UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 1996
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: 0-26818
AHI HEALTHCARE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4556968
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
12620 Erickson Avenue, Suite A, Downey, CA 90241
(Address of principal executive offices) (Zip Code)
(310) 803-5333
(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 the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
14,523,041 shares of Common Stock, $0.01 par value,
as of July 31, 1996
CONTENTS
AHI HEALTHCARE SYSTEMS, INC.
Page #
PART I Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1996 (Unaudited) and
December 31, 1995. 3
Consolidated Statements of Operations for the Second Quarter and
Six Months ended June 30, 1996 and 1995 (Unaudited). 4
Consolidated Statements of Cash Flows for the Six Months ended
June 30, 1996 and 1995 (Unaudited). 5
Notes to Consolidated Financial Statements (Unaudited)--June 30, 1996. 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 8
PART II Other Information
Item 1. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security-Holders 16
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
Exhibit Index 18
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
June 30 December 31
1996 1995
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $24,723,000 $31,608,000
Accounts receivable, net of
allowances 13,801,000 12,639,000
Due from related parties 159,000 177,000
Prepaid expenses 841,000 880,000
Recoverable and deferred income
taxes 2,238,000 1,908,000
Total current assets 41,762,000 47,212,000
Equipment and property improvements,
at cost 8,831,000 6,906,000
Less: accumulated depreciation and
amortization (3,964,000) (3,412,000)
4,867,000 3,494,000
Deposits and other assets 350,000 422,000
Goodwill and other intangible assets,
net 26,105,000 25,128,000
Total assets $73,084,000 $76,256,000
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accrued medical claims $19,072,000 $15,442,000
Accounts payable and accrued
expenses 13,052,000 11,526,000
Notes payable, current portion 3,361,000 3,364,000
Unsecured notes payable to
stockholders - 333,000
Total current liabilities 35,485,000 30,665,000
Notes payable, less current portion 1,130,000 1,203,000
Contingencies
Stockholders' equity:
8% cumulative convertible voting
preferred stock, $0.01 par value,
25,000,000 shares authorized,
none issued - -
Common stock, $0.01 par value,
75,000,000 shares authorized,
14,523,000 shares issued and
outstanding at June 30, 1996 and
December 31, 1995 145,000 145,000
Additional paid-in capital 47,753,000 47,753,000
Accumulated deficit (10,951,000) (2,999,000)
Unamortized deferred compensation
expense (54,000) (61,000)
Due from stockholder (424,000) (450,000)
36,469,000 44,388,000
Total liabilities and stockholders'
equity $73,084,000 $76,256,000
See accompanying notes.
</TABLE>
3
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
Second Quarter Ended Six Months Ended
June 30 June 30
1996 1995 1996 1995
<S> <C> <C> <C> <C>
Total operating revenue $28,420,000 $29,494,000 $59,211,000 $54,441,000
Cost of medical services 25,861,000 24,088,000 49,037,000 43,191,000
Gross margin 2,559,000 5,406,000 10,174,000 11,250,000
Operating expenses:
Medical network operating
expenses 2,371,000 1,604,000 4,524,000 2,979,000
General and administrative 5,952,000 2,670,000 10,779,000 5,066,000
Depreciation and
amortization 591,000 539,000 1,241,000 980,000
Network development 940,000 2,315,000 2,680,000 4,371,000
9,854,000 7,128,000 19,224,000 13,396,000
Loss from operations (7,295,000) (1,722,000) (9,050,000) (2,146,000)
Interest income 311,000 19,000 688,000 46,000
Interest expense (44,000) (132,000) (87,000) (235,000)
Net interest income (expense) 267,000 (113,000) 601,000 (189,000)
Loss before income tax benefit(7,028,000) (1,835,000) (8,449,000) (2,335,000)
Income tax benefit - 1,046,000 497,000 1,219,000
Net loss $(7,028,000) $ (789,000) $(7,952,000) $(1,116,000)
Net loss per share $ (0.48) $ (0.07) $ (0.55) $ (0.10)
Pro forma net loss $ (7,028,000) $(1,051,000) $(7,952,000) $(1,378,000)
Pro forma net loss per share$ (0.48) $ (0.10) $ (0.55) $ (0.13)
Weighted average shares
outstanding 14,523,000 10,912,000 14,523,000 10,901,000
See accompanying notes.
</TABLE>
4
<TABLE>
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
June 30
1996 1995
<S> <C> <C>
Operating activities
Net loss $ (7,952,000) $ (1,116,000)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation and amortization 1,241,000 980,000
Amortization of deferred compensation
expense and other 11,000 -
Changes in operating assets and liabilities:
Accounts receivable (1,062,000) (1,644,000)
Due from related parties 18,000 25,000
Prepaid expenses 39,000 (793,000)
Recoverable and deferred income taxes (330,000) (1,267,000)
Deposits and other assets 72,000 (8,000)
Accrued medical claims 3,162,000 (2,867,000)
Accounts payable and accrued expenses 551,000 3,232,000
Income taxes payable - (810,000)
Net cash used in operating activities (4,250,000) (4,268,000)
Investing activities
Purchases of equipment and property
improvements (1,925,000) (1,095,000)
Acquisitions of affiliates, net of
cash acquired - (2,764,000)
Net cash used in investing activities (1,925,000) (3,859,000)
Financing activities
Cash received on note receivable
from stockholder 26,000 -
Proceeds from issuance of notes payable
and Bank Facility borrowings 9,495,000
Principal payments of notes payable (736,000) (1,407,000)
Net cash provided by (used in)
financing activities (710,000) 8,088,000
Decrease in cash and cash equivalents (6,885,000) (39,000)
Cash and cash equivalents at beginning
of period 31,608,000 655,000
Cash and cash equivalents at end of period $24,723,000 $ 616,000
<CAPTION>
AHI HEALTHCARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (continued)
Six Months Ended
June 30
1996 1995
<S> <C> <C>
Supplemental schedule of noncash
investing and financing activities:
Stockholder note receivable issued
in connection with common stock
issuance $ - $450,000
Details of businesses acquired in purchase
transactions:
Fair value of assets acquired $1,670,000 $17,196,000
Less:
Issuance of promissory notes 327,000 70,000
Other liabilities assumed 1,343,000 13,413,000
Cash paid for acquisitions - (3,713,000)
Cash of acquired businesses - 949,000
Net cash paid $ - $(2,764,000)
Supplemental disclosure of cash flow
information:
Interest paid $ 88,000 $ 182,000
Income taxes paid 103,000 950,000
See accompanying notes.
