**U.S. SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

| **ý** | ** ** | **ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE**** ****SECURITIES EXCHANGE  ACT OF 1934**                               |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                           |
|       |       | **for the fiscal year ended December 31, 2004**                                                                                 |
|       |       | ** **                                                                                                                           |
|       |       | **OR**                                                                                                                               |
|       |       |                                                                                                                                 |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                  |
| ** ** | ** ** | ** **                                                                                                                           |
| ** ** | ** ** | **For the transition period from        to        ** |

 

**Commission File Number: 001-15667**

 

**PRECIS, INC.**

(Exact name of business issuer as specifiedin its charter)

 
| **OKLAHOMA**                                                    |       | **73-1494382**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |
|                                                            | ** ** |                                 |
| **2040 N. HWY 360**                                             |
| **GRAND PRAIRIE, TEXAS 75050**                                  |
| (Address of principal executive offices)                        |
|                                                            |       |                                 |
| **(866) 578-1665**                                              |
| (Issuer’s telephone number)                                |

 

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Securities registered underSection 12(b) of the Exchange Act: **None**

 

Securities registered underSection 12(g) of the Exchange Act:

**Common Stock, $0.01 Par Value**

 

Indicate by check mark whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during thepast 12 months (or for such shorter periods that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to item 405 ofRegulation S-K is not contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. Yes  ̈

 

Indicate by check mark whether the registrant is an accelerated filer(as defined by Rule 12b-2 of the Act.) Yes  ̈  No x

 

The aggregate market value of the voting and non-voting common equityheld by non-affiliates of the registrant as of June 30, 2004 (the lastbusiness day of our most recent second fiscal quarter), was $20,872,394 basedon the closing sale price on that date.

 

As of April 13,2005, 12,011,843 shares of the issuer’s common stock, $.01 par value, wereoutstanding.

 

 

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**PRECIS, INC.**

**FORM 10-K**

**For the Fiscal Year Ended December 31,2004**

 

**TABLE OF CONTENTS**

 
|       |                                                                                                                  | **Page** |
|------------|-----------------------------------------------------------------------------------------------------------------------|----------|
| Part I.    |                                                                                                                  | 3        |
| Item 1.    | Description of Business                                                                                               | 3        |
| Item 2.    | Description of Properties                                                                                             | 20       |
| Item 3.    | Legal Proceedings                                                                                                     | 20       |
| Item 4.    | Submission of Matters to a Vote of Security  Holders                                                                  | 22       |
|       |                                                                                                                  |     |
| Part II.   |                                                                                                                  | 22       |
| Item 5.    | Market for the Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchase of Equity Securities | 22       |
| Item 6.    | Selected Financial Data                                                                                               | 25       |
| Item 7.    | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                           | 26       |
| Item 7A.   | Quantitative and Qualitative Disclosures  About Market Risk                                                           | 37       |
| Item 8.    | Financial Statements and Supplementary Data                                                                           | 37       |
| Item 9.    | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure                                 | 38       |
| Item 9A.   | Controls and Procedures                                                                                               | 38       |
| Item 9B    | Other Information                                                                                                     | 39       |
|       |                                                                                                                  |     |
| Part III.  |                                                                                                                  | 39       |
| Item 10.   | Directors, Executive Officers, Promoters  and Control Persons; Compliance with Section 16(a) of the Exchange Act | 39       |
| Item 11.   | Executive Compensation                                                                                                | 43       |
| Item 12.   | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                       | 48       |
| Item 13.   | Certain Relationships and Related  Transactions                                                                       | 50       |
| Item 14.   | Principal Accounting Fees and Services                                                                                | 51       |
|       |                                                                                                                  |     |
| Part IV.   |                                                                                                                  |     |
| Item 15.   | Exhibits and Financial Statement Schedules                                                                            | 51       |
|       |                                                                                                                  |     |
| SIGNATURES |                                                                                                                  | 53       |

 

**CAUTIONARY STATEMENT REGARDINGFORWARD-LOOKING INFORMATION**

 

Certain statements under the captions “Item 1. Description of Business,”“Item 7. Management’s Discussion and Analysis of Financial Condition andResults of Operations,” and elsewhere in this report constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. Certain, but not necessarily all, of such forward-lookingstatements can be identified by the use of forward-looking terminology such as “anticipates,”“believes,” “expects,” “may,” “will,” or “should” or other variations thereon,or by discussions of strategies that involve risks and uncertainties. Ouractual results or industry results may be materially different from any futureresults expressed or implied by such forward-looking statements. Some of thefactors that could cause actual results to differ materially are describedunder the heading “Additional Factors That May Affect Our Future Results” andinclude general economic and business conditions, our ability to implement ourbusiness strategies, competition, availability of key personnel, increasingoperating costs, unsuccessful promotional efforts, changes in brand awareness,acceptance of new product offerings, retention of members and independentmarketing representatives and changes in, or the failure to comply withgovernment regulations.

 

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**PARTI**

 

**ITEM1. DESCRIPTION OF BUSINESS**

 

Precis, Inc. (“Precis, we or the Company”) primarily offersmemberships in programs that offer savings on a wide range of healthcareservices. Substantially all of our revenue is derived from our healthcaremembership savings programs, which is our primary business segment. See Note 15– Segmented Information in the Financial Statements included herein. For theyear ended December 31, 2004, 86.1% of our consolidated revenue was fromour healthcare membership savings programs. The remaining 13.9%  is derived primarily from providingfull third party administration services to adjudicate and pay medical claimsfor employers who have self-funded at least a portion of their healthcarecosts.

 

Our programs offer savings on healthcare services to persons who areun-insured, under-insured, or who have elected to purchase only high deductibleor limited benefit medical insurance policies, by providing access to the samepreferred provider organizations (PPOs) that are utilized by many insurancecompanies and employers who self-fund at least a portion of their employees’healthcare risk. These programs are sold primarily through a network marketingstrategy under the name Care EntréeTM, but are also offered through resellerswho have privately labeled or co-branded the Care EntréeTM services and throughemployers as part of an employee benefit plan.

 

We design these programs to benefit healthcare providers as well as ourprogram members. Providers commonly give reduced or preferred rates to PPOnetworks in exchange for steerage of patients. However, the providers muststill file claim forms and wait 30 to 60 days to be paid for theirservices. Our programs utilize these same provider networks to obtain the samesavings for the Care EntréeTM program members. However, the healthcare providersare paid much more promptly and without the oversight of the typical claimsreview processes of an insurance company. We provide transaction facilitationservices to both the program member and the healthcare provider.

 

Wealso offer full third party administration services through our wholly-ownedsubsidiary, Access HealthSource, Inc., (“Access”).  Access helps us offer a more complete suiteof healthcare services. We are now able to provide individuals and employeegroups access to preferred provider networks, medical escrow accounts and fullthird party administration capabilities to adjudicate and pay medicalclaims.  We acquired Access in the secondquarter of 2004 and its results of operations have contributed favorably to ourconsolidated results.  Access hassuccessfully secured multi-year contracts on favorable terms with its twolargest clients and has brought us a stable source of revenue.  Moreover, we have realized certain intangiblebenefits from the acquisition.  Forinstance, we have broadened the management responsibilities of several membersof Access’ management team to company-wide roles.  Our new Chief Operating Officer, FrankApodaca, is the President and C.E.O. of Access and he will be implementing, ona company-wide basis, operational controls that have been successful at Access.

 

2004was a difficult year for the Company. The combination of decreasing revenues resulting from a more complexescrow-based healthcare savings product, a frustrated independent marketingsales force, and increased expenses from, among other things, new compensatorysales initiatives produced an operating loss. We discuss these results in detail throughout this report.  In the first quarter of 2005, we haveundertaken measures and initiatives to improve our operating performance.  These measures and initiatives include (i)the integration of Access management members with our management team, asmentioned above, (ii) the termination of certain equipment capital leases,(iii) other cost reduction actions, and (iv) exploration of additional productsto compliment our core healthcare savings product and offer additionalcompensatory incentives to our independent marketing representatives.

 

**INDUSTRY OVERVIEWS**

 

**CONSUMER HEALTHCARE INDUSTRY.**  The healthcare industry remains in a state ofturmoil and crisis. It is estimated that 15.6% of all Americans, or45.0 million individuals, were without health insurance coverage in 2003,up from 15.2% in 2002, an increase of 1.4 million people. [Source: “U.S.Census Bureau Statistics” published by the U.S. Department of Commerce.] Thepercentage of people working full-time without health insurance in 2003 was17.5%, an increase from 16.8% in 2002. [Source: “U.S. Census Bureau Statistics”published by U.S. Department of Commerce] Nationally, healthcare expenditurestopped $1.7 trillion in 2003, up from $1.2 trillion since 1999, [Source:Centers for Medicare and Medicaid Services.]

 

At the workplace, the trends are equally problematic. Between 2003 and2004, monthly premiums for employer-sponsored health insurance rose 11.2%, thefourth consecutive year of double-digit premium increases. The increases

 

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are hitting small employers (under 200 workers) particularly hard.These small firms are more likely to have experienced an increase in premiumsgreater than 15%. These costs are not only being felt by the employer, but alsoby the employees. The average monthly worker contribution for single and familyhealthcare coverage rose from $8 and $52, respectively, in 1988 to $47 and $222in 2004. All told, the average monthly premiums for single and family coverage(including worker and employer share of premium) are $308 and $829respectively. The cost of family coverage is now nearly $9,950 per year. Notsurprisingly, employers are looking for alternatives. In 2004, 56% of employersreported that they shopped for a different healthcare arrangement. [Source: “EmployerHealth Benefits 2004 Summary of Findings”, published by the Kaiser FamilyFoundation]

 

Over utilization of the healthcare system is one of the factors behindthese trends. American citizens are utilizing healthcare services at anever-increasing rate. Behind this phenomenon is the fact that insurance plansand healthcare management organizations are structured to encourage usage.Small co-payments, generally from $10 or $15 per office visit, encourageinsured consumers to use the healthcare system more frequently because they donot perceive themselves ultimately as having to pay the full costs of the medicalservices received.

 

A number of insurers have pulled out of certain states, due to stateregulations that no longer provide for a viable operating environment for manyinsurance companies. As a result of these health coverage cancellations, thoseformerly insured individuals and families are required to pay more for theirinsurance coverage, cannot obtain any coverage because of pre-existingconditions, or simply remain uninsured for healthcare.

 

Corporate America has been hit hard by escalating insurance costs andmany companies are reacting by shifting the cost of insurance coverage toemployees or cutting benefits. Fifty two percent (52%) of large companies (200or more workers) report they are very or somewhat likely to increase theiremployee’s share of the costs of healthcare in 2004. [Source: “Employer HealthBenefits 2004 Summary of Findings,” published by The Kaiser Family Foundation.]This creates a dilemma for the employer, it being difficult to attract and hirequality personnel without providing health benefits at a reasonable cost to theemployee, while the cost of providing employee healthcare benefits may beprohibitive or unaffordable.

 

Tensions between medical providers and the payors are also escalating.The medical decision is often no longer in the hands of the doctor and thepatient. Rather, administrators at healthcare management organizations andinsurance companies determine the procedures to be performed. Doctors andhospitals, having experienced decreases in their income and profits, aredemanding higher compensation, particularly from the healthcare managementorganizations.

 

As a result, more Americans are being forced to self-insure and pay agrowing portion of the cost of their healthcare. Some are entirely uninsured.Others can only afford or choose only a high deductible or limited benefithealth insurance policy. In either case, this patient population increasinglyforgoes medical procedures or relies on emergency care for its healthcare needsand often incurs prohibitive expenses. Additionally, costs of healthcare (indoctors’ offices and hospitals) for this patient population are often farhigher than the amount an insured and the insurance company would pay for thesame healthcare services for its insureds. The uninsured and underinsuredpatients have had no one to negotiate healthcare service costs on their behalf.

 

Additionally,the Bush administration has recently proposed federal legislation which wouldallow individuals who establish Health Savings Accounts (“HSAs”) to deduct fromtheir income taxes the premiums they pay for their high-deductible polices,thus reducing the net cost of those policies. Individuals who set up HSAs can save substantial sums on their healthinsurance and their taxes.  Moreover,HSAs are expected to give Americans more control over their health carespending.  President Bush has alsoproposed giving low-income families a $1,000 contribution made directly totheir HSA, along with a $2,000 refundable tax credit to help purchasehealthcare insurance covering major medical expenses.

 

**OUR CONSUMER HEALTHCARE SAVINGS SOLUTION—CAREENTRÉETM**

 

Our consumer healthcare savings membership programs are offered underthe trade name of Care EntréeTM and are designed in response to risinghealthcare costs and the growing number of people that can no longer affordinsurance coverage. Our healthcare savings programs are based upon andemphasize the following factors:

 

•              responsibilityfor the use of healthcare must be put back in the hands of the patient. Insurancepolicies with low co-pays and deductibles have become very popular; however,these arrangements actually encourage the over-utilization that increases thecosts of healthcare;

 

•              thehealthcare decision must be put back in the hands of the doctor and thepatient; without undue oversight by parties with only economic interests in thedecision; and

 

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•              healthcaremust be affordable for the patient, while providing the medical providers withadequate payment on a timely basis for services provided.

 

For years, insurance companies have been reaping the benefits ofmanaged care by obtaining healthcare for their insureds at much lower pricesthan that obtainable by the self-insured person. These benefits were providedthrough the use of preferred provider organizations (PPOs), where steerage ofpatients was promised in exchange for lower rates. We have contracted with someof these same PPOs to provide healthcare savings to our program members.

 

The elements discussed below are critical to the operation, furtherdevelopment, and offering of our managed healthcare programs.

 

•              *A medical provider network that provides an effectiveand efficient means to deliver healthcare savings to the patient who is atleast partially self-insured*. We have accomplished this througharrangements with reputable, high quality preferred provider organizations. Ourmedical PPO network gives our members access to over 400,000 providers and3,600 facilities throughout the U.S.

 

•              *A computer system that can handle all thecomplexities of healthcare billing and fee schedules with speed and accuracy,enabling efficient re-pricing of medical bills, which is essential in ourinteraction with doctors’ offices*. Accordingly, we have developedin-house systems for immediate eligibility verification and re-pricing ofmedical bills independently as well as with the electronic repricing systems ofour medical PPO network.

 

•              *A staff with managed care backgrounds that interactswith the healthcare providers*. Managed healthcare is an art. Noteveryone has the background to interact professionally and courteously with thethousands of people representing the providers in the network. Our staff isadequately trained to provide customer support and member steerage so that ourmembers can achieve additional medical savings by obtaining the best rates evenwithin the same medical provider network. The backgrounds of our staff includemanaging of claims offices, insurance sales, managing of physicians and physiciansgroups, hospital management, captive physician management, self-funding ofhealthcare, healthcare finance, sales and management of managed care software,and management of physician “front offices”.

 

•              *A commitment to “hands on” customer service for boththe patient-member and the healthcare provider*. Most physicians andhospitals are in multiple preferred provider organization networks and do notknow the negotiated rates at the time and point of healthcare service. Webelieve it is important that our services allow these providers to contact usat the time and point of service for this information so that they canimmediately arrange for the collection of amounts due for the servicesprovided; and

 

•              *Credibility with providers who expect prompt paymentin exchange for access to reduced* rates. During the fourth quarterof 2002, we implemented escrow account requirements in response to the marketchanges in the healthcare savings industry. Members of our Care EntréeTM programare now required to establish and maintain escrow accounts to access andprovide payment for hospital and physician healthcare services. We are thenable to pre-certify the members’ ability to pay based upon the available escrowaccount balances and to process the members’ payments directly to the medicalproviders. This helps us assure that the payment to the provider is madepromptly and efficiently. Foresight, Inc., a licensed third partyadministrator (TPA), administers the accounts. Effective October 1, 2003,these escrow accounts were made mandatory for access to all medical doctors andhospitals. By December 31, 2004, our cash-in-trust, which represents theaggregate amount that our members have on deposit in their escrow accounts was$4.9 million. Our private label partners are not required to offer theseaccounts to their members.

 

The combination of these elements has allowed us to become the “patientadvocate.” We routinely assist our program members in saving 15% to 50% ontheir medical bills, and frequently more, by steering them to the most costeffective healthcare providers in their area. We allow the patient and thehealthcare provider to decide treatment protocols with no interference from anythird party. We facilitate the financial transaction between the healthcare providerand patient-member to allow the provider to receive prompt payment. Finally,because the patient-member is directly responsible for a significant portion ofhis or her medical expenses, the patient has an incentive to minimizeutilization to achieve cost savings, regardless of whether the patient has ahigh deductible insurance policy or is self-insured.

 

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Our membership program encompasses all aspects of healthcare, includingphysicians, hospitals, ancillary services, dentists, prescription drugs, visioncare, hearing aids, chiropractic and alternative care, air ambulance, 24-hournurse hotline assistance, and long term care. Memberships in our Care EntréeTMprograms range from $9.95 to $69.95 per month per family depending on theselected options, plus a one-time enrollment fee of $20.00 to $30.00.

 

**Affordable Healthcare Insurance and Financial Products**

 

Commencingin September 2003, through our subsidiary, Care Financial of Texas, L.L.C.(“Care Financial”), we began offering our high deductible and scheduled benefitinsurance policies. In addition, we have recently added a suite of productsincluding life insurance and annuities, along with health savings accounts(HSAs), Healthcare Reimbursement Arrangements (HRAs) and medical and dependentcare Flexible Spending Accounts (FSAs) offered through Care125, a division ofour Foresight, Inc. subsidiary (“Foresight”). The high deductible and scheduledbenefit insurance policies, HSAs, HRAs and medical and dependent care FSAs,when combined with the Care EntréeTM program, offer affordable, well-roundedsolutions for individuals and employers who are no longer able to afford orobtain traditional health insurance policies. While these products are usuallysold by licensed life and health insurance agents, the HRAs and medical anddependent care FSAs are also sold by our independent marketing representativeswho, from a regulatory standpoint, are not required to be licensed to sellthese products. The life insurance products serve to complement our healthcareproduct offerings by addressing our members’ overall financial condition. Theinsurance policies are sold through our independent marketing representativeswho are licensed insurance agents.

 

**OUR GROUP AND WHOLESALE PRODUCTS**

 

We offer three wholesale membership service solutions:

 

*Private Label and Co-Brand HealthcarePrograms*

 

We design and offer healthcare membership programs for employer groups,retailers and association-based organizations. These programs are marketedunder our “For Your Good Health” label or the privately labeled name of ourclient. Membership in these programs are offered and sold by direct sales orthrough marketing companies that ask prospective customers to call a customerservice center for more information (in-bound direct marketing). We believethat our clients, their members, and the vendors of the products and servicesoffered through the programs, all benefit from our membership service programs.The products and services are bundled, priced and marketed utilizingrelationship marketing strategies or inbound direct marketing to target theprofiled needs of the clients’ particular member base.

 

*Repricing for Governments and OtherSelf-Funded Employers*

 

For governments and other large, self-funded employers seeking toreduce the cost of offering healthcare benefits to their employees, we can alsooffer a more streamlined version of our product. In these cases, we offeraccess to healthcare through our network of providers and the efficientrepricing of bills through our proprietary systems. We offer these services fora price based on either the number of participants per month or as a percentageof savings on healthcare costs actually realized.

 

On June 18, 2004, weacquired Access, a full-service third party administrator, for a purchase priceof $3.4 million, consisting of $2,000,000 of cash and $1,400,000 of our commonstock (488,486 shares).  Through theacquisition of Access, we now provide a wide range of healthcare claims administrationservices and other cost containment procedures that are frequently required bygovernments and other large employers who have chosen to self fund theirhealthcare benefits requirements. Access helps us offer a more complete suiteof healthcare services.  Also throughAccess, we provide individuals and employee groups access to preferred providernetworks, medical escrow accounts and full third party administrationcapabilities to adjudicate and pay medical claims.  From a sales distribution standpoint, we havethe ability to grow Access’ regional business through our numerous independentmarketing representatives who sell both to individuals and employer groupsthroughout the United States.  Ouracquisition of Access serves to complement our most recent entry into thepublic sector market through our agreement with the State of Louisiana.  Access’ primary area of expertise is in thepublic sector market.

 

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*Non-healthcare Related Club Membership Programs*

 

ThroughForesight, we also design non-healthcare related membership programs forrental-purchase companies, financial organizations, employer groups, retailersand association-based organizations. Memberships in these programs are alsooffered and sold as part of a point-of-sale transaction or by direct marketingthrough direct mail or as an insert. Program members are offered and providedwith our and third-party vendors’ products and services. The products andservices are bundled, priced and marketed to target the profiled needs of theclients’ particular customer base. Among the products and services offered are(i) consumer product extended warranties, (ii) tire and wheelguarantee, (iii) insurance products included as association benefits,(iv) emergency travel and living expense reimbursement, (v) access toair ambulance evacuation services, (vi) identity theft protection,(vii) savings on veterinary care, (viii) retail and entertainmentdiscounts, (ix) grocery coupons, (x) a retail savings coupon book, (xi) emergency roadsideassistance, and (xii) auto deductible expense reimbursement. Substantially allof our non-healthcare related membership service programs are offered and soldat retail by clients engaged in the rental-purchase industry.

 

**SALES AND MARKETING CHANNELS**

 

Our Care EntréeTM healthcare programs are offered primarily through ournetwork marketing organization (initially organized in August 1997)  or by way of our private label agreementswith direct marketing or other sales organizations, including insuranceagencies.

 

**NETWORK MARKETING.**  Our independent representatives becomemarketing representatives by paying an enrollment fee (currently $99.95) andsigning a standard representative agreement, and an annual renewal fee(currently $49.95). Independent marketing representatives of Care EntréeTM arenot required to be licensed insurance agents. Independent marketingrepresentatives are paid a 20% commission on the membership fees of each memberthey enroll for the life of that member’s enrollment with Care EntréeTM(assuming such representative continues to meet certain commissionqualifications). Independent marketing representatives may also receivecommissions equal to the membership fees if three or more program members areenrolled in a month. In the month of the membership sales, no overridecommissions are paid to the representative’s upline. Independent marketingrepresentatives may also recruit other representatives and earn overridecommissions on sales made by those representatives. We pay a total of 35% inoverride commissions down through seven levels of marketing representatives. Inaddition, we have established bonus pools that allow independent marketingrepresentatives who have achieved certain levels to receive additional commissionsmeasured by our revenues attributable to the Care EntréeTM programs.

 

The total regular or ongoing commissions payout, including overrides onsecond month membership sales and onward and the amount contributed by us tothe bonus pools, can be as high as 60% of qualified membership sales.

 

**WHOLESALE MEMBERSHIP OR PRIVATE LABEL CLIENTSAND DIRECT SALES.** Primarily through our direct sales team we also contractwith othercompanies under wholesale co-branded or private label arrangements. Under theseagreements, we conduct all customer service and re-pricing operations and mayalso provide the fulfillment and collections services. The client performs allmarketing functions. We intend to expand on our wholesale strategy by alsotargeting self-funded employers and organizations providing administrativeservices to employee benefit plans in order to have our healthcare productssold to groups of employees on a stand-alone basis or as part of an employeebenefit plan.

 

**BUSINESS OBJECTIVES AND PLANS**

 

Our objective is to sustain and expand our leadership position as aprovider of unique healthcare membership service programs and consumer drivenhealthcare plans. Key elements of our business plan are as follows:

 

**CONTINUE TO DEVELOP UNIQUE HEALTHCARE SERVICEPROGRAMS FOR BROAD MARKETS.**  Our focus is on the continued development andintroduction of unique programs that address the health and lifestyle needs oftargeted consumer groups. We anticipate that this plan will allow us to obtaina larger share of the healthcare market through existing marketing channels andthrough establishment of new client relationships.

 

Our subsidiary, Care Financial of Texas, L.L.C. “Care Financial”operates, in many ways, like an insurance agency. Through Care Financial, wecontinue to offer high deductible and scheduled benefit insurance policies, buthave also added a suite of products, including life insurance and annuities.The use of these policies in conjunction with the Care EntréeTM program canprovide a very affordable solution to individuals and groups who previouslycould not afford fully inclusive medical plans and provide greater assurance ofpayment to the healthcare providers. These insurance products are for sale onlyby our marketing

 

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representatives who are also licensed insurance agents.

 

In the fourth quarter of 2003, we established “Care125”.  Care125 provides the administration behind avariety of employee benefit programs that allow employers and employees to savemoney by paying for certain IRS-approved expenses on a pre-tax basis. Care125can assist employers in the offering of Health Reimbursement Arrangements (“HRAs”),Flexible Spending Accounts (“FSAs”), and arrangements to help their employeespay for dependant care and transportation expenses. In the case of the FlexibleSpending Accounts for dependant care, employers can offer these plans as anadditional benefit to their employees at no additional cost to the employerbecause these fees are based on a percentage of the tax savings realized by theemployer in redirecting salary costs for distribution on a pre-tax basis. Theremaining fees for services provided by Care125 are monthly fees based on thenumber of members enrolled.  Care125 ispositioned to provide administrative support services for employers wishing tooffer their employees a Health Savings Account (HSA).  With recent developments to federal taxpolicy encouraging the use of HSA’s, we expect that this portion of Care125’sbusiness will expand.

 

**CONTINUE TO DEVELOP A RECURRING REVENUE BASE.**  Growth in recurring revenue from the Care EntréeTMproduct is dependent on our independent marketing representatives continuing tomarket the Care EntréeTM program memberships and recruit new downlineindependent marketing representatives. We intend to continually increase oursupport for representatives to maximize the volume generated through this saleschannel. Recurring revenue from wholesale and private label clients isdependent upon the client continuously marketing our products to their customerbase. We intend to continue to focus our efforts on retaining our existingclients and obtaining new wholesale and private label clients through ourdirect sales team.

 

**DEVELOP A CORPORATE LEVEL SALES TEAM.**   To complement the individual sales and groupsales and lead generation accomplished through our network marketing strategy,we have undertaken a strategy to promote sales to groups and self-fundedemployers with a corporate level sales team having experience with the groupinsurance market and the operations of a third party administrator.

 

**LEVERAGE AND DEVELOP MULTIPLE NETWORKPARTNERS.**  Whilewe currently have a contractual relationship with a well recognized and fullydeveloped preferred provider organization network for access to savings ondoctors, hospitals, and ancillary healthcare services, we need to continuouslyasses the capabilities of that network and work towards providing alternativenetwork solutions for our members.

 

**PROVIDE HIGH QUALITY CUSTOMER SERVICE.**  In order to achieve our anticipated growthand to ensure client, member and marketing representative loyalty, we continueto develop and invest significantly in our member service systems. We havedeveloped a proprietary computer database system that provides customer servicerepresentatives immediate access to provider demographic data, re-pricinginformation and member information, including the components of each memberprogram or plan and the details a member requires to properly utilize theprogram.

 

**DEVELOP AND MARKET INNOVATIVE PRODUCTOFFERINGS.**  InDecember 2002, we began offering a medical savings program to help provideassurance that healthcare providers would be paid on a timely basis. Ourmembers deposit money into their individual escrow accounts on a monthly basisfrom which healthcare services are paid in whole or in part. A member’s abilityto pay is then certified prior to treatment or hospitalization based in part onthe balance of the member’s escrow account. We hope to also offer our membersaccess to a medical line of credit that can be accessed in addition to or inlieu of a funded escrow account. This line of credit would allow our members tohave access to healthcare providers without an upfront cash outlay.  Developing a line of credit offering that iseasily accessible by a majority of our members is time consuming anddifficult.  We hope to have this offeringavailable by the end of 2005.

 

**CONTINUE TO EXPAND OUR THIRD PARTYADMINISTRATOR SERVICES.**  In response to the needs of our groupcustomers, we have expanded our third party administrator (“TPA”) services. Ouracquisition of Access Healthsource, Inc. in 2004 allows us to offer afull-service TPA function that includes full plan administration, claimsadjudication and claims management services. We plan on developing a marketing plan to offer these new TPA servicecapabilities on a national basis.

 

**MEMBERSHIP SERVICE PROGRAMS**

 

**CONSUMER HEALTHCARE SAVINGS PROGRAMS.**  As of December 31, 2004, we had sixconsumer healthcare savings programs:

 

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***TOTALCARE PROGRAM***—$69.95 per family per month, includesaccess to savings on hospitals, doctors, ancillary services, dentists, visioncare, LASIK-laser vision correction, Instacare emergency card, hearing aids,prescription medications, alternative care, chiropractors, 24-hour healthhotline, $2,000 excess accident medical benefit and three month membership feecontinuation for involuntary unemployment.

 

***ESSENTIALCARE PROGRAM—***$54.95 per family per month, includesaccess to savings on doctors, ancillary services, dentists, vision care,LASIK-laser vision correction, hearing aids, prescription medications,alternative care, chiropractors, 24-hour health hotline, $2,000 excess accidentmedical benefit and three month membership fee continuation for involuntaryunemployment.

 

***BASIC MEDICAL PROGRAM***—$39.95 per familyper month, includes access to savings on hospitals, doctors, ancillary servicesand prescription medications.

 

***CHOICECARD PROGRAM—***$24.95 per family per month, includesaccess to 24-hour health hotline, Instacare emergency card, and savings onhearing aids, prescription medications, vision care, dentists and long termcare services.

 

***DENTALPLUS PROGRAM—***$19.95 per family per month, includesaccess to 24-hour hotline, and savings on dentists, hearing aids, prescriptionmedications, vision care, alternative care and chiropractors.

 

***PRESCRIPTIONPLUS PROGRAM***—$9.95 per family per month, includesaccess to savings on prescription medications, vision care and hearing aids.

 

Members pay a one-time $30 or $20 (depending on the program) processingfee at the time of enrollment. Most members pay for the program on a monthlybasis, either through automatic bank draft or credit card draft, although someelect to have their accounts drafted on a quarterly basis. Individuals who donot wish to have their accounts drafted are required to make a six-month orannual payment. Groups of five or more can also choose to be billed on amonthly basis.

 

Members may cancel their membership at any time by returning theiridentification cards, along with a written notice of cancellation. There is a30-day money back guarantee so that if a member is not completely satisfiedwith the program, the member will be refunded the program fee upon the returnof the identification cards. The processing fee is non-refundable.

 

Upon enrollment, new members receive a member kit that includesinstructions on using the program, directories for their area andidentification cards.

 

**NETWORK CONTRACTS**

 

We contract with numerous preferred provider organization and other medicalnetworks for access to their negotiated rates. We do not contract directly withany medical providers. We only select and utilize those networks that webelieve can deliver adequate savings to our members, while providing supportfor our program with the healthcare providers. We pay each network utilized aper member per month amount for use of the network. Each network is only paidfor those members authorized to utilize the network. Most of our networkcontracts are generally for a one-year term, with subsequent one-year renewalterms at our or the network’s option. Networks may cancel their contracts withus, but in most cases, subject to notice provisions to provide time to locate asubstitute network. Most of our network contracts are not exclusive, but haverequirements that the network and we maintain the confidentiality of the termsof the contract. Our principal preferred provider organization through whichour members receive savings on healthcare services through our Care EntréeTMprogram is Private Healthcare Systems, Inc.

 

**CUSTOMER SERVICE**

 

We believe that a high level of customer service is critical to thesuccess of its program. We provide customer service for three types ofindividuals or organizations:

 

•              Ourmarketing representatives, so that they can be more effective in selling theprogram;

 

•              Ourmembers, in order to assure that they achieve the best available savings whenutilizing the program; and

 

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•              Theproviders, who require assistance in (a) understanding how the programworks for them and (b) in verifying eligibility and arranging for thepayment of the amount billed to the patient for each procedure performed.

 

Toll free support is provided for the members and providers. We maintainmultiple customer service centers with a total of 109 customer servicerepresentatives as of December 31, 2004. These employees provide supportfor our members, our independent marketing representatives, and for providers.Our member and provider service centers are available Monday through Thursdayfrom 7:30 a.m. to 7:00 p.m. central time and 7:30 a.m. to6:00 p.m. on Friday. Our marketing representative service center isavailable Monday through Friday from 7:30 a.m. to 6:00 p.m. centraltime. All new customer service representatives must have a medical background,either processing insurance claims or working in a medical office. Extensiveon-the-job training is also provided to them. Utilizing our systems, thecustomer service representatives are able to provide friendly but efficientservice to our members, marketing representatives, and network providers.

 

**REPRESENTATIVE TRAINING**

 

We provide extensive training to our marketing representatives toassure that they accurately represent our products and services. This trainingis available in a variety of forms, including a training manual, audio, andvideotapes, local and regional training meetings and weekly conference calls.The training encompasses both product training as well as marketing trainingand sales techniques.

 

We have certain policies and procedures in place to control anyadvertising or promotions that are utilized by our marketing representatives.These policies and procedures are necessary to assure the proper representationof the program at all times and include the pre-approval of all advertising,adherence to anti-spamming and anti-fax blasting rules, and limits whererepresentatives can advertise. A representative’s failure to follow these rulescan result in fines or termination.

 

**TECHNOLOGY**

 

We have made substantial investments in our proprietary technology andmanagement information systems. These systems were designed in-house and areused in most aspects of our business, including:

 

•              maintainingmember eligibility and demographic information;

 

•              maintainingrepresentative information including genealogy reporting;

 

•              payingcommissions;

 

•              maintaininga database of all providers and providing provider locator services;

 

•              re-pricingand payment of medical bills;

 

•              draftingmembers accounts on a monthly basis; and

 

•              trackingof cash receipts and revenues.

 

During 2004, we upgraded our technology and management informationsystems. These systems allow for more-timely processing of businesstransactions and contain e-commerce capabilities.

 

We have also established extensive web-sites for our programs thatprovide information about the program, allow for provider searches and allownew members and representatives to enroll on-line. The websites also allowrepresentatives, through a password-protected area to access support andtraining files and to view their genealogy and commission information. Thewebsites are set up as “self-replicating” websites to allow representatives acopy of the websites under a unique web address.

 

**GOVERNMENTAL REGULATION**

 

We are subject to federal, state and local laws, regulations,administrative determinations, court decisions and similar

 

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constraints (hereinafter “regulations”). Because the nature of ourservices is relatively new to the marketplace, we may not be able to accuratelypredict which regulations will be applied to our business and we may becomesubject to new or amended regulations. Some of the areas of our business thatare or may be governed by current or future regulations are:

 

•              ourhealthcare products, in that there is a possibility that our Care EntréeTMmembership program will be regulated as an insurance company;

 

•              ourproduct claims and advertising (including direct claims and advertising as wellas claims and advertising by independent marketing representatives, for whichwe may be held responsible);

 

•              ournetwork marketing organization; and

 

•              ourmedical escrow accounts held on behalf of our members.

 

**POSSIBLE INSURANCE COMPANY REGULATION. **Our Care EntreeTM program is not aninsurance program and we are not subject to regulation as an insurance companyor a seller of insurance.  However,regulations in certain states currently regulate or restrict the offering ofour programs.

 

Occasionally, we receive inquires from insurance commissioners invarious states that require us to supply information about our Care EntréeTMprogram, representatives, etc. to the insurance commissioner or other stateregulatory agency. To date, these agencies have concurred with our view thatthese programs are not a form of insurance and are being sold in a propermanner. There is no assurance that this situation will not change in thefuture, and an insurance commissioner will successfully challenge our abilityto offer our programs without compliance with state insurance regulation.Furthermore, several states have recently enacted or introduced legislationand/or regulations that will likely affect the manner by which we sell ourprograms.  Because this legislation isnew, we do not yet know the scope of that effect and there is a risk thatcompliance with such legislation and/or regulations could have material adverseaffect on our operations and financial condition.  There is also the risk that a state will adoptregulations or enact legislation restricting or prohibiting the sale of ourmedical discount programs in the state.

 

Our Care EntréeTM program is also subject to the review of the attorneygenerals in each state, particularly as it relates to the network marketingaspect of the program. The Care EntréeTM commission plan was designed to meetthe requirements of each state, and we have had no challenges of the plan fromany state attorney general. However, the laws in any state or theinterpretation of these laws could change at any time and we may be preventedfrom selling memberships in our Care EntréeTM programs as a result of thechanges.

 

Compliance with federal and state regulations is generally ourresponsibility. The medical discount program industry is especially susceptibleto charges by the media of regulatory noncompliance and unfair dealing. As isoften the case, the media may publicize perceived non-compliance with consumerprotection regulations and violations of notions of fair dealing withconsumers. Our failure to comply with current, as well as newly enacted oradopted federal and state regulations, could have a material adverse effectupon our business, financial condition and results of operations in addition tothe following:

 

•              non-compliancemay cause us to become the subject of a variety of enforcement or privateactions;

 

•              compliancewith changes in applicable regulations could materially increase the associatedoperating costs;

 

•              non-compliancewith any rules and regulations enforced by a federal or state consumerprotection authority may subject us or our management personnel to fines orvarious forms of civil or criminal prosecution; and

 

•              non-complianceor alleged non-compliance may result in negative publicity potentially damagingour reputation, network relationships, client relationships and therelationship with program members, representatives and consumers in general.

 

**PRODUCT CLAIMS AND ADVERTISING.**  The Federal Trade Commission and certainstates regulate advertising, product claims, and other consumer matters,including advertising of our products. All advertising, promotional andsolicitation materials used by marketing representatives require our approvalprior to use. The Federal Trade Commission may institute enforcement actionsagainst companies for false and misleading advertising of consumer products. Inaddition, the Federal Trade

 

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Commission has increased its scrutiny of the use of testimonials,including those used by us and our marketing representatives. We have not beenthe target of Federal Trade Commission enforcement action.

 

There is no assurance that:

 

•              theFederal Trade Commission will not question our advertising or other operationsin the future;

 

•              astate will not interpret product claims presumptively valid under federal lawas illegal under that state’s regulations; or

 

•              futureFederal Trade Commission regulations or decisions will not restrict thepermissible scope of such claims.

 

We are also subject to the risk of claims by marketing representativesand their customers who may file actions on their own behalf, as a class orotherwise, and may file complaints with the Federal Trade Commission or stateor local consumer affairs offices. These agencies may take action on their owninitiative against us for alleged advertising or product claim violations, oron a referral from independent marketing representatives, customers or others.Remedies sought in these actions may include consent decrees and the refund ofamounts paid by the complaining independent marketing representatives orconsumer, refunds to an entire class of independent marketing representativesor customers, client refunds, or other damages, as well as changes in ourmethod of doing business. A complaint based on the practice of one marketingrepresentative, whether or not we authorized the practice, could result in anorder affecting some or all of our marketing representatives in a particularstate. Also, an order in one state could influence courts or governmentagencies in other states considering similar matters. Proceedings resultingfrom these complaints could result in significant defense costs, settlementpayments or judgments and could have a material adverse effect on us.

 

**NETWORK MARKETING ORGANIZATION.**  Our network marketing system is subject to anumber of federal and state regulations administered by the Federal TradeCommission and various state agencies. These regulations are generally directedat ensuring that advancement, within a network marketing organization, is basedon sales of the organization’s products rather than investment in the organizationor other non-sales related criteria. For instance, in certain markets there arelimits on the extent that marketing representatives may earn royalties on salesgenerated by marketing representatives that were not directly sponsored by themarketing representative.

 

Our network marketing organization and activities are subject toscrutiny by various state and federal governmental regulatory agencies toensure compliance with various types of laws and regulations. These laws andregulations include securities, franchise investment, business opportunity, andcriminal laws prohibiting the use of “pyramid” or “endless chain” types ofselling organizations. The compensation structure of these sellingorganizations is very complex, and compliance with all of the applicable lawsis uncertain in light of evolving interpretation of existing laws and theenactment of new laws and regulations pertaining to this type of productdistribution. We are not aware of any legal actions pending or threatened byany governmental authority against us regarding the legality of our networkmarketing operations.

 

As of December 31, 2004, we had marketing representatives in 48states and the District of Columbia. We review the requirements of variousstates, as well as seek legal advice, regarding the structure and operation ofour network marketing ensure that it complies with all of the applicable lawsand regulations pertaining to network sales organizations. Based on theseefforts and the experience of our management, we believe that we are incompliance with all applicable federal and state regulatory requirements. Wehave not obtained no-action letters or advance rulings from any federal orstate security regulator or other governmental agency concerning the legality ofour network operations, nor are we relying on a formal opinion of counsel tothat effect. We accordingly are subject to the risk that one or more of ournetwork marketing organizations could be found to not comply with applicablelaws and regulations. Our failure to comply with these regulations could have amaterial adverse effect on us in a particular market or in general.

 

We are subject to the risk of challenges to the legality of our networkmarketing organization, including claims by our marketing representatives, bothindividually and as a class. Most likely these claims would be based on thenetwork marketing organization allegedly being operated as an illegal “pyramidscheme” in violation of federal securities laws, state unfair practice andfraud laws, and the Racketeer Influenced and Corrupt Organizations Act. In theevent of challenges to the legality of our network marketing organization bydistributors, we would be required to demonstrate that our network marketingorganization complies with applicable regulatory laws. A final ruling againstus could result in a material liability. Moreover, even if we were

 

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successful in defending against these challenges, the costs of suchdefense, both in dollars spent and in management time, could be material andadversely affect our operating results and financial condition. In addition,the negative publicity of these challenges could adversely affect our revenuesand ability to attract and retain marketing representatives.

 

**HEALTH INSURANCE PORTABILITY ANDACCOUNTABILITY ACT COMPLIANCE.**  In December 2000, The Department ofHealth and Human Services issued final privacy regulations pursuant to theHealth Insurance Portability and Accountability Act of 1996 (“HIPAA”) thatbecame effective in April 2003. HIPAA and the applicable regulationsimpose extensive restrictions on the use and disclosure of individuallyidentifiable health information by certain entities. Also as part of HIPAA, theDepartment of Health and Human Services has issued final regulationsstandardizing electronic transactions between health plans, providers andclearinghouses. Health plans, providers, and clearinghouses, are required toconform their electronic and data processing systems with HIPAA’s electronictransaction requirements. We may be required to comply with certain aspects ofthese regulations pertaining to our business.

 

Our recently purchased re-pricing software systems are considered HIPAAcompliant. We previously engaged a consulting firm to assist us in our effortsto continuously comply with all other HIPAA regulations. We believe that we arein compliance with these regulations. However, because these regulations arenew, we do not know how the interpretation and enforcement of the regulationsmay affect us. We plan to continually audit our compliance, and accordinglycannot give assurance that our costs of continuing to comply with HIPAA willnot be material to us. Sanctions for failing to comply with standards issuedpursuant to HIPAA include criminal penalties and civil sanctions.

 

**COMPETITION**

 

**CONSUMER HEALTHCARE SAVINGS PROGRAMS.**  While the medical savings industry is stillin its early stages, competition for members is becoming more intense. We offermembership programs that provide products and services similar to or directlyin competition with products and services offered by our network-marketingcompetitors as well as the providers of the products and services through otherchannels of distribution. Although not permitted under the current agreementswith our representatives and private label clients, in the future some of ourclients may provide, either directly or through third parties, programs thatdirectly compete with our programs. Competition for new representatives isintense, as these individuals have a variety of products that they can chooseto market, whether competing with us in the healthcare market or not.

 

Our principal competitors are AmeriPlan, Full Access Medical, NewBenefits, Inc., CAREington International, and International Association ofBusinesses (IAB). We also compete with all types of network marketing companiesthroughout the U.S. for new representatives. Our other competitors includelarge retailers, financial institutions, insurance companies, preferredprovider organization networks, and other organizations, which offer benefitprograms to their customers. Many of our competitors have substantially largercustomer bases and greater financial and other resources.

 

We distinguish ourselves from the competition through the offering oftoll-free live customer service to the providers, as well as, the members. Ourstaff is adequately trained to provide not only customer support, but alsomember steerage so that our members are able to achieve additional medicalsavings by obtaining the best rates even within the same medical providernetwork. Additionally, through our subsidiary third-party administrator,Foresight, Inc., we offer an escrow account program that helps ensurepayment to our medical providers. We are not aware of any other competitor thatoffers customer service to the medical providers and members in this manner.

 

**PRINCIPAL COMPETITIVE FACTORS.** We believe that the principal competitivefactors in the consumer healthcare and wholesale membership industries, some ofwhich are not within our control, include:

 

•              theability to maintain contracts with reputable preferred provider organizationnetworks that offer substantial healthcare savings;

 

•              theability to identify, develop and offer unique membership healthcare programs;

 

•              thequality and breadth of the membership programs offered;

 

•              thequality and extent of customer service;

 

•              theability to offer substantial savings on the major-medical costs such ashospital and surgical costs;

 

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•              theability to combine the programs with affordable insurance plans that have highdeductibles or set payment for hospitalization;

 

•              pricesof products and service offered;

 

•              marketingexpertise;

 

•              compensationplans for representatives;

 

•              theability to hire and retain employees;

 

•              thedevelopment by others of member programs that are competitive with Care EntréeTM’sprograms;

 

•              responsivenessto customer needs;

 

•              theability to satisfy investigations on the part of state attorney generals,insurance commissioners and other regulatory bodies;

 

•              theability to finance promotions for the recruiting of members andrepresentatives; and

 

•              theability to effectively market the product on the World Wide Web.

 

While we are considered a leader in the industry, there is no assurancethat:

 

•              competitorswill not develop their own software that re-prices medical bills, afull-service customer service function similar to ours, or a medical escrowconcept similar to ours;

 

•              ourcompetitors will not increase their emphasis on programs similar to ourprograms to more effectively compete with us;

 

•              ourcompetitors will not recruit our independent marketing representatives byoffering more attractive sales commissions;

 

•              ourcompetitors will not provide programs comparable or superior to our programs atlower membership fees;

 

•              ourcompetitors will not adapt more quickly to evolving industry trends or changingmarket requirements;

 

•              newcompetitors will not enter the market;

 

•              otherbusinesses such as insurance companies or preferred provider organizationnetworks will not themselves introduce competing programs; and

 

•              competitorsmay develop more effective marketing campaigns that more effectively utilizedirect mail and television advertising.

 

This increased competition may result in price reductions, reducedgross margins and loss of market share, any of which could have a materialadverse affect on our business, financial condition and results of operations.

 

**EMPLOYEES**

 

As of December 31, 2004, we had 225 full-time employees in thefollowing departments:

 

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| Customer Services                 |   | 109 |   |
|-----------------------------------|--------|-----|--------|
| Executive and Administration      |   | 27  |   |
| Information Services              |   | 15  |   |
| Provider Relations                |   | 14  |   |
| Data Entry                        |   | 13  |   |
| Finance and Accounting            |   | 12  |   |
| Quality Assurance                 |   | 10  |   |
| Sales and Marketing               |   | 8   |   |
| Utilization Review and Management |   | 7   |   |
| Care Financial                    |   | 7   |   |
| Foresight Wholesale Memberships   |   | 3   |   |

 

Our future performance depends in significant part upon the continuedservice of our key technical and management personnel, and our continuingability to attract and retain highly qualified and motivated personnel in allareas of our operations. Competition for qualified personnel is intense. Weprovide no assurance that we can retain key managerial and technical employees,or that we can attract, assimilate or retain other highly qualified personnelin the future. Our employees are not represented by a labor union. We have notexperienced any work stoppages, and consider our employee relations to be good.

 

**ADDITIONAL FACTORS THAT MAY AFFECT OUR FUTURERESULTS**

 

The matters discussed below and elsewhere in this report should beconsidered when evaluating our business operations and strategies.Additionally, there may be risks and uncertainties that we are not aware of orthat we currently deem immaterial, which may become material factors affectingour operations and business success. Many of the factors are not within ourcontrol. We provide no assurance that one or more of these factors will not:

 

•              adverselyaffect the market price of our common stock;

 

•              adverselyaffect our future operations;

 

•              adverselyaffect our business;

 

•              adverselyaffect our financial condition; or

 

•              adverselyaffect our results of operations;

 

•              requiresignificant reduction or discontinuance of our operations;

 

•              requireus to seek a merger partner; or

 

•              requireus to sell additional stock on terms that are highly dilutive to ourshareholders.

 

**THIS REPORT CONTAINS CAUTIONARY STATEMENTSRELATING TO FORWARD LOOKING INFORMATION.**

 

We have included some forward-looking statements in thissection and other places in this report regarding our expectations. Theseforward-looking statements involve known and unknown risks, uncertainties andother factors that may cause our actual results, levels of activity, performanceor achievements, or industry results, to be materially different from anyfuture results, levels of activity, performance or achievements expressed orimplied by these forward-looking statements. Some of these forward-lookingstatements can be identified by the use of forward-looking terminologyincluding “believes,” “expects,” “may,” “will,” “should” or “anticipates” orthe negative thereof or other variations thereon or comparable terminology, orby discussions of strategies that involve risks and uncertainties. You shouldread statements that contain these words carefully because they:

 

•              discussour future expectations;

 

•              containprojections of our future operating results or of our future financialcondition; or

 

•              stateother “forward-looking” information.

 

We believe it is important to discuss our expectations; however, itmust be recognized that events may occur in the future over which we have nocontrol and which we are not accurately able to predict.

 

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**OUR REVENUES ARE PRIMARILY DEPENDENT ON THEINDEPENDENT MARKETING REPRESENTATIVES, WHOSE REDUCED SALES EFFORTS ORTERMINATION MAY RESULT IN SIGNIFICANT LOSS OF REVENUES.**

 

Our success and growth depend in large part upon our ability toattract, retain, and motivate the network of independent marketingrepresentatives who principally market our Care EntréeTM medical savingsprogram. Our independent marketing representatives typically offer and sell theCare EntréeTM program on a part-time basis, and may engage in other businessactivities. These marketing representatives may give higher priority to otherproducts or services, reducing their efforts devoted to marketing our CareEntréeTM program. Also, our ability to attract and retain marketing representativescould be negatively affected by adverse publicity relating to our Care EntréeTMprogram and operations.

 

Under our network marketing system, the marketing representatives’downline organizations are headed by a relatively small number of key representativeswho are responsible for a substantial percentage of our total revenues. Theloss of a significant number of marketing representatives, including any keyrepresentatives, for any reason, could adversely affect our revenues andoperating results, and could impair our ability to attract new distributors.

 

**DEVELOPMENT AND MAINTENANCE OF RELATIONSHIPSWITH PREFERRED PROVIDER ORGANIZATIONS ARE CRITICAL AND THE LOSS OF SUCHRELATIONSHIPS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.**

 

As part of our business operations, we must develop and maintainrelationships with preferred provider organizations within each market areathat our services are offered. Development and maintenance of theserelationships with healthcare providers within a preferred providerorganization is in part based on professional relationships and the reputationof our management and marketing personnel. Because many members that receivehealthcare services are self-insured and responsible for payment for healthcareservices received, failure to pay or late payment by members may negativelyaffect our relationship with the preferred provider organizations.Consequently, preferred provider organization relationships may be adverselyaffected by events beyond our control, including departures of key personneland alterations in professional relationships and members’ failures to pay forservices received. The loss of a preferred provider organization within ageographic market area may not be replaced on a timely basis, if at all. Theloss of a preferred provider organization for any reason could have a materialadverse effect on our business, financial condition, and results of operations.

 

**WE CURRENTLY RELY HEAVILY ON ONE KEYPREFFERED PROVIDER ORGANIZATION AND THE LOSS OF OR A CHANGE IN OUR RELATIONSHIPWITH THIS PROVIDER COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.**

 

Private Healthcare Systems, Inc. is the principal preferredprovider organization through which our members receive savings on healthcareservices through our Care EntréeTM program. The loss of Private HealthcareSystems as a preferred provider organization or disruption of our members’access to this preferred provider organization could adversely affect ourbusiness. While we currently enjoy a good relationship with Private HealthcareSystems, there are no assurances that we will continue to have a goodrelationship with this network in the future, or that the network may choose topartner with one of our competitors or compete directly with our Care EntréeTMprogram.

 

**WE FACE COMPETITION FOR MARKETINGREPRESENTATIVES AS WELL AS COMPETITIVE OFFERINGS OF HEALTHCARE PRODUCTS ANDSERVICES.**

 

Although the medical savings membership industry is in the early stagesof its development, competition for members is becoming more intense. We offermembership programs that provide products and services similar to or directlyin competition with products and services offered by our network-marketingcompetitors as well as the providers of such products and services through otherchannels of distribution. Although not permitted under the current agreementswith our marketing representatives and private label clients, in the futuresome of our clients may provide, either directly or through third parties,programs that directly compete with our programs. Furthermore, marketingrepresentatives have a variety of products that they can choose to market,whether competing with us in the healthcare market or not. Our businessoperations compete in two channels of competition. First, we compete based uponthe healthcare products and services offered. These competitors includecompanies that offer healthcare products and services through membershipprograms much like our programs, as well as insurance companies, preferredprovider organization networks and other organizations that offer benefitprograms to their customers. Second, we compete with all types of networkmarketing companies throughout the U.S. for new marketing representatives. Manyof our competitors have substantially larger customer bases and greaterfinancial and other resources.

 

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We provide no assurance that our competitors will not providehealthcare benefit programs comparable or superior to our programs at lowermembership prices or adapt more quickly to evolving healthcare industry trendsor changing industry requirements. Increased competition may result in pricereductions, reduced gross margins, and loss of market share, any of which couldadversely affect our business, financial condition and results of operations.There is no assurance that we will be able to compete effectively with currentand future competitors.

 

**WE MAY BECOME SUBJECT TO GOVERNMENTREGULATION MUCH LIKE AN INSURANCE COMPANY. SUCH REGULATORY OVERSIGHT MAY AFFECTOR LIMIT OUR OPERATIONS.**

 

The membership and healthcare benefits we offer are sold withoutlicense by any federal, state, or local regulatory licensing agency orcommission. In comparison, companies that provide insurance benefits and operatehealthcare management organizations and preferred provider organizations areregulated by state licensing agencies and commissions. These regulationsextensively cover operations, including scope of benefits, rate formula,delivery systems, utilization review procedures, quality assurance, enrollmentrequirements, claim payments, marketing and advertising. In the future, stateinsurance regulatory agencies and commissions may determine that our CareEntréeTM programs are subject to governmental regulation, which may adverselyaffect or limit our future operations.

 

**WE HAVE A FIDUCIARY RESPONSIBILTY TO OURMEMBERS THROUGH OUR TOTAL CARE AND ESSENTIAL CARE PROGRAM OFFERINGS. IN THISCAPACITY, WE COULD BE LIABLE FOR THE LOSS OF MEMBERS’ FUNDS DEPOSITED WITH USIN ESCROW.**

 

In the fourth quarter of 2002, we initiated a medical savings programthrough our Total Care and Essential Care programs that is processed throughour subsidiary Foresight as a third-party administrator. Under this medicalsavings program, funds collected from members are held in escrow for thebenefit of the member as a source of payment for healthcare services obtainedthrough our Total Care and Essential Care programs. Under the medical savingsprogram we have a fiduciary responsibility to our members for the funds heldfor their benefit much like a trustee. In the unforeseen event of a loss ofthese funds while being held by us or our failure to implement and maintainadequate internal controls, we will be responsible and liable to the affectedmembers for any such loss, including any consequential damages suffered by themembers, which liability could be substantial.

 

**AS A RESULT OF THE INTRODUCTION OFMEDICAL ESCROW ACCOUNTS, OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS MAYCONTINUE TO BE ADVERSELY IMPACTED BY A DECREASE IN THE NUMBER OF HEALTHCARESAVINGS PROGRAM MEMBERSHIPS THAT WE CAN SELL AND MAINTAIN.**

 

While we believe that the introduction of our medical escrow accountswas an important development in our product, the initial impact of suchintroduction has negatively affected our business. This impact is the result ofadditional difficulties in selling and maintaining memberships in our programbecause of the added complexity. There is no assurance that we will be able toovercome these difficulties, and we may not be able to increase the number ofmemberships that are sold and maintained. As a result, our financial positionand results of operations may be negatively affected.

 

**THE FAILURE OF OUR NETWORK MARKETINGORGANIZATION TO COMPLY WITH FEDERAL AND STATE REGULATION COULD RESULT INENFORCEMENT ACTION AND IMPOSITION OF PENALTIES, MODIFICATION OF OUR NETWORKMARKETING SYSTEM, AND NEGATIVE PUBLICITY.**

 

Our network marketing organization is subject to federal and state lawsand regulations administered by the Federal Trade Commission and various stateagencies. These laws and regulations include securities, franchise investment,business opportunity, and criminal laws prohibiting the use of “pyramid” or “endlesschain” types of selling organizations. These regulations are generally directedat ensuring that product and service sales are ultimately made to consumers (asopposed to other marketing representatives) and that advancement within thenetwork marketing organization is based on sales of products and services,rather than on investment in the company or other non-retail sales relatedcriteria.

 

The compensation structure of a network marketing organization is verycomplex. Compliance with all of the applicable

 

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regulations and laws is uncertain because of:

 

•              theevolving interpretations of existing laws and regulations; and

 

•              theenactment of new laws and regulations pertaining in general to networkmarketing organizations and product and service distribution.

 

Accordingly, there is the risk that our network marketing system couldbe found to not comply with applicable laws and regulations that could:

 

•              resultin enforcement action and imposition of penalty;

 

•              requiremodification of the marketing representative network system;

 

•              resultin negative publicity; or

 

•              havea negative effect on distributor morale and loyalty.

 

Any of these consequences could have a material adverse effect on ourresults of operations as well as our financial condition.

 

**THE LEGALITY OF OUR NETWORK MARKETINGORGANIZATION IS SUBJECT TO CHALLENGE BY OUR MARKETING REPRESENTATIVES, WHICHCOULD RESULT IN SIGNIFICANT DEFENSE COSTS, SETTLEMENT PAYMENTS OR JUDGMENTS,AND COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS ANDFINANCIAL CONDITION.**

 

Our network marketing organization is subject to legality challenge byour marketing representatives, both individually and as a class. Generally,these challenges would be based on claims that our marketing network programwas operated as an illegal “pyramid scheme” in violation of federal securitieslaws, state unfair practice and fraud laws and the Racketeer Influenced andCorrupt Organizations Act. Proceedings resulting from these claims could resultin significant defense costs, settlement payments, or judgments, and could havea material adverse effect on us.

 

**WE MAY HAVE EXPOSURE AND LIABILITYRELATING TO NON-COMPLIANCE WITH THE HEALTH INSURANCE PORTABILITY ANDACCOUNTABILITY ACT OF 1996 AND THE COST OF COMPLIANCE COULD BE MATERIAL.**

 

InDecember 2000, The Department of Health and Human Services issued finalprivacy regulations pursuant to the Health Insurance Portability andAccountability Act of 1996 (“HIPAA”) that became effective in April 2003.HIPAA imposes extensive restrictions on the use and disclosure of individuallyidentifiable health information by certain entities. Also as part of HIPAA, theDepartment of Health and Human Services has issued final regulationsstandardizing electronic transactions between health plans, providers andclearinghouses. Health plans, providers and clearinghouses are required toconform their electronic and data processing systems with HIPAA’s electronictransaction requirements. While we believe we are currently compliant withthese regulations, we cannot be certain of the extent to which the enforcementor interpretation of these regulations will affect our business. Our continuingcompliance with these regulations, therefore, may have a significant impact onour business operations and may be at material cost in the event we are subjectto these regulations. Sanctions for failing to comply with standards issuedpursuant to HIPAA include criminal and civil sanctions.

 

**THE PROGRAM MARKETING ACTIVITIES CONDUCTED BY OUR SUBSIDIARYFORESIGHT ARE DEPENDENT UPON OUR CLIENTS.**

 

Incarrying out our program marketing activities through our subsidiaryForesight, Inc., we are dependent on our clients utilizing our services todesign membership programs for their customers. The client approves eachmarketing program prior to presentation to the client’s customers.

 

Ourclient relationships are pursuant to written agreements that typically may beterminated pursuant to 90-day written notice prior to end to the term of the agreementwithout cause and without penalty. Generally, upon termination, the client may

 

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notoffer similar products or services for a one-year period; however, we are notprohibited from continuing to offer or provide membership services and productsdirectly or indirectly to the client’s individual customers. If the agreementis terminated due to our default, we are prohibited from renewing membershipsand the client has the right to cause us to terminate our relationship withexisting program members. Many of the events that constitute default are notwithin our control, including acts and omissions by our third-party product andservice vendors or providers. There is no assurance that our clients will notterminate their relationships with us or cease to provide additional customerlists for our use in further marketing of new or existing membership programs.

 

**WE ARE CURRENTLY IMPLEMENTING A NEWMANAGEMENT INFORMATION SYSTEM. DISRUPTION IN OUR OPERATION RESULTING FROM THISIMPLEMENTATION COULD AFFECT OUR CLIENT RELATIONSHIPS.**

 

We recently transitioned to our new management information system.There is no assurance that we will be able to continue operating withoutexperiencing any disruptions in our operations or that our relationships withour members, marketing representatives or providers will not be adverselyaffected or that our internal controls will not be adversely affected.

 

**WE ASSUMED A CONTINGENT TAX LIABILITY INCONNECTION WITH OUR MERGER-ACQUISITION OF FORESIGHT.**

 

In January 1999, Universal Marketing Services, Inc., theformer parent of our wholly-owned subsidiary, Foresight, Inc., purchasedthe outstanding common stock of Foresight for $4,540,000. Universal MarketingServices agreed to indemnify the shareholders of Foresight for the increase infederal income taxes, and any applicable penalties to the extent that thereported $4,540,000 of the purchase price does not qualify for long-termcapital gain treatment. In connection with our merger-acquisition of Foresight,we assumed the indemnification obligation of Universal Marketing Services.

 

Upon examination, the Internal Revenue Service may take the positionthat all or a portion of the $4,540,000 should be classified as ordinary incometaxable at the maximum federal income tax rate of 39.6% rather than thelong-term capital gain 20% rate. In the event the Internal Revenue Servicesuccessfully asserts that long- term capital gain classification was improper,we will be required to indemnify the former shareholders.

 

**WE HAVE MANY COMPETITORS AND MAY NOT BE ABLETO COMPETE EFFECTIVELY WHICH MAY LEAD TO A LACK OF REVENUES AND DISCONTINUANCEOF OUR OPERATIONS.**

 

We compete with numerous well-established companies that design andimplement membership programs. Some of our competitors may be companies thathave programs that are functionally similar or superior to our membershipprograms. Most of our competitors possess substantially greater financial,marketing, personnel and other resources than us. They may also haveestablished reputations relating to membership programs.

 

Due to competitive market forces, we may experience price reductions,reduced gross margins and loss of market share in the future, any of whichwould result in decreases in sales and revenues. These decreases in revenueswould adversely affect our business and results of operations and could lead todiscontinuance of operations. There can be no assurance that:

 

•              wewill be able to compete successfully;

 

•              ourcompetitors will not develop membership programs that render our programs lessmarketable or even obsolete; or

 

•              wewill be able to successfully enhance our programs when necessary.

 

**THE GOODWILL ACQUIRED PURSUANT TO OURACQUISITIONS OF THE CAPELLA GROUP AND ACCESS MAY BECOME IMPAIRED AND REQUIRE AWRITE-DOWN AND THE RECOGNITION OF AN IMPAIRMENT EXPENSE WHICH MAY BESUBSTANTIAL.**

 

In connection with our acquisitions of The Capella Group and Access, werecorded goodwill that, at December 31, 2004, had an aggregate asset valueof $21,381,316. In the event that the goodwill is determined to be impaired forany reason, we will be required to write-down or reduce the value of thegoodwill and recognize an impairment expense. The impairment expense may besubstantial in amount and, in such case, adversely affect the results of ouroperations for the applicable period

 

19

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and may negatively affect the market value of our common stock.

 

**WE MAY FAIL TO REALIZE SOME OR ALL OF THE ANTICIPATED BENEFITS OF OURACQUISITION OF ACCESS AND THAT FAILURE COULD HAVE A MATERIAL ADVERSE EFFECT ONOUR FINANCIAL CONDITION.**

 

Our combined company mayfail to realize some or all of the anticipated benefits and synergies of thetransaction as a result of, among other things, the failure of Access to renewor maintain its existing service agreements. In addition, the integration of Access’ business and operations withthose of Precis may take longer than anticipated, may be more costly thananticipated, and may have unanticipated adverse results relating to Access’ orPrecis’ existing businesses or customer base.

 

**IF WEISSUE SUBSTANTIAL SHARES OF OUR COMMON STOCK UPON ACCESS MEETING CERTAIN EBITDATARGETS, OUR SHAREHOLDERS COULD SUFFER DILUTION OF THEIR INVESTMENT AND OURSTOCK PRICE COULD DECLINE.**

 

We are obligated to issue anumber of additional common stock shares in the event Access attains certainlevels of earnings before income tax, depreciation and amortization (“EBITDA”),as defined in the purchase contract. Should a significant number of these shares be issued, the resultingincrease in the number of outstanding common stock shares could have asubstantial dilutive effect on our outstanding common stock as of the date ofthis report their market value. The issuance of additional common stock mayalso adversely affect the terms under which we could obtain additional equitycapital.

 

**OURSUBSIDIARY, ACCESS, DERIVES A LARGE PERCENTAGE OF ITS INCOME FROM A FEW KEYCLIENTS AND THE LOSS OF ANY OF THOSE CLIENTS COULD HAVE A MATERIAL ADVERSEEFFECT ON OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.**

 

Access provides full servicethird party administration services to adjudicate and pay medical claims foremployers who have self-funded at least a portion of their healthcarecosts.  Their primary market isgovernmental entities in the El Paso, Texas metropolitan area, including citiesand school districts.  There are alimited number of such entities in that area. A material portion of the revenues of Access is derived from itscontractual relationships with a few key governmental entities.  The loss of any of these relationships wouldadversely affect on our operating results and the loss of more than one ofthese relationships could have a material adverse effect on our financialcondition.

 

# **ITEM 2. DESCRIPTION OF PROPERTY**

 

Our corporate offices, operations, and insurance agency are located in25,000 square feet at 2040 N. Highway 360, Grand Prairie, Texas 75050. Theoffices are occupied under a lease agreement with an unaffiliated third partythat expires December 15, 2006.

 

We consider the space which our offices occupy to be adequate for ourneeds. In the event we are required to relocate our office upon termination ofthe existing leases, we believe other office space is available undercomparable lease terms.

 

Our financial commitment on this lease runs through December 15,2006.

 
| **Description**                   | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| **Contractual Obligation**        | ** ** | **Total**                  | ** ** | **Less Than 1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than 5 Years** | ** ** |
| Operating leases on real property |       | $                          | 726,971    |   | $ | 371,219 |   | $ | 355,752 |   | — |   | — |   |
|                                   |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM3. LEGAL PROCEEDINGS**

 

In the normal course of business, we may become involved in litigationor in settlement proceedings relating to claims arising out of our operations.Except as described below, we are not a party to any legal proceedings, theadverse outcome of which, individually or in the aggregate, could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

20

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*Kirk, et al v. Precis, Inc. and DavidMay*

 

On September 8, 2003, the case styled “*Robert Kirk, Individually and D/B/A US Asian Advisors, LLC, Eugene M.Kennedy, P.A., Stewart & Associates, CPA’s, P.A. and Kimberly Decamp,Plaintiffs vs. Precis, Inc. and David May, Defendants*” wasinitiated in the District Court of Tarrant County, Texas, Case No. 236 201468 03. The plaintiffs Robert Kirk (doing business as US Asian Advisors, LLC orU.S. Asian Capital Investors, LLC and recently convicted of securities fraudand related crimes), Kimberly Decamp and Stewart & Associates, CPA’s,P.A. hold warrants exercisable for the purchase of 9,000, 48,000 and 4,000shares, respectively, of our common stock for $9.00 per share on or before February 8,2005. The plaintiffs Eugene M. Kennedy, P.A. and Kimberly Decamp hold stockoptions that expired on June 30, 2003, and that were exercisable for15,000 and 170,000 shares, respectively, of our common stock for $9.37 pershare. David May was our Secretary and Vice President and General Counselthrough January 5, 2004.

 

Plaintiffs Eugene M. Kennedy, P.A. (Eugene M. Kennedy is a member ofthe Florida bar association and a practicing attorney) and Ms. Decamp (thesister of Mr. Kirk) at no time presented the stock option agreementsevidencing the stock options and payment of the exercise price of the stockoptions, $140,550 and $1,592,900, respectively, as required pursuant to theterms of the stock option agreements for exercise. Furthermore, PlaintiffsRobert Kirk, Kimberly Decamp and Stewart & Associates, CPA’s, P.A. atno time tendered the certificates evidencing the warrants and the completed andexecuted Form of Subscription (Cashless Exercise) required for exercise of thewarrants without payment of the exercise price of those warrants.

 

The plaintiffs allege that they were not allowed to exercise theirstock options and warrants in May of 2003 due to actions and inactions ofMr. May and that these actions and inactions constitute fraud, misrepresentation,negligence and legal malpractice. All communications with Mr. May werethrough the plaintiffs’ broker, Burt Martin Arnold Securities, Inc.Plaintiffs are seeking damages equal to the difference between the exerciseprice of the stock options or warrants and the market value of our common stockon May 7, 2002 (presumably the closing sale price of $15.75) or anaggregate sum of $1,592,050, plus exemplary damages and costs.

 

An answer has been filed setting forth the Company’s position that theplaintiff failed to follow the procedures required by the warrant and stockoption agreements for effective exercise. Although we believe the plaintiffs’claims are without merit, this case, for the second time, is scheduled fortrial in May 2005, and, as of the date of this report, we cannot provide anyassurance regarding the outcome or results of this litigation.

 

*Zermeno v. Precis*

 

The case styled *“Manuela Zermeno,individually and on behalf of the general public; and Juan A. Zermeno,individually and on behalf of the general public vs. Precis, Inc., anOklahoma corporation and Does 1 through 100, inclusive”* wasfiled on August 14, 2003 in the Superior Court of the State of Californiafor the county of Los Angeles.

 

A second case styled *“CaliforniaFoundation for Business Ethics, Inc., a California non-profit corporation,v Precis, Inc., and Does 1 through 100, inclusive”* was filed onSeptember 9, 2003, in the Superior Court of the State of California forthe county of Los Angeles.

 

The two above cases were removed to the United States District Courtfor the Central District of California and consolidated, by order of the court,on December 4, 2003.

 

The Zermeno plaintiffs are former members of the Care EntréeTM discounthealth care program who allege that they (for themselves and for the generalpublic) are entitled to injunctive, declaratory, and equitable relief.Plaintiffs’ First Amended Complaint set forth three distinct claims underCalifornia law. Plaintiffs’ first cause of action alleged that the operation ofthe Care EntréeTM program by Defendants Precis, Inc. and The CapellaGroup, Inc. violates Health and Safety Code § 445 (“Section 445”),which governs medical referral services. Next, Plaintiffs alleged that they areentitled to damages under Civil Code §§ 1812.119 and 1812.123, which arepart of the broader statutory scheme governing the operation of discount buyingorganizations, Civil Code 1812. 100 *et. seq.*(“Section 1812.100”). Plaintiffs’ third cause of action sought reliefunder Business and Professions Code § 17200, California’s UnfairCompetition Law.

 

We have fullysettled all the claims brought by the California Foundation for BusinessEthics, Inc.  With the Zermenoplaintiffs, we have settled the causes of action related to Civil Code§§ 1812.119 and 1812.123.  The claimrelated to Section 445 and the related claim under Section 17200 remain pendingand have been assigned to the Superior Court of California, Los Angeles Countyunder case number BC 300788.  A negativeresult in this case would have a material affect on our financial condition andwould limit our ability (and that of other medical discount cards) to dobusiness in California.

 

21

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We believe that we have complied with all applicable statues andregulations in the state of California. Although we believe the Plaintiffs’ claims are without merit, thisremaining matter in the case remains pending, and, as of the date of thisreport, we cannot provide any assurance regarding the outcome or results ofthis litigation.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

No matters were submitted to vote of our security holders during thethree months ended December 31, 2004.

 

**PARTII**

 

**ITEM 5. MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

Our common stock is traded in the over-the-counter market and is quotedon the Nasdaq SmallCap Market System under the symbol PCIS. Prior toFebruary 9, 2000, there was no public trading market for our common stock.The closing sale prices reflect inter-dealer prices without adjustment forretail markups, markdowns or commissions, and may not reflect actualtransactions. The following table sets forth the high and low closing saleprices of our common stock during the calendar quarters presented, as reportedby the Nasdaq SmallCap Market System.

 

For more information on us, please refer to our website atwww.precis-pcis.com.

 
| ** **              | ** ** | **CLOSING SALE  PRICE** | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **COMMON STOCK**        | ** ** |
| **QUARTER ENDED**       | ** ** | **HIGH**                | ** ** | **LOW** | ** ** |
| March 31, 2003     |       | $                       | 5.55       |   | $ | 2.80 |   |
| June 30, 2003      |       | $                       | 5.50       |   | $ | 3.30 |   |
| September 30, 2003 |       | $                       | 5.69       |   | $ | 3.39 |   |
| December 31, 2003  |       | $                       | 4.45       |   | $ | 3.18 |   |
| March 31, 2004     |       | $                       | 4.50       |   | $ | 3.66 |   |
| June 30, 2004      |       | $                       | 3.89       |   | $ | 2.48 |   |
| September 30, 2004 |       | $                       | 3.12       |   | $ | 2.32 |   |
| December 31, 2004  |       | $                       | 3.04       |   | $ | 2.25 |   |

 

On April 13, 2005, the closing sale price of the common stock asquoted on the Nasdaq SmallCap Market was $1.84. On April 13, 2005, therewere approximately 252 record holders of our common stock.

 

The market price of our common stock is subject to significant fluctuationsin response to, and may be adversely affected by:

 

•              variationsin quarterly operating results;

 

•              changesin earnings estimates by analysts;

 

•              adverseearnings or other financial announcements of our customers or clients;

 

•              announcementsand introductions of product or service innovations or new contracts by us orour competitors; and

 

•              generalstock market conditions.

 

In order to continue inclusion of our common stock on the NasdaqSmallCap Market the minimum listing requirements must be met. If we fail tomeet the minimum requirements, our common stock will be de-listed by Nasdaq andwill become tradable on the over-the-counter market, which will adverselyaffect the sale price of our common stock. In this event, our common stock willthen be traded in the over-the-counter market and may become subject to the “pennystock” trading rules.

 

The over-the-counter market is volatile and characterized as follows:

 

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•              theover-the-counter securities are subject to substantial and sudden priceincreases and decreases;

 

•              attimes the price (bid and ask) information for the securities may not beavailable;

 

•              ifthere are only one or two market makers, there is a risk that the dealers orgroup of dealers may control the market in our common stock and set prices thatare not based on competitive forces; and

 

•              theactual sale price ultimately obtained for a block of stock may be substantiallybelow the quoted bid price.

 

Consequently, the market price of our common stock will be adverselyaffected if our common stock ceases to be included on the Nasdaq SmallCapMarket.

 

**DIVIDEND POLICY**

 

Our dividend policy is to retain our earnings, if any, to support theexpansion of our operations. Our board of directors does not intend to pay cashdividends on our common stock in the foreseeable future. Any future cashdividends will depend on future earnings, capital requirements, our financialcondition and other factors deemed relevant by our board of directors.

 

**SECURITIES AUTHORIZED FOR ISSUANCE UNDEREQUITY COMPENSATION PLANS.**

 

The following table sets forth as of December 31, 2004,information related to each category of equity compensation plan approved ornot approved by our shareholders, including individual compensationarrangements with our non-employee directors. The equity compensation plansapproved by our shareholders are our 1999 Stock Option Plan, 2002 Stock OptionPlan, 2002 IMR Stock Option Plan and the stock option agreement entered intowith Barron Chase Securities, Inc. in connection with ourmerger-acquisition of Foresight, Inc. All stock options, warrants andrights to acquire our equity securities are exercisable for or represent theright to purchase our common stock.

 

 
| **Plan Category**                                                                                             | ** ** | **Number of  Shares  Underlying  Unexercised  Options  and Warrants** | ** ** | **Weighted-  Average  Exercise Price  of  Outstanding  Options and  Warrants** | ** ** | **Number of  Securities  Remaining  Available for  Future  Issuance under  Equity  Compensation  Plans(1)** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| *Equity compensation plans approved by our  shareholders:*                                                    |       |                                                                  |       |                                                                           |       |                                                                                                        |       |
| 2002 Non employee stock option plan                                                                           |       | 376,000                                                               |       | $                                                                              | 4.70       |                                                                                                        | 124,000    |   |
| 2002 IMR stock option plan                                                                                    |       | 116,354                                                               |       | $                                                                              | 4.66       |                                                                                                        | 383,646    |   |
| 1999 stock option plan                                                                                        |       | 888,000                                                               |       | $                                                                              | 3.75       |                                                                                                        | 512,000    |   |
|                                                                                                          |       | 1,380,354                                                             |       | $                                                                              | 4.37       |                                                                                                        | 1,019,646  |   |
|                                                                                                          |       |                                                                  |       |                                                                           |       |                                                                                                        |       |
| *Equity compensation plans not approved by  our shareholders:*                                                |       |                                                                  |       |                                                                           |       |                                                                                                        |       |
| Stock option grants to non-employee  directors in 2000 and 2001(2)                                            |       | 92,000                                                                |       | $                                                                              | 2.55       |                                                                                                        | —     |   |
| Stock options granted to employees in 1997  and 1998(3)                                                       |       | 17,410                                                                |       | $                                                                              | 5.40       |                                                                                                        | —     |   |
| Warrants issued to Barron Chase Securities  and its assigns in 2000 related to our initial public offering(4) |       | 83,500                                                                |       | $                                                                              | 9.00       |                                                                                                        | —     |   |
|                                                                                                          |       | 192,910                                                               |       | $                                                                              | 5.65       |                                                                                                        | —     |   |
| **Total**                                                                                                     |       | 1,573,264                                                             |       | $                                                                              | 6.50       |                                                                                                        | 1,019,646  |   |

 

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(1)           Thenumber of shares of our common stock remaining available for issuance underequity compensation plans is after excluding the number of securities to beissued upon exercise of outstanding options and warrants

 

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(2)           Thestock options were granted in lieu of cash compensation for the services of ournon-employee directors. The purchase price of the shares was equal to or inexcess of the closing sale price of our common stock on the grant date of thestock option grants.

 

(3)           Thestock options were granted to employees during 1997 and 1998 as part of theircompensation for services provided.

 

(4)           Thewarrants were issued to Barron Chase Securities and its assigns as compensationfor the underwriting services of Barron Chase Securities associated with ourinitial public offering that was completed in February 2000.

 

**UNREGISTERED SECURITIES SOLD DURING PRECEDINGTHREE YEARS**

 

**FORESIGHT, INC. MERGER-ACQUISITION.**  OnDecember 7, 2000, we completed the merger-acquisition ofForesight, Inc.. In completion of this merger-acquisition, we issued500,000 shares of our common stock and 166,667 shares of our Series Aconvertible preferred stock to Paul A. Kruger and Mark R. Kidd in exchange forthe outstanding capital stock of Foresight, Inc. Mr. Kruger is ourformer C.E.O. Mr. Kidd is our former C.F.O. Further, at closing of themerger-acquisition of Capella Group, we issued and delivered 1,250,000 sharesof our common stock to Messrs. Kruger and Kidd and agreed to issue oneshare of our common stock for each $1.00 that our consolidated income beforetax expense (as adjusted) for 2001 exceeds $1,750,000, assuming themerger-acquisition of Capella Group was completed on January 1, 2001.Messrs. Kruger and Kidd were issued 2,065,202 shares of our common stockon February 7, 2002. In addition, we granted Barron ChaseSecurities, Inc. stock options exercisable for the purchase on or beforeJune 30, 2003 of 200,000 shares of our common stock for $9.37 per share.These options were granted for the investment banking financial services andconsulting advice provided by Barron Chase Securities in valuing andstructuring the merger. These offerings were made pursuant to the applicableregistration exemptions of Rule 506 of Regulation D of the Securitiesand Exchange Commission, Section 4(2) of the Securities Act of 1933, andapplicable state securities laws. There were no sales commissions or other feespaid in connection with the merger-acquisition, other than granting of thestock options.

 

**THE CAPELLA GROUP, INC. MERGER-ACQUISITION.**  OnJune 8, 2001, we completed the merger-acquisition of The CapellaGroup, Inc. In completion of this merger-acquisition, we issued 2,775,000shares of our common stock to the shareholders of The Capella Group, Inc.in exchange for the outstanding capital stock of The Capella Group, Inc.In addition, we agreed to issue and deliver to the former of shareholders ofCapella Group one share of our common stock for each dollar of Capella Group’sincome before tax expense (increased by certain adjustments) during 2001,assuming the merger-acquisition was completed on January 1, 2001, inexcess of $1,275,000. The former shareholders of The Capella Group were issued2,735,085 shares of common stock on February 7, 2002. This offering wasmade pursuant to the applicable registration exemptions of Rule 506 ofRegulation D of the Securities and Exchange Commission, Section 4(2)of the Securities Act of 1933, and applicable state securities laws. As part ofthe merger-acquisition of The Capella Group, Inc., two of our directors,Messrs. John Simonelli and Larry E. Howell were paid consulting fees of$190,335 each for their assistance and consulting services. There were no salescommissions or other fees paid in connection with the merger-acquisition.

 

**THE ACQUISITION OF ACCESS**.  On June 18, 2004 we(through our subsidiary Precis-Access Acquisition Corporation) completed theacquisition of Access.  In thisacquisition, we issued 488,486 shares of our common stock to National Centerfor Employment of the Disabled, Inc., a Texas nonprofit corporation, theselling shareholder of Access, “NCED”. We also agreed to issue an additional number of shares should Accessmeet certain post-closing earnings targets; provided that in no event shall thetotal number of shares issued to NCED equal or exceed 20% of our outstandingcommon stock at the closing of the transaction. This offering was made pursuant to the applicable registrationexemptions of Rule 506 of Regulation D of the Securities and ExchangeCommission, Section 4(2) of the Securities Act of 1933, and applicablestate securities laws.  We intend toregister the shares issued to Access at some time in the future**. **There were no salescommissions or other fees paid in connection with the merger-acquisition.

 

**REPURCHASES OF THE COMPANY’S SECURITIESDURING THE FOUTH QUARTER OF 2004**

 

On July 8, 2004, the Company’s Board of Directors authorized the repurchase of up to 500,000 shares of our common stock through open market or private purchase transactions over the next year depending on prevailing market conditions.  Through December 31, 2004, the Company has purchased 255,946 shares under this authorization for a total consideration of $681,537 at a weighted average price of $2.66  per share. During the fourth quarter of 2004, repurchases of shares were as follows:

 

24

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| **Month** | ** ** | **Shares  Purchased** | ** ** | **Weighted  Avg. Stock  Price/Share** | ** ** | **Cumulative  Number of  Shares  Purchased** | ** ** | **Number of  Shares That  May Yet Be  Purchased  under the Plan** | ** ** |
|-----------|------------|-----------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| October   |       | 29,200                |       | $                                     | 2.75       |                                         | 161,592    |                                                              | 338,408    |   |
| November  |       | 37,464                |       | $                                     | 2.49       |                                         | 199,056    |                                                              | 300,944    |   |
| December  |       | 56,890                |       | $                                     | 2.48       |                                         | 255,946    |                                                              | 244,054    |   |

 

**ITEM6. SELECTED FINANCIAL DATA**

 

The selected financial data presented below for each of the three yearsended on December 31, 2004, 2003 and 2002 and as of December 31, 2004and 2003 have been derived from our consolidated financial statements includedelsewhere in this report. 

 
| ** **                                                 | ** ** | **For the Year Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                 | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Statement of Operations Data:(1), (2)**                  |       |                                     |       |   |   |   |   |   |   |   |   |
| Product and service revenues                               |       | $                                        | 38,318,696 |   | $ | 42,087,671 |   | $ | 43,115,666 |   | $ | 21,056,164 |   | $ | 595,182 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Operating expenses—                                   |       |                                     |       |   |   |   |   |   |   |   |   |
| Cost of operations                                         |       | 15,101,700                               |       | 13,125,851 |   | 11,543,406 |   | 7,399,283 |   | 430,614 |   |
| Sales and marketing                                        |       | 10,931,392                               |       | 15,572,188 |   | 17,059,248 |   | 7,164,323 |   | 295,942 |   |
| General and administrative                                 |       | 12,919,579                               |       | 6,739,271 |   | 6,095,360 |   | 3,218,261 |   | 531,058 |   |
| Amortization of goodwill (4)                               |       | —                                   |       | — |   | — |   | 578,651 |   | 15,214 |   |
| Impairment charge for goodwill                             |       | 2,000,000                                |       |   |   |   |   |   |   |   |   |
| Total operating expenses                                   |       | 40,952,671                               |       | 35,437,310 |   | 34,698,014 |   | 18,360,518 |   | 1,272,828 |   |
| Operating income (loss)                                    |       | (2,633,975                               | )          | 6,650,361 |   | 8,417,652 |   | 2,695,646 |   | (677,646 | ) |
| Other expense—                                        |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest income and expense, net                           |       | 56,558                                   |       | 149,969 |   | 64,437 |   | (81,278 | ) | (201,252 | ) |
| Total other expense                                        |       | 56,558                                   |       | 149,969 |   | 64,437 |   | (81,278 | ) | (201,252 | ) |
| Earnings (loss) before income taxes                        |       | (2,690,533                               | )          | 6,500,392 |   | 8,353,215 |   | 2,776,924 |   | (476,394 | ) |
| Provision for income tax expense (benefit)                 |       | (734,581                                 | )          | 2,411,066 |   | 2,874,852 |   | 175,846 |   | — |   |
| Net earnings (loss)                                        |       | (1,955,952                               | )          | 4,089,326 |   | 5,478,363 |   | 2,601,078 |   | (476,394 | ) |
| Preferred stock dividend                                   |       | —                                   |       | — |   | 14,137 |   | 236,000 |   | 16,000 |   |
| Net earnings (loss) applicable to common  stockholders     |       | $                                        | (1,955,952 | ) | $ | 4,089,326 |   | $ | 5,464,226 |   | $ | 2,365,078 |   | $ | (492,394 | ) |
| Earnings (loss) per share: (3)                             |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                      |       | $                                        | (0.16      | ) | $ | 0.35 |   | $ | 0.46 |   | $ | 0.30 |   | $ | (0.21 | ) |
| Diluted                                                    |       | $                                        | (0.16      | ) | $ | 0.34 |   | $ | 0.46 |   | $ | 0.29 |   | $ | (0.21 | ) |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Weighted average number of common shares outstanding:  (3) |       |                                     |       |   |   |   |   |   |   |   |   |
| Basic                                                      |       | 11,921,946                               |       | 11,848,789 |   | 11,790,650 |   | 8,000,042 |   | 2,296,000 |   |
| Diluted                                                    |       | 11,921,946                               |       | 11,924,214 |   | 11,996,222 |   | 8,051,607 |   | 2,296,000 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| **Cash Flows Data:**                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Net cash provided by operating activities                  |       | $                                        | 1,758,624  |   | $ | 7,818,885 |   | $ | 3,989,546 |   | $ | 3,079,496 |   | $ | (685,267 | ) |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash used in investing activities                      |       | $                                        | (2,595,057 | ) | $ | (945,344 | ) | $ | (920,408 | ) | $ | (1,702,612 | ) | $ | 193,333 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash used in financing activities                      |       | $                                        | (1,968,534 | ) | $ | (1,397,424 | ) | $ | (1,212,977 | ) | $ | (2,162,615 | ) | $ | 5,011,769 |   |

 

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| ** **                | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------|------------|
| ** **                | ** ** | **2004**         | ** ** | **2003** | ** ** |
| **Balance Sheet Data:**   |       |             |       |   |   |
| Cash and cash equivalents |       | $                | 8,282,953  |   | $ | 11,087,920 |   |
| Current assets            |       | $                | 15,217,980 |   | $ | 15,617,689 |   |
| Working capital           |       | $                | 6,344,954  |   | $ | 8,818,823 |   |
| Total assets              |       | $                | 41,974,616 |   | $ | 40,813,664 |   |
| Current liabilities       |       | $                | 8,873,026  |   | $ | 6,798,866 |   |
| Total liabilities         |       | $                | 9,605,563  |   | $ | 7,211,560 |   |
| Stockholders’ equity |       | $                | 32,369,053 |   | $ | 33,602,104 |   |

 

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(1)           As further described in Note 3 to the Financial Statements,  on June 18, 2004, the Company completedits acquisition of Access, a third party administrator, from National Centerfor the Employment of the Disabled. Access’ results of operations have been included in the Company’sresults of operations from that date. The terms of the transaction were suchthat the Company acquired all of the outstanding capital stock of Access for apurchase price of $3,400,000, consisting of 488,486 shares of common stock ofthe Company valued at $1,400,000 ($2.87 per share), and $2,000,000 in cash.Additionally, the Company incurred acquisition costs of investment banking,valuation and legal and accounting fees of $266,231, for a total purchaseconsideration of $3,666,231. The results of Access’ operations are included inthe consolidated financial statements from the date of acquisition. Also, on June 8,2001, the Company acquired The Capella Group, Inc. for $2,271,609 in cash,$1,000,000 in notes payable and 2,775,000 shares of common stock with anapproximate market value of $5,078,250 as of the closing date, plus additionalcontingent consideration consisting of 4,800,287 shares that were issued on February 7, 2002. Theacquisition was accounted for as a purchase, with the purchase price allocatedto the assets acquired and liabilities assumed based upon their respectiveestimated fair values at the date of acquisition. The results of Capella’soperations are included in the consolidated financial statements from the dateof acquisition.

 

(2)           Certain reclassifications have been made toprior period financial information to conform to the current presentation ofthe financial information.

 

(3)           For the year ended December 31, 2004,54,863 shares related to outstanding stock options were not included in thecalculation of fully diluted earnings per share because the inclusion wouldhave been anti-dilutive.

 

(4)           After the effective date of FAS 142 in 2001, goodwillamortization was ceased.

 

**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

**CONSUMER HEALTHCARE SAVINGS SOLUTIONS.**  Weoffer savings on healthcare services throughout the United States to personswho are under-insured. These savings are offered by accessing the samepreferred provider organizations (PPOs) that are utilized by many insurancecompanies. These programs are sold primarily through a network marketingstrategy under the name Care EntréeTM. We design these programs to benefithealthcare providers as well as the network members. Providers commonly givereduced or preferred rates to PPO networks in exchange for steerage ofpatients. However, the providers must still file claim forms and wait 30 to60 days to be paid for their services. Our programs utilize these samenetworks to obtain the same savings for the Care EntréeTM program members.However, the healthcare providers are paid immediately for their services andare not required to file claim forms. We provide transaction facilitationservices to both the program member and the healthcare provider.

 

Independent MarketingRepresentatives (IMRs) may enroll as representatives by paying an enrollmentfee and signing a standard representative agreement. We pay independentmarketing representatives commissions equal to 20% of the membership fees ofmembers they enroll for the life of that members’ enrollment. Independentmarketing representatives can also recruit other representatives and earn overridecommissions on sales made by those recruited representatives. We pay a total of35% in override commissions down through seven levels. Independent marketingrepresentatives can also earn a commission equal to the membership fees ifthree or more program members are enrolled in a month. In the month ofmembership sales, no override commissions are paid to the representative’supline. The total regular or ongoing commissions payout, including overrides,on second month membership sales and onward and our contribution to the bonuspools, up to 60% of qualified membership sales.

 

**SELF-FUNDEDEMPLOYER HEALTHCARE PLANS**

 

For governments and otherlarge, self-funded employers seeking to reduce the cost of offering healthcarebenefits to

 

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theiremployees, we can also offer a more streamlined version of our product. Inthese cases, we offer access to healthcare through our network of providers andthe efficient repricing of bills through our proprietary systems. We can offerthese services on a price based on either the number of participants per monthor as a percentage of savings on healthcare costs actually realized. On June 18,2004, we acquired Access, a full-service third party administrator, for a purchaseprice of $3.4 million, consisting of $2,000,000 of cash and $1,400,000 of theCompany’s stock.  In addition to thepurchase price consideration, there is a contingency payout should the earningsbefore interest, taxes, depreciation and amortization (“EBITDA”) of Accessreach certain amounts after the closing of the transaction and before December 31,2006.  EBITDA, while not considered ameasure under  accounting principlesgenerally accepted in the United States of America, is the financial measurementutilized for the basis of the contingency payout and additional purchase pricepayments are dependent on Access achieving certain EBITDA levels. Currently,Access’ earnings are on a pace to exceed those EBITDA targets. Through theacquisition of Access, we now provide a wide range of healthcare claimsadministration services and other cost containment procedures that arefrequently required by governments and other employers who have chosen to selffund their healthcare benefits requirements. Access helps us offer a morecomplete suite of healthcare services. We are now able to provide individualsand employee groups access to preferred provider networks, medical escrowaccounts and full third party administration capabilities to adjudicate and paymedical claims.  From a salesdistribution standpoint, we have the ability to grow Access’ regional businessthrough our numerous independent marketing representatives who sell both toindividuals and employer groups throughout the United States.  Our acquisition of Access serves tocomplement our most recent entry into the public sector market through ouragreement with the State of Louisiana. Access’ primary area of expertise is in the public sector market.

 

**AFFORDABLEHEALTHCARE INSURANCE**

 

In September 2003, weorganized a new subsidiary under the name Care Financial of Texas, L.L.C.Through Care Financial, we offer our high deductible and scheduled benefitinsurance policies. In addition, we have recently added a suite of productsincluding life insurance and annuities, along with Healthcare Savings Accounts(HSAs), Healthcare Reimbursement Arrangements (HRAs) and medical and dependentcare Flexible Spending Accounts (FSAs) offered through Care125, a division of ForesightInc.. The high deductible and scheduled benefit insurance policies, HRAs andmedical and dependent care FSAs, when combined with the Care EntréeTM program,offer affordable, well-rounded solutions for individuals and employers who areno longer able to afford or obtain traditional health insurance policies. TheHRAs and medical and dependent care FSAs are also sold by our independentmarketing representatives who, from a regulatory standpoint, are not requiredto be licensed to sell these products. The life insurance products serve tocomplement our healthcare product offerings by addressing our members’ overallfinancial condition. The insurance policies are sold through our independentmarketing representatives who are licensed insurance agents.

 

**WHOLESALEMEMBERSHIP SOLUTION**

 

***Healthcare Membership Programs***

 

We also design healthcaremembership programs for employer groups and third party marketers. Membershipsin these programs are offered and sold by direct marketing through direct salesor in-bound direct marketing. We believe that our clients, their members, andthe vendors of the products and services offered through the programs, allbenefit from our membership service programs. The products and services arebundled, priced and marketed utilizing relationship marketing strategies orinbound direct marketing to target the profiled needs of the clients’particular member base. Our memberships sold by third-party organizations aregenerally marketed using the third-party’s name or brand or under our wholesalebrand “For Your Good Health”. We refer to these programs and membership salesas wholesale programs or private label programs. While the services offered toconsumers by these private label programs are generally similar to the serviceswe offer through Care EntréeTM, each of the private label programs can bundleour services to fit the needs of their consumers. For instance, some of ourprivate label programs do not offer a self-funded escrow program to theirmembers.

 

***Rental Purchase and Club MembershipPrograms***

 

We also design club membershipprograms for rental-purchase companies, financial organizations, employergroups, retailers and association-based organizations. Memberships in theseprograms are offered and sold as part of a point-of-sale transaction or bydirect marketing through direct mail or as inserts. Program members are offeredand provided our third-party vendors’ products and services. The products andservices are bundled, priced and marketed to target the profiled needs of theclients’ particular customer base. Most of our club membership programs aresold by third-party organizations, generally in connection with a point-of-saletransaction. We refer to these programs and membership sales as wholesaleprograms. Revenues

 

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fromthese programs have represented a lesser portion of the Company’s totalrevenues in recent years than in the past.

 

**BENEFITS TOMEMBERS OF OUR PROGRAMS**

 

We believe that our programsoffer members an economic, efficient and convenient method for the selection ofproducts and services. Members are entitled to savings for products andservices that may not otherwise be available to them. Vendors of products andservices offered and sold through the programs to members are benefited.Vendors are provided the opportunity to reach a large number of demographicallytargeted customers with minimal incremental marketing cost.

 

**OPERATIONALREVIEW FOR THE YEAR ENDED DECEMBER 31, 2004**

 

The year ended December 31,2004 was very much another transitional year for us. We implemented memberescrow accounts during the fourth quarter of 2002 in response to the marketchanges in the healthcare savings industry, and on October 1, 2003, weexpanded the escrow requirements to all programs offering access to medicaldoctors and physicians. As a result of this change, we now require all of ourmembers to escrow funds with us prior to utilizing any physician, hospital orancillary services. As of December 31, 2004, the percentage of ourindividual members who have escrowed funds with us was approximately 34.4% ofthe total individual healthcare membership base. This excludes our privatelabel programs, where the escrow requirements have not been mandated.

 

Our healthcare membershipbase was approximately 57,000 members as of December 31, 2004 as comparedto 81,000 members as of December 31, 2003, a decrease of approximately24,000 members or 29.6%. The reduction in our healthcare membership base wasprimarily due to the implementation of the escrow account requirements forhospitalized care in the fourth quarter of 2002, and expansion to physiciansand doctors commencing on October 1, 2003. In addition, our healthcaresavings program has experienced issues with provider acceptance in somemarkets.

 

As a result of some ofhealthcare program changes introduced during 2003 and 2002, our independentmarketing representative base experienced a significant reduction in 2004 and2003. We, however, continue to maintain the majority of our core businessleaders whose downline organizations generate a substantial portion of ourrevenues.

 

Although these escrowrequirements negatively impacted our membership base and consequently ourrevenues and net earnings in 2004, these changes were required to help provideassurance of payment to the healthcare providers and accordingly, theircontinued willingness to provide healthcare services to our members. Thisstrategic move was critical to our long-term operational and financialviability in the health card savings market as many healthcare providers throughoutthe United States will no longer accept a “health discount” card. The successof our new healthcare product offering has not been fully determined.Therefore, its long-term impact on both revenues and net earnings is currentlyunknown and may not be known for some time. The growth of our members escrow orcash-in-trust to $4,921,626 as of December 31, 2004 from $2,768,447 as of December 31,2003 and from $108,152 as of December 31, 2002 and provides preliminaryalthough not conclusive evidence of the acceptance of this form of medicalsavings product offering.

 

Our operating results didbenefit from the acquisition of Access in June of 2004. While included inoperations for only slightly more than six months during 2004, Accesscontributed $3,670,375 or 10% to our 2004 revenue and $298,817 of net earnings(after taxes) to partially offset our other losses. Access has successfullysecured multi-year contracts on favorable terms with its two largest clientsand has brought us a stable source of revenue. Moreover, we have realized certain intangible benefits from theacquisition.  For instance, we havebroadened the management responsibilities of several members of Access’management team to company-wide roles. Our new Chief Operating Officer, Frank Apodaca, is the President andC.E.O. of Access and he will be implementing, on a company-wide basis,operational controls that have been successful at Access.

 

In the fourth quarter of2003, we began reorganizing and rebuilding our corporate sales team to bebetter positioned to enter into the large self-insured employer group andmedical benefits market. We restructured our in-house sales team and in January 2004hired a Executive Vice-President of Sales and Marketing to lead this area, bothfrom a strategy and execution standpoint. Our medical savings product offeringin conjunction with our Care125 medical savings account provide an alternativehealthcare product offering for a growing number of companies that have chosento move towards the self-funded and/or high deductible insurance route. TheGroup Division has positioned itself for growth in 2005 by implementing a morefocused sales strategy that capitalizes on both the consumer-driven health careinterest sweeping the group marketplace as well as the continued decline ingroup insurance participation due to the unrelenting rise in group health careinsurance costs.  By being able to now package its HRA and HSA products,self-funded capabilities, and an A-rated high deductible major medical plan

 

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througha newly formed partnership, Precis is positioned to offer a trueconsumer-driven healthcare strategy to the group marketplace.  Also byrepackaging its non-insurance healthcare saving programs so that it can beeffectively sold by the largest Worksite Brokers in the country we can nowaggressively market a cost effective non-insurance solution to those employeesand/or their dependents who can no longer participate in their groups’healthcare insurance plan due to soaring costs.

 

**CRITICALACCOUNTING POLICIES**

 

**REVENUERECOGNITION**

 

***Healthcare Membership Revenues***

 

The Company recognizesmembership revenues, other than initial enrollment Fees, on each monthlyanniversary date. Membership revenues are reduced by the amount of refundsestimated to be incurred.  For membersthat are billed directly, collection of the billed amount is collected almostentirely by automated clearing house electronic check or by electronic chargeto the members’ credit card. The settlement of those charges occurs within aday or two. In a minority of cases, the membership fees may be billed to themember by our private label partners, and then our portion of such revenue isremitted to us on a periodic basis. During the time from the billing of suchmember fees and their remittance to us, we record a receivable from thoseprivate label partners, for which management must estimate an allowance foruncollectible accounts.

 

Member enrollment fees, netof direct costs, are deferred and amortized over the estimated membershipperiod, which averages eight to ten months. Independent marketingrepresentative fees, net of direct costs, are deferred and amortized over theterm of the contract. Judgment is involved in the allocation of costs to determinethe direct costs netted against those deferred revenues, as well as inestimating the membership period over which to amortize such net revenue. TheCompany maintains analysis of such costs and collects statistics on suchmembership periods as a basis for adjusting these estimates from time to time.

 

***Access Third Party Administration***

 

Access recognizes revenuebased upon the individual contract arrangements that it has with each of its’clients, ie., when the contractual obligations are satisfied.

 

***Rental Purchase and Club MembershipRevenues***

 

Rental purchase and clubmembership revenues are recognized in the month that our products and serviceshave been delivered to our clients. We sell rental purchase and club membershipprograms on a wholesale basis to our clients. The wholesale client remits aportion of the rental purchase and club membership revenues to us and retainsthe balance as compensation for having made the sale. We provide an allowancefor those accounts that we consider to be uncollectible.

 

**COMMISSIONEXPENSE**

 

Commissions are paid to ourindependent marketing representatives in the month following the month in whicha member has enrolled in our Care EntréeTM program. Commissions are only paid inthe following month when the related monthly membership fees have beenreceived. We do not pay advanced commissions on membership sales. The amountsof commission are based upon established commission schedules and aredetermined and accrued based upon the recognition the related healthcare membershiprevenue, as described above.

 

**ACQUISITIONS**

 

During 2004, we acquiredAccess for a total purchase price of $3,666,231.  That purchase price consideration wasallocated in the following amounts: (i) $521,141 has been allocated to networking capital components primarily based upon their respective present valuesof amounts to be received and paid, ii) $1,400,000 has been allocated to acontract acquired in the acquisition of Access based upon its estimated fairvalue, (iii) $ 205,936 has been allocated to fixed assets based upon theirestimated replacement costs and (iv) $2,304,032 has been allocated to goodwillbased upon the excess of the cost of Access over the net amounts assigned toassets acquired and liabilities assumed, as previously described. Theallocation of $2,304,032 to goodwill is considered appropriate, as Accessstrategically complements the Company’s healthcare service offering.

 

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**FIXED ASSETS**

 

Property and equipment arecarried at cost less accumulated depreciation and amortization. Depreciationand amortization are provided using the straight-line method over the estimateduseful lives of the related assets for financial reporting purposes andprincipally on accelerated methods for tax purposes. Leasehold improvements aredepreciated using the straight-line method over their estimated useful lives orthe lease term, whichever is shorter. The estimation of useful lives involvesjudgment and is based, in part, upon past experience with similar assets andupon management’s plans for the utilization of assets in the future.

 

We periodically reviewsproperty and equipment whenever events or changes in circumstances indicatethat their carrying amounts may not be recoverable or their depreciation oramortization periods should be accelerated. When any such impairment exists,the related assets will be written down to their fair value. If we determinethat the remaining useful life, based upon current events and circumstances,should be adjusted, the depreciation or amortization of the related asset isadjusted on a prospective basis.

 

**INTANGIBLEASSET VALUATION**

 

Our intangible assets,consisting primarily of goodwill of $21,381,316 as of December 31, 2004,represented the excess of acquisition costs over the fair value of net assetsacquired. Goodwill is not amortized. During the year ended December 31,2004, our intangible assets were reduced by $2,000,000 to reflect impairment ofthe goodwill arising from our acquisition of Foresight, Inc. in 2000 and were increasedby $2,304,032 to reflect the goodwill arising from our acquisition of Accessand by $1,400,000 allocated to a contract acquired in the acquisition ofAccess. During the year ended December 31, 2002, our goodwill wasdecreased to reflect the recognition of an income tax benefit of $982,236 whichrelates to our 2001 merger-acquisition of The Capella Group, Inc. Duringthe year ended December 31, 2001, our goodwill was increased by $822,076to adjust for deferred fees pertaining to the merger-acquisition of The CapellaGroup, Inc.

 

As of  December 31,2004, our intangible assets represented approximately 54% of our total assets.The intangible assets balance of $22,781,316 as of December 31, 2004consisted of $19,077,284 which arose from the merger-acquisition of The CapellaGroup, Inc. and $3,704,032 from the acquisition of Access, as describedabove.  As of December 31, 2004, weconducted our annual goodwill impairment review.  Our goodwill valuation is dependent primarilyon the projected revenue and net earnings of our Care EntréeTM healthcarebusiness, our Foresight membership business and Access healthcare business. Thecompany estimates the fair value of each of those reporting units, primarily onthe basis of valuing projected revenue and net earnings using marketcomparables and compares it with the reporting unit’s book value, which equalsthe recorded amounts of assets and allocated goodwill less liabilities. Whenthe fair value of those reporting units is greater than the reporting unit’sbook value, there is no impairment, and the test is complete. Otherwise, thecompany estimates the implied fair value of the reporting unit’s goodwill byrepeating the process performed at acquisition. This requires subtractingestimated current fair values of the unit’s identifiable net assets from theunit’s estimated fair value, and comparing the difference with the carryingamount of the goodwill. When the implied fair value of the reporting unit’sgoodwill is greater than carrying amount of the goodwill, the goodwill is notimpaired and there is no write-off. When implied fair value of the reportingunit’s goodwill is less than the carrying amount of the goodwill, however, thecompany must record an impairment write-off equal to the difference. Theprocedures surrounding goodwill valuation can at times be very subjective anddifficult to quantify given that the projected revenue and net earningsassociated with our Care EntréeTM healthcare membership business is based on abusiness strategy that is fairly new, innovative and evolutionary in nature. Thisis particularly difficult given the our recent history of decreasing revenuesresulting from a more complex escrow-based healthcare savings product, afrustrated independent marketing sales force, and  increased expenses from, among other things,new compensatory sales initiatives produced an operating loss.  As stated above, in the first quarter of2005, we have undertaken measures and initiatives to improve our operatingperformance.  These measures andinitiatives include (i) the integration of Access management members with ourmanagement team, as mentioned above, (ii) the termination of certain equipmentcapital leases, (iii) other cost reduction actions, and (iv) exploration ofadditional products to compliment our core healthcare savings product and offeradditional compensatory incentives to our independent marketingrepresentatives. We have incorporated the expected impact of those measures inour estimation of  the projected revenueand net earnings associated with our Care EntréeTM healthcare membershipbusiness for purposes of that goodwill valuation analysis. In the case ofAccess’ more mature business, revenues and earnings are more stable, withgenerally a lower potential growth rate than our Care EntréeTM business, andtherefore the goodwill impairment review process for that reporting unit isless difficult. With respect to the $2,000,000 of goodwill associated with theForesight acquisition in 2000, based upon the operating results of Foresight in2004 and projected revenues and earnings, we determined that the estimated fairvalue of Foresight did not exceed the carrying value of the Foresight tangibleassets.  This impairment arose

 

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from the continuing decline in the revenues,and increases in the losses, in that subsidiary, as detailed in Note 15 —Segmented Information to the Financial Statements included herein. Accordingly,a charge to earnings was recorded to reflect that $2,000,000 impairment of theForesight goodwill.

 

**INCOMETAXES**

 

Income taxes are providedfor the tax effects of transactions reported in the financial statements andconsist of taxes currently due plus deferred taxes related primarily todifferences between the basis of assets and liabilities for financial andincome tax reporting. The net deferred tax assets and liabilities represent thefuture tax return consequences of those differences, which will either betaxable or deductible when the assets and liabilities are recovered or settled.We evaluate the probability of recognizing the benefit of deferred tax assetsthrough the reduction of taxes otherwise payable in the future and the need toprovide an allowance against the carrying amount of such deferred tax assets ifit is more probable than not that some or all of those assets will not berealized.

 

**NEWACCOUNTING PRONOUNCEMENTS**

 

In December 2004,the FASB issued Statement No. 123R, “Share-Based Payment” (SFAS No. 123R), arevision to SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No.123).  SFAS No. 123R eliminates the alternative to use the AccountingPrinciples Board Opinion 25’s (Opinion 25) intrinsic value method of accountingthat was provided in SFAS No. 123 as originally issued.

 

UnderOpinion 25, issuing stock options to employees generally resulted inrecognition of no compensation cost.  SFAS No. 123R requires companies tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award (withlimited exceptions). That cost will be recognized over the period duringwhich an employee is required to provide service, in exchange for the award -the requisite service period (usually the vesting period).  No compensationcost is recognized for equity instruments for which employees do not render therequisite service.

 

Companieswill initially measure the cost of employee services received in exchange foran award of instruments classified as liabilities  based on its current fair value; the fairvalue of the awards classified as a liability will be remeasured subsequentlyat each reporting date through the settlement date.  Changes in fair valueduring the requisite service period will be recognized as compensation costover that period.

 

Thegrant-date fair value of employee share options, or the Company’s restrictedstock and similar instruments classified in the balance sheet as equity will beestimated using option-pricing models adjusted for the unique characteristicsof those instruments (unless observable market prices for the same or similarinstruments are available); the fair value of awards classified as equity willnot be remeasured.  If an equity award is modified after the grant date,incremental compensation cost will be recognized in an amount equal to theexcess of the fair value of the modified award over the fair value of theoriginal award immediately before the modification.

 

Excesstax benefits, as defined by SFAS No. 123R, will be recognized as an addition topaid-in capital.  Cash retained as a result of those excess tax benefitswill be presented in the statement of cash flows as financing cashinflows.  The write-off of deferred tax assets relating to unrealized taxbenefits associated with recognized compensation cost will be recognized asincome tax expense unless there are excess tax benefits from previous awardsremaining in paid-in capital to which it can be offset.

 

SFASNo. 123R applies to all awards granted after the required effective date and toawards modified, repurchased, or cancelled after that date.  As of therequired effective date, companies that used the fair-value-based method foreither recognition or disclosure under SFAS No. 123 will apply SFAS No. 123Rusing a modified version of prospective application.  Under thattransition method, compensation cost is recognized on or after the requiredeffective date for the portion of outstanding awards for which the requisiteservice has not yet been rendered, based on the grant-date fair value of thoseawards calculated under SFAS No. 123 for either recognition or pro formadisclosure.  The cumulative effect of initially applying SFAS No. 123R, ifany, is recognized as of the required effective date.  SFAS No. 123R iseffective as of the beginning of the first interim or annual reporting periodthat begins after June 15, 2005.  Based upon existing optionissuances, management estimates that the adoption of SFAS No. 123R will reduceEPS by approximately $.03 per share for the year ended December 31, 2005.

 

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**RESULTS OFOPERATIONS**

 

The following table setsforth selected results of our operations from our consolidated financialstatements for the years ended December 31, 2004, 2003 and 2002 as apercent of total revenue for the years presented.

 
| ** **                                 | ** ** | **For the Year Ended  December 31,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Product and service revenues               |       | 100                                       | %          | 100 | % | 100 | % |
| Operating expenses:                        |       |                                      |       |   |   |   |   |
| Cost of operations                         |       | 39                                        |       | 31 |   | 27 |   |
| Sales and marketing                        |       | 29                                        |       | 37 |   | 40 |   |
| General and administrative                 |       | 34                                        |       | 16 |   | 14 |   |
| Impairment charge for goodwill             |       | 5                                         |       |   |   |   |   |
| Total operating expenses                   |       | 107                                       |       | 84 |   | 81 |   |
| Operating (loss) income                    |       | (7                                        | )          | 16 |   | 19 |   |
| Other expense:                             |       |                                      |       |   |   |   |   |
| Interest expense, net                      |       | —                                    |       | — |   | — |   |
| Total other expense                        |       | —                                    |       | — |   | — |   |
| Net (loss) earnings before taxes           |       | (7                                        | )          | 16 |   | 19 |   |
| Provision for income tax (benefit) expense |       | (2                                        | )          | 6 |   | 7 |   |
| Net (loss) earnings                        |       | (5                                        | )%         | 10 | % | 12 | % |

 

**COMPARISONOF 2004 AND 2003**

 

**PRODUCT AND SERVICE REVENUES.** During the year ended December 31, 2004, revenues were $38,318,696,a decrease of $3,768,975, or 9.0% from $42,087,671 during 2003. The reductionin 2004 revenues was primarily due to continuing reductions in the members inour Care Entrée program as a result of our implementation of member escrowaccount requirements for hospitalized care commencing in late 2002 of$6,861,920 offset in part by revenues of $3,670,375 from Access that was acquired in June 2004. Therequirement of member escrow deposits was in response to the market changes inthe healthcare savings industry. In addition, effective October 1, 2003,the escrow account requirements was expanded to include all doctors andphysicians. Under the escrow arrangement, we pre-certify the members’ abilityto pay based on available escrow account balances and process the members’payments directly to the medical providers to help assure payment of thehealthcare providers. As a result of these changes, we believe an enhancedhealthcare product offering has been created for members and the healthcareproviders. The overall success and impact of revenues and net earnings of thisnewly restructured product offering will not be known for some time. Theescrowed funds referred to as cash-in-trust on our balance sheet was $4,921,626  as of December 31, 2004.  Through the acquisition of Access, we providea wide range of healthcare claims administration services and other costcontainment procedures that are frequently required by governments and otheremployers who have chosen to self fund their healthcare benefits requirements.For 2004, more than 86.1% of our revenues were attributable to our healthcaremembership program.

 

Additionally, revenue in ourForesight wholesale club membership programs declined by $936,808, or 50.3%,due to the maturity and competitive nature of this business. The reduction inrevenue in our Care EntréeTM program and wholesale club membership programsduring 2004 was offset in part by increased revenue of $359,378 in our CareFinancial division.

 

*Operating Metrics*

 

Our healthcare membershipbase declined during 2004 by approximately 24,000 members or 29.6% toapproximately 57,000 members as of December 31, 2004 as compared to 81,000members as of December 31, 2003, , and as compared to a decrease during2003 of approximately 11,000 members or 12.0% from the approximately 92,000members as of December 31, 2002, Those declines in membership were theprimary cause of the $6,861,920 (approximately 17%) decrease in Care Entréeprogram member revenues from 2003 to 2004 described above.  The reduction in our healthcare membershipbase was due to the

 

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implementationof the escrow account requirements for hospitalized care in the fourth quarterof 2002, and expansion to physicians and doctors commencing on October 1,2003.

 

As a result of some ofhealthcare program changes introduced during 2004 and 2003, our independentmarketing representative base experienced a significant reduction in 2004. We,however, continue to maintain the majority of our core business leaders whosedownline organizations generate a substantial portion of our revenues.

 

**COST OF OPERATIONS.**  Cost of operations for the yearended December 31, 2004 increased $1,975,849 or 15.1% to $15,101,700 from$13,125,851 during 2003. The increase in cost of operations primarily arosefrom inclusion in the operating results $2,052,615 of expenses for Access, fromits acquisition in June 2004. The relatively fixed nature of expenses inour Care Entrée program during a period of declining revenues coupled with ashift toward private label sales of our healthcare membership product led to adrop in gross profit in that program from 2003 to 2004. The relatively fixednature of expenses of our Care Entrée program was largely due to the capitalleases of printing equipment entered into when membership level and enrollmentactivity was at a significantly higher level. Most of these leases terminate inthe first six months of 2005 and the associated equipment will be replaced withequipment costing approximately $1,500,000 less per year. Additionally, duringthe fourth quarter of 2004 and the first quarter of 2005, we experienced adeterioration in the collectibility of receivables and notes from certain of ourprivate label partners, leading to an increase in the allowance for doubtfulaccounts and notes and a charge to costs of operations of $1,012,253. Thoseincreases were offset in part by decreases in costs of access to providernetworks of $455,235. Cost of operations, as a percentage of revenues, was39.4% of revenues during 2004, while in 2003 cost of operations was 31.2% ofrevenues.

 

**SALES AND MARKETING EXPENSES.**  Salesand marketing expenses decreased $4,640,796 or a decrease of 29.8%, to $10,931,392during the year ended December 31, 2004 from $15,572,188 during 2003.Sales and marketing expenses represented 28.5% and 37.0% of the revenues duringthe years ended December 31, 2004 and 2003, respectively. The decrease insales and marketing expense was primarily due to a $4,215,706 decreasecommission expense related to a decrease in revenue from healthcare savingsservices of $6,861,920 from 2003 to 2004 as well as a shift toward privatelabel sales of our healthcare membership product, resulting in lower commissioncosts but also a decline in gross profit margins.  The decrease as a percentage of revenues was alsodue to the inclusion in Access revenues that have a much lower level of associatedsales and marketing costs when compared to our other operations.

 

**GENERAL AND ADMINISTRATIVE EXPENSES.** General and administrative expenses increased $6,180,308 or 91.7% to $12,919,579during the year ended December 31, 2004 from $6,739,271 during 2003. Theincrease in general and administrative expenses was primarily due to the June 2004acquisition of Access that added $1,152,557 to these costs, legal fees andlitigation costs of $868,209, introduction of our Care 125 and Care Financialproducts that increased these costs by $917,803, and management of the memberescrow accounts for our healthcare savings products that increased these costs by$549,473. The additional costs of Care Financial during 2004 include $678,000of management fees paid under an arrangement that ended in March 2005.Additionally, the cost of being a public company increased approximately$200,000 from approximately $600,000 in 2003 to approximately $800,000 in 2004.General and administrative expenses represented 33.7% and 16.0% of revenues forthe years ended December 31, 2004 and 2003, respectively.

 

**IMPAIRMENTOF GOODWILL.**Withrespect to the $2,000,000 of goodwill associated with the Foresight acquisitionin 2000, based upon the operating results of Foresight in 2004 and projectedrevenues and earnings, we determined that the estimated fair value of Foresightdid not exceed the carrying value of the Foresight tangible assets.  This impairment arose from the continuingdecline in the revenues, and increases in the losses, in that subsidiary, asdetailed in Note 15 — Segmented Information to the Financial Statementsincluded herein. Accordingly, a charge to earnings was recorded to reflect that$2,000,000 impairment of the Foresight goodwill.

 

**TOTAL OPERATING EXPENSES.** During the year ended December 31, 2004, total operating expenses(consisting of costs of operations, sales and marketing expenses, general andadministrative expenses and impairment of goodwill) increased $5,515,360 or 15.6%,to $40,952,671 from $35,437,311 during 2003. Total operating expensesrepresented 106.9% and 84.2% of revenues for the years ended December 31,2004 and 2003, respectively. The decrease in operating margins was due to thereasons described above.

 

**OPERATING INCOME AND NET EARNINGS (LOSS).** During the year ended December 31, 2004, our operating loss was $2,633,975,a decrease of $9,284,336 or 139.6% from the operating income of $6,650,361during 2003. Our net loss was $1,955,952, or 5.1% of revenues, net of provisionfor an income tax benefit of  $734,581. Duringthe year ended

 

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December 31,2004, we incurred tax costs of approximately $564,233 with respect to statetaxes. In comparison, during 2003 net earnings were $4,089,326, or 9.7% ofrevenues net of provision for income taxes of $2,411,066. During the yearsended December 31, 2004 and 2003, net earnings (loss) per common share,calculated on a diluted basis, were $(0.16) and $0.34, respectively.

 

**COMPARISONOF 2003 AND 2002**

 

**PRODUCT AND SERVICE REVENUES.** During the year ended December 31, 2003, revenues were $42,087,671,a decrease of $1,027,995, or 2.4% from $43,115,666 during 2002. The reductionin actual revenues for the year ended December 31, 2003 was primarily dueto reductions in (i) the members in our Care Entrée program as a result ofour implementation of member escrow account requirements for hospitalized carecommencing in the fourth quarter of 2002 of $1,028,775 offset in part by escrowmaintenance fees of $442,930 and (ii) our wholesale club membershipprograms of $790,399. The requirement of member escrow deposits was in responseto the market changes in the healthcare savings industry. In addition,effective October 1, 2003, the escrow account requirements forhospitalized care was expanded to include all medical doctors and physicians.Under the escrow arrangement, we pre-certify members’ ability to pay based onavailable escrow account balances and process the members’ payments directly tothe medical providers to help assure the payment of the healthcare providers.As a result of these changes, we believe an enhanced healthcare productoffering has been created for members and the healthcare providers. Theescrowed funds referred to as cash-in-trust on our balance sheet was $2,768,447as of December 31, 2003. The reduction in revenue in our wholesale clubmembership programs was due to the maturity and competitive nature of thisbusiness as compared to our healthcare membership savings business thatoperates in a growth market.

 

For the year ended December 31,2003, more than 90% of our revenues were attributable to our healthcaremembership program.

 

The reduction in revenue inour Care EntréeTM program and wholesale club membership programs during 2003 wasoffset in part by increased revenue of $255,765 in our Care Financial division.

 

*Operating Metrics*

 

Our healthcare membershipbase was approximately 81,000 members as of December 31, 2003 as comparedto 92,000 members as of December 31, 2002, a decrease of approximately11,000 members or 12.0%. The reduction was most noticeable in the fourthquarter of 2003 where our membership decreased by approximately 4,000, or 4.7%during this period. The reduction in our healthcare membership base was due tothe implementation of the escrow account requirements for hospitalized care inthe fourth quarter of 2002, and expansion to physicians and doctors commencing inOctober  2003.

 

As a result of some ofhealthcare program changes introduced during 2003 and 2002, our independentmarketing representative base experienced a significant reduction in 2003. We,however, continue to maintain the majority of our core business leaders whosedownline organizations generate a substantial portion of our revenues.

 

**COST OF OPERATIONS.**  Cost of operations for the yearended December 31, 2003 increased $1,582,445 or 13.7% to $13,125,851 from$11,543,406 during 2002. The increase in cost of operations primarily arosefrom our increased member service staff and other personnel of $479,929necessary to support our operations, particularly our Foresight, Inc.division which acts as a third party administrator for claims review and paymentprocessing from member escrow accounts, the increase in preferred providernetwork costs of $833,794 as a result of several ancillary products introducedin 2003, and the additional full year depreciation expense associated withcapital leases acquired for printing purposes of $442,814 in the fourth quarterof 2002 net of outsourced printing costs.

 

Cost of operations, as apercentage of revenues, were 31.2% of revenues during the year ended December 31,2003, while in 2002 cost of operations were 26.8% of revenues. This increasewas for the reasons described above.

 

**SALES AND MARKETING EXPENSES.**  Salesand marketing expenses decreased $1,487,060 or a decrease of 8.7%, to$15,572,188 during the year ended December 31, 2003 from $17,059,248during 2002. Sales and marketing expenses represented 37.0% and 39.6% of therevenues during the year ended December 31, 2003 and 2002, respectively.The decrease as a percentage of revenues was primarily due to certain thresholdsales qualification requirements not being attained by our independentmarketing representatives as well as a shift in the mix between private labeland healthcare membership business.

 

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**GENERAL AND ADMINISTRATIVE EXPENSES.** General and administrative expenses increased $643,911 or 10.6% to$6,739,271 during the year ended December 31, 2003 from $6,095,360 during2002. The increase in general and administrative expenses for the year ended December 31,2003 was primarily due to additional salaries and other administrative costs of$360,699 necessary to support both our information systems and financialcapabilities and administrative operations as well as the recruitment of aChief Information Officer and a more experienced information systems staff. Inaddition, the Company has incurred additional public company costs of $233,694which include certain effects of Sarbanes-Oxley. General and administrativeexpenses represented 16.0% and 14.1% of revenues for the years ended December 31,2003 and 2002, respectively.

 

**TOTAL OPERATING EXPENSES.** During the year ended December 31, 2003, total operating expenses(consisting of costs of operations, sales and marketing expenses, and generaland administrative expenses) increased $739,296 or 2.1%, to $35,437,310 from $34,698,014during 2002. Total operating expenses represented 84.2% and 80.5% of revenuesfor the years ended December 31, 2003 and 2002, respectively. The decreasein operating margins was due to the reasons described above.

 

**OPERATING INCOME AND NET EARNINGS.** During the year ended December 31, 2003, operating income was$6,650,361, a decrease of $1,767,291, or 21.0% from $8,417,652 during 2002. Netearnings were $4,089,326, or 9.7% of revenues, net of provision for incometaxes of $2,411,066. During the year ended December 31, 2003, we incurredadditional tax costs of approximately $184,000 with respect to state taxes. Incomparison, during 2002 net earnings were $5,478,363, or 12.7% of revenues netof provision for income taxes of $2,874,852. During the years ended December 31,2003 and 2002, net earnings per common share, calculated on a fully dilutedbasis, was $0.34 and $0.46, respectively.

 

**PRO FORMAEFFECT OF STOCK-BASED COMPENSATION**

 

We have historically usedstock options to retain and compensate our officers, directors, employees andothers. During 2004, 2003 and 2002, we granted stock options for the purchaseof our common stock to our officers, directors, employees and others. Inaccordance with Accounting Principles Board Opinion (“APB”) No. 25, nocompensation cost for these stock options was recognized in our financialstatements because the exercise price was equal to or exceeded the fair valueof our common stock at the date of grant. The outstanding stock options grantedin 2004, 2003 and 2002 had an estimated fair value at the date of grant of theoptions of $1,232,405, $728,892, and $1,038,133 , respectively, utilizing themethodology prescribed under Statement of Financial Accounting Standard (“SFAS”)No. 123, *Accounting for Stock-Based Compensations*.  After giving effect to the estimated fairvalue of these options, our pro forma net (loss) earnings were $(2,271,535)($0.16 basic loss per common share) and $3,862,933 ($0.33 basic earnings percommon share) for the years ended December 31, 2004 and 2003, respectively.

 

**INCOME TAXPROVISION**

 

SFAS 109, *Accounting for Income Taxes*, requires theseparate recognition, measured at currently enacted tax rates, of deferred taxassets and deferred tax liabilities for the tax effect of temporary differencesbetween the financial reporting and tax reporting bases of assets andliabilities, and net operating loss carryforwards for tax purposes. A valuationallowance must be established for deferred tax assets if it is “more likelythan not” that all or a portion will not be realized. At December 31, 2004and 2003 , we had deferred tax benefits resulting in large part from thebenefits from net operating loss carryforwards of $1,801,368 and $760,681,respectively,  which, if not utilized,will expire at various dates through 2020. The cumulative net deferred taxasset as of December 31, 2004 and 2003 was $1,146,096 and $623,409,respectively.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

**OPERATING ACTIVITIES.**  Netcash provided by operating activities for the years ended December 31,2004 and 2003 was $1,758,624 and $7,818,885, respectively, an decrease of $6,060,261.The decrease in net cash from operating activities was negatively impactedprimarily due to the decline in profitability discussed above.

 

Net cash provided byoperating activities for the years ended December 31, 2003 and 2002 was$7,818,885 and $3,989,546, respectively, an increase of $3,829,339. Theincrease in net cash from operating activities was positively impactedprimarily due to an increase in depreciation expense of $1,121,794 (a non-cashactivity), an improvement in accounts receivable collection of $1,668,744 andan additional income tax payment of $791,040 that was made during the threemonths ended June 30, 2002.

 

**INVESTING ACTIVITIES.**  Netcash used in investing activities for the years ended December 31, 2004and 2003 

 

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consistedof $2,595,057 and $945,344, respectively, and was used for the acquisition ofAccess in 2004 and to purchase fixed assets necessary to accommodate andsupport our operations. The majority of our fixed asset purchases for the yearsended December 31, 2004 and 2003 were in respect of recently developedcomputer software and some hardware purchases.

 

During the years ended December 31,2004 and 2003, we entered into net issuances (settlements) of capital leaseobligations of $185,813 and $(504,152), respectively. These net settlements ofcapital lease obligations represented the excess of capital lease retirementsover obligations. These leases were not included in our net cash used ininvesting activities because they are considered non-cash in nature. Ourcapital lease obligations are primarily related to the copiers and othermachinery used to develop and produce member and independent marketingrepresentatives’ directories, training videos and sales aids materials.

 

Net cash used in investingactivities for the year ended December 31, 2002, was $920,408. During theyear ended December 31, 2002, net cash of $920,408 was used to purchasefixed assets, primarily computer software and hardware purchases, necessary tosupport the growth in our operations.

 

In connection with theacquisition of Access, there is a contingency payout should the earnings beforeinterest, taxes, depreciation and amortization (“EBITDA”) of Access reachcertain amounts after the closing of the transaction and before December 31,2006.  EBITDA, while not  considered a measure under  accounting principles generally accepted inthe United States of America, is the financial measurement utilized for thebasis of the contingency payout and additional purchase price payments aredependent on Access achieving certain EBITDA levels.  The maximum amount of the consideration thatmay be paid to the seller of Access, including the closing date purchase priceconsideration and investment banking, valuation and legal and accounting fees,is $9,773,500. The amount of contingency payments and common stock deliveriesbased upon EBDITA through December 31, 2006, will be based upon a 3.22multiple of EBITDA of Access determined on a quarterly basis, with effectiveadjustments as of December 31, 2004, 2005 and 2006. The Company expectsthat Access will achieve those EBITDA levels and that, as a result, contingentpayouts will be made. However, the amount of payouts through December 31,2006 cannot be estimated at this time. The contingency payout will be accountedfor as a decrease in the Company’s cash and cash equivalents for the amountpaid, an increase to stockholders’ equity for the fair value issued and acorresponding increase in goodwill for the value of the cash paid and stockissued.

 

**FINANCING ACTIVITIES.**  Netcash used in financing activities for the years ended December 31, 2004,2003 and 2002 were $1,968,534, $1,397,424 and $1,212, 977, respectively. Duringthe year ended December 31, 2004, net cash of $681,537 was used forrepurchase of the Company’s outstanding shares under the Company’s Common StockRepurchase Plan and net cash of $1,291,435 was used for repayments on capitalleases. During the year ended December 31, 2003, net cash of $1,428,530was used for repayments on capital leases. During the year ended December 31,2002, net cash of $1,212,977 was used to redeem preferred stock of $1,000,000 andfor payments on capital leases of $809,091, offset in part by proceeds of$610,251 from exercise of stock options and warrants.

 

At December 31, 2004and 2003, we have working capital of $6,344,954 and $8,818,823, respectively.Other than our capital lease obligations of $591,486, we do not have anycapital commitments. We do not anticipate that our capital expenditures for theyear ending December 31, 2005 will exceed the amount incurred for the yearended December 31, 2004. We believe that our existing cash and cashequivalents, and cash provided by operations will be sufficient to fund ournormal operations and capital expenditures for the next 12 months.

 

Because our capitalrequirements cannot be predicted with certainty there is no assurance that wewill not require any additional financing before the expiration of the 12-monthperiod. There is no assurance that any additional financing will be availableon terms satisfactory to us or advantageous to our shareholders.

 

**CONTRACTUALOBLIGATIONS**

 

**OPERATINGLEASES**

 

We lease various officespaces and certain machinery and equipment. These leases are classified asoperating leases within the meaning of SFAS No. 13, *Accounting for Leases*. Our financialcommitments under these leases continue through

 

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December 15,2006.

 

**CAPITALLEASES**

 

We have several capitalleases for office equipment. These leases are classified as capital leaseswithin the meaning of SFAS No. 13, *Accountingfor Leases*. Our financial commitments under these leases end inearly 2006.

 

 
| **Description**              | ** ** | **Payments Due by Period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                  | ** ** | **Less Than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** |
| Operating Leases             |       | $                          | 789,174    |   | $ | 427,177 |   | $ | 361,997 |   | — |   | — |   |
| Capital Leases               |       | $                          | 666,133    |   | $ | 566,060 |   | $ | 100,073 |   | — |   | — |   |
| Total                        |       | $                          | 1,455,307  |   | $ | 993,237 |   | $ | 462,070 |   | — |   | — |   |

 

The payment amounts forcapital leases include $23,000 of implicit interest.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

We do not have anyinvestments in market risk sensitive investments.

 

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**QUARTERLYRESULTS OF OPERATIONS AND SEASONALITY**

 

The following table presentsour unaudited quarterly results of operations data for each of the eightquarters in 2004 and 2003. The quarterly information is unaudited but, in theopinion of management, reflects all adjustments consisting only of normalrecurring adjustments necessary for a fair presentation of the information forthe periods presented. The results of operations for any quarter are notnecessarily indicative of results for any future period.

 

Our consolidated financialstatements begin on page F-1.

 
| ** **                      | ** ** | **QUARTER ENDED (UNAUDITED)** | ** ** |
|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **March 31**             | ** ** | **June 30** | ** ** | **September 30** | ** ** | **December 31 (2)** | ** ** |
| **2004**                        |       |                          |       |   |   |   |   |   |   |
| Product and service revenues(1) |       | $                             | 9,946,131  |   | $ | 9,403,212 |   | $ | 10,291,188 |   | $ | 8,678,165 |   |
| Total operating expenses(1)     |       | 8,828,299                     |       | 8,801,515 |   | 9,999,726 |   | 13,323,131 |   |
| Operating income                |       | 1,117,832                     |       | 601,697 |   | 291,462 |   | (4,644,966 | ) |
| Earnings before income taxes    |       | 1,088,825                     |       | 580,208 |   | 284,514 |   | (4,644,080 | ) |
| Provision for income taxes      |       | 482,873                       |       | 292,327 |   | 188,231 |   | (1,698,012 | ) |
| Net earnings                    |       | $                             | 605,952    |   | $ | 287,881 |   | $ | 96,283 |   | $ | (2,946,068 | ) |
| Earnings per share: (3)         |       |                          |       |   |   |   |   |   |   |
| Basic                           |       | $                             | 0.05       |   | $ | 0.02 |   | $ | 0.01 |   | $ | (0.24 | ) |
| Diluted                         |       | $                             | 0.05       |   | $ | 0.02 |   | $ | 0.01 |   | $ | (0.24 | ) |
| **2003**                        |       |                          |       |   |   |   |   |   |   |
| Product and service revenues(1) |       | $                             | 10,762,309 |   | $ | 10,963,994 |   | $ | 10,268,629 |   | $ | 10,092,739 |   |
| Total operating expenses(1)     |       | 8,975,850                     |       | 8,971,402 |   | 8,735,312 |   | 8,754,747 |   |
| Operating income                |       | 1,786,459                     |       | 1,992,592 |   | 1,533,317 |   | 1,337,992 |   |
| Earnings before income taxes    |       | 1,757,479                     |       | 1,947,665 |   | 1,493,709 |   | 1,301,538 |   |
| Provision for income taxes(4)   |       | 570,719                       |       | 681,285 |   | 522,739 |   | 636,321 |   |
| Net earnings                    |       | $                             | 1,186,760  |   | $ | 1,266,380 |   | $ | 970,970 |   | $ | 665,217 |   |
| Earnings per share:             |       |                          |       |   |   |   |   |   |   |
| Basic                           |       | $                             | 0.10       |   | $ | 0.11 |   | $ | 0.08 |   | $ | 0.06 |   |
| Diluted                         |       | $                             | 0.10       |   | $ | 0.11 |   | $ | 0.08 |   | $ | 0.05 |   |

 

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(1)           Certain reclassifications have been made toprior quarterly financial information to conform to the current presentation ofthe quarterly financial information.

 

(2)           In the fourth quarter of 2004, a $2,000,000goodwill impairment charge was recorded, provisions for uncollectible accountsand notes were recorded in the aggregate amount of $1,012,253 and a provisionfor costs and losses for pending litigation was recorded in the amount of$187,500.

 

(3)*          *For the year ended December 31, 2004,54,863 shares related to outstanding stock options were not included in thecalculation of diluted earnings per share because the inclusion would have beenanti-dilutive.

 

 (4)          Included in the income tax provision for thefourth quarter of 2003, is an additional amount for state income taxes ofapproximately $184,000.

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ANDFINANCIAL DISCLOSURE**

 

We did not have anydisagreements with our independent accountants concerning matters of accountingprinciple or financial statement disclosure during 2004 of the type requiringdisclosure hereunder.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

Our Chief Executive Officerand Chief Financial Officer are responsible primarily for establishing andmaintaining disclosure controls and procedures designed to ensure that informationrequired to be disclosed in our reports filed or submitted under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the U.S. Securities and Exchange Commission. These controls andprocedures are designed to ensure that information required to be disclosed inour reports filed or submitted under the Exchange Act is accumulated andcommunicated to our management, including our principal executive and principalfinancial officers, or persons performing similar functions, as appropriate toallow timely decisions regarding required disclosure.

 

Furthermore, our ChiefExecutive Officer and Chief Financial Officer are responsible for the designand supervision of our internal controls over financial reporting that are theneffected by and through our board of directors, management and other personnel,to provide reasonable assurance regarding the reliability of our financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. These policies andprocedures

 

•              pertain to the maintenance of records that,in reasonable detail, accurately and fairly reflect the transactions anddispositions of our assets;

 

•              provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat our receipts and expenditures are being made only in accordance withauthorizations of our management and directors, and

 

•              provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets that could have a material effect on our financial statements.

 

Inconnection with our year end close process, the preparation of this AnnualReport on Form 10-K as of December 31, 2004 and in preparation forcommencement of an evaluation of the effectiveness of the Company’s internalcontrol over financial reporting during 2005 based upon the framework inInternal Control — Integrated Framework issued by the Committee of SponsoringOrganizations (COSO), an evaluation was performed under the supervision andwith the participation of the Company’s management, including the CEO and CFO,of the effectiveness of the design and operation of the Company’s disclosurecontrols and procedures. Based on that evaluation, the CEO and CFO haveconcluded that the Company’s disclosure controls and procedures are not effectiveat December 31, 2004, due to one material weakness and four significantdeficiencies in internal control over financial reporting noted below.  Our management reported to our auditors andthe audit committee of our board of directors that, other than the changesimplemented to remediate the material weakness and significant deficienciesnoted below, no other change in our disclosure controls and procedures andinternal control over financial reporting occurred during the fourth quarter of2004 that would materially affect or was reasonably likely to materially affectour disclosure controls and procedures or internal control over financialreporting. In conducting their evaluation of our disclosure controls andprocedures and internal controls over 

 

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financial reporting, our management, including ourChief Executive Officer and Chief Financial Officer, did not discover any fraudthat involved management or other employees who have a significant role in ourdisclosure controls and procedures and internal controls over financialreporting. Furthermore, there were significant changes in our disclosurecontrols and procedures, internal controls over financial reporting, or otherfactors that could significantly affect our disclosure controls and proceduresor internal controls over financial reporting subsequent to the date of theirevaluation consisting of corrective actions necessary or taken to correctsignificant deficiencies in our internal controls and disclosure controls andprocedures.

 

**Changesto Internal Control over Financial Reporting**

 

Duringthe fourth quarter of 2004, management recognized the need to improve itsinternal controls over financial reporting in the following areas:

 

**Material Weakness**

 

•              Wefound that losses were probable in the collection of outstanding accounts andnotes receivable but those losses had not been adequately quantified orprovided for in the allowance for doubtful accounts.

 

**Significant Deficiencies**

 

•              We found general information technologycontrol deficiencies related to disaster recovery and control over the programchange process,

 

•              We found inadequate reconciliation proceduresfor transactions and balances in cash-in-trust held on behalf of members whohave escrowed funds with the Company,

 

•              We found inadequate information technologyapplication controls over the accuracy of claims transactions through ourclaims processing systems, and

 

•              We found inadequately detailed reporting ofmember statistics such as enrollments, terminations, and number of healthcaremembers for use in analytical review and control of our membership revenue,provider network cost and commission expense transactions.

 

Wewere unable to completely remediate these weaknesses before the end of thefourth quarter, although we implemented partial remediation of them in the formof interim changes to internal control over financial reporting that materiallyaffected, or that is reasonably likely to materially affect, our internalcontrol over financial reporting during the fourth quarter. Also, we conductedadditional procedures and implemented interim manual control procedures toenable us to assure the accuracy of the financial statements for the fourthquarter and fiscal year ended December 31, 2004 contained in this Form10-K.

 

Afteryear end, management launched initiatives to put into operation new controls toaddress the material weakness and the significant deficiencies described above.Management believes that these new controls will remediate the significantdeficiencies in the Company’s internal control over financial reporting thatexisted as of December 31, 2004, and that these internal controls will beeffective at the reasonable assurance level. However, since these changes wereimplemented after year end, these changes did not alter the conclusion ofmanagement that our internal controls were not effective at year end.

 

**ITEM 9B.OTHER INFORMATION**

 

Wehave no information to report that should have been reported in a filing onForm 8-K during the fourth quarter of 2004.

 

**PART III**

 

**ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROLPERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT**

 

**OURDIRECTORS AND EXECUTIVE OFFICERS**

 

The following table setsforth information with respect to each of our executive officers and directors.Our directors are 

 

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generallyelected at the annual shareholders’ meeting and hold office until the nextannual shareholders’ meeting or until their successors are elected andqualified. Our executive officers are elected by our board of directors andserve at its discretion. Our bylaws authorize the board of directors to beconstituted of not less than one and the number as our board of directors maydetermine by resolution or election. Our board of directors currently consistsof seven members.

 
| **Name**                   | ** ** | **Age** | ** ** | **Position**                                                                   |
|----------------------------|------------|---------|------------|--------------------------------------------------------------------------------|
| Judith H. Henkels(1)       |       | 50      |       | Chief Executive Officer,  President and Director                               |
| Robert Bintliff            |       | 51      |       | Chief Financial Officer                                                        |
| Frank Apodaca              |       | 42      |       | Chief Operating Officer  and President and C.E.O. of Access HealthSource, Inc. |
| Eliseo Ruiz III            |       | 39      |       | Vice President and General  Counsel and Secretary                              |
| Coleman Orr                |       | 60      |       | President of the Care  Entrée division                                    |
| Kenneth S. George(1)(4)    |       | 56      |       | Director                                                                       |
| Kent H. Webb, M.D.(2)(4)   |       | 47      |       | Director                                                                       |
| Eugene E. Becker(1)(2)(3)  |       | 55      |       | Director                                                                       |
| J. French Hill(2)(3)       |       | 48      |       | Director                                                                       |
| Nicholas J. Zaffiris(4)(1) |       | 41      |       | Director                                                                       |
| Robert E. Jones(1)         |       | 59      |       | Director                                                                       |

 

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(1)           Member of the Compensation Committee.

 

(2)           Member of the Audit Committee.

 

(3)           Member of the Corporate Governance andNominating Committee.

 

(4)           Member of the Medical Committee.

 

The following is a briefdescription of the business background of our executive officers and directors:

 

*Judith H. Henkels* serves as our Chief Executive Officer and President and Chairman ofthe Board of Directors. Ms. Henkels is the founder of Capella Group andhas over 26 years of business experience, with a concentration inaccounting, finance and healthcare. She has over 19 years of experience inthe healthcare industry. Prior to founding Capella Group she was the ExecutiveVice President and CFO for Linnaeus, Inc. during the period 1994 through1997. Linnaeus is a managed care systems company and owned a Third PartyAdministrator (TPA). While at Linnaeus, Ms. Henkels was instrumental inselling the TPA and finding new venture capital to support the ongoingoperations of the systems company. From 1991 through 1994, Ms. Henkels wasCFO and Executive Vice President for Premier BioResources, Inc., a companythat owned and operated plasma centers throughout the U.S. From 1985 through1991 Ms. Henkels worked for The BOC Group (a British Conglomerate) intheir healthcare segment. She held various controllership roles in theanesthesia, critical care and home health care divisions and was the firstwoman to hold the role of Vice President in BOC throughout the world. Prior toBOC, Ms. Henkels also held financial positions in the Worthington Divisionof Dresser Industries (formerly McGraw Edison) and the accounting firmErnst & Whinney, now Ernst & Young. Ms. Henkels is aCertified Public Accountant, and holds an MBA degree from Rutgers Universitywhere she graduated first in her class, and a B.A. degree from Iowa State University.

 

*Robert Bintliff* serves as our Chief Financial Officer and has been with us since August 2004.  Mr. Bintliff’s experience includes six yearsas an audit partner with Coopers & Lybrand (at which he was employed from1985-1995), President and CEO of Jim Bridges Acquisition Company, a privatelyheld firm (1995-1999) and as Chief Financial Officer for Comercis, Inc., abusiness software company that he helped take public (1999-2001).  Earlier in his career, he served as a seniormember of the financial management team of InterFirst Corporation, a $9 billionregional bank holding company (1981-1985). He had most recently operated his own accounting and managementconsulting practice in the Dallas/Fort Worth area (2001-2004).  Mr. Bintliff holds a B.B.A. in accounting****from Texas Christian University.  He is a CPA licensed in Texas, and is amember of the American Institute of Certified Public Accountants.

 

*Frank Apodaca* has served as President and C.E.O. of oursubsidiary, Access HealthSource, Inc., since June 18, 2004, and as ourChief Operating Officer since February 23, 2005.  Mr. Apodaca has been the President and C.E.O.of Access Healthsource, Inc. since 2000. Mr. Apodaca was President of Advantage Care Network, Inc., a privately-heldnetwork of

 

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healthcareproviders, from 1995 to 1997.  From 1997to 2000, Mr. Apodaca was President of Apodaca Health Care Associates and ofFrontera Associates, L.L.C., both privately-held companies providing healthcareservices.   Mr. Apodaca is alsoassociated with various companies operating or associated with National Centerfor Employment of the Disabled (“NCED”), a Texas nonprofit corporation.  His employment agreement with us allows himto spend a portion of his time serving these NCED associated, nonprofit companies.  In this capacity, he holds executive officerpositions with Sahara Companies, and NCED Mental Health Center.  He holds Group I Health, Life, HMO, andAD&D, insurance licenses from the Texas Department of Insurance, and Series6 & 63 Securities Broker/Dealer licenses. He attended the University of Texas at El Paso from 1989 through 1993,majoring in business administration.  Mr.Apodaca serves as a Director of NCED/Sahara Companies, NCED Mental HealthCenter, and Physicians Healthcare Management, Inc., all privately-heldcompanies.

 

*Eliseo Ruiz III* serves as our Vice President and GeneralCounsel and Secretary.  He has been withus since December 2003.  Mr. Ruizhas been a practicing attorney since November 1991.  He most recently was Vice President andGeneral Counsel of CyberBills, Inc. (and its successor entity) in San Jose,California from 1999 thru 2002.  He alsoserved as Associate General Counsel at Concentra, Inc. from 1998 thru 1999 andwas in private practice from 1991 thru 1997. He holds an undergraduate degree (Plan II) and a law degree from theUniversity of Texas at Austin.  He is amember of the State Bar of Texas.

 

*Coleman Orr* servesas the President of our Care Entrée division. He has been with us since February 2,2005.  Mr. Orr previously served asPresident of Main Street Financial Group, a privately held financial servicescompany in Destin, Florida, from 1999 to 2005. From 1996 to 1999, Mr. Orr was employed by World Marketing Alliance, aprivately-held financial services firm. Mr. Orr served United States Army as an Airborne Ranger and member ofthe U.S. Army Sky Diving Team before starting his career in 1970 with the AmwayCorporation.  Mr. Orr is also anaccomplished motivational speaker, appearing at seminars around thecountry.  He holds his Series 6, 63 and65 licenses, is designated as a Registered Investment Advisor with the NASD andis licensed in insurance, variable annuities and variable life.

 

*Kent H. Webb, M.D*., a founder of Precis, has served as one of our Directors since June 1996(and Medical Director since August 2001). He served as Chairman of ourBoard of Directors until December 2000 and was a member or general partnerof our predecessors Advantage Data Systems, Ltd. and Medicard Plus—ADSLimited Partnership. Dr. Webb is a general and vascular surgeon and is thecofounder and a director of Surgical Hospital of Oklahoma. He is a Fellow ofthe American College of Surgeons and serves as a Clinical Professor for theUniversity of Oklahoma. Dr. Webb is a past director of the Smart CardIndustry Association, a nonprofit association. He is a surgical consultant forthe Ethicon Division of Johnson & Johnson Company, a publicly-heldpharmaceutical and consumer products company. Dr. Webb was graduated fromthe University of Oklahoma College of Medicine and completed his residency inGeneral and Vascular Surgery at the University of Oklahoma Health ServicesCenter.

 

*Eugene E. Becker* became one of our directors in August 2002. He is President ofEugene Becker & Associates, Inc., a privately-held marketing andconsulting company. Mr. Becker served as the Chief Executive Officer ofAon Financial Partnerships during May to September 2000. During 1983 to1999, Mr. Becker served as Chief Marketing Officer of American BankersInsurance Group (during 1991 to 1999), Chief Executive Officer, and Presidentand Chairman of the Board of American Bankers Insurance Company, AmericanBankers Life Assurance Company, Voyager Insurance Group, American ReliableInsurance Company and Banker American Life Assurance Company (during 1988 to1999). Mr. Becker currently serves as a member of the board of directorsfor two companies: Signal Holdings Inc. and Pacific Specialty InsuranceCompany. Mr. Becker received a B.A. from Biscayne College (now St. ThomasUniversity), and a M.B.A. from the University of Miami.

 

*J. French Hill* joined the board of directors in January 2003. In 1999,Mr. Hill founded Delta Trust & Banking Corp., a privately heldbanking, trust and investment brokerage company headquartered in Little Rock,AR, following a six year career with Arkansas’ largest publicly traded holdingcompany, First Commercial Corp. First Commercial was sold in 1998 to RegionsFinancial Corp. (RF). As an executive officer of First Commercial,Mr. Hill was chairman of the bank holding company’s trust division and itsinvestment brokerage dealer subsidiary from 1995 until 1998. He also oversaw anumber of other staff functions in the company from 1993 through 1998 includinghuman resources, executive compensation, bank compliance, credit review andstrategic planning. During the last five years he has served as a member of theboard of directors of these companies: Delta Trust & Banking Corp. andits affiliates (1999 to present); Research Solutions LLC, a privately heldcompany in the clinical trials business (1999 to present), a privately heldcompany in the aircraft lighting systems business; and Syair Designs LLC(2000-2003). From May 1989 through January 1993, Mr. Hill was asenior economic policy official in the George H. W. Bush Administration on thestaff of the White House and as deputy assistant secretary of the U.S.Treasury. Mr. Hill graduated magna cum laude in economics from VanderbiltUniversity.

 

*Nicholas J. Zaffiris* became one of our directors in August 2002.He is currently the Vice President of Sales and Account 

 

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Management,West, at Private Healthcare Systems (PHCS), a privately-held preferred providerorganization, and is responsible for new sales and existing customer retentionand grants for the Western region of the country. Mr. Zaffiris joined PHCSin early 1998, and has more than 10 years of healthcare experience,including client management, sales, marketing and customer service. Beforejoining PHCS, he worked for the National Account Service Company, Blue CrossBlue Shield of Florida, and served as a Lieutenant in the United States Navy.Mr. Zaffiris received a B.S. in Political Science from the United StatesNaval Academy.

 

*Kenneth S. George* became one of our directors in June 2003. Mr. Georgerecently finished two terms as a State Representative in the Texas House ofRepresentatives. From 1996 until 2001, he was General Partner of RiversideAcquisitions L.L.C. and was active in commercial real estate, financial andland transactions. From 1994 through 1995, Mr. George was Chairman andChief Executive Officer of Ameristat, Inc., the largest private ambulanceprovider in the state of Texas. From 1988 until 1994, he was Chairman and ChiefExecutive Officer of EPIC Healthcare Group, an owner of 36 suburban/rural acutecare hospitals with 15,000 employees and $1.4 billion in revenues.Mr. George has an M.B.A. from the University of Texas at Austin and a B.A.from Washington and Lee University.

 

*Robert E. Jones* became one of our directors in October 2004.  Mr. Jones has been President and ChiefExecutive Officer of the National Center for Employment of the Disabled (NCED)since 1994. NCED is a not for profit, manufacturing and service corporation.Since 1990, Mr. Jones has been managing Director of JW Investments, JFTManagement and JW Properties. Each of these private companies specializes inthe development and management of commercial and industrial properties.Mr. Jones holds a B.A. degree from the University of Houston.

 

**BOARDCOMMITTEES**

 

Our Board of Directors hasan Audit Committee, a Compensation Committee, and a Corporate Governance andNominating Committee. The Audit Committee is responsible for the selection andretention of our independent auditors, reviews the scope of the audit functionof the independent auditors, and reviews audit reports rendered by theindependent auditors. All of the members of the Audit Committee are all “independentdirectors” as defined in Rule 4200 of the Nasdaq Stock Market, Inc.marketplace rules (the “Nasdaq rules”), and one member serves as the AuditCommittee’s financial expert.

 

The Compensation Committeereviews our compensation philosophy and programs, and exercises authority withrespect to payment of direct salaries and incentive compensation to ourofficers. A discussion of the Compensation Committee interlocks and insiderparticipation is provided below under the section heading “CompensationCommittee Interlocks and Insider Participation”.

 

The Governance andNominating Committee (a) monitors and oversees matters of corporate governance,including the evaluation of Board performance and processes and the “independence”of directors, and (b) selects, evaluates and recommends to the Board qualifiedcandidates for election or appointment to the Board

 

**AUDITCOMMITTEE FINANCIAL EXPERT**

 

Our board of directors hasdetermined that J. French Hill, one of our independent directors and member ofour audit committee, qualifies as a “financial expert.” This determination wasbased upon Mr. Hill’s

 

•              understanding of generally acceptedaccounting principles and financial statements;

 

•              ability to assess the general application ofgenerally accepted accounting principles in connection with the accounting forestimates, accruals and reserves;

 

•              experience preparing, auditing, analyzing orevaluating financial statements that present the breadth and level ofcomplexity of accounting issues that are generally comparable to the breadthand complexity of issues that can reasonably be expected to be raised by ourfinancial statements, or experience actively supervising one or more personsengaged in such activities;

 

•              understanding of internal controls andprocedures for financial reporting; and

 

•              understanding of audit committee functions.

 

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Mr. Hill’s experienceand qualification as a financial expert were acquired through his extensivebackground in financial analysis, investment banking, finance and commercialbanking. He has also participated in the preparation of financial statementsand registration statements filed with the Securities and Exchange Commission.Mr. Hill also currently serves on two other audit committees (in one case,as an *ex officio* member) where he hasoversight responsibility of the financial statements and works with theinternal accountants and external auditors on audit and/or accounting matters.

 

**COMPLIANCEWITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

Section 16(a) of theSecurities Exchange Act of 1934, as amended, requires our directors, officers,and persons who own more than 10% of our common stock or other registered classof our equity securities to file reports of ownership and changes in ownershipwith the Securities and Exchange Commission. Officers, directors and greaterthan 10% shareholders are required to furnish us with copies of all Section 16(a)forms they file.

 

Based solely on our reviewof the copies of the forms we received covering purchase and sale transactionsin our common stock during 2004, we believe that each person who, at any timeduring 2004, was a director, executive officer, or beneficial owner of morethan 10% of our common stock complied with all Section 16(a) filingrequirements during 2004.

 

**CODE OFETHICS**

 

On January 29, 2003,our board of directors adopted our code of ethics that applies to all of ouremployees and directors, including our principal executive officer, principalfinancial officer, principal accounting officer or controller, and personsperforming similar functions. A copy of the portion of this code of ethics thatapplies to our principal executive officer, principal financial officer,principal accounting officer or controller, and persons performing similarfunctions may be obtained by written request addressed to Eliseo Ruiz, III,Corporate Secretary, Precis, Inc., 2040 North Highway 360, Grand Prairie,Texas 75050.

 

Our code of ethics may befound on our website at *www.precis-pcis.com*.We will describe the nature of amendments to the code of ethics on our website,except that we may not describe amendments that are purely a technical,administrative, or otherwise non-substantive. We will also disclose on ourwebsite any waivers from any provision of the code of ethics that we may grant.Information about amendments and waivers to our code of ethics will beavailable on our website for at least twelve months, and thereafter, theinformation will be available upon request for five years.

 

The adoption of our code ofethics is consistent with the requirements of the Sarbanes-Oxley Act of 2002.

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

The following table setsforth the compensation during 2004, 2003 and 2002, paid or accrued, of ourChief Executive Officer, our Chief Financial Officer, and the four other mosthighly compensated executive officers, including the executive officers of oursubsidiaries.

 
| ** **                                                                                              | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **   | ** ** | **Long-Term  Compensation  Awards** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------|------------|--------------|------------|--------------|------------|-------------------------------------|------------|
| ** **                                                                                              | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **   | ** ** | **Shares of**                       | ** ** |
| ** **                                                                                              | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **   | ** ** | **Common Stock**                    | ** ** |
| ** **                                                                                              | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **   | ** ** | **Underlying**                      | ** ** |
| ** **                                                                                              | ** ** | ** ** | ** ** | **Annual Compensation(1)** | ** ** | **Options**  | ** ** |
| **Name Principal Position**                                                                             | ** ** | **Year**   | ** ** | **Salary(2)**              | ** ** | **Bonus(3)** | ** ** | **Other(4)** | ** ** | **Granted**                         | ** ** |
| ** **                                                                                              | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **   | ** ** | ** **                          | ** ** |
| Judith H. Henkels  Chairman, Chief Executive Officer and President(5)(7)                                |       | 2004       |       | $                          | 246,385    |         | $          | 30,000       |       | $                                   | 10,497     |   | 10,000 |   |
| 2003                                                                                                    | $          | 174,065    | $          | 5,000                      | $          | 10,497       | 10,000     |
| 2002                                                                                                    | $          | 160,000    | $          | 50,000                     | —     | —       |
| Bobby R. Rhodes  Vice President of Provider Relations(6)(7)                                             |       | 2004       |       | $                          | 193,231    |         | $          | 30,000       |       | —                              |       | — |   |
| 2003                                                                                                    | $          | 112,156    | $          | 37,790                     | $          | 2,000        | 10,000     |
| 2002                                                                                                    | $          | 95,000     | $          | 50,000                     | —     | —       |
| Terry Brewster (6)  Executive Vice President of Sales & Marketing                                   |       | 2004       |       | $                          | 171,635    |         | $          | 50,000       |       | —                              |       | 100,000 |   |
| 2003                                                                                                    | —     | —     | —     | —                     |
| 2002                                                                                                    | —     | —     | —     | —                     |
| Frank Apodaca   Chief Operating Officer and President and CEO of subsidiary, Access HealthSource,  Inc. |       | 2004       |       | $                          | 129,808    |         | —     |         | $          | 60,800                              |       | 100,000 |   |
| 2003                                                                                                    | —     | —     | —     | —                     |
| 2002                                                                                                    | —     | —     | —     | —                     |
| Robert Bintliff   Chief Financial Officer                                                               |       | 2004       |       | $                          | 59,538     |         | —     |         | $          | 2,580                               |       | 100,000 |   |
| 2003                                                                                                    | —     | —     | —     | —                     |
| 2002                                                                                                    | —     | —     | —     | —                     |
| Dino Eliopoulos(6)   Former Chief Financial Officer                                                     |       | 2004       |       | $                          | 106,682    |         | $          | 30,000       |       | $                                   | 4,500      |   | — |   |
| 2003                                                                                                    | $          | 141,029    | $          | 5,000                      | $          | 3,000        | 110,000    |
| 2002                                                                                                    | —     | —     | —     | —                     |

 

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(1)           The named executive officer receivedadditional non-cash compensation, perquisites and other personal benefits;however, the aggregate amount and value thereof did not exceed 10% of the totalannual salary and bonus paid to and accrued for the named executive officerduring the year.

 

(2)           Dollar value of base salary (both cash andnon-cash) earned during the year.

 

(3)           Dollar value of bonus (both cash andnon-cash) earned during the year.

 

(4)           Includes amounts paid to or on behalf or thenamed executive as a car allowance and, for Mr. Apodaca’s compensation relatedto non-competition provisions in his employment agreement.

 

(5)           In February 2002, Ms. Henkels wasappointed to serve as our Chief Executive Officer and President.Ms. Henkels has served as our President since June 8, 2001.

 

(6)           Mr. Brewster’s employment by the Company wasterminated as of April 5, 2005.  Mr.Rhodes’ employment by the Company was terminated as of March 3, 2005.  Mr. Eliopoulos terminated his employment with theCompany as of July 23, 2004.

 

(7)           The base salaries of Ms. Henkels and Mr.Rhodes were increased in 2004 as a result of our entering into new employmentagreements with each of them.  Inentering the new employment agreements, Ms. Henkels and Mr. Rhodesagreed to terminate their prior employment agreements with the Company. In sodoing, Ms. Henkels and Mr. Rhodes waived certain rights they may havehad, under the prior agreements, to a portion of the Company’s earnings beforeinterest and taxes.

 

**OPTIONGRANTS LAST YEAR**

 

The following table setsforth certain information relating to options granted in 2004 to namedexecutive officers to purchase shares of our common stock.

 
| ** **         | ** ** | ** **       | ** ** | ** **          | ** ** | ** **      | ** ** | ** **     | ** ** | **Potential Realizable**   | ** ** |
|--------------------|------------|------------------|------------|---------------------|------------|-----------------|------------|----------------|------------|----------------------------|------------|
| ** **         | ** ** | **No. of**       | ** ** | ** **          | ** ** | ** **      | ** ** | ** **     | ** ** | **Value at Assumed**       | ** ** |
| ** **         | ** ** | **Securities**   | ** ** | **% of Total**      | ** ** | ** **      | ** ** | ** **     | ** ** | **Annual Rates of Stock**  | ** ** |
| ** **         | ** ** | **Underlying**   | ** ** | **Options Granted** | ** ** | **Exercise or** | ** ** | ** **     | ** ** | **Price Appreciation for** | ** ** |
| ** **         | ** ** | **Options/SARs** | ** ** | **to Employees In** | ** ** | **Base Price**  | ** ** | **Expiration** | ** ** | **Option Term**            | ** ** |
| **Name**           | ** ** | **Granted(#)**   | ** ** | **Fiscal Year(1)**  | ** ** | **($/Sh)**      | ** ** | **Date**       | ** ** | **5%($)**                  | ** ** | **10%($)** | ** ** |
| Judith Henkels     |       | 10,000           |       | 1.2                 | %          | 2.85            |       | 10/27/09       |       | 36,374                     |       | 45,900 |   |
| Terry Brewster (2) |       | 100,000          |       | 11.8                | %          | 3.88            |       | 3/23/09        |       | 495,197                    |       | 624,878 |   |
| Frank Apodaca      |       | 100,000          |       | 11.8                | %          | 2.76            |       | 6/18/09        |       | 352,254                    |       | 444,501 |   |
| Robert Bintliff    |       | 100,000          |       | 11.8                | %          | 2.99            |       | 2/28/09        |       | 381,608                    |       | 481,542 |   |
| Eliseo Ruiz III    |       | 100,000          |       | 11.8                | %          | 3.88            |       | 3/23/09        |       | 495,197                    |       | 624,878 |   |

 

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(1)           Options for the issuance of a total of 845,500shares of common stock were issued to employees in 2004.

 

(2)           Mr. Brewster’s employment by the Company wasterminated as of April 5, 2005.

 

**OPTIONEXERCISES IN LAST FISCAL YEAR**

 

No executive officerexercised options in 2004.

 

**AGGREGATE STOCK OPTION EXERCISE AND YEAR-END OPTION VALUES.**  Thefollowing table sets forth information related to the number and value ofoptions held by the named executive officer at December 31, 2004. During2004, no options to purchase our common stock were exercised by the namedexecutive officers*.*

 

 
| ** **         | ** ** | **Number of Unexercised  Options As Of  December 31, 2004** | ** ** | **Value of Unexercised  In-The-Money  Options As Of  December 31, 2004(1)** | ** ** |
|--------------------|------------|------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **Name**           | ** ** | **Exercisable**                                                  | ** ** | **Unexercisable**                                                                | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Judith H. Henkels  |       | 22,500                                                           |       | 7,500                                                                            |       | — |   | — |   |
| Robert Bintliff    |       | —                                                           |       | 100,000                                                                          |       | — |   | — |   |
| Bobby Rhodes(2)    |       | 12,500                                                           |       | 7,500                                                                            |       | — |   | — |   |
| Terry Brewster (2) |       | —                                                           |       | 100,000                                                                          |       | — |   | — |   |
| Frank Apodaca      |       | —                                                           |       | 100,000                                                                          |       | — |   | — |   |
| Eliseo Ruiz III    |       | —                                                           |       | 100,000                                                                          |       | — |   | — |   |

 

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(1)           The closing sale price of our common stock asreported on the Nasdaq SmallCap Market on December 31, 2004 was $2.66. Theper-share value is calculated based on the applicable closing sale price pershare, minus the exercise price, multiplied by the number of shares of commonstock underlying the options.

 

(2)           Our employment of Mr. Brewster was terminatedas of April 5, 2005.  Our employmentof Mr. Rhodes was terminated as of March 3, 2005.

 

**EQUITYCOMPENSATION PLANS**

 

**1999 STOCK OPTION PLAN.**  Forthe benefit of our employees, directors and consultants, we have adopted thePrecis Smart Card Systems, Inc. 1999 Stock Option Plan (the “stock optionplan” or the “plan”). The plan provides for the issuance of options intended toqualify as incentive stock options for federal income tax purposes to ouremployees and non-employees, including employees who also serve as ourdirectors. Qualification of the grant of options under the plan as incentivestock options for federal income tax purposes is not a condition of the grantand failure to so qualify does not affect the ability to exercise the stockoptions. The number of shares of common stock authorized and reserved forissuance under the plan is 1,400,000.

 

Our board of directorsadministers and interprets the plan (unless delegated to a committee) and hasauthority to grant options to all eligible participants and determine the typesof options granted, the terms, restrictions and conditions of the options atthe time of grant.

 

The exercise price ofoptions may not be less than 85% of the fair market value of our common stockon the date of grant of the option and to qualify as an incentive stock optionmay not be less than the fair market value of common stock on the date of thegrant of the incentive stock option. Upon the exercise of an option, theexercise price must be paid in full, in cash, in our common stock (at the fairmarket value thereof) or a combination thereof.

 

Options qualifying asincentive stock options are exercisable only by an optionee during the periodending three months

 

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afterthe optionee ceases to be our employee, a director, or non-employee serviceprovider. However, in the event of death or disability of the optionee, theincentive stock options are exercisable for one year following death ordisability. In any event options may not be exercised beyond the expirationdate of the options. Options may be granted to our key management employees,directors, key professional employees or key professional non-employee serviceproviders, although options granted non-employee directors do not qualify asincentive stock options. No option may be granted after December 31, 2008.Options are not transferable except by will or by the laws of descent anddistribution.

 

All outstanding optionsgranted under the plan will become fully vested and immediately exercisable if(i) within any 12-month period, we sell an amount of common stock thatexceeds 50% of the number of shares of common stock outstanding immediatelybefore the 12-month period or (ii) a “change of control” occurs. Forpurposes of the plan, a “change of control” is defined as the acquisition in atransaction or series of transactions by any person, entity or group (two ormore persons acting as a partnership, limited partnership, syndicate or othergroup for the purpose of acquiring our securities) of beneficial ownership of50% or more (or less than 50% as determined by a majority of our directors) ofeither the then outstanding shares of our common stock or the combined votingpower of our then outstanding voting securities.

 

**2002 NON-EMPLOYEE STOCK OPTION PLAN.** Effective May 31, 2002 our board of directors approved thePrecis, Inc. 2002 Non-Employee Stock Option Plan (the “2002 Stock OptionPlan”) which was approved by our shareholders on July 29, 2002. Ouremployees who also serve as our directors are not eligible to receive stockoption under this plan. The purpose of the 2002 Stock Option Plan is tostrengthen our ability to attract and retain the services of individuals thatserve as our non-employee directors, consultants and other advisors that areessential to our long-term growth and financial success and thereby to enhanceshareholder value through the grant of stock options. The total number ofshares of common stock authorized and reserved for issuance upon exercise ofoptions granted under the 2002 Stock Option Plan is 500,000.

 

Our Board of Directorsadministers and interprets the 2002 Stock Option Plan and has authority togrant options to eligible recipients and determine the basis upon which theoptions are to be granted and the terms, restrictions and conditions of theoptions at the time of grant. Options granted are exercisable in such amounts,at such intervals and upon such terms as the option grant provides. The pershare purchase price of the common stock under the options is determined by ourboard of directors; however, the purchase price may not be less than theclosing sale price of our common stock on the date of grant of the option. Uponthe exercise of an option, the stock purchase price must be paid in full, incash by check or in our common stock held by the option holder for more thansix months or a combination of cash and common stock.

 

Options granted under the2002 Stock Option Plan may not under any circumstance be exercised after10 years from the date of grant and no option may be granted after March 31,2007. Options are not transferable except by will, by the laws of descent anddistribution, by gift or a domestic relations order to a “family member.”Family member transfers include transfers to parents (and in-laws), to niecesand nephews (adopted or otherwise) as well as trusts, foundations and otherentities principally for their benefit.

 

**2002 IMR STOCK OPTION PLAN.** Effective March 15, 2002 our board of directors approved thePrecis, Inc. 2002 IMR Stock Option Plan (the “IMR Plan”) which wasapproved by our shareholders on July 29, 2002. The purpose of the IMR Planis to strengthen our ability to attract and retain independent marketingrepresentatives, to furnish additional incentive to our independent marketingrepresentatives who are significantly responsible for our success, and therebyto enhance shareholder value. The IMR Plan provides for the grant of stockoptions to our independent marketing representatives. Our employees anddirectors are not eligible to participate in the IMR Plan. The total number ofshares of common stock authorized and reserved for issuance upon exercise ofoptions granted under the IMR Plan is 500,000.

 

Our board of directorsadministers and interprets the IMR Plan and has the authority to grant optionsto all eligible independent marketing representatives, and determine the basisupon which the options are to be granted and the terms, restrictions andconditions of the options at the time of grant. Options granted under the IMRPlan are exercisable in such amounts, at such intervals and upon such terms asthe option grant provides. The purchase price of the common stock under theoption is determined by our board of directors; however, the purchase price maynot be less than the lowest closing sale price of the common stock on the dateof grant of the option or during a period of up to three months following grantof the option. Upon the exercise of an option, the stock purchase price must bepaid in full.

 

Options granted under theIMR Plan may not under any circumstance be exercised after five years from thedate of grant. Subject to the foregoing, options are exercisable only byindependent marketing representatives who are in “good standing” at the time ofexercise. To be in good standing, an independent marketing representative must

 

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•              be in active status at the time of grant andexercise of the option,

 

•              maintain his or her membership in CareEntréeTM program and

 

•              comply with our the policies and proceduresand the terms and conditions of the independent marketing representative’sagreement with us.

 

Options are not transferableexcept by will or by the laws of descent and distribution.

 

On January 29, 2003,our Board voted to discontinue, effective June 1, 2003, any future stockoption grants under the 2002 IMR Stock Option Plan.

 

**DIRECTORLIABILITY AND INDEMNIFICATION**

 

As permitted by theprovisions of the Oklahoma General Corporation Act, our Certificate ofIncorporation eliminates the monetary liability of our directors for a breachof their fiduciary duty as directors. However, these provisions do noteliminate our director’s liability

 

•              for a breach of the director’s duty ofloyalty to us or our shareholders,

 

•              for acts or omissions by a director not ingood faith or which involve intentional misconduct or a knowing violation oflaw,

 

•              arising under Section 1053 of theOklahoma General Corporation Act relating to the declaration of dividends andpurchase or redemption of shares in violation of the Oklahoma GeneralCorporation Act, or

 

•              for any transaction from which the directorderived an improper personal benefit.

 

In addition, theseprovisions do not eliminate liability of a director for violations of federalsecurities laws, nor do they limit our rights or our shareholders rights, inappropriate circumstances, to seek equitable remedies including injunctive orother forms of non-monetary relief. These remedies may not be effective in allcases.

 

Our bylaws require us toindemnify all of our directors and officers. Under these provisions, when anindividual in his or her capacity as an officer or a director is made orthreatened to be made a party to any suit or proceeding, the individual may beindemnified if he or she acted in good faith and in a manner reasonablybelieved to be in or not opposed to our best interest. Our bylaws further providethat this indemnification is not exclusive of any other rights to which theindividual may be entitled. Insofar as indemnification for liabilities arisingunder our bylaws or otherwise may be permitted to our directors and officers,we have been advised that in the opinion of the Securities and ExchangeCommission the indemnification is against public policy and is, therefore,unenforceable.

 

We enter into indemnity andcontribution agreements with each of our directors and executive officers.Under these indemnification agreements we have agreed to pay on behalf of theindemnitee, and his or her executors, administrators and heirs, any amount thathe or she is or becomes legally obligated to pay because the

 

•              indemnitee served as one of our directors orofficers, or served as a director, officer, employee or agent of a corporation,partnership, joint venture, trust or other enterprise at our request or

 

•              indemnitee was involved in any threatened,pending or completed action, suit or proceeding by us or in our right toprocure a judgment in our favor by reason that the indemnitee served as one ofour directors or officers, or served as a director, officer, employee or agentof a corporation, partnership, joint venture, trust or other enterprise at ourrequest.

 

To be entitled toindemnification, indemnitee must have acted in good faith and in a manner thathe or she reasonably believed to be in or not opposed to our best interests. Inaddition, no indemnification is required if the indemnitee is determined to beliable to us unless the court in which the legal proceeding was broughtdetermines that the indemnitee was entitled to indemnification. The costs andexpenses covered by these agreements include expenses of investigations,judicial or

 

46

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administrativeproceedings or appeals, amounts paid in settlement, attorneys’ fees anddisbursements, judgments, fines, penalties and expenses of enforcement of theindemnification rights.

 

We maintain insurance to protectour directors and officers against liability asserted against them in theirofficial capacities for events occurring after June 7, 2001.  This insurance protection covers claims andany related defense costs of up to $5,000,000 with an additional excess of lossof $5,000,000 on excess of $5,000,000 and an additional excess of loss of$5,000,000 on excess of $10,000,000 based on alleged or actual securities lawviolations, other than intentional dishonest or fraudulent acts or omissions,or any willful violation of any statute, rule or law, or claims arising out ofany improper profit, remuneration or advantage derived by an insured directoror officer.

 

**EMPLOYMENTARRANGEMENTS AND LACK OF KEYMAN INSURANCE**

 

As of December 31,2004, we had entered into employment agreements with each of Judith H. Henkelsand Bobby Rhodes. Each agreement is for a three-year term beginning on August 1,2003; however, the term is automatically extended for additional one-yearterms, unless the employee or we give 30 days’ advance notice oftermination. Additionally, an employment agreement was entered into with FrankApodaca on June 18, 2004 for a three year term beginning on thatdate.  Additionally, an employmentagreement was entered into with Robert Bintliff on November 1, 2004 for athree year term beginning on that date. These agreements provide, among otherthings,

 

•              an annual base salary of $263,000 in 2004 forMs. Henkels, $225,000 in 2004 for Mr. Apodaca, $180,000 in 2004 forMr. Bintliff, and $200,000 in 2004 for Mr. Rhodes;

 

•              entitlement to fringe benefits includingmedical and insurance benefits and participation in our 401(k) plan and MSAplan and any other benefit plan we establish; and

 

•              limited salary continuation during any periodof temporary or permanent disability, illness or incapacity to substantiallyperform the services required under the agreement or in the event of employee’sdeath.

 

These agreements require theemployee to devote the required time and attention to our business and affairsnecessary to carry out her or his responsibilities and duties. The employee maynot hold executive positions with other entities or own interests in, manage orotherwise operate other businesses; provided however that Mr. Apodaca may spendup to 20% of his time attending to his duties as an executive officer or a directorof certain nonprofit entities.

 

Under all of theseagreements, “good cause” includes commitment of a felony (excepting any felonytraffic offense) or any crime directly related to the employment which causes asubstantial detriment to us, actions contrary to our best interest, willfulfailure to take actions permitted by law and necessary to implement our writtenpolicies, continued failure or refusal to attend to duties, or willfulmisconduct materially injurious to the Company or its subsidiaries.

 

In entering the employmentagreements referenced above, Ms. Henkels and Mr. Rhodes agreed toterminate their prior employment agreements with the Company. In so doing,Ms. Henkels and Mr. Rhodes waived certain rights they may have had,under the prior agreements, to a portion of the Company’s earnings beforeinterest and taxes.

 

Mr. Rhodes’ employment bythe Company was terminated as of March 3, 2005.

 

As of the date of thisreport, we do not maintain any keyman insurance on the life or disability ofour executive officers. We will consider on a periodic basis whether we will berequired to maintain keyman insurance.

 

**COMPENSATIONOF DIRECTORS**

 

We compensate our directorsas follows:

 

•              Each non-employee member of the boardreceives a quarterly payment of $4,000.

 

•              In addition, each non-employee member of theboard received $500 per quarter for each committee on which he or she servesand an additional $500 per quarter for each committee for which he or sheserves as chairperson.

 

47

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•              We reimburse our directors for travel and outof pocket expenses in connection with their attendance at meetings of theboard.

 

•              We may occasionally grant stock options to ourboard members.

 

The quarterly paymentsreferenced above began in the third quarter of 2003. In 2004, the followingdirectors received compensation in the following aggregate amounts:

 
| Eugene E. Becker     |   | $ | 22,500 |   |
|----------------------|--------|---|--------|--------|
| Kenneth S. George    |   | $ | 20,000 |   |
| J. French Hill       |   | $ | 20,000 |   |
| Kent H. Webb         |   | $ | 22,500 |   |
| Nicholas J. Zaffiris |   | $ | 19,500 |   |

 

Except for the stock optiongrant describe below, Robert E. Jones has waived all rights to compensation forhis service as a member of the board.

 

In 2004, the following boardmembers received grants of stock options to purchase shares of our commonstock. Except as indicated, all the stock options were exercisable on the dategranted.

 

•              On October 27, 2004, Judith H. Henkelswas granted stock options exercisable for the purchase of 10,000 shares at$2.85 per share. These options become exercisable on April 27, 2005.

 

•              On October 27, 2004, each of J. FrenchHill, Kenneth S. George, Eugene. Becker and Nicholas J. Zaffiris was grantedstock options exercisable for the purchase of 10,000 shares at $2.59 pershare.  The options were immediatelyexercisable.

 

•              On October 27, 2004, Kent Webb wasgranted stock options exercisable for the purchase of 22,000 shares at $2.59per share.  The options were immediatelyexercisable.

 

•              On June 18, 2004, Robert E. Jones wasgranted stock options exercisable for the purchase of 100,000 shares at $2.76per share.  The options were immediatelyexercisable.

 

**COMPENSATIONCOMMITTEE INTERLOCKS AND INSIDER PARTICIPATION**

 

Judith Henkels serves as ourPresident and CEO . She also serves on the Board of Directors and on theCompensation Committee of the Board of Directors. Except for Ms. Henkels,none of our officers or employees participates in deliberations of theCompensation Committee. Ms. Henkels does not participate in deliberationsor on votes regarding her compensation. The Board of Directors has determined that it is appropriate for Ms.Henkels and Mr. Jones, as non-independent Directors, to serve on theCompensation Committee because of their direct insight into the performance of ourexecutive management team.  The majorityof the committee is comprised of independent Directors.

 

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The following tablepresents, as of March 25, 2005, information related to the beneficialownership of our common stock of (i) each person who is known to us to bethe beneficial owner of more than 5% of our common stock, (ii) each of ourdirectors and executive officers, and (iii) all of our executive officersand directors as a group, together with their percentage holdings of theoutstanding shares. All persons listed have sole voting and investment powerwith respect to their shares unless otherwise indicated, and there are nofamily relationships amongst our executive officers and directors. For purposesof the following table, the number of shares and percent of ownership of ouroutstanding common stock that the named person beneficially owns includesshares of our common stock that the person has the right to acquire within60 days of the above-mentioned date pursuant to the exercise of stockoptions and warrants, and are deemed to be outstanding, but are not deemed tobe outstanding for the purposes of computing the number of shares beneficiallyowned and percent of outstanding common stock of any other named person.

 

48

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| ** **                                                        | ** ** | **As of March 15, 2005**        | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------|------------|
| **Name of Beneficial Owner**                                      | ** ** | **Shares   Beneficially   Owned(1)** | ** ** | **Percent of   Outstanding  Shares(1)(2)** | ** ** |
| Judith H. Henkels and Leland S. Chaffin,  Jr.(3)                  |       | 3,473,447                            |       | 28.9 | % |
| Kent H. Webb, M.D.(4)                                             |       | 187,019                              |       | 1.6 | % |
| Kenneth S. George(5)                                              |       | 45,000                               |       | * |   |
| Eugene E. Becker(6)                                               |       | 45,000                               |       | * |   |
| Nicholas J. Zaffiris(6)                                           |       | 45,000                               |       | * |   |
| J. French Hill(6)                                                 |       | 47,000                               |       | * |   |
| Robert Jones(7)                                                   |       | 100,000                              |       | * |   |
| Frank Apodaca (8)                                                 |       | 48,849                               |       | * |   |
| Robert Bintliff(9)                                                |       | —                               |       | * |   |
| Eliseo Ruiz III(10)                                               |       | 25,000                               |       | * |   |
| Terry Brewster(11)                                                |       | 25,000                               |       | * |   |
| Executive Officers and Directors as a Group  (eleven persons)(11) |       | 4,041,315                            |       | 33.6 | % |

 

----

| *      |   | Less than 1%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (1)    |   | Shares not outstanding but  deemed beneficially owned by virtue of the right of the named person to  acquire the shares within 60 days of March 15, 2004 are treated as  outstanding for determining the amount and percentage of common stock owned  by the person. Based upon our knowledge, each named person has sole voting  and sole investment power with respect to the shares shown except as noted,  subject to community property laws, where applicable. Except as noted, all options  are exercisable as of March 15, 2004.                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (2)    |   | The percentage shown was  rounded to the nearest one-tenth of one percent, based upon 12,011,843 shares  of common stock being outstanding.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (3)    |   | Judith H. Henkels and  Leland S. Chaffin, Jr. are married and reside in Texas, a community property  state. Ms. Henkels is our Chief Executive Officer and President and  Chairman of the Board of Directors. Ms. Henkels and Mr. Chaffin are  deemed to beneficially own the same number of beneficially owned shares. The  beneficially owned shares and percentage of outstanding shares include  (i) 2,995,000 shares of common stock owned by Ms. Henkels,  (ii) 371,009 shares of common stock owned by Mr. Chaffin,  (iii) 30,000 shares issuable upon exercise of stock options held by  Ms. Henkels, and (iv) 77,438 shares owned by Ms. Henkels but held in a  special purpose account and allocated for purchase by the Company’s  independent marketing representatives.                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (4)    |   | Dr. Webb is one of  our directors. The beneficially owned shares and the percentage of  outstanding shares include 103,000 shares of common stock issuable upon  exercise of stock options.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (5)    |   | Mr. George is one of  our Directors. The beneficially owned shares and the percentage of  outstanding shares include 35,000 shares of common stock issuable upon  exercise of stock options.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (6)    |   | The named person is one of  our directors. The beneficially owned shares and percentage of outstanding  shares include 45,000 shares issuable upon exercise of stock options held by  the named person.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (7)    |   | Mr. Jones is one of  our Directors. The beneficially owned shares and the percentage of  outstanding shares include 100,000 shares of common stock issuable upon  exercise of stock options.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| (8)    |   | Mr. Apodaca is our Chief  Operating Officer and President and C.E.O. of our subsidiary, Access  HealthSource, Inc. He holds options to purchase 100,000 shares of our common  stock, but no such options are exercisable or will be exercisable within 60  days of March 15, 2005. The options become exercisable in increments of  25,000 shares beginning on June 18, 2005. Pursuant to an agreement with  National Center for Employment of the Disabled (“NCED”), Mr. Apodaca is  entitled to and is the beneficial owner of 48,849 shares of our common stock,  the number reported above as being beneficially owned by him. NCED if the  party from whom we bought Access HealthSource, Inc. (“Access”) in  June 2004. Mr. Apodaca’s agreement with NCED predates our acquisition of  Access and entitles him |

 

49

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|   |   | to 10% of the proceeds of  any sale of Access. The number of shares he beneficially owns as of the date  of this report is 10% of the number of our shares currently issued and held  by NCED as consideration for the acquisition.                                                                                                                                                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| (9)    |   | Mr. Bintliff is our  Chief Financial Officer. He holds options to purchase 100,000 shares of our  common stock, but no such options are exercisable or will be exercisable  within 60 days of March 15, 2005. The options become exercisable in  increments of 25,000 shares beginning on August 1, 2005.                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| (10)   |   | Mr. Ruiz is our Vice  President and General Counsel. The beneficially owned shares and percentage  of outstanding shares include 25,000 shares of our common stock issuable upon  exercise of stock options. Mr. Ruiz holds additional options to purchase  75,000 common stock shares that are not exercisable and will not be  exercisable within 60 days of March 15, 2005. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| (11)   |   | Mr. Brewster was our  Executive Vice President for Sales and Marketing through April 5, 2005.  The beneficially owned shares and percentage of outstanding shares include  25,000 shares of our common stock issuable upon exercise of stock options.  Mr. Brewster’s options will terminate ninety (90) days after his last day of  employment by the Company.           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| (12)   |   | The beneficially owned  shares and the percentage of outstanding shares include the shares  beneficially owned by each of our executive officers and directors as  described in footnotes (3) through (11).                                                                                                                                                                         |

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

Contained below is adescription of transactions and proposed transactions we entered into with ourofficers, directors and shareholders that beneficially own more than 5% of ourcommon stock during 2004 and 2003. These transactions will continue in effectand may result in conflicts of interest between us and these individuals.Although our officers and directors have fiduciary duties to us and ourshareholders, there can be no assurance that conflicts of interest will alwaysbe resolved in favor of us and our shareholders.

 

**FORESIGHT, INC. MERGER-ACQUISITION.**  On December 7,2000, we completed the merger-acquisition of Foresight, Inc.. Incompletion of this merger-acquisition, we issued 500,000 shares of our commonstock and 166,667 shares of our Series A convertible preferred stock toPaul A. Kruger and Mark R. Kidd in exchange for the outstanding capital stockof Foresight, Inc. Mr. Kruger is our former C.E.O. and Mr. Kiddis our former C.F.O. Further, at closing of the merger-acquisition of CapellaGroup, we issued and delivered 1,250,000 shares of our common stock toMessrs. Kruger and Kidd and agreed to issue one share of our common stockfor each $1.00 that our consolidated income before tax expense (as adjusted)for 2001 exceeds $1,750,000, assuming the merger-acquisition of Capella Groupwas completed on January 1, 2001. Messrs. Kruger and Kidd were issued2,065,202 shares of our common stock on February 7, 2002. In addition, wegranted Barron Chase Securities, Inc. stock options exercisable for thepurchase on or before June 30, 2003 of 200,000 shares of our common stockfor $9.37 per share. These options were granted for the investment bankingfinancial services and consulting advice provided by Barron Chase Securities invaluing and structuring the merger. These offerings were made pursuant to theapplicable registration exemptions of Rule 506 of Regulation D of theSecurities and Exchange Commission, Section 4(2) of the Securities Act of1933, and applicable state securities laws. There were no sales commissions orother fees paid in connection with the merger-acquisition, other than grantingof the stock options.

 

**THE CAPELLA GROUP, INC. MERGER-ACQUISITION.**  On June 8,2001, we completed the merger-acquisition of The Capella Group, Inc. Incompletion of this merger-acquisition, we issued 2,775,000 shares of our commonstock to the shareholders of The Capella Group, Inc. in exchange for theoutstanding capital stock of The Capella Group, Inc. In addition, weagreed to issue and deliver to the former of shareholders of Capella Group oneshare of our common stock for each dollar of Capella Group’s income before taxexpense (increased by certain adjustments) during 2001, assuming the merger-acquisitionwas completed on January 1, 2001, in excess of $1,275,000. The formershareholders of The Capella Group were issued 2,735,085 shares of common stockon February 7, 2002. This offering was made pursuant to the applicableregistration exemptions of Rule 506 of Regulation D of the Securitiesand Exchange Commission, Section 4(2) of the Securities Act of 1933, andapplicable state securities laws. As part of the merger-acquisition of TheCapella Group, Inc., two of our directors, Messrs. John Simonelli andLarry E. Howell were paid consulting fees of $190,335 each for their assistanceand consulting services. There were no sales commissions or other fees paid inconnection with the merger-acquisition.

 

**FRANKAPODACA’S RELATIONSHIP WITH NCED. **On June 18, 2004, we are acquired AccessHealthSource, Inc. (“Access”).  FrankApodaca was President and C.E.O. of Access and retained that position after theacquisition.  In October 2004, wenamed Mr. Apodaca an Executive Vice President of the Company and in February 2005,we named him our Chief

 

50

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OperatingOfficer.  We purchased Access from itssole shareholder, National Center for Employment of the Disabled (“NCED”).  In addition to the purchase priceconsideration we paid NCED for Access, there is a contingency payout should theearnings before interest, taxes, depreciation and amortization (“EBITDA”) ofAccess reach certain amounts after the closing of the transaction and before December 31,2006.  Prior to our acquisition ofAccess, Mr. Apodaca entered into an agreement with NCED whereby Mr. Apodacawould receive 10% of any consideration received by NCED for the sale of Accesscompanies.  Accordingly, Mr. Apodaca wasdue from NCED at the time of our acquisition of Access, 10% of the closingconsideration and is due from NCED 10% of any additional consideration paid toNCED as a contingency payout.

 

**ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

The aggregate fees forprofessional services rendered to us for the years ended December 31, 2004and 2003 were as follows:

 

*Audit Fees.*  During the years ended December 31,2004 and 2003, we were billed $230,550 and $107,500 to BDO Seidman, LLP foraudit services.

 

*Audit Related Fees.*  Duringthe year ended December 31, 2004, we incurred audit related fees of $15,800related primarily to reviews of SEC filings.

 

*Tax Fees.*  During the years ended December 31,2004, and 2003 we were billed $22,522 and $36,950 by BDO Seidman, LLP and, fortax services. During the years ended December 31, 2004 and 2003, taxservices included fees for tax compliance and consulting services related toour annual federal and state tax returns.

 

*All Other Fees.* During the year ended December 31, 2004, we incurred other fees of$2,500 in connection with a proposed acquisition.

 

In accordance with our AuditCommittee Charter, the Audit Committee approves in advance any and all auditservices, including audit engagement fees and terms, and non-audit servicesprovided to us by our independent auditors (subject to the de minimus exceptionfor non-audit services contained in Section 10A(i)(1)(B) of the SecuritiesExchange Act of 1934, as amended), all as required by applicable law or listingstandards. The independent auditors and our management are required toperiodically report to the Audit Committee the extent of services provided bythe independent auditors and the fees associated with these services.

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

(a)           The following documents are filed as a part of this Form 10-K

 

(1)*          **Index and Consolidated Financial Statements*

 

(2)*          **Financial Statement Schedules required to be filed byItem 8 of this form*

 

None

 

All schedules are omitted because they arenot applicable.

 

(b)*          **Exhibits*

 

51

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**EXHIBIT INDEX**

 
| **EXHIBIT  NO.** | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                         |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |       | Registrant’s Certificate  of Incorporation, incorporated by reference to Exhibit 3.1 of  Registrant’s Form 8-K/A filed with the Commission on July 31, 2001.                                                                                                                                        |
| 3.2              |       | Registrant’s Bylaws,  incorporated by reference to Exhibit 3.2 of Registrant’s Quarterly Report on  Form 10-Q filed with the Commission on May 14, 2003.                                                                                                                                                 |
| 4.1              |       | Form of certificate of the  common stock of Registrant is incorporated by reference to Exhibit 1.1 of  Amendment to Registration Statement on Form 8-A, as filed with the Commission  on July 31, 2001.                                                                                                            |
| 4.2              |       | Form of Underwriter’s  Warrant and Warrant Certificate, incorporated by reference to Exhibit 4.2 of  Registrant’s Form SB-2 Registration Statement (No. 333-86643).                                                                                                                                           |
| 10.1             |       | Precis, Inc. 1999 Stock  Option Plan (amended and restated), incorporated by reference to the  Schedule 14A filed with the Commission on June 23, 2003.                                                                                                                                                       |
| 10.2             |       | Precis, Inc. 2002  Non-Employee Stock Option Plan, incorporated by reference to the  Schedule 14A filed with the Commission on June 26, 2002.                                                                                                                                                                 |
| 10.3             |       | Precis, Inc. 2002 IMR  Stock Option Plan, incorporated by reference to the Schedule 14A filed  with the Commission on June 26, 2002.                                                                                                                                                                          |
| 10.1             |       | The Agreement and Plan of  Merger, dated March 21, 2000, amongst Registrant, Precis— Foresight  Acquisition, Inc., Foresight, Inc., Paul A. Kruger and Mark R. Kidd,  incorporated by reference to the Schedule 14A filed with the Commission  on October 13, 2000.                                 |
| 10.2             |       | The First Amendment to  Agreement and Plan of Merger, dated June 22, 2000, amongst Registrant,  Precis-Foresight Acquisition, Inc., Foresight, Inc., Paul A.  Kruger and Mark R. Kidd, incorporated by reference to the  Schedule 14A filed with the Commission on October 13, 2000. |
| 10.3             |       | The Second Amendment to  Agreement and Plan of Merger, dated August 23, 2000, amongst Registrant,  Precis-Foresight Acquisition, Inc., Foresight, Inc., Paul A. Kruger and Mark  R. Kidd, incorporated by reference to the Schedule 14A filed with the  Commission on October 13, 2000.                  |
| 10.4             |       | Form of Indemnity and  Contribution Agreement between Registrant and each of its executive officers  and directors, incorporated by reference to Exhibit 10.10 of Registrant’s  Quarterly Report on Form 10-Q filed with the Commission on  November 13, 2003.                                           |
| 10.5             |       | The Commercial Lease  Agreement, dated November 8, 2001, between The Capella Group, Inc. and  Assem Family Limited Partnership (Appendices and Exhibits will be provided  Registrant upon request), incorporated by reference to the Schedule 14A  filed with the Commission on June 6, 2002.            |
| 10.6             |       | Employment Agreements dated  August 1, 2003, between registrant and Judith Henkels, Dino Eliopoulos,  and Bobby Rhodes, incorporated by reference to Exhibits 10.2, 10.3, and 10.4  at registrant’s Form 10-Q filed with the Commission on November 13, 2003                                             |
| 10.7             |       | Employment Agreement dated  August 1, 2004, between registrant and Robert Bintliff.                                                                                                                                                                                                                                |
| 10.8             |       | Employment Agreement dated  June 18, 2004, between registrant and Frank Apodaca, incorporated by  reference to Exhibit 2.2 at registrants Form 8-K filed with the Commission on  June 21, 2004.                                                                                                               |
| 10.9             |       | Summary of Terms of  Employment of Executive Officers: Coleman Orr and Eliseo Ruiz III                                                                                                                                                                                                                                  |
| 23.1             |       | Consent of Independent  Registered Public Accounting Firm-Murrell, Hall, McIntosh & Company,  PLLP.                                                                                                                                                                                                                 |
| 23.2             |       | Consent of Independent  Registered Public Accounting Firm-BDO Seidman, LLP.                                                                                                                                                                                                                                             |
| 31.1             |       | Rule 13a-14(a)  Certification of Judith H. Henkels as Chief Executive Officer.                                                                                                                                                                                                                                          |
| 31.2             |       | Rule 13a-14(a)  Certification of Robert Bintliff as Chief Financial Officer.                                                                                                                                                                                                                                            |
| 32.1             |       | Section 1350  Certification of Judith H. Henkels as Chief Executive Officer.                                                                                                                                                                                                                                       |
| 32.2             |       | Section 1350  Certification of Robert Bintliff as Chief Financial Officer.                                                                                                                                                                                                                                         |

 

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**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the Exchange Act, theRegistrant caused this amended report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                      |       | **PRECIS,  INC.**(Registrant) |
|---------------------------|------------|-------------------------------|
| ** **                | ** ** | ** **                    |
|                      |       | By:                           | /s/ JUDITH H. HENKELS |   |
| Date: April 15, 2005 |       |                          | Judith H. Henkels  Chief Executive Officer |
|                      |       |                          |   |
|                      |       | By:                           | /s/ ROBERT BINTLIFF |   |
| Date: April 15, 2005 |       |                          | Robert Bintliff  Chief Financial Officer |
|                           |            |                               |  |  |  |

 

In accordance with the Exchange Act, this report has been signed belowby the following persons on behalf of the Registrant and in the capacities andon the dates indicated.

 
| **Signature**             | ** ** | **Title**                              | ** ** | **Date**             |
|---------------------------|------------|----------------------------------------|------------|----------------------|
| /s/  JUDITH H. HENKELS    |       |                                   |       |                 |
| Judith  H. Henkels        |       | Chief Executive Officer  and President |       | April 15,  2005 |
|                      |       |                                   |       |                 |
| /s/  EUGENE E. BECKER     |       |                                   |       |                 |
| Eugene  E. Becker         |       | Director                               |       | April 15,  2005 |
|                      |       |                                   |       |                 |
| /s/  J. FRENCH HILL       |       |                                   |       |                 |
| J.  French Hill           |       | Director                               |       | April 15,  2005 |
|                      |       |                                   |       |                 |
| /s/  ROBERT JONES         |       |                                   |       |                 |
| Robert  Jones             |       | Director                               |       | April 15,  2005 |
|                      |       |                                   |       |                 |
| /s/  KENT H. WEBB         |       |                                   |       |                 |
| Kent  H. Webb             |       | Director                               |       | April 15,  2005 |
|                      |       |                                   |       |                 |
| /s/  NICHOLAS J. ZAFFIRIS |       |                                   |       |                 |
| Nicholas  J. Zaffiris     |       | Director                               |       | April 15,  2005 |
|                      |       |                                   |       |                 |
| /s/  KENNETH S. GEORGE    |       |                                   |       |                 |
| Kenneth  S. George        |       | Director                               |       | April 15,  2005 |

 

53

----

 

**INDEX TO FINANCIAL STATEMENTS**

 
| Reports  of Independent Registered Public Accounting Firms                                                 |   |   |
|------------------------------------------------------------------------------------------------------------|--------|--------|
| Consolidated  Balance Sheets as of December 31, 2004 and 2003                                         |   |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2004, 2003 and  2002          |   |   |
| Consolidated  Statements of Stockholders’ Equity for the Years December 31, 2004, 2003  and 2002 |   |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and  2002          |   |   |
| Notes to Consolidated  Financial Statements                                                                |   |   |

 

F-1

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

To the Board of Directors and Stockholders of Precis, Inc.

Grand Prairie, Texas

 

We have audited the accompanying consolidated balance sheets ofPrecis, Inc. as of December 31, 2004 and 2003 and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows foreach of the two years in the period ended December 31, 2004.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on the consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. The Company is notrequired to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting. Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall presentation ofthe financial statements. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Precis, Inc. at December 31, 2004 and 2003, and the results of itsoperations and its cash flows for each of the two years in the period ended December 31,2004, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

*(Signed BDO Seidman, LLP)*

 

Dallas, Texas

April 11, 2005

 

F-2

----

 

To the Board of Directors and Stockholders

of Precis, Inc.

 

We have audited the accompanying consolidated statements of operations,stockholders’ equity and cash flows Precis, Inc. (an Oklahoma Corporation) andsubsidiaries for the years ended December 31, 2002. These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe consolidated financial statements are free of material misstatement. Anaudit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated results ofoperations and cash flows for the years ended December 31, 2002 of Precis,Inc. and subsidiaries, in  conformitywith accounting principles generally accepted in the United States of America.

 

 
| */s/ MURRELL, HALL, MCINTOSH & CO., PLLP* |   |
|-----------------------------------------------|--------|
|                                          |
|                                          |
| Norman, Oklahoma                              |
| January 31, 2003                         |

 

F-3

----

 

**PRECIS, INC.CONSOLIDATED BALANCE SHEETSAS OF DECEMBER 31, 2004 AND 2003**

 
| ** **                                                                                                                                                             | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ASSETS                                                                                                                                                                 |       |       |       |       |       |
| Current assets:                                                                                                                                                        |       |       |       |       |       |
| Cash-in-trust                                                                                                                                                          |       | $          | 4,921,626  |       | $          | 2,768,447 |   |
| Cash and cash equivalents                                                                                                                                              |       | 8,282,953  |       | 11,087,920 |       |
| Accounts receivable, net                                                                                                                                               |       | 312,056    |       | 620,026    |       |
| Income taxes receivable                                                                                                                                                |       | 979,851    |       | 120,642    |       |
| Notes receivable, net                                                                                                                                                  |       | —     |       | 467,904    |       |
| Inventory                                                                                                                                                              |       | 174,439    |       | 175,735    |       |
| Prepaid expenses                                                                                                                                                       |       | 547,055    |       | 377,015    |       |
| Total current assets                                                                                                                                                   |       | 15,217,980 |       | 15,617,689 |       |
|                                                                                                                                                                   |       |       |       |       |       |
| Fixed assets, net                                                                                                                                                      |       | 1,988,755  |       | 3,324,410  |       |
| Goodwill                                                                                                                                                               |       | 21,381,316 |       | 21,077,284 |       |
| Other intangible assets                                                                                                                                                |       | 1,400,000  |       | —     |       |
| Deferred tax asset                                                                                                                                                     |       | 1,801,368  |       | 760,681    |       |
| Other assets                                                                                                                                                           |       | 185,197    |       | 33,600     |       |
| Total assets                                                                                                                                                           |       | $          | 41,974,616 |       | $          | 40,813,664 |   |
|                                                                                                                                                                   |       |       |       |       |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                             |       |       |       |       |       |
| Current liabilities:                                                                                                                                                   |       |       |       |       |       |
| Accounts payable                                                                                                                                                       |       | $          | 470,261    |       | $          | 387,824 |   |
| Accrued commissions                                                                                                                                                    |       | 730,965    |       | 1,116,086  |       |
| Other accrued liabilities                                                                                                                                              |       | 1,573,082  |       | 732,321    |       |
| Franchise taxes payable                                                                                                                                                |       | 509,220    |       | 236,022    |       |
| Members’ liabilities                                                                                                                                              |       | 4,921,626  |       | 2,768,447  |       |
| Deferred fees                                                                                                                                                          |       | 153,651    |       | 171,156    |       |
| Current portion of capital leases                                                                                                                                      |       | 514,221    |       | 1,387,010  |       |
| Total current liabilities                                                                                                                                              |       | 8,873,026  |       | 6,798,866  |       |
|                                                                                                                                                                   |       |       |       |       |       |
| Capital lease obligations, net of current  portion                                                                                                                     |       | 77,265     |       | 275,422    |       |
| Deferred income taxes                                                                                                                                                  |       | 655,272    |       | 137,272    |       |
| Total liabilities                                                                                                                                                      |       | 9,605,563  |       | 7,211,560  |       |
|                                                                                                                                                                   |       |       |       |       |       |
| Stockholders’ equity:                                                                                                                                             |       |       |       |       |       |
| Common stock, $.01 par value, 100,000,000  shares authorized; 12,335,766 and 11,872,147 issued, respectively, and  12,079,820 and 11,872,147 outstanding, respectively |       | 123,358    |       | 118,722    |       |
| Additional paid-in capital                                                                                                                                             |       | 27,220,697 |       | 25,820,895 |       |
| Accumulated earnings                                                                                                                                                   |       | 5,706,535  |       | 7,662,487  |       |
| Less: treasury stock (255,946 shares in  2004)                                                                                                                         |       | (681,537   | )          | —     |       |
| Total stockholders’ equity                                                                                                                                        |       | 32,369,053 |       | 33,602,104 |       |
| Total liabilities and stockholders’ equity                                                                                                                        |       | $          | 41,974,616 |       | $          | 40,813,664 |   |

 

**See Accompanying Notes to ConsolidatedFinancial Statements**

 

F-4

----

 

**PRECIS, INC.CONSOLIDATED STATEMENTS OFOPERATIONSFOR THE YEARS ENDED DECEMBER 31, 2004, 2003 and 2002**

 
| ** **                                             | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|--------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                   |       |       |       |       |       |       |       |
| Product and service revenues                           |       | $          | 38,318,696 |       | $          | 42,087,671 |       | $ | 43,115,666 |   |
|                                                   |       |       |       |       |       |       |       |
| Operating expenses:                                    |       |       |       |       |       |       |       |
| Cost of operations                                     |       | 15,101,700 |       | 13,125,851 |       | 11,543,406 |       |
| Sales and marketing                                    |       | 10,931,392 |       | 15,572,188 |       | 17,059,248 |       |
| General and administrative                             |       | 12,919,579 |       | 6,739,271  |       | 6,095,360  |       |
| Impairment charge for goodwill                         |       | 2,000,000  |       | —     |       | —     |       |
| Total operating expenses                               |       | 40,952,671 |       | 35,437,310 |       | 34,698,014 |       |
| Operating (loss) income                                |       | (2,633,975 | )          | 6,650,361  |       | 8,417,652  |       |
| Other expense:                                         |       |       |       |       |       |       |       |
| Interest expense, net                                  |       | 56,558     |       | 149,969    |       | 64,437     |       |
| Total other expense                                    |       | 56,558     |       | 149,969    |       | 64,437     |       |
| Net (loss) earnings before taxes                       |       | (2,690,533 | )          | 6,500,392  |       | 8,353,215  |       |
| Provision for income taxes (benefit)  expense          |       | (734,581   | )          | 2,411,066  |       | 2,874,852  |       |
| Net (loss) earnings                                    |       | (1,955,952 | )          | 4,089,326  |       | 5,478,363  |       |
| Preferred stock dividends                              |       | —     |       | —     |       | 14,137     |       |
| Net (loss) earnings applicable to common  stockholders |       | $          | (1,955,952 | )          | $          | 4,089,326  |       | $ | 5,464,226 |   |
| (Loss) earnings per share :                            |       |       |       |       |       |       |       |
| Basic                                                  |       | $          | (0.16      | )          | $          | 0.35       |       | $ | 0.46 |   |
| Diluted                                                |       | $          | (0.16      | )          | $          | 0.34       |       | $ | 0.46 |   |
| Weighted average number of common shares  outstanding: |       |       |       |       |       |       |       |
| Basic                                                  |       | 11,921,946 |       | 11,848,789 |       | 11,790,650 |       |
| Diluted                                                |       | 11,921,946 |       | 11,924,214 |       | 11,996,222 |       |

 

**See Accompanying Notes to ConsolidatedFinancial Statements**

 

F-5

----

 

**PRECIS,INC.CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITYFOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**

 
| ** **                                            | ** ** | ** **          | ** ** | ** **       | ** ** | ** **  | ** ** | ** **   | ** ** | **ADDITIONAL** | ** ** | ** ** | ** ** | **ACCUMULATED** | ** ** |
|-------------------------------------------------------|------------|---------------------|------------|------------------|------------|-------------|------------|--------------|------------|----------------|------------|------------|------------|-----------------|------------|
| ** **                                            | ** ** | **PREFERRED STOCK** | ** ** | **COMMON STOCK** | ** ** | **PAID-IN** | ** ** | **TREASURY** | ** ** | **EARNINGS**   | ** ** |
| ** **                                            | ** ** | **SHARES**          | ** ** | **AMOUNT**       | ** ** | **SHARES**  | ** ** | **AMOUNT**   | ** ** | **CAPITAL**    | ** ** | **STOCK**  | ** ** | **(DEFICIT)**   | ** ** |
| Balance, December 31, 2001                       |       | 83,333              |       | $                | 1,000,000  |        | 11,696,287 |         | $          | 116,963        |       | $          | 25,181,297 |            | —     |   | $ | (1,891,065 | ) |
| Stock options and warrants exercised, net  of tax     |       | —              |       | —           |       | 155,260     |       | 1,553        |       | 608,698        |       | —     |       | —          |       |
| Redemption of preferred stock                         |       | (83,333             | )          | (1,000,000       | )          | —      |       | —       |       | —         |       | —     |       | —          |       |
| Preferred stock dividends                             |       | —              |       | —           |       | —      |       | —       |       | —         |       | —     |       | (14,137         | )          |
| Net earnings                                          |       | —              |       | —           |       | —      |       | —       |       | —         |       | —     |       | 5,478,363       |       |
| Balance, December 31, 2002                       |       | —              |       | —           |       | 11,851,547  |       | 118,516      |       | 25,789,995     |       | —     |       | 3,573,161       |       |
| Stock option and warrants exercised, net of  tax      |       | —              |       | —           |       | 20,600      |       | 206          |       | 30,900         |       | —     |       | —          |       |
| Net earnings                                          |       | —              |       | —           |       | —      |       | —       |       | —         |       | —     |       | 4,089,326       |       |
| Balance, December 31, 2003                       |       | —              |       | —           |       | 11,872,147  |       | 118,722      |       | 25,820,895     |       | —     |       | 7,662,487       |       |
| Stock option and warrants exercised, net of  tax      |       | —              |       | —           |       | 1,250       |       | 12           |       | 4,426          |       | —     |       | —          |       |
| Issuance of stock in business combinations            |       | —              |       | —           |       | 488,486     |       | 4,885        |       | 1,395,115      |       | —     |       | —          |       |
| Other                                                 |       | —              |       | —           |       | (26,117     | )          | (261         | )          | 261            |       | —     |       | —          |       |
| Purchase of 255,946 shares of treasury  stock at cost |       | —              |       | —           |       | —      |       | —       |       | —         |       | (681,537   | )          | —          |       |
| Net (loss) earnings                                   |       | —              |       | —           |       | —      |       | —       |       | —         |       | —     |       | (1,955,952      | )          |
| Balance, December 31, 2004                       |       | —              |       | —           |       | 12,335,766  |       | $            | 123,358    |           | $          | 27,220,697 |       | $               | (681,537   | ) | $ | 5,706,535 |   |
|                                                       |            |                     |            |                  |            |             |            |              |            |                |            |            |            |                 |            |  |  |  |  |  |

 

**See Accompanying Notes to ConsolidatedFinancial Statements**

 

F-6

----

 

**PRECIS,INC.CONSOLIDATED STATEMENTS OFCASH FLOWSFOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002**

 
| ** **                                                                                  | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Operating activities:                                                                       |       |       |       |       |       |       |       |
| Net (loss) earnings                                                                         |       | $          | (1,955,952 | )          | $          | 4,089,326  |       | $ | 5,478,363 |   |
| Adjustments to reconcile net earnings to  net cash provided by operating activities:        |       |       |       |       |       |       |       |
| Depreciation and amortization                                                               |       | 2,322,891  |       | 2,061,910  |       | 940,116    |       |
| Loss on disposal of fixed assets                                                            |       | 175,510    |       | —     |       | —     |       |
| Write-off of doubtful accounts receivable                                                   |       | 612,253    |       | (204,786   | )          | —     |       |
| Write-off of doubtful notes                                                                 |       | 400,000    |       | —     |       | —     |       |
| Impairment of goodwill                                                                      |       | 2,000,000  |       | —     |       | —     |       |
| Deferred income taxes                                                                       |       | (1,040,687 | )          | 118,891    |       | (7,000     | )          |
| Changes in assets and liabilities (net of  business acquired):                              |       |       |       |       |       |       |       |
| Accounts receivable, net                                                                    |       | (276,668   | )          | 1,187,128  |       | (686,402   | )          |
| Income taxes receivable                                                                     |       | (859,209   | )          | 975,245    |       | (15,645    | )          |
| Notes receivable                                                                            |       | 67,904     |       | (267,069   | )          | (200,835   | )          |
| Inventory                                                                                   |       | 1,295      |       | 60,814     |       | (62,515    | )          |
| Prepaid expenses                                                                            |       | (97,009    | )          | (51,314    | )          | (179,474   | )          |
| Other current assets                                                                        |       | —     |       | 25,000     |       | (25,000    | )          |
| Other assets                                                                                |       | (138,596   | )          | (2,775     | )          | 115,419    |       |
| Accounts payable                                                                            |       | 47,722     |       | 250,926    |       | (194,432   | )          |
| Accrued liabilities                                                                         |       | 243,477    |       | (23,838    | )          | (203,074   | )          |
| Deferred fees                                                                               |       | (17,505    | )          | (567,158   | )          | (83,762    | )          |
| Income taxes payable                                                                        |       | 273,198    |       | 166,585    |       | (886,213   | )          |
| Net cash provided by operating activities                                                   |       | 1,758,624  |       | 7,818,885  |       | 3,989,546  |       |
| Investing activities:                                                                       |       |       |       |       |       |       |       |
| Cash used in business combination                                                           |       | (1,858,736 | )          | —     |       | —     |       |
| Purchase of fixed assets                                                                    |       | (736,321   | )          | (945,344   | )          | (920,408   | )          |
| Net cash used in investing activities                                                       |       | (2,595,057 | )          | (945,344   | )          | (920,408   | )          |
| Financing activities:                                                                       |       |       |       |       |       |       |       |
| Payments of capital leases                                                                  |       | (1,291,435 | )          | (1,428,530 | )          | (809,091   | )          |
| Redemption of preferred stock                                                               |       | —     |       | —     |       | (1,000,000 | )          |
| Purchase of treasury stock                                                                  |       | (681,537   | )          | —     |       | —     |       |
| Payment of preferred stock dividends                                                        |       | —     |       | —     |       | (14,137    | )          |
| Exercise of stock options and warrants                                                      |       | 4,438      |       | 31,106     |       | 610,251    |       |
| Net cash used in financing activities                                                       |       | (1,968,534 | )          | (1,397,424 | )          | (1,212,977 | )          |
| Net (decrease) increase in cash and cash  equivalents                                       |       | (2,804,967 | )          | 5,476,117  |       | 1,856,161  |       |
| Cash and cash equivalents at beginning of  year                                             |       | 11,087,920 |       | 5,611,803  |       | 3,755,642  |       |
| Cash and cash equivalents at end of year                                                    |       | 8,282,953  |       | $          | 11,087,920 |       | $          | 5,611,803 |   |
| Supplemental disclosure:                                                                    |       |       |       |       |       |       |       |
| Income taxes paid                                                                           |       | $          | 1,106,048  |       | $          | 2,277,005  |       | $ | 2,852,252 |   |
| Interest paid                                                                               |       | $          | 90,789     |       | $          | 149,969    |       | $ | 63,416 |   |
| Non-cash investing and financing  activities:                                               |       |       |       |       |       |       |       |
| Business combination purchase price  adjustment due to income tax benefit on stock issuance |       | —     |       | —     |       | $          | 982,236    |   |
| Acquisition of fixed assets through  issuance of capital leases, net of retirements         |       | $          | 185,813    |       | $          | (504,152   | )          | $ | 2,760,638 |   |
| Issuance of stock in business combination                                                   |       | $          | 1,400,000  |       | —     |       | —     |   |
| Cash-in-trust collected                                                                     |       | $          | 2,153,179  |       | $          | 2,660,295  |       | $ | 108,152 |   |

 

**See Accompanying Notes to ConsolidatedFinancial Statements**

 

F-7

----

 

**PRECIS, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1—Nature of Business**

 

Precis, Inc. (the “Company”) is a provider of innovativehealthcare and other membership service programs. The Company offers savings onhealthcare services throughout the United States to persons who are under-insured.These savings are offered by accessing the same preferred providerorganizations (PPOs) that are utilized by many insurance companies. Theseprograms are sold primarily through a network marketing strategy under the nameCare EntréeTM. The Company also addresses the needs of organizations seeking toleverage the expertise of an outside provider in offering membership serviceprograms. Membership service programs offer selected products and services froma variety of vendors intended to enhance the existing relationships betweenbusinesses and consumers.

 

**Note 2—Summary of Significant AccountingPolicies**

 

**BASIS OF PRESENTATION**—Theconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles and include the accounts of theCompany’s wholly-owned subsidiaries, The Capella Group, Inc.,Foresight, Inc., Care Financial, LLC (formerly Smart Care Insurance AgencyLLC) and Access HealthSource Inc. All significant inter-company accounts andtransactions have been eliminated. Certain reclassifications have been made toprior period financial statements to conform to the current presentation of thefinancial statements.

 

**USE OF ESTIMATES**—Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management of the Company to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes. Actual results could differ from those estimates.

 

**REVENUE RECOGNITION—**

 

***HealthcareMembership Revenues.***  The Company recognizes membership revenues,other than initial enrollment fees,  oneach monthly anniversary date. Membership revenues are reduced by the amount ofrefunds estimated to be incurred. Member initial enrollment fees, net of directcosts, are deferred and amortized over the estimated membership period, which averageseight to ten months. Independent marketing representative fees, net of directcosts, are deferred and amortized over the term of the contract.

 

***Access Third Party Administration.***Access recognizes revenue based upon the individual contract arrangements thatit has with each of its’ clients, ie., when the contractual obligations aresatisfied.

 

***Rental Purchase andClub Membership Revenues.***  Rental purchase and club membership revenuesare recognized in the month that the Company’s products and services have beendelivered to its clients. The Company sells rental purchase and club membershipprograms on a wholesale basis to its clients.

 

**COMMISSION EXPENSE**—Commissionsare paid to the Company’s independent marketing representatives in the monthfollowing the month in which a member has enrolled in the Care EntréeTM program.Commissions are only paid in the following month when the related membershipfees have been received by the Company. The Company does not pay advancedcommissions on membership sales.

 

**CASH-IN-TRUST**—Cash-in-trustconsists of cash and cash equivalents held on behalf of members who haveescrowed funds with the Company. These funds are owned by the members and arepresented in the Company’s balance sheet as an asset under the description “cash-in-trust”and as a liability under the description “members’ liabilities”.

 

**CASH AND CASH EQUIVALENTS**—Cashand cash equivalents consist primarily of cash on deposit or cash investmentspurchased with original maturities of three months or less.

 

**TRADE ACCOUNTS RECEIVABLE AND NOTESRECEIVABLE—**Accounts receivable and notes receivable representamounts due from private label partners who market the Company’s Care Entréeproduct and bill the members directly. The Company does not charge interest onany of its outstanding trade accounts receivable. The Company does charge animmaterial amount of interest, at a negotiated rate, on its notes receivable.If there is any doubt about the collectibility of a note, the Company ceases toaccrue interest on that note. The Company reviews accounts receivable and notesreceivable on a monthly

 

F-8

----

 

basis to determine if any receivables will potentially beuncollectible. The Company includes any accounts receivable and notesreceivable balances that are determined to be uncollectible, along with ageneral reserve, in our overall allowance for doubtful accounts and notesreceivable. After all attempts to collect a receivable have failed, thereceivable is written off against the allowance. Based on the informationavailable to the Company, the Company believes its allowances for both doubtfulaccounts and notes receivable as of December 31, 2004 are adequate.However, actual write-offs might exceed the recorded allowance.

 

The Company’s allowance for doubtful accounts was $219,347 and $204,786as of December 31, 2004 and 2003, respectively.

 

**FIXED ASSETS**—Propertyand equipment are carried at cost less accumulated depreciation andamortization. Depreciation and amortization are provided using the straight-linemethod over the estimated useful lives of the related assets for financialreporting purposes and principally on accelerated methods for tax purposes.Leasehold improvements are depreciated using the straight-line method overtheir estimated useful lives or the lease term, whichever is shorter. Ordinarymaintenance and repairs are charged to expense as incurred. Expenditures thatextend the physical or economic life of property and equipment are capitalized.The estimated useful lives of property and equipment are as follows:

 
| Furniture and Fixtures         | 7 years                                                     |
|--------------------------------|------------------------------------------------------------------|
| Leasehold Improvements         | Over the term of the lease, or useful life, whichever is shorter |
| Computers and Office Equipment | 3-5 years                                                   |
| Software                       | 3 years                                                     |
| Automobiles                    | 5 years                                                     |

 

The Company periodically reviews property and equipment whenever eventsor changes in circumstances indicate that their carrying amounts may not berecoverable or their depreciation or amortization periods should beaccelerated. When any such impairment exists, the related assets will bewritten down to their fair value.

 

The Company capitalizes both internal and external costs of developingor obtaining computer software for internal use. Costs incurred to developinternal-use software during the application development stage are capitalized,while data conversion, training and maintenance costs associated withinternal-use software are expensed as incurred. As of December 31, 2004and 2003, the net book value of capitalized software costs was $699,935 and $661,655,respectively. Amortization expense related to capitalized software was $189,832,$143,038 and $28,489 in fiscal years 2004, 2003 and 2002, respectively. At October 1,2004, the Company adjusted the estimated useful life for certain of itsinternal-use software to a period ending June 30, 2005. Depreciationexpense was adjusted from that date in October 2004 forward, increasingdepreciation expense in 2004 by $150,000.

 

**OTHER INTANGIBLE ASSETS**—Otherintangible assets consist of customer contracts and are amortized over theirestimated life, including the initial contract term and probable extensions. Ascircumstances change, the estimated life is re-evaluated or potentialimpairment is assessed.

 

**GOODWILL**—Goodwillrepresents the excess of acquisition costs over the fair value of net assetsacquired. Goodwill is not amortized, but it is reviewed on an annual basis inorder to determine if impairment exists. Where necessary, an impairment chargeis recorded to reflect its revised assessment that, based upon current andprojected revenues and earnings, the estimated fair value of the reportingentity’s goodwill did not exceed the carrying value of that entity’s tangibleassets.  During the year ended December 31,2002, the Company’s goodwill was decreased to reflect the recognition of anincome tax benefit of $982,236 which relates to the Company’s 2001 merger-acquisitionof The Capella Group, Inc.

 

**INCOME TAXES**—Incometaxes are provided for the tax effects of transactions reported in thefinancial statements and consist of taxes currently due plus deferred taxesrelated primarily to differences between the basis of assets and liabilitiesfor financial and income tax reporting. The net deferred tax assets andliabilities represent the future tax return consequences of those differences,which will either be taxable or deductible when the assets and liabilities arerecovered or settled.

 

**NET EARNINGS PER SHARE**—Basicnet earnings per share is calculated by dividing the net earnings available tocommon shareholders by the weighted average number of common shares outstandingfor the year without consideration for common stock equivalents. Diluted netearnings per share gives effect to all dilutive potential common sharesoutstanding for the year.  For the yearended December 31, 2004, 54,863 shares related to outstanding stockoptions were not included in the calculation of fully diluted earnings pershare because the inclusion would have been anti-dilutive.

 

F-9

----

 

**CONCENTRATION OF CREDIT RISK**—TheCompany maintains its cash in bank deposit accounts which, at times, may exceedfederally insured limits. The Company has not experienced any losses in suchaccounts and believes it is not exposed to any significant risk.  The Company attempts to mitigate this risk bytransferring balances not immediately needed into accounts secured with pledgedU.S. government securities of short maturity.

 

The Company’s customers are not concentrated in any specific geographicregion or industry. No single customer accounted for a significant amount ofthe Company’s sales and there were no significant accounts receivable from asingle customer. The Company establishes an allowance for doubtful accountsbased upon factors surrounding the credit risk of specific customers,historical trends and other information.

** **

**FAIR VALUE OF FINANCIAL INSTRUMENTS**—Therecorded amounts of cash, short-term investments, accounts receivable, incometaxes receivable, notes receivable, accounts payable, accrued liabilities,income taxes payable and capital lease obligations approximate fair valuebecause of the short-term maturity of these items.

 

**STOCK-BASED COMPENSATION**—In December 2004, the FinancialAccounting Standard Board (FASB) issued Statement of Financial AccountingStandard (SFAS)123(Revised 2004), “Shared-Based Payment”, which replaces SFAS No. 123, “Accountingfor Stock-Based Compensation,” (“SFAS 123”) and supercedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Revised SFAS 123addresses the requirements that an entity measure the cost of employee servicesreceived in exchange for awards of equity instruments based on the grant-datefair value of the award. The cost of such award will be recognized over theperiod during which an employee is required to provide services in exchange forthe award. The Company will be required to adopt this Statement during thethird quarter of fiscal 2005, beginning July 1, 2005.

 

Aspermitted by SFAS 123, theCompany currently accounts for share-based payments by applying the accountingprovisions of APB 25’s intrinsic value method and, since options issued had nosuch intrinsic value, the Company generally recognizes no compensation cost foremployee stock options. The adoption of Revised SFAS 123’s fair value method is notexpected to have a significant impact on the Company’s results of operations,and it will have no added impact on its overall financial position. The impactof adoption of Revised Statement 123 cannot be predicted at this time because it will dependon level of share-based payments granted in the future. However, had theCompany adopted Revised SFAS 123 in prior periods, the impact of that standard wouldhave approximated the impact of Statement 123 as described in thedisclosure of pro-forma net income and earnings per share below.

 

As stated above, the Company applies APB25  and its related interpretations in accountingfor its stock option plan. Compensation for services that a corporationreceives under APB 25 through stock-based compensation plans should be measuredby the quoted market price of the stock at the measurement date less theamount, if any, that the individual is required to pay. No compensation expensewas recorded during the years ended December 31, 2004, 2003 and 2002 relatedto its stock option plans under APB 25. If the Company had elected to recognizecompensation based on the fair value of the options granted at the grant dateas prescribed by “Statement of Financial Accounting Standards No. 123, (“SFAS 123”)Accounting for Stock-Based Compensation”, net earnings and net earnings pershare would have decreased to the pro forma amounts shown below for the yearsended December 31,:

 
| ** **                                                                                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**  | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Net (loss) earnings applicable to common  stockholders                                                                               |       | $        | (1,955,952 | )        | $          | 4,089,326 |       | $ | 5,464,226 |   |
| Deduct: Total stock-based compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (315,583 | )          | (226,393 | )          | (334,078  | )          |
| Pro forma net (loss) earnings                                                                                                        |       | $        | (2,271,535 | )        | $          | 3,862,933 |       | $ | 5,130,148 |   |

 
| ** **                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Earnings (loss) per share: |       |     |       |     |       |     |       |
| Basic—as reported     |       | $        | (0.16      | )        | $          | 0.35     |       | $ | 0.46 |   |
| Basic—pro-forma       |       | $        | (0.19      | )        | $          | 0.33     |       | $ | 0.43 |   |
| Diluted—as reported   |       | $        | (0.16      | )        | $          | 0.34     |       | $ | 0.46 |   |
| Diluted—pro-forma     |       | $        | (0.19      | )        | $          | 0.32     |       | $ | 0.43 |   |

 

F-10

----

 

For the year ended December 31, 2004, 54,863 shares related tooutstanding stock options were not included in the calculation of fully dilutedearnings per share because the inclusion would have been anti-dilutive.

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option pricing model with the following assumptionsused for grants in 2004, 2003 and 2002:

 
| ** **              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**       | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------------|------------|
| Risk free interest rate |       | 3.94     | %          | 4.90     | %          | 3.74           | %          |
| Volatility rate         |       | 48       | %          | 40       | %          | 40             | %          |
| Dividend yield          |       | None     |       | None     |       | None           |       |
| Option expected lives   |       | 5 yrs    |       | 5yrs     |       | 5 & 10 yrs |       |

 

The intent of the Black-Scholes option valuation model is to provideestimates of fair values of traded options that have no vesting restrictionsand are fully transferable. Option valuation models require the use of highlysubjective assumptions including expected stock price volatility. The Companyhas utilized the Black-Scholes method to produce the pro forma disclosuresrequired under SFAS 123. In management’s opinion, existing valuationmodels do not necessarily provide a reliable single measure of the fair valueof its employee stock options because the Company’s employee stock options havesignificantly different characteristics from those of traded options andbecause changes in the subjective input assumptions can materially affect thefair value estimate. The effects of applying SFAS 123 in this pro formaare not indicative of future amounts.

 

**RECENTLY ISSUED ACCOUNTING STANDARDS**—In December 2004, the FASB issuedStatement No. 123R, a revision to SFAS No. 123.  SFAS No. 123R eliminatesthe alternative to use the Accounting Principles Board Opinion 25’s (Opinion25) intrinsic value method of accounting that was provided in SFAS No. 123 asoriginally issued.

 

UnderOpinion 25, issuing stock options to employees generally resulted inrecognition of no compensation cost.  SFAS No. 123R requires companies tomeasure the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award (withlimited exceptions). That cost will be recognized over the period duringwhich an employee is required to provide service, in exchange for the award -the requisite service period (usually the vesting period).  Nocompensation cost is recognized for equity instruments for which employees donot render the requisite service.

 

Companieswill initially measure the cost of employee services received in exchange foran award of instruments classified as liabilities  based on its current fair value; the fairvalue of the awards classified as a liability will be remeasured subsequentlyat each reporting date through the settlement date.  Changes in fair valueduring the requisite service period will be recognized as compensation costover that period.

 

Thegrant-date fair value of employee share options, or the Company’s restrictedstock and similar instruments classified in the balance sheet as equity will beestimated using option-pricing models adjusted for the unique characteristicsof those instruments (unless observable market prices for the same or similarinstruments are available); the fair value of awards classified as equity willnot be remeasured.  If an equity award is modified after the grant date,incremental compensation cost will be recognized in an amount equal to theexcess of the fair value of the modified award over the fair value of theoriginal award immediately before the modification.

 

Excesstax benefits, as defined by SFAS No. 123R, will be recognized as an addition topaid-in capital.  Cash retained as a result of those excess tax benefitswill be presented in the statement of cash flows as financing cashinflows.  The write-off of deferred tax assets relating to unrealized taxbenefits associated with recognized compensation cost will be recognized asincome tax expense unless there are excess tax benefits from previous awardsremaining in paid-in capital to which it can be offset.

 

SFASNo. 123R applies to all awards granted after the required effective date and toawards modified, repurchased, or cancelled after that date.  As of therequired effective date, companies that used the fair-value-based method foreither recognition or disclosure under SFAS No. 123 will apply SFAS No. 123Rusing a modified version of prospective application.  Under thattransition method, compensation cost is recognized on or after the requiredeffective date for the portion of outstanding awards for which the requisite servicehas not yet been rendered, based on the grant-date fair value of those awardscalculated under SFAS No. 123 for either recognition or pro formadisclosure.  The cumulative effect of initially applying SFAS No. 123R, ifany, is recognized as of the required effective date.  SFAS No. 123R iseffective as of the beginning of the first interim or annual reporting periodthat begins after June 15, 2005.  Management estimates that theadoption of SFAS No. 123R will reduce EPS by approximately $.03 per share for theyear ended December 31, 2005.

 

**Note 3—Business Combination**

 

On June 18, 2004,the Company completed its acquisition of Access HealthSource, Inc. (“Access”),a third party administrator, from National Center for the Employment of theDisabled.  Access’ results of operationshave been included in the Company’s results of operations from that date. Theterms of the transaction were such that the Company acquired all of theoutstanding capital stock of Access for a purchase price of $3,400,000,consisting of 488,486 shares of common stock of the Company valued at $1,400,000($2.87 per share based upon the trading price for ten days before closing), and$2,000,000 in cash. Additionally, the Company incurred acquisition costs ofinvestment banking, valuation and legal and accounting fees of $266,231, for atotal purchase consideration of $3,666,231. In addition to the purchase price consideration, there is a contingencypayout should the earnings before interest, taxes, depreciation andamortization (“EBITDA”) of Access reach certain amounts after the closing ofthe transaction and before December 31, 2006.  EBITDA, while not  considered a measure under  accounting principles generally accepted inthe United States of America, is the financial measurement utilized for thebasis of the contingency payout and additional purchase price payments aredependent on Access achieving certain EBITDA levels.  The maximum amount of the consideration thatmay be paid to the seller of Access, including the closing date purchase priceconsideration and investment banking, valuation and legal and accounting fees,is $9,773,500.  The amount of contingencypayments and common stock deliveries based upon EBDITA through December 31,2006, will be based upon a 3.22 multiple of EBITDA of Access determined on aquarterly basis, with effective adjustments as of December 31, 2004, 2005and 2006. The Company expects that Access will achieve those EBITDA levels andthat, as a result, contingent payouts will be made. However, the amount of payoutsthrough December 31, 2006 cannot be estimated at this time. Thecontingency payout will be accounted for as a decrease in the Company’s cashand cash equivalents for the amount paid, an increase to stockholders’ equity forthe fair value issued and a corresponding increase in goodwill for the value ofthe cash paid and stock issued.

 

F-11

----

 

The closing purchaseprice consideration was allocated as follows:

 
| Net working capital    |   | $         | 274,263   |   |
|------------------------|--------|-----------|-----------|--------|
| Fixed assets           |   | 205,936   |      |
| Customer contract      |   | 1,400,000 |      |
| Goodwill               |   | 2,304,032 |      |
| Deferred tax liability |   | (518,000  | )         |
| Total                  |   | $         | 3,666,231 |   |

 

Net working capitalacquired in the transaction included cash of $407,495, resulting in a net cashoutlay for the acquisition of $1,858,736. The Company anticipates that theamortization of the acquired intangibles will not be deductible for federalincome tax purposes.  The allocation of $2,304,032to goodwill is considered appropriate, as Access strategically complements theCompany’s healthcare service offering. Access completes the Company’s healthcare offering which is to provideindividuals and employee group markets access to preferred provider networks,medical escrow accounts and third party administration capabilities to adjudicateand pay for the medical claims.  From asales distribution standpoint, the Company has the ability to grow Access’regional business as the Company has numerous independent marketingrepresentatives who sell both to the individual and employer groups throughoutthe United States.  The Company’sacquisition of Access serves to complement its most recent entry into thepublic sector market, with the State of Louisiana.  Access’ primary area of expertise is in thepublic sector market.  The contract carryingvalue of $1,400,000, based upon the projected net cash flows from the contract,will be amortized over the contract’s expected life of 10 years.

 

The following financialcondensed results of operations presents the Company’s acquisition of Access preparedon a pro-forma basis, as if the acquisition had occurred at the beginning of2003.

 
| ** **                                             | ** ** | **For the Year Ended  December 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **Unaudited**                             | ** ** |
| ** **                                             | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| Revenues                                               |       | $                                         | 41,197,971 |   | $ | 48,248,855 |   |
|                                                   |       |                                      |       |   |   |
| Net (loss) earnings                                    |       | $                                         | (1,851,905 | ) | $ | 4,448,553 |   |
|                                                   |       |                                      |       |   |   |
| Earnings per common share (1)                          |       |                                      |       |   |   |
| Basic                                                  |       | $                                         | (0.15      | ) | $ | 0.36 |   |
|                                                   |       |                                      |       |   |   |
| Diluted                                                |       | $                                         | (0.15      | ) | $ | 0.36 |   |
|                                                   |       |                                      |       |   |   |
| Weighted average number of common shares  outstanding: |       |                                      |       |   |   |
| Basic                                                  |       | 12,396,114                                |       | 12,337,275 |   |
|                                                   |       |                                      |       |   |   |
| Diluted                                                |       | 12,396,114                                |       | 12,412,700 |   |

 

----

(1) - For the year ended December 31,2004, 54,863 shares related to outstanding stock options were not included inthe calculation of fully diluted earnings per share because the inclusion wouldhave been anti-dilutive.

 

**Note 4—Notes Receivable**

 

During 2004 and 2003, the Company entered into notes receivable withcertain private label clients. During 2004, the Company assessed the collectibilityof certain of these notes and provided an additional allowance foruncollectible notes.

 

F-12

----

 

**Note 5—Fixed Assets**

 

Fixed assets are comprised of the following at December 31, 

 
| ** **                                | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|
| Furniture and fixtures                    |       | $          | 343,606    |       | $          | 329,660 |   |
| Leasehold improvements                    |       | 160,758    |       | 193,530    |       |
| Computers and office equipment            |       | 3,950,943  |       | 4,271,320  |       |
| Software                                  |       | 1,539,767  |       | 1,175,325  |       |
| Automobiles                               |       | 120,805    |       | 120,805    |       |
|                                      |       |       |       |       |       |
|                                      |       | 6,115,879  |       | 6,090,640  |       |
| Accumulated depreciation and amortization |       | (4,127,124 | )          | (2,766,230 | )          |
|                                      |       |       |       |       |       |
| Fixed assets, net                         |       | $          | 1,988,755  |       | $          | 3,324,410 |   |

 

**Note 6—Intangible Assets**

 

The change in the carrying amount of the Company’s intangible assets forthe year ended December 31, 2004 is as follows: 

 
| ** **                                               | ** ** | **Goodwill** | ** ** | **Contracts** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------|------------|--------------|------------|---------------|------------|------------|------------|
| Intangible assets, balance as of  January 1, 2003   |       | $            | 21,077,284 |          | —     |       | $          | 21,077,284 |   |
| Goodwill, acquired during the year                       |       | —       |       | —        |       | —     |       |
| Intangible assets, balance as of  January 1, 2004   |       | 21,077,284   |       |          |       | 21,077,284 |       |
| Goodwill, acquired during the year                       |       | 2,304,032    |       | —        |       | 2,304,032  |       |
| Contracts, acquired during the year                      |       | —       |       | $             | 1,400,000  |       | 1,400,000  |   |
| Impairment charge                                        |       | (2,000,000   | )          | —        |       | (2,000,000 | )          |
| Intangible assets, balance as of  December 31, 2004 |       | $            | 21,381,316 |          | $          | 1,400,000  |       | $ | 22,781,316 |   |

 

During the year ended December 31, 2004, the Company acquired anintangible asset related to a contract between Access and a customer, as shownin the table above. The contract is expected to have a life of ten years andamortization expense in the amount of $140,000 will be recognized each yearbeginning January 1, 2005, the effective date of the contract.

