U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

(Mark One)
ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended March 31, 2003

o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-17192

REVCARE, INC.

(Exact name of small business issuer as specified in its charter)

Nevada		84-1061382
(State or other jurisdiction of incorporation of organization)		(I.R.S. Employer Identification No.)

5400 Orange Avenue, Suite 200, Cypress, CA 90630

(Address of principle executive offices)

Issuer’s telephone number (714) 995-0627

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No ý

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: As of January 29, 2004 the issuer had 21,526,909 shares of common stock outstanding.

Transitional Small Business Disclosure Format (Check one): Yes o No ý

REVCARE, INC.

FORM 10-QSB

INDEX

PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Balance Sheet as of March 31, 2003 (unaudited)

	Condensed Consolidated Statements of Operations for the six-month periods ended March 31, 2003 and 2002 (unaudited)

	Condensed Consolidated Statements of Operations for the three-month periods ended March 31, 2003 and 2002 (unaudited)

	Condensed Consolidated Statements of Cash Flows for the six-month periods ended March 31, 2003 and 2002(unaudited)

	Notes to Condensed Consolidated Financial Statements (unaudited)

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

Item 3.	Controls and Procedures

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Changes in Securities and use of proceeds

Item 3.	Defaults upon Senior Securities

Item 4.	Submission of Matters to a Vote of Security Holders

Item 5.	Other Information

Item 6.	Exhibits and Reports on Form 8-K

REVCARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

MARCH 31, 2003

(UNAUDITED)

ASSETS
Current assets:
Cash	$	258,520
Restricted cash	23,899
Accounts receivable, net of allowance for doubtful accounts of $ 126,084	2,051,051
Prepaid expenses and other	73,644
Employee advances	94,600

Total current assets	2,501,714

Goodwill	8,045,351
Property and equipment, net	3,026,594
Note receivable from officer	100,000

Total assets	$	13,673,659


LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Bank overdraft	$	113,834
Accounts payable	921,540
Collections payable to customers	2,693,259
Accrued liabilities	1,581,414
Lines of credit	716,668
Current portion of mortgage note payable	75,120
Current portion of capital lease obligations	92,285
Current portion of notes payable to related parties	66,728

Total current liabilities	6,260,848

Mortgage note payable, less current portion	2,777,859
Capital lease obligations, less current portion	80,656
Notes payable to related parties, less current portion	5,193,511

Total liabilities		14,312,874

COMMITMENTS AND CONTINGENCIES (Note 9)

SHAREHOLDERS’ EQUITY (DEFICIT):
Series A convertible, redeemable preferred stock, $0.001 par value, stated at $2.00 liquidation preference per share, 5,000,000 shares authorized; 345,000 shares issued and outstanding	690,000
Common stock, $0.001 par value; 55,000,000 shares authorized; 21,526,909 shares issued and outstanding	21,520
Paid-in capital	10,658,282
Accumulated deficit	(11,959,017		)
	(589,215		)
Less common stock in treasury at cost, 33,000 shares	(50,000		)

Total shareholders’ equity (deficit)	(639,215		)
	$	13,673,659

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

REVCARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002

(UNAUDITED)

	2003			2002

REVENUES	$	5,851,937		$	6,889,246

OPERATING EXPENSES
Salaries, wages and related benefits	3,998,306			4,357,430
Other operating expenses	735,622			815,622
Selling, general and administrative	2,154,151			2,373,900
Depreciation and amortization	221,810			493,486
	7,109,889			8,040,438

LOSS FROM OPERATIONS	(1,257,952		)	(1,151,192		)

OTHER INCOME (EXPENSE)
Interest expense, net	(389,510		)	(340,184		)
Rental operations, net	23,570			45,236
	(365,940		)	(294,948		)

LOSS BEFORE BENEFIT FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(1,623,892		)	(1,446,140		)

BENEFIT FOR INCOME TAXES	—			—

LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(1,623,892		)	(1,446,140		)

CUMULATIVE EFFECT ON PRIOR YEARS OF CHANGING METHOD OF ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES WITH INDEFINITE LIVES (NOTE 3 (i))	(1,576,328		)	—

NET LOSS	$	(3,200,220	)	$	(1,446,140	)

Earnings (loss) per share (basic and diluted):
Loss before cumulative effect of change in accounting principle	$	(0.08	)	$	(0.07	)
Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	(0.07		)	—
Net Loss	$	(0.15	)	$	(0.07	)

Number of shares used in computing earnings (loss) per share (basic and diluted):
Loss before cumulative effect of change in accounting principle	21,526,909			21,526,909
Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	21,526,909			21,526,909
Net Loss	21,526,909			21,526,909

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

REVCARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002

(UNAUDITED)

	2003			2002

REVENUES	$	3,091,504		$	3,609,902

OPERATING EXPENSES:
Salaries, wages and related benefits	1,980,761			2,236,021
Other operating expenses	328,443			425,090
Selling, general and administrative	1,071,899			1,132,505
Depreciation and amortization	109,108			246,380
	3,490,211			4,039,996
LOSS FROM OPERATIONS	(398,707		)	(430,094		)

OTHER INCOME (EXPENSE):
Interest expense, net	(199,046		)	(172,332		)
Rental operations, net	8,848			29,533
	(190,198		)	(142,799		)
LOSS BEFORE BENEFIT FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(588,905		)	(572,893		)

BENEFIT FOR INCOME TAXES	—			—

LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(588,905		)	(572,893		)

CUMULATIVE EFFECT ON PRIOR YEARS OF CHANGING METHOD OF ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES WITH INDEFINITE LIVES (NOTE 3 (i))	—			—

NET LOSS	$	(588,905	)	$	(572,893	)

Earnings (loss) per share (basic and diluted):
Loss before cumulative effect of change in accounting principle	$	(0.03	)	$	(0.03	)
Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	—			—
Net Loss	$	(0.03	)	$	(0.03	)

Number of shares used in computing earnings (loss) per share (basic and diluted):
Loss before cumulative effect of change in accounting principle	21,526,909			21,526,909
Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	21,526,909			21,526,909
Net Loss	21,526,909			21,526,909

REVCARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002

(UNAUDITED)

	2003			2002

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(3,200,220	)	$	(1,446,140	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	221,810			493,486
Cumulative effect of change in accounting principle	1,576,328			—
Loss on sale of portfolio receivables	—			70,667
Changes in operating assets and liabilities:
Change in accounts receivable, net	(15,681		)	(666,894		)
Change in prepaid expenses and other	(73,140		)	(33,507		)
Change in accounts payable	223,004			462,939
Change in collections payable to customers	518,111			602,980
Change in accrued liabilities	140,157			185,045

Net cash used in operating activities	(609,631		)	(331,424		)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(1,132		)	(207,227		)
Net proceeds from sale of portfolio receivables	—			34,088
Net change in restricted cash	533			—

Net cash used in investing activities	(599		)	(173,139		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from lines of credit	271,834			593,233
Proceeds from note payable	—			350,000
Principal payments on notes payable	(127,202		)	(197,918		)
Principal payments on mortgage note payable	(33,915		)	—
Principal payments on capital lease obligations	(46,707		)	(49,777		)
Increase in bank overdraft	(77,972		)	(112,674		)

Net cash (used in) provided by financing activities	(13,962		)	582,864

Net (decrease) increase in cash	(624,192		)	78,301

CASH, at beginning of period	882,712			—

CASH, at end of period	$	258,520		$	78,301

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH INVESTING AND FINANCING ACTIVITIES:

Interest Paid	$	184,643		$	—
Interest payable converted to debt	$	290,011		$	—

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

REVCARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2003

(UNAUDITED)

1. Quarterly Information

The accompanying condensed consolidated financial statements have been prepared in accordance with Securities and Exchange Commission requirements for interim financial statements. Therefore, they do not include all disclosures that would be presented in the Annual Report on Form 10-KSB of RevCare, Inc., a Nevada corporation (together with its subsidiaries, the Company). These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements contained in the Company’s 2002 Annual Report on Form 10-KSB.

