<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended January 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 registrant 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
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
There were 2,445,000 shares of the Registrant's common stock outstanding as of
March 1, 1998.
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
FORM 10-QSB
FOR THE QUARTER ENDED JANUARY 31, 1998
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
FORM 10-QSB
FOR THE QUARTER ENDED JANUARY 31, 1998
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OF
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES................ 1
Consolidated Balance Sheet (unaudited)................... 1
Consolidated Statements of Operations 3 months
ended January 31, 1998 (unaudited)....................... 2
Consolidated Statements of Operations 6 months
ended January 31, 1998 (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...................... 8
PART II. OTHER INFORMATION........................................ 12
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................ 12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...... 12
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K......................... 12
SIGNATURES.............................................................. 13
</TABLE>
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) OF SUNSTAR
HEALTHCARE, INC. AND SUBSIDIARIES
Consolidated Balance Sheet
January 31, 1998
(unaudited)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
------------
CURRENT ASSETS:
Cash and cash equivalents $ 3,456,856
Held-to-maturity investments 280,000
Patients accounts receivable, less allowance for doubtful
accounts of approximately $125,000 188,860
Prepaid expenses and other assets 430,232
Deferred taxes 53,000
Other receivables 75,813
-----------
TOTAL CURRENT ASSETS 4,484,761
Other Assets:
Furniture, equipment and leasehold improvements, net 521,582
Goodwill, net 325,225
Deposits and other assets 150,755
Deferred taxes 47,000
-----------
Total $ 5,529,323
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 618,890
Medical claims payable 1,002,849
Estimated settlement - Medicare 247,293
Unearned premium - Medicare 115,700
Unearned premium - HMO 299,024
Capital lease obligations, current 43,144
-----------
TOTAL CURRENT LIABILITIES 2,326,900
Capital lease obligations, noncurrent 144,124
-----------
TOTAL LIABILITIES 2,471,024
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, 2,445,000 shares issued and outstanding 2,445
Additional paid-in capital 7,176,250
Unearned compensation from stock options (97,657)
Retained earnings (deficit) (4,022,739)
-----------
TOTAL SHAREHOLDERS' EQUITY 3,058,299
-----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 5,529,323
===========
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the three months ended January 31, 1997 and 1998
(unaudited)
<TABLE>
<CAPTION>
1997 1998
----------- ------------
<S> <C> <C>
Revenues:
Primary care center $1,197,359 $ 961,721
HMO premiums -0- 1,033,508
Investment income 63,879 49,610
---------- -----------
Total revenues 1,261,238 2,044,839
Operating expenses:
Primary care center 875,259 687,628
HMO medical costs -0- 1,062,998
Selling, general and administrative 730,781 1,705,743
Compensation expense 32,552 16,276
Amortization of intangibles 13,086 17,203
---------- -----------
Total operating expenses 1,651,678 3,489,848
Income (loss) before income taxes (390,440) (1,445,009)
Provision for income taxes -0- -0-
---------- -----------
Net income (loss) $ (390,440) $(1,445,009)
========== ===========
Earnings per share $(0.16) $(0.59)
Weighted average shares outstanding 2,395,000 2,431,413
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the six months ended January 31, 1997 and 1998
(unaudited)
<TABLE>
<CAPTION>
1997 1998
------------ -------------
<S> <C> <C>
Revenues:
Primary care center $2,488,894 $ 1,981,939
HMO premiums -0- 1,508,161
Investment income 133,851 108,704
---------- -----------
Total revenues 2,622,745 3,598,804
Operating expenses:
Primary care center 1,724,287 1,415,618
HMO medical costs -0- 1,611,458
Selling, general and administrative 1,328,301 2,870,662
Compensation expense 32,552 32,552
Amortization of intangibles 21,397 36,903
---------- -----------
Total operating expenses 3,106,537 5,967,193
Income (loss) before income taxes (483,792) (2,368,389)
Provision for income taxes (13,677) -0-
---------- -----------
Net income (loss) $ (470,115) $(2,368,389)
========== ===========
Earnings per share $(0.20) $(0.98)
Weighted average shares outstanding 2,395,000 2,413,207
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the six months ended January 31, 1997 and 1998
(unaudited)
<TABLE>
<CAPTION>
1997 1998
---------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) $ (470,115) $(2,368,389)
