SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A
(Rule 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE
SECURITIES EXCHANGE ACT OF 1934
Filed by the Registrant |X|
---
Filed by a Party other than the Registrant |_|
Check the appropriate box:
|_| Preliminary Proxy Statement
|_| Confidential, for Use of the Commission Only (as permitted by Rule 14a-
6(e)(2))
|X| Definitive Proxy Statement
- ---
|_| Definitive Additional Materials
|_| Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
PACIFIC HEALTH CARE ORGANIZATION INC.
-------------------------------------
(Name of Registrant as Specified In Its Charter)
(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)
Payment of Filing Fee (Check the appropriate box):
|X| No fee required.
|_| Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-
11.
1) Title of each class of securities to which transaction applies:
2) Aggregate number of securities to which transaction applies:
3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
4) Proposed maximum aggregate value of transaction:
5) Total fee paid:
|_| Fee paid previously with preliminary materials:
|_| Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the form or schedule and the date of its filing.
1) Amount previously paid:
2) Form, Schedule or Registration Statement No.:
3) Filing Party:
4) Date Filed:
PACIFIC HEALTH CARE ORGANIZATION, INC.
21 Toulon
Newport Beach, California 92660
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
The Annual Meeting of Stockholders of Pacific Health Care
Organization, Inc., (the "Company") will be held at the Little America
Hotel, located at 500 South Main Street in Salt Lake City, Utah on November
17, 2006, at 7:00 a.m., local time, for the following purposes:
1. To elect three directors to the Company's Board of Directors;
2. To ratify the appointment of Chisholm, Bierwolf & Nilson as the
independent registered public accounting firm of the Company for the
2006 fiscal year;
3. To transact any other business as may properly come before the
meeting or at any adjournment thereof.
Our Board of Directors has fixed the close of business on October 3,
2006, as the record date for determining stockholders entitled to notice
of, and to vote at, the meeting. A list of stockholders eligible to vote
at the meeting will be available for inspection at the meeting and for a
period of 10 days prior to the meeting during regular business hours at the
Company's headquarters, 21 Toulon, Newport Beach, California 92660.
All Company stockholders are cordially invited to attend the meeting
in person. Whether or not you expect to attend the Annual Meeting of
Stockholders, your proxy vote is important. To assure your representation
at the meeting, please sign and date the enclosed proxy card and return it
promptly in the enclosed envelope, which requires no additional postage if
mailed in the United States. Should you receive more than one proxy
because your shares are registered in different names or addresses, each
proxy should be signed and returned to assure that all your shares will be
voted. You may revoke your proxy at any time prior to the meeting. If you
attend the meeting and vote by ballot, your proxy will be revoked
automatically and only your vote at the meeting will be counted.
YOUR VOTE IS IMPORTANT
IF YOU ARE UNABLE TO BE PRESENT PERSONALLY, PLEASE MARK, SIGN AND DATE THE
ENCLOSED PROXY, WHICH IS BEING SOLICITED BY THE BOARD OF DIRECTORS, AND
RETURN IT PROMPTLY IN THE ENCLOSED ENVELOPE.
By order of the President,
October 13, 2006 /S/ Tom Kubota
-------------------------------
Tom Kubota, President
PACIFIC HEALTH CARE ORGANIZATION, INC.
21 Toulon
Newport Beach, California 92660
PROXY STATEMENT
GENERAL
SOLICITATION OF PROXIES. This proxy statement is being furnished
to the stockholders of Pacific Health Care Organization, Inc., a Utah
corporation, in connection with the solicitation of proxies by our
President for use at the Annual Meeting of Stockholders to be held at the
Little America Hotel, located at 500 South Main Street in Salt Lake City,
Utah at 7:00 a.m., local time, on November 17, 2006, or at any adjournment
thereof. A copy of the notice of meeting accompanies this proxy statement.
It is anticipated that the mailing of this proxy statement will commence on
or about October 19, 2006.
COST OF SOLICITATION. The Company will bear the costs of
soliciting proxies. In addition to the use of the mails, certain directors
or officers of our Company may solicit proxies by telephone, telegram,
facsimile, cable or personal contact. Upon request, the Company will
reimburse brokers, dealers, banks and trustees, or their nominees, for
reasonable expenses incurred by them in forwarding proxy material to
beneficial owners of shares of Company common stock.