</TABLE>
AHI HEALTHCARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of AHI
Healthcare Systems, Inc. (the "Company") have been prepared in accordance
with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. All significant intercompany balances and transactions
have been eliminated. Operating results for the second quarter and six
months ended June 30, 1996 are not necessarily indicative of the results that
may be expected for the year ended December 31, 1996. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1995.
2. INCOME TAXES
The Company and all of its affiliated physician networks
("Affiliates") (except Camino Real Medical Group, Inc., which is a
C-corporation) operated as Subchapter S corporations through December 31,
1993. Effective January 1, 1994, the Company elected to operate as a
C-corporation, while its Affiliates continued to elect S-corporation status
through December 31, 1994. Effective January 1, 1995, all except two of the
Affiliates, and effective January 1, 1996, all except one of the Affiliates,
elected C-corporation status.
3. CONTINGENCIES
The Company and its Affiliates are subject to certain legal actions
arising in the ordinary course of business, generally related to professional
liability, employment-related issues and other business-related claims. In
the opinion of management, such actions are either adequately insured or will
not have a material adverse effect on the Company's financial position,
operating results or working capital.
The Company is a defendant in a class action securities lawsuit, which
asserts that the Company, among other things, artificially inflated the price
of its common stock by misleading securities analysts and by failing to
disclose in its initial public offering prospectus alleged difficulties it
was having with the acquisition of Lakewood Health Plan, Inc. and with two of
the Company's contracts with FHP, Inc. The Company intends to vigorously
defend this lawsuit. The Company believes that it is adequately insured and
does not expect that the outcome of this lawsuit will have a material adverse
effect on the financial condition or results of operations of the Company.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Overview
The Company's physician networks contract directly with managed care payors
to deliver covered medical benefits and to coordinate all inpatient and
outpatient care for enrollees. Generally, each physician network receives a
prepaid monthly fee ("capitation payment") from the payor for each enrollee
who selects a primary care physician contracting with the physician network
as the enrollee's primary care provider. In addition, such contracts
typically provide for incentive payments to be paid by the payor to the
physician network to encourage the effective utilization of hospital and other
medical services ("shared risk pools"). All such medical revenue is in turn
assigned to the Company pursuant to an administrative, nonmedical management
agreement between the physician network and the Company, but excludes amounts
that may not be assigned under applicable law.
For the six months ended June 30, 1996, approximately 97% of the Company's
total operating revenue related to contracts under which the Company's
physician networks received a capitation payment for each covered life in
exchange for the responsibility for the provision of specific medical
services to assigned enrollees and bonuses under shared risk pools. Payors
are increasingly overseeing the provision of and the prices charged for
medical services with the goal of reducing costs and lowering reimbursement.
The Company's success therefore depends in large part on the effective
management of health care costs, including controlling utilization of
specialty care physicians, other ancillary providers, inpatient services and
services from third-party providers at competitive prices. Any adjustment
downward in capitation payments or shared risk pools caused by the increasing
efforts by payors to reduce their costs could have a material adverse effect
on the Company's operating results.
The physician networks contract with health care providers to deliver
medical services. The cost of medical services provided by the physician
networks consists of payments to affiliated primary care, specialty care and
ancillary providers. Compensation to such health care providers varies,
typically according to the type of provider. Primary care physicians are
generally compensated on a capitated basis, receiving a fixed monthly fee for
each enrollee selecting such physician, or on a discounted fee-for-service
basis when enrollment is low. Specialist and ancillary providers are
typically compensated on a discounted fee-for-service basis. Two of the
Company's affiliated networks include medical groups owned by the Company.
The associated medical and non-medical costs of operating these owned medical
groups are also included in cost of medical services.
Medical network operating expenses consist primarily of salary-related
expenses for the provision of medical management services to the physician
networks. The majority of costs associated with medical management services
fluctuate commensurate with enrollment and the number of contracted
providers. These costs consist primarily of claims administration,
eligibility management, quality and utilization management, physician
credentialing and other costs associated with the Company's National Service
Center.
Network development expenses include direct and indirect costs associated
with the strategic planning, corporate organization, provider and payor
contracting and relationship building activities that are required to develop
and market a locally integrated managed health care system. Direct costs
include incremental costs of Company personnel physically located in new
markets prior to commencement of operations and certain incremental
administrative costs such as legal, travel and facility expenses. Indirect
costs consist of an allocation of expenses associated with existing executive
and corporate development staff engaged early in the network development
process to conduct market research and assess the operational and strategic
opportunities available in the market. The Company defines a network as
being "in development" once direct, incremental network development costs
have been incurred. Networks are considered operational once network
physicians begin accepting enrollees into the network.
