<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended October 31, 1998
----------------
[ ] 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 1-14382
----------------
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
(Exact name of small business issuer as specified in its charter)
Delaware 59-3361076
- ------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
300 International Pkwy, Ste 230, Heathrow, Florida 32746
---------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(407) 304-1066
----------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all the 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. X Yes No
------- -------
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
There were 2,919,330 shares of the Registrant's common stock outstanding as of
November 30, 1998.
Transitional Small Business Disclosure Format (check one): YES NO X
--- ---
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
FORM 10-QSB
FOR THE QUARTER ENDED OCTOBER 31, 1998
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OF SUNSTAR
HEALTHCARE, INC. AND SUBSIDIARIEs................................................ 2
Consolidated Balance Sheet (unaudited)........................................... 2
Consolidated Statements of Operations (unaudited)................................ 3
Consolidated Statements of Cash Flows (unaudited)................................ 4
Notes to Consolidated Financial Statements....................................... 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONs.............................................. 11
PART II. OTHER INFORMATION................................................................ 17
ITEM 2. CHANGES IN SECURITIES AND USE OF
PROCEEDS......................................................................... 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................. 17
SIGNATURES ................................................................................. 18
</TABLE>
1
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OF SUNSTAR HEALTHCARE,
INC. AND SUBSIDIARIES
Consolidated Balance Sheet
October 31, 1998
(unaudited)
<TABLE>
<CAPTION>
ASSETS
------
CURRENT ASSETS:
<S> <C>
Cash and cash equivalents $11,757,152
Premiums receivable 73,751
Prepaid expenses 236,590
Other current assets 445,140
Deferred taxes 53,000
-----------
TOTAL CURRENT ASSETS 12,565,633
Furniture and equipment, net 380,631
Deposits and other assets 82,428
Deferred taxes 47,000
-----------
Total assets $13,075,692
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Medical claims payable $ 8,211,798
Unearned premium - HMO 2,585,471
Unearned premium - Medicare 94,513
Accounts payable and accrued expenses 909,592
Estimated Medicare settlement 103,175
Capital lease obligations, current 33,819
-----------
TOTAL CURRENT LIABILITIES 11,938,368
Capital lease obligations, noncurrent 73,774
-----------
TOTAL LIABILITIES 12,012,142
Shareholders' equity
Preferred stock, par value $.001 per share, 1,000,000 shares
authorized, no shares outstanding -0-
Common stock, par value $.001 per share, 10,000,000 shares
authorized, 2,919,330 shares issued and outstanding 2,919
Additional paid-in capital 8,531,027
Unearned compensation from stock options (48,829)
Accumulated deficit (7,421,567)
-----------
TOTAL SHAREHOLDERS' EQUITY 1,063,550
-----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $13,075,692
===========
See accompanying notes to consolidated financial statements.
</TABLE>
2
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the three months ended October 31, 1997 and 1998
(unaudited)
<TABLE>
<CAPTION>
1997 1998
----------- -------------
<S> <C> <C>
Revenues:
HMO premiums $ 472,204 $10,522,079
Investment income 54,922 123,364
Other 2,554 -0-
---------- -----------
Total revenues 529,680 10,645,443
Operating expenses:
HMO medical costs 548,460 7,782,343
Selling, general and administrative 917,887 4,038,324
Option based compensation 16,276 16,276
Amortization of intangibles 9,195 8,360
---------- -----------
Total operating expenses 1,491,818 11,845,303
Loss before income taxes (962,138) (1,199,860)
Provision for income taxes -0- -0-
---------- -----------
Loss from continuing operations (962,138) (1,199,860)
Discontinued operations:
Income from discontinued operations 38,758 -0-
---------- -----------
Total discontinued operations 38,758 -0-
---------- -----------
Net loss $ (923,380) $(1,199,860)
========== ===========
Earnings per share
Loss from continuing operations $ (0.40) $ (0.41)
Discontinued operations $ 0.01 $ 0.00
Net loss $ (0.39) $ (0.41)
Weighted average shares outstanding 2,395,000 2,919,330
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended October 31, 1997 and 1998
(unaudited)
<TABLE>
<CAPTION>
1997 1998
----------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (923,380) $(1,199,860)
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities:
Depreciation and amortization 49,184 40,087
Noncash compensation 16,276 16,276
Changes in operating assets and liabilities:
Decrease (increase) in premiums receivables 11,816 (57,658)
Increase (decrease) in prepaid expenses and other assets (101,457) 50,638
Increase in accounts payable and
accrued expenses 26,075 146,504
Increase in medical claims payable 401,076 4,429,083
Increase (decrease) in unearned premium Medicare 124,920 (2,939)
Increase in estimated Medicare settlement 59,593 -0-
Increase in unearned premium HMO 89,636 1,045,263
---------- -----------
Net cash (used in) provided by operating activities (246,261) 4,467,394
Cash flows from investing activities:
Purchase of furniture and equipment (75,557) (49,874)
---------- -----------
Net cash used in investing activities (75,557) (49,874)
Cash flows from financing activities:
Principal payments under capital lease obligations (9,033) (8,152)
---------- -----------
Net cash used in financing activities (9,033) (8,152)
---------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (330,851) 4,409,368
Cash and cash equivalents, beginning of period 4,525,677 7,347,784
---------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $4,194,826 $11,757,152
========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR INTEREST $ 3,997 $ 3,142
========== ===========
NON CASH INVESTING AND FINANCING ACTIVITIES
FURNITURE AND EQUIPMENT ACQUIRED UNDER CAPITAL LEASE OBLIGATIONS $ -0- $ -0-
========== ===========
FURNITURE AND EQUIPMENT DISPOSALS SUBJECT TO INSURANCE RECOVERY $ 59,222 $ -0-
========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
4
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1998
(1) Summary of Significant Accounting Policies
------------------------------------------
(a) Organization
------------
SunStar Healthcare, Inc. ("SunStar" or the "Company") was incorporated
in December 1995 and issued 875,000 shares (prior to a stock split) of
common stock. In January 1996, National Home Health Care Corp.