The information furnished reflects all adjustments (consisting only of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of financial position and results of operations for the interim periods. The operating results are not necessarily indicative of results to be expected for the year ending September 30, 2003.

2. Organization and Basis of Presentation

RevCare, Inc. (formerly known as Cypress Financial Services, Inc.), a Nevada corporation, (together with its subsidiaries, the Company), provides accounts receivable management, administration, and debt collection services primarily to health care providers and consumer credit issuers.

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and settlement of obligations in the normal course of business. The Company generated net losses of $3,565,492, $2,436,347, and $3,200,220 in fiscal years 2002, 2001, and for the six month period ended March 31, 2003, respectively. In addition, the Company had total shareholders’ deficit of $639,215 and a working capital deficit of $3,759,134 at March 31, 2003.

Management believes that the recent losses are attributable to the various acquisitions in 2000, the integration of their operations and the implementation of technology and processes to pursue its strategic objectives. Additionally, the Company lost more clients than it gained. The Company continues to obtain larger, higher margin contracts, while discontinuing contracts with low margins. Management, however, believes that the operating plan for subsequent fiscal years may experience significant challenges in light of ongoing changes in the industry and geographic market it serves which may require the Company to seek alternative sources for cash to support its growth and ongoing operations. Accordingly, the Company has completed several transactions and completed operational changes designed to meet the Company’s liquidity requirements, the most significant of which are as follows:

• On February 11, 2003, the Company entered into a Business Financing Agreement (“Financing Agreement”) with Bridge Bank. The Company may borrow up to $2,500,000 under the conditions set forth in the Financing Agreement and the outstanding balance of principal and accrued interest under this Financing Agreement was $418,913 at December 31, 2003. The maximum amount we can borrow is contingent on and collateralized by qualified invoices, which will fluctuate from time to time depending on our business volume. As of December 31, 2003 we have reached the limit under this line. The obligations under the Financing Agreement are secured by first priority liens in all of the Company’s assets and the assets of its subsidiaries pursuant to the terms and conditions of security agreements. This obligation is also guaranteed by our subsidiaries under the terms and conditions of guaranties.

• On May 21, 2003, the Company’s wholly owned subsidiary, Medical Control Services, Inc. (MCI), which held title to our corporate facility completed the sale of the property to SCP Park Meadows, LLC (SCP). On that same date, the Company entered into a Lease Agreement dated

May 21, 2003 with SCP (the “Lease”). The net proceeds from the sale of the property, after paying off the existing mortgage on the property and paying commissions and expenses, and depositing $1,050,000 to a restricted account to collateralize the letters of credit used as rent deposits to the subsequent lease of the property equaled $1,352,361. See Note 10, “Subsequent Events”, for further information.

• On August 13, 2003, the Company executed the relevant documents under which FBR agreed to provide the Company a $500,000 unsecured note. The proceeds of this note were used for working capital purposes. On August 29, 2003, the Company executed the relevant documents under which FBR agreed to provide the Company a $1,000,000 convertible note. The proceeds from the new $1,000,000 note from FBR will be used to reduce the collections payable to certain of the Company’s California-based delinquent debt collection clients.

• On August 29, 2003, the aforementioned $500,000 unsecured note and the $1,000,000 convertible note including combined accrued interest of $2,000 were amended and restated into a new $1,502,000 secured convertible promissory note.

• Subsequent to September 30, 2001, the Company sold its remaining portfolios and assets included in the Company’s 1998 securitization. The terms of the sale included an immediate payment of $300,000 and a contingency payment of up to $350,000. As of January 15, 2004, no amounts have been received under the contingent payment arrangement. The contingent payment is dependent upon the success of the buyer in collecting the portfolio and therefore, the Company is unable at this time to predict the timing of all or any of this payment.

• In fiscal years 2002 and 2003, the Company has initiated and completed various cost reduction initiatives. Such initiatives are expected to reduce annual operating costs by approximately $2.3 million in fiscal years 2003 and 2004. In March 2003, the Company also initiated the pilot program for a design to perform certain analytical and segmentation processes on selected accounts in an offshore location in order to explore the possibility of further reducing the direct costs of its collection process significantly.

• Management is actively seeking additional funding from traditional providers of corporate financing and strategic alliance partners in case it needs additional funding for fiscal year 2004. The Company’s largest shareholder, FBR, has provided funding to the Company in the past. As a component of the process of requesting any additional financing that may be required, management may approach FBR. However, there can be no assurance that such financing could be arranged on terms satisfactory to us or FBR, or at all.

Based on the financing activities and reductions in operating costs described above, management believes that the Company will have the sufficient working capital it needs to pursue its on going growth and strategic goals for fiscal years 2003 and 2004.

3. Summary of Significant Accounting Policies

a. Principles of Consolidation

The condensed consolidated financial statements include the accounts of RevCare, Inc. and its wholly owned subsidiaries. All significant intercompany accounts have been eliminated.

b. Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported periods. Actual results could materially differ from those estimates.

c. Revenue Recognition

i. Service Fees

The Company provides collection, auditing, billing and staffing services for entities primarily in the healthcare industry for a fee. Revenue recognition varies between the business segments based upon the services provided.

Revenues from the delinquent debt and insurance collection practices are based on a percentage of total collections per each contract. Such revenues are recognized upon receipt of cash from the third-party payers that the Company collects from on behalf of its client.

Revenues from the auditing and billing divisions are based on respective contractual percentage of payments received by our clients. Customers, comprised mostly of insurance companies, generally make payments to our clients who then report such amounts to the Company. The Company recognizes revenues based on such payment reports.

Revenue from the staffing division is recognized based upon hourly rates, and is recorded as services are rendered. The Company’s payroll system posts staffing division hours to individual projects on a monthly basis. The Company bills its clients for the hours incurred at the contract rates. In August 2003, we entered into an Exchange Agreement with Russell and Suzette Mohrmann and their affiliate, Hospital Employee Labor Pool, a California corporation, or HELP, pursuant to which there was a transfer of substantially all the assets related to our administrative and back office temporary staffing division. See Note 10, “Subsequent Events” for more information regarding this matter.

ii. Sale of Portfolio Receivables and Securitized Residual Interest

On November 21, 2001, the Company sold its portfolio receivables as well as its residual interest in the Company’s 1998 securitization. The sale of the portfolios resulted in a net loss of $70,667 after the reversal of the $140,000 servicing fee accrual. This loss is reflected in selling, general and administrative expenses in the accompanying consolidated statement of operations for the three months ended December 31, 2001. The terms of the sale included a contingency payment of up to a maximum of $350,000. The contingent payment is dependent upon the success of the buyer in collecting the portfolio and securitized receivables therefore; we are unable to predict the timing of all or any of this payment. The Company will recognize revenue when, or if any cash payments are received. As of January 15, 2004, no contingency payments have been received.

d. Accounts Receivable and Allowance for Doubtful Accounts

Unbilled receivables primarily relate to the cost of services provided by our managed care unit upon its completion of the work as required by the respective contracts but has not been invoiced at the end of an accounting period. These amounts are subsequently classified as Billed Receivables when the respective invoices are sent to the clients.

We maintain allowances for doubtful accounts for estimated losses resulting from our customer’s inability to make required payments. Management reviews all accounts receivable on a monthly basis. Specific invoices over 60 days are discussed with clients. Based upon historical experience with individual clients, management assesses whether a specific reserve is required for each invoice or client balance.