Adjustments to reconcile net (loss) to
net cash used in operating activities:
Depreciation and amortization 76,590 102,913
Provision for doubtful accounts 107,320 -0-
Noncash compensation 32,552 32,552
Changes in operating assets and liabilities:
Decrease (increase) in accounts and other receivables (199,806) 29,672
Decrease (increase) in prepaid expenses and other assets (66,614) (143,725)
Increase (decrease) in accounts payable,
accrued expenses and other liabilities (26,578) 58,530
Increase (decrease) in medical claims payable -0- 908,991
Increase (decrease) in unearned premium - Medicare ( 10,372) 115,700
Increase (decrease) in estimated settlement - Medicare -0- 116,258
Increase (decrease) in unearned premium - HMO -0- 239,811
---------- -----------
Net cash used in operating activities (557,023) (907,687)
Cash flows from investing activities:
Purchase of furniture, equipment and leasehold improvements (71,101) (152,688)
---------- -----------
Net cash used in investing activities (71,101) (152,688)
Cash flows from financing activities:
Principal payments under capital lease obligations (10,457) (20,946)
Adjustment of initial public offering expenses (30,052) -0-
Exercise of common stock options - 0- 12,500
---------- -----------
Net cash used in financing activities (40,509) (8,446)
---------- -----------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (668,633) (1,068,821)
Cash and cash equivalents, beginning of period 5,993,609 4,525,677
---------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $5,324,976 $ 3,456,856
========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR INTEREST $ 2,740 $ 8,879
========== ===========
NON CASH INVESTING AND FINANCING ACTIVITIES
FURNITURE AND EQUIPMENT ACQUIRED UNDER CAPITAL LEASE OBLIGATIONS $ 80,684 $ 75,177
========== ===========
FURNITURE AND EQUIPMENT DISPOSALS SUBJECT TO INSURANCE RECOVERY $ 0 $ 65,846
========== ===========
</TABLE>
4
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
January 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 discussed
below) 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 100% of the outstanding capital stock of
Brevard's wholly owned subsidiary, SunStar Health Plan, Inc. (SHP)
(formerly known as Boro Medical Corp.). The Company, First Health, Brevard
and SHP collectively are referred to herein as SunStar.
SunStar provides managed healthcare services pursuant to contractual
arrangements, as well as on a fee-for-service basis, through its outpatient
medical centers in central Florida. Throughout fiscal 1997, SunStar's
management was active in developing and obtaining certification for its
health maintenance organization (HMO) product. 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 various counties throughout Florida
in accordance with the provisions of Chapter 641, Florida Statutes. Costs
associated with the development of SunStar's HMO, including management
salaries and benefits, administrative and other indirect costs, have been
reflected as selling, general and administrative expenses in the
accompanying financial statements.
SunStar is authorized to issue 10,000,000 shares of common stock, par value
$.001 per share, and 1,000,000 shares of preferred stock, par value $.001
per share. The preferred stock may be issued in one or more series, the
terms of which may be determined at the time of issuance by the Board of
Directors. In April 1996, the Board of Directors approved a 1.02857 for one
stock split. As a result of the stock split, NHHC holds 900,000 shares of
the Company's common stock representing a 36.8% interest. All share amounts
have been retroactively adjusted for all periods presented.
On May 15, 1996, the Company completed an initial public offering (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 to
purchase additional shares of common stock, pursuant to which the Company
sold 195,000 shares of common stock, par value $.001, resulting in
additional net proceeds to the Company of $853,125. During fiscal year
1997, the Company paid $30,052 of additional stock issuance costs related
to the Offering which has been reflected as a reduction of paid-in capital
in the accompanying financial statements. In November 1997, a consultant
exercised stock options to purchase 50,000 shares of common stock at $.25
per share.
5
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies, continued
-----------------------------------------------------
(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, 1997.
The formation of the Company has been accounted for as a
reorganization. Accordingly, the financial statements have been
prepared using NHHC's historical basis in the assets and liabilities
of First Health and Brevard (the Predecessor), including goodwill and
other intangibles recognized by NHHC in the acquisition of certain
companies. All significant intercompany accounts have been eliminated.
