~~- --------------------------------------------------------------------------- Shares~~
	(a)	a brief description of ~~Percentage Name Common Stock~~the business and the reason for bringing it to the meeting;

By virtue of our continued certification as an HCO, we were performed and payments disbursed prior to the reverse acquisition of Medex. This amount represents funds paid by the Company to Nanko Investments, Inc. These services were provided on terms at least as favorable as could have been negotiated with an independent third party. (2) Doug Hikawa was issued stock options to purchase up to 350,000 shares of restricted common stock in October 2004. The option are exercisable over a three year term, with the right to purchase 100,000 restricted shares for $.05 per share vesting upon the date of grant; the right to purchase an additional an additional 100,000 restricted shares for $.10 per share vesting one year from the date of grant and the right to purchase the remaining 150,000 restricted shares for $.20 per share vesting on the two years from the date of grant. None of Mr. Hikawa's options have been exercised to date. COMPENSATION OF DIRECTORS Effective as of March 2005 our directors are compensated $300 for each monthly directors' meeting attended in person, and $1,000 for then annual directors meeting, plus airfare and hotel expense. No director receives a salary as a director. 5 Compensation of officers and directors is determined by the Company's Board of Directors and is not subject to shareholder approval. The Company has no retirement, pension, or benefit plan at the present time, however, the Board of Directors may adopt plans as it deems to be reasonable under the circumstances. MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS Our business is managed under the direction of our Board of Directors pursuant to the Utah Revised Business Corporations Act and our Bylaws. Our Board has responsibility for establishing broad corporate policies and for the overall performance of the Company. Our Board is kept advised of the Company's business through regular interaction with the President and other officers of the Company and through reviewing materials provided to them and by participating in Board meetings. During fiscal year ended December 31, 2005, there were 12 meetings of the Board of Directors. Each meeting was attended by all members of the Board. Our shares are quoted on the OTC Bulletin Board. Since we are not a listed issuer, we are not subject to various requirements of the Securities and Exchange Commission or certain self-regulatory bodies such as Nasdaq or the American Stock Exchange, which require our Board of Directors to establish and maintain an audit committee, compensation committee and nominating committee. As a result, we do not have standing audit, nominating or compensation committees of our Board of Directors, or committees performing similar functions. PROPOSAL TWO RATIFICATION OF APPOINTMENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The firm of Chisholm, Bierwolf & Nilson served as the Company's independent registered public accounting firm for the fiscal year ended December 31, 2005. Management recommends the Company retain the services of Chisholm, Bierwolf & Nilson to continue in their capacity as the Company's independent registered public accounting firm for the 2006 fiscal year is submitting this matter to shareholders for their approval. AUDIT FEES Principal accounting fees for professional services rendered to the Company by Chisholm, Bierwolf & Nilson for the years ended December 31, 2005 and 2004, are summarized as follows:
~~2005 2004 - ---------------------------------------------------------------------------~~ Audit $16,339 $31,574 Audit related - - Tax - - All other $2,537 $3,647 - --------------------------------------------------------------------------- Total $18,936 $43,357 ===========================================================================
6 0 AUDIT FEES. Audit fees were for professional services rendered in connection with the Company's annual financial statement audits and quarterly reviews of financial statements for filing with the Securities and Exchange Commission. OTHER FEES. Other fees were for EDGAR filing services provided to the Company. BOARD OF DIRECTORS PRE-APPROVAL POLICIES AND PROCEDURES. At its regularly scheduled and special meetings, the Board of Directors, in lieu of an established audit committee, considers and pre-approves any audit and non-audit services to be performed by the Company's independent accountants. The Board of Directors has the authority to grant pre- approvals of non-audit services. In the event of a negative vote, the selection of another independent certified public accounting firm will be made by the Board of Directors. A representative of Chisholm, Bierwolf & Nilson is expected to be present at the Annual Meeting. In the event a representative is present he or she will be given an opportunity to make a statement if he or she desires and if present, he or she is expected to be available to respond to appropriate questions. Notwithstanding approval by the shareholders, the Board or Directors shall have the right to replace the auditors at any time. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSAL TWO, APPOINTING CHISHOLM, BIERWOLF & NILSON AS THE COMPANY'S INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS FOR FISCAL 2006. OTHER MATTERS The Board of Directors knows of no other matters that are to be presented for action at the Annual Meeting of Stockholders other than those set forth above. If any other matters properly come before the Annual Meeting of Stockholders, the person named in the enclosed proxy form will vote the shares represented by proxies in accordance with their best judgment on such matters. 2006 SHAREHOLDER PROPOSALS If you wish to include a proposal in the Proxy Statement for the 2006 Annual Meeting of stockholders, your written proposal must be received by the Company no later than August 15, 2007. The proposal should be mailed by certified mail, return receipt requested, and must comply in all respects with applicable rules and regulations of the Securities and Exchange Commission, the laws of the State of Utah and our Bylaws. Stockholder proposals may be mailed to the Corporate Secretary, Pacific Health Care Organization, Inc., 21 Toulon, Newport Beach, California 92660. For each matter that you wish to bring before the meeting, provide the following information: (a) a brief description of the business and the reason for bringing it to the meeting; (b) your name and record address; (c) the number of shares of Company stock which you own; and (d) any material interest (such as financial or personal interest) that you have in the matter. 7 SELECTED INFORMATION FROM OUR ANNUAL REPORT ON FORM 10-KSB FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 3, 2006 AS AMENDED ON MAY 17, 2006 AND OUR QUARTERLY REPORT ON FORM 10-QSB FOR THE QUARTER ENDED JUNE 30, 2006, FILED ON AUGUST 14, 2006 DESCRIPTION OF BUSINESS - ----------------------- HISTORY OF THE COMPANY ---------------------- Pacific Health Care Organization, Inc. (the "Company") was incorporated under the laws of the State of Utah on April 17, 1970 under the name Clear Air, Inc. The Company was organized and authorized to pursue any lawful purpose or purposes. The Company amended its Articles of Incorporation on September 26, 2000, to effect a seventy-five for one reverse split, and to change the authorized common stock to 50,000,000 shares, par value of $0.001. The Company later amended its Articles of Incorporation on October 30, 2000, changing its name to Immunoclin International, Inc. Due to complications in the proposed business, the Company again amended its Articles of Incorporation on January 31, 2001, changing its name to Pacific Health Care Organization, Inc. In connection with the January 2001 name change, a new board of directors was put in place and new management was subsequently appointed. The Company has had limited business operations since the early 1990's, has not generated any significant revenues and was engaged in searching for business opportunities until 2001. Management believes that the Company has identified a significant opportunity within the Workers' Compensation industry in the State of California. On February 26, 2001, the Company acquired Medex Healthcare, Inc. ("Medex"), a California corporation organized March 4, 1994, in a share for share exchange in which the Company acquired all of the outstanding shares of Medex in exchange for 6,500,000 shares of the Company. The acquisition of Medex by the Company was accounted for as a reverse acquisition, with Medex being considered the accounting acquirer. Medex had limited operations and was primarily engaged in making application for California State licenses to operate as a Health Care Organization for the three years prior to the acquisition. Medex is now a wholly owned subsidiary of the Company. In addition, the Company formed Workers' Compensation Assistance, Inc. ("WCA"), a California corporation on August 14, 2001, which is also a wholly owned subsidiary. WCA does not have any operations to date, and the principal business of the Company is the business of Medex. INDUSTRY BACKGROUND ------------------- The California legislature passed Assembly Bill 110 ("AB 110" or the "bill") in July of 1993 and later deregulated the premiums paid by employers for Workers' Compensation insurance. These two events have given rise to the business of the Company. AB 110 was a collaboration of efforts from both employers and organizations, such as plaintiffs' attorneys who represent injured workers, in an effort to curtail employers from leaving California due to escalating Workers' Compensation costs. The bill addresses the problem of rising medical costs associated with poor quality care to the injured worker. Two of the major problems with the existing system, as identified by the legislature, were fraud and the lack of a managed care program that allowed control of the quality of medical care of an injured worker beyond thirty days. As a result, the bill created a new health care delivery body to solve the unique medical and legal issues of Workers' Compensation. These new entities are called Health Care Organizations ("HCO"). The HCOs are networks of health care professionals specializing in the treatment of workplace injuries and in back-to-work rehabilitation and training. An HCO does not waive the statutory obligation of companies to either possess workers' compensation insurance or qualify as self- insured. 8 HCOs were created to appeal to employees, while providing substantial savings to employers. This is accomplished by providing high quality medical care and increasing the length of time employers are involved in the medical care provided to injured workers. The increased length in control is designed to decrease the incidence of fraudulent claims and disability awards and is also based upon the notion that if there is more control over medical treatment there will be more control over costs, and subsequently, more control over getting injured workers back on the job. This increase in control is intended to reduce the costs of claims and thereby reduce workers' compensation premiums. In addition, the legislature requires that employers who use HCOs give employees a choice of HCOs or managed care physicians for treatment. It is anticipated that this will increase quality and give employees a fair say in their treatment. Prior to the passing of the bill, premiums paid by employers were fixed by law at a rate that was only dependent upon the occupation of the workers covered under the policy. An additional measure enacted by the California legislature deregulated the premiums paid by employers. This encouraged competition for market share of the Workers' Compensation insurance business. The increased competition initially drove premiums down to levels that were not sustainable. In response, insurers have hiked insurance premiums. Drastically rising premiums are forcing employers to search for alternative Workers' Compensation programs such as the HCOs created by AB 110. CERTIFICATION PROCESS --------------------- All applications for HCO license certification are processed by the California Department of Industrial Relations ("DIR"). The application process is time consuming and requires descriptions of applicant's organization and planned methods of operation. The applicant for the HCO license must develop a contracted network of providers for all of the necessary medical services that injured workers may need. This network must be developed to the satisfaction of the DIR. Given the wide range of medical providers needed over a large geographical area, this is a significant undertaking. The network of providers must be under contract with the HCO applicant and be willing to provide the various services in their specialty. All contracts must be approved by the DIR so as to assure the best of care will be provided to the injured worker. Next, the HCO applicant must develop committees of providers that will ensure the injured worker receives the best of care. This requirement includes the development of Quality Assurance, Utilization, Work Safety, Educational and Grievance committees. Finally, an HCO applicant must demonstrate to the DIR's satisfaction that it has the resources necessary to manage and administer a large network of providers. To establish the HCO applicant's ability to administer a network, it requires the applicant to furnish the details of its operating system to the DIR in writing. The Company's wholly owned subsidiary Medex received its first HCO license on March 15, 1997, for its network of primary care providers. Medex later received a second HCO license on October 10, 2000, for its network of primary and specialized care providers. 9 BUSINESS OF THE COMPANY ----------------------- The principle business of the Company is that of its wholly owned subsidiary Medex. Medex is in the business of managing and administering Health Care Organizations. As mentioned previously, these HCOs are networks of medical providers established to serve the Workers' Compensation industry. The California legislature mandated that if an employer contracts services from an HCO, the injured workers must be given a choice between at least two HCOs. The Company recognized early on that two HCO certifications are necessary to be competitive. Instead of aligning with a competitor, the Company elected to go through the lengthy application process with the DIR twice and has subsequently received certification to operate two separate HCOs. While there is no longer a statutory requirement to offer two HCOs to employers Medex continues to retain its two certifications, so that employer clients have the option of offering one or two HCOs to their employees. The Company believes its ability to offer two HCOs gives potential clients greater choice, which is favored by a number of employers, especially those with certified bargaining units. Through the two licenses to operate HCOs, the Company offers the injured worker a choice of enrolling in an HCO with a network managed by primary care providers requiring a referral to specialists or a second HCO where injured workers do not need any prior authorization to be seen and treated by specialists. The two HCO certifications obtained by the Company cover the entire state of California. This geographical area has a multi-billion dollar annual medical and indemnity Workers' Compensation cost. The two HCO networks have contracted with over 3,200 individual providers and clinics, as well as, hospitals, pharmacies, rehabilitation centers and other ancillary services making the Company's HCOs capable of providing comprehensive medical services throughout this region. The Company is developing these networks and further extending its Workers' Compensation business into a statewide entity. The Company, by virtue of its continued certification as an HCO, is statutorily deemed to be qualified as an approved Medical Provider Network (MPN) as created by SB 899, and are effective as of January 1, 2005. It is anticipated that a significant number of employer clients will avail themselves of the MPN program rather than the HCO program; others will utilize the provisions of the HCO program, while still others will use both in conjunction with each other. The Company is currently in continued discussions with insurance brokers, carriers, third party administrators, managed care organizations and with representatives of larger employers, both as partners and potential clients. Based on potential cost savings to employers and the approximately fourteen million workers eligible for the services of the Company, the Company expects that a significant number of employers will sign contracts with the Company to provide services. The Company expects the amount per enrollee it will charge employers will likely vary based upon factors such as employer history and exposure to risk; for instance, a construction company would likely pay more than a payroll service company. In addition, employers who have thousands of enrollees are more likely to get a discount. Because of the relatively new HCO market, and even though the Company makes every effort to charge a sufficient enrollee fee to cover costs and to make a profit, however, there is no assurance that the Company will always properly evaluate the risks associated with each employer or charge sufficient enrollee fees to cover its operational costs and/or be profitable. The Company carefully analyzes each employer prior to quoting an enrollee fee. In the event the Company charges per enrollee fees that are inadequate to cover operational costs, then the Company may not be able to continue business operations. 10 The Company does not anticipate large capital expenditures. Rather, it has contracted with many medical providers, and therefore, equipment such as x-ray machines are not paid for by the Company. The Company will have fixed costs such as liability insurance and other usual costs of running an office. PHYSICIANS ---------- The Company strives to select physicians known for excellence and experience in providing Workers' Compensation care. Two of the Company's founders have been active in the Southern California medical community for many years, and as a result, the Company has been able to recruit physicians with superlative credentials and reputations. The Company has also recruited physicians and allied health workers who reflect the ethnic and cultural diversity of California, thus enabling injured workers to readily find a physician who speaks their native tongue. The Company believes this is a benefit for injured workers and will assist in ensuring a prompt return to the workplace. HCO COMMITTEES -------------- The Company has organized seven committees in compliance with AB 110 to provide the best possible care to injured workers. The following briefly describes each committee: Quality Assurance. - ------------------ As the name implies this committee is charged with the responsibility of monitoring the quality of care that the HCO providers are delivering to the employees. The Company's Quality Assurance committee consists of fifteen separate functioning entities. The ultimate oversight and responsibility for this committee is maintained by the Medical Director. Utilization Review. - ------------------- This committee is responsible for monitoring Provider/Enrollee utilization of health care services under the plan. The activities are reflected in reports documenting examinations of procedures, provider use patterns and other matters. This committee is comprised of seven provider physicians. Case Management. - ---------------- The Case Management committee ("CMC") is charged with working with both the injured worker and the employers to coordinate return to work issues. For example, seeking light duties for an injured worker rather than allowing a protracted period of disability. The Company's ability to compress the time frame between an injured worker's first report of injury and return to work is the most critical factor in the management of Workers' Compensation care. The number of work days the employee misses due to disability translates into great costs to the employer, through medical costs, loss of productivity, the need to hire temporary help and disability insurance indemnity payments. The caseworker will become an intermediary between the physician, employer and employee by coordinating the return of the worker to a position he or she is capable of carrying out while recovering. Work Safety. - ------------ The Company believes that the best method to treat work related injuries is to prevent them from occurring. This committee is a workplace safety conditions and health committee that makes suggestions for ways to improve workplace conditions and to promote healthy habits. This committee seeks to promote safety and health by providing training workers and employers in methods of avoiding work place injuries. For instance, training may include safe methods to lift heavy objects, proper use of safety equipment and safe operation of machinery. In addition, if agreeable to employer and employee, the Company can provide drug and alcohol testing to attempt to mitigate injuries that may be caused by these problems. Furthermore, the Company may provide anonymous referral service for drug and alcohol treatment services. 11 Grievance. - ---------- This committee informs employees upon enrollment and annually thereafter of procedures for processing and resolving grievances. This includes the location and telephone number where grievances may be submitted and where complaint forms are available to employees. The Company establishes procedures for continuously reviewing the quality of care, performance of medical personnel and utilization of services to prevent causes for complaint. Provider Licensing & Performance Review. - ---------------------------------------- Contracting with a high quality professional staff is critical in creating a Workers' Compensation health care delivery system because in Workers' Compensation the physician performs additional unique tasks. A Workers' Compensation physician must understand the requirements of a patient's job to make informed return-to-work recommendations and the physician needs to know how to make impairment ratings and be willing to testify in disputed cases. In addition, the physician must be a healer and patient's advocate. These additional demands make it necessary to use different criteria to select Workers' Compensation physicians. The Company monitors the performance of network physicians. Physicians who produce high quality, cost effective health care are provided with more patients, while physicians who do not are eliminated from the network. Physicians' Continuing Education. - --------------------------------- Physicians are trained in the latest theories and techniques in treating workplace injuries. Protocols and treatment plan suggestions are distributed to providers on the basis of results of outcome studies as established by the State of California's Division of Workers' Compensation, the Medical Disability Advisor and through the State of California's Industrial Medical Protocols as they are published. HOSPITALS --------- The Company has been successful in creating relationships with some of the premier medical centers throughout California. The relationships established with medical centers are not for access or service as they provide access and service to all. Rather, these relationships are maintained by the Company to provide services to the Company's HCO enrollees. ANCILLARY SERVICES ------------------ The Company has contracted a full range of ancillary services to cover all requirements of the California Department of Corporations and Department of Industrial Relations. This includes interpreter services, ambulances, physical therapy, occupational therapy, pharmacies and much more. The ancillary services are vital to ensure there is a complete network capable of independently providing all care that may be necessary. COMPETITION ----------- Although the Company is one of the first commercial enterprises capable of offering HCO services, there are new companies that are currently setting up similar services as those being offered by the Company. Many of these competitors may have greater financial, research and marketing experience and resources than the Company, and will represent substantial long-term competition. In California there are currently nineteen certified health care organization licenses (two of which belong to the Company) issued to twelve companies, although only eight are actively utilizing their HCO certifications. This translates into seven direct HCO competitors, with Comp Partners being the largest. 12 The Company plans to gain a competitive advantage by marketing itself as a legal medical organization not just a medical company. In addition, the Company is the only HCO that directly contracts with a network of providers based on quality determinations rather than the provision of discounted medical services. The Company believes this is advantageous because they can market a direct relationship with providers who have demonstrated expertise in treating work related injuries and writing credible medical reports, rather than relying on third party relationships or those based upon discounts alone. SB 899, signed on April 19, 2004, created Medical Provider Networks (MPNs), to be effective on and after January 1, 2005. The statute deems the Medex network, as a certified HCO is already approved as an MPN. Medex offers both HCO and MPN programs to potential clients, as well as an HCO/MPN hybrid model that will give Medex a competitive advantage, because of the manner in which the network was created. EMPLOYEES --------- The Company, through its subsidiary, currently has eight full time employees and twelve part-time employees. In addition, the officers and directors work on a part time, as needed basis with no commitment for full time employment. Over the next twelve months, the Company anticipates hiring additional employees as needed and as revenues and operations warrant. DESCRIPTION OF PROPERTY - ----------------------- PROPERTY & FACILITIES --------------------- The Company's executive offices are located in Newport Beach, California. The Company's subsidiary Medex leases approximately 3,504 square feet of office space in Long Beach, California. The Company does not anticipate needing any additional office space in the next twelve months. If the need arises, the Company believes it will be able to secure additional office space on acceptable terms. MARKET PRICE OF AND DIVIDENDS ON OUR COMMON EQUITY AND OTHER SHAREHOLDER MATTERS - ------------------------------------------------------------------------- The Company's shares are currently traded on the Over-the-Counter Bulletin Board ("OTCBB") under the symbol PHCO. As of March 17, 2006, the Company had approximately 1,077 shareholders holding 15,427,759 common shares. The published bid and ask quotations from January 1, 2004, through December 31, 2005, are included in the chart below. These quotations represent prices between dealers and do not include retail markup, markdown or commissions. In addition, these quotations do not represent actual transactions. 13
~~BID PRICES ASK PRICES HIGH LOW HIGH LOW~~ 2005 First Quarter .16 .16 1.01 1.01 Second Quarter .16 .16 1.01 1.01 Third Quarter .16 .16 1.01 1.01 Fourth Quarter .16 .16 1.01 .50 2004 First Quarter .16 .16 1.01 1.01 Second Quarter .16 .16 1.01 1.01 Third Quarter .16 .16 1.01 1.01 Fourth Quarter .16 .16 1.01 .50
The above quotations, as provided by the Pink Sheets, LLC., represent prices between dealers and do not include retail markup, markdown or commission. In addition, these quotations do not represent any actual transactions. CASH DIVIDENDS - -------------- The Company has not declared a cash dividend on any class of common equity in the last two fiscal years. There are no restrictions on the Company's ability to pay cash dividends, other than state law that may be applicable; those limit the ability to pay out all earnings as dividends. The Board of Directors does not, however, anticipate paying any dividends in the foreseeable future; it intends to retain the earnings that could be distributed, if any, for the operations, expansion and development of its business. SECURITIES FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS - -------------------------------------------------------
~~Plan Number of Weighted-average Number of securities category securities exercise price remaining available~~ to be ~~issued~~qualified as an approved MPN on January 1, 2005.  Because we already had qualified networks in place through our HCO program, we began offering MPN services in January 2005.  As a licensed HCO and MPN, Medex is able to offer its clients an HCO program, an MPN program and a hybrid of ~~outstanding~~the HCO and MPN programs.  Under this hybrid model, an employer can enroll its employees in the HCO program, then prior to the expiration of the 90 or 180 day treatment period under the HCO program, the employer can enroll the employee into the MPN program.  This allows employers to take advantage of both programs.  Medex is currently the only entity that offers both programs together in its hybrid program.

Unlike HCOs, MPNs are not assessed the annual enrollee fee that must be paid to the DWC.  MPNs have fewer data reporting obligations and no annual enrollment notice delivery requirements.  MPN’s are only required to provide an enrollment notice at the time the employee first joins the MPN and a second notice must be delivered to the employee at the time he suffers a workplace injury.  Because there is no annual fee, and there is less administrative burden upon the employer with an MPN, the primary growth in our business during the 2006 fiscal year was in the number of enrollees in our MPN program.

Comparison of the years ended December 31, 2006 and 2005

Despite a 27% increase in the number of employee enrollees during 2006, total revenues decreased 5% to $1,970,855 as we lost some HCO clients and as increased competition for ~~future issuance upon options, warrants~~MPN services led to lower prices.

During the year ended December 31, 2006, we had approximately 157,000 total enrollees.  This was made up of approximately 49,000 HCO clients and 108,000 MPN clients.  By comparison during the year ended December 31, 2005 we had approximately 124,000 enrollees, including approximately 66,000 HCO enrollees and approximately 58,000 MPN enrollees.  The 26% decrease in HCO enrollees is the result of losing approximately 11% of our HCO customers to other workers’ compensation providers while approximately 15% of our own HCO customers converted to our MPN program.  The 86% increase in our MPN enrollees is the result of a 69% increase in enrollment of new MPN customers coupled with the aforementioned conversions of some of our own HCO clients to our MPN program.