The Company has also entered into new markets by acquiring existing
physician networks. In such acquisitions, the Company has principally
purchased the physician and payor contracts that the network holds; it
generally does not purchase the assets or the practices of the independent
physicians who contract with the network. These contracts represent
significantly all of the assets of the physician network and, accordingly,
result in the recording of goodwill on the Company's balance sheet. In
addition to the consideration paid in the acquisition, all direct costs
associated with these acquisitions are capitalized. In August 1994, the
Company acquired Camino Real Medical Group ("CRMG") in Northern California
(which had approximately 28,000 prepaid covered lives at the date of
acquisition) and in February 1995, the Company acquired The Healthcare
Partnership ("THP") in Houston, Texas (which had approximately 40,600 prepaid
covered lives at the date of acquisition). In March 1996, the Company
acquired Private Physician Group at Stanford ("PPGS") in Northern California
(which had approximately 2,900 prepaid covered lives at the date of
acquisition). Although the Company continues to pursue acquisitions and
other opportunities, there can be no assurance that the Company will be able
to capitalize successfully on such opportunities or that such opportunities
will be available to the Company in the future.
The Company's acquisition and development strategy has had, and will
continue to have, significant revenue and cost implications. This is due to
a number of factors, including market conditions outside of the Company's
base Southern California market requiring more administrative costs, costs of
building infrastructure and the inherently delayed timing of revenue
increases and cost decreases after developing networks or acquiring networks
with higher medical costs.
The Company's operating results are subject to quarter-to-quarter
fluctuations. Quarterly results may be affected by the timing and amount of
costs associated with the Company's development and acquisition of physician
networks (as discussed above), by adverse trends in the cost of medical
services, and by other operational or external factors, including the
movement of enrollees, particularly during periods of open enrollment for HMOs.
The Company has made acquisitions of underperforming companies with
significantly higher costs of medical services as a percentage of revenue, and
there can be no assurance that the Company's acquisitions, including future
acquisitions, will not adversely affect the Company's results of operations
or cause significant quarterly fluctuations and/or adjustments. Quarterly
results may also be affected by significant differences between actual and
estimated amounts receivable or payable related to payor "shared risk" pool
arrangements and provider "incurred but not reported" claims ("IBNR"), which
are adjusted periodically as settlements are made in the case of shared risk
pools or as actual claims are paid in the case of IBNR. The Company has noted
a recent industry trend of increasing health care costs, particularly in
fee-for-service arrangements.
Quarterly results have in the past been subject to fluctuations and, as a
result, the operating results for any quarter are not necessarily indicative
of results for any future period. The Company expects to report a net loss
through at least the fourth quarter of 1996.
On July 2, 1996, pursuant to discussions with the California Department of
Corporations ("DOC"), the regulatory body for all managed care plans in the
State of California, the Company, through a wholly-owned subsidiary, filed an
application for restricted licensure as a Knox-Keene health care service
plan for its California operations. The restricted license, if granted, would
allow for the direct receipt of capitation payments for hospital and medical
professional services, but would not allow the marketing of a health care
service plan to employers and subscribers. The Company may be required to
restructure its California business operations (which, if such license is not
granted, could result in a reduction of revenue) and/or incur additional
administrative costs in the future to meet applicable regulatory
requirements, including the tangible net equity requirements pursuant to DOC
regulations, which could restrict the Company's ability to transfer funds and
pay dividends. Although the Company does not expect the licensure process to
have a material impact on its operations, there can be no assurance that the DOC
will not impose requirements adverse to the Company's business.
Other Operating Data
The following table sets forth certain operating data as of June 30, 1996
and 1995.
<TABLE>
<CAPTION>
June 30
1996 1995
<S> <C> <C>
Affiliated physicians:
Primary care 2,166 1,645
Specialists 5,088 3,474
Total 7,254 5,119
Number of physician networks:
Operational 48 19
In development 45 73
Total 93 92
Number of payor contracts 250 138
Prepaid covered lives by product type:
Commercial 159,826 144,567
Senior 23,205 25,011
Medicaid 6,632 5,093
Total 189,663 174,671
Prepaid covered lives by region:
California 129,045 130,433
Texas 56,147 44,238
Southeast 4,471 -
Total 189,663 174,671
</TABLE>
Results of Operations
The following table sets forth consolidated statements of operations data
expressed as a percentage of total operating revenue for the second quarter
and six months ended June 30, 1996 and 1995.
<TABLE>
<CAPTION>
Quarter Ended Six Months Ended
June 30 June 30
1996 1995 1996 1995
(% of total operating revenue)
<S> <C> <C> <C> <C>
Total operating revenue 100.0 100.0 100.0 100.0
Cost of medical services 91.0 81.7 82.8 79.3
Gross margin 9.0 18.3 17.2 20.7
Operating expenses:
Medical network operating
expenses 8.3 5.4 7.6 5.5
General and administrative 20.9 9.1 18.2 9.3
Depreciation and
amortization 2.2 1.8 2.1 1.8
Network development 3.3 7.8 4.5 8.0
34.7 24.1 32.4 24.6
Loss from operations (25.7) (5.8) (15.2) (3.9)
Interest income 1.2 0.0 1.2 0.1
Interest expense (0.2) (0.3) (0.2) (0.4)
Net interest income (expense) 1.0 (0.3) 1.0 (0.3)
Loss before income taxes (24.7) (6.1) (14.2) (4.2)
Income tax benefit 0.0 3.6 0.8 2.2
Net loss (24.7) (2.5) (13.4) (2.0)
Pro forma net loss (1) (24.7) (3.6) (13.4) (2.5)
___________
<FN>
<FN1> Pro forma net loss has been determined assuming the Company and its
affiliated physician networks had been taxed as C-corporations for all
periods presented.
</FN>
</TABLE>
Second Quarter Ended June 30, 1996 Compared with the Second Quarter Ended June
30, 1995
Total operating revenue decreased 3.6% to $28.4 million for the second
quarter of 1996 from $29.5 million for the second quarter of 1995. The
decrease in total operating revenue was primarily due to a change in reserves
which reduced the Company's risk share revenue by $2.2 million. This
reduction in risk share revenue was related to higher than expected hospital-
based costs under certain of the Company's payor contracts. Because of the
Company's recent experience with higher than expected hospital-based costs under
certain payor contracts, the Company may record less risk share revenue in the
future.