("NHHC"), then the sole shareholder of the Company, contributed to
SunStar 100% of the outstanding capital stock of its wholly owned
subsidiaries, First Health, Inc. ("First Health") and Brevard Medical
Center, Inc. ("Brevard"), which included all of the outstanding
capital stock of Brevard's wholly owned subsidiary, SunStar Health
Plan, Inc. ("SHP"). Subsequent thereto, the Company restructured its
subsidiaries such that Brevard, First Health, and SHP all became
direct, wholly-owned subsidiaries of SunStar. Except where the
context otherwise indicates, the Company, First Health, Brevard and
SHP collectively are referred to herein as "SunStar" or the "Company".
SunStar is engaged in providing managed healthcare services in the
State of Florida by operating a health maintenance organization
("HMO") through SHP. As originally organized, the Company also
operated seven primary care medical centers through Brevard and First
Health. On April 15, 1998, the Company sold substantially all the
assets of Brevard and First Health, thereby completing its
transformation from a "provider" of medical services through its
primary care medical centers to a "payor" for medical services through
its statewide HMO.
On February 24, 1997, SHP was issued a Certificate of Authority by the
Insurance Department of the State of Florida to operate an HMO in
accordance with the provisions of Chapter 641, Florida Statutes.
Effective May 1, 1997, the Company began accepting its first HMO
members. Through October 31, 1998, the Company has been approved to
operate its HMO in 52 counties in the State of Florida and has
accepted members in all of those counties. Costs associated with the
development and operation of SunStar's HMO, including management
salaries and benefits, administrative and other indirect costs have
been reflected as selling, general and administrative expense in the
accompanying consolidated financial statements.
The Company has entered into a service agreement with a third party
administrator ("TPA") for enrollment and underwriting administration,
claims processing, payment of agents' commissions and premium billing
and collection. Service fees charged to operations under such
contract were $49,007 and $847,475 for the quarters ended October 31,
1997 and 1998, respectively. At October 31, 1998, the Company has a
receivable of approximately $404,000 for premiums and collections due
from the TPA which is included in other current assets.
5
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
(b) Basis of Presentation
---------------------
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments, consisting
solely of normal recurring adjustments, necessary for a fair
presentation of the financial results for the interim periods
presented. Pursuant to the rules and regulations of the Securities
and Exchange Commission, certain footnote disclosures which would
substantially duplicate the disclosures contained in the audited
financial statements of the Company have been omitted from these
interim financial statements. Although the Company believes that the
disclosures presented below are adequate to make the interim financial
statements presented not misleading, it is suggested that these
unaudited condensed consolidated financial statements be read in
conjunction with the consolidated financial statements and the notes
thereto included in the Company's Annual Report on Form 10-KSB for the
year ended July 31, 1998.
The accompanying consolidated financial statements have been prepared
in conformity with generally accepted accounting principles ("GAAP").
All significant intercompany transactions and balances have been
eliminated in consolidation.
As discussed in note 2, effective April 15, 1998, the Company sold
substantially all the assets of Brevard and First Health pursuant to
an Asset Purchase Agreement (the "Asset Purchase Agreement").
Accordingly, the results of operations for Brevard and First Health
for all periods presented are reported in the accompanying
consolidated statements of operations under discontinued operations.
Pursuant to the Asset Purchase Agreement, the Company has agreed to
assign the existing Health Care Financing Administration ("HCFA")
contract held by SHP to the buyer subject to HCFA approval, thus,
related HCFA revenues and program costs have also been included in
discontinued operations in the accompanying consolidated statements of
operations for all periods presented.
(c) Furniture and Equipment
------------------------
Furniture and equipment are stated at cost and depreciated over
estimated useful lives of three to ten years on a straight-line basis.