 

As reflected in Note 15 – Segmented Information, the healthcaremembership program which operates within the Foresight Inc. subsidiary hasexperienced significant declines in revenue, which has led to operating losses.Therefore, during the year ended December 31, 2004, the Company impaired$2,000,000 of the carrying value of goodwill related to its acquisition of thatForesight Inc. reporting unit, because based upon current and projectedrevenues and losses, the estimated fair value of our Foresight, Inc. subsidiarywas minimal and did not exceed the carrying value of that entity’s net assets. TheCompany performed the required impairment tests on other goodwill as of the endof 2004, and determined that none of the other goodwill was impaired.

 

**Note 7—Capital Leases**

 

The Company has several capital leases for office equipment with a netbook value of $593,964 and $1,747,683 as of December 31, 2004 and 2003,respectively. These lease purchases have been capitalized at the present valueof fair market value using an interest rate of 8.5% to 9.5% and are beingdepreciated over their estimated useful lives. The following is a schedule byyears of future minimum lease payments under capital leases together with thepresent value of the net lease payments as of December 31, 2004:

 
| 2005                                      |   | $       | 566,060 |   |
|-------------------------------------------|--------|---------|---------|--------|
| 2006                                      |   | 87,048  |    |
| 2007                                      |   | 13,025  |    |
| Total minimum lease payments              |   | 666,133 |    |
| Less: Amount representing executory costs |   | (51,567 | )       |
| Less: Amount representing interest        |   | (23,080 | )       |
| Present value of minimum lease payments   |   | $       | 591,486 |   |

 

F-13

----

 

The following is a schedule of capital leases in effect as of  December 31,:

 
| ** **               | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------|------------|------------|------------|------------|------------|
| Capital lease assets     |       | $          | 3,055,349  |       | $          | 3,067,700 |   |
| Accumulated amortization |       | (2,461,385 | )          | (1,320,017 | )          |
| Net book value           |       | $          | 593,964    |       | $          | 1,747,683 |   |
| Capital lease obligation |       | $          | 591,486    |       | $          | 1,662,432 |   |

 

For the years ended December 31, 2004,2003 and 2002, amortization of capitalized lease assets in the amounts of$1,344,441, $1,536,294 and $427,138, respectively, were included indepreciation and amortization expense.

 

**Note 8—Stockholders’ Equity**

 

Pursuant to its Certificate of Incorporation, the Company is authorizedto issue up to 102,000,000 shares of capital stock, consisting of 100,000,000shares of Common Stock, $0.01 par value per share (the “Common Stock”), and2,000,000 shares of preferred stock, $1.00 par value per share (the “PreferredStock”).

 

On July 8, 2004, the Company’s Board of Directors authorized the repurchase of up to 500,000 shares of our common stock through open market or private purchase transactions over the next year depending on prevailing market conditions.  Through December 31, 2004, the Company has purchased 255,946 shares under this authorization for a total  consideration of $681,537 at a weighted average  price of $2.66  per share.

 
| **Month**                    | ** ** | **Quantity  Purchased** | ** ** | **Weighted  Avg. Stock  Price/Share** | ** ** | **Total Cost** | ** ** |
|------------------------------|------------|-------------------------|------------|---------------------------------------|------------|----------------|------------|
| July                         |       | 21,000                  |       | 2.62                                  |       | $              | 54,984     |   |
| August                       |       | 55,201                  |       | 2.58                                  |       | 142,450        |       |
| September                    |       | 56,191                  |       | 3.01                                  |       | 169,242        |       |
| October                      |       | 29,200                  |       | 2.75                                  |       | 80,261         |       |
| November                     |       | 37,464                  |       | 2.49                                  |       | 93,319         |       |
| December                     |       | 56,890                  |       | 2.48                                  |       | 141,281        |       |
|                         |       |                    |       |                                  |       |           |       |
| As of December 31, 2004 |       | 255,946                 |       | 2.66                                  |       | $              | 681,537    |   |

 

**Note 9—Common Stock Options**

 

As of December 31, 2004, the Company has three stock-basedcompensation plans as described below.

 

In November 1999, our Board of Directors restated and adopted our1999 Stock Option Plan with an effective date of November 30, 1999. TheCompany has reserved 700,000 shares of our common stock for issuance upon theexercise of options granted under this plan. Under the 1999 Stock Option Plan,the Board can determine the date on which options can vest and becomeexercisable as well as the term of the options granted.

 

In July 2002, our shareholders adopted our 2002 Non Employee StockOption Plan with an effective date of July 29, 2002. The Company hasreserved 500,000 shares of our common stock for issuance upon the exercise ofoptions granted under this plan. Under the 2002 Non Employee Stock Option Plan,the Board can determine the date on which options can vest and becomeexercisable as well as the term of the options granted. As of December 31,2004, the number of shares remaining available for future issuance under the2002 Non Employee Stock Option Plan is 286,000.

 

In July 2002, our shareholders adopted our 2002 IMR Stock OptionPlan with an effective date of July 29 2002. The Company has reserved500,000 shares of our common stock for issuance upon the exercise of optionsgranted under this plan. Under the 2002 IMR Stock Option Plan, the Board candetermine the date on which options can vest and become exercisable as well asthe term of the options granted. On January 29, 2003, the Board approved amotion effective June 1, 2003 for the discontinuance of any further stockoption grants under the 2002 IMR Stock Option Plan.

 

On June 29, 2003, the Company’s shareholders approved an amendmentto increase the number of shares reserved under our 1999 Stock Option Plan from700,000 to 1,400,000 shares of common stock for issuance upon the exercise ofoptions under this plan. Under the 1999 Stock Option Plan, the Board candetermine the date on which options can vest and become exercisable as well asthe term of the option granted. As of December 31, 2004, the number ofshares remaining available for future issuance under the 1999 Stock Option Planis 984,750.

 

F-14

----

 

Information with respect to stock optionsoutstanding to certain employees, directors and service providers are asfollows: 

 
| ** **                       | ** ** | **2004**    | ** ** |
|----------------------------------|------------|-------------|------------|
| ** **                       | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                             |       |        |       |   |   |
| Outstanding at beginning of year |       | 991,014     |       | 5.73 |   |
| Granted at market value          |       | 845,500     |       | 3.20 |   |
| Exercised                        |       | (8,750      | )          | 3.55 |   |
| Forfeited                        |       | (338,000    | )          | 7.02 |   |
| Outstanding at end of year       |       | 1,489,764   |       | 4.01 |   |

 
| ** **     | ** ** | **Options Outstanding**      | ** ** | ** **                                     | ** ** | **Options Exercisable**                | ** ** |
|----------------|------------|------------------------------|------------|------------------------------------------------|------------|----------------------------------------|------------|
| ** **     | ** ** | **Outstanding  At 12/31/04** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Outstanding  12/31/04** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|           |       |                         |       |                                           |       |                                   |       |   |   |   |   |
| $1.25 to $1.87 |       | 40,000                       |       | 1.0                                            |       | $                                      | 1.25       |   | 40,000 |   | 1.25 |   |
| $2.40 to $3.55 |       | 652,566                      |       | 4.4                                            |       | 2.84                                   |       | 300,441 |   | 2.95 |   |
| $3.82 to $5.25 |       | 630,460                      |       | 4.1                                            |       | 4.35                                   |       | 216,710 |   | 4.81 |   |
| $5.78 to $8.51 |       | 137,738                      |       | 3.4                                            |       | 7.61                                   |       | 130,238 |   | 7.72 |   |
| $9.37 to $9.50 |       | 29,000                       |       | 2.2                                            |       | 9.50                                   |       | 15,125 |   | 9.50 |   |
|           |       | 1,489,764                    |       | 4.0                                            |       | 4.01                                   |       | 702,514 |   | 4.45 |   |
|                |            |                              |            |                                                |            |                                        |            |  |  |  |  |  |

 

The weighted average fair value stock price of stock options grantedfor the year ended December 31, 2004 was $1.47.

 

During the year ended December 31, 2004, 172,000 stock optionswere granted to the Company’s directors. These stock options had a weightedaverage exercise price of $2.94 and are immediately exercisable. The total outstandingstock options held by Directors as of December 31, 2004 was 498,000 with aweighted average exercise price of $4.29. The Company’s directors did notexercise and/or forfeit any stock options for the year ended December 31,2004. The life of the stock options granted to directors is generally 5 years.

 
| ** **                       | ** ** | **2003**    | ** ** |
|----------------------------------|------------|-------------|------------|
| ** **                       | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at beginning of year |       | 768,073     |       | $ | 6.84 |   |
| Granted                          |       | 479,000     |       | $ | 4.49 |   |
| Exercised                        |       | (20,600     | )          | $ | 3.83 |   |
| Forfeited                        |       | (235,459    | )          | $ | 6.84 |   |
| Outstanding at end of year       |       | 991,014     |       | $ | 5.73 |   |

 

F-15

----

 
| ** **      | ** ** | **Options Outstanding**      | ** ** | ** **                                     | ** ** | **Options Exercisable**                | ** ** |
|-----------------|------------|------------------------------|------------|------------------------------------------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **Outstanding  At 12/31/03** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Outstanding  12/31/03** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $1.00 to $3.00  |       | 85,066                       |       | 5.7                                            |       | $                                      | 2.07       |   | 85,066 |   | $ | 2.07 |   |
| $3.00 to $5.00  |       | 343,050                      |       | 4.0                                            |       | $                                      | 3.99       |   | 136,925 |   | $ | 3.70 |   |
| $5.00 to $7.00  |       | 224,660                      |       | 4.7                                            |       | $                                      | 5.26       |   | 131,410 |   | $ | 5.24 |   |
| $7.00 to $8.00  |       | 100,000                      |       | 3.6                                            |       | $                                      | 7.65       |   | 100,000 |   | $ | 7.65 |   |
| $8.00 to $9.00  |       | 23,738                       |       | 8.2                                            |       | $                                      | 8.51       |   | 23,738 |   | $ | 8.51 |   |
| $9.00 to $10.00 |       | 214,500                      |       | 3.2                                            |       | $                                      | 9.39       |   | 190,875 |   | $ | 9.38 |   |
|            |       | 991,014                      |       | 4.1                                            |       | $                                      | 5.73       |   | 668,014 |   | $ | 6.18 |   |

 

The weighted average fair value stock price of stock options grantedfor the year ended December 31, 2003 was $1.88.

 

During the year ended December 31, 2003, 102,000 stockoptions were granted to the Company’s directors. These stock options had aweighted average exercise price of $4.94 and are immediately exercisable. Thetotal stock options granted to Directors as of December 31, 2003 was266,000 with a weighted average exercise price of $5.52. The Company’sdirectors did not exercise and/or forfeit any stock options for the year ended December 31,2003. The life of the stock options granted to directors is generally 5 years.

 
| ** **                       | ** ** | **2002**    | ** ** |
|----------------------------------|------------|-------------|------------|
| ** **                       | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                             |       |        |       |   |   |
| Outstanding at beginning of year |       | 530,397     |       | $ | 5.76 |   |
| Granted at market value          |       | 488,788     |       | $ | 8.02 |   |
| Exercised                        |       | (124,612    | )          | $ | 5.44 |   |
| Forfeited                        |       | (126,500    | )          | $ | 8.25 |   |
| Outstanding at end of year       |       | 768,073     |       | $ | 6.84 |   |

 
| ** **      | ** ** | **Options Outstanding**      | ** ** | ** **                                     | ** ** | **Options Exercisable**                | ** ** |
|-----------------|------------|------------------------------|------------|------------------------------------------------|------------|----------------------------------------|------------|
| ** **      | ** ** | **Outstanding  At 12/31/02** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Outstanding  12/31/02** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|            |       |                         |       |                                           |       |                                   |       |   |   |   |   |
| $1.00 to $2.00  |       | 30,000                       |       | 3.0                                            |       | $                                      | 1.25       |   | 30,000 |   | $ | 1.25 |   |
| $3.00 to $4.00  |       | 189,175                      |       | 3.7                                            |       | $                                      | 3.60       |   | 37,840 |   | $ | 3.58 |   |
| $5.00 to $6.00  |       | 93,160                       |       | 3.3                                            |       | $                                      | 5.18       |   | 93,160 |   | $ | 3.60 |   |
| $7.00 to $8.00  |       | 125,000                      |       | 3.3                                            |       | $                                      | 7.65       |   | 100,000 |   | $ | 7.65 |   |
| $8.00 to $9.00  |       | 23,738                       |       | 4.0                                            |       | $                                      | 8.51       |   | 23,738 |   | $ | 8.51 |   |
| $9.00 to $10.00 |       | 307,000                      |       | 2.7                                            |       | $                                      | 9.45       |   | 150,000 |   | $ | 9.34 |   |
|            |       | 768,073                      |       | 3.2                                            |       | $                                      | 6.85       |   | 434,738 |   | $ | 6.62 |   |

 

F-16

----

 

The weighted average fair value stock price of stock options grantedfor the year ended December 31, 2002 was $3.27.

 

During the year ended December 31, 2002, 112,000 stockoptions were granted to the Company’s directors. These stock options had aweighted average exercise price of $7.37 and are immediately exercisable. Thetotal stock options granted to Directors as of December 31, 2002 was164,000 with a weighted average exercise price of $5.88. The Company’sdirectors did not exercise and/or forfeit any stock options for the year ended December 31,2002. The life of the stock options granted to directors is generally 5 years.

 

In connection with the Company’s initial public offering, the Companyagreed to sell to the underwriter warrants exercisable for the purchase of100,000 shares of common stock for $9.00 per share during a five-year period.The holders of these warrants will have the right through February 10, 2005,to include such warrants and the shares of common stock issuable upon theirexercise in any registration statement or amendment to a registration statementof the Company at no expense to such holders. As of December 31, 2003,16,500 of these warrants had been exercised at a per share price of $9.00.

 

In November 2000, 200,000 stock options were provided to theCompany’s underwriter exercisable for the purchase of 200,000 shares of commonstock for $9.37 per share. 17,000 of these stock options were exercised during2003 before their expiration on June 30, 2003.

 

**Note 10—Income Taxes**

 

The income tax provision for the years ended December 31, 2004,2003 and 2002 consists of:

 
| ** **                 | ** ** | **2004**   | ** ** | **2003** | ** ** | **2002**  | ** ** |
|----------------------------|------------|------------|------------|----------|------------|-----------|------------|
| Current provision          |       | $          | 306,057    |     | $          | 2,292,175 |       | $ | 2,881,852 |   |
| Deferred provision         |       | (1,040,638 | )          | 118,891  |       | (7,000    | )          |
| Provision for income taxes |       | $          | (734,581   | )        | $          | 2,411,066 |       | $ | 2,874,852 |   |

 

Deferred income tax assets and liabilities as of December 31, 2004and 2003 are comprised of:

 
| ** **                                  | ** ** | **2004**  | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|-----------|------------|----------|------------|
| Deferred income tax assets:                 |       |      |       |     |       |
| Net operating loss carryforwards            |       | $         | 760,681    |     | $          | 760,681 |   |
| Allowance for doubtful accounts             |       | 76,772    |       | —   |       |
| Depreciation and impairment of fixed assets |       | 282,301   |       | —   |       |
| Goodwill                                    |       | 515,409   |       | —   |       |
| Accrued expenses                            |       | 166,205   |       | —   |       |
| Total deferred tax assets                   |       | 1,801,368 |       | 760,681  |       |
| Deferred income tax liabilities:            |       |      |       |     |       |
| Prepaid expenses                            |       | 137,372   |       | —   |       |
| Depreciation                                |       | —    |       | 13,220   |       |
| Intangible asset basis differences          |       | 518,000   |       | 124,052  |       |
| Total deferred tax liabilities              |       | 655,272   |       | 137,272  |       |
| Deferred tax asset, net                     |       | $         | 1,146,096  |     | $          | 623,409 |   |

 

At December 31, 2004 and 2003, the Company had federal and statenet operating loss carryforwards of approximately $2,174,000, expiring atvarious dates through 2020. The Company’s ability to use these losses to offsetfuture taxable income is subject to an annual limitation of approximately$192,000 under the Internal Revenue Code.

 

The Company’s effective income tax rate for continuing operationsdiffers from the U.S. federal statutory rate as follows:

 
| ** **             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal statutory rate |       | (34.0    | )%         | 35.0     | %          | 35.0     | %          |
| State tax              |       | 8.1      | %          | 2.9      | %          | —   |       |
| Other                  |       | (1.4     | )%         | (0.8     | )%         | (0.6     | )%         |
|                   |       | (27.3    | )%         | 37.1     | %          | 34.4     | %          |

 

F-17

----

 

**Note 11—Earnings Per Share**

 

The Company’s earnings or (loss) per share data was computed asfollows:

 
| ** **                                                                        | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| ***Basic earnings per share***                                                    |       |                                      |       |   |   |   |   |
| Net (loss) earnings                                                               |       | $                                         | (1,955,952 | ) | $ | 4,089,326 |   | $ | 5,478,363 |   |
| Less: Preferred stock dividends                                                   |       | (—                                   | )          | (— | ) | (14,137 | ) |
| Net (loss) earnings applicable to common  shareholders                            |       | $                                         | (1,955,952 | ) | $ | 4,089,326 |   | $ | 5,464,226 |   |
| Weighted average number of common shares  outstanding during the year             |       | 11,921,946                                |       | 11,848,789 |   | 11,790,650 |   |
| Basic (loss) earnings per share                                                   |       | $                                         | (0.16      | ) | $ | 0.35 |   | $ | 0.46 |   |
| ***Diluted earnings per share***                                                  |       |                                      |       |   |   |   |   |
| Net (loss) earnings                                                               |       | $                                         | (1,955,952 | ) | $ | 4,089,326 |   | $ | 5,478,363 |   |
| Less: Preferred stock dividends                                                   |       | (—                                   | )          | (— | ) | $ | (14,137 | ) |
| Net (loss) earnings applicable to common  shareholders                            |       | $                                         | (1,955,952 | ) | $ | 4,089,326 |   | $ | 5,464,226 |   |
| Weighted average number of common shares  outstanding during the year             |       | 11,921,946                                |       | 11,848,789 |   | 11,790,650 |   |
| Stock options                                                                     |       | —                                    |       | 75,425 |   | 205,572 |   |
| Weighted average number of shares  outstanding during the year-assumed conversion |       | 11,921,946                                |       | 11,924,214 |   | 11,996,222 |   |
| Diluted (loss) earnings per share                                                 |       | $                                         | (0.16      | ) | $ | 0.34 |   | $ | 0.46 |   |

 

For the year ended December 31, 2004, 54,863 shares related tooutstanding stock options were not included in the calculation of fully dilutedearnings per share because the inclusion would have been anti-dilutive.

 

The number of stock options and warrants that were considered out-of-the-moneyfor purposes of the diluted earnings per share calculation for the years ended December 31,2003 and 2002 was  555,898 and 491,500,respectively.

 

**Note 12—Contingencies**

 

In September 2003, the Company was served with a lawsuit. Theplaintiffs of this lawsuit have alleged that in May 2002 they were notallowed to exercise stock options and warrants issued by the Company. Theplaintiffs are claiming damages based on the difference of the fair marketvalue of the stock price of $15.75 and their exercise prices of $9.00 per shareof common stock for each of the 61,000 warrants and $9.37 per share of commonstock for each of the 185,000 stock options of the Company for potentialdamages of approximately $1.6 million. The Company believes that there areno merits to the plaintiffs’ arguments, as the plaintiffs never rendered theirstock option and warrant exercise documents to the Company, nor did they complywith their terms of agreement regarding the manner in which the stock optionsand warrants should be exercised; however, the lawsuit remains pending and noassurances as to its outcome may be given.

 

In August and September 2003, the Company was served with twolawsuits arising out of the same set of facts. The two lawsuits wereconsolidated into one case now pending in the United States District Court forthe Central District of California. The principal plaintiffs were members ofour Care EntréeTM program. They allege that a provider listed as participatingin our program refused to honor their membership card. The plaintiffs, inaddition to seeking damages for the alleged failure of our services, also seekdamages under various consumer protection statutes in the State of Californiaand for injunctive relief that may affect our ability to do business inCalifornia. These damages may include all fees we have received from members inCalifornia for the past four (4) years. We believe that we have compliedwith all applicable regulations. We have fully settled the case with one of thetwo plaintiffs and have partially settled the case with the remaining set ofplaintiffs.   The remaining portion ofthe case remains pending and no assurances as to its outcome may be given.

 

F-18

----

 

The Company has accrued $187,500 as of December 31, 2004 toprovide for costs of defense and possible settlement of pending and threatenedlitigation, including those matters described above. The Company accrues thecost of defending and settling pending and threatened claims and litigation,including legal fees to be incurred in such defense, when in its judgment suchcosts are estimable and probably will be incurred.

 

In January 1999, the former parent of Foresight, Inc.,Universal Marketing Services, Inc., purchased the outstanding common stockof Foresight, Inc. for $4,540,000. Universal Marketing Services agreed toindemnify the former owners of the common stock of Foresight, Inc. for theincrease in federal income taxes and any applicable penalties to the extentthat $4,540,000 of the purchase price does not qualify for long-term capitalgain treatment. These former shareholders reported $4,540,000 of the purchaseprice as long-term capital gain. In connection with the Company’s merger-acquisition of Foresight, Inc., the Company assumed the indemnificationobligation of Universal Marketing Services. Upon examination, the InternalRevenue Service may take the position that a portion of the $4,540,000 shouldbe classified as ordinary income taxable at the maximum federal income tax rateof 39.6% rather than the long-term capital gain 20% rate. In the event theInternal Revenue Service successfully asserts that long-term capital gainclassification was improper, the Company will be required to indemnify theformer shareholders.

 

The Company has an unused letter of credit in the amount of $1,500,000obtained on commercial terms. The letter of credit is due to expire on June 6,2005.

 

OnJune 18, 2004, the Company completed its acquisition of AccessHealthSource, Inc. (“Access”), a third party administrator, from NationalCenter for the Employment of the Disabled for a purchase price of $3,400,000,consisting of 488,486 shares of common stock of the Company valued at$1,400,000 ($2.87 per share), and $2,000,000 in cash.  In addition to the purchase priceconsideration, there is a contingency payout should the earnings beforeinterest, taxes, depreciation and amortization (“EBITDA”) of Access reachcertain amounts after the closing of the transaction and before December 31,2006.  EBITDA, while not  considered a measure under  accounting principles generally accepted inthe United States of America, is the financial measurement utilized for thebasis of the contingency payout and additional purchase price payments aredependent on Access achieving certain EBITDA levels.  The maximum amount of the consideration thatmay be paid to the seller of Access, including the closing date purchase priceconsideration and investment banking, valuation and legal and accounting fees,is $9,773,500.  The amount of contingencypayments and common stock deliveries based upon EBDITA through December 31,2006, will be based upon a 3.22 multiple of EBITDA of Access determined on aquarterly basis, with effective adjustments as of December 31, 2004, 2005and 2006. The Company expects that Access will achieve those EBITDA levels andthat, as a result, contingent payouts will be made. However, the amount ofpayouts through December 31, 2006 cannot be estimated at this time. Thecontingency payout will be accounted for as a decrease in the Company’s cashand cash equivalents for the amount paid, an increase to stockholders’ equityfor the fair value issued and a corresponding increase in goodwill for thevalue of the cash paid and stock issued.

 

**Note 13—Operating Leases**

 

The Company has leased various office spaces and certain machinery andequipment through December 15, 2006. Future lease commitments on thisspace, machinery and equipment are as follows:

 
| 2005  |   | $       | 427,177 |   |
|-------|--------|---------|---------|--------|
| 2006  |   | 361,997 |    |
| Total |   | $       | 789,174 |   |

 

Management expects that leases currently in effect will be renewed orreplaced with other leases of a similar nature and term. For the years ended December 31,2004, 2003 and 2002, the Company recognized rent expense related to officespace and equipment in the amounts of $514,704, $390,732 and $408,116, respectively.

 

**Note 14—Employee Benefit Plan**

 

The Company has adopted a retirement plan which includes a 401(k)deferred compensation feature. All employees who have completed at least sixmonths of service and are 21 years of age or older may participate in theplan. The Company makes

 

F-19

----

 

matching contributions of up to 50% of a participant’s contributionslimited to 3% of the participant’s annual compensation. The Company matchingcontributions vest 20% per year and become fully vested after the participanthas 6 or more years of service. During 2004, 2003 and 2002, the Company made $32,327,$43,026 and  $33,346, respectively, inmatching contributions to the Plan. All contributions by participants are fullyvested.

 

**Note 15—Segmented Information**

 

TheCompany discloses segment information in accordance with SFAS No. 131, “DisclosureAbout Segments of an Enterprise and Related Information,” which requirescompanies to report selected segment information on a quarterly basis and toreport certain entity-wide disclosures about products and services, majorcustomers, and the material countries in which the entity holds assets andreports revenues. The Company has four reportable segments: healthcaresavings cards, self-funded employer healthcare administration, non-healthcaremembership programs and financial services. The Company’s reportable segments are strategicdivisions that offer different services and are managed separately as eachdivision requires different resources and marketing strategies.  Our healthcare savings cardsegment, our largest segment, offers savings on healthcare services to personswho are un-insured, under-insured, or who have elected to purchase only highdeductible or limited benefit medical insurance policies, by providing accessto the same preferred provider organizations (PPOs) that are utilized by manyinsurance companies and employers who self-fund at least a portion of theiremployees’ healthcare risk. These programs are sold primarily through a networkmarketing strategy.  Our self-funded employerhealthcare administration segment provides a wide range of healthcare claimsadministration services and other cost containment procedures that arefrequently required by governments and other large employers who have chosen toself fund their healthcare benefits requirements.  Our non-healthcare membership division offers non-healthcare relatedmembership programs for rental-purchase companies, financial organizations,employer groups, retailers and association-based organizations. Substantiallyall of our non-healthcare related membership service programs are offered andsold at retail by clients engaged in the rental-purchase industry.  Our financial services segment provides highdeductible and scheduled benefit insurance policies, life insurance andannuities and health savings accounts, healthcare reimbursement arrangementsand medical and dependent care flexible spending accounts.

 

Theaccounting policies of the segments are consistent with those described in thesummary of significant accounting policies in Note 2, intersegment sales arenot material and and all intersegment transfers are eliminated. During 2004,the Company increased the number of segments from one to four, excluding itscorporate activities.

 

No onecustomer represents more than 5% of the Company’s overall revenue. Therefore,the Company does not believe it has a material reliance on any one customer.The Company operates in substantially all of the fifty states in the U.S. butnot in any foreign countries.

 

TheCompany evaluates segment performance based on revenues and income beforeprovision for income taxes. The Company does not allocate income taxes orunusual items to the segments. The following table summarizes segmentinformation:

 

F-20

----

 
| **2004**                          | ** ** | **Healthcare  Savings** | ** ** | **Employee  Healthcare** | ** ** | **Membership  Programs** | ** ** | **Financial  Services** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|-------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|---------------|------------|------------|------------|
| Revenue                           |       | $                       | 32,988,293 |                     | $          | 3,670,374                |       | $                       | 926,077    |          | $          | 733,952    |       | $ | — |   | $ | 38,318,696 |   |
| Income/Loss before Taxes (1)      |       | 2,615,097               |       | 465,204                  |       | (1,212,949               | )          | (1,062,490              | )          | (3,495,395    | )          | (2,690,533 | )          |
| Interest Expense (Income)         |       | —                  |       | —                   |       | —                   |       | —                  |       | 56,558        |       | 56,558     |       |
| Goodwill Impairment               |       | —                  |       | —                   |       | —                   |       | —                  |       | 2,000,000     |       | 2,000,000  |       |
| Depreciation and Amortization     |       | 2,233,866               |       | 58,474                   |       | 12,708                   |       | 17,843                  |       | —        |       | 2,322,891  |       |
| Taxes (Benefit) (2)               |       | —                  |       | —                   |       | —                   |       | —                  |       | (734,581      | )          | (734,581   | )          |
| Assets Acquired, net of disposals |       | 657,804                 |       | 584,721                  |       | (1,585                   | )          | 43,266                  |       | 1,310,851     |       | 2,595,057  |       |
| Intangible Assets (2)             |       | —                  |       | —                   |       | —                   |       | —                  |       | 22,781,316    |       | 22,781,316 |       |
| Assets Held                       |       | 10,742,866              |       | 8,636,346                |       | 1,634,122                |       | 89,920                  |       | 20,871,362    |       | 41,974,616 |       |
|                                   |            |                         |            |                          |            |                          |            |                         |            |               |            |            |            |  |  |  |  |  |  |

 
| **2003**                          | ** ** | **Healthcare  Savings** | ** ** | **Employee  Healthcare** | ** ** | **Membership  Programs** | ** ** | **Financial  Services** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|-------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|---------------|------------|------------|------------|
| Revenue                           |       | $                       | 39,850,213 |                     | $          | —                   |       | $                       | 1,862,885  |          | $          | 374,573    |       | $ | — |   | $ | 42,087,671 |   |
| Income/Loss before Taxes          |       | 7,722,236               |       | —                   |       | (302,393                 | )          | (116,535                | )          | (802,916      | )          | 6,500,392  |       |
| Interest Expense (Income)         |       | —                  |       | —                   |       | —                   |       | —                  |       | 149,969       |       | 149,969    |       |
| Depreciation and Amortization     |       | 2,039,231               |       | —                   |       | 21,811                   |       | 868                     |       | —        |       | 2,061,910  |       |
| Taxes (2)                         |       | —                  |       | —                   |       | —                   |       | —                  |       | 2,411,066     |       | 2,411,066  |       |
| Assets Acquired, net of disposals |       | 934,335                 |       | —                   |       | 8,027                    |       | 17,178                  |       | (14,196       | )          | 945,344    |       |
| Goodwill                          |       | —                  |       | —                   |       | —                   |       | —                  |       | 21,077,284    |       | 21,077,284 |       |
| Assets Held                       |       | 11,212,479              |       | —                   |       | 1,499,075                |       | 19,962                  |       | 28,082,148    |       | 40,813,664 |       |
|                                   |            |                         |            |                          |            |                          |            |                         |            |               |            |            |            |  |  |  |  |  |  |

 
| **2002**                          | ** ** | **Healthcare  Savings** | ** ** | **Employee  Healthcare** | ** ** | **Membership  Programs** | ** ** | **Financial  Services** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|-------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|---------------|------------|------------|------------|
| Revenue                           |       | $                       | 40,335,434 |                     | $          | —                   |       | $                       | 2,661,422  |          | $          | 118,810    |       | $ | — |   | $ | 43,115,666 |   |
| Income/Loss before Taxes          |       | 8,892,725               |       | —                   |       | 460,019                  |       | (438,746                | )          | (560,783      | )          | 8,353,215  |       |
| Interest Expense (Income)         |       | —                  |       | —                   |       | —                   |       | —                  |       | 64,437        |       | 64,437     |       |
| Depreciation and Amortization     |       | 885,216                 |       | —                   |       | 54,900                   |       | —                  |       | —        |       | 940,116    |       |
| Taxes (2)                         |       | —                  |       | —                   |       | —                   |       | —                  |       | 2,874,852     |       | 2,874,852  |       |
| Assets Acquired, net of disposals |       | 920,408                 |       | —                   |       | —                   |       | —                  |       | —        |       | 920,408    |       |
| Goodwill                          |       | —                  |       | —                   |       | —                   |       | —                  |       | 21,077,284    |       | 21,077,284 |       |
| Assets Held                       |       | 10,737,336              |       | —                   |       | 1,179,525                |       | 52,737                  |       | 23,086,088    |       | 35,055,686 |       |
|                                   |            |                         |            |                          |            |                          |            |                         |            |               |            |            |            |  |  |  |  |  |  |

 

----

(1)          – The loss beforeprovision for income taxes for 2004 for the non-healthcare membership programsegment excludes a $2,000,000 charge for impairment of goodwill recorded inconnection with the acquisition of Foresight Inc. in 2000 as such unusualcharges are not allocated to the related segment. That charge is included inthe loss at the corporate level.

 

(2)          – Intangible assets andincome tax expense (benefit) are not allocated to the assets and operations ofthe related segment.

 

**Note 16—Allowancefor Doubtful Accounts**

** **

The following table summarizes activity inthe allowance for doubtful accounts:

 
| **Description**                    | ** ** | **Balance at  Beginning of  Period** | ** ** | **Additions  Charged to Costs  and Expenses** | ** ** | **Deductions-  Describe (1)** | ** ** | **Balance at End  of Period** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|-----------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| Year Ended December 31, 2004: |       |                                 |       |                                          |       |                          |       |                          |       |
| Deducted from assets accounts:     |       |                                 |       |                                          |       |                          |       |                          |       |
| Allowance for doubtful accounts    |       | $                                    | 204,786    |                                          | $          | 1,012,253                     |       | $                             | 997,692    |   | $ | 219,347 |   |
|                               |       |                                 |       |                                          |       |                          |       |                          |       |
| Total                              |       | $                                    | 204,786    |                                          | $          | 1,012,253                     |       | $                             | 997,692    |   | $ | 219,347 |   |
|                               |       |                                 |       |                                          |       |                          |       |                          |       |
| Year Ended December 31, 2003: |       |                                 |       |                                          |       |                          |       |                          |       |
| Deducted from assets accounts:     |       |                                 |       |                                          |       |                          |       |                          |       |
| Allowance for doubtful accounts    |       | $                                    | —     |                                          | $          | 211,635                       |       | $                             | 6,849      |   | $ | 204,786 |   |
|                               |       |                                 |       |                                          |       |                          |       |                          |       |
| Total                              |       | $                                    | —     |                                          | $          | 211,635                       |       | $                             | 6,849      |   | $ | 204,786 |   |
|                               |       |                                 |       |                                          |       |                          |       |                          |       |   |   |   |   |
| Year Ended December 31, 2002: |       |                                 |       |                                          |       |                          |       |                          |       |
| Deducted from assets accounts:     |       |                                 |       |                                          |       |                          |       |                          |       |
| Allowance for doubtful accounts    |       | $                                    | —     |                                          | $          | —                        |       | $                             | —     |   | $ | — |   |
| Total                              |       |                                 |       |                                          |       |                          |       |                          |       |

 

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(1)           Uncollectible accounts written off

 

F-21

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