Although risk share revenue decreased in the second quarter of 1996 compared
with the same period in 1995, the Company experienced an increase in revenue
under capitation arrangements. This increase in capitation revenue was
primarily due to a 9.0% increase in the average number of covered lives.
Average covered lives increased 15,428 to 187,525 for the second quarter of
1996 from 172,097 for the second quarter of 1995. Of this increase, 12,488
average covered lives, or 7.3%, were a result of increased enrollment in
existing networks and acquired networks since acquisition, and 2,940 average
covered lives, or 1.7%, were in an acquired network at the date of
acquisition. Total covered lives at June 30, 1996 increased 8.6% to 189,663
from 174,671 at June 30, 1995.
Cost of medical services increased 7.4% to $25.9 million for the second
quarter of 1996 from $24.1 million for the second quarter of 1995. As a
percentage of total operating revenue, cost of medical services increased
9.3% to 91.0% for the second quarter of 1996 from 81.7% for the second
quarter of 1995. The increase in this percentage was principally due to the
aforementioned reduction in revenue relating to certain of the Company's risk
share arrangements, as well as an increase in medical costs of $2.3 million
due to a revision of claims reserves reflecting recent experience in physician
claims payment patterns. In general, the managed care industry has recently
experienced an increase in medical costs. There can be no assurance that
this recent trend in increasing medical costs will not continue in the future
and, if it does, such trend could have a material adverse effect on the
Company's operating results in the future.
Medical network operating expenses increased 47.8% to $2.4 million for the
second quarter of 1996 from $1.6 million for the second quarter of 1995. As
a percentage of total operating revenue, medical network operating expenses
increased 2.9% to 8.3% in the second quarter of 1996 from 5.4% in the second
quarter of 1995. The Company is experiencing higher claims administration
and medical management costs as it expands outside of its base Southern
California market. This is primarily related to different billing patterns
of physicians in other regions of the country due to a greater percentage of
primary care and specialty physicians being reimbursed on a fee-for-service
versus capitated basis prior to achieving critical mass. Affiliated primary
care and specialty physicians totaled 7,254 and 5,119 at June 30, 1996 and
1995, respectively. In addition, the Company is in the process of
implementing new technologies in the areas of utilization management and
claims administration with the goal of making these processes more efficient.
In the near term, however, these new technologies have caused additional costs
to be incurred while these new technologies are phased into the Company's
operations.
General and administrative expenses increased 123% to $6.0 million for the
second quarter of 1996 from $2.7 million in the second quarter of 1995. As a
percentage of total operating revenue, general and administrative expenses
increased 11.8% to 20.9% for the second quarter of 1996 from 9.1% for the
second quarter of 1995. The increase in these expenses as a percentage of
total operating revenue reflects higher costs relating to newly operational
markets before economies of scale are achieved and additional investments in
infrastructure to support the Company's future growth. Operational networks
totaled 48 at June 30, 1996 compared with 19 at June 30, 1995. Until and if
critical mass is achieved in these newly operational markets, such increases
will result in an increase in overall general and administrative expenses as a
percentage of revenue. In addition, general and administrative expenses also
increased due to regulatory compliance and other costs associated with being
a public company.
Depreciation and amortization increased 9.6% to $591,000 for the second
quarter of 1996 from $539,000 for the second quarter of 1995. The increase
of these expenses was primarily due to additional depreciation related to
recent equipment purchases.
Network development expenses decreased 59.4% to $940,000 for the quarter
ended June 30, 1996 from $2.3 million for the same quarter of 1995. The
decreases in these expenses reflect the Company's emphasis on bringing
previously developmental networks into operation. Networks in development
decreased to 45 at June 30, 1996 compared with 73 at June 30, 1995.
Net interest income was $267,000 for the second quarter of 1996 compared
with net interest expense of $113,000 for the second quarter of 1995. The
Company realized net interest income in the second quarter of 1996 primarily
due to interest earned on the remaining net proceeds from its initial public
offering.
Six Months Ended June 30, 1996 Compared with the Six Months Ended June 30, 1995
Total operating revenue increased 8.8% to $59.2 million for the first six
months of 1996 from $54.4 million for the first six months of 1995. The
increase in total operating revenue reflected an increase in capitation
revenue. Average covered lives increased 28,742, or 18.5%, to 184,064 in the
first six months of 1996 compared with 155,322 in the corresponding period
of 1995. Of this increase, 20,015 average covered lives, or 12.9%, were a
result of increased enrollment in existing networks and acquired networks
since acquisition, and 8,727 average covered lives, or 5.6%, were in acquired
networks at the dates of acquisition.
Offsetting this increase in total operating revenue was a change in
reserves decreasing risk share revenue by $2.2 million. This decrease
resulted from higher than expected hospital-based costs under certain of the
Company's payor contracts. Because of the Company's recent experience with
higher than expected hospital-based costs under certain payor contracts, the
Company may record less risk share revenue in the future.
Cost of medical services increased 13.5% to $49.0 million for the first six
months of 1996 from $43.2 million for the first six months of 1995. As a
percentage of total operating revenue, cost of medical services increased
3.5% to 82.8% for the first six months of 1996 from 79.3% for the
corresponding period of 1995. The increase in this percentage was
principally due to the aforementioned reduction in revenue relating to
certain of the Company's risk share arrangements, as well as an increase in
medical costs of $2.3 million due to a revision of claims reserves reflecting
recent experience in physician claims payment patterns. In general, the
managed care industry recently has experienced an increase in medical costs.
There can be no assurance that this recent trend in increasing medical costs
will not continue, and if it does, such trend could have a material adverse
effect on the Company's operating results in the future.
