**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, 2002** | **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 bySection 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90days.  YES o  NO ý

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B is not contained in this form, and no disclosurewill be contained, to the best of registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB.   ý

 

State issuer’s revenues for its most recent fiscal year:  $13,382,892

 

State the aggregate market value of the voting stock held bynonaffiliates of the registrant: $580,582.

 

State the number of shares outstanding of each of the issuer’s classesof common equity, as of the latest practicable date:  21,526,909 shares of Common Stock issued and outstanding as ofJanuary 29, 2004.

 

Transitional Small Business Disclosure Format (Checkone):   Yes o Noý

 

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# **ITEM 1**                                                        DESCRIPTION OF BUSINESS

 

EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERSDISCUSSED IN THIS ANNUAL REPORT ON FORM 10-KSB ARE FORWARD-LOOKING STATEMENTSTHAT INVOLVE RISKS AND UNCERTAINTIES (SUCH FORWARD-LOOKING STATEMENTS INCLUDE,WITHOUT LIMITATION, STATEMENTS USING SUCH WORDS AS “MAY,” “POTENTIAL,”“EXPECTS,” “BELIEVES,” “ESTIMATES,” “PLANS,” “INTENDS,” “ANTICIPATES” ANDSIMILAR EXPRESSIONS).  FOR A DISCUSSIONOF CERTAIN FACTORS WHICH MAY AFFECT THE OUTCOMES PROJECTED IN SUCH STATEMENTS,SEE “RISK FACTORS” ON PAGES 9 TO 12 OF THIS ANNUAL REPORT ON FORM 10-KSB.ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED.  THESE FORWARD-LOOKING STATEMENTS REPRESENTOUR JUDGMENT AS OF THE DATE OF THE FILING OF THIS ANNUAL REPORT ON FORM 10-KSB.  WE DISCLAIM, HOWEVER, ANY INTENT OR OBLIGATIONTO UPDATE THESE FORWARD-LOOKING STATEMENTS.

## *** ***

***Our Company***

 

RevCare, Inc. is one of the leading providers of revenue cyclemanagement services in California, Nevada and Hawaii.  We have traditionally focused our services on three segments ofthe accounts receivable management industry – healthcare, banking andretail.  However, with our acquisitionof four healthcare revenue cycle management companies in August 2000, we arenow concentrating on offering our comprehensive and integrated suite ofservices to manage the revenue cycle of healthcare providers.  We now have the ability to provide theservices required by our healthcare clients to manage all phases of theirrevenue 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

 

We have significant presence in the Southern California, Las Vegas andHawaii healthcare markets.  We provideservices to approximately 1,288 healthcare facilities in these geographicareas.  We currently manage over $2.1billion in receivables for our billing and collections clients on an annualbasis.  We have contracts to providerevenue cycle management projects to approximately 160 healthcare facilities inthe western region of the United States. We provide back-office temporary staffing and outsourcing toapproximately 33 facilities in Southern California.

 

We believe our acquisitions will allow us to continue to access varioussources of capital to fund our ongoing growth, which may include additionalacquisitions of companies in geographic areas where there is a demand for ourservices.  Our immediate goal is tobecome the most prominent provider of revenue cycle management services tohealthcare providers in the western region of the United States.  We have continued development on twoimportant initiatives that will enhance our client service delivery processes:

 

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an accumulation of our clients’ data that we will process to provideinformation specific to our clients and benchmark statistics about the industry

 

a professional development center designed to continually expand thebasic, technical and regulatory compliance knowledge of our staff.

 

While we are directing our services primarily to the healthcareindustry, we also continue to provide national receivable management servicesto certain non-healthcare companies in the financial services, auto and retailindustries. The retail industry represents approximately 10% of our business.Our clients in these industries primarily utilize our delinquent debt recoveryand litigation management services. In the future, we anticipate a reduction inthe percentage of business related to non-healthcare companies.

 

We have discontinued purchasing charged-off receivable portfolios anddo not intend to participate in this business.

 

## ***Our BusinessStrategy***

 

Our business strategy focuses on positioning ourselves as a strategicpartner and business advisor to healthcare organizations for their revenuecycle management needs.  Key elements inour strategy include:

 

Organizational Intelligence –We are continuing to build a knowledge base that will be enriched by thesignificant amount of data we receive and produce in the course of deliveringour services.** **We believe that ourclients will benefit from the specific performance information and from theindustry level benchmark comparisons that this pool of information may provideonce it is processed and organized, to better manage their businesspractices.  We intend to use the latestapplication service provider (or ASP) technology to provide our clients withsecured, ready access to our knowledge base through our website.

 

Technology – We plan to continue to utilize and leverage technology toprovide our clients with more services and information that are critical totheir business in more convenient and economical ways.

 

Our People – Our success will also largely depend on our ability torecruit, retool and retain smart professionals.  To ensure professionalism and technical knowledge in our people,we created the Professional Development Center.  The center assures us that our people will learn and understandour corporate culture, standardized basic procedures and the latest changes intechnical and regulatory requirements in the industries we serve, and becomeproficient in using the technology tools and resources that are available tothem.

 

Fundamental to our strategy is our attention to:

 

building awareness of our brand in the geographic markets that weservice, which will support the development of our service lines in new markets**.**

 

developing strategic alliances with finance and technology companieswho focus on the healthcare industry, and marketing and cross promotionalliances with other service providers to reach new clients and expandvalue-added services provided to existing clients.

 

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enhancing financial performance in all our service lines by maximizingthe use of technology to streamline internal processes, lowering the cost ofservice and information delivery, and extracting economies of scale frominternal growth and acquisitions.

## *** ***

## ***Our History***

 

In August 2000, we completed our acquisition of California ProfessionalServices, Inc., or CPS, which was founded in 1974 and primarily providescollections services to healthcare clients. As part of our acquisition of CPS, CPS acquired the assets of InsourceMedical Solutions, or Insource, Hospital Employee Labor Pool, or HELP, andRBA-RemCare, or RBA.  Insource, aphysician and hospital 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.

 

On May 30, 2000, FBR Financial Fund II, L.P., now known as FBRFinancial Services 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 focuses 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 will allow 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***

 

BillingServices

 

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;baseline and 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.

 

RecoveryServices

 

Pre-Collect Services – We providepre-delinquency collection services to our clients by acting as an extension ofour clients’ accounts receivable department. We provide clients with speed dialing and professionally trained staffto help them achieve better penetration of their non-delinquent pool ofreceivables.

 

Delinquent Debt Recovery – Whether the causeis improper processing of the claims or the patient’s reluctance or inabilityto pay, 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

 

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future, we expect the account segmentationand filtration processes that may result from the information accumulated inour knowledge base to help us minimize the staff’s efforts on accounts with lowor no collectable value.

 

ReimbursementSolutions

 

Managed Care Audits – We have a comprehensiveaudit program that employs technology and experienced professionals on managedcare accounts that have been closed for over one year.  This process includes a thorough review ofall payments and/or denials received under the terms and conditions of managedcare contracts.  We retain an agreedupon percentage of the re-billed services paid by the insurance carriers.

 

Clinical Denial Audits – Insurance carriersdeny claims due to a variety of reasons. We audit denied claims to determine whether they were appropriatelydenied.  We typically retain an agreedupon percentage of the payment received by our clients from contestedclaims.  The percentage of re-billedclaims varies according to the nature of the claim, the services provided, andthe processes and methods followed by the business office of the healthcareprovider.

 

Zero Balance Reviews - This service is anextension of our managed care****audit service but applies to all accountsthat have been settled at significantly less than the amount originallybilled.  Prior to accepting anengagement, our professionals conduct a feasibility study of the client’sinternal receivable management process. We review a sample of accounts throughout the period and assess theprocesses and methods followed by the back office.  The client ordinarily pays for the feasibility study.  We retain an agreed upon percentage of there-billed services paid by the insurance carriers.

 

Compliance Reviews – We provide consultingservices on healthcare regulatory compliance matters to small- to medium- sizedmedical offices.  This service providesfor a thorough 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 andOutsourcing Services

 

One of the major challenges of financialofficers and business office managers is the maintenance of an adequate numberof properly trained and experienced professionals to perform the continuouslyincreasing workload in the receivable management units.  Unexpected departures or absences ofexperienced coders, billers, abstractors and collectors within a unit maycreate significant backlogs which may lead to potential increases in claimdenials and deterioration of receivable liquidation rates. Some healthcareproviders prefer to outsource portions of or all of their back officeprocesses.  Our seasoned andknowledgeable healthcare receivable specialists are available for various assignmentsthroughout the western region.  Specifichourly rates are determined by the employee’s level and years of experience,expertise and education.

 

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In August 2003, we entered into an ExchangeAgreement with Russell and Suzette Mohrmann and their affiliate, HospitalEmployee Labor Pool, a California corporation, or HELP, pursuant to which therewas a transfer of substantially all the assets related to our administrativeand back office temporary staffing division. Accordingly, we do not expect toearn revenues from this business segment subsequent to August 2003. See alsoItem 6, Management’s Discussion and Analysis of Financial Condition and Resultsof Operations for more discussion on this matter.

 

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

 

We have been providing recovery services to the financial services,retail, and commercial industries for over twenty years.  We have developed a particular expertise inthe handling of accounts financed by retail and finance companies, whichcomprise a large portion of our non-healthcare client base.  Most of our services involve the earlierstages of recovery of our clients’ delinquent accounts receivable.

 

## ***Support Services***

 

To provide effective and thorough services to our clients, we alsooffer the following services and systems to support our core operations:

 

*Litigation Management*– We have 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.

 

*Technology and Information Systems*– We recognize the value of combining human resources with the latest computerand telecommunications technology to manage the receivables assigned to useffectively.  Accordingly, we maintainsophisticated data processing support and management information systems thatcan be easily operated by our billing and recovery specialists.

 

Our receivablemanagement software system is compiled under a widely used, high levelprogramming language.  It operates undera Microsoft Windows environment distributed by a Windows NT networksystem.  A central computer file serverconnected to an array of disc drives maintains our management informationdatabase.

 

We believethat knowledge is a key differentiating factor in our business.  Our long experience in the receivablemanagement business has allowed us to accumulate a base of knowledge which, ifproperly maintained and continually enriched, can provide significantinformation to our clients to enhance their decision making processes to includeanalysis of profitable lines of business and problem areas to avoid.  With the proper management of the data wecontinuously gather from our daily customer interaction, we will improve ourrecovery strategies and management reports for our clients.

 

We continue toexpand our data management capability by utilizing ODBC (Open DatabaseConnectivity) capable report writing on an Oracle open database system.  This system integrates our currentreceivable management operating system and existing telecommunicationtechnology.  This system also allows usto create a more precise coding system to extract, sort, and store informationthat we believe will be useful to our clients’ decision making process withrespect to the relative values and expected performance of their outstandingreceivables.  We intend to use

 

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this system todevelop information retrieval and delivery processes for our clients utilizingthe Internet.

 

*Professional Development 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 humanresources –***R***ecruit,***R***etool, ***R***etain.

 

An effectiverecruiting program reduces the efforts we may need to expend on retooling(training) and retention.  Accordingly,we have established experience-based selection criteria to augment ourrecruiting program.  The criteria arebased upon a careful study of the skills common to our successful employees.  The selection process is conducted through astandardized scoring matrix that effectively sorts candidates according totheir ability to demonstrate the success traits that we look for.

 

Our retooling(training) process is comprised of two programs.  The basic training course is a twelve-week training process.  It starts with a two-week classroom coursethat focuses on teaching the five basic skill sets required to become aneffective recovery specialist. Graduates of this course are accepted to the training division, wheretrainees work on live accounts and fine tune the skills taught during thepreceding two-week course under the close supervision of training supervisors.

