UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549   
 

FORM 10-Q  
 

 
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended September 30, 2017
March 31, 2018

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Transition Period From ________ to _________

Commission File Number 000-50009

PACIFIC HEALTH CARE ORGANIZATION, INC.
  (Exact name of registrant as specified in its charter)
  
Utah
87-0285238
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer I.D. No.)
  
1201 Dove Street, Suite 300 
Newport Beach, California
92660
(Address of principal executive offices)(Zip Code)

(949) 721-8272
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for any shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒   No ☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)   Yes ☒   No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ☐  
Accelerated filer ☐
Non-accelerated filer (Do not check if a smaller reporting company) ☐
Smaller reporting company ☒
Emerging growth company ☐
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)     Yes ☐    No ☒

As of November 10, 2017,May 14, 2018, the registrant had 800,0003,200,000 shares of common stock, par value $0.001, issued and outstanding.
 


 PACIFIC HEALTH CARE ORGANIZATION, INC.
FORM 10-Q
TABLE OF CONTENTS

 
 Page
PART I — FINANCIAL INFORMATION 
  
Item 1.  Condensed Consolidated Financial Statements
 
   
 
(Unaudited) Balance Sheets as of September 30, 2017March 31, 2018 and December 31, 20162017
3
   
 
(Unaudited) Statements of Operations for the Three and Nine Months Ended September 30,March 31, 2018 and 2017 and 2016
4
   
 
(Unaudited) Statements of Cash Flows for the NineThree Months Ended September 30,March 31, 2018 and 2017 and 2016
5
   
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
6
  
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
89
  
Item 3.  Quantitative and Qualitative Disclosure about Market Risk
1915
  
Item 4.  Controls and Procedures
1915
  
PART II — OTHER INFORMATION 
  
Item 1A.  Risk Factors
2016
Item 5.  Other Events
16
  
Item 6.  Exhibits
2017
  
Signatures
2118
 
PART I.   FINANCIAL INFORMATION
 
Item 1.          Financial Information
 
Pacific Health Care Organization, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
  
ASSETS      ASSETS 
 March 31,  December 31, 
 
September 30,
2017
  
December 31,
2016
  2018  2017 
Current Assets            
Cash $5,613,412  $5,005,617  $6,705,681  $5,815,071 
Accounts receivable, net of allowance of $60,150 and $64,150  985,787   849,648 
Deferred tax asset  11,661   11,661 
Accounts receivable, net of allowance of $60,150 and $60,150  663,323   1,041,242 
Deferred tax assets  43,670   43,670 
Prepaid expenses  142,950   136,862   170,657   166,782 
Total current assets  6,753,810   6,003,788   7,583,331   7,066,765 
                
Property and Equipment, net                
Computer equipment  363,402   349,955   366,616   363,627 
Furniture and fixtures  212,823   206,785   209,778   209,779 
Office equipment  9,556   15,595   15,595   15,595 
Total property and equipment  585,781   572,335   591,989   589,001 
Less: accumulated depreciation  (405,154)  (346,295)
Less: accumulated depreciation and amortization  (438,368)  (422,024)
Net property and equipment  180,627   226,040   153,621   166,977 
        
Other Assets  26,788   26,788 
Other assets  26,788   26,788 
Total assets $6,961,225  $6,256,616  $7,763,740  $7,260,530 
                
LIABILITIES AND STOCKHOLDERS’ EQUITY        LIABILITIES AND STOCKHOLDERS’ EQUITY 
   
Current Liabilities        Current Liabilities 
Accounts payable $62,924  $101,294  $23,913  $71,138 
Accrued expenses  278,903   253,367   250,793   255,205 
Income tax payable  237,691   81,715 
Dividends payable  56,923   56,923 
Unearned revenue  38,689   38,357 
Deferred rent expense  39,358   17,485   34,072   35,214 
Income tax payable  21,115   31,226 
Dividend payable  56,923   56,923 
Unearned revenue  37,763   38,748 
Total current liabilities  496,986   499,043   642,081   538,552 
                
Total liabilities  496,986   499,043 
Total Liabilities  642,081   538,552 
                
Commitments and Contingencies  -   -   -   - 
                
Stockholders’ Equity         
Preferred stock, 5,000,000 shares authorized at $0.001 par value of
which 10,000 shares designated as Series A preferred and 1,000 shares
issued and outstanding at September 30, 2017 and December 31, 2016
  1   1 
Common stock, $0.001 par value: 50,000,000 shares authorized; 800,000 shares issued and
outstanding at September 30, 2017 and December 31, 2016
  800   800 
Shareholder’s Equity        
Preferred stock; 5,000,000 shares authorized at $0.001 par value of which 10,000 shares
designated as Series A preferred and 4,000 shares issued and outstanding at March 31, 2018
and December 31, 2017.
  4   4 
Common stock, $0.001 par value, 200,000,000 shares authorized,
3,200,000 shares issued and outstanding
  3,200   3,200 
Additional paid-in capital  428,072   428,072   1,237,348   1,237,348 
Deferred stock compensation  (811,679)  (811,679)
Retained earnings  6,035,366   5,328,700   6,692,786   6,293,105 
Total stockholders’ equity  6,464,239   5,757,573   7,121,659   6,721,978 
        
Total liabilities and stockholders’ equity $6,961,225  $6,256,616  $7,763,740  $7,260,530 
 
The accompanying notes are an integral part of these condensed consolidated financial statementsstatements. 
3

Pacific Health Care Organization, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)

 
For three months ended
September 30,
  
For nine months ended
September 30,
  
For three months ended
March 31,
 
 2017  2016  2017  2016  2018  2017 
            
Revenues            
Revenues:      
HCO fees $377,923  $276,951  $1,041,328  $965,768  $399,442  $302,569 
MPN fees  142,257   146,836   427,228   436,893   134,644   138,281 
NCM fees  582,569   587,236 
UR fees  277,886   221,176   788,229   596,205   287,021   237,045 
MBR fees  147,094   187,829   481,352   517,893   114,039   156,778 
NCM fees  582,544   499,118   1,824,121   1,176,447 
Other  73,203   111,686   255,542   309,260   65,594   119,347 
Total revenues  1,600,907   1,443,596   4,817,800   4,002,466   1,583,309   1,541,256 
                        
Expenses                
Depreciation and amortization  19,462   20,925   58,859   63,247 
Expenses:        
Depreciation  16,344   19,827 
Bad debt provision  15,750   4,500   30,500   13,500   -   (3,250)
Consulting fees  90,079   75,228   246,073   265,296   78,814   77,260 
Salaries and wages  547,963   574,100   1,734,321   1,717,148   491,478   588,657 
Professional fees  109,064   82,105   308,295   224,368   77,470   82,084 
Insurance  79,489   81,452   257,495   243,307   67,029   87,275 
Outsource service fees  146,287   113,017   404,538   288,225��  95,881   112,748 
Data maintenance  12,160   30,160   71,261   113,175   32,431   34,619 
General and administrative  162,164   157,894   495,474   475,230   168,205   161,388 
Total expenses  1,182,418   1,139,381   3,606,816   3,403,496   1,027,652   1,160,608 
                        
Income from operations  418,489   304,215   1,210,984   598,970   555,657   380,648 
                        