Medical network operating expenses increased 51.9% to $4.5 million for the
six months ended June 30, 1996 from $3.0 million for the corresponding period
of 1995. As a percentage of total operating revenue, medical network
operating expenses increased 2.1% to 7.6% in the first six months of 1996
from 5.5% in the corresponding period of 1995. The Company is experiencing
higher claims administration and medical management costs as it expands
outside of its base Southern California market. This is primarily related to
different billing patterns of physicians in other regions of the country due to
a higher percentage of primary care and specialty physicians being reimbursed
on a fee-for-service versus capitated basis prior to achieving critical mass.
Affiliated primary care and specialty physicians totaled 7,254 and 5,119 at
June 30, 1996 and 1995, respectively. In addition, the Company is in the
process of implementing new technologies in the areas of utilization
management and claims administration with the goal of making these processes
more efficient. In the near term, however, these new technologies have caused
additional costs to be incurred while these new technologies are phased into the
Company's operations.
General and administrative expenses increased 113% to $10.8 million for the
first six months of 1996 from $5.1 million in the first six months of 1995.
As a percentage of total operating revenue, general and administrative
expenses increased 8.9% to 18.2% for the six months ended June 30, 1996 from
9.3% for the corresponding period of 1995. The increase in these expenses as
a percentage of total operating revenue reflects higher costs relating to
newly operational markets before economies of scale are achieved and additional
investments in infrastructure to support the Company's future growth.
Operational networks totaled 48 at June 30, 1996 compared with 19 at June 30,
1995. Until and if critical mass is achieved in these newly operational
markets, such increases will result in an increase in overall general and
administrative expenses as a percentage of revenue. In addition, general and
administrative expenses also increased due to regulatory compliance and other
costs associated with being a public company.
Depreciation and amortization increased 26.6% to $1.2 million for the six
months of 1996 from $980,000 for the same period of 1995. The increase in
these expenses was primarily due to additional depreciation related to recent
equipment purchases.
Network development expenses decreased 38.7% to $2.7 million for the first
six months of 1996 from $4.4 million for the corresponding period of 1995.
The decrease in these expenses reflects the Company's emphasis on bringing
previously developmental networks into operation. Networks in development
decreased to 45 at June 30, 1996 compared with 73 at June 30, 1995.
Net interest income was $601,000 for the six months of 1996 compared with
net interest expense of $189,000 for the corresponding period of 1995. The
Company realized net interest income in the first six months of 1996
primarily due to interest earned on the remaining net proceeds from its
initial public offering.
Liquidity and Capital Resources
The Company requires capital primarily to develop and acquire physician
networks and to fund working capital. Capitation arrangements positively
impact the Company's cash flow because the physician networks receive
capitation revenue prior to incurring costs associated with services provided
under payor agreements. Partially offsetting this, the Company's shared risk
pool arrangements negatively impact cash flow due to the fact that
settlements in connection with these arrangements are typically not collected
until at least 150 days following the end of the period in which they are
accrued. Since inception through the date the Company entered into the Bank
Facility (as defined), the Company financed its operations primarily through
internally generated funds.
For the six months ended June 30, 1996, the Company used $4.3 million in
its operating activities. The use of cash in operating activities resulted
primarily from (i) a net loss of $8.0 million (including $2.7 million spent
on network development activities), offset by $1.2 million of depreciation
and amortization, (ii) a $1.1 million increase in accounts receivable and
(iii) a $330,000 increase in recoverable and deferred income taxes, offset by
(iv) a $3.2 million increase in accrued medical claims, (v) and a $551,000
increase in accounts payable and accrued expenses. For the first six months
of 1996, the Company's investing activities included $1.9 million of cash
used for equipment purchases and technology implementation costs and its
financing activities included $736,000 of cash used for principal payments of
notes payable.
The Company has a two-year revolving line of credit bank facility (the "Bank
Facility"), with a maximum borrowing limit of $15.0 million. As of June
30, 1996, the Company had $12.1 million available under the Bank Facility
(represented by the total Bank Facility less a $2.9 million letter of credit
securing a promissory note issued in connection with an acquisition). In
July 1996, $850,000 was drawn against this letter of credit. Interest is
payable on borrowings under the Bank Facility at the bank's prime rate plus
0.25% per annum or, at the Company's option, LIBOR plus 2.50%. Borrowings
under the Bank Facility are secured by the Company's accounts receivable and
certain equipment and, effective June 1996, are secured by an amount of
qualifying investments equal to the borrowing limit plus interest. The Bank
Facility contains certain restrictions on the Company's ability to engage in
certain actions.
At June 30, 1995 and from October 31, 1995 through December 31, 1995, the
Company was in defaulted on its cash flow coverage ratio and obtained waivers
from the Bank Facility lenders on August 21, 1995 and February 20, 1996,
respectively, extending to all periods through March 30, 1996. Effective
March 31, 1996, the Bank Facility was amended to revise the definitions of
cash flow and debt in the computation of the cash flow coverage and debt
coverage ratios. Effective June 30, 1996, the Bank Facility was again amended,
deleting the cash flow coverage and debt coverage ratio covenants. The Company
is currently in full compliance with all covenants under the Bank Facility.
On September 29, 1995, the Company sold 3,600,000 shares of common stock
for net proceeds of approximately $44.5 million. As of June 30, 1996, the
Company had $24.7 million of cash and cash equivalents. During the month of
July 1996, cash and cash equivalents were reduced by approximately $4.5
million, principally due to a reduction of accrued medical claims, the
aforementioned draw on the letter of credit, and continued operating losses.
The Company is considering restructuring its operations to decrease its
operating losses. At this time, a restructuring plan has not been finalized.