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During the 2006 fiscal year, we experienced a 12% decrease in revenue from HCO fees.  This reduction in HCO revenue is directly attributable to the decrease in the number of HCO enrollees compared to fiscal 2005.  Barring legislative changes to reduce or eliminate government fees and otherwise reduce the costs and burdens of administering an HCO program to allow HCOs to be more price competitive with MPNs, we expect that enrollment in our HCO program will continue to decrease.  Based on a review of the expiration dates of current contracts with our existing HCO clients, and our experience over the past year, we anticipate that during fiscal 2007, we will experience a 3% decrease in total HCO enrollees.  We anticipate this will lead to a 3% decrease in HCO revenue in fiscal 2007.

Despite an 86% increase in MPN enrollees in 2006, we realized an 11% decrease in MPN fees.  The average fee we charged per MPN enrollee in during 2006 was 58% lower than in 2005 as increased competition in the MPN market required us to lower our enrollment fees to remain competitive in the market.  We expect the number of MPN enrollees and correspondingly revenue from MPN clients to increase 7% during 2007.  Based on our research, we expect that rates for MPN services will level off and we will not continue to experience the significant reductions in MPN fees per enrollee that we experienced during 2006.

During the year ended December 31, 2006, other revenue increased 156% to $204,423.  The primary component of other revenue is nurse case management.  We retain nurses on our staff who, at the request of our customers, will review the medical portion of a claim on behalf of our employer clients, claims managers and injured workers.  We offer nurse case management services to our customers on an optional basis.  We charge an additional fee for nurse case management services.  We anticipate that demand for and revenue from nurse case management will increase 18% in 2007 as a result of more customers availing themselves of this service.

We expect the aforementioned 3% decrease in HCO fees to more than offset the expected 7% increase in MPN fees and the anticipated 18% increase in other revenue and will result in an overall decrease in total revenue of approximately 3% in 2007.

Total expenses remained flat during the year ended December 31, 2006 compared to 2005, decreasing less than 1%.  We expect total expenses to be approximately 17% lower during the 2007 fiscal year, primarily as a result of settling the aforementioned lawsuit during 2006.

During the year ended December 31, 2006, consulting fees increased to $134,303 from $104,110 during the year ended December 31, 2005.  This increase in consulting fees was primarily due to a former executive officer of Medex leaving his position during 2006 and becoming a consultant.  During 2006 we also realized a 29% increase in consulting fees as a result of a 274% increase in the use of outside temporary help.  We anticipate that consulting fees will increase approximately 37% in 2007 as we continue to retain the consulting services of the former Medex executive officer.

Salaries and wages decreased $53,770 or 7% during the year ended December 31, 2006.  The decrease in salaries & wages is attributable to the aforementioned resignation of the former Medex executive officer.  We expect salaries and wages to be approximately 13% lower in 2007 as a result of the reduction in overall salaries and wages from the resignation of the former Medex executive officer.  As discussed above, however, we expect this decrease in salaries and wages in 2007 will be largely offset by the corresponding increase in consulting fees.

For the year ended December 31, 2006, we incurred professional fees of $435,909 compared to $342,028 during the year ended December 31, 2005.  The increase in professional fees in 2006 is largely attributable to increased legal fees incurred in defending the Company in the legal proceeding brought by Marvin Teitelbaum and Peter Alexakis.  We also realized increase professional fees during fiscal 2006 in connection with compliance with the reporting obligations of the Company under ~~equity exercise~~the Exchange Act of 1934.  We expect professional fees to be about 66% lower in 2007 as a result of the settlement of the lawsuit against the Company during 2006.

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During the year ended December 31, 2006, we incurred insurance expenses of $123,909, a $39,568 increase over the prior year.  The increase in 2006 is related to an increase in professional liability insurance premiums and ~~rights compensation plans outstanding (excluding securities options,~~acquiring directors and officers liability insurance coverage.  We do not expect insurance expense to increase materially in 2007.

Employee enrollment decreased $61,084 to $55,456 during the year ended December 31, 2006, compared to the year ended December 31, 2005.  As an HCO, we are required to pay a fee to the State of California Division of Workers’ Compensation for each person enrolled at the end of the calendar year in our HCO program.  The decrease in employee enrollment expenses in the year ended December 31, 2006 reflects the decreased number of persons enrolled in our HCO program as compared to the same period ended 2005.  Part of the decrease in enrollment expense in 2006 was also the result of our over estimating employee enrollment fees during 2005.  We anticipate employee enrollment expenses to decrease 3% in 2007 consistent with the anticipated decrease in HCO enrollment for the same period.

Under regulations applicable to HCOs and MPNs we are required to comply with certain data reporting and document delivery obligations.  We currently contract out much of these data reporting and document delivery obligations to third parties.  The costs we incur to meet these data reporting and document delivery requirements are reflected in ~~warrants~~our financial statements as Data maintenance.

Data maintenance costs are impacted by several factors, including the overall mix of enrollees in our HCO and ~~columns (a)) rights (a) (b) (c) - ------------------------------------------------------------------------------------~~ ~~Equity compensation plans approved~~MPN programs and the number of new enrollees during the year.  HCOs are required to deliver enrollment notices annually to each HCO enrollee.  By comparison, MPNs are required to deliver an enrollment notice only at the time of initial enrollment and at the time an enrollee is injured.  As a result, after the first year, data maintenance fees for MPN enrollees are consistently about 50% lower than data maintenance costs per HCO enrollee.  Therefore, depending on the mix of HCO and MPN enrollees and the number of new MPN enrollees versus ongoing MPN enrollees, our data maintenance costs may vary significantly from year to year even in years when our overall enrollment does not change materially.

Data maintenance fees may also vary significantly from employee enrollment fees in any given year.  Employee enrollment fees are determined based on the number of HCO enrollees at the end of the calendar.  Employee enrollment fees do not take into account fluctuations in HCO enrollees during the year.  By comparison, data maintenance fees are billed as services are provided.  Therefore, as we experienced in 2006, we may have years when HCO enrollment is higher during the year than it is at the end of the calendar year, resulting in variances in data maintenance fees and employee enrollment fees in a given year.

Finally, data maintenance fees are also impacted by ~~security holders 66,250 $0.05 915,000 - ------------------------------------------------------------------------------------ Equity compensation plans~~the prices we can negotiate with our third party service providers.

During 2006 we experienced a 26% decrease in HCO enrollees and an 86% increase in MPN enrollees, resulting in an overall enrollment increase of 27%.  Data maintenance fees increased 12% during the 2006 fiscal year.  The increase in data maintenance fees is attributable to the increase in total enrollment offset by the somewhat lower data maintenance costs associated with the renewal of MPN enrollees from 2005. During 2007 we expect data maintenance fees will decrease approximately 5% as a result of negotiation of lower printing costs with a vendor and fewer HCO enrollees.
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Bad debt expense was $0 for the year ended December 31, 2006 as compare to $38,000 for year ended December 31, 2005.  A reserve was established during 2005 for several past due accounts.  We incurred no bad debt expense in fiscal 2006.  We do not ~~approved~~expect to incur any bad debt in 2007.

General and administrative expenses decreased nearly 15% to 261,912 during the year ended December 31, 2006.  This decrease in general & administrative expense was attributable to lower advertising cost and shareholders’ meeting expense.  We do not expect a significant change in general and administrative expenses in the upcoming fiscal year.

The 5% decrease in our total revenue more than offset the less than 1% decrease in total expenses during 2006, resulting in a loss from operations $90,912 compared to income from operations of $13,456 during 2005.

Because we realized a loss from operations in 2006, we realized a net operating loss carryforward, or income tax benefit, of $11,243.  By comparison, during fiscal 2005 we realized income tax expense of $45,235 related to taxes for 2002 – 2005.  Since inception we have realized net losses for book purposes. We did not file tax returns until 2006 for the fiscal year ended 2005. At that point, all prior year Federal and state tax returns were filed. For Federal purposes, due to the net operating loss carryforwards, no income tax was due. For California state purposes, however, taxes were due because California suspended net operation loss carryforwards during 2002 and 2003. As a result of the suspension of net loss carryforwards in the state of California, we owed state income taxes in the aggregate amount of $23,750 for the 2002, 2003 and 2004 fiscal years. For the year ended December 31, 2005, there were taxes due in the amount of $21,485.  Since the amount of the tax in any of these years was not significant, the Company decided to expense the amount in the 2005 year.

As a result of decreasing revenue that was only partially offset by security holders 1,167,964 $3.18 -0- - ------------------------------------------------------------------------------------ Total 1,234,214 $3.01 915,000 - ------------------------------------------------------------------------------------
On October 11, 2004, the Company granted stock options to Doug Hikawa, an officer of the Company's subsidiary, Medex Healthcare to purchase up to 350,000 restricted common shares of the Company. The options are exercisable as follows: 100,000 shares the first year with an exercise price of $.05 per share; 100,000 shares the second year with an exercise price of $.10 per share; and 150,000 shares the third year with an exercise price of $.20 per share. The options expire three years from the date of grant. 14 In August 2002, the Company granted options to purchase approximately 85,000 restricted common shares of the Company to four employees pursuant to the PHCO 2002 Stock Option Plan, the adoption of which was recently ratified by the shareholders of the Company. 50% of the options granted vested upon grant, 25% vested on the first annual anniversary of the grant date and the remaining 25% will vest on the second annual anniversary of the grant date. The exercise price of the options is $0.05. The options expire five years from the grant date. To date, options to purchase 18,750 restricted common shares have been exercised. In April 2001 and August 2002, the Company issued approximately 807,964 warrants ("Warrants") comprised of 408,982 A Warrants and 408,982 B Warrants to certain investors and debt holders of the Company. Each A Warrant represents the right to purchase one share of restricted common stock of the Company at an exercise price of $3.00 per share for a period through August of 2006. Each B Warrant represents the right to purchase one share of restricted common stock of the Company at an exercise price of $6.00 per share also for a period through August of 2006. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS FOR THE YEARS DECEMBER 31, 2005 AND 2004 - --------------------------------------------------------------------------- The following information contained in this analysis should be read in conjunction with the audited condensed consolidated financial statements and related disclosures contained in the Company's Annual Report on Form 10-KSB. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company does not currently possess a financial institution source of financing and the Company cannot be certain that its existing sources of cash will be adequate to meet its liquidity requirements. The Company's future capital requirements will depend on its ability to continue to develop its business, including (i) the ability of the Company to maintain its existing customer base and to expand its customer base, and (ii) overall financial market conditions where the Company might seek potential investors. The Company is also seeking potential business acquisitions based on, among other criteria, the economics of any deal and subsequent projected future cash flow. The Company may also seek additional funding through the sale of its common stock. As of December 31, 2005, the Company had cash on hand of $345,091, compared to $506,675 at December 31, 2004. The $161,584 decrease in cash on hand is the result of increased Company expenses as our operations increase. Management believes that cash on hand and anticipated revenues will be sufficient to cover operating costs over the next twelve months. The Company does not anticipate needing to find other sources of capital at this time. If the Company's revenues, however, are less than anticipated the Company will need to find other sources of capital to continue operations. The Company would then seek additional capital in the form of debt and/or equity. While the Company believes that it is capable of raising additional capital, there is no assurance that the Company will be successful in locating other sources of capital on favorable terms or at all. 15 RESULTS OF OPERATIONS --------------------- COMPARISON OF THE YEAR ENDED DECEMBER 31, 2005 AND 2004. -------------------------------------------------------- Workers' compensation costs in California have continued to remain excessive which has continued to motivate employers to search for ways to control this cost. Due to the high workers' compensation costs and the Company's marketing efforts, revenues increased $404,397 to $2,076,391 for the year ended December 31, 2005 compared to $1,671,994for the year ended December 31, 2004. During the year ended December 31, 2005, the Company generated revenue from approximately 395 employers representing approximately 124,000 enrollees compared to 57 employers and approximately 64,000 enrollees during the year ended December 31, 2004. While the Company believes that revenues will continue to increase, it also believes that expenses will continue to increase. Total expenses incurred in the year ended December 31, 2005 totaled $2,063,228, compared to $1,571,190 for the corresponding period ended December 31, 2004, which included increases in bad debt expense, legal fees, public relations fees and salaries and wages. During the year ended December 31, 2005, consulting fees decreased to $104,110 from $109,796 during the year ended December 31, 2004. The reduction was primarily the result of lower information technology expenses and marketing costs. The Company anticipates consulting fees to remain constant in the upcoming fiscal year. Salaries & wages increased $86,684 during the year ended December 31, 2005, to $750,516, compared to $663,832 during the year ended December 31, 2004. The increase in salaries & wages in the year ended 2005 is attributable to the increased number of Medex employees. The Company expects salaries & wages to remain constant in 2006. In the year ended December 31, 2005, the Company incurred professional fees of $342,028 compared to $228,184 during the year ended December 31, 2004. The increase in professional fees in 2005 is largely attributable to increased legal, public relations and accounting fees incurred during the 2005 fiscal year. Legal fees increased, in connection with compliance with the reporting obligations of the Company under the Exchange Act of 1934, and the cost to the Company of defending itself against the legal proceeding brought by Marvin Teitelbaum and Peter Alexakis. While the Company believes that agreeing to submit to binding arbitration will result in lesser legal fees than if this matter were to go to trial, the Company anticipates that the costs of arbitrating this case will result in greater legal fees in fiscal 2006. During the year ended December 31, 2005, the Company incurred insurance expenses of $84,831, a $1,023 decrease over the prior year. The decrease in 2005, is related to a reduction in professional liability insurance premiums. The Company anticipates increases in insurance expense in 2006. Employment enrollment expenses increased $35,676 to $206,204 during the year ended December 31, 2005, compared to the year ended December 31, 2004. As an HCO, the Company is required to pay a fee to the State of California Division of Workers' Compensation for each person it enrolls. The increase in employment enrollment expenses in the year ended December 31, 2005, reflects the increased number of persons enrolled with the Company when compared to the same period ended 2004, including increased fees to the State of California and expenses to its enrollment and tracking technology partner, Harbor Healthcare. The Company anticipates employee enrollment expenses to increase in 2006 at a rate consistent with enrollment increases. 16 For the year ended December 31, 2005, general and administrative expenses increased $312,970 to $550,145, compared to $237,174 for the year ended December 31, 2004. This 132% increase in general & administrative expense was largely attributable to mandatory data maintenance fees paid on increasing numbers of employees enrolled, increased advertising costs, increased printing costs due to enrollment notification requirements for new enrolled employees and due to increased shareholder meeting costs. The Company anticipates general and administrative to increase in proportion to increases in enrolled employees in 2006. Bad debt expense was $38,000 for the year ended December 31, 2005. A reserve was established during the year for several past due accounts. The Company incurred no bad debt expense in fiscal 2004. As a result of increasing revenue, which was offset by increases in salaries and wages, professional fees, employment enrollment, general and administrative expense, bad debts, and income tax expense of $21,192, the Companya decrease in total expenses, we realized a net loss of $77,451 for the year ended December 31, 2006, compared to net loss of $29,323 during the year ended December 31, 2005.  In 2007, we anticipate that a projected 37% increase in consulting fees will be more than offset by a 13% decrease in salaries and wages, and a 66% decrease in professional fees to result in a 15% decrease in total expenses in 2007.  We expect this 15% decrease in total expenses will more than offset the projected 3% decrease in total revenue in 2007, resulting in a net profit in 2007.

In fiscal 2006, net loss of $29,323 for the year ended December 31, 2005, compared to net income of $154,404 during the year ended December 31, 2004. COMPARISON OF THE YEAR ENDED DECEMBER 31, 2004 AND 2003. -------------------------------------------------------- The Company generated $1,671,994 in revenue for the year ended December 31, 2004, compared to revenue of $1,097,930 for the same period of 2003. This increase is largely due to the growth in the number of employers and enrollees using the Company's services in 2004 as compared to 2003. During the year ended December 31, 2004, the Company generated revenue from approximately 57 employers representing approximately 64,000 enrollees compared to 51 employers and approximately 73,700 enrollees during the year ended December 31, 2003. As revenues increased, however, the expenses incurred in providing HCO services also increased from $1,040,071 during the year ended December 31, 2003, to $1,517,190 for the year ended December 31, 2004. The increases in expenses were attributable to increases in consulting fees, salaries and wages, professional fees, insurance, employment enrollment and general and administrative expenses. During the year ended December 31, 2004, consulting fees increased to $109,796 from $84,081 during the year ended December 31, 2003. As the HCO industry in California continues to develop, the Company believes it is important to be as involved as possible in the legislative and policy- making process. Therefore, from time to time, the Company will hire lobbyist and other consultants to represent its interests. The $25,715 increase in 2004 is partially the result of such activities by the Company during 2004. The Company anticipates significant fluctuations in consulting fee expenses from quarter to quarter and year to year as the applicable legislative and rule-making bodies overseeing the HCO industry consider changes that may affect the industry. During 2004, the Company also incurred the costs of approximately $35,500 for retaining a computer consultant to assist in the ongoing development and maintenance of the Company's information systems compared to only $15,000 during 2003. The Company anticipates an ongoing need to retain consultants to assist with its information technology needs in the upcoming year. Salaries & wages increased $162,723 during the year ended December 31, 2004, to $663,832, compared to $501,109 during the year ended December 31, 2003. The increase in salaries & wages in the year ended 2004 is attributable to the increased number of employees employed by Medex Healthcare, the Company's subsidiary, as well as payments of approximately $30,600 in retroactive salary increases and payment for unused vacation to certain executive officers of Medex. The Company expects increases in salaries & wages to continue at about the same rate in 2005. 17 In the year ended December 31, 2004, the Company incurred professional fees of $228,184 compared to $84,492 during the year ended December 31, 2003. The increase in professional fees in 2004 is largely attributable to increased legal and other professional fees incurred during the year ended December 31, 2004, in connection with compliance with the reporting obligations of the Company under the Exchange Act of 1934, and the cost of defending itself against the legal proceeding brought Marvin Teitelbaum and Peter Alexakis. If the lawsuit against the Company goes to trial, the Company anticipates professional fees in the upcoming year may be significantly greater than those incurred in 2004. During the year ended December 31, 2004, the Company incurred insurance expenses of $85,364, an $11,223 increase over the prior year. The increase in 2004, is largely related to the increased number of Company employees and increases in group medical rates as compared to the 2003 fiscal year. The Company anticipates increases in insurance expense in 2005 to be similar to those experienced in 2004. Employment enrollment expenses increased $76,328 to $170,528 during the year ended December 31, 2004, compared to the year ended December 31, 2003. As an HCO, the Company is required to pay a fee to the State of California Division of Workers' Compensation for each person it enrolls. The increase in employment enrollment expenses in the year ended December 31, 2004, reflects the increased number of persons enrolled with the Company when compared to the same period ended 2003, including increased fees to the State of California and expenses to its enrollment and tracking technology partner, Harbor Healthcare. The Company anticipates employee enrollment expenses to increase in 2005 at a rate consistent with enrollment increases. For the year ended December 31, 2004, general & administrative expenses increased $52,402 to $237,174, compared to $184,772 for the year ended December 31, 2003. This 28% increase in general & administrative expense was largely attributable to increases in general & administrative expenses resulting from the Company's increased operations, combined with certain expenses not incurred in 2003, including costs incurred in connection with the special meeting of stockholders of approximately $12,600 and costs of replacing computers and equipment stolen from the Company's offices of approximately $4,500. Because the Company does not expect to incur some of these same expenses in 2005, it anticipates general & administrative expenses will remain fairly consistent with expenses incurred in 2004, as these one time expenses are offset by increasing general & administrative expenses resulting from growth in the Company's business and inflation. As a result of increasing revenue, which was partially offset by increases in depreciation, consulting fees, salaries & wages, professional fees, insurance, employment enrollment and general and administrative expense, the Company realized net income of $154,404 for the year ended December 31, 2004, compared to net income of $57,859 during the year ended December 31, 2003. 18 CASH FLOW During the fiscal year ended December 31, 2005 cash was primarily used to fund operations. We had a net decrease in cash of $161,584 during the 2005 fiscal year. See below for additional discussion and analysis of cash flow.
~~Fiscal 2005 Fiscal 2004 ---------------------------~~ ~~Net cash provided by (used in) operating activities ($161,584) $113,415 Net~~ cash used in operating activities was $72,033, compared to net cash used by operating activities of $161,584 in fiscal 2005.  This change in cash flow from operating activities is the result of lower operating income due to increased legal fees and insurance.

The Company did not engage in investing ~~activities - (5,092) Net cash provided by (used in)~~or financing activities in fiscal 2006 or fiscal 2005.

27
Summary of Material Contractual Commitments

(Stated in thousands)
Payment Period
Contractual Commitments Total 1 Year 2-3 Years 4-5 Years

Operating Leases $ 376,004 $ 86,196 $ 180,236 $ 109,572

Total $ 376,004 $ 86,196 $ 180,236 $ 109,572
Off-Balance Sheet Financing Arrangements

As of December 31, 2006 the Company had no off-balance sheet financing arrangements.

New Accounting Standards

In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement replaces APB No. 20, ACCOUNTING CHANGES and FASB No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies it all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement includes specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS No. 154 did not have an impact on the Company’s consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS   AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140.This Statement amends FASB Statements No. 133, accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issued No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The adoption of SFAS No. 155 did not have an impact on the Company's consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS AN AMENDMENT OF FASB STATEMENT No. 140.  This Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities.  The adoption of SFAS No. 156 did not have an impact on the Company's consolidated financial statements.

28
           In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements.  This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of SFAS 157 did not have an impact on the Company's consolidated financial statements. The Company presently comments on significant accounting policies (including fair value of financial instruments) in Note 2 to the financial statements.

           In September 2006, the FASB issued SFAS No. 158, EMPLOYERS' ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS AN AMENDMENT OF FASB STATEMENTS NO. 87, 88, 106 AND 132(R). This statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other that a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. The adoption of SFAS No. 158 did not have an impact on the Company's consolidated financial statements.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting standards generally accepted in the United States requires management to make estimates and assumptions that affect both the recorded values of assets and liabilities at the date of the financial statements and the revenues recognized and expenses incurred during the reporting period. The company’s estimates and assumptions affect its recognition of deferred expenses, bad debts, income taxes, the carrying value of its long-lived assets and its provision for certain contingencies. The company evaluates the reasonableness of these estimates and assumptions continually based on a combination of historical information and other information that comes to its attention that may vary its outlook for the future. Actual results may differ from these estimates under different assumptions.
Management suggests that the Company’s Summary of Significant Accounting Policies, as described in Note 2 of Notes to Consolidated Financial Statements, be read in conjunction with this Management’s Discussion and Analysis of Financial Condition and Results of Operations. The Company believes the critical accounting policies that most impact the Company’s consolidated financial statements are described below.

Basis of Accounting — The Company uses the accrual method of accounting.

Revenue Recognition— The Company applies the provisions of SEC Staff Accounting Bulletin ("SAB") No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 104"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC.  The SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies.  In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured.

Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber.

29
The Company's subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided.  Advance payments from subscribers are recorded on the balance sheet as deferred revenue.  In circumstance where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured.