“Net” remit option, the company retains the portion of the collections that represent fees to the company instead of remitting the entire amount collected and invoicing the client for the fees due.

e. Property and Equipment

Furniture, fixtures and equipment are carried at cost and depreciated using both straight-line and accelerated methods over the estimated useful lives of the assets, which are generally 4 to 7 years. The building is being depreciated over a period of 39 years. Repairs and maintenance are charged to expense as incurred; replacements and improvements are capitalized.

f. Impairment of Long-Lived Assets

The Company assesses the recoverability of its long-lived assets on an annual basis or whenever adverse events or changes in circumstances or business climate indicate that expected undiscounted future cash flows related to such long-lived assets may not be sufficient to support the net book value of such assets. Such a triggering event could include a significant decrease in the market value of an asset, or a significant change in the extent or manner in which an asset is used or a significant physical change in an asset. If undiscounted cash flows are not sufficient to support the recorded assets, impairment is recognized to reduce the carrying value of the long-lived asset to the estimated fair value. Estimated fair value will be determined by discounting the future expected cash flows using a current discount rate in effect at the time of impairment. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. Additionally, in conjunction with the review for impairment, the remaining estimated lives of certain of the Company’s long-lived assets are assessed.

g. Collections Payable to Customers

The Company records liabilities for collections received on behalf of its customers as collections payable to customers. Most of our customer contracts do not require these collected funds to be segregated from our operating cash accounts. Accordingly, these amounts are included in cash until remitted to customers. Amounts that are required to be segregated and held in separate accounts are shown as Restricted Cash in the accompanying condensed consolidated balance sheet.

Commencing in September 2001, in some cases where California-based delinquent debt collection clients did not have the agreement with the Company which required the Company to maintain the funds collected on the clients’ behalf in a separate account, the Company transferred funds from the client account to its general operating account. In addition, payments to such clients were withheld for 90 to 120 days, and sometimes longer. The Company has relied upon the repeal of previous California statutes requiring segregation of client funds by collection agencies when our client contract did not contain an express provision requiring segregation. In July 2003, the Company determined, despite the lack of clear authority, that the practice of transferring client funds to operating accounts or delay on remitting funds might be deemed a breach of our obligations. Since the Company is unable to determine definitively if this is the case, the Company has taken and is taking additional steps to address this practice. Client funds are no longer transferred to operating accounts for any reason (other than funds owed to the Company for its services to which it is contractually entitled).

h. Fair Value of Financial Instruments

Fair values of financial instruments are estimated using available market information and other valuation methodologies. The fair values of the Company’s financial instruments are estimated to approximate the related book value, unless otherwise indicated.

i. Goodwill

Goodwill represents the excess of cost over the fair value of net assets acquired and prior to fiscal 2003 is amortized using the straight-line method over 20 years. The carrying value of goodwill is reviewed on a regular basis for the existence of facts or circumstances, both internally and externally, that may suggest impairment. The Company annually re-evaluates the original assumptions and rationale utilized in the establishment of the carrying value and estimated useful lives of goodwill. In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, “Intangible Assets.” SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Upon adoption of SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life but is instead subject to periodic testing for impairment. The Company adopted this Statement and completed its initial impairment test for goodwill as of October 1, 2002. As a result of this assessment, the Company determined that one of its segments, HELP, was impaired and recorded an impairment charge of $1,576,328 in the quarter ended December 31, 2002. The impairment has been reported as a cumulative effect of a change in accounting principle. In addition to the impairment, the impact of adopting SFAS No. 142 was to cease the amortization of goodwill, which would have amounted to $132,240 and $264,480 of amortization expense for the three and six months ended March 31, 2003, respectively. Net loss for the three and six months ended March 31, 2003, including amortization of goodwill, would have been $721,145 and $3,464,700 compared to $588,905 and $3,200,220, respectively. For the three and six months ended March 31, 2002, goodwill amortization expense was $132,240 and $264,480. Net loss for the three and six months ended March 31, 2002, excluding amortization of goodwill, would have been $440,653 and $1,181,660 compared to $572,893 and $1,446,140, respectively.

j. Earnings (Loss) Per Share

The Company reports basic and diluted earnings (loss) per share (EPS) in accordance with SFAS No. 128. Basic EPS is computed by dividing losses available to common shareholders by the weighted average number of common shares outstanding. Diluted EPS is computed by adding to the weighted average number of shares the dilutive effect of common stock equivalents, if any.

	Six Months Ending March 31^st
	2003			2002
Loss before cumulative effect of change in accounting principle	$	(1,623,892	)	$	(1,446,140	)

Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	(1,576,328		)	—

Net loss	$	(3,200,220	)	$	(1,446,140	)

Number of shares used in denominator for computing earnings per share (basic and diluted):	21,526,909			21,526,909

Earnings (loss) per share (basic and diluted):

Loss before cumulative effect of change in accounting principle	$	(0.08	)	$	(0.07	)

Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	$	(0.07	)	$	—

Net loss	$	(0.15	)	$	(0.07	)

	Three Months Ending March 31^st
	2003			2002
Loss before cumulative effect of change in accounting principle	$	(588,905	)	$	(572,893	)

Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	—			—

Net Loss	$	(588,905	)	$	(572,893	)

Number of shares used in denominator for computing earnings per share (basic and diluted):	21,526,909			21,526,909

Earnings (loss) per share (basic and diluted):

Loss before cumulative effect of change in accounting principle	$	(0.03	)	$	(0.03	)

Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	$	—		$	—

Net Loss	$	(0.03	)	$	(0.03	)

For the periods presented there were no reconciling items in computing the basic and diluted EPS calculations for either the numerator or the denominator.

k. Income Taxes

The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and the tax basis of assets and liabilities and are measured using the enacted tax rates and laws. A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations.

l. Reclassification

Certain amounts in the accompanying 2002 financial statements have been reclassified to conform to the 2003 presentation.

m. Recent Accounting Pronouncements

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 addresses the recognition and measurement of obligations associated with the retirement of tangible long-lived assets. SFAS No. 143 applies to legal obligations associated with the retirement of long-lived assets resulting from the acquisition, construction, development or the normal operation of a long-lived asset. SFAS No. 143 required that the fair value of an asset retirement obligation be recognized as a liability in the period in which it is incurred. The asset retirement obligation is to be capitalized as part of the carrying amount of the long-lived asset and the expense is to be recognized over the useful life of the long-lived asset. SFAS No. 143 is effective October 1, 2002, with early adoption permitted. The Company adopted SFAS No. 143 effective October 1, 2002, the effect of which was not material to the Company’s financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses the financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of and is effective for

fiscal years beginning after December 15, 2001. This statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of;” however, it retains the fundamental provisions of SFAS No. 121 for (i) recognition and measurement of the impairment of long-lived assets to be held and used and (ii) measurement of long-lived assets to be disposed of by sale. This statement also supersedes the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” for the disposal of a segment of a business. The Company adopted SFAS No. 144 effective October 1, 2002, the effect of which was not material to the Company’s financial position or results of operations.

In April 2002, the FASB issued No. SFAS 145, “Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections.” SFAS No. 145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and SFAS No. 64, “Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements.” Accordingly, a gain or loss from a debt extinguishment should not be classified as an extraordinary item unless it meets the criteria for extraordinary item classification in APB Opinion 30, “Reporting the Results of Operations ¾ Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions.” SFAS No. 145 also rescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers,” because transition to the Motor Carrier Act of 1980 is complete and intrastate operating rights have been deregulated. SFAS No. 145 is effective for financial statements issued on or after May 15, 2002. The implementation of this standard did not have a material effect upon the Company’s financial statements.