(d) Medical Claims Payable
----------------------
Medical claims payable consist of actual claims reported but not paid
and estimates of medical services incurred but not reported. The
medical claims payable is based on historical data, current
enrollment, health service utilization statistics, premium revenues
and other related information. These accruals are continually
monitored and reviewed by the Company and are periodically reviewed by
an independent actuary. Modification in assumptions for medical costs
caused by variances in actual experience could cause these estimates
to change.
6
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
(e) Revenue Recognition
-------------------
Premium revenue under the Company's HMO is recognized as earned on a
pro rata basis over the contract period. Reimbursement for the
Company's participation under a federal third-party reimbursement
contract is based on cost reimbursement principles and is subject to
audit and retrospective adjustment. The accompanying consolidated
financial statements reflect an estimated Medicare settlement for
open-year cost reports subject to audit. As discussed in note 1(b),
the Company has agreed to assign the reimbursement contract to the
buyer subject to HCFA approval. Accordingly, related revenues and
program costs have been reflected in discontinued operations in the
accompanying consolidated financial statements.
(f) Per Share Data
--------------
The Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share," during the quarter ended January 31, 1998
and, accordingly, has restated all prior periods to conform with the
applicable provisions. Common stock options are not included in the
computation of diluted earnings per share as their effect is
antidilutive due to the Company's net losses attributable to common
shares.
(g) Reclassifications
-----------------
Certain reclassifications have been made to the prior year's financial
statement amounts to conform to the current year's financial statement
presentation.
(2) Discontinued Operations
-----------------------
On April 15, 1998, the Company sold substantially all the assets of its
primary care medical centers, Brevard and First Health, pursuant to the
Asset Purchase Agreement, to Brevard Medical Care, Inc. for $1,500,000.
Pursuant to the Asset Purchase Agreement, the Company has agreed to assign
the existing HCFA contract held by SHP to the buyer subject to HCFA
approval. The assets sold consisted primarily of accounts receivable,
furniture, equipment and leasehold improvements and capital lease
commitments associated with these assets as well as physician and other
payor agreements.
Assets excluded from the sale consist of cash and cash equivalents. The
Company retained substantially all obligations and liabilities which arose
from or in connection with operations prior to the sales transaction,
except for those capital lease commitments previously discussed.
The results of operations for Brevard and First Health and HCFA revenues
and program costs for all periods presented are reported in the
accompanying consolidated statements of operations under discontinued
operations.
7
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Information with respect to discontinued operations for the quarters ended
October 31, 1997 and 1998 is summarized as follows:
<TABLE>
<CAPTION>
1997 1998
--------- -------
<S> <C><C> <C>
Revenues $ 1,021,837 292,610
Expenses 983,079 292,610
--------- -------
Income from discontinued operations $ 38,758 -0-
========= =======
</TABLE>
(3) Commitments, Contingencies and Other Matters
--------------------------------------------
(a) Professional Liability
----------------------
The Company insures its professional liability risks on a claims-made
basis. The Company has secured claims-made coverage from December 3,
1998 through December 3, 1999, with retroactive coverage through July
1, 1993 to insure for potential professional liability claims by
patients and others as a result of the negligence of physicians that
occurred prior to the divestment of the primary care medical centers.
The Company could become liable for the negligent acts of physicians,
as well as negligence in recruiting and selecting physicians. The
Company currently maintains professional liability insurance with
limits of $1,000,000 in the aggregate and $1,000,000 per occurrence
and requires physicians to maintain malpractice liability insurance in
amounts which it deems adequate for the type of medical services
provided. No accrual for possible losses attributable to incidents
which may have occurred and not been identified under the Company's
incident reporting system has been made because management has not
identified any such incidents.
The Company carries "stop-loss" reinsurance to reimburse it for costs
resulting from catastrophic injuries or illnesses to its HMO members.
Premiums for these policies are reported as HMO medical costs and
insurance recoveries, if any, are recorded as a reduction of HMO
medical costs. Under the excess loss reinsurance policies, recoveries
are made for claims of each enrollee or each covered dependent of each
enrollee, on an annual basis, in excess of the deductible established
in the policy subject to certain limitations. The deductible under
the policy for commercial healthcare claims is currently $50,000.
(b) Regulatory Requirements
-----------------------
As an HMO licensed in Florida, SHP is required, pursuant to Section
641 of the Florida Insurance Code, to maintain a minimum capital
surplus in an amount which is the greater of $800,000 or 10% of total
liabilities or 1% of annualized premium. The Company is in compliance
with this requirement and had an unaudited statutory surplus of
$1,240,000 at October 31, 1998. Dividends are restricted to 10% of
statutory surplus or the entire net operating profits and related net
capital gains derived during the immediately preceding fiscal year
unless prior approval is received from the Insurance Department of the
State of Florida.