The financial statements reflect the results of operations, financial
condition and cash flows of the Company after the reorganization.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 (SFAS 128),
"Earnings Per Share," effective for periods ending after December 15,
1997. The Company has adopted the provisions of the new standard
during the quarter ended January 31, 1998 and has restated all prior
periods to conform with these provisions.
(c) Revenue Recognition
-------------------
The Company, through its primary care centers, recognizes fee-for-
service revenues based on net realizable amounts due from patients and
third-party payors at the time medical services are rendered and
capitated fees for participating enrollees from outside HMOs during
the month of coverage regardless of utilization. Premium revenue for
prepaid health care under the Company's HMO is recognized as earned on
a pro rata basis over the contract period.
Health care costs relating to capitated fee arrangements from outside
HMOs are recognized as services are provided. 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 settlement for open-year
cost reports subject to audit.
(d) Per Share Data
--------------
The Company has adopted SFAS 128 during the quarter ended January 31,
1998 and, accordingly, has restated all prior periods to conform with
the applicable provisions. Common stock options
6
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
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.
(e) Furniture, Equipment and Leasehold Improvements
-----------------------------------------------
Furniture, equipment and leasehold improvements are stated at cost and
depreciated over estimated useful lives of three to ten years on a
straight-line basis.
(f) Goodwill
--------
Goodwill resulting from the purchase of certain physician practices is
being amortized over periods of 5 to 20 years on a straight-line
basis. Goodwill is evaluated periodically, on a site-by-site basis,
and adjusted, if necessary, if events and circumstances indicate that
an other than temporary decline in value below the current unamortized
historical cost has occurred. Several factors are used to evaluate
goodwill, including but not limited to: management's plans for future
operations, recent operating results and projected undiscounted cash
flows.
(g) Malpractice
-----------
The Company insures its malpractice risks on a claims-made basis. The
Company has secured claims-made coverage from August 1, 1997 through
July 31, 1998, with retroactive coverage through July 1, 1993. 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 the amount, if any, is not
readily estimable.
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 medical expense and
insurance recoveries, if any, are recorded as a reduction of medical
expenses. 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.
(h) 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. Changes in assumptions for medical costs
caused by changes in actual experience could cause these estimates to
change.
(i) Reclassifications
-----------------
Certain reclassifications have been made to the prior year's financial
statement amounts to conform to the current year's financial statement
presentation.
7
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
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 statement was 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 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 ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION AS OF JANUARY 31,
1998 AND THE COMPANY'S RESULTS OF OPERATIONS FOR THE QUARTERS AND SIX MONTH
PERIODS ENDED JANUARY 31, 1998 AND 1997 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 CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES
THERETO INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE YEAR
ENDED JULY 31, 1997.
GENERAL.
On February 24, 1997, SHP was awarded its HMO Certificate of Authority in the
State of Florida. SHP accepted its first HMO members effective May 1, 1997 in
its initial service area of Brevard County, Florida. During the fiscal year
ended July 31, 1997, SHP accelerated its plans to enter markets that the Company
believed were under-served by its managed health care competitors. Thus, SHP
has rapidly expanded and been approved by the State of Florida Agency for
Health Care Administration ("AHCA") to offer its HMO products in Orange,
Osceola, Seminole, Hernando, Lake, Polk, Volusia, Indian River, St. Lucie,
Marion, Citrus, Sumter, Martin, Alachua, Bradford, Columbia, Dixie, Gilchrist,
Lafayette, Levy, Suwannee, Union, Hardee, Highlands, Hillsborough, Manatee,
Okeechobee, Pasco, Pinellas, Baker, Clay, Duval, Nassau and St. Johns
Counties, Florida. 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 with the goal of offering its HMO products throughout the entire
State of Florida over the next fifteen months. SHP currently has over 6,250
physicians and 64 hospitals in its current service areas contracted under the
HMO. As of March 6, 1998, the Company provides coverage to 7,000 members in
this service area. The net losses for the three and six months ended January
31, 1998 are consistent with management's expectations with respect to the costs
associated with the related start-up and development costs of an HMO. SunStar
also provides managed healthcare services pursuant to contractual arrangements,
as well as on a fee-for-service basis, through its outpatient medical centers in
central Florida.
Since accepting its first HMO members in May, 1997, the Company's initial focus
has been on the marketing and sales of its HMO product in the medically
underwritten, individual market. The majority of the Company's growth has come
from the sale of this product 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 product 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.