In June 2002, the FASB approved for issuance SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement provides financial accounting and reporting guidance for costs associated with exit or disposal activities and nullifies EITF Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. Previously issued financial statements should not be restated. The provisions of EITF Issue 94-3 continue to apply for an exit activity initiated under an exit plan that met the criteria in EITF Issue 94-3 before the Statement’s initial application. The implementation of this statement did not have a material effect upon the Company’s financial statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, an amendment of FASB Statement No. 123. The disclosure requirements of Statement 123, “Accounting for Stock-Based Compensation”, which apply to stock compensation plans of all companies, are amended to require certain disclosures about stock-based employee compensation plans in an entity’s accounting policy note. Those disclosures include a tabular format of pro forma net income and, if applicable, earnings per share under the fair value method if the intrinsic value method is used in any period presented. Pro forma information in a tabular format is also required in the notes to interim financial information if the intrinsic value method is used in any period presented. Before amendment by SFAS No. 148, SFAS No. 123 required entities changing to the fair value method of accounting for stock-based employee compensation to account for the change in method prospectively. The Board decided to provide a choice among three transition methods (the prospective method originally required by SFAS 123, the modified prospective method, and the retroactive restatement method) for entities voluntarily adopting the fair value method in periods beginning before December 16, 2003. SFAS No. 123’s original prospective transition method will not be available to entities changing to the fair value method in fiscal years beginning after December 15, 2003.

The amendments to the disclosure and transition provisions of Statement 123 are effective for fiscal years ending after December 15, 2002. Calendar year-end entities are required to include

the new disclosures in their 2002 financial statements. The disclosure requirement for interim financial information is effective for interim periods beginning after December 15, 2002. Management does not intend to transition to the fair value method of accounting for stock options and believes implementation of this standard will not have a material effect upon the Company’s financial statements except to include the additional required disclosures.

The FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” — an interpretation of FASB Nos. 5, 57 and 107 and rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Implementation of these provisions of the Interpretation is not expected to have a material impact on the Company’s consolidated financial statements. The disclosure requirements of the Interpretation are effective for financial statements of interim or annual periods ended after December 15, 2002, and have been adopted in the accompanying consolidated financial statements as of September 30, 2002 (see Note 9 (d)).

The FASB has issued Interpretation No. (FIN) 46, “Consolidation of Variable Interest Entities” –an interpretation of Accounting Research Bulletin (“ARB”) No. 51. This Interpretation defines a variable interest entity and provides that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. Furthermore, the Board indicates that the voting interest approach of ARB No. 51 is not effective in identifying controlling financial interests in entities that are not controllable through voting interest or in which the equity investors do not bear the residual economic risk. This Interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. As a result of the issuance of FASB Staff Position FIN 46-6 “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities,” FIN 46 applies at the end of the interim or annual period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. Management believes the implementation of this Interpretation will not have a material effect upon the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement will not have a material impact on our financial condition or results from operations.

4. Property and Equipment

Property and equipment consists of the following at March 31, 2003:

Land	$	866,575
Building	1,540,577
Equipment and furnishings	2,473,168
	4,880,320
Less—Accumulated depreciation	(1,853,726		)
	$	3,026,594

5. Related Party Transactions

In 1998, as part of Mr. Manny Occiano’s original employment agreement, Mr. Occiano is eligible to participate in the management bonus pool to be established by the Board of Directors and is entitled, during 1999 only, to quarterly advances of $22,500 to be credited against the management bonus when earned. Mr. Occiano received four such advances in 1999 amounting to $90,000. This amount is to be credited against future management bonuses when earned. There have not been any advances made since 1999. Mr. Occiano also received a loan of $100,000 to purchase 66,000 shares of common stock on the open market. The loan is secured by a pledge of the common stock acquired.

In conjunction with the acquisition of OCPS, on August 14, 2000 the Company issued $3,675,000 of secured convertible promissory notes to shareholders and officers of OCPS, who were employees or officers of the Company as of March 31, 2003. All of these notes bear interest at the rate of 8 percent per annum. Of these notes, a total of $3,503,500 mature in January 2003, and the remaining note matures in August 2003, at which time the unpaid principal balances and all accrued and unpaid interest are due. The balance of these notes at March 31, 2003 was $3,860,239. At the option of the holder, the notes are convertible into common stock at $0.735 per share. Certain of these notes were amended and/or retired as part of various transactions that were executed in 2003. See Note 10, “Subsequent Events” for additional information regarding these matters.

On September 28, 2001, the Company entered into a revolving line of credit agreement with two officers of the Company. The agreement permits borrowings up to $350,000 at the bank reference (5.25% at March 31, 2003) rate plus one percent. The line of credit is unsecured and expires on January 2, 2003. At March 31, 2003 we owed $300,000 on this line of credit. On January 2, 2003, we entered into an amendment with these officers in which the maturity date was extended to January 2, 2004. This agreement was amended in June 2003. Please see Note 10, “Subsequent Events” for more information regarding this amendment.

On July 22, 2002, the Company entered into a $100,000 note payable with its majority stockholder, FBR Financial Services Partners, L.P. (FBR) The note bears interest at the bank reference rate (5.25% at March 31, 2003) plus one percent and is payable on demand, but is subordinate to a note from an officer of the Company. The note is unsecured.

On September 19, 2002, the Company entered into a $1,000,000 convertible note payable (“Note”) with its majority shareholder, FBR. The note bears interest at 12 percent per annum and is payable on demand, but is subordinate to a note from an officer of the Company. The note is convertible into the Company’s common stock concurrently or at any time following an equity financing of common stock (“Financing”) at a conversion price equal to eighty-five percent (85%) of the price per share at which the common stock is sold in the Financing. The Company computed the intrinsic value of the beneficial conversion feature attributable to the convertible note to be $176,471, which will be charged to expense at the time of a Financing. This agreement was amended on August 29, 2003.

On August 29, 2003, the aforementioned $100,000 unsecured note payable and the $1,000,000 convertible note payable including combined accrued interest of $120,325 were amended and

restated into a new $1,220,325 secured convertible promissory note. The significant amendments to the previous notes include the following:

• The maturity date was extended to September 1, 2005

• Interest rates on the notes were changed to the prime rate charged by the Company’s lender (5.5% at December 31, 2003) plus 4% per annum payable on the maturity date.

• All or any portion of the unpaid principal balance and any accrued but unpaid interest outstanding under this Note may be converted into fully paid and nonassessable shares of capital stock of the Company (the “Stock”) concurrently upon or at any time following a Financing (as defined below) at the option of Holder. The Stock shall have all of the rights, preferences and privileges of the capital stock issued in the Financing. The number of shares of Stock into which this Note is to be converted shall be determined by dividing said unpaid principal balance and all accrued but unpaid interest by the Conversion Price. The “Conversion Price” shall be determined at such time as the Company closes an equity financing of Stock or debt convertible into Stock with gross proceeds to the Company of least $500,000 (the “Financing”). The Conversion Price shall be the price per share at which the Stock is sold in the Financing or the price at which the debt converts into Stock.

On August 13, 2003, the Company executed the relevant documents under which FBR agreed to provide the Company a $500,000 unsecured note. The proceeds of this note were used for working capital purposes. On August 29, 2003, the Company executed the relevant documents under which FBR agreed to provide the Company a $1,000,000 convertible note. The proceeds for the new $1,000,000 note from FBR will be used to reduce the collections payable to certain of the Company’s California-based delinquent debt collection clients.

On August 29, 2003, the aforementioned $500,000 unsecured note and the $1,000,000 convertible note including combined accrued interest of $2,000 were amended and restated into a new $1,502,000 secured convertible promissory note. The significant amendments to the previous notes include the following:

• The maturity date was extended to September 1, 2005 with all outstanding principal and accrued interest due on this date, subject to customary events of acceleration. As part of this amendment the maturity date of the principal and any accrued interest on the note payable to Rob Perez was also extended.

• Interest rates on the notes were changed to the prime rate charged by the Company’s lender (5.5% at December 31, 2003) plus 4% per annum payable on the maturity date.

