change. Such change could be material to our unaudited condensed consolidated
financial statements. As of June 30 and March 31, 2012, we had accrued $1.6 million and $2.2 million, respectively, in estimated
IBNR.



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

32





ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.



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



ITEM 4. CONTROLS AND PROCEDURES.



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



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



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







33





PART II - OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



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



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



ITEM 1A. RISK FACTORS



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





34









ITEM 6. EXHIBITS





|Exhibit Number |  | Description                                                                                                                                                                                                                                                                                                                                
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|               |  |                                                                                                                                                                                                                                                                                                                                            
|10.10          |  | Amendment No. 3 to Credit and Security Agreement, dated August 1, 2012, by and among the Company, MidCap Funding IV, LLC, as Agent and lender, and Silicon Valley Bank, as lender (incorporated by reference to Exhibit 99.1 to the Registrant’s Report on Form 8-K filed on August 6, 2012).                                              
|               |  |                                                                                                                                                                                                                                                                                                                                            
|10.11          |  | Amendment No. 4 to Credit Agreement and Consent, dated August 1, 2012, by and among the Company, Pacific Coast Holdings Investment, LLC, Ganesha Realty, LLC, SPCP Group IV, LLC, SPCP Group, LLC and Silver Point Finance, LLC (incorporated by reference to Exhibit 99.2 to the Registrant’s Report on Form 8-K filed on August 6, 2012).
|               |  |                                                                                                                                                                                                                                                                                                                                            
|31.1           |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                        
|               |  |                                                                                                                                                                                                                                                                                                                                            
|31.2           |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                        
|               |  |                                                                                                                                                                                                                                                                                                                                            
|32.1           |  | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                        
|               |  |                                                                                                                                                                                                                                                                                                                                            
|32.2           |  | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                        







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












*Pursuant to Rule 405(a)(2) of Regulation S-T, the Company will
furnish the XBRL Interactive Data Files with detailed footnote tagging as Exhibit 101 in an amendment to this Form 10-Q within
the permitted 30-day grace period for the first quarterly period in which detailed footnote tagging is required after the filing
date of this Form 10-Q.





35





SIGNATURES



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





|                       | INTEGRATED HEALTHCARE HOLDINGS, INC |                                                      
|---------------------- | ----------------------------------- | -----------------------------------------------------
|                       |                                     |                                                      
|Dated: August 10, 2012 | By:                                 | /s/ Steven R. Blake                                  
|                       |                                     | Steven R. Blake                                      
|                       |                                     | Chief Financial Officer (Principal Financial Officer)
|                       |                                     |                                                      













36