8
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
Prior to November 1, 1997, the Company's primary care centers had seven service
agreements with Humana Health Care Plans ("Humana"), an HMO. Five of these
agreements were with the Company's subsidiary, Brevard Medical Centers (the
"Humana/Brevard Agreements") and two of the agreements were with the Company's
subsidiary First Health (the "Humana/First Health Agreements"). Humana has
announced its intention to terminate the five Humana/Brevard Agreements in
fiscal 1998, three of which were terminated effective November 30, 1997 and
two of which will be terminated effective March 30, 1998. Thus far over 50% of
the former Humana members treated by Brevard physicians have changed their
coverage to another HMO in the same geographic area and with whom Brevard has
entered into an agreement to provide primary health care services affording
the Company the ability to recover some of this lost revenue. However, in
spite of the Company's efforts to minimize the financial impact resulting from
the termination of the Humana/Brevard Agreements, there can be no assurance
that the Company will not be adversely effected.
Effective November 1, 1997, the method of payment under the two Humana/First
Health Agreements changed from capitation to a fee schedule. Although management
believes that a majority of these capitation fees can be converted to fee for
service revenues, there can be no assurance that such conversion will occur or
that a failure to convert these capitation fees to fee for service revenues
would not have a material adverse impact.
GENERAL FINANCIAL INFORMATION.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JANUARY 31
1997 1998
----------- -----------
<S> <C> <C>
Total Revenue $ 2,622,745 $ 3,598,804
Net loss (470,115) (2,368,389)
Net loss per common share (.20) (.98)
Total Assets 7,065,150 5,529,323
Long term obligations 80,684 144,124
</TABLE>
Results of Operations.
- ----------------------
Six months ended January 31, 1998 compared to six months ended January 31, 1997
Total revenues increased by approximately $976,000 from $2,623,000 for the six
months ended January 31, 1997 to $3,599,000 for the six months ended January 31,
1998. This increase is attributable to $1,508,000 of revenues generated by the
Company's HMO, which commenced operations in the fourth quarter of fiscal 1997,
coupled with a decline in primary care center operations of $507,000 and lower
interest income of approximately $25,000.
As a result of the Company achieving its objective of obtaining an HMO
Certificate of Authority on February 24, 1997 and commencing the enrollment of
its members effective May 1, 1997, the Company realized $1,508,000 in HMO
premium revenues for the six months ended January 31, 1998. The Company
anticipates that HMO premium revenues will rapidly increase over the next
fifteen month period as the Company will continue to implement its accelerated
growth plan. However, there can be no assurance that such growth will occur as
rapidly as the Company expects. Consistent with the Company's initial HMO
product focus the mix of this revenue is approximately 86% individual, 8%
small group and 6% large group.
The decrease in revenues from primary care center operations is the result of a
$53,000 decline in prepaid health clinic revenue, a decrease in HCFA revenue of
$346,000 and a decrease in capitation revenue of $252,000, offset by an increase
in fee-for-service revenue of $144,000. Prepaid health clinic revenue decreased
as SHP was required to phase out this product as a result of receiving its
license to operate as an HMO. Effective September 1, 1997, SHP no longer offers
its prepaid health clinic product. The decline in HCFA revenue is due to a
smaller base of Medicare beneficiaries, coupled with a lower anticipated
reimbursement rate for the six months ended January 31, 1998 when compared to
the same period of the prior year. Amendments to the Social Security Act,
effective January 1, 1996, prohibits SHP from enrolling Medicare beneficiaries
who are not members of employer groups or unions until it establishes Medicare
HMO operations. A Medicare risk contract was filed with HCFA in January 1998.
Capitation revenues declined due to the conversion of the Humana/First Health
Agreements from capitation to a fee schedule effective November 1, 1997 and the
termination of three of the Humana/Brevard Agreements
9
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
effective November 30, 1997. In addition, during the first quarter of 1996 there
was approximately $76,000 in retroactive capitation and bonus payments received
which had not previously been recognized, coupled with a catch up in
establishing an accrual for estimated bonus payments.