• The amended note is secured by substantially all of the Company’s assets, including the shares in the Company’s subsidiary, Orange County Professional Services, Inc., pursuant to a security agreement.

On August 29, 2003, the Company entered into an Exchange Agreement with Russell and Suzette Mohrmann and their affiliate, Hospital Employee Labor Pool, a California corporation, or HELP, pursuant to which the transfer was consummated. See Note 10, “Subsequent Events” for more information regarding this agreement.

6. Notes Payable and Lines of Credit

On November 19, 2001, the Company entered into a secured line of credit, which provides borrowing up to $1,000,000 at the bank’s reference rate of prime plus five percent (9.25 percent at December 31, 2002). The line was set to expire on January 20, 2003 but was extended one month to February 20, 2003. The outstanding balance on this line of credit at December 31, 2002 was $453,869. All outstanding principal and interest owed under this borrowing were paid in full in February 2003.

The Company had a line of credit, which permitted borrowings up to a maximum of $300,000 at the bank’s reference rate of prime plus two percent (6.0 percent at March 31, 2003). At March 31, 2003 borrowings on the line totaled $15,625. The line of credit expired on May 1, 2003 and was paid in full at that time. Borrowings were secured by substantially all the assets of OCPS, including accounts receivable and equipment, as well as guaranteed by the former principal owner of OCPS.

The Company has a mortgage note payable to a bank with $2,852,979 of principal outstanding at March 31, 2003. This note is secured by land and a building, due in monthly payments of $25,984, bearing interest at an interest rate based on the yield of the U.S. Five Year Treasury Swap Rate (“the Index”) plus+ 2.5 percent and no cap. Said rate will be fixed for five years and adjusted on the first business day of each five-year anniversary date of the promissory note dated December 19, 2000 through January 2021, at which time the entire principal balance is due and payable. All outstanding principal and interest owed under this note was paid in May 2003 as part of the Sale and Leaseback transaction that the Company consummated at that time (see Note 10, “Subsequent Events”).

A convertible note payable to an individual (related party) for $66,728 of principal and interest was outstanding at March 31, 2003, and is due in monthly installments of $13,613 through August 2003. Interest on the note is payable at 8 percent per annum. At the option of the holder, any unpaid principal balance may be converted into the Company’s common stock at $.0735 per share. This note was paid in full in August 2003.

On February 11, 2003, the Company entered into a secured line of credit, which provides borrowing up to $2,500,000 at the bank’s reference rate of prime plus 1.5 percent (5.75 percent at March 31, 2003). The maximum amount we can borrow is contingent on and collateralized by qualified invoices, which will fluctuate from time to time depending on our business volume. The line automatically renews upon the one-year anniversary of the execution, and shall continue to renew each subsequent year, unless earlier termination by either parties. The outstanding balance on this line of credit, which represents the maximum we can borrow, at March 31, 2003, was $ 701,043 (see Note 10, “Subsequent Events”).

7. Income Taxes

Income tax expense for the periods presented is based on the estimated effective tax rate to be incurred for the year. Because certain items of income and expense are not recognized in the same year in the financial statements of the Company as in its Federal and California tax returns, deferred assets and liabilities are created. Due to the uncertainty of the Company’s ability to realize its deferred tax assets, a valuation allowance for the full amount of net deferred tax assets has been recorded at March 31, 2003.

8. Reportable Business Segments

The following disclosures are intended to present reportable segments consistent with how the chief operating decision maker organizes segments within the Company for making operating decisions and assessing performance. The chief operating decision maker does not use assets to make financial decisions separately within the segments. All assets are consolidated as a whole and are not identified by segments. Presently, the Company is segregated into four divisions, which are as follows.

Physician Services –

This division provides receivable management services to physician service organizations. While the bulk of the services primarily relate to practice support services, this division has also provided consulting services relating to regulatory compliance as well as education and training of physicians with respect to applicable regulatory matters. Practice support services generally include coding, billings, collections and financial reporting of revenue transactions incurred by physician service organization clients. Fees generated from practice support services are either fixed fee arrangements or a percentage of the volume of revenues managed on behalf of the clients. Hourly or per-diem rates for training and consulting service fees are determined based on the nature of the engagement.

Recovery –

This division provides pre-delinquent and delinquent collection services primarily for hospital organizations, financial institutions, and retail organizations. This division specializes in direct collections from patients or consumers. Clients pay the Company a percentage of the amounts collected as fees for this service.

Reimbursement Solutions –

This division specializes in auditing, re-billing, and follow-up collections of reimbursable costs due to hospital organizations from third party payors, which, include among others, Medicare, MediCal, HMO’s, and health insurance organizations. Fees for these services vary from fixed fee arrangements, pre-determined hourly rates, to percentage of revenues generated on behalf of the clients.

Temporary Staffing –

This division specializes in providing temporary staffing to hospital organizations and physician service organizations. Temporary staffing provided to its clients can include administrative, financial, as well as clinical and operational personnel. In August 2003, we entered into an Exchange Agreement with Russell and Suzette Mohrmann and their affiliate, Hospital Employee Labor Pool, a California corporation, or HELP, pursuant to which there was a transfer of substantially all the assets related to our administrative and back office temporary staffing division (see Note 10, “Subsequent Events”).

Below is a summary of the operating information by segment for the three and six months ended March 31, 2003 and 2002, respectively. The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies. Certain assumptions are made concerning the allocations of costs between segments that may influence relative results, most notably, allocations of various types of technology, legal, recruiting and training costs. Management believes that the allocations utilized below are reasonable and consistent with the way it manages the business.

The following table summarizes the results of our reportable segments for the six months ended March 31, 2003 and 2002:

For the six months ended March 31, 2003:

	Recovery				Physician Services					Reimbursement Solutions				Temporary Staffing				Total

Revenue	$	2,250,902	100	%	$	1,057,614		100	%	$	1,399,449	100	%	$	1,143,972	100	%	$	5,851,937		100	%
Direct Labor	811,442		36	%	810,315			77	%	706,800		51	%	838,807		73	%	3,167,364			54	%
Indirect Labor	344,663		15	%	245,196			23	%	172,389		12	%	68,694		6	%	830,942			14	%
Other Expenses	341,468		16	%	292,182			28	%	65,791		5	%	36,181		3	%	735,622			13	%
Total Expenses	1,497,573		67	%	1,347,693			128	%	944,980		68	%	943,682		82	%	4,733,928			81	%

Operating income (loss)	$	753,329	33	%	$	(290,079	)	(28	)%	$	454,469	32	%	$	200,290	18	%	1,118,009			19	%

Selling, general & administrative expenses																		(2,154,151		)	(37	)%
Depreciation & amortization																		(221,810		)	(4	)%

Loss from Operations																		$	(1,257,952	)	(22	)%

For the six months ended March 31, 2002:

	Recovery				Physician Services					Reimbursement Solutions				Temporary Staffing				Total

Revenue	$	2,635,519	100	%	$	1,535,434		100	%	$	1,959,123	100	%	$	759,170	100	%	$	6,889,246		100	%
Direct Labor	1,085,553		41	%	965,520			63	%	690,150		35	%	521,064		69	%	3,262,287			47	%
Indirect Labor	480,770		18	%	364,534			24	%	199,783		10	%	50,056		7	%	1,095,143			16	%
Other Expenses	310,882		12	%	319,996			21	%	165,976		9	%	18,768		2	%	815,622			12	%
Total Expenses	1,877,205		71	%	1,650,050			108	%	1,055,909		54	%	589,888		78	%	5,173,052			75	%

Operating income (loss)	$	758,314	29	%	$	(114,616	)	(8	)%	$	903,214	46	%	$	169,282	22	%	1,716,193			25	%

Selling, general & administrative expenses																		(2,373,900		)	(34	)%
Depreciation & amortization																		(493,486		)	(7	)%