Other expense  -   - 
Total other expense  -   - 
        
Income before taxes  418,489   304,215   1,210,984   598,970   555,657   380,648 
Income tax provision  174,560   126,882   504,318   249,529   (155,976)  (158,391)
                        
Net income $243,929  $177,333  $706,666  $349,441  $399,681  $222,257 
                        
Basic and fully diluted earnings per share:                
Basic earnings per share:        
Earnings per share amount $.30  $.22  $.88  $.44  $0.12  $0.07 
Weighted average common shares outstanding  800,000   800,000   800,000   800,000 
Basic common shares outstanding  3,200,000   3,200,000 
        
Fully diluted earnings per share:        
Earnings per share amount $0.11  $0.07 
Fully diluted common shares outstanding  3,544,000   3,204,000 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
4

Pacific Health Care Organization, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
Nine Months Ended
September 30,
  
Three Months Ended
March 31,
 
 2017  2016  2018  2017 
Cash flows from operating activities:            
Net income $706,666  $349,441  $399,681  $222,257 
Adjustments to reconcile net income to net cash from operations:        
Depreciation and amortization  58,859   63,247 
Changes in operating assets and liabilities:        
(Decrease) increase in bad debt provision  (4,000)  12,260 
(Increase) decrease in accounts receivable  (132,139)  303,051 
Adjustments to reconcile net income to net cash:        
Increase in depreciation and amortization  16,344   19,827 
Changes in operating assets and liabilities        
(Decrease) in bad debt provision  -   (3,250)
Decrease (increase) in accounts receivable  377,919   (286,412)
(Increase) in prepaid expenses  (6,088)  (58,530)  (3,875)  (5,692)
Decrease in prepaid income tax  -   238,805 
(Decrease) in accounts payable  (38,370)  (22,914)  (47,225)  (53,418)
Increase in deferred rent expense  21,873   10,131 
Increase in accrued expenses  25,536   111,343 
(Decrease) increase in income tax payable  (10,111)  10,424 
(Decrease) in unearned revenue  (985)  (4,692)
Decrease in deferred compensation  -   37,124 
Net cash provided from operating activities  621,241   1,049,690 
(Decrease) increase in deferred rent expense  (1,142)  469 
(Decrease) increase in accrued expenses  (4,412)  35,854 
Increase in income tax payable  155,976   158,391 
Increase (decrease) in unearned revenue  332   (932)
Net cash provided in operating activities  893,598   87,094 
                
Cash flows from investing activities:                 
Purchase of computer equipment, furniture and office equipment  (13,446)  (33,556)
Purchase of furniture and office equipment  (2,988)  (5,754)
Net cash used in investing activities  (13,446)  (33,556)  (2,988)  (5,754)
                
Cash flows from financing activities:                
Issuance of cash dividend  -   (2,063)
Net cash used in financing activities  -   (2,063)  -   - 
Increase in cash  890,610   81,340 
                
Increase in cash  607,795   1,014,071 
Cash at beginning of period  5,005,617   3,834,924   5,815,071   5,005,617 
Cash at end of period $5,613,412  $4,848,995  $6,705,681  $5,086,957 
                
Supplemental cash flow information                
Cash paid for:                
Interest $-  $-  $-  $- 
Income taxes paid $514,429  $300  $-  $- 
 


The accompanying notes are an integral part of these condensed consolidated financial statements.


5
Pacific Health Care Organization, Inc.
Notes to Condensed Consolidated Financial Statements
For the NineThree Months Ended September 30, 2017
(Unaudited)March 31, 2018
 

NOTE 1 - BASIS OF FINANCIAL STATEMENT PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”) and in accordance with accounting principles generally accepted in the United States (“GAAP”).  Certain information and footnote disclosures normally included in consolidated financial statements have been condensed or omitted in accordance with GAAP rules and regulations.  The information furnished in these interim condensed consolidated financial statements includes normal recurring adjustments and reflects all adjustments, which, in the opinion of management, are necessary for a fair presentation of such financial statements.  The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect both the recorded values of assets and liabilities at the date of the condensed consolidated financial statements and the revenues recognized and expenses incurred during the reporting period. These estimates and assumptions affect the Company’s recognition of deferred expenses, bad debts, income taxes, the carrying value of its long-lived assets and its provision for certain contingencies. The reasonableness of these estimates and assumptions is evaluated continually based on a combination of historical information and other information that comes to the Company’s attention that may vary its outlook for the future. While management believes the disclosures and information presented are adequate to make the information not misleading, it is suggested that these interim condensed consolidated financial statements be read in conjunction with the Company’s audited financial statements and notes thereto included in its annual report on Form 10-K for the year ended December 31, 2016.2017.  Operating results for the ninethree months ended September 30, 2017,March 31, 2018, are not necessarily indicative of the results to be expected for the year ending December 31, 2017.2018.

Principles of Consolidation — The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.  Intercompany transactions and balances have been eliminated in consolidation.

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

Revenue Recognition — In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” Either a retrospective or cumulative effect transition method, referred to as the modified retrospective method, is permitted.  The Company adopted Topic 606 on January 1, 2018, using the modified retrospective method.  The adoption of Topic 606 had no material impact on the Company’s interim financial statements.

The core principle underlying Topic 606 is that the Company will recognize revenue to represent the transfer of goods and services to customers in an amount that reflects the consideration to which the Company expects to be entitled in such exchange.  This will require the Company to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer.

The ASU requires the use of a new five-step model to recognize revenue from customer contracts.  The five-step model requires that the Company (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies the performance obligation.  The application of the five-step model to revenue streams compared to the prior guidance did not result in significant changes in the way the Company records its revenue.

In general, the Company recognizes revenue 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) collectability is reasonably assured.  Revenues are generated as services are provided to the customer based on the sales price agreed and collected.  The Company recognizes revenue as the time is worked or as units of production are completed, which is when the revenue is earned and realized.  Labor costs are recognized as the costs are incurred.

The Company derives its revenue from the sale of Managed Care Services, Review Servicesmanaged care, bill review and Case Management Services.nurse case management services.  These services are billed individually as separate components to our customers.

These fees include monthly administration fees, claim network fees, legal support fees, Medicare set asideMedicare-set-aside fees, lien service fees, workers’ compensation carve-outs, flat rate fees or hourly fees depending on the agreement with the client.  Such revenue is recognized at the end of each month for which services are performed.

Management reviews each agreement in accordance with the provisions
6
The Company enters into in such agreements consist ofarrangements for bundled managed care which includes various units of accounting such as network solutions and patient management, including managed care. Such elements are considered separate units of accounting due to each element having value to the customer on a stand-alone basis and are billed separately.  The selling price for each unit of accounting is determined using the contract price.  When the Company’s customers purchase several products the pricing of the products sold is generally the same as if the products were sold on an individual basis.  Revenue is recognized as the work is performed in accordance with the Company’s customer contracts.  Based upon the nature of the Company’s products, bundled managed care elements are generally delivered in the same accounting period.  The Company recognizes revenue for patient management services ratably over the life of the customer contract.  Based upon prior experience in managed care, the Company estimates the deferral amount from when the customer’s claim is received to when the customer contract expires.   Advance payments from subscribers and billings made in advance are recorded on the balance sheet as deferred revenue. 