8
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Pursuant to the Florida Administrative Code, the Department may
require an HMO to submit a corrective action plan in the event that
net income before taxes over the past four quarterly reporting periods
is less than 2% of total revenue. SHP's reported, unaudited,
quarterly net income has met the 2% criteria.
(c) Nasdaq Listing Requirements
---------------------------
The Company's common stock is listed on the Nasdaq Small-Cap Market.
The Company must meet certain listing standards to permit the
continuation of the trading market for the Company's common stock on
the Nasdaq Small-Cap Market. These standards require that the Company
have (i) either $2 million in net tangible assets (total assets,
excluding goodwill, minus total liabilities), $35 million of market
capitalization or $500,000 of net income (in the last fiscal year or
two of the last three fiscal years); (ii) a public float of 500,000
shares having a market value of at least $1,000,000; (iii) a minimum
bid price of not less than $1 per share; (iv) at least two market
makers; and (v) at least 300 round lot shareholders (holders of 100
shares or more). As of October 31, 1998, the Company did not comply
with the net tangible asset requirement of the listing standards. As
a result, the common stock could be delisted from trading on the
Nasdaq Small-Cap Market. A delisting would materially adversely
affect the trading market for the common stock. In such event,
trading in the common stock would be conducted in the over-the-counter
market known as the OTC Electronic Bulletin Board or the "pink
sheets", and trading could be subject to the "Penny Stock"
regulations. The Penny Stock regulations subject trading in the common
stock to the requirements of Rule 15g-9 under the Exchange Act if the
Common Stock is delisted from trading on the Nasdaq SmallCap Market
and the trading price of the Common Stock is less than $5.00 per
share. Under this rule, broker/dealers who recommend low-priced
securities to persons other than established customers and accredited
investors must satisfy special sales practice requirements. The
broker/dealer must make an individualized written suitability
determination for the purchaser and receive the purchaser's written
consent prior to the transaction. The Securities and Exchange
Commission's regulations also require additional disclosure in
connection with any trades involving a stock defined as a "penny
stock" (generally, a stock with a market price of less than $5.00 per
share), including the delivery, prior to any penny stock transaction,
of a disclosure schedule explaining the penny stock market and its
associated risks. Such requirements could severely limit the
liquidity of the common stock in the secondary market, as few
broker/dealers would likely undertake such compliance activities.
(d) Sale of Unregistered Securities
-------------------------------
On July 16, 1998, the Company completed the Private Placement of
474,330 shares of previously unissued Common Stock, at a per share
price of $3.375, resulting in net proceeds to the Company of
$1,355,251. Under the terms of the Private Placement, the Company
agreed to use its reasonable best efforts to file and obtain
effectiveness of a registration statement under the Securities Act
covering the resale of the shares issued in the Private Placement no
later than 90 days after the closing of the Private Placement. If the
registration statement is not declared effective by the Securities and
Exchange Commission within such 90 day period other than by reason of
delay of a selling shareholder or its counsel or the activity or
inactivity of the Securities and Exchange Commission, then the Company
is obligated to pay cash equal to 1% of the aggregate subscription
price of the Private Placement for the first month of such delay and
2% of such aggregate subscription price for each month of delay
thereafter; provided, however, that in calculating the period of any
delay, there shall be excluded any delays attributable to the failure
by a selling shareholder to review the registration statement in a
reasonably prompt manner. All expenses incurred in any registration of
these shares will be paid by the Company, but the Company will not be
liable for any underwriter discounts or commissions, brokerage fees or
stock transfer taxes incurred with respect to the shares or for the
fees and expenses of counsel for any selling shareholder. The Company
intends to file a registration statement covering these shares as
promptly as practicable.
(e) Liquidity
---------
The Company's consolidated financial statements for the quarter ended
October 31, 1998 have been prepared on a going concern basis which
contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. The
Company incurred a net loss of $923,380 and $1,199,860 for the
quarters ended October 31,1997 and 1998, respectively, and as of
October 31, 1998 had an accumulated deficit of $7,421,567. The
Company expects to incur substantial
9
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
expenditures to further its HMO development and to expand its current
commercial service area and enter into the Medicare market. The
Company's working capital at October 31, 1998 will not be sufficient
to fund ongoing business operations. Management recognizes that the
Company must generate additional resources to enable it to continue
operations. Management's plans include consideration of the sale of
additional equity securities under appropriate market conditions,
alliances or other partnership agreements with entities interested in
and having resources to support the Company's expansion plans, or
other business transactions which would generate sufficient resources
to assure continuation of the Company's operations.