Loss from Operations																		$	(1,151,192	)	(16	)%

The following table summarizes the results of our operating units for the quarters ended March 31, 2003 and 2002:

For the quarter ended March 31, 2003:

	Recovery				Physician Services					Reimbursement Solutions				Temporary Staffing				Total

Revenue	$	1,238,552	100	%	$	512,721		100	%	$	734,102	100	%	$	606,129	100	%	$	3,091,504		100	%
Direct Labor	408,220		33	%	381,298			74	%	348,938		47	%	439,193		72	%	1,577,649			51	%
Indirect Labor	160,893		13	%	116,860			23	%	90,434		12	%	34,925		6	%	403,112			13	%
Other Expenses	160,024		13	%	127,877			25	%	26,489		4	%	14,053		2	%	328,443			11	%
Total Expenses	729,137		59	%	626,035			122	%	465,861		63	%	488,171		80	%	2,309,204			75	%

Operating income (loss)	$	509,415	41	%	$	(113,314	)	(22	)%	$	268,241	37	%	$	117,958	20	%	782,300			25	%

Selling, general & administrative expenses																		(1,071,899		)	35	%
Depreciation & amortization																		(109,108		)	3	%

Loss from Operations																		$	(398,707	)	13	%

For the quarter ended March 31, 2002:

	Recovery				Physician Services					Reimbursement Solutions				Temporary Staffing				Total

Revenue	$	1,387,642	100	%	$	786,805		100	%	$	1,049,346	100	%	$	386,109	100	%	$	3,609,902		100	%
Direct Labor	550,180		40	%	480,061			61	%	384,266		36	%	263,355		68	%	1,677,862			46	%
Indirect Labor	236,799		17	%	186,367			24	%	100,847		10	%	34,146		9	%	558,159			16	%
Other Expenses	159,800		11	%	151,991			19	%	100,690		10	%	12,609		3	%	425,090			12	%
Total Expenses	946,779		68	%	818,419			104	%	585,803		56	%	310,110		80	%	2,661,111			74	%

Operating income (loss)	$	440,863	32	%	$	(31,614	)	(4	)%	$	463,543	44	%	$	75,999	20	%	948,791			26	%

Selling, general & administrative expenses																		(1,132,505		)	(31	)%
Depreciation & amortization																		(246,380		)	(7	)%

Loss from Operations																		$	(430,094	)	(12	)%

9. Commitments and Contingencies

a. Lessee - The Company leases certain office space and equipment under non-cancelable operating and capital leases that expire at various times through fiscal 2006.

b. Lessor - The Company sub-leases a portion of its building to unrelated entities under operating leases which expire at various times through fiscal 2005. The Company leases to several tenants on a month-to-month basis.

c. Employment Agreements

On May 30, 2000, the Company entered into a three-year employment agreement with the Chief Executive Officer. On August 14, 2000, the Company entered into a two-year and a three-year employment agreement with two of its Vice Presidents. On January 2, 2001, the Company entered into a three-year employment agreement with its Chief Financial Officer. The agreements provide for annual salaries, paid vacations and other related benefits. The minimum annual compensation pursuant to such agreements, excluding provisions for fringe benefits (e.g., vacations, etc.), will be approximately $710,417 and $66,667 in fiscal years 2003 and 2004, respectively. These employment contracts were amended in 2003 (see Note 10, “Subsequent Events” for relevant information regarding changes to these contracts).

d. Guarantees

The Company indemnifies all directors and officers of the Company and any person who may have been identified by the Board of Directors. The Company is obligated, among other things, to indemnify the directors and officers of the Company against liabilities arising from their actions in their capacity as directors and executive officers. The obligation has no maximum and extends into perpetuity. The Company carries Directors and Officers (D&O) insurance of $1,000,000 for the benefit of such persons. Management expects such insurance would cover any costs that might be incurred under the indemnification agreements.

e. Litigation

The Company is involved, from time to time, in litigation that is incidental to its collection business. The Company regularly initiates legal proceedings as a plaintiff in connection with its routine collection activities. In management’s opinion, none of these legal matters individually will have a material adverse effect on the Company’s financial position or the results of its operations.

f. Other

As discussed in Note 3 (g), the practice of transferring funds collected on behalf of certain California-based delinquent debt clients to operating accounts or delay in remitting funds might be deemed a breach of the Company’s obligations. In July 2003, the Company reported that it has discontinued this practice and has taken steps to reduce the collections payable balance. The Company believes that a potential consequence of any such potential breach is that certain of our California-based delinquent debt collection clients may feel damaged and may request compensation. To the extent the Company is unable to reach an agreement with entities that request compensation; such entities may initiate legal efforts to pursue claims against the Company. In connection with the process to reduce the collections payable balance owed to certain of the Company’s California-based delinquent debt collection clients, the Company will contact those clients and offer to pay interest to those of which assert a claim as a result of the Company’s past practice.

We have provided copies of our reports on Form 8-K filed on July 10, 2003 and August 15, 2003, respectively, to the Division of Enforcement of the Securities and Exchange

Commission. Since that time, the SEC has notified the Company that it has begun an informal investigation involving the Company. The Company is cooperating with the SEC in this process. No provision has been included in the consolidated financial statements for the impact of an unfavorable outcome, if any, should occur.

10. Subsequent Events

a. Changes in Management Employment Agreements

Chief Executive Officer Manuel Occiano’s employment contract expired in May 2003. At this time the employment contract has not been renewed and Mr. Occiano’s employment is considered to be at will.

Chief Financial Officer, Frederick McGee resigned his position on July 28, 2003.

On August 29, 2003, Senior Vice President of Sales and Marketing Executive Robert Perez’ employment contract was extended to September 1, 2005 as part of the restructuring and extension of the note payable Mr. Perez.

On August 29, 2003, as part of the terms of the Exchange Agreement with Russell and Suzette Mohrmann and their affiliate Hospital Employee Labor Pool (HELP), Russell Mohrmann’s employment with the company was terminated.

b. Sale/Leaseback of Building

On May 21, 2003, the Company’s wholly owned subsidiary, Medical Control Services, Inc. (MCI), which held title to our corporate facility completed the sale of the property to SCP Park Meadows, LLC (SCP). On that same date, the Company entered into a Lease Agreement dated May 21, 2003 with SCP (the “Lease”). The net proceeds from the sale of the property, after paying off the existing mortgage on the property and paying commissions and expenses, and depositing $1,050,000 to a restricted account to collateralize the letters of credit used as rent deposits related to the subsequent lease of the property equaled $1,352,361. The transaction will be accounted for as a financing transaction with no gain or loss recorded and the proceeds recorded as a liability. The Lease provides, among other things, all of the following:

• a twelve year term, with two additional renewal options of five years each;

• base rent of $53,937 per month for the first three years of the Lease, with annual adjustments thereafter based on an index, subject to minimum and maximum annual increases;

• a tenant improvement allowance of $50,000;

• the Company has responsibility for various costs, including those associated with maintaining, insuring, repairing and replacing items on the property;

• security deposits in the form of two irrevocable letters of credits totaling $1,050,000, $400,000 of which is subject to release if we satisfy specified conditions no sooner than 12 months from the date of the transaction (May 21, 2004);

• the Company has an option to repurchase the property between the third and fifth years of the Lease term at a purchase price equal to the amount determined by dividing the annual base rent that otherwise would have been payable for the 12 months following the closing of the repurchase of the property by 8.5%; and

• the Company has an option to terminate the Lease between the third and fifth years of the Lease upon payment of a termination fee equal to 50% of the amount equal to the net present value of the aggregate base rent payments remaining through the Lease, using a discount rate of 8.5%.

