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 June 30, 2004

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 principal 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 August 12, 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 June 30, 2004 (unaudited)

	Condensed Consolidated Statements of Operations for the nine- month periods ended June 30, 2004 and 2003 (unaudited)

	Condensed Consolidated Statements of Operations for the three-month periods ended June 30, 2004 and 2003 (unaudited)

	Condensed Consolidated Statements of Cash Flows for the nine-month periods ended June 30, 2004 and 2003 (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

June 30, 2004

(UNAUDITED)

ASSETS
Current assets:
Cash	$	195,572
Restricted cash	1,370,593
Accounts receivable, net of allowance for doubtful accounts of $132,699	1,162,037
Prepaid expenses and other	448,860
Employee advances	90,000
Note receivable from customer, net of reserve of $127,500	—

Total current assets	3,267,062
Goodwill	7,490,793
Property and equipment, net	2,533,814
Note receivable from officer	100,000

Total assets	$	13,391,669

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Bank overdraft	$	117,942
Accounts payable	1,461,227
Collections payable to customers	1,705,986
Accrued liabilities	904,651
Lines of credit	282,595
Notes payable	390,000
Current portion of capital lease obligations	34,500
Current portion of notes payable to related parties	211,347
Current portion of financing obligation	382,162

Total current liabilities	5,490,410

Capital lease obligations, less current portion	29,304
Notes payable to related parties, less current portion	4,798,046
Financing obligation, less current portion	5,039,487

Total liabilities	15,357,247

COMMITMENTS AND CONTINGENCIES (Note 9)

SHAREHOLDERS’ EQUITY (DEFICIT):
Series A convertible, redeemable preferred stock, $0.001 par value, stated at $2 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	(13,285,380		)
	(1,915,578		)
Less common stock in treasury at cost, 33,000 shares	(50,000		)

Total shareholders’ equity (deficit)	(1,965,578		)

	$	13,391,669

The accompanying notes are an integral part of this condensed consolidated financial statement.

REVCARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE NINE MONTHS ENDED JUNE 30, 2004 AND 2003

(UNAUDITED)

	2004			2003
REVENUES
Service fees	$	5,721,858		$	7,046,710
Sale of portfolio receivables	111,134			—
	5,832,992			7,046,710

OPERATING EXPENSES:
Salaries, wages and related benefits	3,171,147			4,480,102
Other operating expenses	606,257			1,039,927
Selling, general and administrative	2,170,181			3,197,003
Depreciation and amortization	278,105			328,721
	6,225,690			9,045,753

OPERATING LOSS	(392,698		)	(1,999,043		)
OTHER INCOME (EXPENSE):
Interest expense, net	(632,348		)	(727,790		)
Rental operations, net	60,001			35,593
Other	10,575			(2,398		)
	(561,772		)	(694,595		)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(954,470		)	(2,693,638		)
INCOME TAX PROVISION				—

LOSS FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(954,470		)	(2,693,638		)

INCOME FROM DISCONTINUED OPERATIONS, NET OF TAXES	—			295,578

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

NET LOSS	$	(954,470	)	$	(3,974,388	)

BASIC AND DILUTED LOSS PER SHARE:
Loss from continuing operations before cumulative effect of change in accounting principle	$	(0.04	)	$	(0.12	)
Income from discontinued operations	—			0.01
Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	—			(0.07		)
Net Loss	$	(0.04	)	$	(0.18	)

Weighted average shares used in all calculations (basic and diluted)	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 JUNE 30, 2004 AND 2003

(UNAUDITED)

	2004			2003
REVENUES
Service fees	$	2,034,202		$	2,338,745
Sale of portfolio receivables	111,134			—
	2,145,336			2,338,745