Accrued HMO medical costs related to the Company's HMO products were $1,601,000
for the six months ended January 31, 1998. Through January 1998, the Company
adopted a policy of accruing medical costs at approximately 107% of gross
premium revenue. This methodology was employed to establish medical liabilities
for the Company's small membership base and not as a direct result of the
Company's actual utilization experience. Total medical payments for all dates
of service totaled approximately $590,000 net of reinsurance premiums paid for
the period. The Company anticipates that as HMO premium revenues increase,
the amount of medical reserve required as a percentage of HMO revenue will
decrease. However, there can be no assurance that such revenue growth or a
decline in medical reserves as a percentage of revenue will occur as the
Company expects. Costs of primary care center operations as a percentage of
primary care center revenues increased from 69% for the six months ended
January 31, 1997 to 71% for the same period in the current year. This increase
is attributable to a decline in revenues that was not offset by a corresponding
decline in center related costs. As the costs to operate the Company's primary
care centers are relatively fixed, the decline in revenues decreased the
operating margins for the six months ended January 31, 1998.
Selling, general and administrative expenses increased by $1,542,000 or 116%
from $1,328,000 for the six months ended January 31, 1997 to $2,870,000 for the
six months ended January 31, 1998. These additional expenses were primarily
incurred in connection with the Company's accelerated expansion into additional
Florida markets, the development of marketing materials and increased
infrastructure and personnel to effect the Company's transformation into an HMO.
The increase is primarily the result of an increase in salaries and related
benefits of approximately $403,000, an increase in professional and outsourcing
fees of $289,000, marketing salaries, benefits and commission expense related to
the HMO product of $373,000, increased advertising expenses of $286,000, an
increase in occupancy, insurance, general office and related costs of
approximately $43,000 and an increase in printing, postage and other selling
costs related to HMO operations of approximately $144,000.
As a result of the foregoing, the net loss increased to $(2,368,000) for the six
months ended January 31, 1998 compared to $(470,000) for the six months ended
January 31, 1997.
Financial Condition, Liquidity and Capital Resources.
- -----------------------------------------------------
At January 31, 1998 the Company had working capital of $2,158,000 as compared to
working capital of $4,116,000 at July 31, 1997. The decline in working capital
from fiscal 1997 is attributable primarily to the development and marketing
costs incurred in order to transform SHP into an HMO and the Company's expansion
of its initial service area.
Net cash used by operating activities was $(908,000) for the six months ended
January 31, 1998, as compared to net cash used by operating activities of
$(557,000) for the quarter ended January 31, 1997. Net cash used by operating
activities in the current period was primarily attributable to the net loss of
$(2,368,000) for the six months ended January 31, 1998, offset by an increase in
the medical claims payable and reserves for incurred but not reported claims of
$909,000 and additional cash received related to unearned and deferred revenues
of approximately $472,000.
Net cash used in investing activities for the six months ended January 31, 1998
was approximately $(153,000) as a result of purchases of new capital items.
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.
10
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
As of January 31, 1998, proceeds from the Offering of approximately $2,182,000
have been used as working capital to finance the HMO development effort. An
additional $419,000 of the Offering proceeds have been used to purchase
furniture, equipment and leasehold improvements.
During fiscal 1998 and beyond, the Company's liquidity will be affected by
continued accelerated HMO development, marketing and operation. As an HMO, SHP
is required to maintain a minimum capital surplus in an amount which is the
greater of $500,000 or 10% of total liabilities pursuant to Section 641 of the
Florida Insurance Code. At December 31, 1997, SHP's unaudited quarterly
statutory financial statements reflect an actual surplus of $1,437,000. The
Company's cash balances are currently maintained as a cash equivalent of a Money
Market Trust Fund which invests in securities issued or guaranteed by the U.S.
Treasury and repurchase agreements relating to such securities.
HMO development costs will continue to be incurred by SHP in fiscal 1998 to
establish arrangements with physicians, hospitals, and other health care
providers as well as 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).
Although the Company is unable to predict with any degree of certainty the
effect on the Company of its proposed shift of business focus (e.g., from the
provision of primary care services under provider agreements to the
establishment of commercial HMO operations), it is possible that the Company's
HMO operations could result in increased competition with HMOs operating in the
State of Florida. As a result of such competition, it is possible that certain
outside HMOs may terminate provider agreements with the Company's primary care
centers, which could result in a significant decline in revenues. In addition,
the Company's operating expenses can be expected to increase significantly in
connection with the Company's proposed expansion, which will require the Company
to make significant up-front expenditures to further develop new provider
relationships, either contractually or otherwise, and pay salaries for
additional personnel. The Company anticipates that it will make additional
capital expenditures associated with, among other things, furniture, leasehold
improvements and office equipment. The Company expects to pay salaries for
additional marketing, development and other personnel to augment the Company's
efforts to successfully manage anticipated growth. There can be no assurance
that the foregoing factors will not adversely affect the Company's future
operating results.