 

The advancedtraining course is designed to train recovery specialists on selected specialtyskills (for example, healthcare billing, specialty recovery, loan servicing andinsurance processing).  Employees areable to expand their skills on some of the more difficult or technical aspectsof the job (for example, negotiation skills, customer service techniques, teambuilding concepts and recent regulatory pronouncements).

 

Trainingprograms are also open to our clients in order to enhance the skills of theiremployees in those areas where the client does not wish to outsource the process.  These classes are conducted at our officesor at the client’s facilities and are scheduled throughout the year.

 

OurProfessional Development Center also offers beginning and advanced coding andbilling classes.  We offer the“Professional Medical Coding Curriculum” that was developed by the AmericanAcademy of Professional Coders.  Thisclass is an extensive 20 week program that will prepare the coder to becomecertified.  The CPC certification examis administered at the completion of the class.

 

## ***Marketing andAdvertising***

## *** ***

Our marketing strategy is focused on three goals - building brandawareness, acquiring specifically targeted clients in the western region of theUnited States and cross selling our value-added services to our existing clientbase.  We pursue these goals through acombination of:

 

marketing through selected trade shows and conventions.

 

marketing on our own websites and other online opportunities.

 

direct mail marketing.

 

attendance at industry-sponsored public relations events.

 

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Our advertising focuses onbuilding 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.

 

## ***GovernmentRegulation***

 

Our healthcare billing services are covered by various regulationsprescribed by Medicare, Medicaid, TRICARE and the Health Care FinancingAdministration, and each major federal healthcare payment program has it ownset of complex and sometimes conflicting regulations.  Additionally, regulations have been mandated by the BalancedBudget Act and the Health Insurance Portability and Accountability Act (HIPAA),each of which could have a significant impact on our business.  Several states have also imposed significantregulatory programs applicable to billing and payment for healthcare services.  The Office of Inspector General of theDepartment of Health and Human Resources has issued compliance guidelines forthird-party billing companies, recommending components for an effective billingcompany compliance program and identifying several risk areas associated withmedical billing.  Such risk areasinclude routine waiver of copayments and deductibles, unbundling, billing forundocumented 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.

 

Our recovery operation is regulated by the Fair Debt CollectionPractice Act and the Telephone Consumer Protection Act, which are enforced bythe Federal Trade Commission.  In 1996,HIPAA was passed, which addresses the compliance requirements to safeguardpatient information that is shared and communicated during the various billingand recovery processes.  In this regard,we devote continuous efforts through ongoing training and monitoring to provideethical, innovative, high quality receivable management services, which meet theneeds of our clients and comply with applicable laws.

 

Although we believe that we are in compliance with all applicable lawsand regulations, there can be no assurance that we will always be able tomaintain such compliance.  Our failureto comply with such statutes and regulations could have a material adverseeffect on us.  Furthermore, the adoptionof additional statutes and regulations, changes in interpretation andenforcement of current statutes and regulations, or the expansion of ourbusiness into jurisdictions that have more stringent regulatory requirementsthan those in which we currently conduct business could have a material adverseeffect on us.

 

## ***Competition***

 

All aspects of our business are highly competitive.  We compete directly with OSI, NCOG, andapproximately 6,000 small businesses operating in any, but not all of oursegments. Many of our competitors such as OSI and NCOG, have far greaterresources and have access to capital markets that may be unavailable to us.

 

We believe that the principal competitive factors affecting ourbusiness are performance, price, and quality of service provided.  We believe that our strategic focus andinnovative approaches will allow us to compete effectively with currentproviders of like services.

 

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## ***Employees***

 

As of September 30, 2002, we had 239 full time employees and 15part time employees.  A total of 232 ofthese employees are based in Southern California, 8 are based in Las Vegas, 2are based in Arizona, and 12 are based in Hawaii.  None of our employees are subject to a collective bargainingagreement.  We believe that ourrelations with our employees are good.

 

RISK FACTORS

 

WE WISH TO CAUTION READERS THAT THE FOLLOWING IMPORTANT FACTORS, AMONGOTHERS, IN SOME CASES HAVE AFFECTED, AND IN THE FUTURE COULD AFFECT, OUR ACTUALRESULTS AND COULD CAUSE OUR ACTUAL CONSOLIDATED RESULTS FOR FUTURE PERIODS TODIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS MADEBY US OR ON OUR BEHALF.  WE EXPRESSLYDISCLAIM ANY OBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES ORREVISIONS TO ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO REFLECT ANYCHANGE IN OUR EXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN EVENTS,CONDITIONS OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.

 

***One of ourshareholders holds a large percentage of our common stock and controls ourboard of directors.***

 

Two of our directors, George L. McCabe and Edward Wheeler, are managingdirectors of our majority shareholder, FBR Financial Fund II, L.P., whichbeneficially owns approximately 70% of the outstanding shares of our commonstock as of September 30, 2002. Accordingly, FBR and Messrs. McCabe and Wheeler are able to control usand our affairs and business, including any future issuances of common stock orother securities, merger and acquisition decisions, declaration of dividendsand the election of directors.  Inaddition, our stock price and our ability to raise capital could be injured ifFBR was to sell a significant 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.***

 

Our growth strategy, including our proposed technological enhancements,may require greater expenditures than expected in our current businessplan.  Our capital requirements willdepend on numerous factors, including:

 

our rate of sales growth—fast growth may actually increase our need foradditional capital to hire additional staff, purchase additional equipment andtechnology, finance the increase in accounts receivable and supply additionalsupport services.

 

our progress in providing improved reporting to our clients willrequire additional capital.

 

the level of resources that we devote to the development and marketingof our services and products—any decision we make to improve, expand or simplychange our process, services or technology will require increased funds.

 

market acceptance and demand for our services and products—althoughgrowth may increase our capital needs, the lack of growth would also increaseour need for capital.

 

We may be unable to predict accurately the timing and amount of ourcapital requirements.  We may berequired to raise additional funds through public or private financing, bankloans, collaborative

 

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relationships or other arrangements earlier than expected.  It is possible that banks, venturecapitalists and other investors may perceive our capital structure, financialperformance or reliance on the healthcare industry and new technology as toogreat a risk to bear.  As a result,additional funding may not be available on attractive terms, or at all.  If we cannot obtain additional capital whenneeded, we may be forced to agree to unattractive financing terms, to changeour method of operation or to curtail our operations.

 

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

 

The number of shares of our common stock that traded daily on the OTCBulletin Board during 2002 averaged less than 5% of the average outstandingcommon stock.  As a result of our lowtrading volume and various other factors beyond our control, the market pricefor our common stock is volatile.  Someof the factors that may subject our stock price to wide fluctuations include:

 

the timing and announcement of acquisitions by us or our competitors.

 

government regulatory action.

 

quarterly variations in operating results.

 

announcements of technological innovations, new services or pricing byour competitors.

 

changes in, or failure to meet, the expectations of investors.

 

the timing and extent of technological advancements.

 

the sales of our common stock by affiliates or other shareholders withlarge holdings.

 

general market conditions.

 

In addition, the stock market has experienced significant price andvolume fluctuations that have affected the market price of the stock of manycompanies and that often have been unrelated to the operating performance ofsuch companies.  These broad marketfluctuations may directly influence the market price of our common stock.

 

***We operate in aregulated business and if we fail to comply with government regulations ourability to conduct business may be suspended or terminated which would have amaterially adverse effect on us.***

 

The accounts receivable management and telemarketing industries areregulated under various United States federal and state laws andregulations.  Many states require thatwe be licensed as a debt collection company. If we fail to comply with applicable laws and regulations, it couldresult in the suspension or termination of our ability to conduct accounts receivablemanagement or telemarketing services, which would have a materially adverseeffect on us.  In addition, new federalor state laws or regulations, or changes in the ways these rules or laws areinterpreted or enforced, could limit our activities in the future orsignificantly increase the cost of regulatory compliance.

 

The healthcare industry and some of the other industries served by usare also subject to varying degrees of government regulation.  Although our clients are generallyresponsible for complying with these regulations, we could be subject to avariety of enforcement or private actions for our failure or the failure of ourclients to comply with these regulations.

 

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***We compete with approximately6,000 providers in the accounts receivable management industry which couldreduce our market share and have a materially adverse effect on our futurefinancial results.***

 

We compete with approximately 6,000 providers in providing accountsreceivable management services.  Wecompete with large national corporations as well as many regional and localfirms.  We may lose existing orprospective business to competitors that have established and larger marketingand sales organizations, significantly greater financial and technicalresources and a larger base of customers or operate in broader geographic areasthan we do.  Because of the largenumbers of providers, in the future we may have to reduce our collection feesto remain competitive.  Many largerclients retain multiple accounts receivable management providers, which exposeus to continuous 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 healthcare and financialservices sectors. If either of these sectors performs poorly, clients in thesesectors may have fewer or smaller accounts to refer to us or they may elect toperform accounts receivable management services in-house.  If there are any trends in either of thesesectors to reduce or eliminate the use of third-party accounts receivablemanagement services, the volume of referrals to us would decrease.  Further, the healthcare industry isundergoing fundamental changes resulting from political, economic andregulatory influences. Significant changes in healthcare systems could have asubstantial impact on the manner in which we conduct our business and couldrequire us to revise our strategies.

 

***Our failure tointroduce value added services and products in a timely manner may affect ourability to compete effectively.***

 

Our success depends in large part on sophisticated telecommunicationsand computer systems.  We use thesesystems to identify and contact large numbers of account debtors and to recordthe results of the collection effort. If we are not able to respond to technological changes intelecommunications and computer systems in a timely manner, we may not be ableto remain competitive.  We have made asignificant investment in technology to remain competitive and anticipate thatit will be necessary to continue to do so in the future.  Computer and telecommunication technologiesare changing rapidly and are characterized by short product life cycles, sothat we must anticipate technological developments.  If we are not successful in anticipating, managing or adoptingany technological changes on a timely basis or if we do not have the capitalresources available to invest in new technologies, our business would bematerially adversely affected.

 

***If ourtelecommunications and computer systems fail or become unavailable, it couldhave a materially adverse effect on our business.***

 

As noted above, our business is highly dependent on ourtelecommunications and computer systems. These systems could be interrupted by natural disasters, power losses,or similar events.  Our data is secureddaily and the computer hardware required to operate it can be replaced quickly.Our business also is materially dependent on service provided by various localand long distance telephone companies. If our equipment or systems cease to work or become unavailable, or ifthere is any significant interruption in telephone services, we may be preventedfrom providing services.  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.

 

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***We may not be ableto manage growth.***

 

If successful, 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 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 OF PROPERTY

# ** **

Throughout fiscal year 2002 and until May 21, 2003, we owned our officebuilding and property located at 5400 Orange Avenue, Cypress, California, wherewe conduct our primary operations.  Theoffice building, which was purchased in 1993, contains approximately 53,000square feet of office space.  Currently,we occupy approximately 37,000 square feet for our operations, and theremainder of the building is available for lease to third party tenants.

 

As previously reported on Form 8-K filed July 10, 2003, on May 21,2003, our subsidiary Medical Control Services, Inc. (MCI) which held title toour corporate facility completed the sale of the property to SCP Park Meadows,LLC (SCP).  On that same date, weentered into a Lease Agreement dated May 21, 2003 with SCP (the “Lease”). TheLease provides, among other things, all of the following:

 

a twelve year term, with two additional renewal options of five yearseach

 

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

 

a tenant improvement allowance of $50,000

 

our responsibility for various costs, including those associated withmaintaining, insuring, repairing and replacing items on the property

 

security deposits in the form of two irrevocable letters of credittotaling $1,050,000, $400,000 of which is subject to release within twelvemonths if we satisfy specified conditions

 

our option to repurchase the property between the third and fifth yearsof the Lease term at a purchase price equal to the amount determined bydividing the annual base rent that otherwise would have been payable for the 12months following the closing of the repurchase of the property by 8.5%

 

our option to terminate the Lease between the third and fifth years ofthe Lease upon payment of a termination fee equal to 50% of the amount equal tothe net present value of the aggregate base rent payments remaining through theLease, using a discount rate of 8.5%

 

Copies of these agreements implementing these transactions are filed asExhibit 10.13 through 10.15 to the Form 8-K filed on July 10, 2003, andincorporated herein by reference.