On July 2, 1996, pursuant to discussions with the California Department of
Corporations, the Company, through a wholly-owned subsidiary, filed an
application for restricted licensure as a Knox-Keene health care service plan
for its California operations. Pursuant to tangible net equity requirements
under regulations governing the Company's license application, the Company
will be required to maintain cash reserves, initially expected to be in the
range of at least $7 million to $10 million. The restricted licensure, if
granted, is expected to occur before the end of 1996.
Because of the Knox-Keene licensure cash reserve requirements (if such
licensure is granted), continued operating losses and future capital
equipment requirements and technology implementation costs, the Company
believes that existing cash balances and amounts available under the Bank
Facility may not be sufficient to finance its operations through the next
twelve months. The Company's Board of Directors has granted approval for
management to proceed with the selection of an investment advisor to explore
strategic opportunities.
Information Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains statements which, to the extent
that they are not recitations of historical fact, constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. The forward-looking statements in this document are intended to be
subject to the safe harbor protection provided by Sections 27A and 21E. All
forward-looking statements involve risks and uncertainties. Althought the
Company believes that its expectations are based upon resonable assumptions
within the bounds of its knowledge of its business and operations, there can
be no assurance that actual results will not materially differ from its
expectations. Factors which could cause actual results to differ from
expectations include, among other things, the difficulty in increasing and
managing growth in covered lives, controlling and estimating health care
costs, estimating revenue from shared-risk arrangements, as well as the
possible negative effects of the health care regulatory environment and the
effects of competition. For other risk factors that may cause actual results
to materially differ from expectations and underlying assumptions, refer to
the Registration Statement on Form S-1 (including the section entitled "Risk
Factors") and periodic reports, including the Annual Report on Form 10-K for
the year ended December 31, 1995, filed by the Company with the Securities
and Exchange Commission.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company and its Affiliates are subject to certain legal actions arising
in the ordinary course of business, generally related to professional
liability, employment-related issues and other business-related claims. In
the opinion of management, such actions are either adequately insured or will
not have a material adverse effect on the Company's financial position,
operating results or working capital.
The Company is a defendant in a class action securities lawsuit entitled In
re AHI Healthcare Systems, Inc. Securities Litigation filed in the United
States District Court for the Central District of California, Western
Division. The plaintiffs initially filed three separate suits against the
Company, certain of its officers and directors and its securities
underwriters on December 20, 1995. Pursuant to an order of the Court, the
plaintiffs filed a Consolidated Amended Class Action Complaint on February 26,
1996. The suit asserts that the Company, among other things, artifically
inflated the price of its common stock by misleading securities analysts and
by failing to disclose in its initial public offering prospectus (the
"Prospectus") alleged difficulties with the acquisition of Lakewood Health
Plan, Inc. and with two of the Company's payor contracts with FHP, Inc. The
plaintiffs seek unspecified damages on behalf of the stockholders who
purchased the Company's common stock between September 28, 1995 and December
19, 1995.
The Court certified a class of plaintiffs on April 29, 1996. On June 25,
1996, the Court certified two subclasses: one comprised of persons who
purchased the Company's common stock on September 28, 1995 in the Company's
initial public offering, and the second comprised of persons who purchased
the Company's common stock in the Nasdaq Stock Market between September 29,
1995 and December 19, 1995. In addition, on April 11, 1996, the Company
filed a Motion for Partial Summary Judgment seeking dismissal of all of the
plaintiffs' claims based on alleged material misrepresentations or omissions in
the Prospectus. This motion will not be heard until at least December 1996.
The Company intends to vigorously defend this lawsuit. The Company believes
that it is adequately insured and does not expect that the outcome of this
lawsuit will have a material adverse effect on the financial condition or
results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security-Holders.
At the Annual Meeting of Stockholders held on June 14, 1996, the
stockholders of the Company as of April 26, 1996 voted to elect three
directors to serve until the Annual Meeting of Stockholders to be held in
1999 and to ratify the selection of Ernst & Young LLP to serve as the
Company's independent public accountants for the fiscal year ending December
31, 1996.
Charles Klieman, M.D., Edward F. Thompson and Roy A. Wilkens, the sole
nominees for election as directors, each received 13,636,313 votes in favor
of election, with 27,290 votes withheld. 13,637,303 shares were voted in
favor of the ratification of the selection of Ernst & Young LLP to serve as
the Company's independent public accountants for the fiscal year ending
December 31, 1996, with 11,500 votes against and 14,800 abstentions.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit No. Description
10.2 Amendment to Imperial Loan Documents dated June 30, 1996 by
and among Imperial Bank, Banque Paribas and Registrant,
amending Loan Documents.
27 Financial Data Schedule.
(b) Reports on Form 8-K
None.
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.
AHI HEALTHCARE SYSTEMS, INC.
Date: August 13, 1996 /s/ LEONARDO A. BEREZOVSKY, M.D.
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
Date: August 13, 1996 /s/ H.R. BRERETON BARLOW
Chief Financial Officer and Senior Vice President
(Principal Financial Officer and
Principal Accounting Officer)
EXHIBIT INDEX
Exhibit
Number Description
10.2 Amendment to Imperial Loan Documents dated June 30, 1996
by and among Imperial Bank, Banque Paribas and Registrant,
amending Loan Documents.