Principles of Consolidation— The accompanying consolidated financial statements include the accounts of the company and it's wholly - ~~- ------------ ------------ Net Change~~owned subsidiary.  Intercompany transactions and balances have been eliminated in ~~Cash ($161,584) $108,323 ============ ============~~
In fiscal 2005, net cash used in operating activities was $161,584, compared to net cash provided by operating activities of $113,415 in fiscal 2004. This change in cash flow from operating activities is the result of lower operating income due to increased salaries, legal fees, bad debt reserve, data and enrollment maintenance fees, advertising and printing. In fiscal 2005 the Company did not engage in investing activities. In fiscal 2004, the Company invested $5,092 to purchase computer equipment. The Company did not engage in financing activities in fiscal 2005 or fiscal 2004.
~~SUMMARY~~consolidation.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF ~~MATERIAL CONTRACTUAL COMMITMENTS (Stated~~RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2007 AND 2006

The following information contained in thousands) - ------------------------------------------------------------------------------------- Payment Period ------------------------------------------------------------- Contractual Commitments Less than After Total 1 year 2-3 years 4-5 years 5 years ------------------------------------------------------------- Operating Leases 459,397 83,044 174,977 185,632 15,744 ------------------------------------------------------------- Total 459,397 83,044 174,977 185,632 15,744 =============================================================
OFF-BALANCE SHEET FINANCING ARRANGEMENTS As of December 31, 2005 the Company had no off-balance sheet financing arrangements. NEW ACCOUNTING STANDARDS In November 2004, the FASB issued SFAS No. 151, INVENTORY COSTS. This statement amends the guidance in ARB No. 43, Chapter 4, INVENTORY PRICING, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The adoption of SFAS No. 151 did not have an impact on the Company's consolidated financial statements. 19 In December 2004, the FASB issues SFAS No. 152, ACCOUNTING FOR REAL ESTATE TIME-SHARING TRANSACTIONS. This Statement amends FASB Statement No. 66, ACCOUNTING FOR SALES OF REAL ESTATE, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, ACCOUNTING FOR REAL ESTATE TIME-SHARING TRANSACTIONS. This Statement also amends FASB Statement No. 67, ACCOUNTING FOR COSTS AND INITIAL RENTAL OPERATIONS OF REAL ESTATE PROJECTS, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2. This Statement is effective for financial statements for fiscal years beginning after June 15, 2005. The adoption of SFAS No. 152 did not have an impact on the Company's consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY ASSETS. The guidance in APB Opinion No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces itthis analysis should be read in conjunction with ~~a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if~~ the unaudited condensed consolidated financial statements and related disclosures contained in the Company’s Quarterly Report on Form 10-QSB for the three and six months ended June 30, 2007.

Our future capital requirements will depend on our ability to continue to develop our business and revenue, including (i) our ability to maintain and expand our customer base, and (ii) the overall financial market conditions if and when we might seek potential investors.  We continue to seek potential business acquisitions based on, among other criteria, the economics of any deal and subsequent projected future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS No. 153 did not have an impact on the Company's consolidated financial statements. In December 2004, the FASB issued SFAS No. 123, SUMMARY OF STATEMENT NO. 123 (REVISED 2004). This Statement is a revision of FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. This Statement supersedes APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHER THAN EMPLOYEES FOR ACQUIRING, OR IN CONJUNCTION WITH SELLING, GOODS OR SERVICES. The Company is currently evaluating the provisions of SFAS 123(R) and the impact that it will have on its share based employee compensation programs. In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement replaces APB No. 20, ACCOUNTING CHANGES and FASB No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies it all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS No. 154 did not have an impact on the Company's consolidated financial statements. 20 CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with accounting standards generally accepted in the United States requires management to make estimates and assumptions that affect both the recorded values of assets and liabilities at the date of the financial statements and the revenues recognized and expenses incurred during the reporting period. The company's estimates and assumptions affect its recognition of deferred expenses, bad debts, income taxes, the carrying value of its long-lived assets and its provision for certain contingencies. The company evaluates the reasonableness of these estimates and assumptions continually based on a combination of historical information and other information that comes to its attention that may vary its outlook for the future. Actual results may differ from these estimates under different assumptions. Management suggests that the company's Summary of Significant Accounting Policies, as described in Note 1 of Notes to Consolidated Financial Statements, be read in conjunction with this Management's Discussion and Analysis of Financial Condition and Results of Operations. The Company believes the critical accounting policies that most impact the Company's consolidated financial statements are described below. BASIS OF ACCOUNTING The Company uses the accrual method of accounting. REVENUE RECOGNITION The Company applies the provisions of SEC Staff Accounting Bulletin ("SAB") No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 104"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. The SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured. Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber. The Company's subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided. Advance payments from subscribers are recorded on the balance sheet as deferred revenue. In circumstance where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the company and it's wholly - owned subsidiary. Intercompany transactions and balances have been eliminated in consolidation. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2006 AND 2005 - --------------------------------------------------------------------------- The following information contained in this analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related disclosures contained in the Company's Quarterly Report on Form 10-QSB for the quarter ended June 30, 2006. 21 LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The Company has limited liquidity and capital resources. The Company does not currently possess a financial institution source of financing and the Company cannot be certain that its existing sources of cash will be adequate to meet its liquidity requirements. The Company's future capital requirements will depend on its ability to successfully implement its business plan and other factors, including (i) the ability of the Company to maintain its existing customer base and to expand its customer base, and (ii) overall financial market conditions where the Company might seek potential investors. The Company is also seeking potential business acquisitions based on, among other criteria, the economics of any deal and subsequent projected cash flow. The Company may also seek additional funding through the sale of its common stock. As of June 30, 2006, the Company had cash on hand of $460,421, compared to $296,436 at June 30, 2005. This $163,985 increase in cash on hand is due primarily to increased revenues. Management believes that cash on hand and anticipated revenues will be sufficient to cover operating costs over the next twelve months. Therefore, the Company does not anticipate needing to find other sources of capital at this time. If the Company's revenues, however, are less than anticipated the Company will need to find other sources of capital to continue operations. The Company would then seek additional capital in the form of debt and/or equity financing. While the Company believes that it is capable of raising additional capital, if needed, there is no assurance that the Company will be successful in locating other sources of capital on favorable terms or at all. RESULTS OF OPERATIONS - --------------------- COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005 --------------------------------------------------------- Workers' compensation costs in California continue to remain excessive which continues to motivate employers to search for ways to control this cost. Revenues for the six months ended June 30, 2006 increased over the same period of 2005, and the Company expects to see new growth in the sign- up of MPN customers. In the six months ended June 30, 2006, revenues increased to $981,415 compared to $794,427 during the six months ended June 30, 2005. A large portion of the revenue increase was attributable to billing employee data maintenance costs to the clients which the Company in turn paid to an outside firm. The Company believes that it can continue to build upon its revenue base during the remainder of the current fiscal year; however, revenues can be adversely affected by the loss of any one major customer or a negative change in laws affecting our business or other factors that may or may not be within our control. During the six months ended June 30, 2006, consulting fees decreased 27% to $44,708. This reduction was primarily the result of lower information systems and marketing expenses. The Company anticipates consulting fees will continue to be lower during the upcoming fiscal quarters in comparison to the prior year. Salaries & wages increased 3% to $361,021. This increase was due to a salary increase given to one of the officers of the Company. The Company expects salaries & wages to remain fairly constant throughout 2006. 22 In the six months ended June 30, 2006, the Company incurred professional fees of $186,533 compared to $210,144 during the six months ended June 30, 2005. The decrease in professional fees in 2006 is largely attributable to lower public relations fees and no longer outsourcing nurse case management. The Company anticipates professional fees will increase significantly during the remainder of the current fiscal year primarily as a result of increased legal costs associated with the lawsuit filed against the Company by Messers, Tietelbaum and Alexakis. In September 2006, the parties to this matter submitted to binding arbitration, which resulted in a settlement between the parties. In the settlement each party to dismiss with prejudice their complaint and/or cross-complaint in the above mentioned action. No party received any money, stock or other compensation as a result of the mutual release and settlement and each party agreed to be responsible for its own attorneys' fees. In the six months ended June 30, 2006, the Company incurred insurance expense of $70,300 compared to $35,977 for June 30, 2005. This increase in insurance expense is the result of the Company acquiring directors and officers' liability insurance coverage. The Company anticipates that insurance costs will be higher during the balance of fiscal 2006. In the six months ended June 30, 2006, the Company incurred employment enrollment fees of $37,533 compared to $128,664 during the six months ended June 30, 2005. The decrease was a result of over estimating employment enrollment fees during the six months ended June 30, 2005. The Company is required to pay a fee to the State of California for each person it enrolls. As a result of the over accrual of employment enrollment fees in 2005, we anticipate lower employment enrollment fees, as compared to 2005, throughout the balance of the 2006 fiscal year. During the six month ended June 30, 2006, general & administrative expenses rose 56% to $307,535 compared to $197,040 in the six months ended June 30, 2005. This increase in general & administrative expenses is attributable to the Company paying an outside firm for employee data maintenance cost. We expect that general & administrative costs will continue to be higher throughout the remainder of the 2006 fiscal year as compared to the 2005 fiscal year. Total expenses incurred in the six months ended June 30, 2006, equaled $1,012,400 compared to $933,647 during the six month ended June 30, 2005. This 8% increase in total expenses is primarily the result of increases in insurance and general and administrative expenses, including outside employment data maintenance fees. As discussed above, these increases were partially offset by decreases in advertising, bad debt reserves, public relations and nurse case management fee expenses. As a result of the aforementioned increases in revenues and total expenses, during the six months ended June 30, 2006, the Company realized a net loss of $29,403 compared to a net loss of $198,140 during the six months ended June 30, 2005. The Company does not anticipate a profit in 2006 compared to 2005 due to the uncertain cost of ongoing litigation COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2006 AND 2005 ----------------------------------------------------------- During the three months ended June 30, 2006, revenues decreased to $408,169 compared to $438,828 during the three months ended June 30, 2005. The primary contributing factor to the decrease in revenue in the current fiscal year was attributable to lower MPN rates paid by one of our major customers. While this customer will continue to pay lower rates throughout the balance of the year, the Company believes that it can continue to build upon its revenue base during the remainder of the current fiscal year. As discussed above, however, revenues can be adversely affected by the loss of any one major customer or a negative change in laws affecting our business or other factors that may or may not be within our control. 23 During the three months ended June 30, 2006, consulting fees decreased 25% to $26,501. This reduction was primarily the result of lower information systems and marketing expenses. The Company anticipates consulting fees will continue to be lower during the upcoming fiscal quarters in comparison to the prior year. Salaries & wages increased 8% to $191,746. This increase was due to a salary increase given to one of the officers of the Company. The Company expects salaries & wages to remain fairly constant throughout the remainder of 2006. In the three months ended June 30, 2006, the Company incurred professional fees of $132,071 compared to $105,705 during the three months ended June 30, 2005. The increases in professional fees in 2006 is largely attributable to higher legal and accounting fees. The increased legal and accounting fees were partially offset by lower public relations fees and no longer outsourcing nurse case management. The Company anticipates professional fees will increase significantly during the rest of the current fiscal year primarily as a result of increased legal costs associated with the lawsuit filed against the Company by Messers, Tietelbaum and Alexakis. Currently, binding arbitration of this matter is scheduled for September 2006. The Company expects legal fees to increase significantly in connection with preparation for and participation in the arbitration. In three months ended June 30, 2006, the Company incurred insurance expense $33,721 compared to $19,462 for June 30, 2005. This increase in insurance expense is the result of the Company acquiring directors and officers' liability insurance coverage. The Company anticipates that insurance costs will be higher during the balance of fiscal 2006. In the three months ended June 30, 2006, the Company incurred employment enrollment fees of $9,333 compared to $78,732 during the three months ended June 30, 2005. The decrease was the result of over estimating employment enrollment fees during the three months ended June 30, 2005. The Company is required to pay a fee to the State of California for each person it enrolls. As a result of the over accrual of employment enrollment fees in 2005, we anticipate lower employment enrollment fees, compared to 2005, throughout the balance of the 2006 fiscal year. During the three month ended June 30, 2006, general & administrative expenses rose 63% to $153,732 compared to $94,380 in the three months ended June 30, 2005. This increase in general & administrative expenses is attributable to the Company paying an outside firm for employee data maintenance costs. This increase was partially offset by reductions in equipment repairs and printing cost. Total expenses incurred in the three months ended June 30, 2006, equaled $549,489 compared to $515,856 during the three month ended June 30, 2005. As discussed above, this 7% increase in total expenses is primarily the result of increases in insurance, professional fees and employee data maintenance fees, which increases were partially offset by decreases in employment enrollment fees. As a result of the aforementioned decrease in revenues and increase in total expenses, during the three months ended June 30, 2006, the Company realized net loss of $95,022 compared to a net loss of $76,538 during the three months ended June 30, 2005. The Company does not anticipate a profit in 2006 compared to 2005 due to the uncertain cost of ongoing litigation. 24 CASH FLOW During the six months ended June 30, 2006 cash was primarily used to fund operations. We had a net increase in cash of $115,330 during the six months ended June 30, 2006. See below for additional discussion and analysis of cash flow.
If needed, we may seek additional funding through the sale of its common stock.

As of June 30, 2007, we had cash on hand of $357,290 compared to $273,058 at December 31, 2006.  The $84,232 increase in cash on hand is the result of increased revenue from operations.  We believe that cash on hand and anticipated revenues from operations will be sufficient to cover our operating costs over the next twelve months.  We do not anticipate needing to find other sources of capital at this time.  If, however, our revenues are less than anticipated we may need to find other sources of capital to continue operations.  Most likely we would seek additional capital in the form of debt and/or equity.  While we believe we are capable of raising additional capital, there is no assurance that we will be successful in locating other sources of capital on favorable terms or at all.

Results of Operations

Comparison of the six months ended June 30, 2007 and 2006

Despite an 18% increase in the total number of employee enrollees during six months ended June 30, 2007 total revenues decreased 6% to $920,688. As a result of goodwill gesture, in February 2007, we entered into an agreement with a major customer to absorb the cost of re-enrolling their employees into the HCO program with no additional revenue being generated.  Another contributing factor to decreasing revenue is the increasing popularity of our a la carte option.  This option allows an employer to enter either our HCO or MPN program at a lower rate and pay a separate cost for other services as needed in the future.  We expect that our goodwill gesture in February 2007 was a one-time event.  We also anticipate that our a la carte option will continue to be a popular option in the future which could contribute to reductions in revenue in future quarters.

30
During the six months ended June 30, 2007, we had approximately 207,000 total enrollees.  This was made up of approximately 66,000 HCO clients and 141,000 MPN clients.  By comparison during the six months ended June 30, 2006 we had approximately 128,000 enrollees, including approximately 48,000 HCO enrollees and approximately 80,000 MPN enrollees.  The 38% increase in HCO enrollees is the result of increasing customers and existing customers increasing their number of enrollees. The 76% increase in our MPN enrollees is the result of increasing customers and existing customers increasing their number of enrollees.

Despite a 38% increase in HCO enrollment, during the six months ended June 30, 2007 we experienced a 24% decrease in revenue from HCO fees.  As discussed above, this decrease was primarily the result of the goodwill gesture we made to one of our clients in February 2007.  Due to increased competition and barring legislative changes to reduce or eliminate government fees and otherwise reduce the costs and burdens of administering an HCO program to allow HCOs to be more price competitive with MPNs, we expect that enrollment in our HCO program will continue to be challenging and could continue to negatively impact revenues from HCO enrollment.  Based on a review of the expiration dates of current contracts with our existing HCO clients and our experience over the past year, we anticipate that during fiscal 2007 we will experience a 3% increase in total HCO enrollment. As a result of our goodwill gesture, we anticipate we will experience a 3% decrease in HCO revenue in fiscal 2007.

With a 76% increase in MPN enrollment during the six months ended June 30, 2007, we realized only an 8% increase in MPN fees.  The average fee we charged per MPN enrollee during the six months ended June 30, 2007 was 58% lower than in six months ended June 30, 2006. In the second and third quarters of 2006, we lowered our rates to be more competitive.  The six months ended June 30, 2007 reflect that significant rate reduction.  While revenue increased slightly from MPN enrollment during the first six months, we expect MPN rates for services to be relatively stable throughout the balance of fiscal 2007. We continue to anticipate that MPN revenue for the 2007 fiscal year will be approximately 7% higher compared to fiscal 2006.

During the six months ended June 30, 2007, other revenue increased 75% to $137,314 from $78,123 for the six months ended June 30, 2006.  The primary component of other revenue is nurse case management.  We retain nurses on our staff who, at the request of our customers, will review the medical portion of a claim on behalf of our employer clients, claims managers and injured workers.  We offer nurse case management services to our customers on an optional basis.  We charge an additional fee for nurse case management services.  We anticipate approximately 18% growth in other revenue by the end of fiscal 2007.

We expect the aforementioned 3% decrease in HCO fees to more than offset the expected 7% increase in MPN fees and the anticipated 18% increase in other revenue and will result in an overall decrease in total revenue of approximately 3% in 2007.

Total expenses decreased 15% during the six months ended June 30, 2007 compared to 2006. We expect total expenses to be approximately 17% lower during the 2007 fiscal year, primarily as a result of settling the aforementioned lawsuit during 2006.

During the six months ended June 30, 2007, consulting fees increased to $97,967 from $44,708 during the six months ended June 30, 2006.  This increase in consulting fees was primarily due to a former executive officer of Medex leaving his position during 2006 and becoming a consultant.  We anticipate that consulting fees will increase approximately 37% in 2007 as we continue to retain the consulting services of the former Medex executive officer.

Salaries and wages decreased $57,384 or 16% during the six months ended June 30, 2007.  The decrease in salaries & wages is attributable to the aforementioned resignation of the former Medex executive officer.  We expect salaries and wages to be approximately 7% lower in 2007 as a result of the reduction in overall salaries and wages from the resignation of the former Medex executive officer, which was partially offset by the hiring of a new sales executive.  As discussed above, however, we expect this decrease in salaries and wages in 2007 will be largely offset by the corresponding increase in consulting fees.

31
For the six months ended June 30, 2007, we incurred professional fees of $86,163 compared to $186,533 during the six months ended June 30, 2006.  We expect professional fees to be about 66% lower in 2007, as compared to 2006, ~~2005 ----------- ----------- (unaudited) (unaudited)~~ ~~~~Net~~as a result of settling the lawsuit against the Company during 2006.~~

During the six months ended June 30, 2007, we incurred insurance expenses of $51,712, an $18,588 decrease over the prior year six months.  The decrease in 2007 is primarily due to a reduction in health insurance premiums resulting from the former Medex executive officer becoming an independent consultant.  We expect insurance expenses to remain lower during the rest of 2007.

Employee enrollment decreased $2,733 to $34,800 during the six months ended June 30, 2007, compared to the six months ended June 30, 2006.  As an HCO, we are required to pay a fee to the DWC for each person enrolled at the end of the calendar year in our HCO program.  Because employee enrollment expenses are not determined until year-end, we accrue expenses during the year based on our estimation of what enrollment will be at year-end.  We anticipate that employee enrollment will be lower at December 31, 2007 than it was at December 31, 2006.  Therefore, we are accruing less for employee enrollment expense in 2007 than we did in 2006.

Under regulations applicable to HCOs and MPNs we are required to comply with certain data reporting and document delivery obligations.  We currently contract out much of these data reporting and document delivery obligations to third parties.  The costs we incur to meet these data reporting and document delivery requirements are reflected in our financial statements as data maintenance.

Data maintenance costs are impacted by several factors, including the overall mix of enrollees in our HCO and MPN programs and the number of new enrollees during the year.  HCOs are required to deliver enrollment notices annually to each HCO enrollee.  By comparison, MPNs are required to deliver an enrollment notice only at the time of initial enrollment and at the time an enrollee is injured.  As a result, after the first year, data maintenance fees for MPN enrollees are consistently about 50% lower than data maintenance fees per HCO enrollee.  Therefore, depending on the mix of HCO and MPN enrollees and the number of new MPN enrollees versus ongoing MPN enrollees, our data maintenance costs may vary significantly from year to year even in years when our overall enrollment does not change materially.

Data maintenance fees may also vary significantly from employee enrollment fees in any given year.  Employee enrollment fees are determined based on the number of HCO enrollees at the end of the calendar.  Employee enrollment fees do not take into account fluctuations in HCO enrollment during the year.  By comparison, data maintenance fees are billed as services are provided.  Therefore, we may have years when HCO enrollment is higher during the year than it is at the end of the calendar year, resulting in variances in data maintenance fees and employee enrollment fees in a given year.

~~Finally, data maintenance fees are also impacted by the prices we can negotiate with our third party service providers.~~

During the six months ended June 30, 2007 we experienced a 38% increase in HCO enrollment and a 76% increase in MPN enrollment, resulting in an overall enrollment increase of 62%.  Data maintenance fees decreased 11% during the six months ended June 30, 2007.  The decrease in data maintenance fees is primarily attributable to lower data maintenance costs associated with the renewal of MPN enrollees.  We expect data maintenance fees will be approximately 5% lower by the end of 2007 as a result of the negotiation of lower printing costs with a vendor.

32
General and administrative expenses decreased 7% to $123,726 during the six months ended June 30, 2007.  This decrease in general & administrative expense was attributable to decreases in travel expenses and lower vacation accruals as a result of resignation of a former Medex executive officer.  We do not expect a significant change in general and administrative expenses in upcoming quarters.

During the six months ended June 30, 2007, total revenues was $920,688.  This 6% decrease in total revenues was partially offset by the 18% decrease in total expenses resulting in a profit from operations of $61,149 compared to loss from operations of $30,985 during six months ended June 30, 2006.  Correspondingly, we realized a net profit of $34,049 for the six months ended June 30, 2007, compared to net loss of $24,403 during the six months ended June 30, 2006.  In 2007, we anticipate that a projected 37% increase in consulting fees will be more than offset by a 7% decrease in salaries and wages, and a 66% decrease in professional fees to result in a 15% decrease in total expenses in 2007.  We expect this 15% decrease in total expenses will more than offset the projected 3% decrease in total revenue in 2007, resulting in a net profit in 2007.

~~Comparison of the three months ended June 30, 2007 and 2006~~

Total revenues increased 26% to $516,369 in the second quarter 2007 over the second quarter 2006. HCO revenues remained constant. MPN revenues increased 74% as a result of increasing customers and existing customers increasing their number of enrollees. Other revenue increased 95% as a result of our providing increased nurse case management services to our customers.

~~Total expenses during the three months ended June 30, 2007 compared to 2006, decreased 27% to $401,054, primarily as a result of settling the aforementioned lawsuit during 2006.~~

During the three months ended June 30, 2007, consulting fees increased to $52,075 from $26,501 during the three months ended June 30, 2006.  This increase in consulting fees was primarily due to a former executive officer of Medex leaving his position during 2006 and becoming a consultant.

Salaries and wages decreased $42,396 or 22% during the three months ended June 30, 2007.  The decrease in salaries & wages is attributable to the aforementioned resignation of the former Medex executive officer.

For the three months ended June 30, 2007, we incurred professional fees of $29,639 compared to $132,071 during the three months ended June 30, 2006.  Professional fees are lower as a result of the settlement of the lawsuit.

During the three months ended June 30, 2007, we incurred insurance expenses of $26,999, a $6,722 decrease over the prior year quarter.  The decrease in 2007 is primarily due to a former Medex executive officer becoming an independent consultant thus lowering the health insurance premium.

Employee enrollment costs increased $8,067 to $17,400 during the three months ended June 30, 2007, compared to the three months ended June 30, 2006.  As an HCO, we are required to pay a fee to the DWC for each person enrolled at the end of the calendar year in our HCO program.  The 2006 second quarter employee enrollment fees were lower due to over accruing employee enrollment fees in 2005.

~~Data maintenance fees decreased $15,037 to $64,706 during the three months ended June 30, 2007. This 19% decrease is due to renegotiation with outside service vendors resulting in lower fees.~~

33
General and administrative expenses decreased 21% to $58,500 during the three months ended June 30, 2007.  This decrease in general & administrative expense was attributable to decreases in travel expenses and lower vacation accruals as a result of resignation of a former Medex executive officer.