 

We also have leased offices located at 2235 E. Flamingo Road, Suite405, Las Vegas, NV 89119; and****at 46-001 Kamehameha Hwy, Suites 308 and309, Kaneohe, HI  96744.

 

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# **ITEM 3**                                                        LEGAL PROCEEDINGS

 

We are involved, from time to time, in litigation that is incidental toour collection business.  We regularlyinitiate legal proceedings as a plaintiff in connection with our routinecollection activities.  In management’sopinion, none of these legal matters individually will have a material adverseeffect on our financial position or the results of our operations.

 

Commencing in September 2001, in some cases where California-baseddelinquent debt collection clients did not have the agreement with the Companywhich required the Company to maintain the funds collected on the clients’behalf in a separate account, the Company transferred funds from the clientaccount to its general operating account. In addition, payments to such clientswere withheld for 90 to 120 days, and sometimes longer. The Company has reliedupon the repeal of previous California statutes requiring segregation of clientfunds by collection agencies when our client contract did not contain anexpress provision requiring segregation. In July 2003, the Company determined, despite the lack of clearauthority, that the practice of transferring client funds to operating accountsor delay on remitting funds might be deemed a breach of our obligations. Sincethe Company is unable to determine definitively if this is the case, theCompany has taken and is taking additional steps to address this practice.Client funds are no longer transferred to operating accounts for any reason(other than funds owed to the Company for its services to which it iscontractually entitled). The Company believes that a consequence of any suchpotential breach is that certain of our California-based delinquent debtcollection clients may feel damaged and may request compensation. To the extentthe Company is unable to reach an agreement with entities that requestcompensation, such entities may initiate legal efforts to pursue claims againstthe Company. In connection with the process to reduce the collections payablebalance owed to certain of the Company’s California-based delinquent debtcollection clients, the Company will contact those clients and offer to payinterest to those of which assert a claim as a result of the Company’s pastpractice.

 

We have provided copies of our reports on Form 8-K filed on July 10,2003 and August 15, 2003, respectively, to the Division of Enforcement of theSecurities and Exchange Commission. Since that time, the Company has beennotified by the SEC that it has begun an informal investigation involving theCompany. The Company is cooperating with the SEC in this process.

 

# **ITEM 4**                                                        SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

 

There were no matters submitted to a vote of security holders duringthe fourth quarter of the fiscal year ended September 30, 2002.

 

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**PARTII**

 

# **ITEM 5**                                                        MARKET FOR COMMON EQUITYAND RELATED STOCKHOLDER MATTERS

# ** **

**EquityCompensation 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**     |   | 1,386,658                                                                                             |   | $                                                                                     | 0.63   |                                                                                                                                                    | 1,863,342 |   |
| **Equity compensation plans not approved by  security holders** |   | 400,000                                                                                               |   | $                                                                                     | 3.06   |                                                                                                                                                    | —    |   |
| **Total**                                                       |   | 1,786,658                                                                                             |   | $                                                                                     | 1.18   |                                                                                                                                                    | 1,863,342 |   |

 

Our common stock, $.001 par value, is traded under the symbol “RVCR.PK”through the OTC Electronic Bulletin Board maintained by the National Associationof Securities 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.

 
|                     |   | **2002** |   | **2001** |   |
|--------------------------|--------|----------|--------|----------|--------|
|                     |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
|                     |   |     |   |     |   |   |   |   |   |
| 4th Quarter ending 9/30  |   | $        | 0.100  |     | $      | 0.090 |   | $ | 0.290 |   | $ | 0.120 |   |
|                     |   |     |   |     |   |   |   |   |   |
| 3rd Quarter ending 6/30  |   | 0.130    |   | 0.070    |   | 0.400 |   | 0.180 |   |
|                     |   |     |   |     |   |   |   |   |   |
| 2nd Quarter ending 3/31  |   | 0.320    |   | 0.080    |   | 0.625 |   | 0.218 |   |
|                     |   |     |   |     |   |   |   |   |   |
| 1st Quarter ending 12/31 |   | 0.300    |   | 0.110    |   | 0.625 |   | 0.187 |   |
|                          |        |          |        |          |        |  |  |  |  |  |  |  |  |

 

As of September 30, 2002 there were 1,479 holders of record of ourcommon stock.

 

14

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## ***Dividend Policy***

 

We have never paid a dividend and do not anticipate paying any cashdividends in the foreseeable future.  Weintend to retain any earnings to provide funds to finance future growth.

 

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

# ** **

EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERSDISCUSSED IN THIS ANNUAL REPORT ON FORM 10-KSB ARE FORWARD-LOOKING STATEMENTSTHAT INVOLVE RISKS AND UNCERTAINTIES (SUCH FORWARD-LOOKING STATEMENTS INCLUDE,WITHOUT LIMITATION, STATEMENTS USING WORDS SUCH AS “MAY,” “POTENTIAL,”“EXPECTS,” “BELIEVES,” “ESTIMATES,” “PLANS,” “INTENDS,” “ANTICIPATES” ANDSIMILAR EXPRESSIONS).  THESEFORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES, INCLUDINGTHOSE SET FORTH BELOW AND IN ITEM 1 OF THIS ANNUAL REPORT ON FORM 10-KSB UNDERTHE CAPTION “RISK FACTORS,” THAT COULD CAUSE ACTUAL RESULTS TO VARY MATERIALLYFROM THOSE PROJECTED.  THESEFORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE HEREOF.  WE EXPRESSLY DISCLAIM ANY OBLIGATION ORUNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANY FORWARD-LOOKINGSTATEMENTS CONTAINED HEREIN TO REFLECT ANY CHANGE IN OUR EXPECTATIONS WITHREGARD THERETO OR ANY CHANGE IN EVENTS, CONDITIONS OR CIRCUMSTANCES ON WHICHANY SUCH STATEMENT IS BASED.  THEFOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OFOPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIALSTATEMENTS (AND NOTES THERETO) CONTAINED ELSEWHERE HEREIN.

 

## ***Critical accounting policies***

 

Revenue Recognition

 

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

 

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

 

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

 

Revenue from the staffing division is recognized based upon hourlyrates, and is recorded as services are rendered.  The Company’s payroll system posts staffing division hours toindividual projects on a monthly basis. The Company bills its clients for the hours incurred at the contractrates. In August 2003, we entered into an Exchange Agreement with Russell andSuzette Mohrmann and their affiliate, Hospital Employee Labor Pool, aCalifornia corporation, or HELP, pursuant to which there was a transfer ofsubstantially all the assets related to our administrative and back officetemporary staffing division. See

 

15

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Note 13, “Subsequent Events”, to our consolidated financial statements,for more information regarding this matter.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated lossesresulting from our customer’s inability to make required payments.  Management reviews all accounts receivableon a monthly basis.  Specific 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.

 

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

 

Impairment of Long-Lived Assets

 

The Company assesses the recoverability of its long-lived assets on anannual basis or whenever adverse events or changes in circumstances or businessclimate indicate 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.

 

## ***Overview***

 

## ***Business***

 

The following discussion and analysis of our financial condition andresults of our operations are based on the consolidated results ofoperations.  A more detailed discussionof the accounting principles used to prepare the consolidated financialstatements (including the assets, liabilities, and results of operations of thebusinesses and the specific entities included in the consolidation) is setforth in Note 2 to our consolidated financial statements included in thisannual report on Form 10-KSB.

 

## ***Revenues***

 

Commissions and fees, which account for most of our total revenues,include commissions earned from billing, recovery, revenue maximizationprojects and consulting services that we provide to our clients.  Commissions and fees for our billing andrecovery operations are primarily affected by the quality and age of thereceivable pool we are asked to manage. In general, commissions and fees for our billing and recovery servicesfluctuate based on the negotiated rate per the contract, and the number ofaccounts we process and manage. Accounts we manage have increased 10% to $2.1 billion as of September30, 2002

 

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from approximately $1.9 billion as of September 30, 2001.  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 the quality and age of thereceivable pools as well as the efficiency of our clients’ back officeoperations.

 

We previously purchased charged-off accounts receivableportfolios.  Collections from theseportfolios represented 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.

 

We also earn revenues from temporary staffing and placement servicesprovided specifically to the healthcare industry.  Revenues from our temporary staffing services are generated basedon hourly and/or per diem rates charged to our clients.  These rates vary according to the level ofskills and technical knowledge of our staff. Placement fees are negotiated on a case-by-case basis and are predominantlydetermined by a percentage 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.

 

While our primary market going forward will be healthcare providers, aportion of our revenues in 2002 consisted of commissions and fees earned fromnon-healthcare clients.  The following isa summary of our revenues:

 
|                    |   | **2002**  |       | **2001**  |   |
|-------------------------|--------|-----------|------------|-----------|--------|
|                    |   |      |       |      |   |
| Revenues:               |   |      |       |      |   |
| Recovery                |   | $         | 5,076,778  |      | $      | 6,536,699 |   |
| Physician Services      |   | 3,137,544 |       | 2,672,615 |   |
| Reimbursement Solutions |   | 3,530,896 |       | 1,245,921 |   |
| Temporary Staffing      |   | 1,637,674 |       | 3,703,509 |   |
| Total revenues          |   | $         | 13,382,892 |      | $      | 14,158,744 |   |

 

## ***Operating Expenses***

 

Our largest operating expense is employee compensation and benefits,which includes salaries and wages, incentive compensation and related employeebenefits and taxes.  Our compensationprogram for recovery specialists includes incentives based on the amount of netfees they individually generate; as such, compensation expense for this groupwill vary directly 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 optionplan.  There were 60,000 and 455,000stock options granted during 2002 and 2001 respectively; however, nocompensation expense was recorded.

 

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Included in other operating expenses are postage and telephone expensesthat account for the 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 customer/payor invoices and statements as well astelecommunication costs incurred in various negotiation activities with suchcustomers.

 

We ratably allocated the cost of purchased loans receivable portfolioson an account-by-account basis. Collections received from any one account are applied to the basis ofthe respective account before revenue was recognized.  Integral to our collection operations was the timelyidentification of accounts that were deemed uncollectible.  The uncollectability of an account wasprimarily based on the current status of the account (such as bankrupt ordeceased) and the historical experience of the specific portfolio as well assimilar portfolios.  We recorded anamortization reflecting the accumulated costs allocated to those accounts deemeduncollectible to properly reflect management’s estimate of the remaining netproceeds to be realized from a given portfolio.  As previously mentioned, we have not purchased any portfoliossince 1999 and we departed from this line of business.  Accordingly, we expect this cost to declineas the remaining unamortized cost basis of the purchased portfolios arerealized through collections or sale of such portfolios.  In December 2001, we sold the remainingportfolios and discontinued amortizing costs related to the portfolios.

 

Depreciation expense relates primarily to the building facility wherewe conduct a significant portion of our operations.  In addition, our investments in technology and telecommunicationequipment over the last several years will continue to impact this expenseitem.

 

The most significant income component of other income and expenserelates primarily to net proceeds received from rental of the portion of ourbuilding that we do not occupy. Interest expense comprises the significantcomponent of other expenses.