6

Accounts Receivables and Bad Debt Allowance – In the normal course of business the Company 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.  A considerable amount of judgment is required in assessing the realization of these receivables including the current creditworthiness of each customer and related aging of the past-due balances, including any billing disputes.  In order to assess the collectability of these receivables, the Company performs ongoing credit evaluations of its customers’ financial condition. Through these evaluations, the Company may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit rating or bankruptcy.  The allowance for doubtful accounts is based on the best information available to the Company and is reevaluated and adjusted as additional information is received.  We evaluate the allowance based on historical write-off experience, the size of the individual customer balances, past-due amounts and the overall national economy.  At September 30, 2017March 31, 2018 and December 31, 2016,2017, our bad debt reserves ofwere $60,150 and $64,150, respectively, wasas a general reserve for certain balances over 90 days past due and for accounts that are potentially uncollectible.

The percentages of the amounts due from major customers to total accounts receivable as of September 30,March 31, 2018 and December 31, 2017 and September 30, 2016, are as follows:
 
 9/30/2017  9/30/2016  3/31/2018  12/31/2017 
Customer A  9%  18%  27%  35%
Customer B  3%  10%  0%  13%
Customer C  -%  12%  11%  5%
Customer D  1%  10%
Customer E  14%  11%
Customer F  32%  -%

Significant Customers - We provide services to insurers, third party administrators, self-administered employers, municipalities and other industries.  We are able to provide our full range of services to virtually any size employer in the state of California.  We are also able to provide UR, MBR and NCM services outside the state of California. 

During the period ended September 30,March 31, 2018 and 2017, and 2016, we had three and fourtwo customers respectively, that accounted for more than 10% of our total sales.  The following table sets forth details regarding the percentage of total sales attributable to our significant customers in the past two years:

 9/30/2017 9/30/2016  3/31/2018  3/31/2017 
Customer A  20% 0%  32%  18%
Customer B 13% 15%  11%  7%
Customer C 11% 10%  6%  13%
Customer D 7% 13%
Customer E 7% 10%


NOTE 2 - SUBSEQUENT EVENTS

In accordance with ASC 855-10 Company management reviewed all material events through the date of issuance and other than disclosed in this Note 2 there are no material subsequent events to report.

7
As disclosed in the Definitive Information Statement the Company filed with the Commission on March 6, 2018, and mailed to its shareholders by March 14, 2018, during the first quarter of 2018 the Company’s board of directors and majority shareholder approved a four-shares-for-one-share forward split of our outstanding common stock (the “Forward Split”).  The number of authorized shares of the Company’s common stock also increased at the same ratio, from 50,000,000 shares to 200,000,000 shares.  The number of authorized shares of Company preferred stock did not increase.  The Forward Split took effect on April 5, 2018.  As a result of the Forward Split, the number of outstanding shares of Company common stock increased from 800,000 shares to 3,200,000 shares and, consistent with the Articles of Incorporation of the Company, the number of outstanding shares of Series A Preferred Stock increased from 1,000 to 4,000.  As a result of the Forward Split, the number of shares available for issuance under the Company’s 2002 Stock Option Plan (the “2002 Plan”) and the Company’s 2005 Stock Option Plan (the “2005 Plan”), as well as all awards outstanding under those plans also increased at the same four-shares-for-one-share ratio, and the exercise prices of stock options outstanding at the time of the Forward Split were adjusted to reflect the Forward Split.  On April 6, 2018, the day immediately following the effective date of the Forward Split, the Company’s 2018 Equity Incentive Plan (the “2018 Plan”) became effective.
On May 14, 2018, the Company entered into Stock Option Cancellation Agreements (the “Cancellation Agreements”) with certain executive officers, directors and other senior level employees/consultants of the Company, pursuant to which such individuals (the “Optionholder”) agreed to the surrender and cancellation of certain previously granted stock options (the “Cancelled Options”) under the 2002 Plan and the 2005 Plan to purchase 85,000 pre-Forward Split shares (340,000 post-Forward Split shares) of the Company’s common stock.  Under the terms of the Cancellation Agreements, each Optionholder and the Company acknowledged and agreed that the surrender and cancellation of the Cancelled Options was without any expectation on the part of the Optionholder to receive, and without any obligation on the Company to pay or grant, any cash, equity awards or other consideration presently or in the future with respect to the Cancelled Options.  Following the surrender and cancellation of the Cancelled Options there were no awards outstanding under the 2002 Plan or the 2005 Plan and pursuant to the provisions of the 2002 Plan and the 2005 Plan, the Company’s board of directors terminated the 2002 Plan and the 2005 Plan.



8

Item 2.          Management’s Discussion and Analysis of Financial Statements and Results of Operations

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are based on our management’s beliefs and assumptions and on information currently available to them.  For this purpose, any statement contained in this report that is not a statement of historical fact may be deemed to be forward-looking, including statements about our revenue, spending, cash flow, products, new customer acquisitions, trends, actions, intentions, plans, strategies and objectives.  Without limiting the foregoing, words such as “may,” “hope,” “will,” “expect,” “believe,” “anticipate,” “estimate,” “project,” “intend,” “budget,” “plan,” “forecast,” “predict,” “could,” “should,” or “continue” or comparable terminology are intended to identify forward-looking statements.  These statements by their nature involve substantial riskrisks and uncertainty, and actual results may differ materially depending on a variety of factors, many of which are not within our control.  These factors include but are not limited to economic conditions generally and in the industry in which we and our customers participate; cost reduction efforts by our existing and prospective customers; competition within our industry, including competition from much larger competitors; business combinations; legislative requirements or changes which could render our services less competitive or obsolete; our failure to successfully develop new services, and/or products or to anticipate current or prospective customers’ needs; our ability to retain existing customers and to attract new customers; price increases; employee limitations; and delays, reductions, or cancellations of contracts we have previously entered.

Forward-looking statements are predictions and not guarantees of future performance or events.  Forward-looking statements are based on current industry, financial and economic information, which we have assessed but which, by its nature, is dynamic and subject to rapid and possibly abrupt changes.  Our actual results could differ materially from those stated or implied by such forward-looking statements due to risks and uncertainties associated with our business.  We hereby qualify all our forward-looking statements by these cautionary statements. These forward-looking statements speak only as of their dates and should not be relied upon.  We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise (other than pursuant to reporting obligations imposed on registrants pursuant to the Exchange Act) to reflect subsequent events or circumstances.

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes contained elsewhere in this report and in our other filings with the Commission.

Throughout this quarterly report on Form 10-Q, unless the context indicates otherwise, the terms, “we,” “us,” “our” or “the Company” refer to Pacific Health Care Organization, Inc., (“PHCO”) and our wholly-owned subsidiaries Medex Healthcare, Inc. (“Medex”), Industrial Resolutions Coalition, Inc. (“IRC”), Medex Managed Care, Inc. (“MMC”), Medex Medical Management, Inc. (“MMM”) and Medex Legal Support, Inc., (“MLS”).