c. Disposition of Segment

On August 29, 2003 the Company negotiated the disposition of its temporary staffing segment (the “Staffing Business”), and entered into an Exchange Agreement with Russell and Suzette Mohrmann and their affiliate, Hospital Employee Labor Pool, a California corporation, or HELP,

pursuant to which the transfer was consummated. Pursuant to the terms of the Exchange Agreement, HELP has acquired substantially all of the assets of the Staffing Business in exchange for: (1) the reduction of $1,900,000 of the indebtedness that the Company owed to the Mohrmanns and their affiliates under various notes that the Company had previously issued to them when the Company acquired a number of businesses from them in 2000, (2) the modification of the terms on the remaining $646,719 owed to the Mohrmanns, including the extension of the Company’s payment obligation, with payments of $25,000 now being due each month commencing approximately September 1, 2004, the termination of the security interest held by the Mohrmanns and the subordination of their debt to the Company’s other lenders. The impact of this disposition, had it occurred at beginning of fiscal 2003, would be a reduction in revenue for the three and six months ended March 31, 2003 of $606,129 and $1,143,972, respectively and an increase in loss from operations for the three and six months ended March 31, 2003 of $117,958 and $200,290, respectively.

d. Modifications to debt maturities/renegotiation of debt instruments

On September 28, 2001, the Company entered into a revolving line of credit agreement with two officers of the Company. The agreement permits borrowings up to $350,000 at the bank reference rate plus one percent. The line of credit is unsecured and expires on January 2, 2003. At September 30, 2002 we owed $350,000 on this line of credit. On January 2, 2003, the Company entered into an amendment with these officers in which the maturity date was extended to January 2, 2004. See next paragraph for additional information on this transaction.

In connection with the transfer of all of the assets of the staffing business, the Company further amended and restated the terms of the promissory note originally issued to these officers. In September 2001, the officers personally borrowed funds from a commercial bank and then loaned the proceeds to us. The Company agreed to make interest payments to their commercial lender to the same extent the officers were required to make payments under their commercial bank loan, which interest payments would be credited against the note the Company had issued. In June 2003, the terms of the officers’ commercial bank loan were modified to require monthly payments of principal in the amount of $25,000 plus all accrued but unpaid interest. Accordingly, the Company modified the terms of its promissory note in favor of the officers to provide for the same payment terms, which payments shall be paid directly by us to the commercial lender and shall be credited against the amended and restated note. The new and amended note expires in June 2004.

e. New financing

On February 11, 2003, the Company entered into a Business Financing Agreement (“Financing Agreement”) with Bridge Bank. The Company may borrow up to $2,500,000 under the conditions set forth in the Financing Agreement and the outstanding balance of principal and accrued interest under this Financing Agreement was $701,043 at March 31, 2003. The maximum amount we can borrow is contingent on and collateralized by qualified invoices, which will fluctuate from time to time depending on our business volume. As of December 31, 2003 we have borrowed the maximum amount available under this line. Part of the proceeds of this Financing Agreement was used to pay all outstanding principal and interest under the Company’s Line of Credit Agreement, which expired in February 2003. The obligations under the Financing Agreement are secured by first priority liens in all of the Company’s assets and the assets of its subsidiaries pursuant to the terms and conditions of security agreements. The obligations are also guaranteed by the subsidiaries under the terms and conditions of guaranties.

In November 2003, the Company entered into a “Business Financing Agreement” with Bridge bank whereby the Company borrowed $135,000. This amount was increased to $225,000 in January 2004. The proceeds of the note were used for working capital. The agreement, which bears interest at prime plus 4%, requires the Company to make 12 monthly principal and interest payments of $22,444 through February 2005. The obligation is guaranteed by FBR.

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

General

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this report. Certain statements included in this Management’s Discussion and Analysis of

Financial Condition and Results of Operations, as well as elsewhere in this Quarterly Report on Form 10-QSB, are forward-looking statements that involve risks and uncertainties. Such forward-looking statements include, without limitation, statements using words such as “may,” “potential,” “expects,” “believes,” “estimates,” “plans,” “intends,” “anticipates,” and similar expressions. These forward-looking statements are subject to risks and uncertainties that could cause actual results to vary materially from those expressed, implied or projected by such statements. Certain factors that might cause a difference as well as other risks are detailed in the Company’s Annual Report on Form 10-KSB for the fiscal year ended September 30, 2002. These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based.

Results of Operations:

Recovery Operations

Net Fees generated from its collection activities on receivables that the Company manages on behalf of fee-for-service clients showed a decrease of $149,090 and $ 384,617 for the quarter and six month period ended March 31, 2003 as compared to the quarter and six month periods ended March 31, 2002. The decrease relates to a general decline in placements from existing clients. In addition, contracts for certain clients were not renewed due to various reasons which include, among others, 1) the Company’s decision not to meet lower price and additional requirements; 2) certain clients were acquired by larger entities, 3) natural attrition and 4) general decline in prevailing rates charged for collection services as a result of increasing competition.

Direct Labor as a percentage of revenue decreased 7% and 5% between the same two quarters and six month periods, respectively due to the application of initiatives designed to reduce direct operating costs and improve employee productivity. Indirect Labor as a percentage of revenue also decreased 4% and 3% between the same respective periods for the same reasons. Other operating expenses remain relatively unchanged between the quarters ended March 31, 2003, and March 31, 2002 respectively, but showed an increase of $30,586 between the six month period ended March 31, 2003 and 2002. The increase is primarily due to increases in postage and customer data expenses incurred as part of installation costs for certain placements of accounts that were received in the first quarter of fiscal year 2003. The same amount of placements were not received in the first quarter of fiscal year 2002.

Physician Services

Revenue received for services to physician service organizations decreased by $274,084 and $477,820 for the three and six month-month periods ended March 31, 2003 as compared to the same period in 2002 due primarily to the termination of two significant contracts during the second half of fiscal year 2002. These clients decided to cease outsourcing the billing functions of their business. There were new contracts signed to replace the void created during the last quarter of fiscal year 2002 and this quarter but the cumulative volume of the new contracts were less than the volume lost from the two aforementioned clients. In addition these new contracts were in various stages of installation, which will tend to increase labor and operating costs as a percentage of revenue generated. Accordingly, direct labor as a percentage of revenue increased 14% between the same comparative periods. Indirect labor expenses and other direct operating expenses decreased due to cost reductions made as a result of the decrease in business volume in this segment.

Reimbursement Solutions

Revenue decreased by $315,244 and $559,674 for the quarters and six-month periods ended March 31, 2003 and March 31, 2002, respectively. The reductions were primarily due to completion of certain large non-recurring insurance follow-up projects in fiscal year 2002. In addition we also experienced reductions in recurring outsourced work from existing clients as they attempt to control their own

internal revenue sources by increasing the age of outsourced accounts. Direct labor as a percentage of revenue increased 11% and 16% for the quarters and six month periods ended March 31,2003 as compared to the same periods ended March 31, 2002. Most of these increases happened in the first quarter when the Company was increasing its staff to support a new engagement with a large hospital organization. Indirect labor as a percentage of revenue increased 2 % in both comparative periods due to the reduction in revenue. However, the actual dollar value of indirect labor decreased by $10,413 and $27,394 for the three and six month periods ended March 31, 2003 as compared to the same periods ended March 31, 2002, respectively. Other operating expenses decreased by $74,201 and $100,185 for the three and six-month periods ended March 31, 2003 as compared to the same periods ended March 31, 2002. Successful implementation of virtual private networks with our remote clients allowed us to directly access client computer systems and thereby significantly reducing travel, lodging and related client support costs.