 

We have experienced substantial changes in our business and operationssince we completed 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.

 

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**Result of Operationand Financial Overview—Years ended September 30, 2002 and 2001**

 
|                                  |   | **2002**   |       | **2001**                 |   |
|---------------------------------------|--------|------------|------------|--------------------------|--------|
|                                  |   | **Amount** |       | **Percent of  Revenues** |   | **Amount** |   | **Percent of  Revenues** |   |
|                                  |   |       |       |                     |   |   |   |   |   |
| **Revenues**                          |   |       |       |                     |   |   |   |   |   |
| Recovery                              |   | $          | 5,076,778  |                     | 37.9   | % | $ | 6,536,699 |   | 46.2 | % |
| Physician Services                    |   | 3,137,544  |       | 23.5                     |   | 2,672,615 |   | 18.9 |   |
| Reimbursement Solutions               |   | 3,530,896  |       | 26.4                     |   | 1,245,921 |   | 8.8 |   |
| Temporary Staffing                    |   | 1,637,674  |       | 12.2                     |   | 3,703,509 |   | 26.1 |   |
| Total revenues                        |   | 13,382,892 |       | 100.0                    |   | 14,158,744 |   | 100.0 |   |
|                                  |   |       |       |                     |   |   |   |   |   |
| **Operating Expenses**                |   |       |       |                     |   |   |   |   |   |
| Employee compensation and benefit     |   | 8,247,166  |       | 61.6                     |   | 9,093,213 |   | 64.2 |   |
| Other operating expenses              |   | 1,945,938  |       | 14.5                     |   | 2,166,736 |   | 15.3 |   |
| Selling, general & administrative |   | 5,093,529  |       | 38.1                     |   | 3,723,136 |   | 26.3 |   |
| Depreciation and amortization         |   | 995,759    |       | 7.4                      |   | 888,029 |   | 6.3 |   |
| Losses on Loan Portfolios             |   | 70,667     |       | —                   |   | 241,381 |   | 1.7 |   |
| Loss From Operations                  |   | (2,970,167 | )          | (22.2                    | )      | (1,953,751 | ) | (13.8 | ) |
| Other Expenses                        |   | (595,325   | )          | (4.4                     | )      | (482,596 | ) | (3.4 | ) |
| Net Loss                              |   | $          | (3,565,492 | )                        | (26.6  | ) | $ | (2,436,347 | ) | (17.2 | ) |

 

## ***Revenues***-

 

Total revenues decreased by $775,852 or 5% to $13,382,892 for the yearended September 30, 2002 from $14,158,744 for the year endedSeptember 30, 2001.  Recoveryrevenue declined $1.5 million, due to the delay in the assignment of bad debtcollection receivables and the sale of our purchased portfolios.  Staffing revenues declined $2.1 million dueto discontinued contracts and a reduction in our temporary staffing workforceas a result of more stringent employment requirements.  As previous discussed, we have discontinuedour operations in the staffing segment of our business in fiscal 2003 as aresult of a transfer of substantially all the assets related to ouradministrative and back office temporary staffing division.  Reimbursement Solutions revenue increased$2.3 million due to increases in managed care placements, new client contracts,and special projects.  Some of theReimbursement Solutions projects are expected to expire in the next year andwhile the Company will make its best effort to replace these contracts therecan be no guarantee that we will be successful.  Accordingly we may see a reduction in Reimbursement Solutions’revenue in 2003.  Physician Servicesrevenue increased $465,000 due to new client contracts.  During the second half of fiscal year endedSeptember 30, 2002, two of our largest clients in this segment decided to taketheir billing activities in-house resulting in a reduction of annualizedrevenue of approximately $1.9 million. While the Company has been successful in adding new clients in thissegment, it may not be able to replace the annualized revenue lost related tothese clients in the near term.

 

**Operating Expenses**-

 

Our operating expenses increased by $240,564 or 1% to $16,353,059 forthe year ended September 30, 2002 from $16,112,495 for the year endedSeptember 30, 2001.  Employeecompensation, which is comprised of payroll and benefit costs related topersonnel operating the various business segments, decreased by approximately$846,047.  The decrease is primarily dueto reduction in our staffing division, continued refinement and improvement inproductivity, and the resulting staffing adjustments that vary with businessvolume.  In June 2001, the Companyexecuted certain measures to restructure the policies

 

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and procedures of the staffing division in anticipation of stricterrequirements that the Company’s clients might impose on companies providingtemporary staffing to healthcare organizations with respect to the protectionand dissemination of patient information. As a result, the Company displaced alarge number of staff available for placement during the previous quarters.Employee compensation as a percentage of revenues decreased from 64.2% in 2001to 61.6% in 2002.  The increases inSelling, general and administrative expenses of $1,370,393 was primarily due toincreases in our sales and administrative personnel of approximately $400,000,approximately $500,000 in legal and professional fees, approximately $100,000in bank charges and related financing costs and an increase in bad debt expenseof approximately $62,000.

 

**Other Income andExpenses**

 

Interest expenses increased $121,030 primarily as a result ofadditional borrowings to fund technology and equipment acquisitions as well asinterest paid on the sellers’ notes payable.****Rental income net of relatedexpenses increased $8,301 as a result of a reduction in repairs andmaintenance, and due to rental increases in tenant leases.

 

## ***Net Loss***

 

As a result of the various items discussed above, net loss for the yearincreased $1,129,145 or 46% to $3,565,492 for the year ended September 30, 2002from a loss of $2,436,347 for the year ended September 30, 2001.  As a percentage of revenues, the net lossincreased from 17.2% in 2001 to 26.6% in 2002.

 

## ***Liquidity andCapital Resources***

 

Historically, we have financed our operations through cash flowsgenerated by operations and borrowings from credit facilities that are in placeas well as received funding from certain related party sources. Capitalexpenditures and investments in new technology have been primarily financedthrough non-cancelable capital leases, which expire at various times throughfiscal year 2006.  As ofSeptember 30, 2002, we have outstanding long-term debt with a financialinstitution in the form of a mortgage note on our building facility with aremaining balance of approximately $2,886,894 at a variable interest rate thatapproximates 8.5% and is due in January 2021. As of September 30, 2002, our networking capital deficit totaled $2,507,290. The Company has completed several transactions designed to meet theCompany’s liquidity requirements including, among other things, the followingsignificant transactions:

 

•                  On February 11,2003, we entered into a Business Financing Agreement (“Financing Agreement”)with Bridge Bank.  We may borrow up to$2,500,000 under the conditions set forth in the Financing Agreement and theoutstanding balance of principal and accrued interest under this FinancingAgreement was $418,913 at December 31, 2003. The maximum amount we can borrowis contingent on and collateralized by qualified invoices, which will fluctuatefrom time to time depending on our business volume.  As of December 31, 2003 we have borrowed the maximum amountavailable under this line.    Our obligationsunder the Financing Agreement are secured by first priority liens in all of ourassets and the assets of our subsidiaries pursuant to the terms and conditionsof security agreements. Our obligations are guaranteed by our subsidiariesunder the terms and conditions of guaranties.

 

•                  On May 21, 2003,we completed the sale of the corporate facility to SCP.  The net proceeds from the sale of theproperty, after paying off the existing mortgage on the property and payingcommissions and expenses, and depositing $1,050,000 in a restricted account tocollateralize the letters of credit used as rent deposits for the subsequentlease of the building, equaled $1,352,361 (See Note 13, “Subsequent Events”).

 

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

 

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

 

•                  The maturitydate was extended to September 1, 2005 with all outstanding principal andaccrued 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.

 

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

 

•                  All or anyportion of the unpaid principal balance and any accrued but unpaid interestoutstanding under this Note may be converted into fully paid and nonassessableshares of capital stock of the Company (the “Stock”) concurrently upon or atany time following a Financing (as defined below) at the option of Holder.  The Stock shall have all of the rights,preferences and privileges of the capital stock issued in the Financing.  The number of shares of Stock into which thisNote 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 financing of Stock or debtconvertible into Stock with gross proceeds to the Company of least $500,000(the “Financing”).  The Conversion Priceshall be the price per share at which the Stock is sold in the Financing or theprice at which the debt converts into Stock.

 

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

 

•                  Subsequent toSeptember 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.

 

•                  In fiscal years2002 and 2003, 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.

 

•                  Management isactively seeking additional funding from traditional providers of corporatefinancing and strategic alliance partners in case it needs additional fundingfor fiscal year 2004.

 

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The Company’s largest shareholder, FBR, has provided funding to theCompany in the past. As a component of the process of seeking any additionalfinancing that may be required, management may approach FBR.  However,there can be no assurance that such financing could be arranged on termssatisfactory to us or FBR, or at all.

 

Based on the financing activities and reductions in operating costsdescribed above, management believes that the Company will have the sufficientworking capital it needs to pursue its on going growth and strategic goals infiscal years 2003 and 2004.

 

## ***Management Changes***

 

While our chief financial officer, Fred McGee, agreed with the AuditCommittee’s decision to discontinue the practice of transferring fundscollected on behalf of certain California-based delinquent debt collectionclients to operating accounts (see item 3 “Legal Proceedings), he disagreeswith its conclusion that certain of our past business practices might be deemeda breach of our obligations to such clients. As a consequence of this disagreement on July 28, 2003 Mr. McGeeresigned as our CFO. We anticipate initiating a search for his replacement shortly.  In the interim, we have appointed our ChiefInformation Officer, Kenneth Leighton, as our Acting Chief Financial Officer.

 

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.

 

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# **ITEM 7**                                                        FINANCIAL STATEMENTS

 

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

 

# **ITEM 8**                   CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

# ** **

On June 3, 2002, RevCare, Inc. determined to dismiss its independentauditors, Arthur Andersen LLP (“Andersen”), and engaged Grant Thornton LLP(“Grant Thornton”) as its new independent auditors.    This determination followed RevCare’s decision to seekproposals from independent accountants to audit the financial statements ofRevCare, and was approved by RevCare’s Board of Directors upon therecommendation of its Audit Committee.

 

Andersen’s reports on RevCare’s consolidated financial statements forthe past two years did not contain an adverse opinion or disclaimer of opinion,nor were they qualified or modified as to uncertainty, audit scope oraccounting principles.

 

During RevCare’s two most recent fiscal years and through the date ofAndersen’s dismissal, there were no disagreements with Andersen on any matterof accounting principles or practices, financial statement disclosure, orauditing scope or procedure which, if not resolved to Andersen’s satisfaction,would have caused them to make reference to the subject matter in connectionwith their report on RevCare’s consolidated financial statements for such years;and there were no reportable events, as listed in Item 304(a)(I)(v) ofRegulation S-K.

 

On October 17, 2003, the Company determined to dismiss its independentaccountants, Grant Thornton LLP (“Grant Thornton”). Grant Thornton was engagedeffective June 5, 2002 to audit the financial statements of RevCare for thefiscal year ended September 30, 2002 but did not complete its audit and did notexpress an opinion on the financial statements for the year ended September 30,2002.  We have informed Grant Thorntonthat the reason for the dismissal was the cost of future services.

 

During the period from June 5, 2002 through October 17, 2003, therewere no disagreements 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.

 

On October 17, 2003, the Company appointed Mayer Hoffman McCann P.C. asits new independent accountants to audit the Company’s financial statements forthe years ended September 30, 2002 and 2003. The decision not to continue toretain Grant Thornton and to retain Mayer Hoffman McCann P.C. was approved bythe Company’s Board of Directors upon the recommendation of its AuditCommittee.

 

# **ITEM 8A                CONTROLSAND PROCEDURES**

 

The Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the Company’s “disclosure controls andprocedures” as of the end of the period covered by this report, pursuant toRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended.  Based on that evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat the Company’s disclosure controls and procedures, as of the end of theperiod covered by this report, were effective in timely alerting them tomaterial information relating to the Company required to be included in theCompany’s periodic SEC filings.  Therehas been no change in the Company’s internal control over financial reporting duringthe period covered by this report that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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**PARTIII**

 

# **ITEM 9**                   DIRECTORS, EXECUTIVEOFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THEEXCHANGE ACT

 

The company’s Board of Directors is comprised of the followingindividuals:

 

George L. McCabe, Jr., 42, was elected to serve as our chairman ofthe board of directors on May 30, 2000. Mr. McCabe has served in a management capacity with FBR, the holder of69% of our voting securities, since 1996. He is responsible for the management of a private equity fund focused onthe financial services industry.

 

Edward M. Wheeler, 34, was elected to serve as a director onMay 30, 2000.  Mr. Wheeler hasserved in a management capacity with FBR since 1996.  He is responsible for the management of a private equity fundfocused on the financial services industry.

 

Manuel Occiano, 50, was elected to serve as a director onJanuary 26, 2001.  On May 30,2000, our board of directors appointed Manuel Occiano as our chief executiveofficer.  Mr. Occiano assumedmanagement responsibility for the daily operations and reports directly to theboard.  Mr. Occiano succeeded JohnHindman, who had been serving as the interim chief executive officer sinceDecember 22, 1999.  Mr. Occianopreviously served as our president and chief executive officer, as well as adirector, from September 16, 1998 until he resigned from both positions inDecember 1999.  Mr. Occiano served asexecutive vice president and chief operating officer of West Capital FinancialServices, Corp., a division of SunAmerica Life from July 1996 to September1998. He spent 13 years with Arthur Andersen LLP as senior manager directingfinancial services and business consulting practices for the San Diego office.Chief Executive Officer Manuel Occiano’s employment contract expired in May2003. At this time the employment contract has not been renewed and Mr.Occiano’s employment is considered to be at will.

 

Additional Executive Officers and Key Employees

 

Russell Mohrmann, 63, was appointed as an executive vice president, aswell as president of our recently acquired subsidiary, CPS, on August 14,2000.  He had been a co-owner and thepresident of CPS, which primarily provided collection services to healthcareclients, since 1974. On August 29, 2003, as part of the terms of the ExchangeAgreement with Russell and Suzette Mohrmann and their affiliate HospitalEmployee Labor Pool (HELP), Russell Mohrmann’s employment contract with thecompany was terminated.

 

Robert Perez, 39, was appointed as our senior vice president of salesand marketing on August 14, 2000. Prior to joining us, he was a co-owner and the Secretary/Treasurer ofCPS, and was responsible for new business development.  Prior to joining CPS, Mr. Perez owned andoperated a firm that provided financial and reimbursement consulting servicesto the healthcare industry. On August 29, 2003, Senior Vice President of Salesand Marketing Executive Robert Perez’ employment contract was extended toSeptember 1, 2005 as part of the restructuring and extension of the notepayable to Mr. Perez.

 

On January 2, 2001, our board of directors appointedFrederick C. McGee, 55, as our chief financial officer and secretary.  Mr. McGee succeeds Kenneth Leighton, who hadbeen serving as the secretary and interim chief financial officer since July25, 2000.  Prior to joining us, Mr.McGee served as chief financial officer of TeraGlobal Communications Corp. (oneyear), DAOU Systems, Inc., an IT Services company specializing in healthcare(three years) and Infrasonics, Inc, a medical device manufacturing company(eight years), all public corporations. Chief Financial Officer, Frederick McGee resigned his position on July28, 2003.

 

24

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# **ITEM 10**                                                 EXECUTIVE COMPENSATION

 

The following table sets forth the annual and long-term cash andnon-cash compensation paid by us for services rendered in all capacities duringthe fiscal years ended September 30, 2001, 2000 and 1999 to those persons whowere, as of September 30, 2001, our chief executive officer and our other mosthighly compensated executive officers whose total annual salary and bonusexceeded $100,000 during the fiscal year ended September 30, 2001:

 
|                              |   |             |   |                    |   |           |   |   |   | **Long-Term Compensation**         |   |                   |   |
|-----------------------------------|--------|------------------|--------|-------------------------|--------|----------------|--------|--------|--------|------------------------------------|--------|------------------------|--------|
|                              |   |             |   |                    |   |           |   |   |   | **Awards**                         |   | **Payout**             |   |   |   |
|                              |   |             |   |                    |   |           |   |   |   | **Restricted  Stock  Award(s)($)** |   | **Options/  SARs (#)** |   | **LTIP  Payout  ($)** |   | **All  Other  Compen-  sation ($)(1)** |   |
| **Name  and Principal  Position** |   | **Fiscal  Year** |   | **Annual Compensation** |   |           |   |   |   |                               |   |
|                              |   | **Salary  ($)**  |   | **Bonus  ($)**          |   | **Other  ($)** |   |   |   |                               |   |
| Manuel Occiano (2)                |   | 2002             |   | 250,000                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| chief executive                   |   | 2001             |   | 239,583                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| officer and president             |   | 2000             |   | 135,799                 |   | -0-            |   | -0-    |   | -0-                                |   | 697,308                |   | -0- |   | -0- |   |
|                              |   |             |   |                    |   |           |   |   |   |                               |   |                   |   |   |   |   |   |
| Russell Mohrmann (3)              |   | 2002             |   | 200,000                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| executive vice                    |   | 2001             |   | 200,000                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| President                         |   | 2000             |   | 21,667                  |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
|                              |   |             |   |                    |   |           |   |   |   |                               |   |                   |   |   |   |   |   |
| Robert Perez (4)                  |   | 2002             |   | 175,000                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| senior vice president             |   | 2001             |   | 167,886                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
|                              |   | 2000             |   | 21,875                  |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
|                              |   |             |   |                    |   |           |   |   |   |                               |   |                   |   |   |   |   |   |
| Fred McGee (5)                    |   | 2002             |   | 200,000                 |   | -0-            |   | -0-    |   | -0-                                |   | 0                      |   | -0- |   | -0- |   |
| chief financial officer           |   | 2001             |   | 141,667                 |   | -0-            |   | -0-    |   | -0-                                |   | 300,000                |   | -0- |   | -0- |   |
| and secretary                     |   | 2000             |   | -0-                     |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
|                              |   |             |   |                    |   |           |   |   |   |                               |   |                   |   |   |   |   |   |
| Kenneth Leighton                  |   | 2002             |   | 124,800                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| chief information                 |   | 2001             |   | 110,718                 |   | -0-            |   | -0-    |   | -0-                                |   | -0-                    |   | -0- |   | -0- |   |
| Officer                           |   | 2000             |   | 108,782                 |   | -0-            |   | -0-    |   | -0-                                |   | 50,000                 |   | -0- |   | -0- |   |
|                                   |        |                  |        |                         |        |                |        |        |        |                                    |        |                        |        |  |  |  |  |  |  |

 

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(1)                                  The remunerationdescribed in the table does not include the cost to us of benefits furnished tothe named executive officers, including premiums for health insurance and otherpersonal benefits provided to such individuals in connection with theiremployment.  The value of such benefitscannot be precisely determined; however, the named executive officers did notreceive other compensation in excess of the lesser of $50,000 or 10% of suchofficers’ cash compensation.

(2)                                  Mr. Occiano began hisemployment with us on September 16, 1998 under a three-year contract.  He resigned his positions as director,president and chief executive officer on December 22, 1999.  Our board of directors reappointed him asour chief executive officer on May 30, 2000.

(3)                                  Mr. Mohrmann beganhis employment with us on August 14, 2000 upon the completion of the Company’sacquisition of CPS. See “Employment Agreements” below. On August 29, 2003, aspart of the terms of the Exchange Agreement with Russell and Suzette Mohrmann

 

25

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and their affiliate Hospital Employee Labor Pool (HELP), RussellMohrmann’s employment contract with the company was terminated.

(4)                                  Mr. Perez began hisemployment with us on August 14, 2000 upon completion of the Company’sacquisition of CPS.

(5)                                  Mr. McGee began hisemployment with us on January 2, 2001 under a three-year contract.  See “Employment Agreements” below.  Chief Financial Officer, Frederick McGeeresigned his position on July 28, 2003.

 

Employment Agreements, Termination of Employment and Change-In-ControlArrangements

 

In connection with FBR’s investment in us in May 2000, Mr. ManuelOcciano was reappointed our chief executive officer on May 30, 2000 under an employmentagreement expiring on May 30, 2003 that is renewable for one-year periods.  He will receive a base salary of$250,000.  He was granted options topurchase 692,308 shares of our common stock exercisable at $0.50 per share,323,076 of which are vested.  Thebalance of the options vest at the rate of one-half on the second and thirdanniversary of the date of grant. Mr. Occiano had previously served as our president and chiefexecutive officer and as a director from September 16, 1998 until December 22,1999 when he resigned his positions. The 300,000 options that he had been granted in 1998 expired 90 daysafter Mr. Occiano’s resignation.  Hisemployment as president and chief executive officer at that time was subject toa three-year employment agreement at a base salary of $180,000 per year.  His base salary was subject to an increaseof up to 20% each year if he met certain performance criteria as mutuallyagreed to with the Compensation Committee of the board of directors.  He was eligible to participate in themanagement bonus pool to be established by the board of directors and wasentitled, during 1999 only, to quarterly advances of $22,500 to be creditedagainst the management bonus when earned.

 

In connection with our acquisition of CPS, Mr. Russell Mohrmann wasappointed as an executive vice president as well as president of oursubsidiary, CPS, on August 14, 2000 under an employment agreement expiring onJuly 31, 2003 that is renewable for one-year periods.  He will receive a base salary of $200,000.  If we terminate his employment, with orwithout cause, he will continue to receive his base salary for 90 days after weprovide him with notice of such termination. On August 29, 2003, as part of theterms of the Exchange Agreement with Russell and Suzette Mohrmann and theiraffiliate Hospital Employee Labor Pool (HELP), Russell Mohrmann’s employmentcontract with the company was terminated.

 

In connection with our acquisition of CPS, Mr. Robert Perez wasappointed as senior vice president, sales and marketing, on August 14, 2000under an employment agreement expiring on July 31, 2003 that is renewable forone-year periods.  He will receive abase salary of $175,000.  If weterminate his employment without cause, or if he resigns within 60 days afterhe is removed from his position by the Company, he is forced to relocate morethan 100 miles from the site of his present employment or we reduce his salary,he will continue to receive his base salary for 180 days after such terminationor resignation.

 

On January 2, 2001, Mr. Fred McGee was appointed as chief financialofficer and secretary under an employment agreement expiring on January 1, 2004that is renewable for one-year periods. He will receive a base salary of $200,000.  In addition to the base salary, he is entitled to a GuaranteedBonus on the first and second anniversary of the date of his employmentagreement in the amount of $20,000 each. He was granted options to purchase 300,000 shares of our common stockexercisable at $0.50 per share.  Theoptions vest at the rate of one-third on the first, second and thirdanniversary of the date of grant.  If weterminate his employment without cause or if he resigns within 60 days after heis removed from his position by us, he is forced to relocate more than 100miles from the site of his present employment or we reduce his salary, he willcontinue to receive his base salary for 180 days after such termination and all

 

26

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unvested options will immediately become vested. Chief FinancialOfficer, Frederick McGee resigned his position on July 28, 2003.

 

# **ITEM 11**                                                 SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

Certain Beneficial Owners and Management

 

The following tables set forth information, as of December 31, 2002,concerning shares of our voting securities beneficially owned by (i) eachstockholder known by us to be the beneficial owner of more than 5% of any classof our outstanding voting securities, (ii) each of our directors and ourexecutive officers, and (iii) all of our directors and executive officers as agroup.  Unless otherwise indicated, eachperson listed has sole voting and investment power over the shares beneficiallyowned by him or her.

 
| **Title of Class**            |    | **Name and  Address  of Beneficial Owner**                                                                  |   | **Amount and  Nature of  Beneficial Ownership(1)** |      | **Percent  of Class** |   |
|-------------------------------|---------|-------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------|-----------|-----------------------|--------|
| common stock                  |    | FBR Financial Services Partners (2)  Potomac Tower  1001 Nineteenth Street North  Arlington, VA  22209 |   | 15,000,000                                         |      | 69.7                  | %      |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | Pacific Life Insurance Company (3)  700 Newport Center Drive  Newport Beach, CA 92660                       |   | 2,310,000                                          |      | 10.7                  | %      |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock  preferred stock |    | Farrest Hayden (4)  P.O. Box 814  Los Alamitos, CA 90630                                                    |   | 7,449                                              |      |                  | *      |
|                          | 121,088 |                                                                                                        | 35.1   | %                                                  |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock  preferred stock |    | Lacayo Family Trust (5)  234 E Colorado Blvd, Suite 300  Pasadena, CA 91101                                 |   | 387,048                                            |      | 1.8                   | %      |
|                          |    | 117,060                                                                                                     |   | 33.9                                               | %         |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | Manuel Occiano (6)                                                                                          |   | 507,691                                            |      | 2.3                   | %      |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | Fred McGee (7)                                                                                              |   | 200,000                                            |      |                  | *      |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | George L. McCabe, Jr. (8)                                                                                   |   | 15,000,000                                         |      |                  |   |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | Edward M. Wheeler (9)                                                                                       |   | 15,000,000                                         |      |                  |   |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | Russell Mohrmann (10)                                                                                       |   | $                                                  | 2,278,500 |                  |   |   |
|                          |    |                                                                                                        |   |                                               |      |                  |   |
| common stock                  |    | Robert Perez (11)                                                                                           |   | $                                                  | 1,225,000 |                  |   |   |
|                          |    |                                                                                                        |   |                                               |      |                  |   |   |
| all directors  and officers   |    | Common stock                                                                                                |   | 15,489,076                                         |      | 71.9                  | %      |
| as a group  (4 persons)       |    | Preferred stock                                                                                             |   | —                                             |      |                  |   |

 

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(1).                     Beneficial ownership is determinedin accordance with the applicable rules under the Securities Exchange Act of1934.  In computing the number of sharesbeneficially owned by a person and the percentage ownership of that person,shares of common stock subject to options held by that person that arecurrently exercisable, or become exercisable within 60 days from the datehereof, are deemed outstanding.  However, such shares are not deemed outstanding for purposes ofcomputing the percentage ownership deemed outstanding of any other person.  Percentage of ownership is based on21,526,909 shares of common stock and 345,000 shares of preferred stock.

 

27

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(2).                     Messrs. George L. McCabe, Jr. andEdward C. Wheeler, our directors, are managing directors of FBR FinancialServices Partners.

(3).                     Includes 10,000 shares of commonstock that can be acquired within 60 days of the date of this Form 10-KSB uponthe exercise of options.

(4).                     Mr. Farrest Hayden was a directoruntil he resigned in April, 2000.

(5).                     Mr. Otto J. Lacayo, a trustee forthe Lacayo Family Trust, was a director until he resigned on May 30, 2000.

(6).                     Mr. Manuel Occiano is a directorand our chief executive officer. Includes 507,691 shares of common stock that can be acquired within 60days of the date of this Form 10-KSB upon the exercise of options.

(7).                     Mr. Fred McGee was our chieffinancial officer and secretary until he resigned on July 28, 2003.  Includes 200,000 shares of common stock thatare exercisable until January 28, 2004.

(8).                     Includes 15,000,000 shares ofcommon stock held by FBR Financial Services Partners.  Mr. McCabe, our director, is a managing director of FBR, and maybe deemed to have voting or investment control with respect to theseshares.  Mr. McCabe disclaims beneficialownership with respect to these shares.

(9).                     Includes 15,000,000 shares ofcommon stock held by FBR Financial Services Partners.  Mr. Wheeler, our director, is a managing director of FBR, and maybe deemed to have voting or investment control with respect to theseshares.  Mr. Wheeler disclaimsbeneficial ownership with respect to these shares.

(10).               Mr. Russell Mohrmann was an executivevice president and president of our subsidiary, CPS until he resigned on August29, 2003.  Includes 3,255,000 shares ofcommon stock that could have been acquired upon the exercise of convertiblenotes held by himself, Hospital Employee Labor Pool, Insource MedicalSolutions, and RBA REM-CARE if they had been exercised prior to August 29,2003.  On August 29, 2003, as part ofthe terms of the Exchange Agreement with Russell and Suzette Mohrmann and theiraffiliate Hospital Employee Labor Pool (HELP), Russell Mohrmann’s exerciserights under the terms of the convertible note were terminated.

(11).               Mr. Robert Perez is senior vicepresident of sales and marketing. Includes 1,750,000 shares of common stock that can be acquired within 60days of the date of this Form 10-KSB upon the exercise of a convertible noteheld by him.

*Represents less than 1% of the class of shares

 

# **ITEM 12**                                                 CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS

 

Effective May 30, 2000, we completed the sale of 15,000,000 shares ofour common stock at $0.50 per share to FBR Financial Services Partners(formerly FBR Financial Fund II, L.P.), or FBR, which has become our principalstockholder, owning 69.7% of our outstanding common stock and 68.6% of ouroutstanding voting securities.

 

On August 29, 2003 the Company negotiated the disposition of itstemporary staffing segment (the “Staffing Business”), and 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. Pursuant to the terms of the ExchangeAgreement, HELP has acquired substantially all of the assets of the StaffingBusiness in exchange for: (1) the reduction of $1,900,000 of the indebtednessthat the Company owed to the Mohrmanns and their affiliates under various notesthat the Company had previously issued to them when the Company acquired anumber of businesses from them in 2000, (2) the modification of the terms on theremaining $646,719 owed to the Mohrmanns, including the extension of theCompany’s payment obligation, with payments of $25,000 now being due each monthcommencing approximately September 1, 2004, the termination of the securityinterest held by the Mohrmanns and the subordination of their debt to theCompany’s other lenders.

 

28

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In connection with the transfer of all of the assets of the staffingbusiness, the Company further amended and restated the terms of the promissorynote originally issued to Mr. Mohrmann and our chief executive officer, ManuelOcciano, In September 2001.  InSeptember 2001, Messrs. Mohrmann and Occiano personally borrowed funds from acommercial bank and then loaned the proceeds to us.  The Company agreed to make interest payments to their commerciallender to the same extent the officers were required to make payments undertheir commercial bank loan, which interest payments would be credited againstthe note the Company had issued.  InJune 2003, the terms of Messrs. Mohrmann and Occiano’s commercial bank loanwere modified to require monthly payments of principal in the amount of $25,000plus all accrued but unpaid interest. Accordingly, the Company modified the terms of its promissory note infavor of Messrs. Mohrmann and Occiano to provide for the same payments terms,which payments shall be paid directly by us to the commercial lender and shallbe credited against the amended and restated note.

 

**PART IV**

 

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

 

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

 

**(A)****                               FinancialStatements:**

 

See “Index to Consolidated Financial Statements” on Page F1 of thisReport.

 

**(B)****                               FinancialStatement Schedules:**

 

All schedules are omitted as the information is not required, is notmaterial or is otherwise furnished.

 

**(C)****                               Reportson Form 8-K:**

 

No reports on Form 8-K were filed during the quarter ended September30, 2002.

 

**(D)****                               Exhibits****   **

 

The exhibits listed below are required by Item 601 of RegulationS-B.  Each management contract orcompensatory plan or arrangement required to be filed as an exhibit to thisForm 10-KSB has been identified with an asterisk (“*”) in the table of exhibitsset 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)                                       |

 

29

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| 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)                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                     |
| 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)                                     |

 

30

----

 
| 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)                                                                                                  |
|   |   |                                                                                                                                                                                                                                    |
| 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 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                              |
|   |   |                                                                                                                                                                                                                                    |
| *31.2  |   | CFO Certification pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                              |
|   |   |                                                                                                                                                                                                                                    |
| *32.1  |   | CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                    |
| *32.2  |   | CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                                                                                                                                                            |

 

31

----

 

**SIGNATURES**

 

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

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

 

In accordance with the Exchange Act, this report has been signed belowby the following persons on behalf of the registrant and in the capacities andon the date 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 |             | January 29, 2004 |   |
| Kenneth Leighton       |   |      |                           |             |             |
|                        |        |           |                                |                  |                  |  |  |  |

 

32

----

 

**Indexto Consolidated Financial Statements**

 

The financial statementsrequired Item 13 as follows:

 
| Report of Independent Public Accountants –  Mayer Hoffman McCann P.C.                            |   |
|-------------------------------------------------------------------------------------------------------|--------|
|                                                                                                  |   |
| Report of Independent Public Accountants –  Arthur Andersen LLP                                  |   |
|                                                                                                  |   |
| Consolidated Balance Sheet as of September 30, 2002                                                   |   |
|                                                                                                  |   |
| Consolidated Statements of Operations for  the Years ended September 30, 2002 and 2001                |   |
|                                                                                                  |   |
| Consolidated Statements of Shareholders’  Equity for the Years Ended September 30, 2002 and 2001 |   |
|                                                                                                  |   |
| Consolidated Statements of Cash Flows for  the Years Ended September 30, 2002 and 2001                |   |
|                                                                                                  |   |
| Notes to Consolidated Financial Statements                                                            |   |

 

(1) Financial StatementSchedules

 

Financial statement scheduleshave been omitted since they are either not required or not applicable, or theinformation 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, 2002, and therelated consolidated statements of operations, shareholders’ equity, and cashflows for the year then ended.  These consolidated financial statementsare the responsibility of the Company’s management.  Our responsibility isto express an opinion on these consolidated financial statements based on ouraudit.  The consolidated financialstatements of RevCare, Inc. as of and for the year ended September 30, 2001were audited by other auditors who have ceased operations.  Those auditors expressed an unqualifiedopinion on those consolidated financial statements in their report datedJanuary 11, 2002.

 

We conducted our audit in accordance with auditing standards generallyaccepted in the United States.  Those standards require that we plan andperform the audit 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 audit provides a reasonable basis for our opinion.

 

As more fully discussed in Note 1, the Company has experiencedoperating losses in 2002 and 2001 and management has described its plans toaddress certain liquidity issues.

 

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, 2002, and the results of theiroperations and their cash flows for the year then ended, in conformity withaccounting principles generally accepted in the United States.

 

 
| /s/ Mayer Hoffman McCann P.C. |   |
|-------------------------------|--------|
|                          |
| MAYER HOFFMAN MCCANN P.C.     |

 

 

Los Angeles, California

January 21, 2004

 

F-2

----

 

**REPORTOF INDEPENDENT****PUBLIC ACCOUNTANTS**

 

 

To the Shareholders of RevCare, Inc.:

 

We have audited the accompanying consolidatedbalance sheets of RevCare, Inc. (formerly known as Cypress Financial Services,Inc.), a Nevada corporation, and subsidiaries as of September 30, 2001 and2000, and the related consolidated statements of operations, shareholders’equity and cash flows for the years then ended.  These consolidated financial statements are the responsibility ofthe Company’s management.  Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our audits in accordance withauditing standards generally accepted in the United States.  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of RevCare, Inc. and subsidiaries as of September 30, 2001and 2000, and the results of their operations and their cash flows for theyears then ended in conformity with accounting principles generally accepted inthe United States.