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1996
<CASH> 24,723
<SECURITIES> 0
<RECEIVABLES> 13,801
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 41,762
<PP&E> 8,831
<DEPRECIATION> (3,964)
<TOTAL-ASSETS> 73,084
<CURRENT-LIABILITIES> 35,485
<BONDS> 0
0
0
<COMMON> 145
<OTHER-SE> 36,324
<TOTAL-LIABILITY-AND-EQUITY> 73,084
<SALES> 28,420
<TOTAL-REVENUES> 28,420
<CGS> 25,861
<TOTAL-COSTS> 25,861
<OTHER-EXPENSES> 9,854
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 44
<INCOME-PRETAX> (7,028)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,028)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,028)
<EPS-PRIMARY> (0.48)
<EPS-DILUTED> (0.48)
</TABLE>
AMENDMENT TO LOAN DOCUMENTS
This AMENDMENT TO LOAN DOCUMENTS (this "Amendment") is entered into as of
June 30, 1996, by and among: AHI HEALTHCARE SYSTEMS, INC., a Delaware
corporation ("AHI"), AHI ACCESS HEALTHCARE SYSTEMS, INC., a Arizona
corporation, AHI ARIZONA HEALTHCARE SYSTEMS, INC., a Arizona corporation, AHI
ARIZONA HOLDINGS, INC., a Arizona corporation, AHI MARICOPA COUNTY
HEALTHCARE SYSTEMS, INC., a Arizona corporation, AHI PIMA COUNTY HEALTHCARE
SYSTEMS, INC., a Arizona corporation, AHI (TEXAS) HEALTHCARE SYSTEMS, INC., a
LTHCARE SYSTEMS, INC., a Florida corporation, AHI FLORIDA HOLDINGS, INC., a
Florida corporation, AHI ATLANTA HEALTHCARE SYSTEMS, INC., a Georgia
corporation, AHI GEORGIA HEALTHCARE SYSTEMS, INC., a Georgia corporation, AHI
GEORGIA HOLDINGS, INC., a Georgia corporation, AHI LOUISIANA HEALTHCARE
SYSTEMS, INC., a Louisiana corporation, AHI LOUISIANA HOLDINGS, INC., a
Louisiana corporation, AHI TENNESSEE HEALTHCARE SYSTEMS, INC., a Tennessee c
orporation, AHI TENNESSEE HOLDINGS, INC., a Tennessee corporation, AH
orporation, AHI EL PASO HEALTHCARE SYSTEMS, INC., a Texas corporation, AHI
SAN ANTONIO HEALTHCARE SYSTEMS, INC., a Texas corporation, AHI TEXAS HOLDINGS
, INC., a Texas corporation, AHI LOUISVILLE HEALTHCARE SYSTEMS, INC., a
Kentucky corporation, AHI KENTUCKY HEALTHCARE SYSTEMS, INC., a Kentucky
corporation, and AHI KENTUCKY HOLDINGS, INC., a Kentucky corporation,
(individually, a "Debtor", and collectively, together with any other direct
or indirect subsidiary of AHI that hereafter becomes a party to this A
rower"); IMPERIAL BANK, a California banking corporation ("Imperial"), and
BANQUE PARIBAS, LOS ANGELES AGENCY ("Paribas") (Imperial and Paribas
hereinafter are referred to collectively as the "Banks" and individually as a
"Bank"); and Imperial, as agent ("Agent") for the Bank Group (as used herein
, "Bank Group means, individually and collectively, Agent, each Bank, and
Imperial in its capacity as "Issuing Bank"); with reference to the following
facts:
AHI heretofore has executed in favor of and delivered to Imperial, among
other things, that certain letter, dated May 15, 1995, regarding credit terms
and conditions in order to induce Imperial to make loans evidenced by the
Note (the "Original Terms and Conditions Letter"; the Original Terms and
Conditions Letter, as amended by the Master Agreement and otherwise as
amended, restated, supplemented, renewed, extended, or modified from time to
time, is referred to herein as the "Terms and Conditions Letter");
Borrower and the Bank Group heretofore have entered into that certain Master
Agreement and Amendment to Loan Documents, dated as of August 21, 1995 (as
amended, restated, supplemented, renewed, extended, or modified from time to
time, the "Master Agreement") to amend and supplement the Primary Loan
Documents (including the Original Terms and Conditions Letter) and other Loan
Documents identified in the Master Agreement;
Borrower has requested the Bank Group to (i) delete the financial covenants
set forth in Items B.5 and B.6 of the Terms and Conditions Letter, and (ii)
to add the pledge of a certificate of deposit, in the amount of $15,318,750
in form and substance satisfactory to Agent, to be held by Agent to secure
Borrower's obligations under the Terms and Conditions Letter and/or the
Master Agreement;
The Bank Group is willing to so amend the Terms and Conditions Letter and the
Master Agreement, in accordance with the terms hereof; and
Capitalized terms used herein and not otherwise defined herein shall have the
meaning ascribed to them in the Master Agreement.
NOW, THEREFORE, in consideration of the above recitals and the mutual promises
contained herein and for other good and valuable consideration, the receipt and
sufficiency of which hereby are acknowledged, Borrower and the Bank Group
hereby agree as follows:
Amendments to Loan Documents.
Item B.5 of the Terms and Conditions Letter hereby is deleted and the
following hereby is substituted in lieu thereof:
[Intentionally Omitted.]
Item B.6 of the Terms and Conditions Letter hereby is deleted and the
following hereby is substituted in lieu thereof:
[Intentionally Omitted.]
Conditions Precedent to Amendment. The satisfaction of each of the
following on or before August ___, 1996 (the "Effective Date") shall
constitute conditions precedent (or, if indicated as such, as a condition
subsequent) to the effectiveness of this Amendment:
Agent shall have received the Reaffirmation and Consent, attached hereto as
Exhibit A-1, duly executed by each of the persons or corporations identified
on Schedule 1 to the Master Agreement; and
Agent shall have received a Deposit Account Security Agreement, in the form
of that attached hereto as Exhibit A-2 (the "Security Agreement"), duly
executed by each Debtor and shall have received satisfactory evidence that
the certificate of deposit pledged hereunder (the "Pledged Certificate of
Deposit") shall have been issued, in form and substance satisfactory to
Agent, and shall not have matured or been terminated; and
Agent shall have received a Notice to Depositary Institution, in the form of
that attached hereto as Exhibit A-3 (the "Notice to Depositary Institution")
, duly executed by each Debtor and the Depositary Institution named therein; and
Borrower shall have reimbursed the Bank Group for, or shall have paid
directly, the fees and expenses (including an estimate of fees and expenses
incurred post-closing) of the Bank Group's counsel, Brobeck, Phleger &
Harrison LLP, incurred in connection with the preparation, negotiation, and
execution of this Amendment and any other documents executed in connection
herewith.