The Company has retained investment banking advisors and independent
consultants to counsel it on the possible sale of equity securities as
well as to introduce and assist in the evaluation of potential merger
and partnering opportunities. However, no assurance can be given that
the Company will be successful in raising additional capital or
entering into a business alliance. Further, there can be no
assurance, assuming the Company successfully raises additional funds
or enters into a business alliance, that the Company will achieve
profitability. If the Company is unable to obtain adequate additional
financing or enter into such business alliance it will not be able to
meet ongoing business operation needs. The consolidated financial
statements do not include any adjustments that may result from the
possible inability of the Company to continue as a going concern.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
"FORWARD-LOOKING" INFORMATION
This report on Form 10-QSB contains certain "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), which represent the Company's expectations and
beliefs, including, but not limited to statements concerning the Company's
expected growth. The words "believe," "expect," "anticipate," "estimate,"
"project," and similar expressions identify forward-looking statements, which
speak only as of the date such statements were made. These statements by their
nature involve substantial risks and uncertainties, certain of which are beyond
the Company's control, and actual results may differ materially depending on a
variety of important factors, including the Company's ability to forge
satisfactory
10
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
relationships with physician groups and provider networks and enroll sufficient
numbers of HMO members; sources for sufficient additional capital to meet the
Company's growth and operations; the failure to properly manage growth and
successfully integrate additional physician groups and providers; changes in
economic conditions; demand for the Company's products; and changes in the
competitive and regulatory environment. Future events and actual results could
differ materially from those expressed in, contemplated by, or underlying any
such forward-looking statements.
THE FOLLOWING DISCUSSION AND ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION AS OF
OCTOBER 31, 1998 AND THE COMPANY'S RESULTS OF OPERATIONS FOR THE QUARTERS ENDED
OCTOBER 31, 1997 AND 1998 SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S
FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS REPORT.
ALTHOUGH THE COMPANY BELIEVES THAT THE DISCLOSURES PRESENTED BELOW ARE ADEQUATE
TO MAKE THE INTERIM FINANCIAL STATEMENTS PRESENTED NOT MISLEADING, IT IS
SUGGESTED THAT THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS BE
READ IN CONJUNCTION WITH THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND THE
NOTES THERETO INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE
YEAR ENDED JULY 31, 1998.
GENERAL.
On February 24, 1997, SHP was awarded its HMO Certificate of Authority by
the Department of Insurance in the State of Florida ("DOI"). SHP accepted its
first HMO members effective May 1, 1997 in its initial service area of Brevard
County, Florida. SHP has rapidly expanded and been approved by the Florida
Agency for Healthcare Administration ("AHCA") to offer its HMO products in 52
counties in central, northern, southwestern and southeastern Florida, including
the metropolitan areas of Tampa, Orlando, Jacksonville, Sarasota, Naples, Fort
Meyers, Miami, Fort Lauderdale and Palm Beach. As a result of this accelerated
growth, development costs have also been accelerated in the areas of
advertising, marketing and materials, personnel and related expenses. SHP
intends to continue this rapid expansion throughout the entire State of Florida
over the next nine months. As of November 1, 1998, the Company provides
coverage to approximately 57,000 members in its current service areas. The
Company has established a growing distribution network of more than 5,500
brokers and 100 general agencies to market its HMO products. The Company has
also established a comprehensive delivery system of contractual providers
numbering approximately 15,000 physicians and 125 hospitals. The net losses for
the three months ended October 31, 1998 and 1997 are consistent with
management's expectations with respect to the costs associated with the start-
up, development and expansion of an HMO. However, if such losses continue
without the Company obtaining additional financing, they would have a material
adverse effect on the Company's business and financial condition. See
"Financial Condition, Liquidity and Capital Resources."
As originally organized, the Company also provided managed healthcare
services pursuant to contractual arrangements, as well as on a fee-for-service
basis, through its seven primary care Medical Centers in central Florida. On
April 15, 1998, the Company sold substantially all the assets of the Medical
Centers and agreed to assign the existing HCFA contract held by SHP upon
approval by HCFA pursuant to the Asset Purchase Agreement, thereby completing
the Company's transformation from a "provider" of medical services through its
Medical Centers to a "payor" for medical services through its statewide HMO.
The Company's sale of its Medical Centers has permitted it to focus its full
attention and resources on the rapid expansion of SHP.
Since accepting its first HMO members in May, 1997, the Company's initial
focus has been on the marketing and sale of its HMO product in the medically
underwritten individual market. The majority of the Company's initial growth
came from the sale of its products in the individual market. The Company's
strategy is to establish a sufficient base of customers for its HMO product in
the individual market within a geographic area, and then to broaden its focus to
the marketing and sale of its HMO products to include the small and large group
markets. The Company has already begun to broaden its focus in several of the
geographic areas in which the Company is currently licensed.
11
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
GENERAL FINANCIAL INFORMATION.
<TABLE>
<CAPTION>
QUARTER ENDED OCTOBER 31
1997 1998
------------ ------------
<S> <C> <C>
Total Revenue $ 529,680 $10,645,443
Loss from continuing operations (962,138) (1,199,860)
Discontinued operations 38,758 -
Net loss (923,380) (1,199,860)
Net loss per common share (.39) (.41)
Total Assets 6,156,012 13,075,692
Long term obligations 100,435 73,774
</TABLE>
Results of Operations.