 

 

ARTHUR ANDERSEN LLP

 

Orange County, California

January 11, 2002

 

THIS REPORT IS A COPY OF A PREVIOUSLY ISSUED ARTHUR ANDERSEN LLP REPORTAND THE REPORT HAS NOT BEEN RE-ISSUED BY ARTHUR ANDERSEN LLP.

 

F-3

----

 

 

**REVCARE,INC. AND SUBSIDIARIES**

 

ConsolidatedBalance Sheet – September 30, 2002

 
| Assets                                                                                                                                                                                     |   |       |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|------------|
|                                                                                                                                                                                       |   |       |       |
| Current Assets:                                                                                                                                                                            |   |       |       |
| Cash                                                                                                                                                                                       |   | $          | 882,712    |   |
| Restricted cash                                                                                                                                                                            |   | 24,432     |       |
| Accounts receivable, net of allowance for  doubtful accounts of $167,081                                                                                                                   |   | 2,035,370  |       |
| Employee advances                                                                                                                                                                          |   | 94,600     |       |
| Prepaid expenses                                                                                                                                                                           |   | 504        |       |
|                                                                                                                                                                                       |   |       |       |
| Total current assets                                                                                                                                                                       |   | 3,037,618  |       |
|                                                                                                                                                                                       |   |       |       |
| Goodwill, net                                                                                                                                                                              |   | 9,621,679  |       |
| Property and equipment, net                                                                                                                                                                |   | 3,247,273  |       |
| Note receivable from officer                                                                                                                                                               |   | 100,000    |       |
|                                                                                                                                                                                       |   |       |       |
| Total assets                                                                                                                                                                               |   | $          | 16,006,570 |   |
|                                                                                                                                                                                       |   |       |       |
|                                                                                                                                                                                       |   |       |       |
| Liabilities and Shareholders’ Equity                                                                                                                                                  |   |       |       |
|                                                                                                                                                                                       |   |       |       |
| Current liabilities:                                                                                                                                                                       |   |       |       |
| Bank overdraft                                                                                                                                                                             |   | $          | 191,806    |   |
| Accounts payable                                                                                                                                                                           |   | 698,536    |       |
| Collections payable to customers                                                                                                                                                           |   | 2,175,148  |       |
| Accrued liabilities                                                                                                                                                                        |   | 1,731,270  |       |
| Lines of credit                                                                                                                                                                            |   | 444,834    |       |
| Current portion of mortgage note payable                                                                                                                                                   |   | 72,041     |       |
| Notes payable to related parties                                                                                                                                                           |   | 143,930    |       |
| Current portion of capital lease  obligations                                                                                                                                              |   | 87,343     |       |
|                                                                                                                                                                                       |   |       |       |
| Total current liabilities                                                                                                                                                                  |   | 5,544,908  |       |
|                                                                                                                                                                                       |   |       |       |
| Mortgage note payable, less current portion                                                                                                                                                |   | 2,814,853  |       |
| Capital lease obligations, less current  portion                                                                                                                                           |   | 132,305    |       |
| Notes payable to related parties, less  current portion                                                                                                                                    |   | 4,953,500  |       |
|                                                                                                                                                                                       |   |       |       |
| Total liabilities                                                                                                                                                                          |   | 13,445,566 |       |
|                                                                                                                                                                                       |   |       |       |
| Commitments and contingencies (Note 10)                                                                                                                                                    |   |       |       |
|                                                                                                                                                                                       |   |       |       |
| Shareholders’ Equity:                                                                                                                                                                 |   |       |       |
| 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                                                                                                                                                                        |   | (8,758,798 | )          |
|                                                                                                                                                                                       |   |       |       |
|                                                                                                                                                                                       |   | 2,611,004  |       |
| Less common stock in treasury at cost,  33,000 shares                                                                                                                                      |   | (50,000    | )          |
|                                                                                                                                                                                       |   |       |       |
| Total shareholders’ equity                                                                                                                                                            |   | 2,561,004  |       |
|                                                                                                                                                                                       |   |       |       |
|                                                                                                                                                                                       |   | $          | 16,006,570 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-4

----

 

**REVCARE, INC. ANDSUBSIDIARIES**

 

ConsolidatedStatements of OperationsFor the Years Ended September 30, 2002 and 2001

 
|                                                |   | **2002**   |       | **2001**   |   |
|-----------------------------------------------------|--------|------------|------------|------------|--------|
|                                                |   |       |       |       |   |
| Revenues:                                           |   |       |       |       |   |
| Service fees                                        |   | $          | 13,382,892 |       | $      | 13,771,909 |   |
| Portfolio receivables revenue                       |   | —     |       | 386,835    |   |
|                                                |   |       |       |       |   |
|                                                |   | 13,382,892 |       | 14,158,744 |   |
|                                                |   |       |       |       |   |
|                                                |   |       |       |       |   |
| Operating expenses:                                 |   |       |       |       |   |
| Salaries, wages and related benefits                |   | 8,247,166  |       | 9,093,213  |   |
| Business segment operating expenses                 |   | 1,945,938  |       | 2,166,736  |   |
| Selling, general and administrative                 |   | 5,093,529  |       | 3,723,136  |   |
| Depreciation and amortization                       |   | 995,759    |       | 888,029    |   |
| Losses on portfolio receivables                     |   | 70,667     |       | 241,381    |   |
|                                                |   |       |       |       |   |
|                                                |   | 16,353,059 |       | 16,112,495 |   |
|                                                |   |       |       |       |   |
| Loss from operations                                |   | (2,970,167 | )          | (1,953,751 | )      |
|                                                |   |       |       |       |   |
| Other Income (Expense):                             |   |       |       |       |   |
| Interest expense, net                               |   | (687,769   | )          | (566,739   | )      |
| Rental income, net                                  |   | 92,444     |       | 84,143     |   |
|                                                |   |       |       |       |   |
|                                                |   | (595,325)  |       | (482,596   | )      |
|                                                |   |       |       |       |   |
| Net loss                                            |   | $          | (3,565,492 | )          | $      | (2,436,347 | ) |
|                                                |   |       |       |       |   |
| Loss per share:                                     |   |       |       |       |   |
| Basic                                               |   | $          | (0.17      | )          | $      | (0.11 | ) |
| Diluted                                             |   | $          | (0.17      | )          | $      | (0.11 | ) |
|                                                |   |       |       |       |   |
| Number of shares used in computing loss per  share: |   |       |       |       |   |
| Basic                                               |   | 21,526,909 |       | 21,526,909 |   |
| Diluted                                             |   | 21,526,909 |       | 21,526,909 |   |

 

The accompanying notes are an integral part of these consolidated financialstatements.

 

F-5

----

 

**REVCARE, INC. ANDSUBSIDIARIES**

 

ConsolidatedStatements of Shareholders’ Equity

For the Years Ended September 30, 2002 and 2001

 
|                            |   | **Series A  Convertible  Redeemable Preferred  Stock** |   | **Common  Stock** |    | **Paid-in  Capital** |       | **Accumulated  Deficit** |   | **Treasury  Stock** |   | **Total  Shareholders’  Equity** |       |
|---------------------------------|--------|--------------------------------------------------------|--------|-------------------|---------|----------------------|------------|--------------------------|--------|---------------------|--------|---------------------------------------|------------|
|                            |   | **Shares**                                             |   | **Amount**        |    | **Shares**           |       | **Amount**               |
|                            |   |                                                   |   |              |    |                 |       |                     |   |                |   |                                  |       |   |   |   |   |
| BALANCES, at September 30, 2000 |   | 345,000                                                |   | $                 | 690,000 |                 | 21,526,909 |                     | $      | 21,520              |   | $                                     | 10,658,282 |   | $ | (2,756,959 | ) | $ | (50,000 | ) | $ | 8,562,843 |   |
|                            |   |                                                   |   |              |    |                 |       |                     |   |                |   |                                  |       |   |   |   |   |
| Net Loss                        |   | —                                                 |   | —            |    | —               |       | —                   |   | —              |   | (2,436,347                            | )          | — |   | (2,436,347 | ) |
|                            |   |                                                   |   |              |    |                 |       |                     |   |                |   |                                  |       |   |   |   |   |
| 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 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-6

----

 

**REVCARE, INC. ANDSUBSIDIARIES**

 

ConsolidatedStatements of Cash Flows

For the Years Ended September 30, 2002 and 2001

 
|                                                                         |   | **2002**  |       | **2001**   |   |
|------------------------------------------------------------------------------|--------|-----------|------------|------------|--------|
|                                                                         |   |      |       |       |   |
| Cash flows from operating activities:                                        |   |      |       |       |   |
| Net loss                                                                     |   | $         | (3,565,492 | )          | $      | (2,436,347 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |      |       |       |   |
| Depreciation and amortization                                                |   | 995,759   |       | 888,029    |   |
| Losses on portfolio receivables                                              |   | 70,667    |       | 241,381    |   |
| Changes in operating assets and  liabilities:                                |   |      |       |       |   |
| Increase in accounts receivable, net                                         |   | (329,832  | )          | (341,329   | )      |
| Decrease in portfolio receivables                                            |   | —    |       | 28,749     |   |
| Decrease in prepaid expenses and other                                       |   | 4,816     |       | 1,869      |   |
| Increase in accounts payable                                                 |   | 207,231   |       | 164,020    |   |
| Increase in collections payable to  customers                                |   | 1,482,027 |       | 302,860    |   |
| Increase in accrued liabilities                                              |   | 796,276   |       | 29,420     |   |
|                                                                         |   |      |       |       |   |
| Net cash used in operating activities                                        |   | (338,548  | )          | (1,121,348 | )      |
|                                                                         |   |      |       |       |   |
| Cash flows from investing activities:                                        |   |      |       |       |   |
| Purchases of property and equipment                                          |   | (237,161  | )          | (514,877   | )      |
| Net proceeds from sale of portfolio  receivables                             |   | 34,088    |       | —     |   |
| Increase in restricted cash                                                  |   | (24,432   | )          | —     |   |
|                                                                         |   |      |       |       |   |
| Net cash used in investing activities                                        |   | (227,505  | )          | (514,877   | )      |
|                                                                         |   |      |       |       |   |
| Cash flows from financing activities:                                        |   |      |       |       |   |
| Proceeds from notes payable to related  parties                              |   | 1,450,000 |       | —     |   |
| Proceeds from mortgage note payable                                          |   | —    |       | 2,990,000  |   |
| Increase in bank overdraft                                                   |   | 79,132    |       | 112,674    |   |
| Net borrowings on line of credit                                             |   | 319,614   |       | —     |   |
| Principal payments on mortgage note payable                                  |   | —    |       | (1,802,002 | )      |
| Principal payments on notes payable to  related parties                      |   | (338,679  | )          | (481,499   | )      |
| Principal payments on capital lease obligations                              |   | (61,302   | )          | (121,608   | )      |
|                                                                         |   |      |       |       |   |
| Net cash provided by financing activities                                    |   | 1,448,765 |       | 697,565    |   |
|                                                                         |   |      |       |       |   |
| Net increase (decrease) in cash                                              |   | 882,712   |       | (938,660   | )      |
|                                                                         |   |      |       |       |   |
| Cash, at beginning of year                                                   |   | —    |       | 938,660    |   |
|                                                                         |   |      |       |       |   |
| Cash, at end of year                                                         |   | $         | 882,712    |       | $      | — |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

F-7

----

 
|                                                     |   | **2002** |    | **2001** |   |
|----------------------------------------------------------|--------|----------|---------|----------|--------|
|                                                     |   |     |    |     |   |
| Supplemental Disclosure of Cash Flow  Information – |   |     |    |     |   |
| Cash paid during the period for:                         |   |     |    |     |   |
| Interest                                                 |   | $        | 483,162 |     | $      | 566,739 |   |
|                                                          |        |          |         |          |        |  |  |

 

Supplemental Disclosure of Non Cash Investing, Financing and OperatingActivities –

 

The Company entered into a capital lease during the year endedSeptember 30, 2002 to acquire equipment for $25,150.