As a condition subsequent to the effectiveness of this Amendment, within 5
business days of the Effective Date, Agent shall have received a certificate
from the Secretary of each Debtor, in form and substance satisfactory to the
Bank Group, attesting to the incumbency and signatures of authorized officers
of such Debtor and to the resolutions of such Debtor's board of directors
authorizing its execution and delivery of this Amendment, the Security
Agreement, the Notice to Depositary Institution, and any ot
specific officers of such Debtor to execute and deliver the same.
Post Closing Date Covenants.
So long as any Debtor has any obligation owing to the Bank Group under the
Loan Documents, Borrower shall not terminate the Pledged Certificate of
Deposit and shall renew the Pledged Certificate of Deposit at each successive
date on which it would otherwise mature until such time as any and all
obligations owed by Borrower to the Bank Group under the Loan Documents have
been fully and finally paid in cash and the commitments of the Bank Group to
extend credit to Borrower irrevocably have been terminated.
Representations and Warranties. Each Debtor hereby represents and warrants
to the Bank Group that: (a) the execution, delivery, and performance of this
Amendment and the Loan Documents as amended by this Amendment are within its
corporate powers, have been duly authorized by all necessary corporate
action, and are not in contravention of any law, rule, or regulation, or any
order, judgment, decree, writ, injunction, or award of any arbitrator, court,
or governmental authority, or of the terms of its chart
may be bound or affected; (b) this Amendment and the Loan Documents as
amended by this Amendment constitute its legal, valid, and binding obligations,
enforceable against it in accordance with their respective terms, except as the
enforceability hereof or thereof may be affected by (i) bankruptcy, insolvency,
reorganization, moratorium, or other similar laws affecting the enforcement of
creditors' rights generally, or (ii) the limitation of certain remedies by
certain equitable principles of general applica
s Amendment are true and correct in all respects on and as of the date hereof
, as though made on such date (except to the extent that such representations
and warranties relate solely to an earlier date); and (d) as of the date
hereof no event of default or event which with the giving of notice or
passage of time or both would constitute an event of default has occurred and
is continuing, nor will result from the consummation of the transactions
contemplated herein.
Effect on Loan Documents. The Loan Documents, as amended hereby, shall be
and remain in full force and effect in accordance with their respective terms
and hereby are ratified and confirmed in all respects. Except as expressly
set forth herein, the execution, delivery, and performance of this Amendment
shall not operate as a waiver or as an amendment of any right, power, or
remedy of Agent or the Bank Group, nor as a consent to any further or other
matter, under the Loan Documents.
Miscellaneous.
Any reference in the Master Agreement or any of the other Loan Documents to
the Master Agreement or any of the other Loan Documents shall include all
alterations, amendments (including this Amendment), changes, extensions,
modifications, renewals, replacements, substitutions, and supplements,
thereto and thereof, as applicable.
This Amendment is a Loan Document.
Each reference in the Loan Documents to the "Loan Documents" or words of
like import referring to one or more Loan Document shall include the
Security Agreement and the Notice to Depositary Institution.
This Amendment may be executed in any number of counterparts, all of which
taken together shall constitute one and the same instrument and any of the
parties hereto may execute this Agreement by signing any such counterpart.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed as of the date first written above.
AHI HEALTHCARE SYSTEMS, INC.
By: /S/ Leonardo A. Berezovsky, M.D.
Title: Chairman and Chief Executive Officer
AHI ACCESS HEALTHCARE SYSTEMS, INC.
AHI ARIZONA HEALTHCARE SYSTEMS, INC.
AHI ARIZONA HOLDINGS, INC.
AHI MARICOPA COUNTY HEALTHCARE SYSTEMS, INC.
AHI PIMA COUNTY HEALTHCARE SYSTEMS, INC.
AHI (TEXAS) HEALTHCARE SYSTEMS, INC.
AHI DADE COUNTY HEALTHCARE SYSTEMS, INC.
AHI FLORIDA HEALTHCARE SYSTEMS, INC.
AHI FLORIDA HOLDINGS, INC.
AHI ATLANTA HEALTHCARE SYSTEMS, INC.
AHI GEORGIA HEALTHCARE SYSTEMS, INC.
AHI GEORGIA HOLDINGS, INC.
AHI LOUISIANA HEALTHCARE SYSTEMS, INC.
AHI LOUISIANA HOLDINGS, INC.
AHI TENNESSEE HEALTHCARE SYSTEMS, INC.
AHI TENNESSEE HOLDINGS, INC.
AHI (HOUSTON) HEALTHCARE SYSTEMS, INC.
AHI AUSTIN HEALTHCARE SYSTEMS, INC.
AHI EL PASO HEALTHCARE SYSTEMS, INC.
AHI SAN ANTONIO HEALTHCARE SYSTEMS, INC.
AHI TEXAS HOLDINGS, INC.
AHI LOUISVILLE HEALTHCARE SYSTEMS, INC.
AHI KENTUCKY HEALTHCARE SYSTEMS, INC.
AHI KENTUCKY HOLDINGS, INC.
By: /S/ Leonardo A. Berezovsky, M.D.
Title: Chairman
IMPERIAL BANK, as Agent, Issuing Bank, and a Bank
By: /S/ Tony Vedova
Title: Vice President
By: /S/ Caroline Harkins
Title: Regional Vice President
BANQUE PARIBAS, LOS ANGELES AGENCY
By: /S/ Don L. Unruh
Title: Assistant Vice President
By: /S/ Stanley P. Berkman
Title: General Manager, Western Region