- ----------------------
Quarter ended October 31, 1997 compared to quarter ended October 31, 1998
Total revenues increased by approximately $10,115,000 from
approximately $530,000 for the three months ended October 31, 1997 to
approximately $10,645,000 for the three months ended October 31, 1998. This
increase is attributable to a $10,050,000 increase in revenues generated by the
Company's HMO, which commenced operations in the fourth quarter of fiscal 1997,
coupled with an increase in interest income of approximately $68,000 and a
decline in other revenues of approximately $2,600.
As a result of the Company obtaining an HMO Certificate of Authority
on February 24, 1997 and commencing the enrollment of its members effective May
1, 1997, the Company realized approximately $472,000 and $10,522,000 in HMO
premium revenues for the quarters ended October 31, 1997 and 1998,
respectively. This HMO premium revenue increase is consistent with enrolled
membership growth to approximately 46,000 at October 31, 1998 from approximately
2,600 at October 31, 1997. The Company anticipates that HMO premium revenues
will continue to rapidly increase over the next nine month period as the Company
further implements its accelerated growth plan. However, there can be no
assurance that such growth will occur as rapidly as the Company expects.
Other revenues declined as SHP was required to phase out its prepaid health
clinic product as a result of receiving its license to operate as an HMO.
Effective September 1, 1997, SHP no longer offered its prepaid health clinic
product.
HMO medical costs were approximately $548,000 and $7,782,000 for the
quarters ended October 31, 1997 and 1998, respectively, resulting in medical
loss ratios of approximately 116% and 74% for the respective periods. HMO
medical costs include amounts accrued for actual claims reported but not paid
and estimates of medical services incurred but not reported. Total medical
payments for all dates of service were approximately $147,000 and $3,701,000,
including net reinsurance premiums paid, for the three months ended October 31,
1997 and 1998, respectively. This reduction of HMO medical costs as a percentage
of HMO revenues was directly attributable to the Company establishing reserves
for its small membership in its new HMO products during the quarter ended
October 31, 1997. The medical reserves as of October 31, 1998 have been
certified by an independent actuary.
Selling, general and administrative expenses increased by
approximately $3,120,000 from approximately $918,000 for the quarter ended
October 31, 1997 to approximately $4,038,000 for the quarter ended October 31,
1998. The increase is primarily the result of an increase in sales and
marketing salaries, benefits and commission expense related to the HMO products
of approximately $1,347,000, an increase in professional and outsourcing fees of
$857,000, additional administrative salaries and related benefits of
approximately $277,000, increased advertising expenses of approximately
$224,000, an increase in printing, postage and other selling costs related to
HMO operations of approximately $204,000, an increase in occupancy, insurance,
general office and related costs of approximately $147,000 and an increase of
approximately $64,000 in other general and administrative expenses, including
costs related to HMO enrollee medical records, benefit statements and other
miscellaneous office expenses. These additional expenses were primarily incurred
in connection with the Company's accelerated
12
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
expansion into additional Florida markets, the development of marketing
materials and increased infrastructure and personnel to support the Company's
transformation into an HMO. Selling, general and administrative expenses as a
percentage of total revenues decreased to 38% for the three months ended October
31, 1998 from 173% for the three months ended October 31, 1997. This decline in
selling, general and administrative expenses as a percentage of total revenues
resulted because the Company was required to make significant up-front
expenditures to acquire HMO membership and develop new provider relationships in
addition to hiring the additional personnel to effect the Company's
transformation into an HMO and to support and manage the related growth and
expansion. The Company expects selling, general and administrative expenses as a
percentage of revenues to continue to decrease as membership and premium
revenues grow. However, there can be no assurance that such membership and
revenue growth or a decline in selling, general and administrative expenses as a
percentage of revenues will occur as the Company anticipates.
As a result of the foregoing, the net loss increased from
approximately $923,000 for the quarter ended October 31, 1997 to approximately
$1,200,000 for the quarter ended October 31, 1998.
Financial Condition, Liquidity and Capital Resources.
- -----------------------------------------------------
At July 31, 1998 the Company had working capital of $1,831,000 as
compared to working capital of $627,000 at October 31,1998. The decline in
working capital from the end of fiscal 1998 is attributable primarily to the
development, marketing and personnel costs incurred in order to support and
manage the continued growth and expansion of the HMO.
Net cash used by operating activities was approximately $246,000 for
the quarter ended October 31, 1997, as compared to net cash provided by
operating activities of approximately $4,467,000 for the quarter ended October
31, 1998. Offsetting the net loss of approximately $1,200,000 for the quarter
ended October 31, 1998 was an increase in the medical claims payable and
reserves for incurred but not reported claims of approximately $4,429,000,
additional cash received related to unearned and deferred revenues of
approximately $1,045,000 and an increase in accounts payable and accrued
expenses of approximately $147,000.