Overview

We are workers’ compensation cost containment specialists.  Our business objective is to deliver value to our clients that reduces their workers’ compensation related medical claims expense in a manner that will assure that injured employees receive high quality healthcare that allows them to recover from injury and return to gainful employment without undue delay.  According to studies conducted by auditing bodies on behalf of the California Division of Workers’ Compensation, (“DWC”) the two most significant cost drivers for workers’ compensation are claims frequency and medical treatment costs.
8


Our core service focuses on the reduction of medical treatment costs by enabling our client/employers to share the control over the medical treatment process.  This control is obtained by participation in one of our medical treatment networks.  We hold several valuable government-issued licenses to operate medical treatment networks.  Through Medex we hold two of the total of nine licenses issued by the State of California to establish and manage a Health Care Organization (“HCO”) within the state of California. We also hold approvals issued by the State of California to act as a Medical Provider Network (“MPN”).  Our HCO and MPN programs provide our client/employers with provider networks within which the client/employer has some ability to direct the administration of the claim.  This is designed to decrease the incidence of fraudulent claims and disability awards and ensure injured employees receive the necessary back-to-work rehabilitation and training they need.  We also offer a Nurse Case Management program that keeps medical treatment claims progressing to a resolution and assures treatment plans are aligned from a medical perspective.  Nurse oversight is a collaborative process that assesses plans, implements, coordinates, monitors and evaluates the options and services required to meet an injured worker’s health needs.needs

9
Our clients include self-administered employers, insurers, third party administrators, municipalities and others.  Our principal clients are located in the State of California where the high cost of workers’ compensation insurance is a critical problem for employers.  Our networks have contracted with approximately 3,900 individual medical providers and clinics, as well as hospitals, pharmacies, rehabilitation centers and other ancillary services enabling our networks to provide comprehensive medical services throughout California.  Our provider networks are composed of experts in treating worker injuries. 

Beyond the core services we provide to facilitate client/employeremployers’ involvement in employee medical treatment claims administration and patient treatment options, we also provide to our HCO and MPN clients a number ofseveral claims-related services that bring efficiencies to claim processing and management that further reduce the overall burden of workers’ compensation claims resolution.  These services include various back office type functions that assure cost efficiency and accuracy in claim processing, claim reimbursement and claim dispute resolution.

Recent Developments

MPN Enrollment Count
Changes to the MPN regulations in August 2014 eliminated the notice requirements to employees covered under an MPN program.  This change eliminated the need for our MPN clients to submit employee rosters for MPN notice mailings.  As a result, over the past several years, many of our MPN client/employers have stopped sending us employee rosters which we have historically used to determine employee/enrollee headcount information.  Enough of our MPN client/employers have stopped submitting to us such information that we can no longer accurately track the overall number of MPN participants.  Therefore, beginning in the first quarter 2017, we ceased tracking the overall number of MPN participants of all client/employers in our MPN program.
HCO Enrollment Count

 Historically, the HCO employee/enrollee headcount was directly related to the amount of revenue generated by HCO clients.  We were, however, at risk of losing several clients under this pricing model.  To remain competitive in the marketplace, we developed a new pricing model, which includes both a fixed monthly flat rate pricing option that is negotiated per client and/or a per claim incurred pricing model.  Under the per claim model, our client/employers do not incur this cost as an out of pocket cost, but rather apply the cost directly to the insured or self-insured claim.  As a result of moving from our fixed fee per number of employee/enrollees per customer model, beginning in the first quarter 2017 we have discontinued reporting the direct relationship between the number of HCO employee/enrollees and total HCO revenues because that historical relationship has become distorted as a result of the implementation of our new pricing model. This change in our pricing model had no significant impact to our current level of HCO revenues and we expect the same level of impact over the remaining months of 2017.
9

Results of Operations

Comparison of the three months ended September 30, 2017 and 2016

The following represents selected components of our consolidated results of operations, for the three-month periodsperiod ended September 30,March 31, 2018 and 2017, and 2016, respectively, together with changes from period-to-period:

 For three months ended March 31, 
 For three months ended September 30,        2018  2017  Amount Change  % Change 
 2017  2016  Amount Change  % Change       
Revenues:                        
HCO fees $377,923  $276,951  $100,972   36% $399,442  $302,569  $96,873   32%
MPN fees  142,257   146,836   (4,579)  (3%)  134,644   138,281   (3,637)  (3%)
NCM fees  582,544   499,118   83,426   17%  582,569   587,236   (4,667)  (1%)
UR fees  277,886   221,176   56,710   26%  287,021   237,045   49,976   21%
MBR fees  147,094   187,829   (40,735)  (22%)  114,039   156,778   (42,739)  (27%)
Other  73,203   111,686   (38,483)  (34%)  65,594   119,347   (53,753)  (45%)
Total revenues  1,600,907   1,443,596   157,311   11%  1,583,309   1,541,256   42,053   3%
                                
Expense:                                
Depreciation and amortization  19,462   20,925   (1,463)  (7%)
Depreciation  16,344   19,827   (3,483)  (18%)
Bad debt provision  15,750   4,500   11,250   250%  -   (3,250)  3,250   100%
Consulting fees  90,079   75,228   14,851   20%  78,814   77,260   1,554   2%
Salaries and wages  547,963   574,100   (26,137)  (5%)  491,478   588,657   (97,179)  (17%)
Professional fees  109,064   82,105   26,959   33%  77,470   82,084   (4,614)  (6%)
Insurance  79,489   81,452   (1,963)  (2%)  67,029   87,275   (20,246)  (23%)
Outsource service fees  146,287   113,017   33,270   29%  95,881   112,748   (16,867)  (15%)
Data maintenance  12,160   30,160   (18,000)  (60%)  32,431   34,619   (21,188)  (6%)
General and administrative  162,164   157,894   4,270   3%  168,205   161,388   6,817   4%
Total expenses  1,182,418   1,139,381   43,037   4%  1,027,652   1,160,608   (132,956)  (11%)
                                
Income from operations  418,489   304,215   114,274   38%  555,657   380,648   175,009   46%
                                
                
Income before taxes  418,489   304,215   114,274   38%  555,657   380,648   175,009   46%
Income tax provision  174,560   126,882   47,678   38%  155,976   158,391   (2,415)  (2%)
                                
Net income $243,929  $177,333  $66,596   38% $399,681  $222,257  $177,424   80%

Revenue

Total revenues during the three-month period ended September 30, 2017,March 31, 2018, increased 11%3% to 1,600,907$1,583,309 compared to $1,443,596$1,541,256 during the three-month period ended September 30, 2016.March 31, 2017.

10
During the thirdfirst quarter 2017,2018, HCO nurse case management, and utilization reviewUR fees increased 36%, 17%,32% and 26%21%, respectively, while MPN, Medical Bill ReviewMBR, NCM and other feesrevenue decreased by 3%, 22%27%, 1% and 34%45%, respectively.  Other revenues consisted of revenues derived primarily from network claims repricing services, lien representation services, legal support services, workers’ compensation carve out revenues and Medicare set asideMedicare-set-aside revenues.

HCO fees

During the three-month periods ended September 30,March 31, 2018 and 2017, and 2016, HCO fee revenues were $377,923$399,442 and $276,951,$302,569 respectively.  The 36%32% increase in HCO revenue was primarily attributable to adding two new customers, increased revenues derived from one major client during the third quarter of 2017, coupled with increased fees primarily from three other existing customers.
10
employee enrollment and rate increases in program administration services.