The 26% increase in our total revenue and 27 % decrease in total expenses during the three months ended June 30, 2007, resulted in a profit from operations of $115,315 compared to loss from operations of $141,320 during three months ended June 30, 2006.

As a result of increasing revenues and decreasing expenses, we realized a net profit of $78,411 for the three months ended June 30, 2007, compared to net loss of $95,022 during the three months ended June 30, 2006.

~~Cash Flow~~

During the six months ended June 30, 2007 cash was primarily used to fund operations. We had a net increase in cash of $84,232 during the six months ended June 30, 2007 as compared to June 30, 2006. See below for additional discussion and analysis of cash flow.

For the six months ended June 30,

2007
(unaudited)

2006
(unaudited)

Net cash provided by operating activities $ 84,232 $ 115,330
Net cash used in investing activities - -
Net cash provided by (used in) financing activities - -

Net Change in Cash $ 84,232 $ 115,330

During the six months ended June 30, 2007, net cash provided by ~~(used in)~~ operating activities ~~$115,330 ($210,239) Net cash used in investing activities - - Net~~was $84,232, compared to net cash provided by ~~(used in)~~operating activities of $115,330 during the six months ended June 30, 2006.  Although we realized net income from operations of $34,049 during the six months ended June 30, 2007, compared to a net loss of $24,403 during the six months ended June 30, 2006, this significant increase in cash provided from operating activities was more than offset by a $97,151 decrease in accounts receivable, a $30,117 decrease in accounts payable and a $64,611 decrease in unearned revenue.  The factors contributed to a $31,098 decrease in cash on hand at June 30, 2007.

We did not engage in investing or financing activities ~~- - ----------- ----------- Net Change~~during the six months ended June 30, 2007 or 2006.

~~Summary of Material Contractual Commitments~~
Payment Period
Total Less than 1 year 2-3 years 4-5 years After 5 Years

Operating Leases $ 333,514 $ 43,308 $ 180,234 $ 109,972 $ -

Total
$ 333,514 $ 43,308 $ 180,234 $ 109,972 $ -
34
~~Balance Sheet Financing Arrangements~~

~~As of June 30, 2007 the Company had no off-balance sheet financing arrangements.~~

~~Recent Accounting Pronouncements~~

In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS – AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140.This Statement amends FASB Statements No. 133, accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in ~~Cash $115,330 ($210,239) =========== ===========~~
During the six months ended June 30, 2006, net cash provided by operating activities was $115,330, compared to net cash used in operating activities of $210,239 during the six months ended June 30, 2005. This increase in cash flow from operating activities is a result of collections of accounts receivable, an increase in unearned revenue and accrued expenses, which increases were partially offset by decreases in accounts payable and income tax payable. The Company did not engage in investing activities during the first six months of 2006 or 2005. The Company did not engage in financing activities in the first six months of 2006 or 2005.
~~SUMMARY~~Statement 133 Implementation Issued No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The adoption of SFAS No. 155 did not have an impact on the Company's consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF ~~MATERIAL CONTRACTUAL COMMITMENTS (Stated~~FINANCIAL ASSETS – AN AMEDNMENT OF FASB STATEMENT No. 140. This Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The adoption of SFAS No. 156 did not have an impact on the Company's consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS. This statement defines fair value, establishes a framework for measuring fair value in thousands) - ------------------------------------------------------------------------------------- Payment Period ------------------------------------------------------------- Contractual Commitments Less than After Total 1generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of SFAS 157 did not have an impact on the Company’s consolidated financial statements. The Company presently comments on significant accounting policies (including fair value of financial instruments) in Note 2 to the financial statements.

In September 2006, the FASB issued SFAS No. 158,  EMPLOYERS’ ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS –AN AMENDMENT OF FASB STATEMENTS NO. 87, 88, 106 AND 132(R). This statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other that a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year ~~2-3 years 4-5 years 5 years -------------------------------------------------------------~~ Operating Leases $231,900 $42,048 $174,982 $185,646 $15,776 ------------------------------------------------------------- Total $231,900 $42,048 $174,982 $185,646 $15,776 =============================================================
OFF-BALANCE SHEET FINANCING ARRANGEMENTS As of June 30, 2006 the Company had no off-balance sheet financing arrangements. RECENT ACCOUNTING PRONOUNCEMENTS In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement replaces APB No. 20, ACCOUNTING CHANGES and FASB No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies it all voluntary changes in accounting principle. It also applies to changes 25 required by an accounting pronouncement in the unusual instance that the pronouncement includes specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS No. 154 did not have an impact on the Company's consolidated financial statements. In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140. This Statement amends FASB Statements No. 133, accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issued No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The adoption of SFAS No. 155 did not have an impact on the Company's consolidated financial statements. In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS AN AMEDNMENT OF FASB STATEMENT No. 140. This Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The adoption of SFAS No. 156 did not have an impact on the Company's consolidated financial statements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with accounting standards generally accepted in the United States requires management to make estimates and assumptions that affect both the recorded values of assets and liabilities at the date of the financial statements and the revenues recognized and expenses incurred during the reporting period. The company's estimates and assumptions affect its recognition of deferred expenses, bad debts, income taxes, the carrying value of its long-lived assets and its provision for certain contingencies. The company evaluates the reasonableness of these estimates and assumptions continually based on a combination of historical information and other information that comes to its attention that may vary its outlook for the future. Actual results may differ from these estimates under different assumptions. Management suggests that the company's Summary of Significant Accounting Policies, as described in Note 1 of Notes to Consolidated Financial Statements, be read in conjunction with this Management's Discussion and Analysis of Financial Condition and Results of Operations. The Company believes the critical accounting policies that most impact the Company's consolidated financial statements are described below. BASIS OF ACCOUNTING - The Company uses the accrual method of accounting. REVENUE RECOGNITION The Company applies the provisions of SEC Staff Accounting Bulletin ("SAB") No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 104"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. The SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured. 26 Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber. The Company's subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided. Advance payments from subscribers are recorded on the balance sheet as deferred revenue. In circumstance where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the company and it's wholly-owned subsidiary. Intercompany transactions and balances have been eliminated in consolidation. FINANCIAL STATEMENTS - -------------------- See Consolidated Financial Statement listed in the accompanying index to the Consolidated Financial Statements on Page F-1 herein. LEGAL PROCEEDINGS - ----------------- A complaint was filed in Orange County Superior Court by plaintiffs Marvin Teitelbaum, a shareholder of the Company, and Peter Alexakis, a shareholder of the Company and former director (collectively "Plaintiffs") on or about April 7, 2004 against the Company's president Tom Kubota, secretary Rudy LaRusso and the Company (collectively "Defendants"). The action seeks cancellation of a stock issuance, an order for Mr. Kubota to pay the Company $150,000 and other damages to be determined based upon allegations that Defendants breached various fiduciary duties. The Company has retained the Law Offices of Joseph J. Nardulli, Newport Beach, California, and Mr. Kubota and Mr. LaRusso have retained the Law Offices of L. Scott Karlin, Tustin, California, to represent them in this matter. Subsequent to the filing of the Annual Report on Form 10-KSB and the filing of the Quarterly Report on Form 10-QSB for the quarter ended June 30, 2006, on September 22, 2006, a settlement agreement was reached between Pacific Health Care Organization, Inc. ("PHCO"), Medex Healthcare, Inc. ("Medex"), and Tom Kubota, ("Kubota") and Marvin Teitelbaum and Peter Alexakis ("Plaintiffs") dismissing the complaint and cross complaint in the matter entitled Teitelbaum et. al. vs. Kubota et. al., filed in Orange County Superior Court, Case No. 04cc04645. Each party to the action agreed to dismiss with prejudice their complaint and/or cross-complaint in the above mentioned action. No party received any money, stock or other compensation as a result of the mutual release and settlement and each party agreed to be responsible for its own attorneys' fees. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------- On February 17, 2004, our independent auditors, Bierwolf, Nilson & Associates, Certified Public Accountants, informed us that on February 10, 2004, that their firm had merged its operations into Chisholm, Bierwolf & Nilson, LLC ("CBN") and was therefore effectively resigning as our auditors. Beirwolf, Nilson & Associates had audited our financial statements for the fiscal years ended December 31, 2001 and 2002 and its reports for each of the two fiscal years did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles. There were no disagreements between us and Bierwolf, Nilson & Associates on any matter regarding accounting principles or practices, financial statement disclosure, or auditing scope or procedure during the past two fiscal years or any subsequent interim period of Bierwolf, Nilson & Associates as our auditors. 27 WHERE STOCKHOLDERS CAN FIND MORE INFORMATION We file annual and quarterly reports with the Securities and Exchange Commission. Stockholders may obtain, without charge, a copy of the most recent Form 10-KSB (without exhibits) by requesting a copy in writing from us at the following address: Pacific Health Care Organization 21 Toulon Newport Beach, California 92660 The exhibits to the Form 10-KSB are available upon payment of charges that approximate reproduction costs. If you would like to request documents, please do so by November 1, 2006, to receive them before the Annual Meeting of Stockholders. By order of the President, October 13, 2006 Tom Kubota, President STOCKHOLDERS ARE REQUESTED TO MARK, DATE AND SIGN THE ENCLOSED PROXY AND RETURN IT IN THE ENCLOSED, SELF-ADDRESSED ENVELOPE. NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES. YOUR PROMPT RESPONSE WILL BE HELPFUL, AND YOUR COOPERATION WILL BE APPRECIATED. 28 INDEX TO FINANCIAL STATEMENTS Page ---- Report of Chisholm, Bierwolf & Nilson, Independent Registered Public Accounting Firm F-1 Balance Sheets as of December 31, 2005 and 2004 F-2 Statements of Operations for the year ended December 31, 2005 and 2004 F-4 Statements of Stockholders' Equity and Comprehensive Income from January 1, 2004 to December 31, 2005 F-5in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. The adoption of SFAS No. 158 did not have an impact on the Company’s consolidated financial statements.

INDEX TO FINANCIAL STATEMENTS

Page

Report of Chisholm, Bierwolf & Nilson, Independent Registered Public Accounting Firm

F-1

Balance Sheets as of December 31, 2006 and 2005

F-2

Statements of Operations for the year ended December 31, 2006 and 2005

F-3

Statements of Stockholders’ Equity from January 1, 2005 to December 31, 2006

F-4

Statements of Cash Flows for the Years Ended December 31, 2005 and 2004 F-6 Notes to Consolidated Financial Statements for the years ended December 31, 2005 and 2004 F-7 Balance Sheets as of June 30, 2006 and December 31, 2005 (audited) F-20 Unaudited Statements of Operations for the three and six months ended June 30, 2006 and 2005 F-21 Unaudited Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005 F-22 Notes to Unaudited Consolidated Financial Statements for the six months ended June 30, 2006 F-23 /Letterhead/ REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders Pacific Health Care Organization, Inc. We have audited the accompanying consolidated balance sheets of Pacific Health Care Organization Inc., as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders' equity and comprehensive income and cash flows for the years then ended. These consolidated financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the PCAOB (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatements. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the aforementioned consolidated financial statements present fairly, in all material respects, the financial position of Pacific Health Care Organization, Inc., as of December 31, 2005 and 2004, and the results of its consolidated operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 12 to the financial statements, there were errors in reporting the Company's income tax expense, liability and deferred tax assets. that were discovered by management as a result of the preparation of the Company's federal and state income tax returns. Accordingly, the financial statements have been restated to correct the errors. Chisholm, Bierwolf & Nilson, LLC Bountiful, Utah March 24, 2006 except for Notes 2E and 5 dated May 15, 2006 F-1 Pacific Health Care Organization, Inc. Balance Sheets

The accompanying notes are an integral part of these financial statements. F-2 Pacific Health Care Organization, Inc. Balance Sheets

The accompanying notes are an integral part of these financial statements. F-3 Pacific Health Care Organization, Inc. Statements of Operations

The accompanying notes are an integral part of these financial statements F-4 Pacific Health Care Organization, Inc. Statements of Stockholders' Equity and Comprehensive Income From January 1, 2004 to December 31, 2005

The accompanying notes are an integral part of these financial statements. F-5 Pacific Health Care Organization, Inc. Statements of Cash Flows For the Years Ended December 31,

2006 and 2005
	F-5

Notes to Consolidated Financial Statements for the years ended December 31, 2006 and 2005		F-6

Balance Sheets as of June 30, 2007 and December 31, 2006 (audited)		F-20

Unaudited Statements of Operations for the three and six months ended June 30, 2007 and 2006		F-21

Unaudited Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006		F-22

Notes to Unaudited Consolidated Financial Statements for the six months ended June 30, 2007F		F-23

/Letterhead/

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Pacific Health Care Organization, Inc.

We have audited the accompanying balance sheets of Pacific Health Care Organization Inc., as of December 31, 2006 and 2005, and the related statements of operations, stockholders’ equity and comprehensive income and cash flows for the years then ended. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the PCAOB (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatements. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the aforementioned financial statements present fairly, in all material respects, the financial position of Pacific Health Care Organization, Inc., as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/S/ Chisholm, Bierwolf & Nilson, LLC

Chisholm, Bierwolf & Nilson, LLC

Bountiful, Utah

February 2, 2007

F-1

Pacific Health Care Organization, Inc.
Balance Sheets
ASSETS
	December 31,			December 31,
	2006			2005

Current Assets
Cash	$	273,058		$	345,091
Accounts receivable, net of allowance of $20,000		213,738			351,311
Income tax receivable		27,355			-
Deferred tax asset		14,615			19,620
Prepaid state income tax		1,600
Prepaid expenses		49,548			42,871
Total current assets		579,914			758,893

Property & Equipment, net (Note 4)
Computer equipment		60,922			60,922
Furniture & fixtures		24,766			24,766
Total property & equipment		85,688			85,688

Less: accumulated depreciation		(75,317	)		(65,777	)

Net property & equipment		10,371			19,911

Total assets	$	590,285		$	778,804

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
Accounts payable	$	9,910		$	41,083
Accrued expenses (note 8)		142,065			236,176
Income tax payable		-			40,812
Unearned revenue		83,521			35,352
Total current liabilities		235,496			353,423
Total liabilities		235,496			353,423

Commitment		-			-

Shareholder's Equity
Preferred stock; 5,000,000 shares
authorized at $0.001 par value;
zero shares issued and outstanding		-			-
Common stock; 50,000,000 shares
authorized at $0.001 par value;
15,427,759 shares issued and outstanding		15,428			15,428
Additional paid-in capital		610,007			603,148
Accumulated (deficit)		(270,646	)		(193,195	)
Total stockholders' equity		354,789			425,381

Total liabilities and stockholders' equity	$	590,285		$	778,804

F-2

Pacific Health Care Organization, Inc.
Statements of Operations

	December 31,			December 31,
	2006			2005
				(Restated)
Revenues
HCO fees	$	1,229,816		$	1,399,012
MPN fee		536,616			597,404
Other		204,423			79,975
Total revenues		1,970,855			2,076,391

Expenses
Depreciation		9,540			11,341
Consulting fees		134,303			104,110
Salaries & wages		696,746			750,516
Professional fees		435,909			342,028
Insurance		123,909			84,341
Employee enrollment		55,456			116,540
Data maintenance		343,992			309,017
Bad debt expense		-			38,000
General & administrative		261,912			307,042

Total expenses		2,061,767			2,062,935

Income (loss) from operations		(90,912	)		13,456

Other income
Interest income		2,218			2,456
Total other income		2,218			2,456

Income (loss) before income tax provision (benefit)		(88,694	)		15,912


Income tax provision (benefit)		(11,243	)		45,235

Net income (loss)	$	(77,451	)	$	(29,323	)

	December 31,			December 31,
	2006			2005
Basic and fully diluted earnings per share:
Earnings per share amount	$	0.00		$	0.00
Weighted average common shares outstanding		15,427,759			15,427,759

F-3

Pacific Health Care Organization, Inc.
Statements of Stockholders’ Equity
From January 1, 2005 to December 31, 2006

	Preferred Stock				Common Stock				Paid in		Accumulated
	Shares		Amount		Shares		Amount		Capital		Deficit

Balance, January 1, 2005		-	$	-		15,427,759	$	15,428	$	586,169	$	(163,872	)

Valuation Stock Options		-		-		-		-		16,979		-

Net Income for the Year Ended December 31, 2005		-		-		-		-		-		(29,323	)

Balance, December 31, 2005		-	$	-		15,427,759	$	15,428	$	603,148	$	(193,195	)

Valuation of Stock Options		-		-		-		-		6,859		-

Net Income for the Year Ended December 31, 2006		-		-		-		-		-		(77,451	)

Balance, December 31, 2006		-	$	-		15,427,759	$	15,428	$	610,007	$	(270,646	)

F-4

Pacific Health Care Organization, Inc.
Statements of Cash Flows
For the Years Ended December 31

	2006			2005
Cash Flows from Operating Activities				(Restated)
Net income (loss)	$	(77,451	)	$	(29,323	)
Adjustments to reconcile net income to net cash:
Depreciation		9,540			11,341
Stock options issued for services		6,859			16,979
Changes in operating assets & liabilities:
(Increase) decrease in accounts receivable		137,573			(171,920	)
Increase in income tax receivable		(27,355	)		-
(Increase) decrease in deferred tax asset		5,005			(19,620	)
Increase in prepaid state income tax		(1,600	)
(Increase) decrease in prepaid expenses		(6,677	)		(2,156	)
Increase (decrease) in accounts payable		(31,173	)		19,270
Increase (decrease) in accrued expenses		(94,111	)		57,289
Increase (decrease) in income tax payable		(40,812	)		40,812
Increase (decrease) in unearned revenue		48,169			(84,256	)
Net cash provided by operating activities		(72,033	)		(161,584	)

Cash Flows from Investing Activities
Net cash used by investing activities		-			-

Cash Flows from Financing Activities

Net cash provided by financing activities		-			-

Increase (decrease) in cash		(72,033	)		(161,584	)

Cash at beginning of period		345,091			506,675

Cash at End of Period	$	273,058		$	345,091

Supplemental Cash Flow Information
Interest	$	-		$	-
Taxes		1,600			24,043

F-5

Pacific Health Care Organization, Inc.

Notes to Financial Statements

December 31, 2006

NOTE 1 - CORPORATE HISTORY

Pacific Health Care Organization, Inc., was incorporated under the laws of the state of Utah on April 17, 1970 under the name Clear Air, Inc. On September 25, 2000, the Company changed its name to Pacific Health Care Organization, Inc. On February 26, 2001, the Company acquired Medex Healthcare, Inc. ("Medex"), a California corporation organized March 4, 1994, in a share for share exchange in which the Company acquired all of the outstanding shares of Medex in exchange for 6,500,000 shares of the Company. The acquisition of Medex by the Company was accounted for as a reverse acquisition, and therefore Medex was considered the accounting acquirer. The financial statements, contained herein, are those of Medex Healthcare, Inc., for all periods presented.

The principle business of the Company is that of its wholly owned subsidiary Medex. Medex is in the business of managing and administering Health Care Organizations (“HCOs”). HCOs are networks of medical providers established to serve the Workers' Compensation industry. The California legislature mandated that if an employer contracts services from an HCO, the injured workers must be given a choice between at least two HCOs. The Company recognized early on that two HCO certifications were necessary to be competitive. Instead of aligning with the competitor, the Company elected to go through the lengthy application process with the Department of Industrial Relations twice and subsequently received certification to operate two separate HCOs.

Through the two licenses to operate HCOs, the Company offers the injured worker a choice of enrolling in an HCO with a network managed by primary care providers requiring a referral to specialists or a second HCO where injured workers do not need any prior authorization to be seen and treated by specialists.

The two HCO certifications obtained by the Company cover the entire state of California. The geographical area has a multi-billion dollar annual medical and indemnity Worker's Compensation cost. The two HCO networks have contracted with over 3,800 provider locations making the Company's HCOs capable of providing comprehensive medical services throughout this region.

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES

A. Basis of Accounting

The Company uses the accrual method of accounting.

B. Revenue Recognition

The Company applies the provisions of SEC Staff Accounting Bulletin (“SAB”) No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS (“SAB 104”), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured.

Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber.

The Company's subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided. Advance payments from subscribers are recorded on the balance sheet as deferred revenue. In circumstance where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured.

F-6

Pacific Health Care Organization, Inc.

Notes to Financial Statements

December 31, 2006 and 2005

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

C. Cash Equivalents

The Company considers all short term, highly liquid investments that are readily convertible, within three months, to known amounts as cash equivalents. The Company currently has no cash equivalents.

D. Concentrations

Financial instruments that potentially subject Pacific Health Care Organization, Inc. (the Company) to concentrations of credit risks consist of cash and cash equivalents. The Company places its cash and cash equivalents at well-known, quality financial institutions. At times, such cash and investments may be in excess of the FDIC insurance limit.

E. Net Earnings (Loss) Per Share of Common Stock

The computation of earning (loss) per share of common stock is based on the weighted average number of shares outstanding at the date of the financial statements. Potentially issuable common shares totaling 817,964 related to warrants and 416,500 related to options were excluded from the calculation of fully diluted loss per share during 2005 because their inclusion would have been anti-dilutive.

	For the Years Ended December 31,
	2006			2005
Basic Earnings per share:				(Restated)
Income (loss) (numerator)	$	(77,451	)	$	(29,323	)
Shares (demoninator)		15,427,759			15,427,759
Per share amount	$	.00		$	.00

Fully Diluted Earnings per share:
Income (loss) (numerator)	$	(77,451	)	$	(29,323	)
Shares (demoninator)		15,427,759			15,427,759
Per share amount	$	.00		$	.00

F. Depreciation

The cost of property and equipment is depreciated over the estimated useful lives of the related assets. The cost of leasehold improvements is depreciated over the lesser of the length of the lease of the related assets for the estimated lives of the assets. Depreciation is computed on the straight line method.

F-7

Pacific Health Care Organization, Inc.

Notes to Financial Statements

December 31, 2006 and 2005

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

G. Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles, in the United States of America, require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

H. Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the company and it's wholly - owned subsidiary. Intercompany transactions and balances have been eliminated in consolidation.

I. Fair Value of Financial Instruments

The fair value of the Company's cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate carrying value based on their effective interest rates compared to current market prices.

J. General and Administrative Costs

General and administrative expenses include fees for office space, insurance, compensated absences, travel expenses and entertainment costs.

K. Income Taxes

The Company utilizes the liability method of accounting of income taxes. Under the liability method, deferred income tax assets and liabilities are provided based on the difference between the financial statements and tax basis of assets and liabilities measured by the currently enacted tax rates in effect for the years in which these differences are expected to reverse. Deferred tax expense or benefit is the result of changes in deferred tax assets and liabilities.

L. Capital Structure

The Company has two classes of stock. Preferred stock, 5,000,000 shares authorized, zero issued. Voting rights and liquidation preferences have not been determined. The Company also has voting common stock of 50,000,000 shares authorized, with 15,427,759 shares issued and outstanding. No dividends were paid in the 2006 and 2005 years.

M. Share - Based Payment

The Company has adopted the fair value method of accounting for stock-based employee compensation in accordance with statement of Financial Accounting Standards No. 123 (Revised 2004), “Accounting for Stock-Based Compensation” (SFS123[R]). This standard requires the company to record compensation expense using the Black-Scholes pricing model.

F-8

Pacific Health Care Organization, Inc.