Temporary Staffing

In June 2001, the Company executed certain measures to restructure the policies and procedures of this segment in anticipation of stricter requirements that the Company’s clients might impose on companies providing temporary staffing to healthcare organizations with respect to the protection and dissemination of patient information. Such measures include, among other things, background investigations and elevation of employee standards, which are applied to current and future staff in this segment. As a result, the Company displaced a large number of staff available for placement during the previous quarters. Displaced staff members are currently being replaced with those who conform to new standards. The restructuring process resulted in an increase in revenues in this segment to $606,129 and $1,143,972 during the three and six months ended March 31, 2003, respectively, as compared to $386,109 and $759,170 for the three and six months ended March 31, 2002. Direct labor as a percentage of revenue increased 4% for both comparative periods primarily due to increased rates we paid to better qualified temporary staffing employees in order to meet the new internal standards Indirect labor costs remained relatively the same for the comparative periods.. Other operating costs also remained relatively unchanged for the comparative periods. This business segment was discontinued during the latter part of the fiscal year 2003. See Note 10, “Subsequent Events” for more information.

Selling, General, and Administrative Expenses

Selling, general and administrative expenses decreased to $1,071,899 and $2,154,151 during the three and six months ended March 31, 2003 as compared to $1,132,505 and $2,373,900 for the three months ended March 31, 2002. The decrease is the effect of an ongoing initiative to reduce overhead expenses in the Company through reductions in administrative personnel.

Depreciation expense decreased 3% over the same comparative periods last year principally due to certain assets becoming fully depreciated.

Amortization expense for goodwill decreased to $0 for the three and six months ended March 31, 2003 from $132,240 and $264,480 for the three and six months ended March 31, 2002, respectively. This is due to the adoption of SFAS No. 142.

Interest expense increased to $199,046 and $389,510 for the three and six months ended March 31, 2003 from $172,332 and $340,184 for the three and six months ended March 31, 2002. The increases were the result of additional net borrowings during the period.

Net income from rental operations decreased by $20,685 and $21,666 from $29,533 and $45,236 for the three and six months ended March 31, 2002 to $8,848 and $23,570 for the three and six months ended March 31, 2003, due to an increase in property taxes, worker’s compensation insurance and utility expenses.

Liquidity and Capital Resources

Historically, we have financed our operations through cash flows generated by operations and borrowings from credit facilities that are in place as well as received funding from certain related party

sources. Capital expenditures and investments in new technology have been primarily financed through non-cancelable capital leases, which expire at various times through fiscal year 2006. As of March 31 2003, we have outstanding long-term debt with a financial institution in the form of a mortgage note on our building facility with a remaining balance of approximately $2,852,979 at a variable interest rate that approximates 8.5% and is due in January 2021. As of March 31, 2003, our net working capital deficit totaled $3,759,134. The Company has completed several transactions designed to meet the Company’s liquidity requirements including, among other things, the following significant transactions:

• On February 11, 2003, we entered into a Business Financing Agreement (“Financing Agreement”) with Bridge Bank. We may borrow up to $2,500,000 under the conditions set forth in the Financing Agreement and the outstanding balance of principal and accrued interest under this Financing Agreement was $418,913 at December 31, 2003. The maximum amount we can borrow is contingent on an collateralized by qualified invoices. As of December 31, 2003, we have reached the limit under this line. Our obligations under the Financing Agreement are secured by first priority liens in all of our assets and the assets of our subsidiaries pursuant to the terms and conditions of security agreements. Our obligations are guaranteed by our subsidiaries under the terms and conditions of guaranties.

• On May 21, 2003, we completed the sale of the corporate facility to SCP. The net proceeds from the sale of the property, after paying off the existing mortgage on the property and paying commissions and expenses, and depositing $1,050,000 to a restricted account to collateralize the letters of credit used as rent deposits to the subsequent lease of the property equaled $1,352,361. See Note 10, “Subsequent Events”, for further information.

• On August 13, 2003, the Company executed the relevant documents under which FBR agreed to provide the Company a $500,000 unsecured note. The proceeds of this note were used for working capital purposes. On August 29, 2003, the Company executed the relevant documents under which FBR agreed to provide the Company a $1,000,000 convertible note. The proceeds for the new $1,000,000 note from FBR will be used to reduce the collections payable to certain of the Company’s California-based delinquent debt collection clients.

• Interest rates on the notes were changed to the prime rate charged by the Company’s lender (5.5% at December 31, 2003) plus 4% per annum payable on the maturity date.

Critical Accounting Policies

Revenue Recognition

Allowance for Doubtful Accounts

The Company has generally improved the size and quality of its clients, which has reduced the level of write-offs. The financial condition of a potential client is reviewed to determine credit worthiness. Should a potential client’s credit worthiness come into question, the Company has two options; either reject the engagement or accept the client as a “Net” remit client. Under the “Net” remit option, the Company retains the portion of the collections that represent fees to the Company instead of remitting the entire amount collected and invoicing the client for the fees due.

Impairment of Long-Lived Assets

Item 3 Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s “disclosure controls and procedures” as of the end of the period covered by this report, pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures, as of the end of the period covered by this report, were effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic SEC filings. There has been no change in the Company’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.		Legal Proceedings

Not Applicable

Item 2.		Changes in Securities

Not Applicable

Item 3.		Defaults Upon Senior Securities

Not Applicable

Item 4.		Submission of Matters to a Vote of Security Holders

Not Applicable

Item 5.		Other Information

Not Applicable

Item 6.		Exhibits and Reports on Form 8-K

Exhibit		Name of Exhibit

10.1		Modification Agreement dated as of January 8, 2003 by and between the Registrant and Russ Mohrmann (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.1).

10.2		Modification Agreement dated as of January 8, 2003 by and between the Registrant and Rob Perez (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.2).

10.3		Amended and Restated Secured Convertible Promissory Note dated January 8, 2003 issued by the Registrant in favor of Russ Mohrmann and Suzette Mohrmann (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.3)

10.4		Amended and Restated Secured Convertible Promissory Note dated January 8, 2003 issued by the Registrant in favor of RBA Rem-Care, Inc. (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.4).

10.5		Amended and Restated Secured Convertible Promissory Note dated January 8, 2003 issued by the Registrant in favor of Insource Medical Solutions, Inc. (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.5).

10.6		Amended and Restated Secured Convertible Promissory Note dated January 8, 2003 issued by the Registrant in favor of Hospital Employee Labor Pool (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.6).

10.7		Amended and Restated Security Agreement dated January 8, 2003 by and among the Registrant and Russ Mohrmann (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.7).

10.8		Amended and Restated Employment Agreement dated January 8, 2003 by and between the Registrant and Russ Mohrmann (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.8).

10.9		Second Amendment dated January 2, 2003 by and among the Registrant and many Occiano and Russ Mohrmann (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.9).

10.10		Business Financing Agreement dated as of February 11, 2003 by and between the Registrant and Bridge Bank, National Association (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.10).

10.11		Form of Security Agreement dated as of February 11, 2003 by and between the Registrant, its subsidiaries and Bridge Bank, National Association (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.11).

10.12		Form of Guaranty dated as of February 11, 2003 by and between the Registrant’s subsidiaries and Bridge Bank, National Association (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.12).

10.13		Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate dated March 24, 2003 by and between the Registrant’s subsidiary, Medical Control Services, Inc., and SCP Park Meadows, LLC (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.13).

10.14		Addendum to Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate dated March 24, 2003 by and between the Registrant’s subsidiary, Medical Control Services, Inc. and SCP Park Meadows, LLC (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.14).

31.1		CEO Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		CFO Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		CEO Certifications pursuant to 18 U.S.C. Section 1350 as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		CFO Certifications pursuant to 18 U.S.C. Section 1350 as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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.

		REVCARE, INC.


Date:	January 29, 2004	By:	/s/ Manuel Occiano
			Manuel Occiano
			Chief Executive Officer


		By:	/s/ Ken Leighton
			Ken Leighton
			Acting Chief Financial Officer

Revcare (RVCR) Inactive 10QSB2003 Q2 Quarterly report (small business)

APPLICABLE ONLY TO CORPORATE ISSUERS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS