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

**Washington, D.C. 20549**

 

**FORM 10-KSB**

 
| **ý**                                             | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  [Fee Required]** |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                      |
| **For the fiscal year ended  September 30, 2003** | **Commission File Number:  0-17192**                                                                 |
|                                                        |                                                                                                           |  |

 

**REVCARE, INC.**

(Name of small business issuer in its charter)

 

| **Nevada**                                                       |   | **84-1061382**                                |
|------------------------------------------------------------------|--------|-----------------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |   | (IRS  Employer  Identification No.)           |
|                                                             |   |                                          |
| **5400 Orange Avenue, Suite 200, Cypress, California**           |   | **90630**                                     |
| (Address of principal executive offices)                         |   | (Zip Code)                                    |
|                                                             |   |                                          |
| Issuer’s Telephone Number:  **(714) 995-0627**         |
|                                                             |   |                                          |
| Securities registered under Section 12(b) of the  Exchange Act:  |
| (Title of each  class)                                           |   | (Name of each  exchange on  which registered) |
| **NONE**                                                         |   | **NONE**                                      |
|                                                             |   |                                          |
| Securities registered under Section 12(g) of the  Exchange Act:  |
| (Title of class)                                                 |
| **COMMON STOCK**                                                 |

 

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

 

Check if there is nodisclosure of delinquent filers in response to Item 405 of Regulation S-B isnot contained in this form, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB.  ý

 

State issuer’s revenuesfor its most recent fiscal year:  **$9,195,693**

 

State the aggregatemarket value of the voting stock held by nonaffiliates of the registrant:  **$580,582.**

 

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of the latestpracticable date:  **21,526,909 shares of Common Stock issued andoutstanding as of January 29, 2004.**

 

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

 

 

----

 

**PART I**

 

# **ITEM 1**           DESCRIPTION OFBUSINESS

# ** **

EXCEPT FOR THE HISTORICALINFORMATION CONTAINED HEREIN, THE MATTERS DISCUSSED IN THIS ANNUAL REPORT ONFORM 10-KSB ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES(SUCH FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS USINGSUCH WORDS AS “MAY,” “POTENTIAL,” “EXPECTS,” “BELIEVES,” “ESTIMATES,” “PLANS,”“INTENDS,” “ANTICIPATES” AND SIMILAR EXPRESSIONS).  FOR A DISCUSSION OF CERTAIN FACTORS WHICH MAY AFFECT THE OUTCOMESPROJECTED IN SUCH STATEMENTS, SEE “RISK FACTORS” ON PAGES 9 TO 12 OF THISANNUAL REPORT ON FORM 10-KSB. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSEPROJECTED.  THESE FORWARD-LOOKINGSTATEMENTS REPRESENT OUR JUDGMENT AS OF THE DATE OF THE FILING OF THIS ANNUALREPORT ON FORM 10-KSB.  WE DISCLAIM,HOWEVER, ANY INTENT OR OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS.

 

 

## ***Our Company***

## *** ***

RevCare,Inc. is one of the leading providers of revenue cycle management services inCalifornia, Nevada and Hawaii.  We havetraditionally focused our services on three segments of the accounts receivablemanagement industry – healthcare, banking and retail.  However, with our acquisition of four healthcare revenue cyclemanagement companies in August 2000, we are now concentrating on offering ourcomprehensive and integrated suite of services to manage the revenue cycle ofhealthcare providers.  We now have theability to provide the services required by our healthcare clients to manageall phases of their revenue cycle, which include:

 

physician and hospital billing,

 

non-delinquent and delinquent receivable collections,

 

reimbursement maximization projects,

 

back-office staffing and outsourcing, and

 

litigation management services

 

 

Wehave significant presence in the Southern California, Las Vegas and Hawaiihealthcare markets.  We provide servicesto approximately 1,253 healthcare facilities in these geographic areas.  We currently manage over $1 billion inreceivables for our billing and collections clients on an annual basis.  We have contracts to provide reimbursementmaximization projects to approximately 157 healthcare facilities in the westernregion of the United States.

 

Webelieve our unique combination of services will allow us to continue to accessvarious sources of capital to fund our ongoing growth, which may includeadditional acquisitions of companies in geographic areas where there is ademand for our services.  Our immediategoal is to become the most

 

2

----

 

prominentprovider of revenue cycle management services to healthcare providers in thewestern region of the United States.  Wehave continued development on two important initiatives that will enhance ourclient service delivery processes:

 

an accumulation of our clients’ data that we willprocess to provide information specific to our clients and benchmark statisticsabout the industry

 

a professional development center designed tocontinually expand the basic, technical and regulatory compliance knowledge ofour staff.

 

Whilewe are directing our services primarily to the healthcare industry, we alsocontinue to provide national receivable management services to certainnon-healthcare companies in the financial services, auto and retail industries.The retail industry represents approximately 10% of our business. Our clientsin these industries primarily utilize our delinquent debt recovery andlitigation management services. In the future, we anticipate a reduction in thepercentage of business related to non-healthcare companies.

 

Wehave discontinued purchasing charged-off receivable portfolios and do notintend to participate in this business.

 

## ***Our BusinessStrategy***

 

Ourbusiness strategy focuses on positioning ourselves as a strategic partner andbusiness advisor to healthcare organizations for their revenue cycle managementneeds.  Key elements in our strategyinclude:

 

Organizational Intelligence –We are continuing to build a knowledgebase that will be enriched by the significant amount of data we receive andproduce in the course of delivering our services.** **We believe that our clients will benefit from the specificperformance information and from the industry level benchmark comparisons thatthis pool of information may provide once it is processed and organized, tobetter manage their business practices. We intend to use the latest application service provider (or ASP)technology to provide our clients with secured, ready access to our knowledgebase through our website.

 

Technology – We plan to continue to utilize andleverage technology to provide our clients with more services and informationthat are critical to their business in more convenient and economical ways.

 

Our People – Our success will also largely depend onour ability to recruit, retool and retain smart professionals.  To ensure professionalism and technical knowledgein our people, we created the Professional Development Center.  The center assures us that our people willlearn and understand our corporate culture, standardized basic procedures andthe latest changes in technical and regulatory requirements in the industrieswe serve, and become proficient in using the technology tools and resourcesthat are available to them.

 

Fundamental to our strategy is our attention to:

 

building awareness of our brand in the geographicmarkets that we service, which will support the development of our servicelines in new markets**.**

 

3

----

 

developing strategic alliances with finance andtechnology companies who focus on the healthcare industry, and marketing andcross promotion alliances with other service providers to reach new clients andexpand value-added services provided to existing clients.

 

enhancing financial performance in all our servicelines by maximizing the use of technology to streamline internal processes,lowering the cost of service and information delivery, and extracting economiesof scale from internal growth and acquisitions.

 

## ***Our History***

 

InAugust 2000, we completed our acquisition of California Professional Services,Inc., or CPS, which was founded in 1974 and primarily provides collectionsservices to healthcare clients.  As partof our acquisition of CPS, CPS acquired the assets of Insource MedicalSolutions, or Insource, Hospital Employee Labor Pool, or HELP, and RBA-RemCare,or RBA.  Insource, a physician andhospital billing company, started its operations in 1996.  HELP, a staffing and back office outsourcingfirm, started its operations in 1988. RBA, a healthcare reimbursement maximization consulting company, wasformed in 1990.

 

OnMay 30, 2000, FBR Financial Fund II, L.P., now known as FBR FinancialServices Partners (FBR), purchased newly issued shares representingapproximately 70% of our outstanding stock for $7.5 million.  With the proceeds of this investment, wewere able to complete our acquisition of CPS, Insource, HELP and RBA in August2000.  We have combined these companieswith our previously owned subsidiaries Medical Control Services, Inc. and LienSolutions, Inc**.,** which specialize in the healthcare industry and MerchantsRecovery Services, Inc**.,** which focus on non-healthcareclients.  These subsidiaries startedtheir operations at various times from 1977 through 1982.   As part of the transition we also changedour name to RevCare, Inc.  We believethe combination of experience and knowledge acquired through the addition ofthese companies has allowed us to provide an integrated and comprehensive suiteof services to manage the revenue cycle of most healthcare providers.  We also extended our geographic presence tothe Nevada and Hawaii markets with these acquisitions.

 

## ***Our Services tothe Healthcare Industry***

 

Billing Services

 

We perform coding, processing and electronicsubmission of claims (including Medicare and MediCal) arising from servicesperformed by medium to large physician groups and hospitals.  We currently utilize IDX billing technologyto process claims for our clients. Additional services provided eitherindependently or in conjunction with the above billing services include; baselineand annual physician audits and physician and staff education.  We perform charge ticket reviews anddevelopment, as well as, reviewing the charge capture process.  Other services include; operationalconsulting services and compliance reviews. We earn our revenue based on acontractual percentage of the dollar value of claims paid or on a fixed feebasis.

 

Recovery Services

 

Pre-Collect Services – We provide pre-delinquencycollection services to our clients by acting as an extension of our clients’accounts receivable department.  Weprovide clients with speed dialing and professionally trained staff to helpthem achieve better penetration of their non-delinquent pool of receivables.

 

4

----

 

Delinquent Debt Recovery – Whether the cause isimproper processing of the claims or the patient’s reluctance or inability topay, certain receivables require specialized skills to achieve maximumliquidity.  Our staff is trained toidentify the causes and the appropriate approaches to ensure professionaltreatment of our clients’ patients and customers.  In the future, we expect the account segmentation and filtrationprocesses that may result from the information accumulated in our knowledgebase to help us minimize the staff’s efforts on accounts with low or nocollectable value.

 

Reimbursement Solutions

 

Managed Care Audits – We have a comprehensive auditprogram that employs technology and experienced professionals on managed careaccounts that have been closed for over one year.  This process includes a thorough review of all payments and/ordenials received under the terms and conditions of managed care contracts.  We retain an agreed upon percentage of there-billed services paid by the insurance carriers.

 

Clinical Denial Audits – Insurance carriers deny claimsdue to a variety of reasons.  We auditdenied claims to determine whether they were appropriately denied.  We typically retain an agreed uponpercentage of the payment received by our clients from contested claims.  The percentage of re-billed claims variesaccording to the nature of the claim, the services provided, and the processesand methods followed by the business office of the healthcare provider.

 

Zero Balance Reviews - This service is an extension ofour managed care audit service but applies to all accounts that have beensettled at significantly less than the amount originally billed.  Prior to accepting an engagement, ourprofessionals conduct a feasibility study of the client’s internal receivable managementprocess.  We review a sample of accountsthroughout the period and assess the processes and methods followed by the backoffice.  The client ordinarily pays forthe feasibility study.  We retain anagreed upon percentage of the re-billed services paid by the insurancecarriers.

 

Compliance Reviews – We provide consulting services onhealthcare regulatory compliance matters to small- to medium- sized medicaloffices.  This service provides for athorough review of the medical facility. Process flow is documented for each component of the accounts receivablemanagement process.  The review producesdetailed documentation, which forms the basis of our recommendations forimplementing an effective compliance program. The ultimate goal of the compliance program is to promote prevention,detection, and resolution of instances of conduct that do not conform toFederal and state laws.  Fees for thisservice are generally fixed rates based on the size of the office and otherfactors.

 

Staffing and Outsourcing Services

 

One of the major challenges of financial officers andbusiness office managers is the maintenance of an adequate number of properlytrained and experienced professionals to perform the continuously increasingworkload in the receivable management units. Unexpected departures or absences of experienced coders, billers,abstractors and collectors within a unit may create significant backlogs whichmay lead to potential increases in claim denials and deterioration ofreceivable liquidation rates. Some healthcare providers prefer to outsourceportions of or all of their back office processes.  Our seasoned and knowledgeable healthcare receivable specialistsare available for various assignments throughout the western region.  Specific hourly rates are determined by theemployee’s level and years of experience, expertise and education.

 

In August 2003, we entered into an Exchange Agreementwith Russell and Suzette Mohrmann and their affiliate, Hospital Employee LaborPool, a California corporation, or HELP, pursuant to which there was a transferof substantially all the assets related to our administrative and back officetemporary staffing

 

5

----

 

division. Accordingly, we do not expect to earnrevenues from this business segment subsequent to August 2003 (see Item 6 ofMD&A and Note 13 of the consolidated Financial Statements for moreinformation regarding this transaction).

 

## ***Our Services toNon-Healthcare Clients***

## *** ***

Wehave been providing recovery services to the financial services, retail, and commercialindustries for over twenty years.  Wehave developed a particular expertise in the handling of accounts financed byretail and finance companies, which comprise a large portion of ournon-healthcare client base.  Most of ourservices involve the earlier stages of recovery of our clients’ delinquentaccounts receivable.

 

## ***Support Services***

 

Toprovide effective and thorough services to our clients, we also offer thefollowing services and systems to support our core operations:

 

*LitigationManagement* – Wehave a specialty recovery department with a full time attorney to managelitigation and bankruptcy related activities. The attorney and support staff have more than ten years of full timeemployment with us.  Litigationmanagement includes filing legal actions on collection accounts, enforcement ofjudgments, and the perfecting of Chapter 13 bankruptcy claims nationwide.

 

*Technologyand Information Systems* – We recognize the value of combining human resources with the latestcomputer and telecommunications technology to manage the receivables assignedto us effectively.  Accordingly, wemaintain sophisticated data processing support and management informationsystems that can be easily operated by our billing and recovery specialists.

 

Our receivable management software system is compiledunder a widely used, high level programming language.  It operates under a Microsoft Windows environment distributed bya Windows NT network system.  A centralcomputer file server connected to an array of disc drives maintains ourmanagement information database.

 

We believe that knowledge is a key differentiatingfactor in our business.  Our longexperience in the receivable management business has allowed us to accumulate abase of knowledge which, if properly maintained and continually enriched, canprovide significant information to our clients to enhance their decision makingprocesses to include analysis of profitable lines of business and problem areasto avoid.  With the proper management ofthe data we continuously gather from our daily customer interaction, we willimprove our recovery strategies and management reports for our clients.

 

We continue to expand our data management capabilityby utilizing ODBC (Open Database Connectivity) capable report writing on anOracle open database system.  Thissystem integrates our current receivable management operating system andexisting telecommunication technology. This system also allows us to create a more precise coding system toextract, sort, and store information that we believe will be useful to ourclients’ decision making process with respect to the relative values andexpected performance of their outstanding receivables.  We intend to use this system to developinformation retrieval and delivery processes for our clients utilizing theInternet.

 

*ProfessionalDevelopment Center*–**Notwithstandingthe factors discussed above, the most critical factor that impacts our abilityto execute our operating mission is our ability to manage the three ***R***’s of human resources–***R***ecruit, ***R***etool, ***R***etain.

 

6

----

 

An effective recruiting program reduces the efforts wemay need to expend on retooling (training) and retention.  Accordingly, we have establishedexperience-based selection criteria to augment our recruiting program.  The criteria are based upon a careful studyof the skills common to our successful employees.  The selection process is conducted through a standardized scoringmatrix that effectively sorts candidates according to their ability todemonstrate the success traits that we look for.

 

Our retooling (training) process is comprised of twoprograms.  The basic training course isa twelve-week training process.  Itstarts with a two-week classroom course that focuses on teaching the five basicskill sets required to become an effective recovery specialist.  Graduates of this course are accepted to thetraining division, where trainees work on live accounts and fine tune theskills taught during the preceding two-week course under the close supervisionof training supervisors.

 

The advanced training course is designed to trainrecovery specialists on selected specialty skills (for example, healthcarebilling, specialty recovery, loan servicing and insurance processing).  Employees are able to expand their skills onsome of the more difficult or technical aspects of the job (for example,negotiation skills, customer service techniques, team building concepts andrecent regulatory pronouncements).

 

Training programs are also open to our clients inorder to enhance the skills of their employees in those areas where the clientdoes not wish to outsource the process. These classes are conducted at our offices or at the client’s facilitiesand are scheduled throughout the year.

 

Our Professional Development Center also offersbeginning and advanced coding and billing classes.  We offer the “Professional Medical Coding Curriculum” that wasdeveloped by the American Academy of Professional Coders.  This class is an extensive 20 week programthat will prepare the coder to become certified.  The CPC certification exam is administered at the completion ofthe class.

 

## ***Marketing andAdvertising***

 

Ourmarketing strategy is focused on three goals - building brand awareness,acquiring specifically targeted clients in the western region of the UnitedStates and cross selling our value-added services to our existing clientbase.  We pursue these goals through acombination of:

 

marketing through selected trade shows andconventions;

 

marketing on our own websites and other onlineopportunities;

 

direct mail marketing;

 

attendance at industry-sponsored public relationsevents.

 

Ouradvertising focuses on building awareness of the RevCareÔbrand and related services and positioning ourselves as a strategic partner andbusiness advisor to our clients.  Weplace print advertisements in various industry publications and our websiteincorporates a description of the comprehensive suite of services that we nowprovide to our clients.

 

7

----

 

## ***GovernmentRegulation***

 

Ourhealthcare billing services are covered by various regulations prescribed byMedicare, Medicaid, TRICARE and the Health Care Financing Administration, andeach major federal healthcare payment program has it own set of complex andsometimes conflicting regulations. Additionally, regulations have been mandated by the Balanced Budget Actand the Health Insurance Portability and Accountability Act (HIPAA), each ofwhich could have a significant impact on our business.  Several states have also imposed significantregulatory programs applicable to billing and payment for healthcareservices.  The Office of InspectorGeneral of the Department of Health and Human Resources has issued complianceguidelines for third-party billing companies, recommending components for aneffective billing company compliance program and identifying several risk areasassociated with medical billing.  Suchrisk areas include routine waiver of copayments and deductibles, unbundling,billing for undocumented services, and upcoding.  The continual implementation of measures to restrict payments forhealthcare services by governmental and private payors may result in a decreasein revenue to our provider clients, and as a result, a decrease in revenuederived by us from such clients as well as an increase in the cost of providingservices.

 

Ourrecovery operation is regulated by the Fair Debt Collection Practice Act andthe Telephone Consumer Protection Act, which are enforced by the Federal TradeCommission.  In 1996, HIPAA was passed,which addresses the compliance requirements to safeguard patient informationthat is shared and communicated during the various billing and recoveryprocesses.  In this regard, we devotecontinuous efforts through ongoing training and monitoring to provide ethical,innovative, high quality receivable management services, which meet the needsof our clients and comply with applicable laws.

 

Althoughwe believe that we are in compliance with all applicable laws and regulations,there can be no assurance that we will always be able to maintain suchcompliance.  Our failure to comply withsuch statutes and regulations could have a material adverse effect on us.  Furthermore, the adoption of additional statutesand regulations, changes in interpretation and enforcement of current statutesand regulations, or the expansion of our business into jurisdictions that havemore stringent regulatory requirements than those in which we currently conductbusiness could have a material adverse effect on us.

 

## ***Competition***

 

Allaspects of our business are highly competitive.  We compete directly with OSI, NCOG, and approximately 6,000 smallbusinesses operating in any, but not all of our segments. Many of ourcompetitors such as OSI and NCOG, have far greater resources and have access tocapital markets that may be unavailable to us.

 

Webelieve that the principal competitive factors affecting our business areperformance, price, and quality of service provided.  We believe that our strategic focus and innovative approacheswill allow us to compete effectively with current providers of like services.

 

## ***Employees***

 

As ofSeptember 30, 2003, we had 137 full time employees and 4 part timeemployees.  A total of 127 of theseemployees are based in Southern California, 4 are based in Las Vegas, 1 isbased in Arizona, and 9 are based in Hawaii. None of our employees are subject to a collective bargaining agreement.  We believe that our relations with ouremployees are good.

 

8

----

 

RISK FACTORS

 

WE WISH TO CAUTIONREADERS THAT THE FOLLOWING IMPORTANT FACTORS, AMONG OTHERS, IN SOME CASES HAVEAFFECTED, AND IN THE FUTURE COULD AFFECT, OUR ACTUAL RESULTS AND COULD CAUSEOUR ACTUAL CONSOLIDATED RESULTS FOR FUTURE PERIODS TO DIFFER MATERIALLY FROMTHOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY US OR ON OURBEHALF.  WE EXPRESSLY DISCLAIM ANYOBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANYFORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO REFLECT ANY CHANGE IN OUREXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN EVENTS, CONDITIONS ORCIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.

 

***One of our shareholdersholds a large percentage of our common stock and controls our board ofdirectors.***

 

Two ofour directors, George L. McCabe and Edward Wheeler, are managing directors ofour majority shareholder, FBR Financial Fund II, L.P., which beneficially ownsapproximately 70% of the outstanding shares of our common stock as of September30, 2003.  Accordingly, FBR and Messrs.McCabe and Wheeler are able to control us and our affairs and business,including any future issuances of common stock or other securities, merger andacquisition decisions, declaration of dividends and the election ofdirectors.  In addition, our stock priceand our ability to raise capital could be injured if FBR was to sell asignificant portion of its holdings on the open market.  Generally, FBR may either sell its sharesunder a registration statement or in compliance with the volume limitations andother requirements imposed by Rule 144 adopted by the SEC.

 

***We may need additionalcapital, which may be unavailable.***

 

Ourgrowth strategy, including our proposed technological enhancements, may requiregreater expenditures than expected in our current business plan.  Our capital requirements will depend onnumerous factors, including:

 

our rate of sales growth—fast growth may actuallyincrease our need for additional capital to hire additional staff, purchaseadditional equipment and technology, finance the increase in accountsreceivable and supply additional support services.

 

our progress in providing improved reporting to ourclients will require additional capital.

 

the level of resources that we devote to thedevelopment and marketing of our services and products—any decision we make toimprove, expand or simply change our process, services or technology willrequire increased funds.

 

market acceptance and demand for our services andproducts—although growth may increase our capital needs, the lack of growthwould also increase our need for capital.

 

We may be unable topredict accurately the timing and amount of our capital requirements.  We may be required to raise additional fundsthrough public or private financing, bank loans, collaborative relationships orother arrangements earlier than expected. It is possible that banks, venture capitalists and other investors mayperceive our capital structure, financial performance or reliance on the healthcareindustry and new technology as too great a risk to bear.  As a result, additional funding may not beavailable on attractive terms, or at all. If we cannot obtain additional capital when needed, we may be

 

9

----

 

forced to agree tounattractive financing terms, to change our method of operation or to curtailour operations.

 

***Our common stock issubject to price volatility.***

 

Thenumber of shares of our common stock that traded daily during 2003 averagedless than 5% of the average outstanding common stock.  As a result of our low trading volume and various other factorsbeyond our control, the market price for our common stock is volatile.  Some of the factors that may subject ourstock price to wide fluctuations include:

 

the timing and announcement of acquisitions by us orour competitors.

 

government regulatory action.

 

quarterly variations in operating results.

 

announcements of technological innovations, newservices or pricing by our competitors.

 

changes in, or failure to meet, the expectations ofinvestors.

 

the timing and extent of technological advancements.

 

the sales of our common stock by affiliates or othershareholders with large holdings.

 

general market conditions.

 

In addition, the stock market has experiencedsignificant price and volume fluctuations that have affected the market priceof the stock of many companies and that often have been unrelated to theoperating performance of such companies. These broad market fluctuations may directly influence the market priceof our common stock.

 

***We operate in a regulated business and ifwe fail to comply with government regulations our ability to conduct businessmay be suspended or terminated which would have a materially adverse effect onus.***

 

Theaccounts receivable management and telemarketing industries are regulated undervarious United States federal and state laws and regulations.  Many states require that we be licensed as adebt collection company.  If we fail tocomply with applicable laws and regulations, it could result in the suspensionor termination of our ability to conduct accounts receivable management ortelemarketing services, which would have a materially adverse effect onus.  In addition, new federal or statelaws or regulations, or changes in the ways these rules or laws are interpretedor enforced, could limit our activities in the future or significantly increasethe cost of regulatory compliance.

 

Thehealthcare industry and some of the other industries served by us are alsosubject to varying degrees of government regulation.  Although our clients are generally responsible for complying withthese regulations, we could be subject to a variety of enforcement or privateactions for our failure or the failure of our clients to comply with theseregulations.

 

***We compete with approximately 6,000providers in the accounts receivable management industry which could reduce ourmarket share and have a materially adverse effect on our future financialresults.***

 

10

----

 

Wecompete with approximately 6,000 providers in providing accounts receivablemanagement services.  We compete withlarge national corporations as well as many regional and local firms.  We may lose existing or prospective businessto competitors that have established and larger marketing and salesorganizations, significantly greater financial and technical resources and alarger base of customers or operate in broader geographic areas than we do.  Because of the large numbers of providers,in the future we may have to reduce our collection fees to remaincompetitive.  Many larger clients retainmultiple accounts receivable management providers, which expose us tocontinuous competition in order to remain a preferred vendor.

 

***Our business isdependent on the healthcare and financial services industries.***

 

Our business is dependent on clients in the healthcareand financial services sectors. If either of these sectors performs poorly,clients in these sectors may have fewer or smaller accounts to refer to us orthey may elect to perform accounts receivable management servicesin-house.  If there are any trends ineither of these sectors to reduce or eliminate the use of third-party accountsreceivable management services, the volume of referrals to us woulddecrease.  Further, the healthcareindustry is undergoing fundamental changes resulting from political, economicand regulatory influences. Significant changes in healthcare systems could havea substantial impact on the manner in which we conduct our business and couldrequire us to revise our strategies.

 

***Our failure to introduce value addedservices and products in a timely manner may affect our ability to competeeffectively.***

 

Oursuccess depends in large part on sophisticated telecommunications and computersystems.  We use these systems toidentify and contact large numbers of account debtors and to record the resultsof the collection effort.  If we are notable to respond to technological changes in telecommunications and computersystems in a timely manner, we may not be able to remain competitive.  We have made a significant investment intechnology to remain competitive and anticipate that it will be necessary tocontinue to do so in the future. Computer and telecommunication technologies are changing rapidly and arecharacterized by short product life cycles, so that we must anticipatetechnological developments.  If we arenot successful in anticipating, managing or adopting any technological changeson a timely basis or if we do not have the capital resources available toinvest in new technologies, our business would be materially adverselyaffected.

 

***If our telecommunications and computersystems fail or become unavailable, it could have a materially adverse effecton our business.***

 

Asnoted above, our business is highly dependent on our telecommunications andcomputer systems.  These systems couldbe interrupted by natural disasters, power losses, or similar events.  Our data is secured daily and the computerhardware required to operate it can be replaced quickly. Our business also ismaterially dependent on service provided by various local and long distancetelephone companies.  If our equipmentor systems cease to work or become unavailable, or if there is any significantinterruption in telephone services, we may be prevented from providingservices.  Because we generallyrecognize income only as accounts are collected, any failure or interruption ofcommunication services would mean that we would continue to incur payroll andother expenses without any corresponding income.

 

***We may not be able tomanage growth.***

*** ***

Ifsuccessful, we will experience a period of growth that could place asignificant strain upon our managerial, financial and operationalresources.  Our infrastructure,procedures and controls may not be adequate to support our operations and toachieve the execution necessary to successfully market our

 

11

----

 

services.  To continue our future growth, we will alsobe required to improve our operational and financial systems and obtainadditional management, operational and financial resources.  If we are unable to manage future expansioneffectively, our business, results of operations and financial condition willsuffer, our senior management will be less effective, and our revenues maydecrease.

 

# **ITEM 2**           DESCRIPTION OFPROPERTY

 

Throughoutfiscal year 2002 and until May 21, 2003, we owned our office building andproperty located at 5400 Orange Avenue, Cypress, California, where we conductour primary operations.  The officebuilding, which was purchased in 1993, contains approximately 53,000 squarefeet of office space.  Currently, weoccupy approximately 37,000 square feet for our operations, and the remainderof the building is available for lease to third party tenants.

 

Aspreviously reported on Form 8-K filed July 10, 2003, on May 21, 2003, oursubsidiary Medical Control Services, Inc. (MCI) which held title to ourcorporate facility completed the sale of the property to SCP Park Meadows, LLC(SCP).  On that same date, we enteredinto a Lease Agreement dated May 21, 2003 with SCP (the “Lease”). The Leaseprovides, among other things, all of the following:

 

•      a twelve year term, with two additionalrenewal options of five years each

 

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

 

•      a tenant improvement allowance of $50,000

 

•      our responsibility for various costs,including those associated with maintaining, insuring, repairing and replacingitems on the property

 

•      security deposits in the form of twoirrevocable letters of credit totaling $1,050,000, $400,000 of which is subjectto release within twelve months if we satisfy specified conditions

 

•      our option to repurchase the propertybetween the third and fifth years of the Lease term at a purchase price equalto the amount determined by dividing the annual base rent that otherwise wouldhave been payable for the 12 months following the closing of the repurchase ofthe property by 8.5%

 

•      our option to terminate the Lease betweenthe third and fifth years of the Lease upon payment of a termination fee equalto 50% of the amount equal to the net present value of the aggregate base rentpayments remaining through the Lease, using a discount rate of 8.5%

 

Copies of these agreements implementing thesetransactions are filed as Exhibit 10.13 through 10.15 to the Form 8-K filed onJuly 10, 2003, and incorporated herein by reference.

 

Wealso have leased offices located at 2235 E. Flamingo Road, Suite 405, LasVegas, NV 89119; and****at 46-001 Kamehameha Hwy, Suites 308 and309, Kaneohe, HI  96744.

 

12

----

 

# **ITEM 3**           LEGAL PROCEEDINGS

 

We areinvolved, from time to time, in litigation that is incidental to our collectionbusiness.  We regularly initiate legalproceedings as a plaintiff in connection with our routine collectionactivities.  In management’s opinion,none of these legal matters individually will have a material adverse effect onour financial position or the results of our operations.

 

Commencingin September 2001, in some cases where California-based delinquent debtcollection clients did not have the agreement with the Company which requiredthe Company to maintain the funds collected on the clients’ behalf in aseparate account, the Company transferred funds from the client account to itsgeneral operating account. In addition, payments to such clients were withheldfor 90 to 120 days, and sometimes longer. The Company has relied upon therepeal of previous California statutes requiring segregation of client funds bycollection agencies when our client contract did not contain an express provisionrequiring segregation.  In July 2003,the Company determined, despite the lack of clear authority, that the practiceof transferring client funds to operating accounts or delay on remitting fundsmight be deemed a breach of our obligations. Since the Company is unable todetermine definitively if this is the case, the Company has taken and is takingadditional steps to address this practice. Client funds are no longertransferred to operating accounts for any reason (other than funds owed to the Companyfor its services to which it is contractually entitled). The Company believesthat a consequence of any such potential breach is that certain of ourCalifornia-based delinquent debt collection clients may feel damaged and mayrequest compensation. To the extent the Company is unable to reach an agreementwith entities that request compensation, such entities may initiate legalefforts to pursue claims against the Company. In connection with the process toreduce the collections payable balance owed to certain of the Company’sCalifornia-based delinquent debt collection clients, the Company will contactthose clients and offer to pay interest to those of which assert a claim as aresult of the Company’s past practice.

 

 We have provided copies of our reports onForm 8-K filed on July 10, 2003 and August 15, 2003, respectively, to theDivision of Enforcement of the Securities and Exchange Commission. Since thattime, the Company has been notified by the SEC that it has begun an informalinvestigation involving the Company. The Company is cooperating with the SEC inthis process.

 

# **ITEM 4**           SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

 

Therewere no matters submitted to a vote of security holders during the fourthquarter of the fiscal year ended September 30, 2003.

 

13

----

 

**PART II**

 

# **ITEM 5**           MARKET FOR COMMONEQUITY AND RELATED STOCKHOLDER MATTERS

 

**Equity Compensation Plan Information**

 
| **Plan category**                                               |   | **Number of  securities to be  issued upon  exercise of  outstanding  options, warrants  and rights** |   | **Weighted-average  exercise price of  outstanding  options, warrants  and rights** |   | **Number of  securities  remaining available  for future issuance  under equity  compensation plans  (excluding  securities reflected  in column (a))** |      |
|-----------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
|                                                            |   | **(a)**                                                                                               |   | **(b)**                                                                             |   | **(c)**                                                                                                                                                 |      |
| **Equity  compensation plans approved by security holders**     |   | 1,094,908                                                                                             |   | $                                                                                   | 0.65   |                                                                                                                                                    | 2,155,092 |   |
| **Equity  compensation plans not approved by security holders** |   | 400,000                                                                                               |   | $                                                                                   | 3.06   |                                                                                                                                                    | —    |   |
| **Total**                                                       |   | 1,494,908                                                                                             |   | $                                                                                   | 1.30   |                                                                                                                                                    | 2,155,092 |   |

 

Ourcommon stock, $.001 par value, is traded under the symbol “RVCR.PK” through theOTC Electronic Bulletin Board maintained by the National Association ofSecurity Dealers, Inc.  The OTCElectronic Bulletin Board has no financial eligibility standards and is totallyseparate from the Nasdaq Stock Market. The OTC Electronic Bulletin Board does not constitute an active tradingmarket and trading in our common stock is limited and sporadic.  The following table sets forth the range ofhigh bid and low bid quotations for our common stock for the periodsindicated.  The quotations areinter-dealer prices in the over-the-counter market without retail mark-ups,markdowns or commissions, and may not represent actual transactions.

 
|                     |   | **2003** |   | **2002** |   |
|--------------------------|--------|----------|--------|----------|--------|
|                     |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
|                     |   |     |   |     |   |   |   |   |   |
| 4th Quarter ending 9/30  |   | $        | 0.040  |     | $      | 0.040 |   | $ | 0.100 |   | $ | 0.090 |   |
| 3rd Quarter ending 6/30  |   | 0.090    |   | 0.010    |   | 0.130 |   | 0.070 |   |
| 2nd Quarter ending 3/31  |   | 0.070    |   | 0.010    |   | 0.320 |   | 0.080 |   |
| 1st Quarter ending 12/31 |   | 0.080    |   | 0.070    |   | 0.300 |   | 0.110 |   |
|                          |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

As of September 30,2003 there were 1,479 holders of record of our common stock.

 

## ***Dividend Policy***

 

Wehave never paid a dividend and do not anticipate paying any cash dividends inthe foreseeable future.  We intend toretain any earnings to provide funds to finance future growth.

 

14

----

 

# **ITEM 6**           MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

EXCEPT FOR THE HISTORICALINFORMATION CONTAINED HEREIN, THE MATTERS DISCUSSED IN THIS ANNUAL REPORT ONFORM 10-KSB ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES(SUCH FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS USINGWORDS SUCH AS “MAY,” “POTENTIAL,” “EXPECTS,” “BELIEVES,” “ESTIMATES,” “PLANS,”“INTENDS,” “ANTICIPATES” AND SIMILAR EXPRESSIONS).  THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS ANDUNCERTAINTIES, INCLUDING THOSE SET FORTH BELOW AND IN ITEM 1 OF THIS ANNUALREPORT ON FORM 10-KSB UNDER THE CAPTION “RISK FACTORS,” THAT COULD CAUSE ACTUALRESULTS TO VARY MATERIALLY FROM THOSE PROJECTED.  THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATEHEREOF.  WE EXPRESSLY DISCLAIM ANYOBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANYFORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO REFLECT ANY CHANGE IN OUREXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN EVENTS, CONDITIONS ORCIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.  THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITIONAND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATEDFINANCIAL STATEMENTS (AND NOTES THERETO) CONTAINED ELSEWHERE HEREIN.

 

## ***Critical accounting policies***

 

RevenueRecognition

 

TheCompany provides collection, auditing, billing and staffing services forentities primarily in the healthcare industry for a fee.  Revenue recognition varies between thebusiness segments based upon the services provided.

 

Revenuesfrom the delinquent debt and insurance collection practices are based on apercentage of total collections per each contract. Such revenues are recognizedupon receipt of cash from the third-party payers that the Company collects fromon behalf of its client.

 

Revenuesfrom the auditing and billing divisions are based on respective contractualpercentage of payments received by our clients.  Customers, comprised mostly of insurance companies, generallymake payments to our clients who then report such amounts to the Company. TheCompany recognizes revenues based on such payment reports.

 

Revenuefrom the staffing division is recognized based upon hourly rates, and isrecorded as services are rendered.  TheCompany’s payroll system posts staffing division hours to individual projectson a monthly basis.  The Company billsits clients for the hours incurred at the contract rates. In August 2003, weentered into an Exchange Agreement with Russell and Suzette Mohrmann and theiraffiliate, Hospital Employee Labor Pool, a California corporation, or HELP,pursuant to which there was a transfer of substantially all the assets relatedto our administrative and back office temporary staffing division. See Note 12,to our consolidated financial statements, for more information regarding thismatter.

 

Allowancefor Doubtful Accounts

 

Wemaintain allowances for doubtful accounts for estimated losses resulting fromour customer’s inability to make required payments.  Management reviews all accounts receivable on a monthlybasis.  Specific

 

15

----

 

invoicesover 60 days are discussed with clients. Based upon historical experience with individual clients, managementassesses whether a specific reserve is required for each invoice or clientbalance.

 

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

 

Impairmentof Long-Lived Assets

 

TheCompany assesses the recoverability of its long-lived assets on an annual basisor whenever adverse events or changes in circumstances or business climateindicate that expected undiscounted future cash flows related to suchlong-lived assets may not be sufficient to support the net book value of suchassets. Such a triggering event could include a significant decrease in themarket value of an asset, or a significant change in the extent or manner inwhich an asset is used or a significant physical change in an asset. Ifundiscounted cash flows are not sufficient to support the recorded assets,impairment is recognized to reduce the carrying value of the long-lived assetto the estimated fair value. Estimated fair value will be determined bydiscounting the future expected cash flows using a current discount rate ineffect at the time of impairment. Cash flow projections, although subject to adegree of uncertainty, are based on trends of historical performance andmanagement’s estimate of future performance, giving consideration to existingand anticipated competitive and economic conditions. Additionally, inconjunction with the review for impairment, the remaining estimated lives ofcertain of the Company’s long-lived assets are assessed.

 

## ***Overview***

 

## ***Business***

 

Thefollowing discussion and analysis of our financial condition and results of ouroperations are based on the consolidated results of operations.  A more detailed discussion of the accountingprinciples used to prepare the consolidated financial statements (including theassets, liabilities, and results of operations of the businesses and thespecific entities included in the consolidation is set forth in Note 2 to ourconsolidated financial statements included in this annual report on Form10-KSB.

 

## ***Revenues***

 

Commissionsand fees, which account for most of our total revenues, include commissionsearned from billing, recovery, revenue maximization projects and consultingservices that we provide to our clients. Commissions and fees for our billing and recovery operations areprimarily affected by the quality and age of the receivable pool we are askedto manage.  In general, commissions andfees for our billing and recovery services fluctuate based on the number ofaccounts we process and manage. Accounts we manage have decreased 52% to approximately $1.0 billion asof September 30, 2003 from approximately $2.1 billion as ofSeptember 30, 2002. The decrease primarily relate to completion ofnon-recurring projects in our Reimbursement Solutions segment and the loss oftwo significant clients in our Physician Services segment.  Fees for our special projects and consultingservices depend largely on the type of service or project we perform and, therefore,are arranged on a case-by-case basis. Such fees are primarily affected by thequality and age of the receivable pools, as well as the efficiency of ourclients’ back office operations.

 

16

----

 

Wepreviously purchased charged-off accounts receivable portfolios.  Collections from these portfoliosrepresented a portion of our revenues. Portions of these portfolios were also sold to provide additionalrevenues.  We discontinued purchasingthese portfolios in 1999 and subsequent to September 30, 2001, we sold ourremaining portfolios and assets included in the Company’s 1998securitization.  The terms of the saleincluded an immediate payment of $300,000 and a contingency payment of up to$350,000. The contingent payment is dependent upon the success of the buyer incollecting the portfolio and therefore, we are unable at this time to predictthe timing of all or any of this payment. Collectively, the sales are notexpected to have a material impact on our results of operations.

 

Wealso earn revenues from temporary staffing and placement services providedspecifically to the healthcare industry. Revenues from our temporary staffing services are generated based onhourly and/or per diem rates charged to our clients.  These rates vary according to the level of skills and technicalknowledge of our staff.  Placement feesare negotiated on a case-by-case basis and are predominantly determined by apercentage of the annual salaries of the placed employees.  These services are provided by one of theacquired businesses.  Accordingly, wedid not perform these services prior to August 14, 2000. In August 2003,we entered into an Exchange Agreement with Russell and Suzette Mohrmann andtheir affiliate, Hospital Employee Labor Pool, a California corporation, orHELP, pursuant to which there was a transfer of substantially all the assetsrelated to our administrative and back office temporary staffing division.Accordingly, we do not expect to earn any revenues from the temporary staffingand placement services after August 2003.

 

Whileour primary market going forward will be healthcare providers, a portion of ourrevenues in 2003 and 2002 consisted of commissions and fees earned fromnon-healthcare clients.  The followingis a summary of our revenues:

 
|                                        |   | **2003**  |       | **2002**   |   |
|---------------------------------------------|--------|-----------|------------|------------|--------|
| Revenues:                                   |   |      |       |       |   |
| Recovery                                    |   | $         | 4,570,450  |       | $      | 5,076,778 |   |
| Physician Services                          |   | 2,056,578 |       | 3,137,544  |   |
| Reimbursement Solutions                     |   | 2,568,665 |       | 3,530,896  |   |
| Total revenues from continuing operations   |   | 9,195,693 |       | 11,745,218 |   |
|                                        |   |      |       |       |   |
| Total revenues from discontinued operations |   | 2,040,654 |       | 1,637,674  |   |
|                                        |   | $         | 11,236,347 |       | $      | 13,382,892 |   |

 

## ***Operating Expenses***

## *** ***

Ourlargest operating expense is employee compensation and benefits, which includessalaries and wages, incentive compensation and related employee benefits andtaxes.  Our compensation program forrecovery specialists includes incentives based on the amount of net fees theyindividually generate; as such, compensation expense for this group will varydirectly with the amount of fees generated by our recovery business.  Most of our managers receive annualincentive compensation based on the overall results of our operations in eachof our business lines as well as their individual performance.  Therefore, a significant portion ofcompensation and benefits expense will fluctuate based on our operatingresults.  Compensation expense may alsoreflect stock options granted to our employees under our stock option plan;however, there were no charges for stock options recorded in 2003 or 2002.

 

Includedin other operating expenses are postage and telephone expenses that account forthe next largest components of our operating expenses.  These expenses will fluctuate based on thevolume of accounts we manage and, correspondingly, with the commissions andfees we generate.  These expensesreflect our primary methods of communication with our clients’ customers andthey include costs to send

 

17

----

 

customer/payorinvoices and statements as well as telecommunication costs incurred in variousnegotiation activities with such customers.

 

Depreciationexpense relates primarily to the building facility where we conduct asignificant portion of our operations. In addition, our investments in technology and telecommunication equipmentover the last several years will continue to impact this expense item.

 

Themost significant income component of other income and expense relates primarilyto net proceeds received from rental of the portion of our building that we donot occupy and our interest expense. Interest expense is primarily made up of interest we pay for our linesof credit and notes payable to various related parties.

 

Wehave experienced substantial changes in our business and operations since wecompleted the acquisition of certain companies in August 2000.  Developmental spending which includes, amongother things, product and service rollouts, and certain information technologysystems improvements, is expected to be discretionary and will vary in responseto various market conditions.  However,a significant portion of our expenses, such as administrative salaries andwages, occupancy and equipment, and depreciation should not vary, at least inthe short term, with fluctuations in our revenues.  We expect to continue to experience periods of rapid change inthe future.  Our current expansion hasplaced, and any future expansion would place, significant demands on ouradministrative, operational, financial and other resources.

 

18

----

 

**Results of Operations and FinancialOverview—Years ended September 30, 2003 and 2002**

 
|                                                |   | **2003**      |         | **2002**                   |         |
|-----------------------------------------------------|--------|---------------|--------------|----------------------------|--------------|
|                                                |   | **Amount**    |         | **Percent of****Revenues** |         | **Amount** |   | **Percent of  Revenues** |   |
|                                                |   |          |         |                       |         |   |   |   |   |
| **Continuing  Operations:**                         |   |          |         |                       |         |   |   |   |   |
|                                                |   |          |         |                       |         |   |   |   |   |
| **Revenues**                                        |   |          |         |                       |         |   |   |   |   |
|                                                |   |          |         |                       |         |   |   |   |   |
| Recovery                                            |   | $             | 4,570,450    |                       | 49.7         | % | $ | 5,076,778 |   | 43.2 | % |
| Physician services                                  |   | 2,056,578     |         | 22.4                       |         | 3,137,544 |   | 26.7 |   |
| Reimbursement solutions                             |   | 2,568,665     |         | 27.9                       |         | 3,530,896 |   | 30.1 |   |
| Total revenues                                      |   | 9,195,693     |         | 100.0                      |         | 11,745,218 |   | 100.0 |   |
|                                                |   |          |         |                       |         |   |   |   |   |
| **Operating  Expenses**                             |   |          |         |                       |         |   |   |   |   |
|                                                |   |          |         |                       |         |   |   |   |   |
| Employee compensation and benefit                   |   | 5,730,064     |         | 62.3                       |         | 7,020,996 |   | 59.8 |   |
| Other operating expenses                            |   | 1,377,180     |         | 15.0                       |         | 1,888,448 |   | 16.1 |   |
| Selling, general & administrative               |   | 4,248,596     |         | 46.2                       |         | 5,093,529 |   | 43.4 |   |
| Depreciation and amortization                       |   | 433,581       |         | 4.7                        |         | 995,759 |   | 8.5 |   |
| Losses on loan portfolios                           |   | —        |         | —                     |         | 70,667 |   | 0.5 |   |
| Total operating expenses                            |   | 11,789,421    |         | 128.2                      |         | 15,069,399 |   | 128.3 |   |
| Operating loss                                      |   | (2,593,728    | )            | (28.2                      | )            | (3,324,181 | ) | (28.3 | ) |
|                                                |   |          |         |                       |         |   |   |   |   |
| Other Income/(Expenses)                             |   | (1,005,349    | )            | (10.9                      | )            | (595,325 | ) | (5.1 | ) |
|                                                |   | (3,599,077    | )            | (39.1                      | )            | (3,919,506 | ) | (33.4 | ) |
|                                                |   |          |         |                       |         |   |   |   |   |
| **Discontinued Operations:**                        |   |          |         |                       |         |   |   |   |   |
|                                                |   |          |         |                       |         |   |   |   |   |
| Revenues                                            |   | 2,040,654     |         | 22.2                       |         | 1,637,674 |   | 13.9 |   |
| Employee compensation and benefit                   |   | (1,633,638    | )            | (17.8                      | )            | (1,226,170 | ) | (10.4 | ) |
| Other operating expenses                            |   | (57,490       | )            | (0.6                       | )            | (57,490 | ) | (0.5 | ) |
| ***Income from discontinued operations***           |   | ***349,526*** | *** *** | ***3.8***                  | *** *** | ***354,014*** | *** *** | ***3.0*** | *** *** |
| Gain on sale of HELP                                |   | 1,253,767     |         | 13.6                       |         | — |   | — |   |
| Cumulative effect of change in accounting principle |   | (1,576,328    | )            | (17.1                      | )            | — |   | — |   |
| Net loss                                            |   | $             | (3,572,112   | )                          | (38.8        | ) | $ | (3,565,492 | ) | (30.4 | ) |

 

***Revenues***

 

Totalrevenues for continuing operations decreased by $2,549,525 to $9,195,693 forthe year ended September 30, 2003 from $11,745,218 for the year ended September30, 2002.  Recovery revenue declined$506,328, due to a decrease in placements from existing clients and a generaldecline in the rates we receive for our services as a result of increasedcompetition. In addition, contracts for certain clients were not renewed due tovarious reasons which, include among other things, 1) the Company’s decisionnot to meet lower price and additional requirements, 2) certain clients wereacquired by larger entities, and 3) natural attrition. Physician Servicesdecreased $1,080,966 due to the loss of two large clients during the secondhalf of fiscal year 2002. These clients decided to cease outsourcing thebilling functions of their business. There were new contracts signed to replacethe void created during the current year but the cumulative volume of the newcontracts were less than the volume lost from the two aforementioned clients.Reimbursement solutions revenue decreased $962,231 primarily due to thecompletion of certain large

 

19

----

 

non-recurringinsurance follow-up projects and reductions in recurring outsourced work fromexisting clients as they attempt to increase their own internal revenue sourcesby increasing the age of outsourced accounts.

 

***Operating Expenses***

 

Operating expenses for continuing operations decreasedby $3,279,978 to $11,789,421 for the year ended September 30, 2003 from$15,069,399 for the year ended September 30, 2002. Employee compensationand benefit from continuing operations which is comprised of payroll costs inour operating segments and does not include sales and administrative personnel,decreased by approximately $1,290,932 primarily due to reductions of operatingstaff predicated by reductions in business volume and application of newproduction processes. Other operating expenses which is comprised of all othernon-payroll costs directly related to the continuing operations of our varioussegments decreased by $511,268 to $1,377,180 for the year ended September 30,2003 from $1,888,448 for the year ended September 30, 2002. Other operatingexpenses decreased due to cost reductions made as a result of the decrease inbusiness volume in the various operating segments.  In addition, successful implementation of virtual privatenetworks with our remote clients allowed us to directly access client computersystems and thereby significantly reducing travel, lodging and related clientsupport costs.

 

Accumulated increases inlegal and insurance expenses of approximately $156,054 reduced the net decreaseto $844,933 in selling, general and administrative expenses. The overalldecrease resulted from sales and administrative personnel cutbacks as well asreductions in all administrative operating expenses as part of a Company wideinitiative to reduce overhead expenses. Further reductions are expected tooccur in fiscal year 2004.

 

Depreciation and amortization expense decreased as theCompany no longer amortizes goodwill with the of adoption of SFAS No. 142 infiscal year 2003.

 

***Other Income and Expenses***

 

Interestexpense increased $346,053 primarily as a result of prepayment penalties andinterest of approximately $112,000 from the sale and leaseback transactioninvolving our facility on May 21, 2003. In addition, interest expense increaseddue the to overall increase in borrowings.****Rental income, net of related expenses,decreased $54,379 between 2003 and 2002 as a result of an increase in utilitycosts, and expired tenant leases and the non-renewal of these leases.

 

***Discontinued Operations***

 

***Hospital Employee Labor Pool (temporary staffing)(discontinued August 29, 2003):***

 

The restructuring processundertaken in the past resulted in an increase in revenues in this segment to$2,040,654 for the year ended September 30, 2003 as compared to $1,637,674 forthe year ended September 30, 2002. Operating expenses for discontinuedoperations increased by $407,468 to $1,691,128 for the year ended September 30,2003 from $1,283,660 for the year ended September 30, 2002. This increase wasdue to an increase of $407,468 in employee compensation due to increases instaff hired to fulfill client orders. In addition rates paid for new staffingpersonnel increased due to the higher quality of staff hired as a result ofchanges in hiring standards. Other operating expenses for the discontinuedoperation remained the same between periods. This segment was discontinued in

 

20

----

 

August 2003 as part of anExchange Agreement with a former officer of the Company (see Note 12 in ourconsolidated financial statements).

 

## ***Cumulative Effect of Changein Accounting Principle***

## *** ***

The Company changed its method of accounting for goodwill as of October1, 2002, conforming to Statement of Financial Accounting Standards No. 142,“Goodwill and other intangible assets” (see Note 2 of our consolidatedfinancial statements for discussion of impact of adoption).

 

## ***Net Loss***

 

Thenet loss decreased $6,620 to $3,572,112 for the year ended September 30, 2003from a loss of $3,565,492 for the year ended September 30, 2002.  Two significant events that impacted theloss for year ended September 30, 2003 are the impairment of goodwillassociated with the cumulative effect of the change in accounting principle andthe impact of our discontinued operations associated with the Hospital EmployeeLabor Pool exchange agreement.

 

## ***Liquidity andCapital Resources***

 

Historically, we havefinanced our operations through cash flows generated by operations andborrowings from credit facilities that are in place.  Capital expenditures and investments in new technology have beenprimarily financed through non-cancelable capital leases, which expire atvarious times through fiscal year 2006. As of September 30, 2003, our networking capital deficit totaled $1,524,631 and shareholders’ deficit of$1,011,108.  The Company has completedseveral transactions designed to meet the Company’s liquidity requirementsincluding, among other things, the following significant transactions:

 

•      OnFebruary 11, 2003, we entered into a Business Financing Agreement (“FinancingAgreement”) with Bridge Bank.  We mayborrow up to $2,500,000 under the conditions set forth in the FinancingAgreement and the outstanding balance of principal and accrued interest underthis Financing Agreement was $418,913 at December 31, 2003. The maximum amountwe can borrow is contingent on and collateralized by qualified invoices, whichwill fluctuate from time to time depending on our business volume.  At December 31, 2003 we have borrowed themaximum amount available under this line. Our obligations under the FinancingAgreement are secured by first priority liens in all of our assets and theassets of our subsidiaries pursuant to the terms and conditions of securityagreements. Our obligations are guaranteed by our subsidiaries under the termsand conditions of guaranties.

 

•      OnMay 21, 2003, we completed the sale of the corporate facility to SCP.  The net proceeds from the sale of theproperty, after paying off the existing mortgage on the property and payingcommissions and expenses, and depositing $1,050,000 to a restricted account($400,000 of which is subject to release if we satisfy specified conditions nosooner than 12 months from the date of the transaction) to collateralize theletters of credit used as rent deposits to the subsequent lease of the propertyequaled $1,352,361.

 

•      OnAugust 13, 2003, the Company executed the relevant documents under which FBRagreed to provide the Company a $500,000 unsecured note. The proceeds of thisnote were used for working capital purposes. On August 29, 2003, the Company executed the relevant documents

 

21

----

 

under which FBR agreed toprovide the Company a $1,000,000 convertible note.  The proceeds for the new $1,000,000 note from FBR will be used toreduce the collections payable to certain of the Company’s California-baseddelinquent debt collection clients.

 

•      OnAugust 29, 2003, the aforementioned $500,000 unsecured note and the $1,000,000convertible note including combined accrued interest of $2,000 were amended andrestated into a new $1,502,000 secured convertible promissory note.  The significant amendments to the previousnotes include the following:

 

•      Thematurity date was extended to September 1, 2005 with all outstanding principaland accrued interest due on this date, subject to customary events ofacceleration.  As part of this amendmentthe maturity date of the principal and any accrued interest on the note payableto Rob Perez was also extended.

 

•      Interestrates on the notes were changed to the prime rate charged by the Company’slender (5.5% at December 31, 2003) plus 4% per annum payable on the maturitydate.

 

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

 

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

 

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

 

•      Infiscal years 2002 and 2003, the Company has initiated and completed variouscost reduction initiatives. Such initiatives are expected to reduce annualoperating costs by approximately $2.3 million in fiscal years 2003 and 2004. InMarch 2003, the Company also initiated the pilot program for a design toperform certain analytical and segmentation processes on selected accounts inan offshore location in order to explore the possibility of further reducingthe direct costs of its collection process significantly.

 

22

----

 

•      Managementis actively seeking additional funding from traditional providers of corporatefinancing and strategic alliance partners in case it needs additional fundingfor fiscal year 2004. The Company’s largest shareholder, FBR, has providedfunding to the Company in the past.  As a component of the process ofrequesting any additional financing that may be required, management mayapproach FBR.  However, there can be no assurance that such financingcould be arranged on terms satisfactory to us or FBR, or at all.

 

Based on the financingactivities and reductions in operating costs described above, managementbelieves that the Company will have the sufficient working capital it needs topursue its ongoing growth and strategic goals in fiscal 2004.

 

## ***Management Changes***

## *** ***

While our chief financialofficer, Fred McGee, agreed with the Audit Committee’s decision to discontinuethe practice of transferring funds collected on behalf of certainCalifornia-based delinquent debt collection clients to operating accounts (seeitem 3 “Legal Proceedings), he disagrees with its conclusion that certain ofour past business practices might be deemed a breach of our obligations to suchclients.  As a consequence of thisdisagreement on July 28, 2003 Mr. McGee resigned as our CFO. We anticipateinitiating a search for his replacement shortly.  In the interim, we have appointed our Chief Information Officer,Kenneth Leighton, as our Acting Chief Financial Officer.

 

On August 29, 2003, aspart of the terms of the Exchange Agreement with Russell and Suzette Mohrmannand their affiliate Hospital Employee Labor Pool (HELP), Russell Mohrmann’semployment with the Company was terminated.

 

23

----

 

# **ITEM 7**           FINANCIALSTATEMENTS

 

See“Index to Consolidated Financial Statements” for a listing of the consolidatedfinancial statements filed with this report.

 

# **ITEM 8**           CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

OnJune 3, 2002, RevCare, Inc. determined to dismiss its independent auditors,Arthur Andersen LLP (“Andersen”), and engaged Grant Thornton LLP (“GrantThornton”) as its new independent auditors.   This determination followed RevCare’s decision to seek proposals fromindependent accountants to audit the financial statements of RevCare, and wasapproved by RevCare’s Board of Directors upon the recommendation of its AuditCommittee.

 

Andersen’sreports on RevCare’s consolidated financial statements for the fiscal yearsended 2001 and 2000 did not contain an adverse opinion or disclaimer ofopinion, nor were they qualified or modified as to uncertainty, audit scope oraccounting principles.

 

DuringRevCare’s two most recent fiscal years that were audited by Arthur Andersen andthrough the date of Andersen’s dismissal, there were no disagreements withAndersen on any matter of accounting principles or practices, financialstatement disclosure, or auditing scope or procedure which, if not resolved toAndersen’s satisfaction, would have caused them to make reference to thesubject matter in connection with their report on RevCare’s consolidatedfinancial statements for such years; and there were no reportable events, aslisted in Item 304(a)(I)(v) of Regulation S-K.

 

On October 17, 2003, theCompany determined to dismiss its independent accountants, Grant Thornton LLP(“Grant Thornton”). Grant Thornton was engaged effective June 5, 2002 to auditthe financial statements of RevCare for the fiscal year ended September 30,2002 but did not complete its audit and did not express an opinion on thefinancial statements for the year ended September 30, 2002.  We have informed Grant Thornton that thereason for the dismissal was the cost of future services.

 

Duringthe period from June 5, 2002 through October 17, 2003, there were nodisagreements between the Company and Grant Thornton on any matter ofaccounting principles or practices, financial statement disclosure, or auditingscope of procedure, which disagreements if not resolved to Grant Thornton’ssatisfaction would have caused them to make reference to the subject matter ofthe disagreement if they had issued reports.

 

OnOctober 17, 2003, the Company appointed Mayer Hoffman McCann P.C. as its newindependent accountants to audit the Company’s financial statements for theyears ended September 30, 2002 and 2003. The decision not to continue to retainGrant Thornton and to retain Mayer Hoffman McCann P.C. was approved by theCompany’s Board of Directors upon the recommendation of its Audit Committee.

 

 

# **ITEM 8A**        CONTROLS ANDPROCEDURES

# ** **

The Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Acting Chief Financial Officer, ofthe effectiveness of the Company’s “disclosure controls and procedures” as ofthe end of the period covered by this report, pursuant to Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on thatevaluation, the Company’s Chief Executive Officer and Acting 

 

24

----

 

Chief Financial Officer have concluded that theCompany’s disclosure controls and procedures, as of the end of the periodcovered by this report, were effective in timely alerting them to materialinformation relating to the Company required to be included in the Company’speriodic SEC filings. There has been no change in the Company’s internalcontrol over financial reporting during the period covered by this report thathas materially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

25

----

 

**PART III**

 

# **ITEM 9**           DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION16(a) OF THE EXCHANGE ACT

 

Informationrequired by this item will be contained in our proxy or information statementto be filed with the Securities and Exchange Commission within 120 days afterSeptember 30, 2003 and is incorporated herein by reference.

 

# **ITEM 10**        EXECUTIVECOMPENSATION

 

Theinformation required by this item will be contained in our proxy or informationstatement to be filed with the Securities and Exchange Commission within 120days after September 30, 2003 and is incorporated herein by reference.

 

# **ITEM 11**        SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

Theinformation required by this item will be contained in our proxy or informationstatement to be filed with the Securities and Exchange Commission within 120days after September 30, 2003 and is incorporated herein by reference.

 

# **ITEM 12**        CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

 

Theinformation required by this item will be contained in our proxy or informationstatement to be filed with the Securities and Exchange Commission within 120days after September 30, 2003 and is incorporated herein by reference.

 

**PART IV**

 

# **ITEM 13**        EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 

Thefollowing documents are filed as part of this Form 10-KSB:

 

**(A)**          Financial Statements:

** **

See “Index to Consolidated Financial Statements” onPage F1 of this Report.

 

** (B)**         Financial StatementSchedules:

** **

All schedules are omitted as the information is notrequired, is not material or is otherwise furnished.

 

** (C)**         Reports on Form 8-K:

** **

Reports on Form 8-K were filed during the fourth quarterended September 30, 2003. (incorporated herein by reference)

 

26

----

 

•      FiledJuly 10, 2003 covering:

 

•      Leaseagreement dated May 21, 2003 by and between the Registrant and SCP ParkMeadows, LLC

 

•      $650,000Irrevocable Standby Letter of Credit issued by Union Bank of California infavor of SCP Park Meadows LLC dated May 19, 2003

 

•      $400,000Irrevocable Standby Letter of Credit issued by Union Bank of California infavor of SCP Park Meadows LLC dated May 19, 2003

 

•      FiledAugust 15, 2003 covering:

 

•      Negotiationsregarding FBR financing;

 

•      Negotiationsregarding HELP division

 

•      Clarificationof current report dated July 10, 2003

 

•      Resignationof CFO

 

•      FiledAugust 29, 2003 covering:

 

•      Exchange agreement for Hospital Employee Labor Pool (HELP)

 

** (D)**         Exhibits

 

The exhibits listed below are required by Item 601 ofRegulation S-B.  Each managementcontract or compensatory plan or arrangement required to be filed as an exhibitto this Form 10-KSB has been identified with an asterisk (“*”) in the table ofexhibits set forth below.

 
| **Exhibit** |   | **Name of  Exhibit**                                                                                                                                                                                                                               |
|-------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                               |
| 2.1         |   | Definitive Purchase  Agreement and Plan of Reorganization dated September 12, 1995 (incorporated  by reference from September 12, 1995 Form 8-K, Exhibit 7(b)(i))                                                                                  |
|        |   |                                                                                                                                                                                                                                               |
| 2.2         |   | Purchase Agreement by  and among RevCare, CPS, Impact, RBA, Insource, Russell Mohrmann, Suzette  Mohrmann, Robert Perez, Barbara Perez and Maureen Brooks dated May 30, 2000  (incorporated by reference from June 14, 2000 Form 8-K, Exhibit 2.1) |
|        |   |                                                                                                                                                                                                                                               |
| 2.3         |   | Asset Purchase  Agreement by and among RevCare, CPS, HELP, Russell Mohrmann, Suzette Mohrmann  and Allen Berman dated May 30, 2000 (incorporated by reference from June 14,  2000 Form 8-K, Exhibit 2.2)                                           |
|        |   |                                                                                                                                                                                                                                               |
| 3.1         |   | Amended and Restated  Articles of Incorporation as filed with the Secretary of State of Nevada on  December 7, 1995 (incorporated by reference from December 20, 1995 Form 8-K,  Exhibit 3.1)                                                      |
|        |   |                                                                                                                                                                                                                                               |
| 3.2         |   | Bylaws of RevCare  (incorporated by reference from RevCare’s registration statement on Form S-18  (SEC No. 233-12361-LA) filed on March 18, 1987, Exhibit 3.2)                                                                                |
|        |   |                                                                                                                                                                                                                                               |
| 3.3         |   | Certificate of  Determination re: Series A Preferred Stock (incorporated by reference from  December 27, 1996 Form 10-KSB, Exhibit 3.3)                                                                                                            |

 

27

----

 
| 3.4    |   | Certificate of  Amendment of Articles of Incorporation as filed with the Secretary of State  of Nevada on August 9, 2000 (incorporated by reference from August 29, 2000  Form 8-K, Exhibit 4.3)                                                    |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                |
| 4.1    |   | Specimen of Common  Stock of RevCare (incorporated by reference from RevCare’s Form 8-K filed on  December 20, 1995, Exhibit 4.2)                                                                                                              |
|   |   |                                                                                                                                                                                                                                                |
| 4.2    |   | Investor’s Rights  Agreement by and among RevCare and FBR Financial Fund II, L.P., dated May 30,  2000 (incorporated by reference from June 14, 2000 Form 8-K, Exhibit 99.2)                                                                   |
|   |   |                                                                                                                                                                                                                                                |
| 4.3    |   | Investors’ Rights  Agreement by and among RevCare, CPS, RBA, Insource, HELP, Russell Mohrmann,  Suzette Mohrmann, Robert Perez and Barbara Perez dated August 14, 2000  (incorporated by reference from August 29, 2000 Form 8-K, Exhibit 4.4) |
|   |   |                                                                                                                                                                                                                                                |
| 10.1   |   | 1995 Stock Option Plan of RevCare (incorporated by  reference from RevCare’s Form 8-K filed on December 20, 1995, Exhibit 10.2)                                                                                                                |
|   |   |                                                                                                                                                                                                                                                |
| 10.2   |   | Preferred Stock  Purchase Agreement dated September 30, 1996 (incorporated by reference from  RevCare’s Form 10-KSB filed on December 27, 1996)                                                                                                |
|   |   |                                                                                                                                                                                                                                                |
| 10.3   |   | Warrant to Purchase  400,000 Shares of Common Stock dated February 12, 1999 issued to Batchelder  & Partners, Inc. (incorporated by reference from RevCare’s Form 10-QSB  filed on February 12, 1999)                                      |
|   |   |                                                                                                                                                                                                                                                |
| 10.4   |   | Employment Agreement  between CPS and Russell Mohrmann dated August 14, 2000 (incorporated by  reference from August 29, 2000 Form 8-K, Exhibit 10.1)                                                                                               |
|   |   |                                                                                                                                                                                                                                                |
| 10.5   |   | Employment Agreement  between RevCare and Robert Perez dated August 14, 2000 (incorporated by reference  from August 29, 2000 Form 8-K, Exhibit 10.2)                                                                                               |
|   |   |                                                                                                                                                                                                                                                |
| 10.6   |   | Employment Agreement  between RevCare and Manuel Occiano dated May 30, 2000 (incorporated by  reference from RevCare’s Form 10-KSB filed on January 15, 2001)                                                                                  |
|   |   |                                                                                                                                                                                                                                                |
| 10.7   |   | Common Stock Purchase  Agreement by and between RevCare and FBR Financial Fund, II, L.P., dated May  30, 2000 (incorporated by reference from June 14, 2000 Form 8-K, Exhibit  10.1)                                                                |
|   |   |                                                                                                                                                                                                                                                |
| 10.8   |   | Voting Agreement by and  among the Company, FBR Financial Fund II, L.P. and Pacific Life Insurance  Company, dated May 30, 2000 (incorporated by reference from RevCare’s June  14, 2000 Form 8-K, Exhibit 99.1)                               |
|   |   |                                                                                                                                                                                                                                                |
| 10.9   |   | Forms of Secured  Convertible Promissory Notes issued by the Company dated August 14, 2000  (incorporated by reference from August 29, 2000 Form 8-K, Exhibit 4.5)                                                                                  |
|   |   |                                                                                                                                                                                                                                                |
| 10.10  |   | Employment Agreement  between RevCare and Fred McGee dated January 2, 2001 (incorporated by  reference from September 30, 2001 Form 10-KSB, Exhibit 10.10)                                                                                          |
|   |   |                                                                                                                                                                                                                                                |
| 10.11  |   | Revolving Note issued  by the Company September 24, 2001(incorporated by reference from September  30, 2001 Form 10-KSB, Exhibit 10.13)                                                                                                             |

 

28

----

 
| 10.12  |   | First Amendment to  Promissory Note issued by the Company September 24, 2001 extending maturity  date to January 2, 2003(incorporated by reference from September 30, 2001  Form 10-KSB, Exhibit 10.13)                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                    |
| 10.13  |   | Forms of First  Amendment to Secured Convertible Promissory Notes issued by the Company dated  August14, 2000 extending maturity date to January 2, 2003(incorporated by  reference from September 30, 2001 Form 10-KSB, Exhibit 10.13) |
|   |   |                                                                                                                                                                                                                                    |
| 10.14  |   | Form of Secured  Convertible Promissory Note issued by the Company dated September 19, 2002  (incorporated by reference from July 10, 2003 Form 8-K, Exhibit 10.18)                                                                     |
|   |   |                                                                                                                                                                                                                                    |
| 10.15  |   | Form of Secured  Promissory Note issued by the Company dated July 21, 2002 (incorporated by  reference from July 10, 2003 Form 8-K, Exhibit 10.19)                                                                                      |
|   |   |                                                                                                                                                                                                                                    |
| 16.1   |   | Letter on Change in  Certifying Accountant (incorporated by reference from June 5, 2002 Form8-K, Exhibit  16.1)                                                                                                                         |
|   |   |                                                                                                                                                                                                                                    |
| *21.1  |   | Subsidiaries of the  Registrant                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                    |
| *31.1  |   | CEO - Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                    |
| *31.2  |   | CFO - Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                    |
| *32.1  |   | CEO Certification  pursuant to 18 USC Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                |
|   |   |                                                                                                                                                                                                                                    |
| *32.2  |   | CFO Certification  pursuant to 18 USC Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                                |

 

29

----

 

**SIGNATURES**

 

Inaccordance with Section 13 or 15(d) of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                         | REVCARE, INC.                          |
|------------------------------|----------------------------------------|
|                         |                                   |
|                         |                                   |
| Date:  January 29, 2004 |                                   |
|                         |                                   |
|                         | By:                                    | /s/ Manuel Occiano |   |
|                         | Manuel Occiano                         |
|                         | President and  Chief Executive Officer |

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedate indicated.

 
| **Signatures**         |   | **Title** |   | **Date Signed**                     |
|------------------------|--------|-----------|--------|-------------------------------------|
|                   |   |      |   |                                |
| /s/ George McCabe, Jr. |   |      |   | Director                            |   |   | January 29, 2004 |
| George McCabe, Jr.     |   |      |   |                                |   |   |   |
|                   |   |      |   |                                |   |   |   |
|                   |   |      |   |                                |   |   |   |
| /s/ Edward Wheeler     |   |      |   | Director                            |   |   | January 29, 2004 |
| Edward Wheeler         |   |      |   |                                |   |   |   |
|                   |   |      |   |                                |   |   |   |
|                   |   |      |   |                                |   |   |   |
| /s/ Manuel Occiano     |   |      |   | Chief Executive Officer             |   |   | January 29, 2004 |
| Manuel Occiano         |   |      |   |                                |   |   |   |
|                   |   |      |   |                                |   |   |   |
|                   |   |      |   |                                |   |   |   |
| /s/ Kenneth Leighton   |   |      |   | Acting Chief Financial  Officer and |   |   | January 29, 2004 |
| Kenneth Leighton       |   |      |   | Principal Accounting  Officer       |   |   |   |
|                        |        |           |        |                                     |  |  |  |  |  |  |  |

 

----

 

**Indexto Consolidated Financial Statements**

 
| The financial  statements required Item 13 as follows: |                                                                                                             |
|--------------------------------------------------------|------------------------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                             |   |
|                                                   | Report of  Independent Public Accountants – Mayer Hoffman McCann P.C.                                       |   |
|                                                   |                                                                                                             |   |
|                                                   | Consolidated Balance Sheet as of  September 30, 2003                                                             |   |
|                                                   |                                                                                                             |   |
|                                                   | Consolidated  Statements of Operations for the Years ended  September 30, 2003 and 2002                          |   |
|                                                   |                                                                                                             |   |
|                                                   | Consolidated  Statements of Shareholders’ Equity (Deficit) for the Years Ended  September 30, 2003 and 2002 |   |
|                                                   |                                                                                                             |   |
|                                                   | Consolidated  Statements of Cash Flows for the Years Ended  September 30, 2003 and 2002                          |   |
|                                                   |                                                                                                             |   |
|                                                   | Notes to  Consolidated Financial Statements                                                                      |   |
|                                                   |                                                                                                             |   |
|  (1) Financial Statement Schedules                |                                                                                                             |

 

Financialstatement schedules have been omitted since they are either not required or notapplicable, or the information is otherwise included.

 

F-1

----

 

**Reportof Independent Public Accountants**

To RevCare, Inc.:

 

We have audited the accompanying consolidated balance sheet of RevCare,Inc. (a Nevada corporation) and subsidiaries as of September 30, 2003, and therelated consolidated statements of operations, shareholders’ equity (deficit),and cash flows for each of the two years in the period ended September 30,2003.  These consolidated financial statements are the responsibility ofthe Company’s management.  Our responsibility is to express an opinion onthese consolidated financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States.  Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the financialstatements are free of material misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of RevCare,Inc. and subsidiaries as of September 30, 2003, and the results of theiroperations and their cash flows for each of the two years in the period endedSeptember 30, 2003, in conformity with accounting principles generally acceptedin the United States.

 

As discussed in Note 2 to the consolidated financial statements, theCompany changed its method of accounting for goodwill as of October 1, 2002 toconform to Statement of Financial Accounting Standards No. 142, “Goodwill andOther Intangible Assets.”

 

The accompanying consolidated financialstatements have been prepared assuming that the Company will continue as agoing concern.  As discussed in Note 1, the Company incurred net losses ofapproximately $3.6 million and $3.6 million during the years ended September30, 2003 and 2002, respectively, and, as of September 30, 2003, the Company’scurrent liabilities exceeded its current assets by approximately $1.5 millionand has a deficit in shareholders’ equity of approximately $1.0 million. Thesefactors, among others, as discussed in Note 1 to the consolidated financialstatements, raise substantial doubt about the Company’s ability to continue asa going concern.  Management’s plans in regard to these matters are alsodescribed in Note 1. The consolidated financial statements do not include anyadjustments relating to the recoverability and classification of asset carryingamounts or the amount and classification of liabilities that might resultshould the Company be unable to continue as a going concern.

 

 
| /s/ Mayer Hoffman McCann P.C. |   |
|-------------------------------|--------|
| MAYER HOFFMAN MCCANN P.C.     |
|                          |   |
|                          |   |
| Los Angeles, California       |   |
| January 21, 2004              |   |

 

F-2

----

 

## ***REVCARE, INC. AND SUBSIDIARIES***

 

Consolidated Balance Sheet – September 30, 2003

 
| Assets                                                                                                                                                                                      |   |        |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|------------|
| Current  assets:                                                                                                                                                                            |   |        |       |
| Cash                                                                                                                                                                                        |   | $           | 577,404    |   |
| Restricted  cash                                                                                                                                                                            |   | 1,051,970   |       |
| Accounts  receivable, net of allowance for doubtful accounts of $181,468                                                                                                                    |   | 1,668,202   |       |
| Employee  advances                                                                                                                                                                          |   | 90,000      |       |
| Prepaid  expenses and other                                                                                                                                                                 |   | 349,537     |       |
| Note  receivable from customer, net of reserve of $88,361                                                                                                                                   |   | 39,139      |       |
| Total  current assets                                                                                                                                                                       |   | 3,776,252   |       |
|                                                                                                                                                                                        |   |        |       |
| Goodwill                                                                                                                                                                                    |   | 7,490,793   |       |
| Property  and equipment, net                                                                                                                                                                |   | 2,814,822   |       |
| Note  receivable from officer                                                                                                                                                               |   | 100,000     |       |
|                                                                                                                                                                                        |   |        |       |
| Total  assets                                                                                                                                                                               |   | $           | 14,181,867 |   |
|                                                                                                                                                                                        |   |        |       |
|                                                                                                                                                                                        |   |        |       |
| Liabilities and Shareholders’ Equity (Deficit)                                                                                                                                         |   |        |       |
| Current  liabilities:                                                                                                                                                                       |   |        |       |
| Bank  overdraft                                                                                                                                                                             |   | $           | 124,921    |   |
| Accounts  payable                                                                                                                                                                           |   | 1,062,638   |       |
| Collections  payable to customers                                                                                                                                                           |   | 1,827,953   |       |
| Accrued  liabilities                                                                                                                                                                        |   | 961,586     |       |
| Line  of credit                                                                                                                                                                             |   | 565,744     |       |
| Notes  payable to related parties                                                                                                                                                           |   | 300,000     |       |
| Current  portion of capital lease obligations                                                                                                                                               |   | 90,052      |       |
| Current  portion of financing obligation – SCP Park Meadows                                                                                                                            |   | 367,989     |       |
|                                                                                                                                                                                        |   |        |       |
| Total  current liabilities                                                                                                                                                                  |   | 5,300,883   |       |
|                                                                                                                                                                                        |   |        |       |
| Capital  lease obligations, less current portion                                                                                                                                            |   | 36,269      |       |
| Notes  payable to related parties, less current portion                                                                                                                                     |   | 4,526,315   |       |
| Financing  obligation – SCP Park Meadows, less current portion                                                                                                                         |   | 5,329,508   |       |
|                                                                                                                                                                                        |   |        |       |
| Total  liabilities                                                                                                                                                                          |   | 15,192,975  |       |
|                                                                                                                                                                                        |   |        |       |
| Commitments and  contingencies (Note 9)                                                                                                                                                     |   |        |       |
|                                                                                                                                                                                        |   |        |       |
| Shareholders’  Equity (Deficit):                                                                                                                                                       |   |        |       |
| Series  A convertible, redeemable preferred stock, $0.001 par value, stated at $2.00  liquidation preference per share, 5,000,000 shares authorized; 345,000 shares  issued and outstanding |   | 690,000     |       |
| Common  stock, $0.001 par value; 50,000,000 shares authorized; 21,526,909 shares  issued and outstanding                                                                                    |   | 21,520      |       |
| Paid-in  capital                                                                                                                                                                            |   | 10,658,282  |       |
| Accumulated  deficit                                                                                                                                                                        |   | (12,330,910 | )          |
|                                                                                                                                                                                        |   |        |       |
|                                                                                                                                                                                        |   | (961,108    | )          |
| Less  common stock in treasury at cost, 33,000 shares                                                                                                                                       |   | (50,000     | )          |
|                                                                                                                                                                                        |   |        |       |
| Total  shareholders’ deficit                                                                                                                                                           |   | (1,011,108  | )          |
|                                                                                                                                                                                        |   |        |       |
|                                                                                                                                                                                        |   | $           | 14,181,867 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

 

F-3

----

 

**REVCARE,INC. AND SUBSIDIARIES**

#### Consolidated Statements of Operations

#### For the YearsEnded September 30, 2003 and 2002

 
|                                                                                                          |   | **2003**   |       | **2002**   |   |
|---------------------------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
| Revenues:                                                                                                     |   |       |       |       |   |
| Service  fees                                                                                                 |   | $          | 9,195,693  |       | $      | 11,745,218 |   |
|                                                                                                          |   |       |       |       |   |
| Operating  expenses:                                                                                          |   |       |       |       |   |
| Salaries,  wages and related benefits                                                                         |   | 5,730,064  |       | 7,020,996  |   |
| Business  segment operating expenses                                                                          |   | 1,377,180  |       | 1,888,449  |   |
| Selling,  general and administrative                                                                          |   | 4,248,596  |       | 5,093,528  |   |
| Depreciation  and amortization                                                                                |   | 433,581    |       | 995,759    |   |
| Losses  on portfolio receivables                                                                              |   | —     |       | 70,667     |   |
| Total operating  expenses                                                                                     |   | 11,789,421 |       | 15,069,399 |   |
|                                                                                                          |   |       |       |       |   |
| Operating loss                                                                                                |   | (2,593,728 | )          | (3,324,181 | )      |
|                                                                                                          |   |       |       |       |   |
| Other Income (Expense):                                                                                       |   |       |       |       |   |
| Interest  expense, net                                                                                        |   | (1,033,822 | )          | (687,769   | )      |
| Rental  income, net                                                                                           |   | 38,065     |       | 92,444     |   |
| Other                                                                                                         |   | (9,592     | )          | —     |   |
|                                                                                                          |   |       |       |       |   |
| Loss from continuing  operations before income taxes and cumulative effect of change in accounting  principle |   | (3,599,077 | )          | (3,919,506 | )      |
|                                                                                                          |   |       |       |       |   |
| Income tax provision                                                                                          |   | —     |       | —     |   |
|                                                                                                          |   |       |       |       |   |
| Loss  from continuing operations before cumulative effect of change in accounting  principle                  |   | (3,599,077 | )          | (3,919,506 | )      |
|                                                                                                          |   |       |       |       |   |
| Income  from discontinued operations, net of taxes (including gain on sale of HELP of  $1,253,767 in 2003)    |   | 1,603,293  |       | 354,014    |   |
|                                                                                                          |   |       |       |       |   |
| Cumulative  effect of change in accounting principle                                                          |   | (1,576,328 | )          | —     |   |
|                                                                                                          |   |       |       |       |   |
| Net  loss                                                                                                     |   | $          | (3,572,112 | )          | $      | (3,565,492 | ) |
|                                                                                                          |   |       |       |       |   |
| Basic and diluted loss  per share:                                                                            |   |       |       |       |   |
|                                                                                                          |   |       |       |       |   |
| Loss  from continuing operations before cumulative effect of change in accounting  principle                  |   | $          | (0.17      | )          | $      | (0.18 | ) |
|                                                                                                          |   |       |       |       |   |
| Income  from discontinued operations, net of taxes (including gain on sale of HELP of  $1,253,767 in 2003)    |   | 0.07       |       | 0.01       |   |
|                                                                                                          |   |       |       |       |   |
| Cumulative  effect of change in accounting principle                                                          |   | (0.07      | )          | —     |   |
|                                                                                                          |   |       |       |       |   |
| Net  loss                                                                                                     |   | $          | (0.17      | )          | $      | (0.17 | ) |
|                                                                                                          |   |       |       |       |   |
| Weighted  average shares used in all calculations (basic and diluted)                                         |   | 21,526,909 |       | 21,526,909 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

F-4

----

 

**REVCARE, INC. AND SUBSIDIARIES**

 

Consolidated Statements of Shareholders’ Equity(Deficit)

For the Years Ended September 30, 2003 and 2002

 
|                            |   | **Series A  Convertible   Redeemable Preferred  Stock** |       | **Common  Stock** |       | **Paid-in  Capital** |       | **Accumulated  Deficit** |   | **Treasury  Stock** |   | **Total  Shareholders’  Equity (Deficit)** |       |
|---------------------------------|--------|---------------------------------------------------------|------------|-------------------|------------|----------------------|------------|--------------------------|--------|---------------------|--------|-------------------------------------------------|------------|
| **Shares**                      |   | **Amount**                                              | **Shares** |              | **Amount** |
|                            |   |                                                    |       |              |       |                 |       |                     |   |                |   |                                            |       |   |   |   |   |
| BALANCES, at September 30, 2001 |   | 345,000                                                 |       | $                 | 690,000    |                 | 21,526,909 |                     | $      | 21,520              |   | $                                               | 10,658,282 |   | $ | (5,193,306 | ) | $ | (50,000 | ) | $ | 6,126,496 |   |
|                            |   |                                                    |       |              |       |                 |       |                     |   |                |   |                                            |       |   |   |   |   |
| Net Loss                        |   | —                                                  |       | —            |       | —               |       | —                   |   | —              |   | (3,565,492                                      | )          | — |   | (3,565,492 | ) |
|                            |   |                                                    |       |              |       |                 |       |                     |   |                |   |                                            |       |   |   |   |   |
| BALANCES, at September 30, 2002 |   | 345,000                                                 |       | 690,000           |       | 21,526,909           |       | 21,520                   |   | 10,658,282          |   | (8,758,798                                      | )          | (50,000 | ) | 2,561,004 |   |
|                            |   |                                                    |       |              |       |                 |       |                     |   |                |   |                                            |       |   |   |   |   |
| Net Loss                        |   | —                                                  |       | —            |       | —               |       | —                   |   | —              |   | (3,572,112                                      | )          | — |   | (3,572,112 | ) |
|                            |   |                                                    |       |              |       |                 |       |                     |   |                |   |                                            |       |   |   |   |   |
| BALANCES, at September 30, 2003 |   | 345,000                                                 |       | $                 | 690,000    |                 | 21,526,909 |                     | $      | 21,520              |   | $                                               | 10,658,282 |   | $ | (12,330,910 | ) | $ | (50,000 | ) | $ | (1,011,108 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements. 

 

F-5

----

 

**REVCARE, INC.AND SUBSIDIARIES**

 

Consolidated Statements of Cash Flows

For the Years Ended September 30, 2003 and 2002

 
|                                                                                                   |   | **2003**   |       | **2002**  |   |
|--------------------------------------------------------------------------------------------------------|--------|------------|------------|-----------|--------|
|                                                                                                   |   |       |       |      |   |
| Cash flows from  operating activities:                                                                 |   |       |       |      |   |
| Loss from continuing operations                                                                        |   | $          | (3,599,077 | )         | $      | (3,919,506 | ) |
| Adjustments to  reconcile loss from continuing operations to net cash used for continuing  operations: |   |       |       |      |   |
| Depreciation and  amortization                                                                         |   | 433,581    |       | 995,759   |   |
| Losses on  portfolio receivables                                                                       |   | —     |       | 70,667    |   |
| Changes in  operating assets and liabilities:                                                          |   |       |       |      |   |
| Decrease  (Increase) in accounts receivable, net                                                       |   | 367,168    |       | (329,832  | )      |
| Increase in  notes receivable to customer                                                              |   | (39,139    | )          | —    |   |
| (Increase)  Decrease in prepaid expenses and other                                                     |   | (344,433   | )          | 4,816     |   |
| Increase in  accounts payable                                                                          |   | 364,102    |       | 207,231   |   |
| (Decrease)  Increase in collections payable to customers                                               |   | (347,195   | )          | 1,482,027 |   |
| (Decrease)  Increase in accrued liabilities                                                            |   | (321,424   | )          | 796,276   |   |
|                                                                                                   |   |       |       |      |   |
| Net cash used  for continuing operations                                                               |   | (3,486,417 | )          | (692,562  | )      |
|                                                                                                   |   |       |       |      |   |
| Income from  discontinued operations                                                                   |   | 349,526    |       | 354,014   |   |
|                                                                                                   |   |       |       |      |   |
| Net cash used for operating activities                                                                 |   | (3,136,891 | )          | (338,548  | )      |
|                                                                                                   |   |       |       |      |   |
| Cash flows from  investing activities:                                                                 |   |       |       |      |   |
| Purchases of property and equipment                                                                    |   | (1,132     | )          | (237,161  | )      |
| Net proceeds from sale of portfolio  receivables                                                       |   | —     |       | 34,088    |   |
| Increase in restricted cash                                                                            |   | (1,027,538 | )          | (24,432   | )      |
|                                                                                                   |   |       |       |      |   |
| Net cash used in investing activities                                                                  |   | (1,028,670 | )          | (227,505  | )      |
|                                                                                                   |   |       |       |      |   |
| Cash flows from financing activities:                                                                  |   |       |       |      |   |
| Proceeds from  financing obligation – SCP Park Meadows                                            |   | 5,786,633  |       | —    |   |
| Proceeds from  related party notes payable                                                             |   | 1,500,000  |       | 1,450,000 |   |
| (Decrease)  Increase in bank overdraft                                                                 |   | (66,885    | )          | 79,132    |   |
| Net borrowings  on line of credit                                                                      |   | 120,910    |       | 319,614   |   |
| Principal  payments on mortgage note payable                                                           |   | (2,886,894 | )          | —    |   |
| Principal  payments on notes payable to related parties                                                |   | (411,048   | )          | (338,679  | )      |
| Principal payments on capital lease  obligations                                                       |   | (93,327    | )          | (61,302   | )      |
| Principal payments on financing obligation –  SCP Park Meadows                                    |   | (89,136    | )          | —    |   |
|                                                                                                   |   |       |       |      |   |
| Net cash  provided by financing activities                                                             |   | 3,860,253  |       | 1,448,765 |   |
|                                                                                                   |   |       |       |      |   |
| Net increase  (decrease) in cash                                                                       |   | (305,308   | )          | 882,712   |   |
|                                                                                                   |   |       |       |      |   |
| Cash, at  beginning of year                                                                            |   | 882,712    |       | —    |   |
|                                                                                                   |   |       |       |      |   |
| Cash, at end of  year                                                                                  |   | $          | 577,404    |      | $      | 882,712 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements. 

 

F-6

----

 

 
|                                                                     |   | **2003** |      | **2002** |   |
|--------------------------------------------------------------------------|--------|----------|-----------|----------|--------|
|                                                                     |   |     |      |     |   |
| Supplemental  Disclosure of Cash Flow Information                        |   |     |      |     |   |
| Cash paid during  the period for:                                        |   |     |      |     |   |
| Interest                                                                 |   | $        | 615,605   |     | $      | 482,741 |   |
|                                                                     |   |     |      |     |   |
| Supplemental  Disclosure of Non Cash Investing and Financing Activities: |   |     |      |     |   |
|                                                                     |   |     |      |     |   |
| Interest payable  converted to debt                                      |   | $        | 539,933   |     | $      | — |   |
| Exchange of HELP for reduction of debt                                   |   | $        | 1,900,000 |     | $      | — |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

F-7

----

 

**REVCARE, INC. AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

 

September 30, 2003

 

1.     Organization and Basis of Presentation

 

RevCare, Inc.(formerly known as Cypress Financial Services, Inc.), a Nevada corporation,(together with its subsidiaries, the “Company” or “We”), provides accountsreceivable management, administration, and debt collection services primarilyto health care providers and consumer credit issuers.

 

The accompanyingconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and settlement of obligations inthe normal course of business.  TheCompany generated net losses of $3,572,112 and $3,565,492 in fiscal years 2003and 2002, respectively.  In addition,the Company had total shareholders’ deficit of $1,011,108 and a working capitaldeficit of $1,524,631 at September 30, 2003. The consolidated financialstatements do not include any adjustments relating to the recoverability andclassification of asset carrying amounts or the amount and classification ofliabilities that might result should the Company be unable to continue as agoing concern.

 

Managementbelieves that the recent losses are attributable to the various acquisitions in2000, the integration of their operations and the implementation of technologyand processes to pursue its strategic objectives.  Additionally, the Company lost more clients than it gained. TheCompany continues to obtain larger, higher margin contracts, whilediscontinuing contracts with low margins. Management, however, believes that the operating plan for subsequentfiscal years may experience significant challenges in light of ongoing changesin the industry and geographic market it serves which may require the Companyto seek alternative sources for cash to support its growth and ongoingoperations. Accordingly, the Company has completed several transactions andcompleted operational changes designed to meet the Company’s liquidityrequirements, the most significant of which are as follows:

 

•      On February 11, 2003, theCompany entered into a Business Financing Agreement (“Financing Agreement”)with Bridge Bank. The Company may borrow up to $2,500,000 under the conditionsset forth in the Financing Agreement and the outstanding balance of principaland accrued interest under this Financing Agreement was $418,913 at December31, 2003.  The maximum amount we canborrow is contingent on and collateralized by qualified invoices, which willfluctuate from time to time depending on our business volume.  As of December 31, 2003 we have reached themaximum amount available under this line. The obligations under the Financing Agreement are secured by firstpriority liens in all of the Company’s assets and the assets of itssubsidiaries pursuant to the terms and conditions of security agreements. Thisobligation is also guaranteed by our subsidiaries under the terms andconditions of guaranties.

 

•      On May 21, 2003, theCompany’s wholly owned subsidiary, Medical Control Services, Inc. (MCI), whichheld title to our corporate facility completed the sale of the property to SCPPark Meadows, LLC (SCP).  On that samedate, the Company entered into a Lease Agreement dated May 21, 2003 with SCP (the“Lease”). The net proceeds from the sale 

 

F-8

----

 

of the property, after paying off the existingmortgage on the property and paying commissions and expenses, and depositing$1,050,000 to a restricted account ($400,000 of which is subject to release ifwe satisfy specified conditions no sooner than 12 months from the date of thetransaction) to collateralize the letters of credit used as rent deposits tothe subsequent lease of the property equaled $1,352,361.

 

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

 

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

 

•      Subsequent to September 30,2001, the Company sold its remaining portfolios and assets included in theCompany’s 1998 securitization.  Theterms of the sale included an immediate payment of $300,000 and a contingencypayment of up to $350,000.  As of January15, 2004, no amounts have been received under the contingent paymentarrangement.  The contingent payment isdependent upon the success of the buyer in collecting the portfolio andtherefore, the Company is unable at this time to predict the timing of all orany of this payment.

 

•      In fiscal years 2002 and2003, the Company has initiated and completed various cost reductioninitiatives. Such initiatives are expected to reduce annual operating costs byapproximately $2.3 million in fiscal years 2003 and 2004. In March 2003, theCompany also initiated the pilot program for a design to perform certainanalytical and segmentation processes on selected accounts in an offshorelocation in order to explore the possibility of further reducing the directcosts of its collection process significantly.

 

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

 

Based on thefinancing activities and reductions in operating costs described above,management believes that the Company will have the sufficient working capitalit needs to pursue its on going growth and strategic goals for fiscal year2004.

 

F-9

----

 

2.     Summary of Significant AccountingPolicies

 

a.     Principles of Consolidation

 

The accompanyingconsolidated financial statements include the accounts of RevCare, Inc. and itswholly owned subsidiaries. All significant intercompany accounts have beeneliminated in consolidation.

 

b.     Use of Estimates

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make certain estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. Actual results could materially differ from those estimates.

 

c.     Revenue Recognition

 

The Companyprovides collection, auditing, billing and staffing services for entitiesprimarily in the healthcare industry for a fee.  Revenue recognition varies between the business segments basedupon the services provided.

 

Revenues from thedelinquent debt and insurance collection practices are based on a percentage oftotal collections per each contract. Such revenues are recognized upon receiptof cash from the third-party payers that the Company collects from on behalf ofits client.

 

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

 

Revenue from thestaffing division is recognized based upon hourly rates, and is recorded asservices are rendered.  The Company’spayroll system posts staffing division hours to individual projects on amonthly basis.  The Company bills its clientsfor the hours incurred at the contract rates. In August 2003, we entered intoan Exchange Agreement with Russell and Suzette Mohrmann and their affiliate,Hospital Employee Labor Pool, a California corporation, or HELP, pursuant towhich there was a transfer of substantially all the assets related to ouradministrative and back office temporary staffing division. See Note 12, formore information regarding this matter.

 

d.     Accounts Receivable and Allowance forDoubtful Accounts

 

As of September30, 2003, Accounts Receivable and the related Allowance for Doubtful Accountswere comprised of the following:

 
| Billed Receivables                                           |   | $         | 1,627,508 |   |
|--------------------------------------------------------------|--------|-----------|-----------|--------|
| Unbilled Receivables                                         |   | 222,162   |      |
|                                                         |   |      |      |
| Total                                                        |   | 1,849,670 |      |
|                                                         |   |      |      |
| Allowance for Doubtful Accounts                              |   | (181,468  | )         |
|                                                         |   |      |      |
| Accounts Receivable, net of allowance for doubtful  accounts |   | $         | 1,668,202 |   |

 

F-10

----

 

UnbilledReceivables primarily relate to the cost of services provided by our managedcare unit upon its completion of the work as required by the respectivecontracts but has not been invoiced at the end of an accounting period. Theseamounts are subsequently classified as Billed Receivables when the respectiveinvoices are sent to the clients.

 

We maintainallowances for doubtful accounts for estimated losses resulting from ourcustomer’s inability to make required payments.  Management reviews all accounts receivable on a monthlybasis.  Specific invoices over 60 daysare discussed with clients.  Based uponhistorical experience with individual clients, management assesses whether aspecific reserve is required for each invoice or client balance.

 

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

 

e.     Property and Equipment

 

Furniture,fixtures and equipment are carried at cost and depreciated using eitherstraight-line or accelerated methods over the estimated useful lives of theassets, which are generally 4 to 7 years. The building is depreciated over aperiod of 39 years. Repairs and maintenance are charged to expense as incurred;replacements and improvements that extend the useful life of the assets arecapitalized. As of May 21, 2003, the building was sold and leased back to theCompany (see Note 7).

 

f.      Collections Payable to Customers

 

The Companyrecords liabilities for collections received on behalf of its customers as collectionspayable to customers.  Most of ourcustomer contracts do not require these collected funds to be segregated fromour operating cash accounts. Accordingly, these amounts are included in cash until remitted tocustomers.  Amounts that are required tobe segregated and held in separate accounts are shown as restricted cash in theaccompanying consolidated balance sheet.

 

Commencing inSeptember 2001, in some cases where California-based delinquent debt collectionclients did not have the agreement with the Company which required the Companyto maintain the funds collected on the clients’ behalf in a separate account,the Company transferred funds from the client account to its general operatingaccount. In addition, payments to such clients were withheld for 90 to 120days, and sometimes longer. The Company has relied upon the repeal of previousCalifornia statutes requiring segregation of client funds by collectionagencies when our client contract did not contain an express provisionrequiring segregation.  In July 2003,the Company determined, despite the lack of clear authority, that the practiceof transferring client funds to operating accounts or delay on remitting fundsmight be deemed a 

 

F-11

----

 

breach of ourobligations. Since the Company is unable to determine definitively if this isthe case, the Company has taken and is taking additional steps to address thispractice. Client funds are no longer transferred to operating accounts for anyreason (other than funds owed to the Company for its services to which it iscontractually entitled).

 

 

g.     Fair Value of Financial Instruments

 

Fair value offinancial instruments is estimated using available market information and othervaluation methodologies. Financial instruments include accounts receivable,note receivable from officer, mortgage and notes payable and capital leaseobligations.  The fair values of theCompany’s financial instruments are estimated to approximate the carrying valuedue to their relatively short-term nature and fluctuating interest rates withmarket rates.

 

h.     Restricted Cash

 

As a condition ofthe Lease Agreement dated May 21, 2003 with SCP Park Meadows, LLC (SCP) (the“Lease”), we set aside $1,050,000 in a restricted account to collateralize theletters of credit used as rent deposits to the subsequent lease of the property(see Note 7).

 

i.      Goodwill

 

Goodwillrepresents the excess of cost over the fair value of net assets acquired andprior to our adoption of SFAS No. 142 was amortized using the straight-linemethod over 20 years.  The carryingvalue of goodwill is reviewed on a regular basis for the existence of facts orcircumstances, both internally and externally, that may suggest impairment.  The Company annually re-evaluates theoriginal assumptions and rationale utilized in the establishment of thecarrying value and estimated useful lives of goodwill.

 

In June 2001,the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This statement addresses financial accounting and reporting for acquiredgoodwill and other intangible assets and supersedes APB Opinion No. 17,“Intangible Assets.”  SFAS No. 142 addresses how intangible assets thatare acquired individually or with a group of other assets (but not those acquiredin a business combination) should be accounted for in financial statements upontheir acquisition.  This statement also addresses how goodwill and otherintangible assets should be accounted for after they have been initiallyrecognized in the financial statements.  Upon adoption of SFAS No. 142,goodwill is no longer subject to amortization over its estimated useful lifebut is instead subject to periodic testing for impairment.  The Companyadopted this Statement and completed its initial impairment test for goodwillas of October 1, 2002.  As a result of this assessment, the Companydetermined that one of its segments, HELP, was impaired and recorded animpairment charge of $1,576,328 in the quarter ended December 31, 2002. Theimpairment has been reported as a cumulative effect of a change in accountingprinciple. In addition to the impairment, the impact of adopting SFAS No. 142was to cease the amortization of goodwill, which would have amounted to$528,960 of amortization expense for the year ended September 30, 2003. Net loss for the year ended September 30, 2003, including amortization ofgoodwill, would have been $4,101,072 compared to $3,572,112. For the year endedSeptember 30, 2002, goodwill amortization expense was $528,960.  Net loss for the year ended September 30,2002, excluding amortization of goodwill, would have been $3,036,532 comparedto $3,565,492.

 

F-12

----

 

j.      Impairment of Long-LivedAssets

 

The Companyassesses the recoverability of its long-lived assets on an annual basis orwhenever adverse events or changes in circumstances or business climateindicate that expected undiscounted future cash flows related to suchlong-lived assets may not be sufficient to support the net book value of suchassets. Such a triggering event could include a significant decrease in themarket value of an asset, or a significant change in the extent or manner inwhich an asset is used or a significant physical change in an asset. Ifundiscounted cash flows are not sufficient to support the recorded assets,impairment is recognized to reduce the carrying value of the long-lived assetto the estimated fair value. Estimated fair value will be determined bydiscounting the future expected cash flows using a current discount rate ineffect at the time of impairment. Cash flow projections, although subject to adegree of uncertainty, are based on trends of historical performance andmanagement’s estimate of future performance, giving consideration to existing andanticipated competitive and economic conditions. Additionally, in conjunctionwith the review for impairment, the remaining estimated lives of certain of theCompany’s long-lived assets are assessed.

 

k.     Loss Per Share

 

The Companyreports basic and diluted earnings (loss) per share (EPS) in accordance withSFAS No. 128.  Basic EPS is computed bydividing losses available to common shareholders by the weighted average numberof common shares outstanding.  DilutedEPS is computed by adding to the weighted average number of shares the dilutiveeffect of common stock equivalents, if any.

 

For the yearsended September 30, 2003 and 2002, the computations of basic and diluted EPSwere as follows:

 
|                                                                                                       |   | **Years Ended September 30,** |       |
|------------------------------------------------------------------------------------------------------------|--------|-------------------------------|------------|
|                                                                                                       |   | **2003**                      | ** ** | **2002** | ** ** |
|                                                                                                       |   |                          |       |   |   |
| Loss from continuing operations before  cumulative effect of change in accounting principle                |   | $                             | (3,599,077 | ) | $ | (3,919,506 | ) |
|                                                                                                       |   |                          |       |   |   |
| Income from  discontinued operations, net of taxes (including gain on sale of HELP of  $1,253,767 in 2003) |   | 1,603,293                     |       | 354,014 |   |
|                                                                                                       |   |                          |       |   |   |
| Cumulative  effect of change in accounting principle                                                       |   | (1,576,328                    | )          | — |   |
|                                                                                                       |   |                          |       |   |   |
| Net loss                                                                                                   |   | $                             | (3,572,112 | ) | $ | (3,565,492 | ) |
|                                                                                                       |   |                          |       |   |   |
| Basic and diluted loss per share:                                                                          |   |                          |       |   |   |
|                                                                                                       |   |                          |       |   |   |
| Loss from  continuing operations before cumulative effect of change in accounting  principle               |   | $                             | (0.17      | ) | $ | (0.18 | ) |
|                                                                                                       |   |                          |       |   |   |
| Income from  discontinued operations, net of taxes (including gain on sale of HELP of  $1,253,767 in 2003) |   | 0.07                          |       | 0.01 |   |
|                                                                                                       |   |                          |       |   |   |
| Cumulative  effect of change in accounting principle                                                       |   | (0.07                         | )          | — |   |
|                                                                                                       |   |                          |       |   |   |
| Net loss                                                                                                   |   | $                             | (0.17      | ) | $ | (0.17 | ) |
|                                                                                                       |   |                          |       |   |   |
| Weighted average  shares used in all calculations (basic and diluted)                                      |   | 21,526,909                    |       | 21,526,909 |   |

 

F-13

----

 

For the yearsended September 30, 2003 and 2002, the denominator in the diluted EPScomputation was the same as the denominator for basic EPS due to theanti-dilutive effects of preferred stock, warrants stock options on theCompany’s net loss.  As of September 30,2003 and 2002, the Company had outstanding warrants and stock options andconvertible preferred stock of 5,176,775 and 7,094,148 respectively, that wereanti-dilutive and excluded from the computation of dilutive EPS.

 

l.      Income Taxes

 

The Companyaccounts for income taxes using the asset and liability method. Under thismethod, deferred tax assets and liabilities are determined based on differencesbetween the financial reporting and the tax basis of assets and liabilities andare measured using the enacted tax rates and laws.  A valuation allowance is provided for certain deferred tax assetsif it is more likely than not that the Company will not realize tax assetsthrough future operations.

 

m.    Stock Option Plan

 

As permitted under SFAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure,” which amended SFAS No.123, “Accounting for Stock-Based Compensation,” the Company has elected tocontinue to account for its stock-based compensation in accordance with theprovisions of Accounting Principles Board Opinion (APB) No. 25, “Accounting forStock Issued to Employees.”  Under APB25, compensation expense is recognized over the vesting period based on theexcess of the fair market value over the exercise price on the date of grant.It is the Company’s policy to issue options at fair market value or at a 10percent premium over fair market value if the individual is a 10 percent ormore shareholder. Since the exercise price is never below fair market value,there is no compensation expense to be realized.

 

In 1995, the Company adopted, and the shareholdersapproved, the 1995 Stock Option Plan (the Plan) which authorized 450,000 stockoption grants to purchase the Company’s common stock. In August 1998, the Boardof Directors and Shareholders approved a 500,000-share increase to the Plan increasingthe total number of shares reserved for issuance pursuant to the Plan to950,000 shares.  During fiscal year2000, the Board of Directors and Shareholders approved increasing the totalnumber of shares reserved for issuance pursuant to the Plan to 3,250,000shares.

 

The Plan provides for the grant by the Company, ofoptions to purchase shares of the Company’s common stock to its officers,directors, employees, consultants and advisors. The Plan provides that it is tobe administered by a committee appointed by the Board of Directors (theCommittee) all of whom are “disinterested” under 16b-3 of the SecuritiesExchange Act of 1934, as amended. The Committee has discretion, subject to theterms of the Plan, to select the persons entitled to receive options under thePlan, the terms and conditions on which options are granted, the exerciseprice, the time period for vesting such shares, the number of shares subjectthereto, and whether such options shall qualify as “incentive stock options”within the meaning of Section 422 of the Internal Revenue Code, or“non-qualified stock options.”

 

The Company has granted 2,489,708 options under thePlan, of which 1,394,800 have been forfeited. These options are issued at fairmarket value or at a 10 percent premium over fair 

 

F-14

----

 

market value if the individual is a 10 percent or moreshareholder. All options granted expire ten years from the date of grant. AtSeptember 30, 2003, there were 2,155,092 additional shares available forgrant under the Plan.

 

During fiscal year 2003, the Company granted 50,000options to an employee at an exercise price of $0.25 per share, which was equalto the fair market value of the Company’s common stock at the date of grant.Accordingly, no compensation expense was recorded.

 

A summary of the status of the Plan at September 30,2003 and 2002 and changes during the years then ended is presented in the tableand narrative below:

 
|                              |   | **September 30, 2003** |   | **September 30, 2002**                     |   |
|-----------------------------------|--------|------------------------|--------|--------------------------------------------|--------|
|                              |   | **Shares**             |   | **Weighted****Average  Exercise****Price** |   | **Shares** |   | **Weighted****Average  Exercise****Price** |   |
| Outstanding at  beginning of year |   | 1,386,658              |   | $                                          | 0.65   |   | 1,931,908 |   | $ | 0.65 |   |
| Granted                           |   | 50,000                 |   | 0.25                                       |   | 60,000 |   | 0.50 |   |
| Exercised                         |   | —                 |   | —                                     |   | — |   | — |   |
| Forfeited                         |   | (341,750               | )      | 0.52                                       |   | (605,250 | ) | 0.67 |   |
|                              |   |                   |   |                                       |   |   |   |   |   |
| Outstanding at  end of year       |   | 1,094,908              |   | $                                          | 0.65   |   | 1,386,658 |   | $ | 0.63 |   |
|                              |   |                   |   |                                       |   |   |   |   |   |
| Exercisable at  end of year       |   | 1,091,574              |   | $                                          | 0.65   |   | 955,373 |   | $ | 0.69 |   |

 
| **Range of  Exercise Price** |   | **Number of  Shares  Outstanding** |   | **Weighted  Average  Remaining  Contractual Life   in Years** |   | **Weighted Average Exercise Price** |   |
|------------------------------|--------|------------------------------------|--------|---------------------------------------------------------------|--------|-------------------------------------|--------|
| $0.25 – $1.03           |   | 1,072,974                          |   | 6.4                                                           |   | $                                   | 0.61   |   |
| $2.75                        |   | 18,600                             |   | 3.0                                                           |   | $                                   | 2.75   |   |
|                         |   | 1,091,574                          |   |                                                          |   |                                |   |

 

The fair value of each option grant is estimated onthe date of grant using the Black Scholes Option Pricing Model with thefollowing assumptions in 2003 and 2002: weighted average risk-free interestrate of 5.1 and 5.1 percent; a weighted average volatility of 354.9 and 231.1percent; an expected life of 5 and 5 years respectively; and no expected dividendyield. Under the accounting provisions of SFAS Statement 123, the pro formaimpact to Net Loss and EPS is as follows:

 

F-15

----

 

 
|         |   |        |   | **2003** |       | **2002** |   |
|--------------|--------|-------------|--------|----------|------------|----------|--------|
| Net Loss:    |   | As Reported |   | $        | (3,572,112 | )        | $      | (3,565,492 | ) |
|         |   | Pro Forma   |   | $        | (3,626,275 | )        | $      | (3,701,406 | ) |
| Basic EPS:   |   | As Reported |   | $        | (0.17      | )        | $      | (0.17 | ) |
|         |   | Pro Forma   |   | $        | (0.17      | )        | $      | (0.17 | ) |
| Diluted EPS: |   | As Reported |   | $        | (0.17      | )        | $      | (0.17 | ) |
|         |   | Pro Forma   |   | $        | (0.17      | )        | $      | (0.17 | ) |

 

n.     Rental Operations

 

The Company leasesa portion of its building to unrelated parties. Management allocates certaincosts incurred to rental operations based on a ratio of square footage to thetotal square footage of the respective building. The results of rentaloperations for the years ended September 30, 2003 and 2002 are as follows:

 
|                 |   | **2003** |    | **2002** |   |
|----------------------|--------|----------|---------|----------|--------|
|                 |   |     |    |     |   |
| Rental income        |   | $        | 188,998 |     | $      | 210,244 |   |
| Utilities and  other |   | (150,933 | )       | (117,800 | )      |
|                 |   | $        | 38,065  |     | $      | 92,444 |   |

 

o.     Recent Accounting Pronouncements

 

In June 2001, theFASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFASNo. 143 addresses the recognition and measurement of obligations associatedwith the retirement of tangible long-lived assets.  SFAS No. 143 applies to legal obligations associated with theretirement of long-lived assets resulting from the acquisition, construction,development or the normal operation of a long-lived asset. SFAS No. 143required that the fair value of an asset retirement obligation be recognized asa liability in the period in which it is incurred. The asset retirementobligation is to be capitalized as part of the carrying amount of thelong-lived asset and the expense is to be recognized over the estimated usefullife of the long-lived asset. SFAS No. 143 is effective June 15, 2002, withearly adoption permitted. The Company adopted SFAS No. 143 effective October 1,2002, which did not have a material impact on the Company’s financial positionor results of operations.

 

In August 2001,the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets.”  SFAS No. 144addresses the financial accounting and reporting for the impairment oflong-lived assets and for long-lived assets to be disposed of and is effectivefor fiscal years beginning after December 15, 2001.  This statement supersedes SFAS No. 121, “Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of;”however, it retains the fundamental provisions of SFAS No. 121 for (i)recognition and measurement of the impairment of long-lived assets to be heldand used and (ii) measurement of long-lived assets to be disposed of bysale.  This statement also supersedesthe accounting and reporting provisions of APB Opinion No. 30, “Reporting the Resultsof Operations – Reporting 

 

F-16

----

 

the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions” for the disposal of a segmentof a business.  The adoption of SFAS No.144 did not have a material impact on the Company’s consolidated financialposition or results of operations (see also Note 12 “Disposition of BusinessSegment”).

 

In April 2002, the FASB issued No. SFAS 145,“Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13,and Technical Corrections.”  SFAS No.145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment ofDebt,” and SFAS No. 64, “Extinguishment of Debt Made to Satisfy Sinking-FundRequirements.”  Accordingly, a gain or lossfrom a debt extinguishment should not be classified as an extraordinary itemunless it meets the criteria for extraordinary item classification in APBOpinion 30, “Reporting the Results of Operations 3⁄4Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual, and Infrequently Occurring Events andTransactions.”  SFAS No. 145 alsorescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers,”because transition to the Motor Carrier Act of 1980 is complete and intrastateoperating rights have been deregulated. SFAS No. 145 is effective for financial statements issued on or afterMay 15, 2002.  The implementation ofthis standard did not have a material effect upon the Company’s consolidatedfinancial statements.

 

In June 2002, theFASB approved for issuance SFAS No. 146, “Accounting for Costs Associated withExit or Disposal Activities.”  ThisStatement provides financial accounting and reporting guidance for costsassociated with exit or disposal activities and nullifies EITF Issue 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit an Activity (including Certain Costs Incurred in aRestructuring).” SFAS No.  146 iseffective for exit or disposal activities initiated after December 31,2002.  Previously issued financialstatements should not be restated.  Theprovisions of EITF Issue 94-3 continue to apply for an exit activity initiatedunder an exit plan that met the criteria in EITF Issue 94-3 before theStatement’s initial application.  Theimplementation of this statement did not have a material effect upon theCompany’s consolidated financial statements.

 

In December 2002,the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation —Transition and Disclosure”, an amendment of FASB Statement No. 123.  The disclosure requirements of Statement123, “Accounting for Stock-Based Compensation”, which apply to stockcompensation plans of all companies, are amended to require certain disclosuresabout stock-based employee compensation plans in an entity’s accounting policynote.  Those disclosures include atabular format of pro forma net income and, if applicable, earnings per shareunder the fair value method if the intrinsic value method is used in any periodpresented.  Pro forma information in atabular format is also required in the notes to interim financial informationif the intrinsic value method is used in any period presented.  Before amendment by SFAS No. 148, SFAS No.123 required entities changing to the fair value method of accounting forstock-based employee compensation to account for the change in methodprospectively.  The Board decided toprovide a choice among three transition methods (the prospective methodoriginally required by SFAS 123, the modified prospective method, and theretroactive restatement method) for entities voluntarily adopting the fairvalue method in periods beginning before December 16, 2003.  SFAS No. 123’s original prospective transitionmethod will not be available to entities changing to the fair value method infiscal years beginning after December 15, 2003.

 

F-17

----

 

The amendments tothe disclosure and transition provisions of Statement 123 are effective forfiscal years ending after December 15, 2002. Calendar year-end entities are required to include the new disclosuresin their 2002 financial statements.  Thedisclosure requirement for interim financial information is effective forinterim periods beginning after December 15, 2002.  Management did not transition to the fair value method ofaccounting for stock options and the implementation of this standard did nothave a material effect upon the Company’s consolidated financial statementsexcept to include the additional required disclosures.

 

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

 

The FASB hasissued Interpretation No. (FIN) 46, “Consolidation of Variable InterestEntities” – an interpretation of Accounting Research Bulletin (“ARB”) No.51.  This Interpretation defines avariable interest entity and provides that if a business enterprise has acontrolling financial interest in a variable interest entity, the assets,liabilities, and results of the activities of the variable interest entityshould be included in consolidated financial statements with those of thebusiness enterprise.  Furthermore, theBoard indicates that the voting interest approach of ARB No. 51 is noteffective in identifying controlling financial interests in entities that arenot controllable through voting interest or in which the equity investors donot bear the residual economic risk. This Interpretation applies immediately to variable interest entitiescreated after January 31, 2003, and to variable interest entities in which anenterprise obtains an interest after that date.  As a result of the issuance of FASB Staff Position FIN 46-6“Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entitites,” FIN 46 applies atthe end of the interim or annual period ending after December 15, 2003, tovariable interest entities in which an enterprise holds a variable interest thatit acquired before February 1, 2003. Management believes the implementation of this Interpretation will nothave a material effect upon the Company’s consolidated financial statements.

 

In May 2003, theFASB issued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of Both Liabilities and Equity.” This Statement establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity. It requires thatan issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances). This Statement is effective forfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the 

 

F-18

----

 

beginning of thefirst interim period beginning after June 15, 2003. The adoption of thisstatement did not have a material impact on our financial condition or resultsfrom operations.

 

p.     Reclassification

 

Certain amounts inthe accompanying 2002 consolidated financial statements have been reclassifiedto conform to the presentation used in 2003.

 

 

3.     Acquisition and Goodwill

 

On August 14, 2000, the Company completed the purchaseof all of the outstanding stock of Orange County Professional Service, Inc.(“OCPS”).  OCPS became a subsidiary ofCypress Financial Services, which changed its name to RevCare Inc.  Concurrent with this acquisition, OCPSacquired substantially all of the assets of RBA Rem-Care, Inc., InsourceMedical Solutions, LLC and Hospital Employee Labor Pool, affiliates ofOCPS.  This acquisition was accountedfor using the purchase method of accounting. The Company paid approximately $11,000,000 in cash and issued notespayable for $3,675,000.  The excess ofthe purchase price over the fair value of the net assets acquired of$10,773,940 was recorded as goodwill. The operations of OCPS have been included in the accompanyingconsolidated financial statements from the date of acquisition. In 2003, wewrote off goodwill by $2,130,887 due to the impairment identified in connectionwith the adoption of SFAS No. 142 and the disposition of the Hospital EmployeeLabor Pool segment of our business (see Notes 2 and 12).

 

4.     Related Party Transactions

 

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

 

In conjunctionwith the acquisition of OCPS on August 14, 2000 the Company issued $3,675,000of secured convertible promissory notes to shareholders and officers of OCPS,currently employees or officers of the Company.  All of these notes bear interest at the rate of 8 percent perannum. These notes had an original maturity date of January 2003, however thesenotes were amended. On January 8, 2003, the notes were increased from a totalof $3,503,500 to $3,793,512, due to the accrued and unpaid interest of $290,012being added to the principal balance owed to the related parties. These notesmature on January 5, 2004, at which time the unpaid principal balances and allaccrued and unpaid interest are due. At the option of the holder, the notes areconvertible into common stock at $0.735 per share. On August 29, 2003, allrelated party notes for Russell Mohrmann were once again amended due to thedisposition of the HELP segment. (See Note 12, “Disposition of BusinessSegment”).

 

F-19

----

 

On September 28, 2001, the Company entered into arevolving line of credit agreement with two officers of the Company.  The agreement permits borrowings up to$350,000 at the bank reference rate (5.25% at September 30, 2003) plus onepercent.  The line of credit isunsecured and expires on January 2, 2003. At September 30, 2003 we owed $225,000 on this line of credit.  In June 2003, we entered into an amendmentwith these officers in which the maturity date was extended to June 2004.

 

On July 22, 2002, the Company entered into a $100,000note payable with its majority stockholder, FBR Financial Services Partners,L.P. The note bears interest at the bank reference rate plus one percent and ispayable on demand, but is subordinate to a note from an officer of theCompany.  The note is unsecured. Thisnote was amended on August 29, 2003, and consolidated with the September 19,2002 $1,000,000 note payable. (See the following paragraph for details.)

 

On September 19, 2002, the Company entered into a$1,000,000 convertible note payable (“Note”) with its majority shareholder, FBRFinancial Services Partners, L.P.  Thenote bears interest at 12 percent per annum and is payable on demand, but issubordinate to a note from an officer of the Company.   The note is convertible into the Company’s common stockconcurrently or at any time following an equity financing of common stock(“Financing”) at a conversion price equal to eighty-five percent (85%) of theprice per share at which the common stock is sold in the Financing.  The Company computed the intrinsic value ofbeneficial conversion feature attributable to the convertible note to be$176,471, which will be charged to expense at the time of a Financing. Thisnote was amended on August 29, 2003, and consolidated with the July 22, 2002,$100,000 note payable above. Upon the amendment of this note payable, $120,325of accrued an unpaid interest was added to the principal $1,100,000 notebalance for a new note totaling $1,220,325. This note matures on September 1,2005, at which time all accrued interest and principal are due. This Note shall bear interest at the rate ofthe prime rate of interest charged by the Company’s lender plus four percent(4%) per annum.

 

On August 29, 2003, the aforementioned $100,000unsecured note payable and the $1,000,000 convertible note payable includingcombined accrued interest of $120,325 were amended and restated into a new$1,220,325 secured convertible promissory note. The significant amendments tothe previous notes include the following:

 

•      The maturity date wasextended to September 1, 2005.

 

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

 

•      All or any portion of theunpaid principal balance and any accrued but unpaid interest outstanding underthis Note may be converted into fully paid and nonassessable shares of capitalstock of the Company (the “Stock”) concurrently upon or at any time following aFinancing (as defined below) at the option of Holder.  The Stock shall have all of the rights, preferences andprivileges of the capital stock issued in the Financing.  The number of shares of Stock into whichthis Note is to be converted shall be determined by dividing said unpaid principalbalance and all accrued but unpaid interest by the Conversion Price.  The “Conversion Price” shall be determinedat such time as the Company closes an equity 

 

F-20

----

 

financing of Stock or debt convertible into Stock withgross proceeds to the Company of least $500,000 (the “Financing”).  The Conversion Price shall be the price pershare at which the Stock is sold in the Financing or the price at which thedebt converts into Stock.

 

On August 13, 2003, the Company executed the relevantdocuments under which FBR agreed to provide the Company a $500,000 unsecurednote. The proceeds of this note were used for working capital purposes.  On August 29, 2003, the Company executed therelevant documents under which FBR agreed to provide the Company a $1,000,000convertible note.  The use of proceedsfor the new $1,000,000 note from FBR will be used to reduce the collectionspayable to certain of the Company’s California-based delinquent debt collectionclients.

 

On August 29, 2003, the aforementioned $500,000unsecured note and the $1,000,000 convertible note including combined accruedinterest of $2,000 were amended and restated into a $1,502,000 securedconvertible promissory note.  Thesignificant amendments to the previous notes include the following:

 

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

 

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

 

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

 

•      The amended note is securedby substantially all of the Company’s assets, including the shares in theCompany’s subsidiary, Orange County Professional Services, Inc., pursuant to asecurity agreement.

 

On August 29, 2003, the Company entered into anExchange Agreement with Russell and Suzette Mohrmann and their affiliate,Hospital Employee Labor Pool, a California corporation, or HELP, pursuant towhich the transfer was consummated. See Note 12, for more information regardingthis agreement.

 

5.     Property and equipment

 

Property andequipment consists of the following at September 30, 2003:

 
| Land                               |   | $          | 866,575   |   |
|------------------------------------|--------|------------|-----------|--------|
| Building                           |   | 1,540,577  |      |
| Furniture, fixtures and equipment  |   | 2,473,168  |      |
|                               |   | 4,880,320  |      |
| Less—Accumulated depreciation |   | (2,065,498 | )         |
|                               |   | $          | 2,814,822 |   |

 

F-21

----

 

Depreciation expensefor the years ended September 30, 2003 and 2002 totaled $433,581 and $452,228,respectively.

 

6.     Line of Credit

 

On February 11,2003, the Company entered into a Business Financing Agreement (“FinancingAgreement”) with Bridge Bank. The Company may borrow up to $2,500,000 under theconditions set forth in the Financing Agreement and the outstanding balance ofprincipal and accrued interest under this Financing Agreement was $565,744 atSeptember 30, 2003. The maximum amount we can borrow is contingent on andcollateralized by qualified invoices, which will fluctuate from time to timedepending on our business volume.  As ofSeptember 30, 2003 we have borrowed the maximum amount available under thisline.  Part of the proceeds of thisFinancing Agreement was used to pay all outstanding principal and interestunder the Company’s Line of Credit Agreement, which expired in January 2003.The obligations under the Financing Agreement are secured by first priorityliens in all of the Company’s assets and the assets of its subsidiariespursuant to the terms and conditions of security agreements. The obligationsare also guaranteed by the subsidiaries under the terms and conditions ofguaranties.

 

7.     Sale and Leaseback of Building

 

The Company had amortgage note payable to a bank in the amount of $2,886,894, collateralized byland and a building, due in monthly payments of $25,984, bearing interest at aninterest rate based on the yield of the U.S. Five Year Treasury Swap Rate (“theIndex”) plus 2.5 percent and no cap. Said rate will be fixed for five years and adjusted on the firstbusiness day of each five-year anniversary date of the promissory note datedDecember 19, 2000 through January 2021, at which time the entire principalbalance becomes due and payable

 

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

 

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

 

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

 

F-22

----

 

• a tenant improvement allowance of $50,000;

 

• the Company has responsibility for variouscosts, including those associated with maintaining, insuring, repairing andreplacing items on the property;

 

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

 

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

 

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

 

Accordingly, thefuture scheduled maturities after September 2003, as disclosed below, reflectthe amounts due under the Lease Agreement.

 

Future scheduledmaturities of the Lease Agreement at September 30, 2003 are as follows:

 
| Fiscal Years Ending September 30,         |   |       |      |
|-------------------------------------------|--------|------------|-----------|
| 2004                                      |   | $          | 647,244   |   |
| 2005                                      |   | 647,244    |      |
| 2006                                      |   | 647,244    |      |
| 2007                                      |   | 647,244    |      |
| 2008                                      |   | 647,244    |      |
|                                      |   | 4,314,960  |      |
| Thereafter                                |   | 7,551,180  |      |
| Less – Amounts representing interest |   | (1,853,683 | )         |
| Present value of financing obligation     |   | 5,697,497  |      |
| Less – Current portion               |   | (367,989   | )         |
| Total                                     |   | $          | 5,329,508 |   |

 

8.     Capital Transactions

 

a.     Series A Convertible, RedeemablePreferred Stock

 

OnSeptember 30, 1996, the Company converted the balance of notes issued inconnection with the acquisition of Medical Control Services, Inc. (“MCSI”)totaling $690,000 into 345,000 shares of the Company’s Series A convertible,redeemable preferred stock.  MCSI wasacquired in 1995 by Cypress Financial Services, Inc.  The preferred stock is convertible into shares of common stock at$1.50 per share at the option of the holders, subject to antidilutionprovisions. The Company has the right to redeem these preferred shares at $2.50per share. The holders of the Company’s Series A convertible, redeemablepreferred shares are entitled to the same voting and dividend rights as thecommon shareholders. Such preferred shares have a liquidation preference at $2.00per share over common shareholders.

 

F-23

----

 

b.     Common Stock

 

On May 30, 2000,the Company sold 15,000,000 shares of its common stock to FBR FinancialServices Partners, L.P. for $7,500,000 (FBR), representing 69.8 percent of theoutstanding common stock of the Company on a fully diluted basis.  Offering costs related to this transactionwere $446,856.

 

In August 2000,the Company forgave a $50,000 note receivable from a former officer in exchangefor 33,000 shares of the Company’s common stock.

 

c.     Warrants

 

On February 12,1999, the Company issued a warrant to Batchelder & Partners, Inc. topurchase up to 400,000 shares of the Company’s common stock in connection withtheir agreement to act as the Company’s non-exclusive financial advisor. Thiswarrant is subject to specific exercise prices ranging from $1.75 to $4.75 witha weighted average exercise price of $3.06. Additionally, this warrant issubject to vesting provisions whereas 100,000 shares vested immediately and thebalance vests if and when certain defined targets are achieved based upon theCompany’s enterprise value, as defined. The next 50,000 warrants vest upon an enterprise value of $17.29million.    The warrant is exercisableuntil November 13, 2005.

 

The fair value ofthe warrant was estimated to be $415,000 on the date of grant using the BlackScholes Option Pricing model with the following assumptions: weighted averagerisk-free interest rate of 4.5 percent; a weighted average volatility of 86.9percent; an expected life of 6.75 years; and no expected dividend yield. Thisamount will be recognized in the income statement during the period theservices are deemed to have been provided. During the year ended September 30,1999, the Company recognized advisory fees of $100,000 relating to this warrantand no expense has been recognized for any period since then. Any remainingexpense will be recognized in future periods if and when various conditions tovesting have been met.

 

9.     Commitments and Contingencies

 

a.             Lessee - The Company leases certainoffice space and equipment under non-cancelable operating and capital leasesthat expire at various times through fiscal 2006.  Future annual minimum lease payments, in the aggregate, underoperating and capital leases at September 30, 2003 are as follows(excluding the lease of the building discussed in Note 7):

 

Year Ending September 30

 
|                                       |   | **Operating** |   | **Capital** | ** ** |
|--------------------------------------------|--------|---------------|--------|-------------|------------|
|                                       |   |          |   |        |       |
| 2004                                       |   | $             | 36,248 |        | $          | 102,557 |   |
| 2005                                       |   | 967           |   | 41,294      |       |
| 2006                                       |   | —        |   | 16,013      |       |
| Total minimum lease payments               |   | $             | 37,215 |        | 159,864    |   |
| Less – Amounts representing interest  |   |          |   | (33,543     | )          |
| Present value of capital lease obligations |   |          |   | 126,321     |       |
| Less – current portion                |   |          |   | (90,052     | )          |
|                                       |   |          |   | $           | 36,269     |   |

 

F-24

----

 

Rent expense under all operating leases totaled $64,859 in 2003 and$66,433 in 2002.

 

b.             Lessor - As discussed in Note 2, theCompany sub-leases a portion of its building to unrelated entities underoperating leases which expire at various times through fiscal 2005. The Companyleases to several tenants on a month-to-month basis. Future annual collectionsunder non-cancelable operating leases as of September 30, 2003 arescheduled as follows:

 

 

Years Ending September 30,

 
| 2004   |   | $       | 171,251 |   |
|--------|--------|---------|---------|--------|
| 2005   |   | 180,725 |    |
| 2006   |   | 143,235 |    |
|   |   | $       | 495,211 |   |

 

c.     Employment Agreements

 

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

 

Chief Financial Officer, Frederick McGee resigned his position on July28, 2003.

 

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

 

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

 

d.     Guarantees

 

The Companyindemnifies all directors and officers of the Company and any person who mayhave been identified by the Board of Directors.  The Company is obligated, among other things, to indemnify thedirectors and officers of the Company against liabilities arising from theiractions in their capacity as directors and executive officers.  The obligation has no maximum and extendsinto perpetuity.  The Company carriesDirectors and Officers (D&O) insurance of $1,000,000 for the benefit ofsuch persons.  Management expects such insurance would cover any coststhat might be incurred under the indemnification agreements.

 

e.     Litigation

 

The Company isinvolved, from time to time, in litigation that is incidental to its collectionbusiness. The Company regularly initiates legal proceedings as a plaintiff inconnection with its 

 

F-25

----

 

routine collectionactivities. In management’s opinion, none of these legal matters individually willhave a material adverse effect on the Company’s financial position or theresults of its operations

 

f.      Other

 

As discussed inNote 2 (f), the practice of transferring funds collected on behalf of certainCalifornia-based delinquent debt clients to operating accounts or delay inremitting funds might be deemed a breach of the Company’s obligations. In July2003, the Company reported that it has discontinued this practice and has takensteps to reduce the collections payable balance. The Company believes that apotential consequence of any such potential breach is that certain of ourCalifornia-based delinquent debt collection clients may feel damaged and mayrequest compensation. To the extent the Company is unable to reach an agreementwith entities that request compensation, such entities may initiate legalefforts to pursue claims against the Company. In connection with the process toreduce the collections payable balance owed to certain of the Company’sCalifornia-based delinquent debt collection clients, the Company will contactthose clients and offer to pay interest to those of which assert a claim as aresult of the Company’s past practice.

 

We have providedcopies of our reports on Form 8-K filed on July 10, 2003 and August 15, 2003,respectively, to the Division of Enforcement of the Securities and ExchangeCommission. Since that time, the SEC has notified the Company that it has begunan informal investigation involving the Company. The Company is cooperatingwith the SEC in this process.  No provisionhas been included in the consolidated financial statements for the impact of anunfavorable outcome, if any, should occur.

 

10.   Income Taxes

 

The benefits forincome taxes for the years ended September 30, 2003 and 2002 are shown inthe table below:

 
|              |   | **2003** |   | **2002** |   |
|-------------------|--------|----------|--------|----------|--------|
| Federal:          |   |     |   |     |   |
| Current           |   | $        | — |     | $      | — |   |
| Deferred          |   | —   |   | —   |   |
| State:            |   |     |   |     |   |
| Current           |   | —   |   | —   |   |
| Deferred          |   | —   |   | —   |   |
|              |   |     |   |     |   |
| Total tax benefit |   | $        | — |     | $      | — |   |

 

A reconciliationof the total tax benefit from the Federal statutory rate of 34 percent is asfollows:

 
|                                                   |   | **2003** |   | **2002** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                   |   |     |   |     |   |
| Federal statutory tax rate                             |   | (34.0    | )%     | (34.0    | )%     |
| State income taxes, net of Federal income tax  benefit |   | (8.6     | )      | (8.6     | )      |
| Other                                                  |   | 6.0      |   | 6.0      |   |
| Valuation Allowance                                    |   | 36.6     |   | 36.6     |   |
| Actual tax benefit                                     |   | —   | %      | —   | %      |

 

F-26

----

 

Because certainitems of income and expense are not recognized in the same year in theCompany’s financial statements as in its Federal and California tax returns,deferred assets and liabilities are created. As of September 30, 2003, the accompanying consolidated balance sheetreflects no deferred tax assets. The net deferred tax assets as of September30, 2003 are disclosed in the table below:

 

 
| Deferred tax assets:              |   |       |   |
|-----------------------------------|--------|------------|--------|
| Allowance for doubtful accounts   |   | $          | 54,053 |   |
| Deferred gain on sale of building |   | 1,392,490  |   |
| Vacation accrual                  |   | 47,886     |   |
| Net operating losses              |   | 2,301,625  |   |
| Warrants                          |   | 42,840     |   |
| Other                             |   | 42,460     |   |
|                              |   |       |   |
| Total deferred tax assets         |   | 3,881,354  |   |
| Deferred tax liabilities:         |   |       |   |
| Securitization                    |   | (673,420   | )      |
| Other                             |   | (529       | )      |
|                              |   |       |   |
| Total deferred tax liabilities    |   | (673,949   | )      |
|                              |   | 3,207,405  |   |
|                              |   |       |   |
| Valuation allowance               |   | (3,207,405 | )      |
| Net deferred tax asset            |   | $          | — |   |

 

As of September30, 2003, the Company had approximately $6.3 million and $3.4 million offederal and state net operating carry forwards, respectively.  The federal amount is available to offsetfuture taxable incomes, which expire in various years through 2023.  The state amount has been deferred bylegislative action and will not be available for use for two years beginningwith the fiscal year ending September 30, 2003.

 

11.   Reportable Business Segments

 

The following disclosures are intended to present reportable segmentsconsistent with how the chief operating decision maker organizes segmentswithin the Company for making operating decisions and assessing performance.The chief operating decision maker does not use assets to make financialdecisions separately within the segments. All assets are consolidated as awhole and are not identified by segments. Presently, the Company is segregatedinto three divisions, which are as follows:

 

F-27

----

 

*PhysicianServices**–*

 

This division provides receivable management services to physicianservice organizations. While the bulk of the services primarily relate topractice support services, this division has also provided consulting servicesrelating to regulatory compliance as well as education and training ofphysicians with respect to applicable regulatory matters. Practice supportservices generally include coding, billings, collections and financialreporting of revenue transactions incurred by physician service organizationclients. Fees generated from practice support services are either fixed feearrangements or a percentage of the volume of revenues managed on behalf of theclients.  Hourly or per-diem rates fortraining and consulting service fees are determined based on the nature of theengagement.

 

*Recovery–*

 

This division provides pre-delinquent and delinquent collectionservices primarily for hospital organizations, financial institutions, andretail organizations. This division specializes on direct collections frompatients or consumers. Clients pay the company a percentage of the amountscollected as fees for this service.

 

*ReimbursementSolutions –*

 

This division specializes on auditing, re-billing, and follow-upcollections of reimbursable costs due to hospital organizations from thirdparty payors, which, include among others, Medicare, MediCal, HMO’s, and healthinsurance organizations. Fees for these services vary from fixed feearrangements, pre-determined hourly rates, to percentage of revenues generatedon behalf of the clients.

 

Below is a summarystatement of operations for the twelve months ended September 30, 2003 and2002. The accounting policies used in the disclosure of business segments arethe same as those described in the summary of significant accounting policies.Certain assumptions are made concerning the allocations of costs between segmentsthat may influence relative results, most notably, allocations of various typesof technology, legal, recruiting and training costs. Management believes thatthe allocations utilized below are reasonable and consistent with the way itmanages the business.

 

F-28

----

 

The followingtable summarizes the results of our operating units for the twelve months endedSeptember 30, 2003 and 2002:

 

*Forthe twelve months ended September 30, 2003:*

 

 
|                                            |   | **Recovery** |       |   |   | **Physician  Services** |   |      |   | **Reimbursement  Solutions** |   |   |      | **Total** |   |   |      |
|-------------------------------------------------|--------|--------------|------------|--------|--------|-------------------------|--------|-----------|--------|------------------------------|--------|--------|-----------|-----------|--------|--------|-----------|
|                                            |   |         |       |   |   |                    |   |      |   |                         |   |   |      |      |   |   |      |
| Revenue                                         |   | $            | 4,570,450  |   | 100    | %                       | $      | 2,056,578 |   | 100                          | %      | $      | 2,568,665 |      | 100    | %      | $         | 9,195,693 |   | 100 | % |
| Direct Labor                                    |   | 1,613,871    |       | 35     | %      | 1,472,256               |   | 72        | %      | 1,183,395                    |   | 46     | %         | 4,269,522 |   | 46     | %         |
| Indirect Labor                                  |   | 678,150      |       | 15     | %      | 453,331                 |   | 22        | %      | 329,061                      |   | 13     | %         | 1,460,542 |   | 16     | %         |
| Other Expenses                                  |   | 738,280      |       | 16     | %      | 540,150                 |   | 26        | %      | 98,750                       |   | 4      | %         | 1,377,180 |   | 15     | %         |
| Total Expenses                                  |   | 3,030,301    |       | 66     | %      | 2,465,737               |   | 120       | %      | 1,611,206                    |   | 63     | %         | 7,107,244 |   | 77     | %         |
|                                            |   |         |       |   |   |                    |   |      |   |                         |   |   |      |      |   |   |      |
| Operating income (loss)                         |   | $            | 1,540,149  |   | 34     | %                       | $      | (409,159  | )      | (20                          | )%     | $      | 957,459   |      | 37     | %      | 2,088,449 |   | 23 | % |
|                                            |   |         |       |   |   |                    |   |      |   |                         |   |   |      |      |   |   |      |
| Selling, general &  administrative expenses |   | (4,248,596   | )          | (38    | )%     |
| Depreciation &  amortization                |   | (433,581     | )          | (4     | )%     |
|                                            |   |         |       |   |   |                    |   |      |   |                         |   |   |      |      |   |   |      |
| Loss from Operations                            |   | $            | (2,593,728 | )      | (28    | )%                      |

 

F-29

----

 

*Forthe twelve months ended September 30, 2002:*

 
|                                            |   | **Recovery** |       |   |   | **Physician  Services** |   |      |   | **Reimbursement Solutions** |   |   |      | **Total** |   |   |      |
|-------------------------------------------------|--------|--------------|------------|--------|--------|-------------------------|--------|-----------|--------|-----------------------------|--------|--------|-----------|-----------|--------|--------|-----------|
|                                            |   |         |       |   |   |                    |   |      |   |                        |   |   |      |      |   |   |      |
| Revenue                                         |   | $            | 5,076,778  |   | 100    | %                       | $      | 3,137,544 |   | 100                         | %      | $      | 3,530,896 |      | 100    | %      | $         | 11,745,218 |   | 100 | % |
| Direct Labor                                    |   | 1,898,482    |       | 37     | %      | 1,654,391               |   | 53        | %      | 1,506,815                   |   | 43     | %         | 5,059,688 |   | 43     | %         |
| Indirect Labor                                  |   | 863,844      |       | 17     | %      | 695,949                 |   | 22        | %      | 401,515                     |   | 11     | %         | 1,961,308 |   | 17     | %         |
| Other Expenses                                  |   | 750,599      |       | 15     | %      | 850,236                 |   | 27        | %      | 287,613                     |   | 8      | %         | 1,888,449 |   | 16     | %         |
| Total Expenses                                  |   | 3,512,925    |       | 69     | %      | 3,200,576               |   | 102       | %      | 2,195,943                   |   | 62     | %         | 8,909,445 |   | 76     | %         |
|                                            |   |         |       |   |   |                    |   |      |   |                        |   |   |      |      |   |   |      |
| Operating income (loss)                         |   | $            | 1,563,853  |   | 31     | %                       | $      | (63,032   | )      | (2%                         | )      | $      | 1,334,953 |      | 38     | %      | 2,835,773 |   | 24 | % |
|                                            |   |         |       |   |   |                    |   |      |   |                        |   |   |      |      |   |   |      |
| Selling, general &  administrative expenses |   | (5,093,528   | )          | (43    | )%     |
| Depreciation &  amortization                |   | (995,759     | )          | (8     | )%     |
| Losses on portfolio  receivables                |   | (70,667      | )          | (1     | )%     |
|                                            |   |         |       |   |   |                    |   |      |   |                        |   |   |      |      |   |   |      |
| Loss from Operations                            |   | $            | (3,324,181 | )      | (28    | )%                      |

 

F-30

----

 

12.   Disposition of Business Segment

 

On August 29, 2003, we entered into anExchange Agreement with Russell and Suzette Mohrmann and their affiliate,Hospital Employee Labor Pool, a California corporation, or HELP, pursuant towhich we transferred substantially all of the assets related to ouradministrative and back office temporary staffing division (the “StaffingBusiness”). Pursuant to the terms of the Exchange Agreement, HELP has acquiredsubstantially all of the assets of the Staffing Business in exchange for:

 

•      the reduction of $1,900,000 of the indebtedness we owed to the Mohrmannsand their affiliates under various notes we had previously issued to them whenwe acquired a number of businesses from them in 2000.

 

•      the modification of the terms on the remaining $646,719 owed to theMohrmanns, including the extension of our payment obligation, with payments of$25,000 now being due each month commencing approximately September 1, 2004,the termination of the security interest held by the Mohrmanns and thesubordination of their debt to our other lenders.

 

Upon the effectiveness of the transfer, ouremployment relationship with all of the employees of the Staffing Business,including Mr. Mohrmann, was terminated and they commenced employment withHELP.  HELP will sublease space from usunder a two-year sublease.  We agreed tocertain restrictions on our ability to compete or solicit customers oremployees with respect to the Staffing Business for a period of two years.  HELP and the Mohrmanns agreed to similarrestrictions with respect to customers and employees of ours.

 

In connection with the transfer arrangements,we also amended and restated the terms of the promissory note we originallyissued to Mr. Mohrmann and our chief executive officer, Manuel Occiano, inSeptember 2001.  In September 2001,Messrs. Mohrmann and Occiano personally borrowed funds from a commercial bankand then loaned the proceeds to us.  Weagreed to make interest payments to their commercial lender to the same extentMessrs. Mohrmann and Occiano were required to make payments under theircommercial bank loan, which interest payments would be credited against thenote we had issued.  In June 2003, theterms of Messrs. Mohrmann and Occiano’s commercial bank loan were modified torequire monthly payments of principal in the amount of $25,000 plus all accruedbut unpaid interest.  Accordingly, wemodified the terms of our promissory note in favor of Messrs. Mohrmann andOcciano to provide for the same payment terms, which payments shall be paiddirectly by us to the commercial lender and shall be credited against theamended and restated note.

 

This division specializes on providing temporary staffing to hospitalorganizations and physician service organizations.  Temporary staffing provided to its clients can includeadministrative, financial, as well as clinical and operational personnel.

 

F-31

----

 

The following table summarizes the results of operations for theTemporary Staffing Division for the twelve months ended September 30, 2003 and2002:

 
|                    |   | **September 30,  2003** |      |   |   | **September 30,  2002** |   |      |   |
|-------------------------|--------|-------------------------|-----------|--------|--------|-------------------------|--------|-----------|--------|
|                    |   |                    |      |   |   |                    |   |      |   |
| Revenue                 |   | $                       | 2,040,654 |   | 100    | %                       | $      | 1,637,674 |   | 100 | % |
| Direct Labor            |   | 1,510,251               |      | 74     | %      | 1,118,997               |   | 68        | %      |
| Indirect Labor          |   | 123,387                 |      | 6      | %      | 107,173                 |   | 7         | %      |
| Other Expenses          |   | 57,490                  |      | 3      | %      | 57,490                  |   | 3         | %      |
| Total Expenses          |   | 1,691,128               |      | 83     | %      | 1,283,660               |   | 78        | %      |
|                    |   |                    |      |   |   |                    |   |      |   |
| Operating income (loss) |   | $                       | 349,526   |   | 17     | %                       | $      | 354,014   |   | 22 | % |

 

In connection with the disposition, the Company wrote off the remaininggoodwill attributable to this segment of $554,559, derecognized the $1.9million amount payable to Mr. Mohrmann, and recognized a gain of$1,253,767.  The results of operations attributableto the Staffing Business have been shown as discontinued operations in 2003 and2002 in the accompanying consolidated statements of operations.

 

13.   Subsequent Events

 

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

 

F-32

----