Notes to Financial Statements

December 31, 2006 and 2005

NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

N. Trade Receivables

The Company in the normal course of business extends credit to its customers on a short-term basis. Although the credit risk associated with these customers is minimal, the Company routinely reviews its accounts receivable balances and makes provisions for doubtful accounts. The Company ages its receivables by date of invoice. Management reviews bad debt reserves quarterly and reserves specific accounts as warranted or sets up a general reserve based on amounts over 90 days past due. When an account is deemed uncollectible, the Company charges off the receivable against the bad debt reserve. At the 2006 year end, the Company’s bad debt reserve of $20,000 is a general reserve for balances over 90 days past due.

The percentages of the major customers to total accounts receivable for the year ended 2006 are as follows:

Customer A 13%

Customer B 12%

NOTE 3 - NEW TECHNICAL PRONOUNCEMENTS

In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement replaces APB No. 20, ACCOUNTING CHANGES and FASB No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies it all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS No. 154 did not have an impact on the Company’s consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140.This Statement amends FASB Statements No. 133, accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issued No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The adoption of SFAS No. 155 did not have an impact on the Company's consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS AN AMENDMENT OF FASB STATEMENT No. 140. This Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The adoption of SFAS No. 156 did not have an impact on the Company's consolidated financial statements.

F-9

Pacific Health Care Organization, Inc.

Notes to Financial Statements

December 31, 2006 and 2005

NOTE 3 - NEW TECHNICAL PRONOUNCEMENTS (CONTINUED)

In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of SFAS 157 did not have an impact on the Company's consolidated financial statements. The Company presently comments on significant accounting policies (including fair value of financial instruments) in Note 2 to the financial statements.

In September 2006, the FASB issued SFAS No. 158, EMPLOYERS' ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS AN AMENDMENT OF FASB STATEMENTS NO. 87, 88, 106 AND 132(R). This statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other that a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. The adoption of SFAS No. 158 did not have an impact on the Company's consolidated financial statements.

NOTE 4 - FIXED ASSETS

The Company capitalizes the purchase of equipment and fixtures for major purchases in excess of $1,000 per item. Capitalized amounts are depreciated over the useful life of the assets using the straight line method of depreciation which is 3 and 7 years for the office equipment, and furniture and fixtures, respectively. Scheduled below are the assets, costs and accumulated depreciation at December 31, 2006 and 2005.

	Cost				Depreciation Expense				Accumulated Depreciation
	December 31, 2006		December 31, 2005		December 31, 2006		December 31, 2005		December 31, 2006		December 31, 2005
Assets
Computer equipment	$	60,922	$	60,922	$	6,386	$	7,801	$	60,922	$	54,536
Furniture & fixtures		24,766		24,766		3,154		3,540		14,395		11,241
Totals	$	85,688	$	85,688	$	9,540	$	11,341	$	75,317	$	65,777

NOTE 5 – INCOME TAXES

The Company accounts for corporate income taxes in accordance with Statement of Accounting Standards Number 109 (“SFAS No. 109”) “Accounting for Income Taxes.” SFAS No. 109 requires an asset and liability approach for financial accounting and reporting for income tax purposes.

The tax provision (benefit) for the year-ended December 31, 2006 and the year ended December 31, 2005 ~~31, 2004 ------------ ------------ (Restated)~~ ~~Cash Flows from Operating Activities - ------------------------------------ Net income (loss) $ (29,323) $ 154,404 Adjustments~~consisted of the following:

2006
2005
(Restated)

Current:
Federal $ (17,948 ) $ 23,216
State 1,700 17,596
Deferred
Federal 4,240 (17,070 )
State 765 $ (2,550 )
Total tax provision (benefit) $ (11,243 ) $ 21,192

~~F-10~~

~~Pacific Health Care Organization, Inc.~~

Notes to reconcile net income to net cash: Depreciation 11,341 22,312 Stock options issued for services 16,979 13,511 Changes in operating assets & liabilities: (Increase) decrease in prepaid expenses (2,156) (16,549) (Increase) decrease in accounts receivable (171,920) (58,657) (Increase) decrease in deferred tax asset (19,620) - Increase (decrease) in accounts payable 19,270 4,820 Increase (decrease) in taxes payable 40,812 - Increase (decrease) in accrued expenses 57,289 38,967 Increase (decrease) in unearned revenue (84,256) (45,393) ------------ ------------ Net cash provided by operating activities 161,584 113,415 Cash Flows from Investing Activities - ------------------------------------ Purchase of computer equipment - (5,092) ------------ ------------ Net cash used by investing activities - (5,092) Cash Flows from Financing Activities - ------------------------------------ Net cash provided by financing activities - 938 ------------ ------------ Increase (decrease) in cash (161,584) 108,323 Cash at beginning of period 506,675 398,352 ------------ ------------ Cash at End of Period $ 345,091 $ 506,675 ============ ============ Supplemental Cash Flow Information - ---------------------------------- Interest $ - $ - Taxes 293 671

The accompanying notes are an integral part of these financial statements F-6 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 1 - CORPORATE HISTORY Pacific Health Care Organization, Inc., was incorporated under the laws of the state of Utah on April 17, 1970 under the name Clear Air, Inc. On September 25, 2000, the Company changed its name to Pacific Health Care Organization, Inc. On February 26, 2001, the Company acquired Medex Healthcare, Inc. ("Medex"), a California corporation organized March 4, 1994, in a share for share exchange in which the Company acquired all of the outstanding shares of Medex in exchange for 6,500,000 shares of the Company. The acquisition of Medex by the Company was accounted for as a reverse acquisition, and therefore Medex was considered the accounting acquirer. The financial statements, contained herein, are those of Medex Healthcare, Inc., for all periods presented. The principle business of the Company is that of its wholly owned subsidiary Medex. Medex is in the business of managing and administering Health Care Organizations ("HCOs"). HCOs are networks of medical providers established to serve the Workers' Compensation industry. The California legislature mandated that if an employer contracts services from an HCO, the injured workers must be given a choice between at least two HCOs. The Company recognized early on that two HCO certifications were necessary to be competitive. Instead of aligning with the competitor, the Company elected to go through the lengthy application process with the Department of Industrial Relations twice and subsequently received certification to operate two separate HCOs. Through the two licenses to operate HCOs, the Company offers the injured worker a choice of enrolling in an HCO with a network managed by primary care providers requiring a referral to specialists or a second HCO where injured workers do not need any prior authorization to be seen and treated by specialists. The two HCO certifications obtained by the Company cover the entire state of California. The geographical area has a multi-billion dollar annual medical and indemnity Worker's Compensation cost. The two HCO networks have contracted with over 3,800 provider locations making the Company's HCOs capable of providing comprehensive medical services throughout this region. NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES A. Basis of Accounting ------------------- The Company uses the accrual method of accounting. B. Revenue Recognition ------------------- The Company applies the provisions of SEC Staff Accounting Bulletin ("SAB") No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 104"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured. Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber. F-7 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company's subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided. Advance payments from subscribers are recorded on the balance sheet as deferred revenue. In circumstance where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured. C. Cash Equivalents ---------------- The Company considers all short term, highly liquid investments that are readily convertible, within three months, to known amounts as cash equivalents. The Company currently has no cash equivalents. D. Concentrations -------------- Financial instruments that potentially subject Pacific Health Care Organization, Inc. (the Company) to concentrations of credit risks consist of cash and cash equivalents. The Company places its cash and cash equivalents at well-known, quality financial institutions. At times, such cash and investments may be in excess of the FDIC insurance limit. E. Net Earnings (Loss) Per Share of Common Stock (Restated) -------------------------------------------------------- The computation of earning (loss) per share of common stock is based on the weighted average number of shares outstanding at the date of the financial statements. Potentially issuable common shares totaling 817,964 related to warrants and 416,500 related to options were excluded from the calculation of fully diluted loss per share during 2005 because their inclusion would have been anti-dilutive, however, they were included as part of the calculation during 2004.
~~For the Years Ended~~ Financial Statements
December 31, 2006 and 2005 ~~2004 ------------ ------------~~ Basic Earnings per share: Income (loss) (numerator) $ (29,323) $ 154,404 Shares (demoninator) 15,427,759 15,427,759 ------------ ------------ Per share amount $ .00 $ .01 ============ ============ Fully Diluted Earnings per share: Income (loss) (numerator) $ (29,323) $ 154,404 Shares (demoninator) 15,427,759 16,662,223 ------------ ------------ Per share amount $ .00 $ .00 ============ ============
F. Depreciation ------------ The cost of property and equipment is depreciated over the estimated useful lives of the related assets. The cost of leasehold improvements is depreciated over the lesser of the length of the lease of the related assets for the estimated lives of the assets. Depreciation is computed on the straight line method. F-8 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) G. Use of Estimates ---------------- The preparation of the financial statements in conformity with generally accepted accounting principles, in the United States of America, require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. H. Principles of Consolidation --------------------------- The accompanying consolidated financial statements include the accounts of the company and it's wholly - owned subsidiary. Intercompany transactions and balances have been eliminated in consolidation. I. Fair Value of Financial Instruments ----------------------------------- The fair value of the Company's cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate carrying value based on their effective interest rates compared to current market prices. J. General and Administrative Costs -------------------------------- General and administrative expenses include fees for office space, insurance, compensated absences, travel expenses and entertainment costs. K. Income Taxes ------------ The Company utilizes the liability method of accounting of income taxes. Under the liability method, deferred income tax assets and liabilities are provided based on the difference between the financial statements and tax basis of assets and liabilities measured by the currently enacted tax rates in effect for the years in which these differences are expected to reverse. Deferred tax expense or benefit is the result of changes in deferred tax assets and liabilities. L. Capital Structure ----------------- The Company has two classes of stock. Preferred stock, 5,000,000 shares authorized, zero issued. Voting rights and liquidation preferences have not been determined. The Company also has voting common stock of 50,000,000 shares authorized, with 15,427,759 shares issued and outstanding. No dividends were paid in the 2005 and 2004 years. M. Stock-Based Compensation ------------------------ As permitted by SFAS No. 123, the Company has elected to measure and record compensation cost relative to stock option costs in accordance with SFAS 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which requires the company to record compensation using the Black-Scholes pricing model to estimate fair value of the options at the grant date. F-9 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) N. Trade Receivables ----------------- The Company in the normal course of business extends credit to its customers on a short-term basis. Although the credit risk associated with these customers is minimal, the Company routinely reviews its accounts receivable balances and makes provisions for doubtful accounts. The Company ages its receivables by date of invoice. Management reviews bad debt reserves quarterly and reserves specific accounts as warranted or sets up a general reserve based on amounts over 90 days past due. When an account is deemed uncollectible, the Company charges off the receivable against the bad debt reserve. Since inception of the Company, no receivables have been charged off against the bad debt reserve. At the 2005 year end, the Company's bad debt reserve of $38,000 includes one specific account for $18,000 and a general reserve of $20,000 for balances over 90 days past due. The percentages of the major customers to total accounts receivable for the year ended 2005 are as follows: Customer A 20% Customer B 15% Customer C 12% NOTE 3 - NEW TECHNICAL PRONOUNCEMENTS In November 2004, the FASB issued SFAS No. 151, INVENTORY COSTS. This statement amends the guidance in ARB No. 43, Chapter 4, INVENTORY PRICING, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The adoption of SFAS No. 151 did not have an impact on the Company's consolidated financial statements. In December 2004, the FASB issues SFAS No. 152, ACCOUNTING FOR REAL ESTATE TIME-SHARING TRANSACTIONS. This Statement amends FASB Statement No. 66, ACCOUNTING FOR SALES OF REAL ESTATE, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, ACCOUNTING FOR REAL ESTATE TIME-SHARING TRANSACTIONS. This Statement also amends FASB Statement No. 67, ACCOUNTING FOR COSTS AND INITIAL RENTAL OPERATIONS OF REAL ESTATE PROJECTS, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2. This Statement is effective for financial statements for fiscal years beginning after June 15, 2005. The adoption of SFAS No. 152 did not have an impact on the Company's consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY ASSETS. The guidance in APB Opinion No. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS No. 153 did not have an impact on the Company's consolidated financial statements. F-10 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 3 - NEW TECHNICAL PRONOUNCEMENTS (CONTINUED) In December 2004, the FASB issued SFAS No. 123 (R), SHARE-BASED PAYMENT, SUMMARY OF STATEMENT NO. 123 (REVISED 2004). This Statement is a revision of FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. This Statement supersedes APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and its related implementation guidance. This Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity's equity instruments or that may be settled by the issuance of those equity instruments. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement does not change the accounting guidance for share-based payment transactions with parties other than employees provided in Statement 123 as originally issued and EITF Issue No. 96-18, ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHER THAN EMPLOYEES FOR ACQUIRING, OR IN CONJUNCTION WITH SELLING, GOODS OR SERVICES. The adoption of SFAS No. 123 (R) will have an immaterial impact on the Company's consolidated financial statements. In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement replaces APB No. 20, ACCOUNTING CHANGES and FASB No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies it all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS No. 154 did not have an impact on the Company's consolidated financial statements. NOTE 4 - FIXED ASSETS The Company capitalizes the purchase of equipment and fixtures for major purchases in excess of $1,000 per item. Capitalized amounts are depreciated over the useful life of the assets using the straight line method of depreciation which is 3 and 7 years for the office equipment, and furniture and fixtures, respectively. Scheduled below are the assets, costs and accumulated depreciation at December 31, 2005 and 2004.
Depreciation Accumulated Cost Expense Depreciation -------------------- -------------------- -------------------- December December December December December December Assets 31, 2005 31, 2004 31, 2005 31, 2004 31, 2005 31, 2004 - ------------------------------------------------------------------------------- Computer Equipment $60,922 $60,922 $ 7,801 $18,776 $54,536 $46,735 Furniture & Fixtures 24,766 24,766 3,540 3,536 11,241 7,701 ---------------------------------------------------------------- Totals $85,688 $85,688 $11,341 $22,312 $65,777 $54,436 ================================================================
F-11 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 5 INCOME TAXES (Restated) The Company accounts for corporate income taxes in accordance with Statement of Accounting Standards Number 109 ("SFAS No. 109") "Accounting for Income Taxes." SFAS No. 109 requires an asset and liability approach for financial accounting and reporting for income tax purposes. The tax provision (benefit) for the year ended December 31, 2005 consisted of the following:
~~2005 2004 ------------ ------------~~ Current: Federal $ 23,216 $ - State 17,596 - Deferred Federal (17,070) - State (2,550) - ------------ ------------ Total Tax Provision (Benefit) $ 21,192 $ - ============ ============
NOTE 5 – INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The ~~Company's~~Company’s total deferred tax liabilities, deferred tax assets, and deferred tax asset valuation allowances at December 31, 2006 and December 31, 2005 are as follows: Depreciation Federal $ (2,175) $ - State (325) - Reserve for Bad Debts Federal 12,890 - State 1,930 - Vacation Accrual Federal 6,355 - State 945 - ------------ ------------ $ 19,620 $ - ============ ============
Depreciation
Federal $ (1,060 ) $ (2,175 )
State (160 ) (325 )
Reserve for bad debts
Federal 6,770 12,890
State 1,030 1,930
Vacation accrual
Federal 6,135 6,355
State 915 945
Charitable contribution 985 -
Deferred tax asset $ 14,615 $ 19,620
The reconciliation of income tax computed at statutory rates of income tax benefits is as follows: Expense at Federal Statutory Rate 34% $ (2,765) $ 60,780 State Tax Effects 7,707 (60,780) Non Deductible Expenses 18,800 - Taxable Temporary Differences 17,505 - Deductible Temporary Differences (435) - Asset Valuation Allowance (19,620) - ------------ ------------ Income Tax Expense $ 21,192 $ - ============ ============
NOTE 6 OPERATING LEASES The Company's lease on its 3,504 square feet of office space at 5150 East Pacific Coast Highway, Long Beach, California 90804 expired on February 28, 2006. Prior to expiration of the lease, the Company was leasing the space for $6,482 per month. Subsequent to the year end, the Company negotiated a five year extension of its lease agreement. The monthly lease payments increased to $7,008 per month for the first year with 3% annual increased in the following years, resulting in monthly lease payment of $7,887 at the expiration of the lease. The space the Company is leasing is sufficiently large enough to accommodate all of its administrative needs. F-12 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 6 OPERATING LEASES (CONTINUED)
~~Total Lease Commitments: Year Amount ------------ ------------~~ 2006 $ 83,044 2007 86,196 2008 88,786 2009 91,450 2010 94,196 Thereafter 15,776 ------------ Total $ 459,448 ============
~~Rent~~

~~NOTE 5 – INCOME TAXES~~

The Company recognized a total of $45,235 in income tax expense for the year ended December 31, 2005.  This amount was comprised of $21,485 for the year ended December 31, 2005 and December 31, 2004 was $81,240 and $76,973, respectively. NOTE 7 MAJOR CUSTOMERS The Company had two customers who, accounted for 10 percent, or more, of the Company's total revenues during the years ending December 31, 2005, and December 31, 2004. The percentages of total revenues for the years ended 2005 and 2004 are as follows:
~~2005 2004 ------------ ------------~~ ~~Customer A 21% 14% Customer B 10% 13%~~
~~NOTE 8 ACCRUED AND OTHER LIABILITIES~~
~~2005 2004 ------------ ------------~~ Accrued liabilities consist of the following: Employment Enrollment Fees $ 144,000 $ 17,000 Compensated Absences 18,719 12,121 Legal Fees 48,000 41,125 Other 25,457 8,641 ------------ ------------ Total $ 236,176 $ 178,887 ============ ============
NOTE 9 OPTIONS FOR PURCHASE OF COMMON STOCK In August 2002, the Company adopted a stock option plan. The Company adopted a plan which provides for the grant of options to officers, consultants and employees to acquire shares of the Company's common stock at a purchase price equal to or greater than fair market value as of the date of the grant. Options are exercisable six months after the grant date and expire five years from the grant date. The exercise price of the options is $.05. The fair market value of the options at the date of grant was determined to be $.035 due to earlier issuances for cash of this stock. The plan calls for a total of 1,000,000 shares to be held for grant. A summary of activity follows: F-13 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 9 OPTIONS FOR PURCHASE OF COMMON STOCK (CONTINUED)
2002 Stock Option Plan Weighted Average Number Exercise of Shares Price ------------ ------------ Outstanding, January 1, 2004 66,250 $ .05 Granted - - Exercised - - Canceled - - ------------ ------------ Outstanding, December 31, 2004 66,250 $ .05 ============ ============ Exercisable, December 31, 2004 66,250 $ .05 ============ ============ Outstanding, January 1, 2005 66,250 $ .05 Granted - - Exercised - - Canceled - - ------------ ------------ Outstanding, December 31, 2005 ~~66,250 $ .05 ============ ============ Exercisable,~~and a total of $23,750 for the prior years of 2002, 2003 and 2004.  The Company failed to file tax returns for the prior years and was unaware that the state of California had suspended NOL carryforwards for those years.  There was no federal income tax recognized for those years.  The Company deemed this appropriate treatment since the state tax expense was not material for the years the tax was incurred.
NOTE 6 – OPERATING LEASES

The Company’s lease on its 3,504 square feet of office space at 5150 East Pacific Coast Highway, Long Beach, California 90804 expired on February 28, 2006.  Prior to expiration of the lease, the Company was leasing the space for $6,482 per month.  Subsequent to the year end, the Company negotiated a five year extension of its lease agreement.  The monthly lease payments increased to $7,008 per month for the first year with 3% annual increased in the following years, resulting in monthly lease payment of $7,887 at the expiration of the lease.  The space the Company is leasing is sufficiently large enough to accommodate all of its administrative needs. Also the Company approximately 600 square feet of office space in Newport Beach, California on a month to month basis.

F-11
Pacific Health Care Organization, Inc.
Notes to Financial Statements
December 31, 2006 and 2005
NOTE 6 – OPERATING LEASES (CONTINUED)
Total Lease Commitments: Year Amount
2007 86,198
2008 88,784
2009 91,450
2010 94,196
Thereafter 15,776
Total $ 376,404

Rent expense for the year ended December 31, 2006 and December 31, 2005 ~~66,250 $ .05 ============ ============~~
In accordance with SFAS 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, $1,858 and $0 has been charged to compensation expense for the years ended December 31, 2005 and December 31, 2004, respectively. The fair value of the option grant was established at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions: 2005 ---------- Risk-free interest rate 4.0% Dividend yield 0% Volatility 119% ---------- Average expected term (years to exercise date) 1/2 Employee stock options outstanding and exercisable under this plan as of December 31, 2005 are:
~~Weighted Weighted Average Weighted Range~~was $89,673 and $81,240, respectively.