OPERATING EXPENSES:
Salaries, wages and related benefits	973,986			1,389,297
Other operating expenses	206,264			340,486
Selling, general and administrative	741,891			1,042,852
Depreciation and amortization	89,203			106,911
	2,011,344			2,879,546
OPERATING INCOME (LOSS)	133,992			(540,801		)
OTHER INCOME (EXPENSE):
Interest expense, net	(166,221		)	(338,280		)
Rental operations, net	19,810			12,023
Other	10,575			(2,398		)
	(135,836		)	(328,655		)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND CUMULATIVE EFFECT CHANGE IN ACCOUNTING PRINCIPLE	(1,844		)	(869,456		)
INCOME TAX PROVISION	—			—

LOSS FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE	(1,844		)	(869,456		)

INCOME FROM DISCONTINUED OPERATIONS, NET OF TAXES	—			95,288

CUMULATIVE EFFECT ON PRIOR YEARS OF CHANGING METHOD OF ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES WITH INDEFINITE LIVES (NOTE 3 (j))	—			—
NET LOSS	$	(1,844	)	$	(774,168	)

BASIC AND DILUTED LOSS PER SHARE:
Loss from continuing operations before cumulative effect of change in accounting principle	$	(0.00	)	$	(0.04	)
Income from discontinued operations	—			—
Cumulative effect on prior years of changing method of accounting for goodwill and other intangibles with indefinite lives	—			—
Net Loss	$	(0.00	)	$	(0.04	)

Weighted average shares used in all calculations (basic and diluted)	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 CASH FLOWS

FOR THE NINE MONTHS ENDED JUNE 30, 2004 AND 2003

(UNAUDITED)

	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss from continuing operations	$	(954,470	)	$	(2,693,638	)
Adjustments to reconcile loss from continuing operations to net cash provided by (used in) continuing operations:
Depreciation and amortization	278,105			328,721
Sale of portfolio receivables	(32,097		)	—
Changes in operating assets and liabilities:
Decrease in accounts receivable, net	475,914			58,695
Increase in prepaid expenses and other	(99,323		)	(379,112		)
Increase in accounts payable	398,589			4,632
(Decrease) increase in collections payable to customers	(121,967		)	565,878
Net change in restricted cash	133,044			(1,030,617		)
Decrease in notes receivable	39,139			—
Decrease in accrued liabilities	8,476			6,163
Net cash used in continuing operations	125,410			(3,139,278		)
Income from discontinued operations	—			295,578

Net cash used in operating activities	125,410			(2,843,700		)

CASH FLOWS FROM INVESTING ACTIVITIES:
Sale (purchases) of property and equipment, net	2,903			(1,132		)

Net cash provided by (used in) investing activities	2,903			(1,132		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in lines of credit	(283,149		)	291,673
Proceeds from note payable	780,015			—
Net proceeds from financing obligation	—			5,786,633
Principal payments on financing obligation	(275,848		)	—
Increase in related party notes payable	150,000			—
Principal payments on notes payable	(135,000		)	(461,307		)
Principal payments on mortgage note payable	—			(2,886,894		)
Principal payments on related party notes	(225,000		)	—
Principal payments on capital lease obligations	(62,517		)	(70,167		)
Decrease in bank overdraft	(6,979		)	(77,972		)

Net cash (used in) provided by financing activities	(58,478		)	2,581,966

NET DECREASE IN CASH	69,835			(262,866		)

CASH, at beginning of period	125,737			882,712

CASH, at end of period	$	195,572		$	619,846

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH INVESTING AND FINANCING ACTIVITIES:
Interest paid	$	340,748		$	417,266
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

JUNE 30, 2004

(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 2003 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 consolidated financial position and consolidated 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, 2004.