OUTSTANDING VOTING SHARES. Company stockholders of record at the
close of business on October 3, 2006, the record date for the meeting, will
be entitled to notice of and to vote at the meeting. On the record date,
the Company had 15,427,759 shares of common stock outstanding, which are
its only securities entitled to vote at the meeting, each share being
entitled to one vote.
VOTE REQUIRED FOR APPROVAL. Shares of common stock will vote
with respect to each proposal. Under the Company's Bylaws, Proposals 2 and
3 each require the affirmative vote of a majority of the votes eligible to
be voted by holders of shares represented at the Annual Meeting in person
or by proxy. With respect to Proposal 1 votes may be cast by a stockholder
in favor of the nominee or withheld or an alternative candidate may be
written in. With respect to Proposals 2 and 3, votes may be cast by a
stockholder in favor or against the Proposals or a stockholder may elect to
abstain. Since votes withheld and abstentions will be counted for quorum
purposes and are deemed to be present for purposes of the respective
proposals, they will have the same effect as a vote against each matter.
Under the NASD Rules of Fair Practice, brokers who hold shares in
street name have the authority, in limited circumstances, to vote on
certain items when they have not received instructions from beneficial
owners. A broker will only have such authority if (i) the broker holds the
shares as executor, administrator, guardian, trustee or in a similar
representative or fiduciary capacity with authority to vote or (ii) the
broker is acting under the rules of any national securities exchange of
which the broker is also a member. Broker abstentions or non-votes will be
counted for purposes of determining the presence or absence of a quorum at
the meeting. Abstentions are counted in tabulations of the votes cast on
proposals presented to stockholders, but broker non-votes are not counted
for purposes of determining whether a proposal has been approved.
VOTING YOUR PROXY. Proxies in the accompanying form, properly
executed and received by the President of the Company prior to the Annual
Meeting and not revoked, will be voted as directed. In the absence of
direction from the stockholder, properly executed proxies received prior to
the Annual Meeting will be voted FOR the nominees of the Board of Directors
and FOR Proposals 2 and 3. You may revoke your proxy by giving written
notice of revocation to the Company Secretary at any time before it is
voted, by submitting a later-dated proxy or by attending the Annual Meeting
and voting your shares in person. Stockholders are urged to sign and date
the enclosed proxy and return it as promptly as possible in the envelope
enclosed for that purpose.
PROPOSAL ONE
ELECTION OF DIRECTOR
Our Bylaws provide that our Board of Directors will consist of not
less than two nor more than seven persons, the exact number to be fixed
from time-to-time by the Board of Directors. Currently, the Board of
Directors has three members. The Directors have decided to fix the number
of directorships at three for the upcoming year. Management has nominated
three individuals to serve as Directors for a one-year term expiring on the
date of the next Annual Meeting of Stockholders of the Company, and until
their successors are duly elected and qualified. Mr. Tom Kubota, Mr. Donald
Hellwig and Mr. Thomas Iwanski, have been nominated by management to stand
for election as Directors, all of whom currently serve as directors of the
Company.
NOMINEES
Set forth below is certain information as of October 10, 2006,
concerning the nominees for election at the Annual Meeting and our current
officers, including the business experience of each for at least the past
five years:
<Table>
<Caption>
Present Position Director
Name Age With the Company Since
- ---------------- ------ --------------------------- ---------------
Tom Kubota 67 Director September 2000
President and Interim Secretary
Donald Hellwig 65 Director January 2005
Chief Financial Officer
Thomas Iwanski 48 Director November 2004
</Table>
TOM KUBOTA. Mr. Kubota has thirty years of experience in the
investment banking, securities and corporate finance field. He held the
position of Vice President at Drexel Burnham Lambert; at Stem, Frank, Meyer
and Fox; and at Cantor Fitzgerald. Mr. Kubota is the president of Nanko
Corporation, which specializes in capital formation services for high
technology and natural resources companies. He has expertise in counseling
emerging public companies and has previously served as a director of both
private and public companies. For the last five years, Mr. Kubota has been
primarily engaged in running the Company. During the past five years, Mr.