The Company conducted an initial public offering in May, 1996 to provide funds
for its expansion plans. The net proceeds from such offering, approximating
$6,000,000, have been and will continue to be used to implement such expansion.
The Company anticipates, based on currently proposed plans and assumptions
relating to its operations (including the costs associated with, and the
accelerated timetable for, its proposed expansion), that remaining offering
proceeds will be sufficient to satisfy its net tangible asset requirements as
governed by Nasdaq and other equity requirements as governed by certain
regulatory entities including, without limitation, the Florida Department of
Insurance, AHCA and HCFA into the third quarter of fiscal 1998. However, during
fiscal 1998, the Company intends to seek additional capital to further fund the
HMO development and expansion and continue to satisfy the aforesaid net tangible
asset and equity requirements. Such additional capital may be accomplished
through equity or debt financings. There can be no assurance that additional
financing will be available to the Company on acceptable terms, or at all. 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 stockholders.
11
<PAGE>
SUNSTAR HEALTHCARE, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) On January 10, 1996, the Company entered into a consulting agreement for
certain management consulting services, unrelated to any financial,
capital-raising or securities advice or services. Part of the compensation
granted to the consultant included a ten-year nonqualified stock option (the
"Option") to purchase up to 50,000 shares of the Company's Common Stock, par
value $.001 per share, at an exercise price per share equal to $0.25. On
November 26, 1997, the consultant exercised the Option and, upon the payment of
$12,500 in cash, was issued 50,000 shares of the Company's Common Stock. No
underwriter discounts or commissions were payable upon the granting or exercise
of the Option.
The Company issued the Option and, subsequent to the exercise thereof, the
Common Stock underlying the Option in reliance upon Rule 701 of the Securities
Act of 1933, as amended. The grant of the Option, and the subsequent issuance of
the underlying Common Stock to the consultant was done pursuant to a written
contract relating to the compensation of a consultant who provided bona fide
services to the Company, not in connection with the offer and sale of securities
in a capital-raising transaction.
(d) On May 15, 1996, the Company completed an initial public offering (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 to purchase additional shares of common
stock, pursuant to which the Company sold 195,000 shares of common stock, par
value $.001, resulting in additional net proceeds to the Company of $853,125.
The Company filed Forms S-R, Report of Sales of Securities and Use of Proceeds
Therefrom, on August 27, 1996, February 24, 1997 and August 23, 1997. As of
January 31, 1998, proceeds from the Offering of approximately $2,182,000 have
been used as working capital to finance the HMO development effort. An
additional $419,000 of the Offering proceeds have been used to purchase
furniture, equipment and leasehold improvements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on December 15, 1997. The
persons named below were elected as Directors by holders of the Company's common
stock, casting votes as indicated:
<TABLE>
<CAPTION>
IN FAVOR AGAINST
--------- -------
<S> <C> <C>
Warren D. Stowell 1,633,613 1,200
David A. Jesse 1,633,613 1,200
Frederick H. Fialkow 1,633,613 1,200
Steven Fialkow 1,633,613 1,200
Bernard Levine, M.D. 1,633,613 1,200
Richard Seidelman, M.D. 1,633,613 1,200
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
NONE
12
<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: /s/ Jack Shields
-------------------- --------------------------
Jack Shields
Vice President,
Chief Financial and
Accounting Officer
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SUNSTAR
HEALTHCARE, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENT FOR JANUARY
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> NOV-01-1997
<PERIOD-END> JAN-31-1997
<CASH> 3,457
<SECURITIES> 280
<RECEIVABLES> 314
<ALLOWANCES> 125
<INVENTORY> 0
<CURRENT-ASSETS> 4,485
<PP&E> 1,922
<DEPRECIATION> 1,400
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0
0
<COMMON> 2
<OTHER-SE> 3,056
<TOTAL-LIABILITY-AND-EQUITY> 5,529
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<EPS-PRIMARY> (.59)
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