2. Organization and Basis of Presentation

RevCare, Inc. 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 $3,572,112 for fiscal year 2003 and $954,470 and $1,844 for the nine months and quarter ended June 30, 2004, respectively. In addition, the Company had total shareholders’ deficit of $1,965,578 and a working capital deficit of $2,478,363 at June 30, 2004. The accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. The Company continues to initiate operational changes and seek financing transactions designed to meet the Company’s liquidity requirements, which include the following:

• Since the fiscal year 2002, the Company has initiated and completed various cost reduction initiatives. Such initiatives were expected to reduce annual operating costs by approximately $2.3 million in fiscal year 2004. For the nine months ended June 30, 2004 operating expenses related to continuing operations were $2,820,063 lower or 31% less than the same period in 2003. In addition, the Company generated operating income of $133,992 during the quarter ended June 30, 2004 as compared to an operating loss of $540,801 for the comparative quarter in 2003. On February 9, 2004, the Company formalized its offshore process initiative when it entered into an outsourcing agreement with Lighthouse Partners, Inc. (Lighthouse), a business process outsourcing company located in Manila, Philippines. Under the agreement, Lighthouse shall perform selected processes for the Company in Lighthouse’s facilities. These initiatives have been instrumental in the continuing improvement in the financial performance of the Company’s collection operations.

• 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 Financial Services Partners, L.P. (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. On February 9, 2004, the Company entered into a secured convertible note payable agreement for $250,000 with the principal owner of Lighthouse. On February 19, 2004 and March 16, 2004, the Company entered into secured convertible note payable agreements with FBR for $100,000 and $50,000, respectively. Finally, on March 17, 2004 (modified April 2, 2004 and August 5, 2004), the Company modified its Business Financing Agreement with Bridge Bank to allow the Company to draw up to $625,000 for working capital. As of, June 30, 2004, the outstanding balance of borrowings under this modified agreement was $390,000 (Note 11). The balance of this note is included in notes payable in the accompanying balance sheet.

Based on the financing activities and reductions in operating costs described above, management believes that the Company will have sufficient working capital required to pursue its strategic goals for fiscal year 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 inter-company 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 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.

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.

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 terms of the sale included a contingency payment of up to a maximum of $350,000. As of May 2004, the Company received additional consideration of $111,134 from the buyer for collections received through April 2004 that were subject to the contingency payment. This amount was recognized as revenue on sale of portfolio receivables in the accompanying financial statements and was settled by cash receipts of $79,037, the elimination of a $62,348 liability due to buyer and the collection of $30,251 receivables. Additional receipt of contingent payments will be dependent upon the success of the buyer in collecting the portfolio and securitized receivables; therefore, we are unable to predict the timing of any additional payments.

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.

The Company maintains 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.

The Company has generally improved the size and quality of its clients, which has reduced the level of write-offs over the last nine months and quarter ended June 30, 2004. 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.

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

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. Amounts are segregated and held in separate accounts are shown as restricted cash in the accompanying condensed consolidated balance sheet.

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. Restricted Cash

Restricted cash is primarily comprised of cash in clients’ trust accounts and lease deposits. As a condition of our lease agreement dated May 21, 2003, we set aside $1,050,000 in a restricted account to collateralize the letters of credit used as deposits to the subsequent lease of the property (see Note 6).

j. Goodwill

Goodwill represents the excess of cost over the fair value of net assets acquired and prior to our adoption of SFAS No. 142 was amortized 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 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, recording an impairment charge related to its HELP segment 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.

k. 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.

For the nine months ended June 30, 2004 and 2003, the computations of basic and diluted EPS were as follows:

	Nine Months Ended June 30,
	2004			2003

Loss from continuing operations before cumulative effect of change in accounting principle	$	(954,470	)	$	(2,693,638	)
Income from discontinued operations, net of taxes	—			295,578
Cumulative effect of change in accounting principle	—			(1,576,328		)
Net loss	$	(954,470	)	$	(3,974,388	)

Earnings (loss) per share (basic and diluted):
Loss from continuing operations before cumulative effect of change in accounting principle	$	(0.04	)	$	(0.12	)
Income from discontinued operations, net of taxes	—			0.01
Cumulative effect of change in accounting principle	—			(0.07		)
Net loss	$	(0.04	)	$	(0.18	)

Weighted average shares used in all calculations (basic and diluted)	21,526,909			21,526,909