Kubota also served as CEO of Fabrics International, Ltd., a privately held
corporation. Fabrics International recently terminated operations and
filed for bankruptcy. Mr. Kubota is not a director or nominee of any other
reporting company.
DONALD HELLWIG. Mr. Hellwig has been primarily engaged as a self-
employed accountant for the last fifteen years working with various
businesses and high net worth individuals. Mr. Hellwig received an
Associates of Arts in 1961 from Santa Monica City College and a Bachelors
of Science degree from UCLA in 1964 in Business Administration with an
emphasis in accounting. Prior to being self employed Mr. Hellwig held
various positions with several companies such as Chief Accountant at
Continental Airlines and the Manager of Accounting at Flying Tiger Lines.
Mr. Hellwig is not a director or nominee of any other reporting company.
2
THOMAS IWANSKI. Since September 2006, Mr. Iwanski has served as Chief
Financial Officer of SyncVoice Communications, Inc. From April 2005
through July 2006, Mr. Iwanski served as Senior Vice President, Corporate
Secretary and Chief Financial Officer of IP3 Networks, Inc. From February
2003 through April 2005 Mr. Iwanski served as a Special Advisor to the CEO
of Procom Technology, Inc., where he played a prominent role in the
development and implementation of business and financial strategies. Mr.
Iwanski has also served in various positions including, Vice President
Finance, Chief Financial Officer, Director and Secretary for a number of
companies, including Cognet, Inc., NetVantage, Inc., Kimalink, Inc.,
Xponent Photonics, Inc., Prolong, Inc., and Memlink, Inc. Mr. Iwanski also
has approximately ten years of public accounting experience having worked
for KPMG, LLP, as a Senior Audit Manager and a Certified Public Accountant.
Mr. Iwanski received a Bachelor of Business Administration from the
University of Wisconsin-Madison in 1980. Mr. Iwanski is not a director or
nominee of any other reporting company.
There are no family relationships among the current members or
nominees of the Board of Directors.
Management does not expect that any of the nominees will become
unavailable for election as a director, but, if for any reason that should
occur prior to the Annual Meeting, the person named in the proxy will vote
for such substitute nominee, if any, as may be recommended by management.
VOTE REQUIRED
Directors are elected by a plurality of votes cast at the Annual
Meeting. Unless contrary instructions are set forth in the proxies, the
persons with full power of attorney to act as proxies at the Annual Meeting
will vote all shares represented by such proxies for the election of the
nominees named therein as director. Should any of the nominees become
unable or unwilling to accept nomination or election, it is intended that
the person acting under the proxy will vote for the election, in the
nominee's stead, of such other person as the President of the Company may
recommend. The Company has no reason to believe that the nominees will be
unable or unwilling to stand for election or to serve if elected. Should
you desire to elect an individual other than the nominees listed in this
proxy statement, you may write in that individual in the space provided on
your proxy.
OUR BOARD OF DIRECTORS RECOMMENDS THAT OUR STOCKHOLDERS
VOTE "FOR" EACH OF THE NOMINEES LISTED ABOVE TO SERVE ON THE
COMPANY'S BOARD OF DIRECTORS
SECURITY OWNERSHIP OF DIRECTORS, EXECUTIVE OFFICERS AND NOMINEES
As of October 10, 2006, the Company had 15,427,759 shares of its
common stock issued and outstanding. The following table sets forth the
beneficial ownership of Company common stock as of that date, of each
director, nominee, the President, the other executive officers, and for all
directors and executive officers as a group.
<Table>
<Caption>
- ---------------------------------------------------------------------------
Shares of Percentage
Name Common Stock of Class
- ---------------------------------------------------------------------------
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%
- ---------------------------------------------------------------------------
</Table
*The number of shares attributed to Mr. Kubota includes 1,702,305
shares held of record by Nanko Investments, Inc. Mr. Kubota is the
president of Nanko Investments, Inc. As such, Mr. Kubota may be deemed to
have voting and/or investment power over the shares held by Nanko
Investments and therefore may be deemed to be the beneficial owner of those
shares.
3
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
As of October 10, 2006, the persons named below were, to the knowledge
of the Board of Directors of the Company, the only beneficial owners of
more than 5% of the outstanding common stock, other than directors,
nominees and executive officers whose beneficial ownership is described in
the above table.
<Table>
<Caption>
Shares of Percentage
Name Common Stock of Class
- ---------------------------------------------------------------------------
Peter G. Alexakis 1,083,333 7.0%
Amafin Trust 1,500,000 9.7%
Eurifa Anstalt 955,343 6.2%
Donald P. Balzano 1,083,335 7.0%
Manfred Heeb 1,445,982 9.4%
Auric Stiftung 1,500,000 9.7%
Marvin Teitelbaum 1,083,333 7.0%
William Rifkin 1,083,333 7.0%
Tom Roush 1,083,333 7.0%
Janet Zand 1,083,333 7.0%
- ---------------------------------------------------------------------------
TOTAL 11,901,325 77%
- ---------------------------------------------------------------------------
</Table>
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Directors, executive officers and beneficial owners of greater than
10% of the Company's outstanding common stock are required to comply with
Section 16(a) of the Securities Exchange Act of 1934, which requires
generally that such persons file reports regarding ownership of and
transactions in securities of the Company on Forms 3, 4, and 5. Form 3 is
an initial statement of ownership of securities, Form 4 is to report
changes in beneficial ownership and Form 5 is an annual statement of
changes in beneficial ownership. Based solely on a review of Forms 3, 4
and 5 and amendments thereto furnished to the Company during its most
recent fiscal year it appears that none of the Company's directors,
executive officers or beneficial owners purchased or sold shares during the
year ended December 31, 2005.
4
Executive Compensation
The following chart sets forth the compensation paid to each Executive
Officer and Director of the Company during the last three fiscal years:
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
Annual Compensation Long Term Compensation
Awards Payouts
Other Restr All
Name & Annual icted LTIP Other
Principal Compen Stock Options Payout Compen
Position Year Salary Bonus sation Awards /SARs # ($) sation
- -------------------------------------------------------------------------------------
Tom Kubota 2005 $42,000 $10,000 $-0- -0- -0- $-0- $-0-
President, CEO 2004 -0- -0- -0- -0- -0- -0- -0-
Director 2003 3,700(1) -0- -0- -0- -0- -0- -0-
Donald Hellwig 2005 3,600 -0- -0- -0- -0- -0- -0-
CFO, Director 2004 -0- -0- -0- -0- -0- -0- -0-
2003 -0- -0- -0- -0- -0- -0- -0-
Donald Balzano 2005 172,341 8,600 -0- -0- -0- -0- -0-
Former CEO of 2004 165,338 -0- -0- -0- -0- -0- -0-
Company Subsidiary 2003 132,000 -0- -0- -0- -0- -0- -0-
Medex
Doug Hikawa 2005 138,846 6,400 -0- -0- -0- -0- -0-
President of Company 2004 135,234 -0- -0- -0- 350,000(2) -0- -0-
Subsidiary Medex 2003 100,000 -0- -0- -0- -0- -0- -0-
</Table>
(1) Tom Kubota provided consulting services to the Company through
Nanko Investments, Inc., his private consulting business, which services
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:
<Table>
<Caption>
2005 2004
- ---------------------------------------------------------------------------
Audit $16,339 $31,574
Audit related - -
Tax - -
All other $2,537 $3,647
- ---------------------------------------------------------------------------
Total $18,936 $43,357
===========================================================================
</Table>
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
<Table>
<Caption>
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
</Table>
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
- -------------------------------------------------------
<Table>
<Caption>
Plan Number of Weighted-average Number of securities
category securities exercise price remaining available
to be issued of outstanding for future issuance
upon options, warrants under equity
exercise of and rights compensation plans
outstanding (excluding securities
options, reflected in
warrants and columns (a))
rights
(a) (b) (c)
- ------------------------------------------------------------------------------------
Equity compensation
plans approved by
security holders 66,250 $0.05 915,000
- ------------------------------------------------------------------------------------
Equity compensation
plans not approved
by security holders 1,167,964 $3.18 -0-
- ------------------------------------------------------------------------------------
Total 1,234,214 $3.01 915,000
- ------------------------------------------------------------------------------------
</Table>
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
Company realized a 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.