Net cash used in investing activities for the quarters ended October 31,
1997 and 1998 was approximately $76,000 and $50,000, respectively, primarily as
a result of purchases of furniture and equipment associated with the development
of the Company's new administrative offices.
Net cash used in financing activities for the quarters ended October 31,
1997 and 1998 was approximately $9,000 and $8,000, respectively, as a result of
principal payments under capital lease obligations.
The Company has reviewed the Year 2000 problem as it relates to the
Company's internal systems as well as those of its vendors and determined that
it will not have a material impact on its business, operations nor its financial
condition. Nevertheless, the Company's rapid expansion has resulted in an
increasing number of entities with which the Company does business. While the
Company believes that the Year 2000 issue will not have a material impact on the
Company's internal operations or those of its current vendors, there can be no
guarantee that the systems of other unrelated entities on which its systems and
operations rely, or on which its systems and operations may rely in the future,
will be corrected on a timely basis and will not have a material adverse impact
on the Company.
During fiscal 1999, the Company's liquidity will be affected by continued
accelerated HMO development, marketing and operation. Since September 30, 1998,
SHP has been required to maintain a minimum capital surplus in an amount which
is the greater of $800,000 or 10% of total liabilities or 1% of annualized
premium pursuant to Section 641 of the Florida Insurance Code. At October 31,
1998, SHP is in compliance with this requirement as the unaudited monthly
statutory financial statements reflect an actual surplus of approximately
$1,240,000. The Company's cash balances are currently maintained as a cash
equivalent in a Money Market Trust Fund which invests in securities issued or
guaranteed by the U.S. Treasury and repurchase agreements relating to such
securities.
13
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
HMO development costs will continue to be incurred by SHP in fiscal 1999 to
further establish arrangements with physicians, hospitals, and other healthcare
providers as well as to develop marketing materials and strategies necessary to
operate and maintain HMO operations in accordance with statutory requirements
(which shall include the costs of key employee's salaries and expenses). In
order to support the significant growth of the Company's HMO operations,
additional marketing, development and other personnel were hired throughout
fiscal 1998 to augment the Company's efforts to support and manage this growth.
Expenditures for such employees' salaries and related benefits will continue to
be incurred in the future and may increase as additional personnel are needed to
support further HMO membership growth. In addition, the Company anticipates that
it will make additional capital expenditures associated with, among other
things, furniture and equipment necessary due to personnel increases. There can
be no assurance that the foregoing factors will not adversely affect the
Company's future operating results.
The Company's common stock is listed on the Nasdaq Small-Cap Market. The
Company must meet certain listing standards to permit the continuation of the
trading market for the Company's common stock on the Nasdaq Small-Cap Market.
These standards require that the Company have (i) either $2 million in net
tangible assets (total assets, excluding goodwill, minus total liabilities), $35
million of market capitalization or $500,000 of net income (in the last fiscal
year or two of the last three fiscal years); (ii) a public float of 500,000
shares having a market value of at least $1,000,000; (iii) a minimum bid price
of not less than $1 per share; (iv) at least two market makers; and (v) at least
300 round lot shareholders (holders of 100 shares or more). As of October 31,
1998, the Company did not comply with the net tangible asset requirement of the
listing standards. As a result, the common stock could be delisted from trading
on the Nasdaq Small-Cap Market. A delisting would materially adversely affect
the trading market for the common stock. In such event, trading in the common
stock would be conducted in the over-the-counter market known as the OTC
Electronic Bulletin Board or the "pink sheets", and trading could be subject to
the "Penny Stock" regulations. The Penny Stock regulations subject trading in
the common stock to the requirements of Rule 15g-9 under the Exchange Act if the
common stock is delisted from trading on the Nasdaq SmallCap Market and the
trading price of the common stock is less than $5.00 per share. Under this
rule, broker/dealers who recommend low-priced securities to persons other than
established customers and accredited investors must satisfy special sales
practice requirements. The broker/dealer must make an individualized written
suitability determination for the purchaser and receive the purchaser's written
consent prior to the transaction. The Securities and Exchange Commission's
regulations also require additional disclosure in connection with any trades
involving a stock defined as a "penny stock" (generally, a stock with a market
price of less than $5.00 per share), including the delivery, prior to any penny
stock transaction, of a disclosure schedule explaining the penny stock market
and its associated risks. Such requirements could severely limit the liquidity
of the common stock in the secondary market, as few broker/dealers would likely
undertake such compliance activities.
The Company conducted an initial public offering (the "Offering") in May 1996
and a Private Placement (the "Private Placement") in July 1998 to provide funds
for its growth and expansion plans. The net proceeds from such offerings,
approximating $7,400,000, have been used to implement such expansion. The
Company anticipates, based on currently proposed plans and assumptions relating
to its operations (including the costs associated with its accelerated
expansion), that additional offering proceeds will be needed to fund ongoing
business operations and to satisfy its net tangible asset requirements as
governed by the Nasdaq Small-Cap Market and other equity requirements as
governed by certain regulatory entities including, without limitation, the
Florida Department of Insurance, AHCA and HCFA. Management's plans include
consideration of the sale of additional equity securities under appropriate
market conditions, alliances or other partnership agreements with entities
interested in and having resources to support the Company's expansion plans, or
other business transactions which would generate sufficient resources to assure
continuation of the Company's operations.