	Three Months Ended June 30,
	2004			2003

Loss from continuing operations before cumulative effect of change in accounting principle	$	(1,844	)	$	(869,456	)
Income from discontinued operations, net of taxes	—			95,288
Cumulative effect of change in accounting principle	—			—
Net loss	$	(1,844	)	$	(774,168	)

Earnings (loss) per share (basic and diluted):
Loss from continuing operations before cumulative effect of change in accounting principle	$	—		$	(0.04	)
Income from discontinued operations, net of taxes	—			—
Cumulative effect of change in accounting principle	—			—
Net loss	$	—		$	(0.04	)

Weighted average shares used in all calculations (basic and diluted)	21,526,909			21,526,909

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

For the periods ended June 30, 2004 and 2003, the denominator in the diluted EPS computation was the same as the denominator for basic EPS due to the anti-dilutive effects of convertible preferred stock, warrants and stock options on the Company’s net loss. As of June 30, 2004 and 2003, the Company had outstanding warrants, stock options and convertible preferred stock of 2,779,908 and 2,176,158, respectively, that were anti-dilutive and excluded from the computation of dilutive EPS. Additionally, the computation of diluted net income per share excludes the effect common stock issuable upon conversion of the Convertible Notes (Notes 5 and 6) since their inclusion would also have had an anti-dilutive effect.

l. 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.

m. Reclassification

Certain amounts in the accompanying fiscal 2003 condensed consolidated financial statements have been reclassified to conform to the fiscal 2004 presentation.

n. Recent Accounting Pronouncements

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 FASB 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 adopted this Interpretation effective the end of the three months ended December 31, 2003, which did 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 did 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 June 30, 2004:

Land	$	866,575
Building	1,540,577
Equipment and furnishings	2,465,938

	4,873,090
Less - Accumulated depreciation	(2,339,276		)

	$	2,533,814

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, one of whom is still an employee of the Company. These notes have been paid and/or amended since that time. The remaining notes bear interest at the Prime rate of interest charged by the Company’s lender per annum (4.0% at June 30, 2004) plus 4% payable on September 1, 2005, the maturity date of the notes. The principal balance of these notes at June 30, 2004 was $1,878,990.

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 (4.0% at June 30, 2004) rate plus one percent. The line of credit is unsecured and expired in June 2004. As of June 30, 2004, the Company had fully paid its borrowings on this line of credit.

As of June 30, 2004, the total principal balance of the Company’s borrowings from FBR Financial Services Partners, L.P. (FBR), was $2,875,387 under secured convertible notes payable agreements. The significant attributes of these notes include the following:

• The maturity date is September 1, 2005 on notes totaling $2,722,325.

• Interest rates on the notes is the prime rate charged by the Company’s lender (4.0% at June 30, 2004) 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 these Notes 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 these Notes are 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 February 19 and March 16, 2004 the Company entered into secured convertible notes payable agreements for $100,000 and $50,000, respectively, with FBR. The notes bear interest at the prime rate, defined as the base rate on corporate loans posted by at least 75% of the nation’s 30 largest banks as recorded in the Wall Street Journal, (4.0% at June 30, 2004) plus four percent (4%), compounded quarterly. The principal and all accrued interest are due on November 1, 2005, the maturity date of the notes. All or any portion of the unpaid principal balance and any accrued but unpaid interest outstanding under this Note may be converted (the “Optional Conversion”) at any time at the option of the Holder into fully paid and nonassessable shares of capital common stock of the Company (the “Stock”). 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 calculated at the time of the Optional Conversion based on a Company valuation of 90% of 12 times the average prior 12 months monthly revenue prior to the Optional Conversion, the result will then be divided by the number of then outstanding shares on a fully converted basis.

The total interest expense on related party notes for the nine-month period and quarter ended June 30, 2004 is $309,654 and $110,025, respectively.

The notes are 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.

6. Notes Payable and Lines of Credit

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 (the minimum amount this can be according to the terms of the agreement is 4.25% at June 30, 2004) plus 2.5 percent. 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 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 outstanding balance on this line of credit at June 30, 2004 was $282,595, which was the maximum amount available to the Company under this line at that time.

In November 2003, the Company entered into a “Business Financing Modification Agreement” with Bridge bank whereby the Company borrowed $135,000. The amount borrowed increased to $225,000 in January 2004 and the capacity to borrow was increased to $625,000 in February 2004. The proceeds of the note were used for working capital. The agreement, which bears interest at prime as published in the Wall Street Journal Western edition (4.0% at June 30, 2004) plus 4.3%, required the Company to make 12 monthly principal and interest payments of $19,694 through February 2005. Under the Agreement, $625,000 is guaranteed by FBR. The cost to the Company for this guarantee is 8% of the total $625,000 or $50,000 due within 30 days of the end of the term of the note. The draws under these agreements amortize over twelve months. The principal balance outstanding under these modification agreements was $390,000 at June 30, 2004. As of August 5, 2004, the Company signed a “Business Financing Modification Agreement” which allows the Company to make additional advance of $287,083 on or before August 16, 2004 and only make interest payment each month. The total amount of advances shall not exceed $625,000 and is payable on or before August 5, 2005 (Note 11).

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 was 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 “Initial Release Date”. As of June 30, 2004, the Company did not meet the specified conditions.

• 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%.

On February 9, 2004 the Company entered into a secured convertible note payable agreement for $250,000 with the principal owner of Lighthouse. The note bears interest at the prime rate, defined as the base rate on corporate loans posted by at least 75% of the nation’s 30 largest banks as recorded in the Wall Street Journal, (4.0% at June 30, 2004) plus four percent (4%), compounded quarterly. The principal and all accrued interest are due on November 1, 2005, the maturity date of the note. All or any portion of the unpaid principal balance and any accrued but unpaid interest outstanding under this Note may be converted (the “Optional Conversion”) at any time at the option of the Holder into fully paid and nonassessable shares of capital common stock of the Company (the “Stock”). 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 calculated at the time of the Optional Conversion based on a Company valuation of 90% of 12 times the average prior 12 months monthly revenue prior to the Optional Conversion, the result will then be divided by the number of then outstanding shares on a fully converted basis.

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 consolidated 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 June 30, 2004.

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 three 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.

Below is a summary of the operating information by segment for the nine and three months ended June 30, 2004 and 2003, 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 nine months ended June 30, 2004 and 2003:

For the nine months ended June 30, 2004:

	Recovery				Physician Services					Reimburse- ment Solutions				Total
Revenue	$	3,762,824	100	%	$	879,020		100	%	$	1,191,148	100	%	$	5,832,992		100	%
Direct Labor	1,134,553		30	%	653,617			75	%	601,796		51	%	2,389,966			41	%
Indirect Labor	428,147		11	%	177,047			20	%	175,987		15	%	781,181			14	%
Other Expenses	326,330		9	%	214,171			24	%	65,756		5	%	606,257			10	%
Total Expenses	1,889,030		50	%	1,044,835			119	%	843,539		71	%	3,777,404			65	%

	$	1,873,794	50	%	$	(165,815	)	-19	%	$	347,609	29	%	$	2,055,588		35	%

Selling, general & administrative expenses														(2,170,181		)	-37	%
Depreciation & amortization														(278,105		)	-5	%

Operating income (loss)														$	(392,698	)	-7	%

For the nine months ended June 30, 2003:

	Recovery				Physician Services					Reimburse- ment Solutions				Total
Revenue	$	3,435,897	100	%	$	1,644,490		100	%	$	1,966,323	100	%	$	7,046,710		100	%
Direct Labor	1,229,896		36	%	1,171,866			71	%	945,277		48	%	3,347,039			47	%
Indirect Labor	526,326		15	%	357,504			22	%	249,233		13	%	1,133,063			16	%
Other Expenses	558,446		16	%	399,355			24	%	82,126		4	%	1,039,927			15	%
Total Expenses	2,314,668		67	%	1,928,725			117	%	1,276,636		65	%	5,520,029			78	%

	$	1,121,229	33	%	$	(284,235	)	-17	%	$	689,687	35	%	$	1,526,681		22	%

Selling, general & administrative expenses														(3,197,003		)	-45	%
Depreciation & amortization														(328,721		)	-5	%

Operating income (loss)														$	(1,999,043	)	-28	%

The following table summarizes the results of our reportable segments for the quarters ended June 30, 2004 and 2003:

For the three months ended June 30, 2004:

	Recovery				Physician Services					Reimburse- ment Solutions				Total
Revenue	$	1,489,101	100	%	$	253,913		100	%	$	402,322	100	%	$	2,145,336		100	%
Direct Labor	385,389		26	%	186,296			73	%	182,676		46	%	754,361			35	%
Indirect Labor	137,379		9	%	41,228			16	%	41,018		10	%	219,625			10	%
Other Expenses	103,572		7	%	77,713			31	%	24,979		6	%	206,264			10	%
Total Expenses	626,340		42	%	305,237			120	%	248,673		62	%	1,180,250			55	%

	$	862,761	58	%	$	(51,324	)	-20	%	$	153,649	38	%	$	965,086		45	%
Selling, general & administrative expenses														(741,891		)	-35	%
Depreciation & amortization														(89,203		)	-4	%

Operating income (loss)														$	133,992		6	%

For the three months ended June 30, 2003:

	Recovery				Physician Services				Reimburse-ment Solutions				Total
Revenue	$	1,184,995	100	%	$	586,876	100	%	$	566,874	100	%	$	2,338,745		100	%
Direct Labor	418,454		35	%	361,551		62	%	238,477		42	%	1,018,482			43	%
Indirect Labor	181,663		16	%	112,308		19	%	76,844		14	%	370,815			16	%
Other Expenses	216,978		18	%	107,173		18	%	16,335		3	%	340,486			15	%
Total Expenses	817,095		69	%	581,032		99	%	331,656		59	%	1,729,783			74	%

	$	367,900	31	%	$	5,844	1	%	$	235,218	41	%	$	608,962		26	%
Selling, general & administrative expenses													(1,042,852		)	-45	%
Depreciation & amortization													(106,911		)	-4	%

Operating income (loss)													$	(540,801	)	-23	%

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 2015.

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 - The Company has an employment agreement with its Senior Vice President - Sales which expires on September 1, 2005.

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 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 - 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. Shortly thereafter, the SEC has notified the Company that it has begun an informal investigation involving the Company. The Company has cooperated with the SEC in this process, but has not heard from them since as to the status of the investigation. No provision has been included in the condensed consolidated financial statements for the impact of an unfavorable outcome, if any, should occur.

10. Disposition of Business Segment

On August 29, 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 we transferred substantially all of the assets related to our administrative and back office temporary staffing division (the “Staffing Business”). Pursuant to the terms of the Exchange Agreement, HELP has acquired substantially all of the assets of the Staffing Business. This division specialized in providing temporary staffing to hospital organizations and physician service organizations. Temporary staffing provided to its clients included administrative, financial, as well as clinical and operational personnel.

In connection with the disposition, the Company wrote off the remaining goodwill attributable to this segment of $554,559, de-recognized the $1.9 million amount payable to Mr. Mohrmann, and recognized a gain of $1,253,767. The results of operations attributable to the Staffing Business have been shown as discontinued operations for the nine-month period and quarter ended June 30, 2003 in the accompanying condensed consolidated statements of operations.