<Table>
<Caption>
Fiscal 2005 Fiscal 2004
---------------------------
Net cash provided by (used in)
operating activities ($161,584) $113,415
Net cash used in investing activities - (5,092)
Net cash provided by (used in) financing
activities - -
------------ ------------
Net Change in Cash ($161,584) $108,323
============ ============
</Table>
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.
<Table>
<Caption>
SUMMARY OF MATERIAL CONTRACTUAL COMMITMENTS
(Stated 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
=============================================================
</Table>
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 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.
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.
<Table>
<Caption>
For the six months
ended June 30,
2006 2005
----------- -----------
(unaudited) (unaudited)
Net cash provided by (used in)
operating activities $115,330 ($210,239)
Net cash used in investing activities - -
Net cash provided by (used in)
financing activities - -
----------- -----------
Net Change in Cash $115,330 ($210,239)
=========== ===========
</Table>
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.
<Table>
<Caption>
SUMMARY OF MATERIAL CONTRACTUAL COMMITMENTS
(Stated in thousands)
- -------------------------------------------------------------------------------------
Payment Period
-------------------------------------------------------------
Contractual Commitments Less than After
Total 1 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
=============================================================
</Table>
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-5
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
<Table>
<Caption>
December December
31, 2005 31, 2004
------------ ------------
(Restated)
Assets
Current Assets
- --------------
Cash $ 345,091 $ 506,675
Accounts receivable, net of allowance
of $38,000 351,311 179,391
Deferred tax asset 19,620 -
Prepaid expenses 42,871 40,715
------------ ------------
Total current assets 758,893 726,781
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) (54,436)
------------ ------------
Net property & equipment 19,911 31,252
------------ ------------
Total assets $ 778,804 $ 758,033
============ ============
</Table>
The accompanying notes are an integral part of these financial statements.
F-2
Pacific Health Care Organization, Inc.
Balance Sheets
<Table>
<Caption>
December December
31, 2005 31, 2004
------------ ------------
(Restated)
Liabilities & Stockholders' Equity
Current Liabilities
- -------------------
Accounts payable $ 41,083 $ 21,813
Accrued expenses 236,176 178,887
Income tax payable 40,812 -
Unearned revenue 35,352 119,608
------------ ------------
Total current liabilities 353,423 320,308
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 603,148 568,169
Accumulated (deficit) (193,195) (163,872)
------------ ------------
Total stockholders' equity 425,381 437,725
------------ ------------
Total liabilities & stockholders' equity $ 778,804 $ 758,033
============ ============
</Table>
The accompanying notes are an integral part of these financial statements.
F-3
Pacific Health Care Organization, Inc.
Statements of Operations
<Table>
<Caption>
December December
31, 2005 31, 2004
------------ ------------
(Restated)
Revenues $ 2,076,391 $ 1,671,994
- -------- ------------ ------------
Expenses
- --------
Depreciation 11,341 22,312
Consulting fees 104,110 109,796
Salaries & wages 750,516 663,832
Professional fees 342,028 228,184
Insurance 84,341 85,364
Employment enrollment 206,204 170,528
Bad debt expense 38,000 -
General & administrative 550,145 237,174
------------ ------------
Total expenses 2,086,685 1,571,190
------------ ------------
Income (loss) from operations (10,294) 154,804
Other income (expenses)
Interest income 2,456 271
------------ ------------
Total other income (expenses) 2,456 271
------------ ------------
Income (loss) before taxes (7,838) 155,075
Tax expense 21,485 671
------------ ------------
Net income (loss) $ (29,323) $ 154,404
============ ============
Basic earnings per share:
- -------------------------
Earnings per share amount $ 0.00 $ 0.01
Weighted average common shares outstanding 15,427,759 15,427,759
Fully diluted earnings per share:
- ---------------------------------
Earnings per share amount $ 0.00 $ 0.00
Weighted average common shares outstanding 15,427,759 16,662,223
</Table>
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
<Table>
<Caption>
Preferred Stock Common Stock Paid in Accumulated
Shares Amount Shares Amount Capital Deficit
-------- ------- ------------ --------- ---------- -----------
Balance,
January 1, 2004 - $ - 15,427,759 $ 15,428 $ 572,658 $ (318,276)
Issuance of
Stock Options - - - - 13,511 -
Net Income for the
Year Ended
December 31, 2004 - - - - - 154,404
-------- ------- ------------ --------- ---------- -----------
Balance,
December 31, 2004 - - 15,427,759 15,428 586,169 (163,872)
Valuation of
Stock Options - - - - 16,979 -
Net Income for the
Year Ended
December 31, 2005 - - - - - (29,323)
(Restated) -------- ------- ------------ --------- ---------- -----------
Balance,
December 31, 2005 - $ - 15,427,759 $ 15,428 $ 603,148 $ (193,195)
(Restated) ======== ======= ============ ========= ========== ===========
</Table>
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
<Table>
<Caption>
December December
31, 2005 31, 2004
------------ ------------
(Restated)
Cash Flows from Operating Activities
- ------------------------------------
Net income (loss) $ (29,323) $ 154,404
Adjustments 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
</Table>
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.