The Company has retained investment banking advisors and independent
consultants to counsel it on the possible sale of equity securities as well as
to introduce and assist in the evaluation of potential merger and partnering
opportunities. However, no assurance can be given that the Company will be
successful in raising additional capital or entering into a business alliance.
Further, there can be no assurance, assuming the Company
14
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
successfully raises additional funds or enters into a business alliance, that
the Company will achieve profitability. If the Company is unable to obtain
adequate additional financing or enter into such business alliance, it will not
be able to meet ongoing business operation needs. To the extent that the
Company's available cash resources are insufficient to allow the Company to
engage in operations sufficient to generate meaningful revenues or achieve
profitable operations, the inability to obtain additional financing will have a
material adverse effect on the Company. Additional equity financing may involve
substantial dilution to the interests of the Company's existing stockholders.
On December 2, 1998, the Company signed a letter of intent with Brookstreet
Securities Corporation ("Brookstreet") for a proposed private placement to
accredited investors of $6,000,000 in $10.00 units consisting of one share of
Preferred Stock and one warrant to purchase common stock at an exercise price of
$5.00 per share. The Preferred Stock would have a $10.00 liquidation preference
per share, would accrue dividends at 10% per annum, payable quarterly, and would
be convertible at $3.75 per share of common stock, to be adjusted after 2 and 4
years to 75% of the market price of the Company's common stock (but in no cases
below $2.75 per share). The Company would be required to register the shares of
common stock into which the Preferred Stock would be convertible and into which
the warrants would be exercisable within 90 days following the completion of the
offering. In connection with this offering, Brookstreet would receive a 10%
commission, an expense reimbursement of 3%, a warrant to purchase up to 100,000
shares of common stock at $1.50 per share and a warrant to purchase up to
500,000 shares of common stock at $4.00 per share.
This proposed private placement is subject to a number of conditions,
including the completion of a due diligence review by Brookstreet and approval
of the stockholders of the Company in the event the Company desires to issue
more than 150,000 units. While the Company intends to proceed with this
offering, there can be no assurance that it will be completed.
15
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
USE OF PROCEEDS
On May 15, 1996, the Company completed the Offering, pursuant to which the
Company sold 1,300,000 shares of previously unissued common stock, par value
$.001. The Offering resulted in net proceeds to the Company of $5,230,372. On
June 7, 1996, the underwriters in the Offering exercised their over-allotment
option, pursuant to which the Company sold 195,000 shares of Common Stock,
resulting in additional net proceeds to the Company of $853,125. The Company
filed Forms SR, "Report of Sales of Securities and Use of Proceeds Therefrom,"
on August 27, 1996, February 24, 1997 and August 23, 1997. As of October 31,
1998, proceeds from the Offering of approximately $2,571,000 have been directly
invested in SHP and $2,927,000 has been used as working capital to finance the
HMO development effort. An additional $585,000 of the Offering proceeds has
been used to purchase furniture and equipment.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) Exhibits:
<S> <C>
3.1 Certificate of Incorporation*
3.2 By-Laws*
4.1 Specimen Certificate of the Company's Common Stock**
4.2 Form of Warrant Agreement (including Form of Underwriter's Common Stock Purchase Warrant)*
4.3 1996 Stock Option Plan*
4.4 Form of 1996 Stock Option Contract**
27 Financial Data Schedule***
(b) Reports on Form 8-K:
NONE
</TABLE>
- -----------------
* Filed as same exhibit reference to Form SB-2 Registration Statement, filed
on February 26, 1996, File No. 333-1650.
** Filed as same exhibit reference to Amendment No. 2 to Form SB-2 Registration
Statement, filed on May 9, 1996, File No. 333-1650.
*** Filed herewith.
16
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SUNSTAR HEALTHCARE, INC.
Date: December 15, 1998 /s/ Jack Shields
---------------------------- ----------------------------
Jack Shields
Vice President and
Chief Financial Officer
SUNSTAR HEALTHCARE, INC.
Date: December 15, 1998 /s/ David Jesse
---------------------------- ----------------------------
David Jesse
Executive Vice President and
Chief Operating Officer
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SUNSTAR
HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENT FOR OCTOBER
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 11,757
<SECURITIES> 0
<RECEIVABLES> 74
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 12,566
<PP&E> 519
<DEPRECIATION> 138
<TOTAL-ASSETS> 13,076
<CURRENT-LIABILITIES> 11,938
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0
0
<COMMON> 3
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<TOTAL-LIABILITY-AND-EQUITY> 13,076
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