The following table summarizes the results of operations for the Temporary Staffing Division for the three and nine months ended June 30, 2003:

For the nine months ended June 30, 2003:

Revenue	$	1,712,533	100	%
Direct Labor	1,265,275		74	%
Indirect Labor	102,210		6	%
Other Expenses	49,470		3	%
Total Expenses	1,416,955		83	%

Operating income (loss)	$	295,578	17	%

For the quarter ended June 30, 2003:

Revenue	$	568,561	100	%
Direct Labor	426,467		75	%
Indirect Labor	33,516		6	%
Other Expenses	13,290		2	%
Total Expenses	473,273		83	%

Operating income (loss)	$	95,288	17	%

11. Subsequent Event

On August 5, 2004, the Company signed a “Business Financing Modification Agreement” with Bridge Bank whereby it may request an additional $287,083 advance on or before August 16, 2004. The additional advance of $287,083 plus the balance owed to Bridge Bank as of June 30, 2004 of $390,000 (Note 6) less the principal payment made after June 30, 2004 of $52,083 equals $625,000, which is the maximum amount of all advances that could be made. The loan which bears interest at prime published in the Money Rates section of the Western Edition of the Wall Street Journal, or 4.25% whichever is greater plus 4.3% shall be due on August 5, 2005. The Company shall pay Bridge Bank only the interest (placeholder advance fee) on each month (reconciliation date) before the due date of the entire principal. Under the agreement, $625,000 is guaranteed by FBR Financial Services Partners, L.P. Also, the agreement is conditioned upon the Company delivering a signed warrant to purchase stock with terms and conditions acceptable to Bridge Bank, granting the latter a right to purchase 100,000 shares of the Company’s common stock at $0.25 per share, bearing a term of seven years.

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, 2003. 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 collection activities on receivables that the Company manages on behalf of fee-for-service clients showed increases of $326,928 and $304,106 for the nine-month period and quarter ended June 30, 2004, respectively as compared to the nine-month period and quarter ended June 30, 2003. This increase is attributable to a net gain on sale of portfolio receivables of $111,134 and improved collections on existing account inventory. Direct Labor as a percentage of revenue showed a decrease of 6% for the nine-month period ended June 30, 2004 as compared to the same period ended June 30, 2003 due to the application of initiatives designed to reduce direct operating costs and improve employee productivity during the periods presented which include, among other initiatives, the utilization of offshore processes. Indirect Labor and other operating expenses as a percentage of revenue also decreased slightly between the nine-month period ended June 30, 2004 for the same reasons. Total labor costs decreased by approximately $193,522 and $77,349 and non labor operating costs decreased by approximately $232,116 and $113,406 between the comparable nine-month periods and quarters, respectively. The changes in Net Fees and related expenses resulted in an increase in contribution from this segment’s operations of approximately $752,565 and $494,861 during the comparable nine-month periods and quarters ended June 30, 2004 and 2003.

Physician Services

Revenue received for services to physician service organizations decreased to $879,020 and $253,913 for the nine-month period and quarter ended June 30, 2004, as compared to $1,644,490 and $586,876 the same periods in 2003, due primarily to the reduction in client base in this segment. There were new contracts signed to replace the void, but the cumulative volume of the new contracts were less than the volume lost from the previous clients. Accordingly, significant cost reductions were made resulting in a decrease in direct and indirect labor costs of $698,706 and $246,335 between the two comparable nine-month periods and quarters ended June 30, 2004 and 2003, respectively. Additionally, non-labor operating expenses decreased by $185,184 and $29,460, during the comparable periods for the same reasons. As a result of these changes, losses in this segment decreased to $165,815 as compared to $284,235 for the nine-month periods ended June 30, 2004 and 2003. For the quarters ended June 30, 2004 and 2003, loss and income from segment operations were $51,324 and $ 5,844, respectively. Management expects to continue further cost reductions in this segment until new clients are obtained.