MPN fees

MPN fee revenue for the three-month periods ended September 30,March 31, 2018 and 2017, was $134,644 and 2016, were $142,257 and $146,836,$138,281, respectively, a decrease of 3%, resulting mainly from lower revenues from one existing customer.customer phasing out its business through bankruptcy. 

NCM fees

During the three months ended September 30,March 31, 2018 and 2017, and 2016, nurse case management revenue was $582,544$582,569 and $499,118,$587,236, respectively.  The increasedecrease in nurse case management revenue of $83,426$4,667 was primarily from increased revenues from five existing customersthe result of a net decrease in case management activity during the first quarter of 2018 when compared to the same period in 2016.  There is no assurance that nurse case management revenue will continue to grow at the rate realized in the quarter ended September 30, 2017 for the remaining months of fiscal 2017.

UR fees

During the three-month periods ended September 30,March 31, 2018 and 2017, and 2016, utilization review revenue was $277,886$287,021 and $221,176$237,045, respectively.  The increase of $56,710$49,976 in the 20172018 period was primarily attributable to addingincreased utilization reviews from two new clients in the fourth quarter of fiscal 2016 and increases in revenues from other existingmajor customers. Utilization review can provide a safeguard against unnecessary and inappropriate medical treatment from the perspective of medical necessity, quality of care, appropriateness of decision-making, etc.   Through our skilled staff and automated review system, we are able to deliver utilization review services that cut overhead costs for the self-insured clients, insurance companies and the public entities we service. 

MBR fees

During the three-month period ended September 30, 2017,March 31, 2018, medical bill review revenue decreased $40,735$42,739 to $147,094$114,039 when compared to the same period a year earlier.  This decrease was mainly caused by processing fewer hospital bills from existing customers.terminations of three customers during fiscal 2017.  Medical bill review involves analyzing medical provider services and equipment billing to ascertain proper reimbursement.  Such services include, but are not limited to, coding review and rebundling, confirming that the services are customary and reasonable, fee schedule compliance, out-of-network bill review, pharmacy review, and preferred provider organization repricing arrangements.  These services can result in significant network savings. 

Other

Other fees consist of revenue derived from network access and claims repricing, lien representation, legal support services, Medicare set asideMedicare-set-aside and worker’sworkers’ compensation carve-outcarve-outs services.  Other fee revenue for three-month periods ended September 30,March 31, 2018 and 2017, was $65,594 and 2016, were $73,203 and $111,686$119,347, respectively. The decrease of $38,483$53,753 was mainlyprimarily the result of decreased network access fees from one customer having realized lower levels of savings from using our PPO network. We expect this downward trend for this customer to continue fornetwork access revenues and the remainderloss of 2017.one major customer.

Expenses
 
Total expenses for the three months ended September 30,March 31, 2018 and 2017, were $1,027,652 and 2016, were $1,182,418 and $1,139,381,$1,160,608, respectively.  The increasedecrease of $43,037$132,956 was the result primarily of increases in bad debt provision, consulting fees, professional fees, outsource service fees, and general and administrative expense partially offset by decreases in depreciation and amortization,lower salaries and wages, professional fees, insurance expense and data maintenance expense.outsource service fees.

Depreciation

During the three-month period ended March 31, 2018, we recorded depreciation expense of $16,344 compared to $19,827 during the comparable 2017 period.  The decrease in depreciation was primarily attributable to certain fixed assets being fully depreciated during the last nine months of 2017 and the first quarter of 2018.

11

Depreciation and Amortization

During the three-month period ended September 30, 2017, we recorded depreciation and amortization expense of $19,462 compared to $20,925 during the comparable 2016 period.  The decrease in depreciation and amortization was primarily attributable to certain fixed assets being fully depreciated during the fourth quarter of 2016.

Bad Debt

During the three-month period ended September 30, 2017,March 31, 2018, we did not record any bad debt provision increased by $11,250 compared towhich resulted in our allowance for bad debt allowance remaining at $60,150 for the three-month period ended September 30, 2016.  This increase was primarily the result of recording additional bad debt provision for one existing uncollectable account.March 31, 2018 and 2017.

Consulting Fees

During the three months ended September 30, 2017,March 31, 2018, consulting fees increased to $90,079$78,814 from $75,228$77,260 during the three months ended September 30, 2016.March 31, 2017.   This increase of $1,554 was primarily the result on hiring aof an increase in fees paid to one consultant as Directorduring the first quarter of Medical Management in August 2017.2018.

Salaries and Wages

During the three-month period ended September 30, 2017,March 31, 2018, salaries and wages decreased 5%17% to $547,963$491,478 compared to $574,100$588,657 during the same period in 2016. The2017.  This decrease in salaries and wages of $26,137 was primarily the result of lower deferred compensation expense, payroll related taxes, commission expensethe net termination of six employees from April 2017 to March 2018. We employed 33 and lower levels39 full-time employees as of other salariesMarch 31, 2018 and wages in Medex and PHCO.2017, respectively.

Professional Fees

For the three months ended September 30, 2017,March 31, 2018, we incurred professional fees of $109,064$77,470, compared to $82,105$82,084 during the three months ended September 30, 2016.March 31, 2017.   The $26,959 increase$4,614 decrease in professional fees was primarilymainly the result of higher accounting expense, legal expenses, medical consultant fees anddecreased professional fees paid for nurse case management services resulting from increased numbers of cases processed.partially offset by fee increases to our medical consultant.

Insurance

During the three-month period ended September 30, 2017,March 31, 2018, we incurred insurance expenses of $79,489,$67,029, a 2%23% decrease over the same three-month period in 2016.  This2017.  The decrease in insurance expense was primarily attributableattributed to lower group healthworkers compensation and director and officer’s insurance premiums resulting from a decreased numberduring the first three months of employees when2018 compared to the same period in 2016.2017. We do not expect current insurance fees to moderately increase significantly over the remaining months of 2017.2018.

Outsource Service Fees

Outsource service fees consist of costs incurred by our subsidiaries in outsourcing utilization review, medical bill review Medicare set aside services and fieldnurse case management feesservices, and typically tends to increase and decrease in correspondence with increases and decreases in demand for those services.  We incurred $146,287$95,881 and $113,017$112,748 in outsource service fees during the three-month periods ended September 30,March 2018 and 2017, and 2016, respectively.  The increasedecrease of $33,270$16,867 was primarily the result of increasesdecreases in outsource services required for utilization review, Medicare set aside servicesMedicare-set-aside, NCM and nurse case management.MBR, partially offset by increases in UR.  We anticipate our outsource service fees will continue to move in correspondence with the level of utilization review, medical bill review and certain nurse case management services we provide in the future.  
12


Data Maintenance

During the three-month periodsperiod ended September 30,March 31, 2018 and 2017, and 2016, data maintenance fees were $12,160$32,431 and $30,160,$34,619, respectively.  The decrease of $18,000$2,188 was primarily the result of recording lower levels of customer notificationsnotification fees realized for new and existing customersassociated with a customer’s annual renewal during the three-month period ended September 30, 2017March 31, 2018 when compared to the same period in 2016.  Data maintenance fees tend to fluctuate from month to month depending on when new customers are enrolled and when the annual renewal of existing customer notification are due.2017.