<Table>
<Caption>
For the Years Ended
December 31,
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
============ ============
</Table>
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.
<Table>
<Caption>
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
================================================================
</Table>
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:
<Table>
<Caption>
2005 2004
------------ ------------
Current:
Federal $ 23,216 $ -
State 17,596 -
Deferred
Federal (17,070) -
State (2,550) -
------------ ------------
Total Tax Provision (Benefit) $ 21,192 $ -
============ ============
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 total deferred tax liabilities, deferred tax assets, and deferred
tax asset valuation allowances at 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 $ -
============ ============
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 $ -
============ ============
</Table>
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)
<Table>
<Caption>
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
============
</Table>
Rent expense 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:
<Table>
<Caption>
2005 2004
------------ ------------
Customer A 21% 14%
Customer B 10% 13%
</Table>
NOTE 8 ACCRUED AND OTHER LIABILITIES
<Table>
<Caption>
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
============ ============
</Table>
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)
<Table>
<Caption>
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, December 31, 2005 66,250 $ .05
============ ============
</Table>
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:
<Table>
<Caption>
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 66,250 $ .05 1.67 66,250 $ .05
</Table>
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
<Table>
<Caption>
Weighted
Average
Number Exercise
of Shares Price
------------ ------------
Outstanding, January 1, 2004 - $ -
Granted 350,000 .68
Exercised - -
Canceled - -
------------ ------------
Outstanding, December 31, 2004 350,000 $ .68
============ ============
Exercisable, December 31, 2004 100,000 $ .05
============ ============
Outstanding, January 1, 2004 350,000 $ .68
Granted - -
Exercised - -
Canceled - -
------------ ------------
Outstanding, December 31, 2005 350,000 $ .68
============ ============
Exercisable, December 31, 2005 200,000 $ .23
============ ============
</Table>
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 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:
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:
<Table>
<Caption>
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
</Table>
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
<Table>
<Caption>
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
============ ============ ============
</Table>
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
<Table>
<Caption>
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
============ ============ ============
</Table>
{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
<Table>
<Caption>
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
</Table>
{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
<Table>
<Caption>
As
Previously As
Reported Restated Change
----------- ------------ ----------
Cash Flows from Operating Activities
- ------------------------------------
Net income (loss) $ (8,131) $ (29,323) $ (21,192) {a}
Adjustments 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) -
----------- ------------ ----------
Net cash provided by operating activities 161,584 161,584 -
Cash Flows from Investing Activities
- ------------------------------------
Purchase of computer equipment - - -
----------- ------------ ----------
Net cash used by investing activities - - -
Cash Flows from Financing Activities
- ------------------------------------
Net cash provided by financing activities - - -
----------- ------------ ----------
Increase (decrease) in cash (161,584) (161,584) -
Cash at beginning of period 506,675 506,675 -
----------- ------------ ----------
Cash at End of Period $ 345,091 $ 345,091 $ -
=========== ============ ==========
Supplemental Cash Flow Information
- ----------------------------------
Interest $ - $ - $ -
Taxes 23,750 293 (23,457)
</Table>
{a} Record tax effects of current year operations.
F-19
Pacific Health Care Organization, Inc.
Balance Sheets
<Table>
<Caption>
ASSETS
June 30, December 31,
2006 2005
(Unaudited)
------------ ------------
Current Assets
Cash $ 460,421 $ 345,091
Accounts receivable, net of allowance
of $20,000 242,904 351,311
Deferred tax asset 25,920 19,620
Prepaid expenses 49,560 42,871
------------ ------------
Total current 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' 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, 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
============ ============
</Table>
The accompanying notes are an integral part of
these consolidated financial statements
F-20
Pacific Health Care Organization, Inc.
Statements of Operations
(Unaudited)
<Table>
<Caption>
For three months ended For 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)
Tax expense (benefit) (45,600) - (5,000) -
------------ ------------ ------------ ------------
Net loss $ (95,022) $ (76,538) $ (24,403) $ (198,140)
============ ============ ============ ============
</Table>
The accompanying notes are an integral part of
these consolidated financial statements
F-21
Pacific Health Care Organization, Inc.
Statements of Cash Flows
(Unaudited)
<Table>
<Caption>
For the six months ended
June 30,
2006 2005
------------ ------------
Cash flows from Operating Activities:
Net loss $ (24,403) $ (198,140)
Adjustments 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 in accounts receivable 108,407 (51,259)
Decrease in accounts payable (32,830) (4,345)
Increase 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 In Investing Activities - -
------------ ------------
Cash flows from Financing Activities:
------------ ------------
Net Cash Provided By Financing Activities - -
------------ ------------
Increase (decrease) in cash 115,330 (210,239)
Cash at beginning of period 345,091 506,675
------------ ------------
Cash at end of period $ 460,421 $ 296,436
============ ============
Supplemental Cash Flow Information
Cash paid for:
Interest $ - $ -
============ ============
Taxes $ 1,857 $ 293
============ ============
</Table>
The accompanying notes are an integral part of
these consolidated financial statements
F-22
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.
<Table>
<Caption>
For the six Months Ended
June 30,
2006 2005
------------ ------------
Basic Earnings per share:
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:
Income (Loss) (numerator) $ (24,403) $ (198,140)
Shares (denominator) 15,427,759 15,427,759
------------ ------------
Per Share Amount $ .00 $ (.01)
============ ============
</Table>
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 receivable
for the six months ended June 30, 2006 (unaudited) are as follows:
<Table>
Customer A 52%
Customer B 13%
</Table>
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.
<Table>
<Caption>
Depreciation Accumulated
Cost Expense Depreciation
------------------- ------------------- -------------------
Assets June December 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
========= ========= ========= ========= ========= =========
</Table>
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:
<Table>
<Caption>
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
============ ============
<Caption>
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 total deferred tax liabilities, deferred tax assets, and deferred
tax asset valuation allowances at June 30, 2006 (unaudited) and December
31, 2005 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
============ ============
<Caption>
The reconciliation of income tax computed at statutory rates of income tax
benefits is as follows:
Expense 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
============ ============
</Table>
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 $7,435 at the expiration of the
lease. The space the Company is leasing is sufficiently large enough to
accommodate all of its administrative needs.
<Table>
<Caption>
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
============
</Table>
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, 2006 and the year ended December
31, 2005 are as follows:
<Table>
<Caption>
June 30, December 31,
2006 2005
------------ ------------
(unaudited)
Customer A 24% 21%
Customer B 12% 10%
</Table
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
<Table>
<Caption>
June 30, December 31,
2006 2005
------------ ------------
Accrued liabilities consist 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
============ ============
</Table>
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:
<Table>
<Caption>
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
============ ============
</Table>
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:
<Table>
<Caption>
2006
------------
Risk-free interest rate 4.0%
Dividend yield 0%
Volatility 71%
Average expected term (years to exercise date) 1/2
</Table>
Employee stock options outstanding and exercisable under this plan as of
June 30, 2006 are:
<Table>
<Caption>
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
</Table>
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)
<Table>
<Caption>
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
============ ============
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 and
year ended December 31, 2005. 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:
</Table>
<Table>
<Caption>
June 30, 2006
-------------
Risk-free interest rate 4.0%
Dividend yield 0%
Volatility (71%)
Average expected term (years to exercise date) 1/2
</Table>
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:
<Table>
<Caption>
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
</Table>
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