Reimbursement Solutions

Revenue decreased by $775,175 and $164,552 for the nine-month period and quarter ended June 30, 2004 as compared to the nine-month period and quarter ended June 30, 2003. The reduction was primarily due to completion of certain large non-recurring insurance follow-up projects in fiscal year 2003. In addition, we also discontinued our services on certain recurring outsourced work from existing clients due to financial difficulties experienced by such clients. New clients and projects were signed during the latter part of the quarter ended June 30, 2004. We expect the impact of these new clients and projects to occur in the months succeeding June 2004. Direct and indirect labor decreased $416,727 and $91,627, respectively, between the comparable nine-month periods and quarters as a result of cost reduction initiatives predicated by the decrease in business volume in this segment. Additionally, other operating expenses decreased by $16,370 for the nine-month period and remained relatively the same for the quarter ended June 30, 2004 as compared to the same nine-month period and quarter ended June 30, 2003 for the reasons discussed above. The changes in Net Fees and related expenses resulted in a decrease in contribution from this segment’s operations of approximately $342,078 and $81,569 during the comparable nine-month periods and quarters ended June 30, 2004 and 2003. We do not expect a significant increase in operating costs as a result of the aforementioned new clients and projects.

Temporary Staffing

This business segment was discontinued in August 2003.

Selling, General, and Administrative Expenses

Total payroll costs decreased by $667,099 and $161,684 during the nine-month period and quarter ended June 30, 2004 as compared to June 30, 2003. Non-payroll costs decreased by $359,722 and $139,276, respectively, for the same comparable periods. The decrease was a result of continued implementation of cost reduction initiatives designed to improve the financial performance of the Company.

Depreciation expense decreased by $50,616 and $17,708 for the nine-month period and quarter ended June 30, 2004 as compared to June 30, 2003, as more of the Company’s depreciable assets become fully depreciated. There were no significant additions to depreciable assets in the periods presented. Amortization expense ceased completely due to adoption of SFAS No. 142. Net interest expense decreased by $95,442 and $172,059 for the nine-month periods and quarters ended June 30, 2004, respectively, due to lower interest rates prevailing during the current period and a decrease in the total borrowings during the comparable periods. Income from rental operations increased by $24,408 and $7,787 for the comparable periods due to increases in the number of sub-lease tenants.

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 June 30, 2004, our net working capital deficit totaled $2,478,363. Management believes that the previous losses are attributable to the various acquisitions in 2000, the integration of those operations and the implementation of technology and processes to pursue our 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 we serve which may require the Company to seek alternative sources for cash to support its growth and ongoing operations. Accordingly, the Company continues to pursue potential financing transactions and operational changes designed to meet the Company’s liquidity requirements, which now include the following:

• Since the fiscal year 2002, the Company has initiated and completed various cost reduction initiatives. Such initiatives were expected to reduce annual operating costs by approximately $2.3 million in fiscal year 2004. For the nine months ended June 30, 2004 operating costs were $2,820,063 lower than the same period in 2003. On February 9, 2004, the Company formalized its outsourcing initiative when it entered into an outsourcing agreement with Lighthouse Partners, Inc. (Lighthouse), a business process outsourcing company located in Manila, Philippines. Under the agreement, Lighthouse shall perform selected processes for the Company in Lighthouse’s facilities. The process has been instrumental in the continuing improvement in the financial performance of the Company’s collection operations.

• 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 Financial Services Partners, L.P. (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. On February 9, 2004, the Company entered into a secured convertible note payable agreement for $250,000 with the principal owner of Lighthouse. On February 19, 2004 and March 16, 2004, the Company entered into secured convertible note payable agreements for $100,000 and $50,000, respectively. Finally, on March 17, 2004 (modified April 2, 2004), the Company modified its Business Financing Agreement with Bridge Bank to allow the Company to draw up to $625,000 for working capital. As of, June 30, 2004, the outstanding balance of borrowings under this modified agreement was $390,000.

Critical Accounting Policies

Revenue Recognition

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.

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.

Allowance for Doubtful Accounts

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.

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

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.

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, 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 has 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

31.1		CEO 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

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:	August 12, 2004	By: /s/	Manuel Occiano
			Manuel Occiano
			Chief Executive Officer and
			Acting Chief Financial Officer

Revcare (RVCR) Inactive 10QSB2004 Q3 Quarterly report (small business)

APPLICABLE ONLY TO CORPORATE ISSUERS

REVCARE, INC. AND SUBSIDIARIES