NOTE 7– MAJOR CUSTOMERS

The Company had two customers who, accounted for 10 percent, or more, of Average of Remaining Average of Exercise Outstanding Exercise Contractual Exercisable Exercise Price Options Price Life (years) Options Price ----------- ----------- ----------- ----------- ----------- ----------- ~~$ .05 66,250 $ .05 1.67 66,250 $ .05~~
F-14 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 10 - STOCK OPTION AGREEMENT On April 20, 2004, the board of directors agreed to a stock option agreement with an officer of the Company, effective as of October 11, 2004. The agreement calls for the grant of 350,000 options that rest and are exercisable as follows: 100,000 the first year, with an exercise price of $.05; 100,000 the second year, with an exercise price of $.10; and 150,000 the third year, with an exercise price of $.20. The options expire three years from the date of grant. 2004 Stock Option Agreement
Weighted Average Number Exercise of Shares Price ------------ ------------ Outstanding, January 1, 2004 - $ - Granted 350,000 .68 Exercised - - Canceled - - ------------ ------------ Outstanding,the Company’s total revenues during the years ending December 31, ~~2004 350,000 $ .68 ============ ============ Exercisable,~~2006, and December 31, 2004 100,000 $ .05 ============ ============ Outstanding, January 1, 2004 350,000 $ .68 Granted - - Exercised - - Canceled - - ------------ ------------ Outstanding,2005.  The percentages of total revenues for the years ended 2006 and 2005 are as follows:

2006 2005
Customer A 10 % 21 %
Customer B 10 % 10 %

NOTE 8– ACCRUED AND OTHER LIABILITIES

Accrued liabilities consist of the following: 2006 2005
Employee enrollment fees $ 100,000 $ 144,000
Compensated absences 18,065 18,719
Legal fees 12,000 48,000
Other 12,000 25,457
Total $ 142,065 $ 236,176

F-12
Pacific Health Care Organization, Inc.
Notes to Financial Statements
December 31, 2006 and 2005

NOTE 9– OPTIONS FOR PURCHASE OF COMMON STOCK

In August 2002, the Company adopted a stock option plan.  The Company adopted a plan which provides for the grant of options to officers, consultants and employees to acquire shares of the Company’s common stock at a purchase price equal to or greater than fair market value as of the date of the grant.   Options are exercisable six months after the grant date and expire five years from the grant date.  The exercise price of the options is $.05.  The fair market value of the options at the date of grant was determined to be $.035 due to earlier issuances for cash of thisstock.  The plan calls for a total of 1,000,000 shares to be held for grant.  A summary of activity follows:

2002 Stock Option Plan
Number
of Shares

Weighted
Average
Exercise
Price

Outstanding, January 1, 2005 66,250 $ .05
Granted - -
Exercised - -
Canceled - -
Outstanding, December 31, 2005 66,250 $ .05
Exercisable, December 31, 2005 66,250 $ .05

Outstanding, January 1, 2006 66,250 $ .05
Granted - -
Exercised - -
Canceled - -
Outstanding, December 31, 2006 66,250 $ .05
Exercisable, December 31, 2006 66,250 $ .05
In accordance with SFAS 123, Accounting for Stock-Based Compensation, $0 and $1,858 has been charged to compensation expense for the years ended December 31, 2006 and December 31, 2005, respectively.
The fair value of the option grant was established at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:

2006
Risk-free interest rate 4.0 %
Dividend yield 0 %
Volatility 119 %
Average expected term (years to exercise date) ½
Employee stock options outstanding and exercisable under this plan as of December 31, 2006 are:
Range of
Exercise
Price

Outstanding
Options Price

Weighted
Average of
Exercise

Weighted
Average
Remaining
Contractual
Life (years)

Outstanding
Options

Weighted
Average of
Exercise
Price

$ .05 66250 $ .05 1.67 66,250 $ .05

NOTE 10- STOCK OPTION AGREEMENT

On April 20, 2004, the board of directors agreed to a stock option agreement with an officer of the Company, effective as of October 11, 2004.  The agreement calls for the grant of 350,000 ~~$ .68 ============ ============ Exercisable,~~options that rest and are exercisable as follows: 100,000 the first year, with an exercise price of $.05; 100,000 the second year, with an exercise price of $.10; and 150,000 the third year, with an exercise price of $.20.  The options expire three years from the date of grant

F-13
Pacific Health Care Organization, Inc.
Notes to Financial Statements
December 31, 2006 and 2005

NOTE 10- STOCK OPTION AGREEMENT (CONTINUED)

2004 Stock Option Agreement

Number of
Shares

Weighted
Average
Exercise
Price

Outstanding, January 1, 2005 - $    -
Granted 350,000     .68
Exercised -     -
Canceled -     -
Outstanding, December 31, 2005 350,000 $    .68
Exercisable, December 31, 2005 200,000 $    .05

Outstanding, January 1, 2006 350,000 $    .68
Granted -     -
Exercised -     -
Canceled -     -
Outstanding, December 31, 2006 350,000 $    .68
Exercisable, December 31, 2006 350,000 $    .23
In accordance with SFAS 123, Accounting for Stock-Based Compensation, $15,121 and $13,511 has been charged to compensation expense for the years ended December 31, 2006 and 2005, respectively.  The fair value of the option grant was established at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

2006
Risk-free interest rate 4.0 %
Dividend yield 0 %
Volatility 119
Average expected term (years to exercise date) 1/2
Employee stock options outstanding and exercisable under this agreement as of December 31, 2006 are:

Range of
Exercise
Price

Outstanding
Options Price

Weighted
Average of
Exercise

Weighted
Average
Remaining
Contractual
Life (years)

Outstanding
Options

Weighted
Average of
Exercise
Price

$ .05 - .20 350,000 $ .68 .34 350,000 $ .23

NOTE 11 - LITIGATION

A complaint was filed in Orange County, California Superior Court, Case No. 04cc04645, by plaintiffs Marvin Teitelbaum, a shareholder of the Company, and Peter Alezakis, a shareholder and former director of the Company (collectively "Plaintiffs") on or about April 7, 2004 against the Company's president Tom Kubota, former secretary and director, now deceased, Rudy LaRusso and the Company (collectively "Defendants").

On September 22, 2006, a settlement agreement was reached between the Company, Medex and Tom Kubota and Marvin Teitelbaum and Peter Alexakis dismissing the complaint and cross complaint in the matter.

Each party to the action agreed to dismiss with prejudice their complaint and/or cross complaint in the above mentioned action. No party received any money, stock or other compensation as a result of the mutual release and settlement and each party agreed to be responsible for its own attorneys’ fee.

F-14
Pacific Health Care Organization, Inc.
Notes to Financial Statements
December 31, 2006 and 2005
NOTE 12 – SUBSEQUENT EVENT

As result of a goodwill gesture, in February 2007, Medex entered into an agreement with a major customer to absorb cost of re-enrolling their employees into the HCO program. Medex will incur costs for printing and postage. The net impact on the Company’s Financial Statements will not exceed $38,000 for the year end December 31, 2007.
NOTE 13 -   RESTATEMENT AND RECLASSIFICATION

The Company has restated our financial statements for the year ended December 31, 2005 ~~200,000 $ .23 ============ ============~~
In accordance with SFAS 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, $15,121 and $13,511 has been charged to compensation expense for the years ended December 31, 2005 and 2004, respectively. The fair valueon May 17, 2006, to reflect certain issues identified during a regulatory review of our financial statements associated with the SEC form 10KSB filing on April 3, 2006. The Company’s management and our board of directors have concluded this additional restatement of the option grant was established at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: 2005 ------------ Risk-free interest rate 4.0% Dividend yield 0% Volatility 119 Average expected term (years to exercise date) 1/2 ------------ Employee stock options outstanding and exercisable under this agreement as of December 31, 2005 are:
Weighted Weighted Average Weighted Range of Average of Remaining Average of Exercise Outstanding Exercise Contractual Exercisable Exercise Price Options Price Life (years) Options Price ----------- ----------- ----------- ----------- ----------- ----------- ~~$ .05-.20 350,000 $ .68 1.34 200,000 $ .23~~
F-15 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 11 - LITIGATION A complaint was filed in Orange County, California Superior Court by plaintiffs Marvin Teitelbaum, a shareholder of the Company, and Peter Alezakis, a shareholder and former director of the Company (collectively "Plaintiffs") on or about April 7, 2004 against the Company's president Tom Kubota, secretary Rudy LaRusso and the Company (collectively "Defendants"). The action seeks cancellation of a stock issuance, an order for Mr, Kubota to pay the Company $150,000 and other damages to be determined based upon allegations that Defendants breached various fiduciary duties. The Company has retained the services of the Law Offices of Joseph Nardulli of Newport Beach, CA, and Mr. Kubota and the estate of Mr. LaRusso have retained the services of the Law Offices of L. Scott Karlin, of Newport Beach, CA, to represent them in this matter and intend to contest the case vigorously. The Defendants have answered the complaint and the parties are engaged in discovery. The parties to the litigation have agreed to submit to binding arbitration, which the Company expects will occur sometime later this year. The Company believes that the claims by Plaintiffs are without merit. NOTE 12 - RESTATEMENT AND RECLASSIFICATION We have restated our financial statements for the year ended December 31, 2005 to reflect issues identified during the preparation of the Company's federal and state income tax returns. Management and the board of directors concluded these restatements were necessary to reflect the changes described below. Pacific Health Care Organization, Inc. Balance Sheets
As Previously As Reported Restated Change ------------ ------------ ------------ Assets Current Assets - -------------- Cash $ 345,091 $ 345,091 $ - Accounts receivable, net of allowance of $38,000 351,311 351,311 - Deferred tax asset - 19,620 19,620 {a} Prepaid expenses 42,871 42,871 - ------------ ------------ ------------ Total current assets 739,273 758,893 19,620 Property & Equipment (Note 5) - -------------------- Computer equipment 60,922 60,922 - Furniture & fixtures 24,766 24,766 - ------------ ------------ ------------ Total property & equipment 85,688 85,688 - Less: accumulated depreciation (65,777) (65,777) - ------------ ------------ ------------ Net property & equipment 19,911 19,911 - ------------ ------------ ------------ Total assets $ 759,184 $ 778,804 $ 19,620 ============ ============ ============
F-16 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 NOTE 12 - RESTATEMENT AND RECLASSIFICATION (CONTINUED) Pacific Health Care Organization, Inc. Balance Sheets
As Previously As Reported Restated Change ------------ ------------ ------------ Liabilities & Stockholders' Equity Current Liabilities - ------------------- Accounts payable $ 41,083 $ 41,083 $ - Accrued expenses 236,176 236,176 - Income tax payable - 40,812 40,812 {a} Unearned revenue 35,352 35,352 - ------------ ------------ ------------ Total current liabilities 312,611 353,423 40,812 Commitments - - - - ----------- ------------ ------------ ------------ Stockholders' Equity (Note 8) Preferred stock; 5,000,000 shares Authorized at $0.001 par value; zero shares issued and outstanding - - - Common stock; 50,000,000 shares authorized at $0.001 par value; 15,427,759 and 15,427,759 shares issued and outstanding, respectively 15,428 15,428 - Additional paid in capital 603,148 603,148 - Accumulated (deficit) (172,003) (193,195) 21,192 ------------ ------------ ------------ Total stockholders' equity 446,573 425,381 21,192 ------------ ------------ ------------ Total liabilities & stockholders' equity $ 759,184 $ 778,804 $ 19,620 ============ ============ ============
{a} Record tax effects of current year operations. F-17 Pacific Health Care Organization, Inc. Notes to Financial Statements December 31, 2005 & 2004 Pacific Health Care Organization, Inc. Statements of Operations
As Previously As Reported Restated Change ------------ ------------ ------------ Revenues $ 2,076,391 $ 2,076,391 $ - - -------- ------------ ------------ ------------ Expenses - -------- Depreciation 11,341 11,341 - Consulting fees 104,110 104,110 - Salaries & wages 750,516 750,516 - Professional fees 342,028 342,028 - Insurance 84,341 84,341 - Employment enrollment 206,204 206,204 - Bad debt expense 38,000 38,000 - General & administrative 526,688 550,145 23,457 {b} ------------ ------------ ------------ Total expenses 2,063,228 2,086,685 23,457 ------------ ------------ ------------ Income (loss) from operations 13,163 (10,294) (23,457) Other income (expenses) Interest income 2,456 2,456 - ------------ ------------ ------------ Total other income (expenses) 2,456 2,456 - ------------ ------------ ------------ Income (loss) before taxes 15,619 (7,838) (23,457) Tax expense 23,750 21,485 (2,265) ------------ ------------ ------------ Net income (loss) $ (8,131) $ (29,323) $ (21,192) {a} ============ ============ ============ Basic earnings per share: - ------------------------- Earnings per share amount $ 0.00 $ 0.00 $ 0.00 Weighted average common shares outstanding 15,427,759 15,427,759 15,427,759 Fully diluted earnings per share: - --------------------------------- Earnings per share amount $ 0.00 $ 0.00 $ 0.00 Weighted average common shares outstanding 15,427,759 15,427,759 15,427,759
{a} Record tax effects of current year operations. {b} Reclassification of general & administrative expenses. F-18 Pacific Health Care Organization, Inc. Statements of Cash Flows For the Years Ended December 31,
As Previously As Reported Restated Change ----------- ------------ ---------- ~~Cash Flows from Operating Activities - ------------------------------------ Net income (loss) $ (8,131) $ (29,323) $ (21,192) {a} Adjustments~~2005 is necessary to reconcile net income to net cash: Depreciation 11,341 11,341 - Stock options issued for services 16,979 16,979 - Changes in operating assets & liabilities: (Increase) decrease in prepaid expenses (2,156) (2,156) - (Increase) decrease in accounts receivable (171,920) (171,920) - (Increase) decrease in deferred tax asset - (19,620) (19,620) {a} Increase (decrease) in accounts payable 19,270 19,270 - Increase (decrease) in taxes payable - 40,812 40,812 {a} Increase (decrease) in accrued expenses 57,289 57,289 - Increase (decrease) in unearned revenue (84,256) (84,256) - ----------- ------------ ---------- Netreflect the changes described below. There was no effect on cash provided by operating activities 161,584 161,584 - Cash Flows from Investing Activities - ------------------------------------ Purchase of computer equipment - - - ----------- ------------ ---------- Netor cash used by investing ~~activities - - - Cash Flows from Financing Activities - ------------------------------------ Net cash provided by~~and financing activities ~~- - - ----------- ------------ ---------- Increase (decrease)~~as a result of these corrections.

Revisions affecting our statement of operations:

The Company’s Amended 2005 10KSB filed on May 17, 2006 only showed only one revenue line for year-ended 2005. The Company divided the revenue line into three subcategories which reflect the program revenue sources.  The Total revenues amount did not change for 2005.

The Company added a new expense line item “Data maintenance” to provide more transparent disclosure of data maintenance costs.  This did not result in ~~cash (161,584) (161,584) - Cash at beginning~~an increase in total expenses in 2006 and 2005.

The Company reclassified the $89,664 of ~~period 506,675 506,675 - ----------- ------------ ---------- Cash at End~~data maintenance fees from a particular third party provider, which had incorrectly been classified in Employment enrollment to Data maintenance.  The Company also reclassified the balance of Period $ 345,091 $ 345,091 $ - =========== ============ ========== Supplemental Cash Flow Information - ---------------------------------- Interest $ - $ - $ - Taxes 23,750 293 (23,457)
~~{a} Record tax effects of current year operations. F-19 Pacific Health Care Organization, Inc. Balance Sheets~~
~~ASSETS June 30,~~ the data maintenance costs incurred in 2005, which was $219,353, from General and administrative to Data maintenance.  This resulted in total Data maintenance costs of $309,017 for the year ended December 31, 2005.

Also for the year-ended December 31, 2005, the Company reclassified the $23,750 income tax expense for the years 2002, 2003, and 2004 from General & administrative to the Tax expense line.  Total expenses decrease by $23,750 due to the tax reclassification. The net income (loss) amount did not change.

        A summary of the effects of these changes is as follows:
F-15
Pacific Health Care Organization, Inc.
Notes to Financial Statements
December 31, 2006 and 2005 ~~(Unaudited) ------------ ------------~~ ~~Current Assets~~
~~NOTE 13 -   RESTATEMENT AND RECLASSIFICATION – (CONTINUED)~~
Pacific Health Care Organization, Inc.

Balance Sheets

For the year ended December 31, 2005

As Reported in Amended 10KSB
May 17, 2006
As Restated Change

ASSETS

Current Assets

Cash $ 345,091 $ 345,091 $ -
Accounts receivable, net of allowance of
$38,000
351,311 351,311 -
Deferred tax asset 19,620 19,620 -
Prepaid expenses 42,871 42,871 -
Total current assets 758,893 758,893 -

Property & Equipment, net
Computer equipment 60,922 60,922 -
Furniture & fixtures 24,766 24,766 -
Total property & equipment 85,688 85,688 -

Less: accumulated depreciation (65,777 ) (65,777 ) -

Net property & equipment 19,911 19,911 -

Total assets $ 778,804 $ 778,804 $ -

LIABILITIES AND STOCK HOLDERS' EQUITY

Current Liabilities

Accounts payable $ 41,083 $ 41,083 $ -
Accrued expenses 236,176 236,176 -
Income tax payable 40,812 40,812 -
Unearned revenue 35,352 35,352 -
Total current liabilities 353,423 353,423 -

Total liabilities 353,423 353,423 -

Commitment
- - -

F-16
Pacific Health Care Organization, Inc.
Notes to Financial Statements
December 31, 2006 and 2005
NOTE 13 -   RESTATEMENT AND RECLASSIFICATION – (CONTINUED)


Shareholders' Equity

Perferred stock; 5,000,000 shares authorized at
$0.001 par value; zero shares issued and outstanding
Common stock; 50,000,000 shares authorized at
$0.001 par value; 15,427,759 shares issued and
Outstanding    15,428 15,428 -
Additional paid-in-capital    603,148 603,148 -
Accumulated (deficit)    (193,195 ) (193,195 ) -
Total stockholders' equity   425,381 425,381 -

Total liabilities and stockholders' equity $ 778,804 $ 778,804 $ -


(a) Reclassification of revenue line into subcategories
(b) Reclassification of tax expense
(c) Reclassification of fees for data maintenance from Employee enrollment and General & administrative to Data maintenance
~~F-17~~
~~Pacific Health Care Organization, Inc.~~
~~Notes to Financial Statements~~
~~December 31, 2006 and 2005~~
~~NOTE 13 -   RESTATEMENT AND RECLASSIFICATION – (CONTINUED)~~

Pacific Health Care Organization, Inc.
Statements of Operations
For the year ended December 31, 2005


As Reported in Amended 10KSB
May 17, 2006
As Restated Change

Revenues $ 2,076,391 $ - $ (2,076,391 ) (a)
HCO fees - 1,399,012 1,399,012 (a)
MPN fees - 597,404 597,404 (a)
Other   - 79,975 79,975 (a)
Total revenues 2,076,391 2,076,391 -

Expenses
Depreciation 11,341 11,341 -
Consulting fees 104,110 104,110 -
Salaries & wages 750,516 750,516 -
Professional fees 342,028 342,028 -
Insurance 84,341 84,341 -
Employee enrollment 206,204 116,540 (89,664 ) (c)
Data maintenance - 309,017 309,017 (c)
Bad debt expense 38,000 38,000 -
General & administrative 550,145 307,042 (243,103 ) (c)
Total expenses 2,086,685 2,062,935 (23,750 ) (b)

Income (loss) from operations (10,294 ) 13,456 23,750 (b)

Other income
Interest income 2,456 2,456 -
Total other income 2,456 2,456 -

Income (loss) before income
Tax provision (benefit) (7,838 ) 15,912 23,750 (b)

Income tax
provisions (benefit) 21,485 45,235 23,750 (b)

Net income (loss) $ (29,323 ) $ (29,323 ) $ -

Basic earnings per share:
Earnings per share amount $ - $ - $ -
Weighted average common
shares outstanding 15,427,759 15,427,759 -

Fully diluted earnings per share:
Earnings per share amount $ - $ - $ -

Weighted average common
shares outstanding 15,427,759 15,427,759 -

(a) Reclassification of revenue line into subcategories
(b) Reclassification of tax expense
(c) Reclassification of fees for data maintenance from Employee enrollment and General & administrative to Data maintenance

~~F-18~~

Pacific Health Care Organization, Inc.

Balance Sheets
ASSETS

June 30,
2007
(Unaudited)

December 31,
2006

Current Assets

Cash $ 357,290 $ 273,058
Accounts receivable, net of allowance of $20,000 202,482 213,738
Income tax receivable 32,623 27,355
Deferred tax asset 15,577 14,615
Prepaid state income tax 0 1,600
Prepaid expenses 53,237 49,548
Total current assets 661,209 579,914

Property and equipment, (note 4)

       Computer equipment
60,922 60,922
       Furniture & fixtures 24,766 24,766
             Total property & equipment 85,688 85,688

              Less: accumulated depreciation
(80,087 ) (75,317 )

              Net property & equipment 5,601 10,371

              Total assets $ 666,810 $ 590,285

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities

Accounts payable $ 7,197 $ 9,910
Accrued expenses (note 8) 149,351 142,065
Tax payable 28,340 -
Unearned revenue 93,084 83,521
Total current liabilities 277,972 235,496
Total liabilities 277,972 235,496

Commitments and Contingencies
- -

Shareholders’ Equity

Preferred stock; 5,000,000 shares
authorized at $0.001 par value;
zero shares issued and outstanding
- -
Common stock; 50,000,000 shares
authorized at $ 0.001 par value;
15,427,759 shares issued and outstanding
15,428 15,428
Additional paid-in capital 610,007 610,007
Accumulated (deficit) (236,597 ) (270,646 )
Total stockholders' equity 338,838 354,789

Total liabilities and stockholders’ equity $ 666,810 $ 590,285

~~The accompanying notes are an integral part of these consolidated financial statements~~
~~F-19~~

Pacific Health Care Organization, Inc.

Statements of Operations

(Unaudited)

For three months ended
June 30,

For six months ended
June 30,

2007 2006 2007 2006
Revenues:
HCO fees $ 273,811 $ 273,947 $ 460,034 $ 605,256
MPN fees 166,674 95,385 323,340 298,036
Other 75,884 38,837 137,314 78,123
     Total revenues 516,369 408,169 920,688 981,415

Expenses:
  Depreciation 2,385 2,385 4,770 4,770
  Consulting fees 52,075 26,501 97,967 44,708
  Salaries & wages 149,350 191,746 303,637 361,021
  Professional fees 29,639 132,071 86,163 186,533
  Insurance 26,999 33,721 51,712 70,300
  Employee enrollment 17,400 9,333 34,800 37,533
  Data maintenance 64,706 79,743 154,002 173,914
  General & administrative 61,261 73,989 126,488 133,621

     Total expenses 403,815 549,489 859,539 1,012,400

Income (loss) from operations
112,554
(141,320 )
61,149
(30,985 )

Other income:
  Interest income 329 698 610 1,582
     Total other income 329 698 610 1,582

Income (loss) before taxes 112,883 (140,622 ) 61,759 (29,403 )

     Income tax provision (benefit) 34,472 (45,600 ) 27,710 (5,000 )

     Net income (loss) $ 78,411 $ (95,022 ) $ 34,049 $ (24,403 )

~~The accompanying notes are an integral part of these consolidated financial statements~~
~~F-20~~

Pacific Health Care Organization, Inc.

Statements of Cash Flows
(Unaudited)

Six Months Ended June 30,
2007 2006
Cash flows from operating activities:
Net Income (Loss) $ 34,049 $ (24,403 )
Adjustments to reconcile net income (loss) to net cash:
Depreciation 4,770 4,770
     Stock options issued for services - 6,569
Changes in operating assets & liabilities
Decrease in accounts receivable 11,256 108,407
Increase in income tax receivable (5,268 ) -
Increase in deferred tax asset (962 ) (6,300 )
Decrease in prepaid state income tax 1,600 -
Increase in prepaid expenses (3,689 ) (6,689 )
Decrease in accounts payable (2,713 ) (32,830 )
Increase in accrued expenses 7,286 30,011
Increase (decrease) in income tax payable 28,340 (38,379 )
Increase in unearned revenue 9,563 74,174
Net cash provided by operating activities 84,232 115,330

Cash Flows from Investing Activities
Net cash used by investing activities - -

Cash Flows from Financing Activities
Net cash used by financing activities - -
��
Increase in cash 84,232 115,330

Cash at beginning of period 273,058 345,091
Cash at end of period $ 357,290 $ 460,421

Supplemental Cash Flow Information
Cash paid for:
Interest $ - $ -
Taxes 27,710 1,857

~~The accompanying notes are an integral part of these consolidated financial statements~~
~~F-21~~
~~Pacific Health Care Organization, Inc.~~
~~Notes to Financial Statements~~
~~For the Six Months Ended June 30, 2007~~
~~NOTE 1 - Corporate History~~

Pacific Health Care Organization, Inc. (the “Company”) was incorporated under the laws of the state of Utah on April 17, 1970 under the name Clear Air, Inc.  The Company changed its name to Pacific Health Care Organization, Inc., on January 31, 2001.  On February 26, 2001, the Company acquired Medex Healthcare, Inc. (“Medex”), a California corporation organized March 4, 1994, in a share for share exchange.  Medex is now a wholly owned subsidiary of the Company.  Medex is in the business of managing and administering Health Care Organizations and Medical Provider Networks in the state of California.

The principle business of the Company is that of its wholly owned subsidiary Medex. Medex is in the business of managing and administering Health Care Organizations (“HCOs”).  HCOs are networks of medical providers established to serve the Workers’ Compensation industry. In the original legislation establishing HCOs, the California legislature mandated that if an employer contracts services from an HCO, the injured workers must be given a choice between at least two HCOs. Medex recognized early on that two HCO certifications were necessary to be competitive. Instead of aligning with a competitor, Medex elected to go through the lengthy application process with the California Department of Industrial Relations (“DIR”) twice and received certification to operate two separate HCOs. While there is no longer a statutory requirement to offer two HCOs to employers Medex continues to retain its two certifications, so that employer clients have the option of offering one or two HCOs to their employees. The Company believes its ability to offer two HCOs gives potential clients greater choice, which is favored by a number of employers, especially those with certified bargaining units.

Through the two licenses to operate HCOs, the Company offers injured workers a choice of enrolling in an HCO with a network managed by primary care providers requiring a referral to specialists or a second HCO where injured workers do not need any prior authorization to be seen and treated by specialists.

The two HCO certifications obtained by Medex cover the entire state of California. Medical and indemnity costs associated with Workers’ Compensation in the state California are billions of dollars annually. The two HCO networks have contracted with over 3,300 individual providers and clinics, as well as, hospitals, pharmacies, rehabilitation centers and other ancillary services making the Company's HCOs capable of providing comprehensive medical services throughout this region. The Company is continually developing these networks based upon the nominations of new clients and the approvals of their claims' administrators.

By virtue of our continued certification as an HCO, we were statutorily deemed to be qualified as an approved MPN on January 1, 2005.  Because we already had qualified networks in place through our HCO program, we began offering MPN services in January 2005.  As a licensed HCO and MPN, we are able to offer our clients an HCO program, an MPN program and a hybrid of the HCO and MPN programs.  Under this hybrid model, an employer can enroll its employees in the HCO program, and then prior to the expiration of the 90 or 180 day treatment period under the HCO program, the employer can enroll the employee into the MPN program.  This allows employers to take advantage of both programs.  To the best of our knowledge, we are currently the only entity that offers both programs together in a hybrid program.

~~F-22~~
~~Pacific Health Care Organization, Inc.~~
~~Notes to Financial Statements~~
~~For the Six Months Ended June 30, 2007~~
~~NOTE 1 - Corporate History (continued)~~

The Company is currently in continued discussions with insurance brokers, carriers, third party administrators, managed care organizations and with representatives of self-insured employers, both as partners and potential clients. Based on potential cost savings to employers and the approximately fourteen million workers eligible for the services of the Company, the Company expects that employers will continue to sign contracts with the Company to retain the services it provides. The amounts the Company charges employers per enrollee may vary based upon factors such as employer history and exposure to risk; for instance, a construction company would likely pay more than a payroll service company. In addition, employers who have thousands of enrollees are more likely to get a discount.

Because the Company contracts with medical providers, who own their own medical equipment such as x-ray machines, the Company does not typically incur large capital expenditures.  The Company does, however, incur fixed costs such as liability insurance and other usual costs of running an office.

~~NOTE 2 - Significant Accounting Policies~~

~~A.   Basis of Accounting~~

~~The Company uses the accrual method of accounting.~~

~~B.   Revenue Recognition~~

The Company applies the provisions of SEC Staff Accounting Bulletin No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS (“SAB 104”), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured.

~~Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber.~~

The Company’s subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided. Advance payments from subscribers are recorded on the balance sheet as unearned revenue.  In circumstances where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured.

~~F-23~~
~~Pacific Health Care Organization, Inc.~~
~~Notes to Financial Statements~~
~~For the Six Months Ended June 30, 2007~~
~~NOTE 2 - Significant Accounting Policies (continued)~~
~~C.   Cash ~~$ 460,421 $ 345,091 Accounts receivable, net~~Equivalents~~

~~The Company considers all short term, highly liquid investments that are readily convertible, within three months, to known amounts as cash equivalents. The Company currently has no cash equivalents.~~
~~D.   Concentrations~~

Financial instruments that potentially subject the Company to concentrations of ~~allowance~~credit risks consist of ~~$20,000 242,904 351,311~~cash. The Company places its cash at well-known, quality financial institutions. At times, such cash may be in excess of the FDIC insurance limit.

~~E.   Net Earnings (Loss) Per Share of Common Stock (unaudited)~~

The computation of earning (loss) per share of common stock is based on the weighted average number of shares outstanding at the date of the financial statements. Potentially issuable common shares totaling 416,250 related to options were considered but excluded from the calculation of fully diluted loss per share during 2007 and 2006 because their inclusion would have been anti-dilutive.
For the Six Months Ended June 30,
2007 2006
Basic Earnings per share:
Income (Loss) (numerator) $ 34,049 $ (24,403 )
Shares (denominator) 15,427,759 15,427,759
Per Share Amount $ .00 $ (.00 )
Fully Diluted Earnings per share:
Income (Loss) (numerator) $ 34,049 $ (24,403 )
Shares (denominator) 15,427,759 15,427,759
Per Share Amount $ .00 $ (.00 )

~~F.   Depreciation~~

The cost of property and equipment is depreciated over the estimated useful lives of the related assets. The cost of leasehold improvements is depreciated over the lesser of the length of the lease of the related assets for the estimated lives of the assets.  Depreciation is computed on the straight line method.

~~F-24~~
~~Pacific Health Care Organization, Inc.~~
~~Notes to Financial Statements~~
~~For the Six Months Ended June 30, 2007~~
~~NOTE 2 - Significant Accounting Policies (continued)~~
~~G.   Use of Estimates~~

The preparation of the financial statements in conformity with generally accepted accounting principles, in the United States of America, requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

~~H.   Principles of Consolidation~~

~~The accompanying consolidated financial statements include the accounts of the Company and it's wholly - owned subsidiary. Intercompany transactions and balances have been eliminated in consolidation.~~

~~I.   Fair Value of Financial Instruments~~

~~The fair value of the Company's cash, receivables, accounts payable and accrued liabilities approximate carrying value based on their effective interest rates compared to current market prices.~~

~~J.   General and Administrative Costs~~

~~General and administrative expenses include fees for office space, compensated absences, travel expenses and entertainment costs.~~

~~K.   Income Taxes~~

The Company utilizes the liability method of accounting of income taxes. Under the liability method, deferred income tax assets and liabilities are provided based on the difference between the financial statements and tax basis of assets and liabilities measured by the currently enacted tax rates in effect for the years in which these differences are expected to reverse. Deferred tax asset 25,920 19,620 Prepaid expenses 49,560 42,871 ------------ ------------ Total currentexpense or benefit is the result of changes in deferred tax assets ~~778,805 758,893 Property~~ and equipment, net (note 4) Computer equipment 60,922 60,922 Furniture & fixtures 24,766 24,766 ------------ ------------ Total property & equipment 85,688 85,688 Less: accumulated depreciation (70,547) (65,777) ------------ ------------ Net property & equipment 15,141 19,911 ------------ ------------ Total assets $ 793,946 $ 778,804 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 8,253 $ 41,083 Accrued expenses (note 8) 266,187 236,176 Income tax payable 2,433 40,812 Unearned revenue 109,526 35,352 ------------ ------------ Total current liabilities 386,399 353,423 Commitments Shareholders' Equityliabilities.

~~L.   Capital Structure~~

The Company has two classes of stock.  Preferred ~~stock;~~stock, 5,000,000 shares authorized, ~~at $0.001 par value;~~ zero issued and outstanding. Voting rights and liquidation preferences have not been determined. The Company also has voting common stock of 50,000,000 shares authorized, with 15,427,759 shares issued and outstanding - - Common stock; 50,000,000 shares authorized at $ 0.001 par value; 15,427, shares issued and outstanding, 15,428 15,428 Additional paid-in capital 610,007 603,148 Accumulated (deficit) (217,598) (193,195) ------------ ------------ Total stockholders' equity 407,837 425,381 ------------ ------------ Total liabilities and stockholders' equity $ 793,946 $ 778,804 ============ ============
The accompanying notes are an integral part of these consolidated financial statements F-20 Pacific Health Care Organization, Inc. Statements of Operations (Unaudited)
~~For three months ended For~~outstanding.  No dividends were paid in the six months ended 2007 and 2006.

F-25
Pacific Health Care Organization, Inc.
Notes to Financial Statements
For the Six Months Ended June 30, ~~June 30, 2006 2005 2006 2005 ------------ ------------ ------------ ------------~~ Revenues $ 408,169 $ 438,828 $ 981,415 $ 794,427 Expenses Depreciation 2,385 5,578 4,770 11,156 Consulting fees 26,501 35,223 44,708 60,833 Salaries & wages 191,746 176,776 361,021 349,833 Professional fees 132,071 105,705 186,533 210,144 Insurance 33,721 19,462 70,300 35,977 Employment enrollment 9,333 78,732 37,533 128,664 General & administrative 153,732 94,380 307,535 197,040 ------------ ------------ ------------ ------------ Total expenses 549,489 515,856 1,012,400 933,647 ------------ ------------ ------------ ------------ Loss from operations (141,320) (77,028) (30,985) (199,220) Other income: Interest income 698 490 1,582 1,080 ------------ ------------ ------------ ------------ Total other income 698 490 1,582 1,080 ------------ ------------ ------------ ------------ Loss before taxes (140,622) (76,538) (29,403) (198,140) Tax2007
~~NOTE 2 - Significant Accounting Policies (continued)~~

~~M.   Stock-Based Compensation~~

The Company has adopted the fair value method of accounting for stock-based employee compensation in accordance with statement of Financial Accounting Standards No. 123 (Revised 2004), “Accounting for Stock-Based Compensation” (SFS123[R]). This standard requires the company to record compensation expense (benefit) (45,600) - (5,000) - ------------ ------------ ------------ ------------ Net loss $ (95,022) $ (76,538) $ (24,403) $ (198,140) ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements F-21 Pacific Health Care Organization, Inc. Statements of Cash Flows (Unaudited)
~~For~~using the Black-Scholes pricing model.
N.   Trade Receivables

The Company, in the normal course of business, extends credit to its customers on a short-term basis. Although the credit risk associated with these customers is minimal, the Company routinely
reviews its accounts receivable balances and makes provisions for doubtful accounts. The Company ages its receivables by date of invoice. Management reviews bad debt reserves quarterly and reserves specific accounts as warranted or sets up a general reserve based on amounts over 90 days past due. When an account is deemed uncollectible, the Company charges off the receivable against the bad debt reserve.  At the six months ended June 30, ~~2006 2005 ------------ ------------~~ ~~Cash flows from Operating Activities: Net loss $ (24,403) $ (198,140) Adjustments~~2007, a $20,000 general reserve for balances over 90 days past due has been established.

The percentages of the major customers to reconcile net loss to net cash: Depreciation 4,770 11,156 Stock options issued for services 6,859 4,035 Changes in operating assets & liabilities: Increase in prepaid expenses (6,689) (717) (Increase) decrease in deferred tax asset (6,300) - (Increase) decrease intotal accounts receivable ~~108,407 (51,259) Decrease~~for the six months ended June 30, 2007 (unaudited) are as follows:

            ~~Customer A          25%~~
            ~~Customer B          15%~~

~~NOTE 3 - New Technical Pronouncements~~

In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS – AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140. This Statement amends FASB Statements No. 133, accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in ~~accounts payable (32,830) (4,345) Increase~~Statement 133 Implementation Issued No. D1, “Application of Statement 133 to Beneficial Interests in accrued expenses 30,011 19,084 Increase (decrease) in income tax payable (38,379) - Increase in unearned revenue 74,174 9,947 ------------ ------------ Net Cash Provided By (Used In) Operating Activities 115,330 (210,239) ------------ ------------ Cash flows from Investing Activities: ------------ ------------ Net Cash Used Securitized Financial Assets.” The adoption of SFAS No. 155 did not have an impact on the Company's consolidated financial statements.

In Investing Activities - - ------------ ------------ Cash flows from Financing Activities: ------------ ------------ Net Cash Provided By Financing Activities - - ------------ ------------ Increase (decrease) in cash 115,330 (210,239) Cash at beginningMarch 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS – AN AMENDMENT OF FASB STATEMENT No. 140. This Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of ~~period 345,091 506,675 ------------ ------------ Cash at end~~Financial Assets and Extinguishments of period $ 460,421 $ 296,436 ============ ============ Supplemental Cash Flow Information Cash paid for: Interest $ - $ - ============ ============ Taxes $ 1,857 $ 293 ============ ============
The accompanying notes are an integral part of these consolidated financial statements F-22 Pacific Health Care Organization, Inc. Notes to Financial Statements Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The adoption of SFAS No. 156 did not have an impact on the Company's consolidated financial statements.

~~F-26~~

~~Pacific Health Care Organization, Inc.~~

~~Notes to Financial Statements~~

For the Six Months Ended June 30, 2006 NOTE 1 - Corporate History Pacific Health Care Organization, Inc. (the "Company") was incorporated under the laws of the State of Utah on April 17, 1970 under the name Clear Air, Inc. The Company changed its name to Pacific Health Care Organization, Inc., on January 31, 2001. On February 26, 2001, the Company acquired Medex Healthcare, Inc. ("Medex"), a California corporation organized March 4, 1994, in a share for share exchange. Medex is now a wholly owned subsidiary of the Company. Medex is in the business of managing and administering Health Care Organizations and Medical Provider Networks in the state of California. The principle business of the Company is that of its wholly owned subsidiary Medex. These Health Care Organizations ("HCOs") are networks of medical providers established to serve the Workers' Compensation industry. The California legislature originally mandated that if an employer contracts services from an HCO, the injured workers must be given a choice between at least two HCOs. The Company recognized early on that two HCO certifications were necessary to be competitive. Instead of aligning with a competitor, the Company elected to go through the lengthy application process with the DIR twice and has subsequently received certification to operate two separate HCOs. While there is no longer a statutory requirement to offer two HCOs to employers Medex continues to retain its two certifications, so that employer clients have the option of offering one or two HCOs to their employees. The Company believes its ability to offer two HCOs gives potential clients greater choice, which is favored by a number of employers, especially those with certified bargaining units. Through the two licenses to operate HCOs, the Company offers the injured worker a choice of enrolling in an HCO with a network managed by primary care providers requiring a referral to specialists or a second HCO where injured workers do not need any prior authorization to be seen and treated by specialists. The two HCO certifications obtained by the Company cover the entire state of California. This geographical area has a multi-billion dollar annual medical and indemnity Workers' Compensation cost. The two HCO networks have contracted with over 3,200 individual providers and clinics, as well as, hospitals, pharmacies, rehabilitation centers and other ancillary services making the Company's HCOs capable of providing comprehensive medical services throughout this region. The Company is continually developing these networks based upon the nominations of new clients and the approvals of their claims' administrators. The Company, by virtue of its continued certification as an HCO, is statutorily deemed to be qualified as an approved Medical Provider Network ("MPN") as created by SB 899, and effective as of January 1, 2005. It is anticipated that a significant number of employer clients will avail themselves of the MPN program rather than the HCO program; others will utilize the provisions of the HCO program, while still others will use both in conjunction with each other. Medex is currently the only entity that offers both programs together in its hybrid program. F-23 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 1 - Corporate History (continued) The Company is currently in continued discussions with insurance brokers, carriers, third party administrators, managed care organizations and with representatives of self-insured employers, both as partners and potential clients. Based on potential cost savings to employers and the approximately fourteen million workers eligible for the services of the Company, the Company expects that employers will continue to sign contracts with the Company to retain the services it provides. The amounts the Company charges employers per enrollee may vary based upon factors such as employer history and exposure to risk; for instance, a construction company would likely pay more than a payroll service company. In addition, employers who have thousands of enrollees are more likely to get a discount. The Company does not anticipate large capital expenditures. Rather, it contracts with many medical providers, and therefore, equipment such as x-ray machines are not paid for by the Company. The Company has fixed costs such as liability insurance and other usual costs of running an office. NOTE 2 - Significant Accounting Policies A. Basis of Accounting - ------------------------ The Company uses the accrual method of accounting. B. Revenue Recognition - ------------------------ The Company applies the provisions of SEC Staff Accounting Bulletin No. 104, REVENUE RECOGNITION IN FINANCIAL STATEMENTS ("SAB 104"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 104 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. In general, the Company recognizes revenue related to monthly contracted amounts for services provided when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the fee is fixed or determinable and (iv) collectibility is reasonably assured. Health care service revenues are recognized in the period in which fees are fixed or determinable and the related services are provided to the subscriber. The Company's subscribers generally pay in advance for their services by check or electronic check payment, and revenue is then recognized ratably over the period in which the related services are provided. Advance payments from subscribers are recorded on the balance sheet as deferred revenue. In circumstance where payment is not received in advance, revenue is only recognized if collectibility is reasonably assured. F-24 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 2 - Significant Accounting Policies (continued) C. Cash Equivalents - --------------------- The Company considers all short term, highly liquid investments that are readily convertible, within three months, to known amounts as cash equivalents. The Company currently has no cash equivalents. D. Concentrations - ------------------- Financial instruments that potentially subject Pacific Health Care Organization, Inc. (the Company) to concentrations of credit risks consist of cash and cash equivalents. The Company places its cash and cash equivalents at well-known, quality financial institutions. At times, such cash and investments may be in excess of the FDIC insurance limit. E. Net Earnings (Loss) Per Share of Common Stock (unaudited) - -------------------------------------------------------------- The computation of earning (loss) per share of common stock is based on the weighted average number of shares outstanding at the date of the financial statements. Potentially issuable common shares totaling 817,964 related to warrants and 416,500 related to options were excluded from the calculation of fully diluted loss per share during 2006 and 2005.
~~For the six~~ Months Ended June 30, 2007
NOTE 3 - New Technical Pronouncements (continued)
In September 2006, ~~2005 ------------ ------------~~ ~~Basic Earnings~~the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The adoption of SFAS 157 did not have an impact on the Company’s consolidated financial statements. The Company presently comments on significant accounting policies (including fair value of financial instruments) in Note 2 to the financial statements.
In September 2006, the FASB issued SFAS No. 158,  EMPLOYERS’ ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS –AN AMENDMENT OF FASB STATEMENTS NO. 87, 88, 106 AND 132(R). This statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other that a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. The adoption of SFAS No. 158 did not have an impact on the Company’s consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES – INCLUDING AN AMENDMENT OF FASB STATEMENT NO.115. This statements objective is to improve financial reporting by providing the Company with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objective for accounting for financial instruments. The adoption of SFAS 159 did not have an impact on the Company’s financial statements. The Company presently comments on significant accounting policies (including fair value of financial instruments) in Note 2 to the financial statements.

~~F-27~~
~~Pacific Health Care Organization, Inc.~~
~~Notes to the Financial Statements~~
~~For the Six Months Ended June 30, 2007~~
~~NOTE 4 - Fixed Assets~~

The Company capitalizes the purchase of equipment and fixtures for major purchases in excess of $1,000 per ~~share:~~item. Capitalized amounts are depreciated over the useful life of the assets using the straight line method of depreciation which is 3 and 7 years for the computer equipment, and furniture and fixtures, respectively. Scheduled below are the assets, costs and accumulated depreciation at June 30, 2007 (unaudited) and December 31, 2006.

Cost Depreciation Expense Accumulated Depreciation

For the Six
Months Ended
June 30, 2007

For the
Year Ended
December 31, 2006

For the Six
Months Ended
June 30, 2007

For the
Year Ended
December 31, 2006

For the Six
Months Ended
June 30, 2007

For the
Year Ended
December 31, 2006

Assets
Computer Equipment $ 60,922 $ 60,922 $ - $ 6,386 $ 60,922 $ 60,922
Furniture & Fixtures 24,766 24,766 4,770 3,154 19,165 14,395
     Totals $ 85,688 $ 85,688 $ 4,770 $ 9,540 $ 80,087 $ 75,317
NOTE 5 - Income (Loss) (numerator) $ (24,403) $ (198,140) Shares (denominator) 15,427,759 15,427,759 ------------ ------------ Per Share Amount $ .00 $ ( .01) ============ ============ Fully Diluted Earnings per share:Taxes

The Company accounts for corporate income taxes in accordance with Statement of Accounting Standards Number 109 (“SFAS No. 109”) “Accounting for Income (Loss) (numerator) $ (24,403) $ (198,140) Shares (denominator) 15,427,759 15,427,759 ------------ ------------ Per Share Amount $ .00 $ (.01) ============ ============
F. Depreciation - ----------------- The cost of property and equipment is depreciated over the estimated useful lives of the related assets. The cost of leasehold improvements is depreciated over the lesser of the length of the lease of the related assets for the estimated lives of the assets. Depreciation is computed on the straight line method. F-25 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 2 - Significant Accounting Policies (continued) G. Use of Estimates - --------------------- The preparation of the financial statements in conformity with generally accepted accounting principles, in the United States of America, require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. H. Principles of Consolidation - -------------------------------- The accompanying consolidated financial statements include the accounts of the company and it's wholly - owned subsidiary. Intercompany transactions and balances have been eliminated in consolidation. I. Fair Value of Financial Instruments - ---------------------------------------- The fair value of the Company's cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate carrying value based on their effective interest rates compared to current market prices. J. General and Administrative Costs - ------------------------------------- General and administrative expenses include fees for office space, compensated absences, travel expenses and entertainment costs. K. Income Taxes - ----------------- The Company utilizes the liability method of accounting of income taxes. Under the liability method, deferred income tax assets and liabilities are provided based on the difference between the financial statements and tax basis of assets and liabilities measured by the currently enacted tax rates in effect for the years in which these differences are expected to reverse. Deferred tax expense or benefit is the result of changes in deferred tax assets and liabilities. L. Capital Structure - ---------------------- The Company has two classes of stock. Preferred stock, 5,000,000 shares authorized, zero issued. Voting rights and liquidation preferences have not been determined. The Company also has voting common stock of 50,000,000 shares authorized, with 15,427,759 shares issued and outstanding. No dividends were paid in the six months ended 2006 and 2005. F-26 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 2 - Significant Accounting Policies (continued) M. Stock-Based Compensation - ----------------------------- As permitted by SFAS No. 123, the Company has elected to measure and record compensation cost relative to stock option costs in accordance with SFAS 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which requires the company to record compensation using the Black-Scholes pricing model to estimate fair value of the options at the grant date. N. Trade Receivables - ---------------------- The Company in the normal course of business extends credit to its customers on a short-term basis. Although the credit risk associated with these customers is minimal, the Company routinely reviews its accounts receivable balances and makes provisions for doubtful accounts. The Company ages its receivables by date of invoice. Management reviews bad debt reserves quarterly and reserves specific accounts as warranted or sets up a general reserve based on amounts over 90 days past due. When an account is deemed uncollectible, the Company charges off the receivable against the bad debt reserve. Since inception of the Company, no receivables have been charged off against the bad debt reserve. At the six months ended June 30, 2006, the Company's bad debt reserve was decreased to $20,000 due to revised contract collections with a specific customer. The $20,000 is a general reserve for balances over 90 days past due. The percentages of the major customers to total accounts receivableTaxes.”  SFAS No. 109 requires an asset and liability approach for financial accounting and reporting for income tax purposes.

The tax provision (benefit) for the six months ended ~~June 30, 2006 (unaudited) are as follows:~~ ~~Customer A 52% Customer B 13%~~
NOTE 3 - New Technical Pronouncements In May 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement replaces APB No. 20, ACCOUNTING CHANGES and FASB No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies it all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement includes specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of SFAS No. 154 did not have an impact on the Company's consolidated financial statements. F-27 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 3 - New Technical Pronouncements (continued) In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS - AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140. This Statement amends FASB Statements No. 133, accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issued No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The adoption of SFAS No. 155 did not have an impact on the Company's consolidated financial statements. In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS - AN AMENDMENT OF FASB STATEMENT No. 140. This Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The adoption of SFAS No. 156 did not have an impact on the Company's consolidated financial statements. NOTE 4 - Fixed Assets The Company capitalizes the purchase of equipment and fixtures for major purchases in excess of $1,000 per item. Capitalized amounts are depreciated over the useful life of the assets using the straight line method of depreciation which is 3 and 7 years for the office equipment, and furniture and fixtures, respectively. Scheduled below are the assets, costs and accumulated depreciation at June 30, 2006 (unaudited) and December 31, 2005.
Depreciation Accumulated Cost Expense Depreciation ------------------- ------------------- ------------------- Assets June 30, 2007 and the year ended December 31, 2006 consisted of the following:
2007 2006
(unaudited)
Current:
Federal $ 24,870 $ (17,948 )
State 3,802 1,700
Deferred
Federal (710 ) 4,240
State (252 ) $ 765
     Total tax (benefit) $ (27,710 ) $ (11,243 )

F-28
Pacific Health Care Organization, Inc.
Notes to Financial Statements
For the Six Months Ended June ~~December June December~~ 30, ~~2006 31, 2005 30, 2006 31, 2005 30, 2006 31, 2005 --------- --------- --------- --------- --------- ---------~~ Computer Equipment $ 60,922 $ 60,922 $ 3,004 $ 7,801 $57,540 $ 54,536 Furniture & Fixtures 24,766 24,766 1,766 3,540 13,007 11,241 --------- --------- --------- --------- --------- --------- Totals $ 85,688 $ 85,688 $ 4,770 $ 11,341 $ 70,547 $ 65,777 ========= ========= ========= ========= ========= =========
F-28 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 5 - Income Taxes The Company accounts for corporate income taxes in accordance with Statement of Accounting Standards Number 109 ("SFAS No. 109") "Accounting for Income Taxes." SFAS No. 109 requires an asset and liability approach for financial accounting and reporting for income tax purposes. The tax provision (benefit) for the period June 30, 2006 (unaudited) and the year ended December 31, 2005 consisted of the following:
~~2006 2005 ------------ ------------~~ Current: Federal $ 1,000 $ 23,216 State 300 17,596 Deferred: Federal (5,100) (17,070) State (1,200) (2,550) ------------ ------------ Total Tax Provision (Benefit) $ (5,000) $ 21,192 ============ ============ 2007
NOTE 5 - Income Taxes (continued)
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  The ~~Company's~~Company’s total deferred tax liabilities, deferred tax assets, and deferred tax asset valuation allowances at June 30, ~~2006 (unaudited)~~2007 and December 31, ~~2005~~2006 are as follows: Depreciation Federal $ (2,175) $ (2,175) State (325) (325) Reserve for Bad Debts Federal 12,890 12,890 State 1,930 1,930 Vacation Accrual Federal 11,455 6,355 State 2,145 945 ------------ ------------ $ 25,920 $ 19,620 ============ ============
2007 2006
Net operating loss $ - $ -
Depreciation
Federal (788 ) (1,060 )
State (120 ) (160 )
Reserve for bad debts
Federal 6,770 6,770
State 1,030 1,030
Vacation accrual
Federal 7,561 6,135
State 1,124 915
Charitable contribution - 985
Deferred tax asset $ 15,577 $ 14,615

The reconciliation of income tax computed at statutory rates of income tax benefits is as follows: ~~Expense~~
2007 2006
Expense at federal statutory rate $ 19,145 $ (26,043 )
State tax effects 3,799 1,700
Non deductible expenses 5,015 12,335
Taxable temporary differences 1,698 2,100
Deductible temporary differences (985 ) (6,340 )
Deferred tax asset valuation increase (962 ) 5,005
Income tax (benefit) $ 27,710 $ (11,243 )
NOTE 6 - Operating Leases (unaudited)

The Company leases 3,504 square feet of office space at Federal Statutory Rate - 34% $ (8,345) $ (2,765) State Tax Effects (1,005) 7,707 Non Deductible Expenses 4,215 18,800 Taxable Temporary Differences 135 17,505 Deductible Temporary Differences - (435) Asset Valuation Allowance - (19,620) ------------ ------------ Income Tax Expense $ (5,000) $ 21,192 ============ ============
F-29 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 6 - Operating Leases (unaudited) The Company's lease on its 3,504 square feet of office space at 5150 East Pacific Coast Highway, Long Beach, California 90804 expired on February 28, 2006. Prior to expiration of the lease, the Company was leasing the space for $6,482 per month. Subsequent to the year end, the Company negotiated a five year extension of its lease agreement. In July 2006, the Company negotiated an amendment to its lease agreement granting the Company a one time right to terminate the lease after three years in accordance with the terms of the amendment. The monthly lease payments increased to $7,008 per month for the first year with 3% annual increased in the following years, resulting in monthly lease payment of $7,4355150 East Pacific Coast Highway, Long Beach, California 90804 that terminates in February 2011.  The current monthly lease payment on this office space is $7,218  per month with 3% annual increases in each subsequent year, resulting in monthly lease payment of $7,887 at the expiration of the lease.  The space the Company is leasing is sufficiently large enough to accommodate all of its administrative needs.
~~Total Lease Commitments: Year Amount ------------ ------------~~ 2006 $ 72,598 2007 86,198 2008 88,784 2009 91,450 2010 94,196 Thereafter 15,776 ------------ Total $ 438,424 ============
Also the Company leases approximately 600 square feet of office space in Newport Beach, California on a month to month basis for $1,200 per month.

Total Lease Commitments:
Year Amount
2007 $ 43,308
2008 88,784
2009 91,450
2010 94,196
Thereafter 15,776
Total $ 333,514

Rent expense for the six months ended June 30, 2006 and June 30, 2005 was $45,548 and $40,247 respectively. NOTE 7 - Major Customers The Company had two customers who, accounted for 10 percent, or more, o the Company's total revenues during the six months ended June 30, 2006 and two customers in the year ended December 31, 2005. The percentages of total revenues for the six months ended June 30, 2007 and June 30, 2006 was $50,089 and $45,548, respectively.

~~F-29~~

~~Pacific Health Care Organization, Inc.~~

~~Notes to Financial Statements~~

~~For the Six Months Ended June 30, 2007~~

~~NOTE 7 - Major Customers~~

The Company had three customers who, accounted for 10 percent, or more of the Company’s total revenues during the six months ended June 30, 2007 and two customers in the year ended December 31, 2006. The percentages of total revenues for the six months ended June 30, 2007 and the year ended ~~December 31, 2005 are as follows:~~
~~June 30,~~ December 31, 2006 ~~2005 ------------ ------------ (unaudited)~~ ~~Customer~~are as follows:

June
30, 2007
December 31, 2006
(unaudited)
Customer A 17 % 10 %
Customer B 13 % 10 %
Customer C 11 % - %

NOTE 8 - Accrued and Other Liabilities

June
30, 2007

December
31, 2006

(unaudited)
Accrued liabilities consist of the following:
Employment Enrollment Fees $ 70,237 $ 100,000
Compensated Absences 18,114 18,065
Legal Fees 44,000 12,000
Other 17,000 12,000
Total $ 149,351 $ 142,065
NOTE 9 - Options for Purchase of Common Stock

In August 2002, the Company adopted a stock option plan. The Company adopted a plan which provides for the grant of options to officers, consultants and employees to acquire shares of the Company’s common stock at a purchase price equal to or greater than fair market value as of the date of the grant. Options are exercisable six months after the grant date and expire five years from the grant date. Under the Plan, the exercise price of any options granted is determined at the time of grant. Currently there are options outstanding under the Plan to purchase up to a total of 66,250 shares. The exercise price of these outstanding options is $.05. The fair market value of these options at the date of grant was determined to be $.035 due to earlier issuances for cash of this stock. The plan calls for a total of 1,000,000 shares to be held for grant. A ~~24% 21% Customer B 12% 10%~~
~~Pacific Health Care Organization, Inc. Notes to Financial Statements~~ summary of activity follows:

2002 Stock Option Plan
Number of
Shares

Weighted Average
Exercise Price

Outstanding, January 1, 2006 66,250 $ .05
Granted - -
Exercised - -
Canceled - -
Outstanding, December 31, 2006 66,250 $ .05
Exercisable, December 31, 2006 66,250 $ .05

Outstanding, January 1, 2007 66,250 $ .05
Granted - -
Exercised - -
Canceled - -
Outstanding, June 30, 2007 66,250 $ .05
Exercisable, June 30, 2007 66,250 $ .05

~~F-30~~

~~Pacific Health Care Organization, Inc.~~

~~Notes to Financial Statements~~

For the Six Months Ended ~~June 30, 2006 NOTE 8 - Accrued and Other Liabilities~~
June 30, December 31, 2006 2005 ------------ ------------ Accrued liabilities consist2007
NOTE 9 - Options for Purchase of ~~the following: (unaudited)~~ Employment Enrollment Fees $ 131,805 $ 144,000 Compensated Absences 34,139 18,719 Legal Fees 76,057 48,000 Other 24,186 25,457 ------------ ------------ Total $ 266,187 $ 236,176 ============ ============
~~NOTE 9 - Options for Purchase of~~ Common Stock In August 2002, the Company adopted a stock option plan. The Company adopted a plan which provides for the grant of options to officers, consultants and employees to acquire shares of the Company's common stock at a purchase price equal to or greater than fair market value as of the date of the grant. Options are exercisable six months after the grant date and expire five years from the grant date. The exercise price of the options is $.05. The fair market value of the options at the date of grant was determined to be $.035 due to earlier issuances for cash of this stock. The plan calls for a total of 1,000,000 shares to be held for grant. A summary of activity follows:
~~2002~~ Stock Option Plan Weighted Average Number Exercise of Shares Price ------------ ------------ Outstanding, January 1, 2005 66,250 $ .05 Granted - - Exercised - - Canceled - - ------------ ------------ Outstanding, December 31, 2005 66,250 $ .05 ============ ============ Exercisable, December 31, 2005 66,250 $ .05 ============ ============ Outstanding, January 1, 2006 66,250 $ .05 Granted - - Exercised - - Canceled - - Outstanding, June 30, 2006 66,250 $ .05 ============ ============ Exercisable, June 30, 2006 66,250 $ .05 ============ ============
F-31 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 9 - Options for Purchase of Common Stock (continued) In accordance with SFAS 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, $0 and $1,858 has been charged to compensation expense for the six months ended June 30, 2006 and year ended December 31, 2005. The fair value of the option grant was established at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:
~~2006 ------------~~ Risk-free interest rate 4.0% Dividend yield 0% Volatility 71% Average expected term (years to exercise date) 1/2
~~Employee stock options outstanding and exercisable under this plan as of June 30, 2006 are:~~
Weighted Weighted Average Weighted Range of Average of Remaining Average of Exercise Exercise Contractual Exercise Price Options Price Life (years) Options Price - ---------- --------- ----------- ------------ --------- ----------- ~~$ .05 66,250 $ .05 1.17 66,250 $ .05~~
On November 18, 2005, at the Annual Meeting of Stockholders of the Company, the Company and its shareholders adopted the Pacific Health Care Organization, Inc., 2005 Stock Option Plan. The plan provides for the grant of Company securities, including options, warrants and restricted stock to officers, consultants and employees to acquire shares of the Company's common stock at a purchase price equal to or greater than fair market value as of the date of the grant. Options are exercisable six months after the grant date and expire five years from the grant date. The plan permits the granting of up to 1,000,000 common shares of the Company. NOTE 10 - Stock Option Agreement On April 20, 2004, the board of directors agreed to a stock option agreement with an officer of the Company's subsidiary, Medex, effective as of October 11, 2004. The agreement calls for the grant of 350,000 options that vest and are exercisable as follows: 100,000 the first year, with an exercise price of $.05; 100,000 the second year, with an exercise price of $.10; and 150,000 the third year, with an exercise price of $.20. The options expire three years from the date of grant. F-32 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 10 - Stock Option Agreement (continued)
2004 Stock Option Agreement Weighted Average Number Exercise of Shares Price ------------ ------------ Outstanding, January 1, 2005 350,000 $ .13 Granted 350,000 - Exercised - - Canceled - - ------------ ------------ Outstanding, December 31, 2005 350,000 $ .13 ============ ============ Exercisable, December 31, 2005 200,000 .04 ============ ============ Outstanding, January 1, 2006 350,000 $ .13 Granted - - Exercised - - Canceled - - ------------ ------------ Outstanding, June 30, 2006 350,000 $ .13 ============ ============ Exercisable, June 30, 2006 350,000 $ .13 ============ ============ (continued)
In accordance with SFAS 123, ~~ACCOUNTING FOR STOCK-BASED COMPENSATION,~~Accounting for Stock-Based Compensation, $0 has been charged to compensation expense for the six months ended June 30, 2007 and December 31, 2006, respectively, as no new options were granted.

The fair value of the option grant was established at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:
Risk-free interest rate 4.0 %
Dividend yield 0 %
Volatility -50 %
Average expected term (years to exercise date) ¼

Employee stock options outstanding and exercisable under this plan as of June 30, 2007 are:
Range of
Exercise Priace

Outstanding
Options

Weighted Average
of Exercise Price

Weighted Average Remaining Contractual
Life (years)

Outstanding
Options

Weighted Average
of Exercise Price

$ .05 66,250 $ .05 .25 66,250 $ .05

NOTE 10- Stock Option Agreement

On April 20, 2004, the board of directors agreed to a stock option agreement with an officer of the Company, effective as of October 11, 2004.  The agreement calls for the grant of 350,000 options that rest and are exercisable as follows: 100,000 the first year, with an exercise price of $.05; 100,000 the second year, with an exercise price of $.10; and 150,000 the third year, with an exercise price of $.20.  The options expire three years from the date of grant.
2004 Stock Option Agreement Number of Shares Weighted Average Exercise Price
Outstanding, January 1, 2006 - $ -
Granted 350,000 .68
Exercised - -
Canceled - -
Outstanding, December 31, 2006 350,000 .68
Exercisable, December 31, 2006 200,000 .05

Outstanding, January 1, 2007 350,000 $ .68
Granted - -
Exercised - -
Canceled - -
Outstanding, June 30 2007 350,000 .68
Exercisable, June 30, 2007 350,000 .23

F-31
Pacific Health Care Organization, Inc.
Notes to Financial Statements
For the Six Months Ended June 30, 2007
NOTE 10- STOCK OPTION AGREEMENT (continued)

In accordance with SFAS 123, Accounting for Stock-Based Compensation, $0 and $15,121 has been charged to compensation expense for the six months ended June 30, ~~2006~~2007 and year ended December 31, ~~2005.~~2006, respectively.  The fair value of the option grant was established at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

Risk-free interest rate 4.0 %
Dividend yield 0 %
Volatility -50 %
Average expected term (years to exercise date) 1 ¾
Employee stock options outstanding and exercisable under this agreement as of June 30, 2007 are:
Range of
Exercise Price

Outstanding
Options
Weighted Average of Exercise Price
Weighted Average Remaining Contractual
Life (years)

Outstanding
Options

Weighted Average
of Exereise Price

$ .05 - .20 350,000 $ .68 1.75 350,000 $ .23

NOTE 11 - Litigation

A complaint was filed in Orange County, California Superior Court, Case No. 04cc04645, by plaintiffs Marvin Teitelbaum, a shareholder of the Company, and Peter Alezakis, a shareholder and former director of the Company (collectively "Plaintiffs") on or about April 7, 2004 against the Company's president Tom Kubota, former secretary and director, now deceased, Rudy LaRusso and the Company (collectively "Defendants").

On September 22, 2006, ~~-------------~~ Risk-free interest rate 4.0% Dividend yield 0% Volatility (71%) Averagea settlement agreement was reached between the Company, Medex and Tom Kubota and Marvin Teitelbaum and Peter Alexakis dismissing the complaint and cross complaint in the matter.

Each party to the action agreed to dismiss with prejudice their complaint and/or cross complaint in the above mentioned action. No party received any money, stock or other compensation as a result of the mutual release and settlement and each party agreed to be responsible for its own attorneys’ fee.

~~NOTE 12 - Unaudited Information~~

The financial statement for the six months ended June 30, 2007 and 2006 were taken from the books and records of the Company without audit.  However, such information reflects all adjustments, which are in the opinion of management, necessary to properly reflect the results of the six months ended June 30, 2007 and 2006, and are of a normal, recurring nature.  The information presented is not necessarily indicative of the results from operations expected ~~term (years to exercise date) 1/2~~
F-33 Pacific Health Care Organization, Inc. Notes to Financial Statements For the Six Months Ended June 30, 2006 NOTE 10 - Stock Option Agreement (continued) Employee stock options outstanding and exercisable under this agreement as of June 30, 2006 are:
Weighted Weighted Average Weighted Range of Average of Remaining Average of Exercise Exercise Contractual Exercise Price Options Price Life (years) Options Price - ---------- --------- ----------- ------------ --------- ----------- ~~$.05 -.20 350,000 $ .13 .83 350,000 $ .3~~
NOTE 11 - LITIGATION A complaint was filed in Orange County, California Superior Court by plaintiffs Marvin Teitelbaum, a shareholder of the Company, and Peter Alezakis, a shareholder and former director of the Company (collectively "Plaintiffs") on or about April 7, 2004 against the Company's president Tom Kubota, former secretary and director, now deceased, Rudy LaRusso and the Company (collectively "Defendants"). The action seeks cancellation of a stock issuance, damages related to the stock issuance, an order for Mr, Kubota to pay the Company $150,000 and other damages to be determined based upon allegations that Defendants breached various fiduciary duties. The Company has retained the services of the Law Offices of Joseph Nardulli of Newport Beach, CA, and Mr. Kubota and the estate of Mr. LaRusso have retained the services of the Law Offices of L. Scott Karlin, of Tustin, CA, to represent them in this matter and intend to contest the case vigorously. The Defendants have answered the complaint and defendants along with Medex have filed a Cross-Complaint against the Plaintiffs based in part on certain alleged misrepresentations made by Plaintiffs at the time of the merger between Medex and PHCO. The parties are currently engaged in discovery. The parties to the litigation have agreed to submit to binding arbitration, which is currently scheduled to occur in September 2006. The Company believes that the claims by Plaintiffs are without merit. NOTE 12 - Unaudited Information The financial statement for the six months ended June 30, 2006 was taken from the books and records of the Company without audit. However, such information reflects all adjustments which are in the opinion of management, necessary to properly reflect the results of the six months ended June 30, 2006, and are of a normal, recurring nature. The information presented is not necessarily indicative of the results from operations expected for the full fiscal year. F-34

Name and Principal Position	Year	Salary ($)		Bonus ($)		Option Awards⁽²⁾ ($)		All Other Compensation⁽⁴⁾ ($)		Total ($)
Tom Kubota	2006		71,400		-0-		-0-		-0-		71,400
President and Director	2005		42,000		10,000		-0-		-0-		52,000

Doug Hikawa⁽¹⁾	2006		137,908		3,400		6,860		-0-		148,168
President, Medex	2005		138,846		6,400		16,979		-0-		162,225
Healthcare
Geri Plotzke⁽³⁾	2006		92,800		2,600		-0-		-0-		134,243
Vice President,
Medex Healthcare

Donald Balzano ⁽⁵⁾	2006		125,875		-0-		-0-		38,842		164,717
Former CEO,	2005		172,341		8,600		-0-		-0-		181,475
Medex Healthcare

	Option Awards
Name		Number of Securities Underlying Unexercised Options (#) Exercisable	Number of Securities Underlying Unexercised Options (#) Unexercisable	Option Exercise Price ($)	Option Expiration Date

Tom Kubota		-0-	-0-	-0-	-
Doug Hikawa		350,000	-0-	(1)	10/11/2007

Name	Fees Earned or Paid in Cash ($)	Total ($)
Tom Iwanski	4,600	4,600
Don Hellwig	4,600	4,600
Tom Kubota	4,600	4,600

Name	Shares of Common Stock		Percentage of Class

Tom Kubota (1)		3,212,305		20.8	%
Donald Hellwig (2)		3,000		0.0	%
Thomas Iwanski		0		0.0	%
All directors, nominees and executive officers as a group (3 persons)		3,215,305		20.8	%

		By order of the President,


October 15, 2007		Tom Kubota, President

	2006		2005
Audit	$	34,934	$	16,399
Audit related	$	-	$	-
Tax	$	11,250	$	-
All Other	$	-	$	2,537
Total	$	46,184	$	18,936

		By order of the President,


October 15, 2007		Tom Kubota* 2,158,931 14.0% Donald Hellwig 3,000 0.0% Thomas Iwanski 0 0.0% - --------------------------------------------------------------------------- All directors, nominees and executive officers as a group (3 persons): 2,161,931 14.0% - --------------------------------------------------------------------------- Kubota, President

	BID PRICE				ASK PRICE
	HIGH		LOW		HIGH		LOW
			��
2006
First Quarter	$	.10	$	.10	$	.19	$	.19
Second Quarter		.12		.12		.19		.19
Third Quarter		.10		.10		.40		.40
Fourth Quarter		.10		.10		.35		.35

2005
First Quarter		.16		.16		1.01		1.01
Second Quarter		.16		.16		1.01		1.01
Third Quarter		.16		.16		1.01		1.01
Fourth Quarter		.16		.16		1.01		.50

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders		66,250	$	0.05		915,000
Equity compensation plans not approved by security holders		350,000	$	0.13		-0-
Total		416,250	$	0.12		915,000

	Fiscal 2006			Fiscal 2005

Net cash provided by (used in) operating activities	$	(72,033	)	$	(161,584	)
Net cash used in investing activities		-			-
Net cash provided by (used in) financing activities		-			-

Net Change in Cash	$	(72,033	)	$	(161,584	)

Expense at federal statutory rate	$	(26,043	)	$	5,410
State tax effects		1,700			23,575
Non deductible expenses		12,335			18,800
Taxable temporary differences		2,100			17,505
Deductible temporary differences		(6,340	)		(435	)
Change in deferred tax asset valuation		5,005			(19,620	)
Income tax provision (benefit)	$	(11,243	)	$	45,235

Total Lease Commitments:
	Year	Amount
	2007	$	43,308
	2008		88,784
	2009		91,450
	2010		94,196
	Thereafter		15,776
	Total	$	333,514

2002 Stock Option Plan	Number of Shares		Weighted Average Exercise Price
Outstanding, January 1, 2006		66,250	$	.05
Granted		-		-
Exercised		-		-
Canceled		-		-
Outstanding, December 31, 2006		66,250	$	.05
Exercisable, December 31, 2006		66,250	$	.05

Outstanding, January 1, 2007		66,250	$	.05
Granted		-		-
Exercised		-		-
Canceled		-		-
Outstanding, June 30, 2007		66,250	$	.05
Exercisable, June 30, 2007		66,250	$	.05

Name	Shares of Common Stock	Percentage of Class

Amafin Trust 121 Meierhofstasse FL 9495 Triesen Lichtenstien	1,500,000	9.7%

Eurifa Anstalt 121 Meierhofstrasse FL 9495 Triesen Liechtenstein	955,343	6.2%

Donald P. Balzano 5422 Mitchell Drive Torrance, CA. 90503	1,083,335	7.0%

Manfred Heeb 121 Meierhofstrasse FL 9495 Triesen Liechtenstein	1,445982	9.4%

Auric Stifung P.O. Box 83 Aeulestrasse 5 FL 9490 Vaduz Liechenstein	1,500,000	9.7%

Janet Zand 1505 Rockcliff Road Austin, Texas 78796	1,083,333	7.0%

Total	7,567,993	49.1%

Present Position ~~Director Name Age~~
With the Company

Director Since ~~- ---------------- ------ --------------------------- ---------------~~

Tom Kubota 67

Director and Iterim Secretary

September 2000 ~~President and Interim Secretary Donald Hellwig 65 Director January 2005 Chief Financial Officer~~

Thomas Iwanski 48

November 2004