General and Administrative
 
During the three-month period ended September 30, 2017,March 31, 2018, general and administrative expenses increased 3%4% to $162,164$168,205 when compared to the three-month period ended September 30, 2016.March 31, 2017.  This increase of $4,270$6,817 was primarily attributable to increases in auto expense, duestelephone, office rent IT enhancement, office rent and subscriptions, employment agency fees, IT enhancements, rental equipment, telephone expense and travel and entertainmentshareholders expense, partially offset by decreases in office rent expense, office supplies, postage expense, paid time off expensemiscellaneous general and miscellaneousadministrative expenses. We do not expect current levels of general and administrative expenses to materially increase during the remaining months of 2017.2018, providing revenues continue to also increase.

12
Income from Operations

As a result of the 11%3% increase in total revenue during the three-month period ended September 30, 2017, which was partially offset by the 4% increaseMarch 31, 2018, together with an 11% decrease in total expenses, during the same period, our income from operations increased by 38% during the three-month period ended September 30, 2017,46% when compared to the same period in 2016.quarter 2017. 

Income Tax Provision

Because weWe realized income before taxes of $418,489$555,657 and $304,215$380,648 during the three-month periods ended September 30,March 31, 2018 and 2017, respectively. As a result of Federal and 2016, respectively,State income tax reductions of approximately 13% we realized a $47,678,$2,415, or 38%2%, increasedecrease in our income tax provision. 

Net Income

During the three-month period ended September 30, 2017,March 31, 2018, total revenues of $1,600,907$1,583,309 was 11%3% higher when compared to the same period in 2016.2017.  This increase in total revenues was partially offset bywith a 4% increasedecrease in total expenses resultingof 11% resulted in a 38%46% increase in income from operations compared to the three months ended September 30, 2016.March 31, 2017.  Correspondingly, we realized net income of $243,929$399,681 for the three-month period ended September 30, 2017, also a 38%March 31, 2018, an 80% increase compared to the three-month period ended September 30, 2016.March 31, 2017. 

13

Comparison of nine months ended September 30, 2017 and 2016

The following represents selected components of our consolidated results of operations, for the nine-month periods ended September 30, 2017 and 2016, respectively, together with changes from period-to-period:

  For nine months ended September 30,       
  2017  2016  Amount Change  % Change 
Revenues:            
HCO fees $1,041,328  $965,768  $75,560   8%
MPN fees  427,228   436,893   (9,665)  (2%)
NCM fees  1,824,121   1,176,447   647,674   55%
UR fees  788,229   596,205   192,024   32%
MBR fees  481,352   517,893   (36,541)  (7%)
Other  255,542   309,260   (53,718)  (17%)
Total revenues  4,817,800   4,002,466   815,334   20%
                 
Expense:                
Depreciation and amortization  58,859   63,247   (4,388)  (7%)
Bad debt provision  30,500   13,500   17,000   126%
Consulting fees  246,073   265,296   (19,223)  (7%)
Salaries and wages  1,734,321   1,717,148   17,173   1%
Professional fees  308,295   224,368   83,927   37%
Insurance  257,495   243,307   14,188   6%
Outsource service fees  404,538   288,225   116,313   40%
Data maintenance  71,261   113,175   (41,914)  (37%)
General and administrative  495,474   475,230   20,244   4%
Total expenses  3,606,816   3,403,496   203,320   6%
                 
Income from operations  1,210,984   598,970   612,014   102%
                 
Income before taxes  1,210,984   598,970   612,014   102%
Income tax provision  504,318   249,529   254,789   102%
                 
 Net income $706,666  $349,441  $357,225   102%

Revenue

Total revenues during the nine-month period ended September 30, 2017, increased 20% to 4,817,800 compared to $4,002,466 during the nine-month period ended September 30, 2016.

During the first nine-months of 2017, HCO, nurse case management, and utilization review, increased 8%, 55% and 32% respectively, while MPN, MBR and other fees decreased by 2%, 7%, and 17%, respectively.  Other revenues consisted of revenues derived primarily from network claims repricing services, lien representation services, legal support services, workers’ compensation carve out revenues and Medicare set aside revenues.

HCO fees

During the nine-month periods ended September30, 2017 and 2016, HCO fee revenues were $1,041,328 and $965,768 respectively. The 8% increase in HCO revenue was primarily attributable to the addition of one major customer in January 2017, partially offset by lower revenues from several existing HCO customers when compared to the same period in 2016


MPN fees

MPN fee revenue for the nine-month periods ended September 30, 2017 and 2016, was $427,228 and $436,893 respectively, a decrease of 2%, resulting from lower revenues from one existing customer. 

NCM fees
During the nine-months ended September 30, 2017 and 2016, nurse case management revenue was $1,824,121 and $1,176,447, respectively.  The increase in nurse case management revenue of $647,674 was primarily the result of adding new customers during the third and fourth quarters of 2016, and increases in revenues from existing customers.  As a result of losing a significant customer in October 2017, we do not expect nurse case management revenue to increase at the rate realized during the nine months ended September 30, 2017, for the remainder of fiscal 2017.

UR fees

During the nine-month periods ended September 30, 2017 and 2016, utilization review revenue was $788,229 and $596,205, respectively.  The increase of $192,024 in the 2017 period was attributable to adding new clients in the third and fourth quarters of fiscal 2016.  Utilization review can provide a safeguard against unnecessary and inappropriate medical treatment from the perspective of medical necessity, quality of care, appropriateness of decision-making, etc.   Through our skilled staff and automated review system, we are able to deliver utilization review services that cut overhead costs for the self-insured clients, insurance companies and the public entities we service. 
MBR fees

During the nine-month period ended September 30, 2017, medical bill review revenue decreased $36,541 to $481,352 when compared to the same period a year earlier.  This 7% decrease was mainly caused by processing fewer hospital claims from existing customers.  Medical bill review involves analyzing medical provider services and equipment billing to ascertain proper reimbursement.  Such services include, but are not limited to, coding review and re-bundling, confirming that the services are customary and reasonable, fee schedule compliance, out-of-network bill review, pharmacy review, and preferred provider organization repricing arrangements.  These services can result in significant network savings. 

Other

Other fees consist of revenue derived from network access and claims repricing, lien representation, legal support services, Medicare set aside and worker’s compensation carve-outs services.  Other fee revenue for nine-month periods ended September 30, 2017 and 2016, was $255,542 and $309,260, respectively. The decrease of $53,718 was mainly the result of decreased network access fees from one customer having realized lower savings from using our PPO network. We expect this downward trend for this customer to continue for the remainder of 2017.

Expenses
Total expenses for the nine-months ended September 30, 2017 and 2016, were $3,606,816 and $3,403,496, respectively.  The increase of $203,320 was the result of increases in bad debt, salaries and wages, professional fees, insurance, outsource service fees, and general and administrative expense, partially offset by decreases in depreciation and amortization, consulting fees and data maintenance expense.

Depreciation and Amortization
During the nine-month period ended September 30, 2017, we recorded depreciation and amortization expense of $58,859 compared to $63,247 during the comparable 2016 period.  The decrease in depreciation and amortization was primarily attributable to certain fixed assets being fully depreciated during the fourth quarter of 2016.

Bad Debt

During the nine-month period ended September 30, 2017, bad debt provision increased by $17,000 compared to the nine-month period ended September 30, 2016.  This increase was primarily the result of additional provisions required for one potential uncollectable account.

Consulting Fees

During the nine-months ended September 30, 2017, consulting fees decreased to $246,073 from $265,296, when compared the nine months ended September 30, 2016.   This 7% decrease was mainly the result of a reduction in fees paid to two consultants commencing in June 2016 and converting a consultant to an employee in March 2016.
Salaries and Wages

During the nine-month period ended September 30, 2017, salaries and wages increased 1% to $1,734,321 compared to $1,717,148 during the same period in 2016.  This increase was primarily the result of additional staffing in nurse case management and higher levels of commissions, partially offset by salary reductions of 10% by several senior executives in June 2016.

Professional Fees

For the nine-months ended September 30, 2017, we incurred professional fees of $308,295 compared to $224,368 during the nine months ended September 30, 2016.   The $83,927 increase in professional fees was primarily the result of higher professional fees paid for nurse case management services resulting from increased numbers of cases processed.

Insurance

During the nine-month period ended September 30, 2017, we incurred insurance expenses of $257,495, a 6% increase over the same nine-month period in 2016.  The increase in insurance expense was primarily attributed to higher workers’ compensation premiums for our employees and directors’ and officers’ insurance premiums during the nine months period ended September 30, 2017 compared to the same period in 2016. We do not expect current insurance fees to increase significantly over the remaining months of 2017.

Outsource Service Fees

Outsource service fees consist of costs incurred by our subsidiaries in outsourcing utilization review, medical bill review, Medicare set aside services, nurse case management services, and typically tends to increase and decrease in correspondence with increases and decreases in demand for those services.  We incurred $404,538 and $288,225 in outsource service fees during the nine-month periods ended September 2017 and 2016, respectively.  The increase of $116,313 was primarily the result of increases in outsource services required for utilization review, Medicare set aside fees and field case management fees.  We anticipate our outsource service fees will continue to move in correspondence with the level of utilization review, medical bill review and certain nurse case management services we provide in the future.  


Data Maintenance

During the nine-month period ended September 30, 2017 and 2016, data maintenance fees were $71,261 and $113,175, respectively.  The decrease of $41,914 was primarily the result of recording notification fees associated with the addition of a major HCO customer in the first quarter 2016, with a lower level of notification fees recorded for this same customer during the nine-month period ended September 30, 2017.

General and Administrative
During the nine-month period ended September 30, 2017, general and administrative expenses increased 4% to $495,474 when compared to the nine-month period ended September 30, 2016.  This increase of $20,244 was primarily attributable to increases in dues and subscriptions, employment agency fees, IT enhancement, license and permits, telephone expense, rent expense, travel and entertainment expense and miscellaneous expense, partially offset by decreases in charitable contributions, auto expense, postage expense, office supplies and paid time off expense. We do not expect current levels of general and administrative expenses to materially increase during the remaining months of 2017.

Income from Operations

As a result of the 20% increase in total revenue during the nine-month period ended September 30, 2017, which was partially offset by the 6% increase in total expenses, our income from operations before taxes increased to $1,210,984, a 102% increase compared to the same period in 2016. 

Income Tax Provision

Because we realized income before taxes of $1,210,984 and $598,970 during the nine-month periods ended September 30, 2017 and 2016, respectively, we realized a $254,789 or 102%, increase in our income tax provision. 

Net Income

During the nine-month period ended September 30, 2017, total revenues of $4,817,800 was 20% higher when compared to the same period in 2016.  This increase in total revenues was partially offset by a 6% increase in total expenses, resulting in a 102% increase in income from operations.  Correspondingly, we realized net income of $706,666 for the nine-month period ended September 30, 2017, also a 102% increase compared to the nine-month period ended September 30, 2016. 

Liquidity and Capital Resources

As of September 30, 2017,March 31, 2018, we had cash on hand of $5,613,412$6,705,681 compared to $5,005,617$5,815,071 at December 31, 2016.2017.  The $607,795$890,610 increase was primarily the result of net cash provided by our operating activities, partially offset by cash used in investing activities.  Net cash provided by our operating activities was the result of realizing net income coupled with increases in accumulated depreciation accrued expenses, and deferred rent expense,amortization, income tax payable and unearned revenue and decreases in accounts receivable and partially offset by increases in prepaid expense and decreases in our bad debt, prepaid expense,accrued expenses, accounts payable income tax payable, unearned revenues and increases in our accounts receivable.deferred rent.  We used $13,446$2,988 in investing activities for purchases of computers, furniture and equipment.  Barring a significant downturn in the economy or the loss of major customers, we believe that cash on hand and anticipated revenues from operations will be sufficient to cover our operating expenses over the next twelve months.
17


We currently have planned certain capital expenditures during fiscal 20172018, to support potential new customers’ software requirements.expand our IT capabilities.  We do not expectbelieve we have adequate capital on hand to cover these software expenditures to be material.   Weand do not anticipate this will require us to seek outside sources of funding.  

We do, however, from timecontinue to time, investigate potential opportunities to expand our business either through the creation of new business lines or the acquisition of existing businesses.  We are taking stepsalso looking to look atexpand our business into the insurance industry during 2018, but have not identified any suitable merger or acquisition candidates to vertically grow our Company.  In October 2017, we announced that we had retained a west-coast based investment banking firm to assist us in identifying potential merger and acquisition opportunities, as well as, to explore sources of institutional source of financing.   We have not found any suitable candidateor opportunities at the current time.  We could use cash or stock of our Company or some combination of both in anyanticipate an expansion or acquisition.  An expansion or acquisition of this sort may require greater capital resources than we currently possess.  Should we need additional capital resources, we most likely wouldcould seek to obtain such through equitydebt and/or debtequity financing.  ThereWe do not currently possess an institutional source of financing and there is no assurance that we could be successful in obtaining equity or debt financing when needed on favorable terms, or at all.  We could also use shares of our capital stock as consideration for a business acquisition transaction.

CashCash Flow

During the ninethree months ended September 30, 2017,March 31, 2018, cash was primarily used to fund operations. We had a net increase in cash of $607,795$890,610 during the ninethree months ended September 30,March 31, 2018, compared to a net increase of $81,340 during the three months ended March 31, 2017.  See below for additional information.

For the nine months ended September  For the three months ended March 31, 
2017
(unaudited)
 
2016
(unaudited)
  
2018
(unaudited)
  
2017
(unaudited)
 
          
Net cash provided from operating activities $621,241  $1,049,690 
Net cash provided by operating activities $893,598  $87,094 
Net cash used in investing activities  (13,446)  (33,556)  (2,988)  (5,754)
Net cash used in financing activities  -   (2,063)  -   - 
                
Net increase in cash $607,795  $1,014,071  $890,610  $81,340 

During the ninethree months ended September 30,March 31, 2018 and 2017, and 2016, net cash provided by operating activities was $621,241$893,598 and $1,049,690,$87,094, respectively. As discussed herein, we realized net income of $706,666$399,681 during the ninethree months ended September 30, 2017,March 31, 2018, compared to net income of $349,441$222,257 during the ninethree months ended September 30, 2016.  March 31, 2017. The increase of $806,504 in cash flow from operating activities was primarily the result of increases in net income, accumulated depreciation and amortization, income tax payable, unearned revenue, and decreases in accounts receivable, partially offset by increases in prepaid expense and decreases in accounts payable, accrued expenses, and deferred rent expense.

Net cash used in investing activities was $13,446$2,988 and $33,556$5,754 during the nine-monththree-month periods ended September 30,March 31, 2018 and 2017, and 2016, respectively.  During the nine-month periods ended September 30, 2017 and 2016, netNet cash used in investing activities was used to purchase computer equipment,lower by $2,766 during the three-month period ended March 31, 2018, because of lower expenditures for computers, furniture, and office equipment.

Net cash used in financing activities during the nine-month periods ended September 30, 2017 and 2016 was $0 and $2,063, respectively, resulting from lower cash dividends paid.

Summary of Material Contractual Commitments

The following is a summary of our material contractual commitments as of September 30, 2017.March 31, 2018.

Payments Due By Period  Payments Due By Period 
Total Less than 1 year 1-3 years 3-5 years More than 5 years  Total  Less than 1 year  1-3 years  3-5 years  More than 5 years 
Operating Leases:                         
Operating Leases – Equipment(1) $56,857  $20,675  $36,182  $-  $-  $46,519  $20,675  $25,844  $-  $- 
Office Leases(2) $1,177,515   255,608   775,791   146,116   -  $1,031,400   255,608   775,792   -   - 
Total Operating Leases $1,234,372  $276,283  $811,973  $146,116  $-  $1,077,919  $276,283  $801,636  $-  $- 
 
(1)In March 2017, we entered a 39-month operating lease for an office copy machine with scanner with monthly payment at $1,723, commencing in April 2017.
(2)In July 2015, we entered a 79-month lease to lease approximately 9,439 square feet of office space that commenced in September 2015.  This office space serves as our principal executive offices, as well as, the principal offices of our operating subsidiaries.

Off-Balance Sheet Financing Arrangements

As of March 31, 2018, we had no off-balance sheet financing arrangements.

Inflation

We experience pricing pressures in the form of competitive prices.  We are also impacted by rising costs for certain inflation-sensitive operating expenses such as labor and employee benefits and facility leases.  However, we generally do not believe these impacts are material to our revenues or net income.

Critical Accounting Policies and Estimates

See Note 1 to our condensed consolidated financial statements included elsewhere in this report.
Item 3.          Quantitative and Qualitative Disclosure about Market Risk

This information is not required for smaller reporting companies.

Item 4.          Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, which are controls and other procedures that are designed to provide reasonable assurance that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’sSEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Our management, under the supervision and with the participation of our principal executive officer and principal financial officer, conducted an evaluation the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q.  Based on the evaluation of our disclosure controls and procedures as of September 30, 2017,March 31, 2018, the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2017,March 31, 2018, that materially affected or are reasonably likely to materially affect, our internal control over financial reporting.


PART II.   OTHER INFORMATION

Item 1A.       Risk Factors

Management does not believe there have been any material changes to the risk factors listed in Part I, “Item 1A, Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2016.2017.  These risk factors should be carefully considered with the information provided elsewhere in this report, which could materially adversely affect our business, financial condition or results of operations.

Item 5.Other Events

As disclosed in more detail in Note 2 to the Condensed Consolidated Financial Statements to this Quarterly Report on Form 10-Q, on April 5, 2018, the Forward Split became effective.  As a result, the number of authorized shares of our common stock increased from 50,000,000 shares to 200,000,000 shares, our outstanding common stock increased from 800,000 shares to 3,200,000 shares and our outstanding Series A Preferred Stock increased from 1,000 shares to 4,000 shares.  The number of shares available for issuance under our 2002 Plan and our 2005 Plan, as well as all awards outstanding under those plans also increased at the same four-shares-for-one-share ratio, and the exercise prices of stock options outstanding at the time of the Forward Split were adjusted to reflect the Forward Split.  On April 6, 2018, the date immediately following the effective date of the Forward Split, the 2018 Plan became effective.

On May 14, 2018, we entered into the Cancellation Agreements with certain executive officers, directors and other senior level employees/consultants of the Company, pursuant to which such Optionholders agreed to the surrender and cancellation of certain previously granted stock options to purchase shares of the Company’s common stock pursuant to our 2002 Plan and our 2005 Plan.  Under the terms of the Cancellation Agreements, each Optionholder and the Company acknowledged and agreed that the surrender and cancellation of the Cancelled Options was without any expectation on the part of the Optionholder to receive, and without any obligation on our part to pay or grant, any cash, equity awards or other consideration presently or in the future with respect to the Cancelled Options.
The executive officers and directors that entered into Cancellation Agreements and the aggregate number of shares of our common stock underlying the Cancelled Options surrendered by each such officer and/or director are as follows:

  Cancelled Option Amount 
Name of Optionholder Pre-Forward Split  Post-Forward Split 
Tom Kubota
  50,000   200,000 
Fred Odaka  11,000   44,000 
Kristina Kubota  1,000   4,000 
Lauren Kubota  1,000   4,000 

Two senior level employees/consultants of the Company surrendered Cancelled Options covering a total of 22,000 pre-Forward Split (88,000 post-Forward Split) shares.

The foregoing description of the Cancellation Agreements is qualified by reference to the full text of the Stock Option Cancellation Agreement, the form of which is filed herewith as Exhibit 99.1 to this Quarterly Report on Form 10-Q and is incorporated herein by reference.

Following the surrender and cancellation of the Cancelled Options there were no awards outstanding under the 2002 Plan or the 2005 Plan and pursuant to the provisions of the 2002 Plan and the 2005 Plan, our board of directors terminated the 2002 Plan and the 2005 Plan.
Item 6.          Exhibits
 
Exhibits.  The following exhibits are filed or furnished, as applicable, as part of this report:
 
 Exhibit Number Title of Document
Exhibit 4.1
Pacific Health Care Organization, Inc. 2018 Equity Incentive Plan
    
 Exhibit 31.1 
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    
 Exhibit 31.2 
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    
 Exhibit 32.1 
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    
 Exhibit 99.1
Form of Stock Option Cancellation Agreement
Exhibit 101 
The following materials from Pacific Health Care Organization, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 2017,March 31, 2018, formatted in XBRL (eXtensible Business Reporting Language): (i) the Unaudited Condensed Consolidated Balance Sheets, (ii) the Unaudited Condensed Consolidated Statements of Operations, (iii) the Unaudited Condensed Consolidated Statements of Cash Flows, and (iv) Notes to the Unaudited Condensed Consolidated Financial Statements.
 


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
  PACIFIC HEALTH CARE ORGANIZATION, INC.
    
    
Date:November 14, 2017May 15, 2018/s/ Tom Kubota 
  
Tom Kubota
Chief Executive Officer

    
Date:November 14, 2017May 15, 2018/s/ Fred Odaka 
  
Fred Odaka
Chief Financial Officer
 

2118