 

During the year ended September 30, 2001, goodwill and accruedliabilities were reduced by $91,674 due to a post closing adjustment related tothe OCPS acquisition.

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-8

----

 

**REVCARE, INC. ANDSUBSIDIARIES**

Notes toConsolidated Financial Statements

 

September 30, 2002

 

1.               Organization and Basis of Presentation

 

RevCare, Inc. (formerly known as Cypress Financial Services, Inc.), aNevada corporation, (together with its subsidiaries, the “Company” or “we”),provides accounts receivable management, administration, and debt collectionservices primarily to healthcare providers and consumer credit issuers.

 

The accompanying consolidated financial statements have been preparedon a going concern basis, which contemplates the realization of assets andsettlement of obligations in the normal course of business.  The Company generated net losses of$3,565,492 and $2,436,347 in fiscal years 2002 and 2001, respectively.  In addition, the Company had totalshareholders’ equity of $2,561,004 and a working capital deficit of $2,507,290at September 30, 2002.

 

Management believes that the recent losses are attributable to thevarious acquisitions in 2000, the integration of their operations and theimplementation of technology and processes to pursue its strategicobjectives.  Additionally, the Companycontinues to obtain larger, higher margin contracts, while discontinuingcontracts with low margins.  Management,however, believes that the operating plan for subsequent fiscal years mayexperience significant challenges in light of ongoing changes in the industryand geographic market it serves which may require the Company to seek alternativesources for cash to support its growth and ongoing operations. Accordingly, theCompany has completed several transactions and completed operational changesdesigned to meet the company’s liquidity requirements, the most significant ofwhich are as follows:

 

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

 

•                                          OnMay 21, 2003, the Company’s wholly owned subsidiary, Medical Control Services,Inc. (MCI), which held title to our corporate facility completed the sale ofthe property to SCP Park Meadows, LLC (SCP). On that same date, the Company entered into a Lease Agreement dated May21, 2003 with SCP (the “Lease”). 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 tocollateralize the letters of credit used as rent deposits related to thesubsequent lease of the property equaled $1,352,361. See also Note 13,Subsequent Events, for more information on this matter.

 

F-9

----

 

•                                          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 underwhich FBR agreed to provide the Company a $1,000,000 convertible note.  The use of proceeds for the new $1,000,000note from FBR will be to reduce the collections payable to certain of theCompany’s California-based delinquent 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.

 

•                                          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 year 2003 and 2004.

 

•                                          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, hasprovided funding to the Company in the past.  As a component of theprocess of seeking any additional financing that may be required, managementmay approach 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 financing activities and reductions in operating costsdescribed above, management believes that the Company will have the sufficientworking capital it needs to pursue its ongoing growth and strategic goals forfiscal year 2003 and 2004.

 

2.               Summary of Significant AccountingPolicies

 

a.               Principles of Consolidation

 

The accompanying consolidated financial statements include the accountsof RevCare, Inc. and its wholly owned subsidiaries. All significantintercompany accounts have been eliminated in consolidation.

 

b.              Use of Estimates

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makecertain estimates and assumptions that affect the reported amounts of assetsand

 

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liabilities and disclosure of contingent assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting periods. Actual results could materially differfrom those estimates.

 

c.               Revenue Recognition

 

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

 

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

 

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

 

Revenue from the staffing division is recognized based upon hourlyrates, and is recorded as services are rendered.  The Company’s payroll system posts staffing division hours toindividual projects on a monthly basis. The Company bills its clients for the hours incurred at the contractrates. In August 2003, we entered into an Exchange Agreement with Russell andSuzette Mohrmann and their affiliate, Hospital Employee Labor Pool, aCalifornia corporation, or HELP, pursuant to which there was a transfer ofsubstantially all the assets related to our administrative and back officetemporary staffing division. See Note 13, “Subsequent Events” for moreinformation regarding this matter.

 

d.              Accounts Receivable and Allowance forDoubtful Accounts

 

As of September 30, 2002, Accounts Receivable and the related Allowancefor Doubtful Accounts were comprised of the following:

 
| Billed Receivables                                           |   | $         | 1,942,461 |   |
|--------------------------------------------------------------|--------|-----------|-----------|--------|
| Unbilled Receivables                                         |   | 259,990   |      |
| Total                                                        |   | 2,202,451 |      |
| Allowance for Doubtful Accounts                              |   | (167,081  | )         |
| Accounts Receivable, net of allowance for  doubtful accounts |   | $         | 2,035,370 |   |

 

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

 

We maintain allowances for doubtful accounts for estimated lossesresulting from our customer’s inability to make required payments.  Management reviews all accounts receivableon a monthly basis.  Specific 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.

 

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

 

e.               Property and Equipment

 

Property and equipment are carried at cost less accumulateddepreciation and amortization and are depreciated using either straight-line oraccelerated methods over the estimated useful lives of the assets, which aregenerally 4 to 7 years. The building is depreciated over a period of 39years.  Repairs and maintenance arecharged to expense as incurred; replacements and improvements that extend theuseful life of the assets are capitalized.

 

f.                 Collections Payable to Customers

 

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

 

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

 

g.              Fair Value of Financial Instruments

 

Fair value of financial instruments is estimated using available marketinformation and other valuation methodologies. Financial instruments includeaccounts receivable, note receivable from officer, mortgage and notes payableand capital lease obligations.  The fairvalues of the Company’s financial instruments are estimated to approximate thecarrying value due to their relatively short-term nature and fluctuatinginterest rates with market rates.

 

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h.              Goodwill

 

Goodwill represents the excess of cost over the fair value of netassets acquired and is amortized using the straight-line method over 20years.  The carrying value of goodwillis reviewed on a regular basis for the existence of facts or circumstances,both internally and externally, that may suggest impairment.  The Company periodically re-evaluates the originalassumptions and rationale utilized in the establishment of the carrying valueand estimated useful lives of goodwill. Upon the occurrence of a triggering event suggesting impairment exists,the Company uses a model similar to SFAS No. 121.  “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to Be Disposed Of” to determine the amount of any impairment.

 

i.                  Impairment of Long-Lived Assets

 

The Company assesses the recoverability of its long-lived assets on anannual basis or whenever adverse events or changes in circumstances or businessclimate indicate 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.

 

j.                  Loss Per Share

 

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

 

For the year ended September 30, 2002, the computations of basic anddiluted EPS and the reconciliation of the numerator and denominator included inthe calculations were as follows:

 
|                                                    |   | **Basic EPS** |       | **Diluted  EPS** |   |
|---------------------------------------------------------|--------|---------------|------------|------------------|--------|
|                                                    |   |          |       |             |   |
| Numerator – net loss                               |   | $             | (3,565,492 | )                | $      | (3,565,492 | ) |
|                                                    |   |          |       |             |   |
| Denominator – weighted average shares  outstanding |   | 21,526,909    |       | 21,526,909       |   |
|                                                    |   |          |       |             |   |
| Loss per share                                          |   | $             | (0.17      | )                | $      | (0.17 | ) |

 

For the year ended September 30, 2001, the computations of basic anddiluted EPS and the reconciliation of the numerator and denominator included inthe calculations were as follows:

 

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|                                                    |   | **Basic EPS** |       | **Diluted  EPS** |   |
|---------------------------------------------------------|--------|---------------|------------|------------------|--------|
|                                                    |   |          |       |             |   |
| Numerator – net loss                               |   | $             | (2,436,347 | )                | $      | (2,436,347 | ) |
|                                                    |   |          |       |             |   |
| Denominator – weighted average shares  outstanding |   | 21,526,909    |       | 21,526,909       |   |
|                                                    |   |          |       |             |   |
| Loss per share                                          |   | $             | (0.11      | )                | $      | (0.11 | ) |

 

For the years ended September 30, 2002 and 2001, the denominator in thediluted EPS computation was the same as the denominator for basic EPS due tothe anti-dilutive effects of preferred stock, warrants and stock options on thecalculation. As of September 30, 2002 and 2001, the Company had outstandingwarrants and stock options and convertible preferred stock of 7,094,148, and8,107,352 respectively, that were anti-dilutive and excluded from thecomputation of dilutive EPS.

 

k.               Income Taxes

 

The Company accounts for income taxes using the asset and liabilitymethod. Under this method, deferred tax assets and liabilities are determinedbased on differences between the financial reporting and the tax basis ofassets and liabilities and are measured using the enacted tax rates andlaws.  A valuation allowance is providedfor certain deferred tax assets if it is more likely than not that the Companywill not realize tax assets through future operations.

 

l.                  Stock Option Plan

 

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

 

In 1995, the Company adopted, and the shareholders approved, the 1995Stock Option Plan (the Plan) which authorized 450,000 stock option grants topurchase the Company’s common stock. In August 1998, the Board of Directors andShareholders approved a 500,000-share increase to the Plan increasing the totalnumber of shares reserved for issuance pursuant to the Plan to 950,000shares.  During fiscal year 2000, theBoard of Directors and Shareholders approved increasing the total number ofshares reserved for issuance pursuant to the Plan to 3,250,000 shares.

 

The Plan provides for the grant by the Company, of options to purchaseshares of the Company’s common stock to its officers, directors, employees,consultants and advisors. The Plan provides that it is to be administered by acommittee appointed by the Board of Directors (the Committee) all of whom are“disinterested” under 16b-3 of the Securities Exchange Act of 1934, as amended.

 

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The Committee has discretion, subject to the terms of the Plan, toselect the persons entitled to receive options under the Plan, the terms andconditions on which options are granted, the exercise price, the time periodfor vesting such shares, the number of shares subject thereto, and whether suchoptions shall qualify as “incentive stock options” within the meaning ofSection 422 of the Internal Revenue Code, or “non-qualified stock options.”

 

The Company has granted 2,439,708 options under the Plan, of which1,053,050 have been forfeited. These options are issued at fair market value orat a 10 percent premium over fair market value if the individual is a 10percent or more shareholder. All options granted expire ten years from the dateof grant. At September 30, 2002, there were 1,863,342 additional sharesavailable for grant under the Plan.

 

During fiscal year 2002, the Company granted 60,000 options toemployees at an exercise price of $0.50 per share, which was equal to the fairmarket value of the Company’s common stock at the date of grant. Accordingly nocompensation expense was recorded.  Theoptions were later forfeited in fiscal 2002 when the employees terminated theiremployment with the Company.

 

A summary of the status of the Plan at September 30, 2002 and 2001 andchanges during the years then ended is presented in the table and narrativebelow:

 
|                             |   | **September  30, 2002** |   | **September  30, 2001**                    |   |
|----------------------------------|--------|-------------------------|--------|--------------------------------------------|--------|
|                             |   | **Shares**              |   | **Weighted****Average  Exercise****Price** |   | **Shares** |   | **Weighted****Average  Exercise****Price** |   |
| Outstanding at beginning of year |   | 1,931,908               |   | $                                          | 0.65   |   | 1,484,608 |   | $ | 0.70 |   |
| Granted                          |   | 60,000                  |   | 0.50                                       |   | 455,000 |   | 0.50 |   |
| Exercised                        |   | —                  |   | —                                     |   | — |   | — |   |
| Forfeited                        |   | (605,250                | )      | 0.67                                       |   | (7,700 | ) | 2.08 |   |
| Outstanding at end of year       |   | 1,386,658               |   | $                                          | 0.63   |   | 1,931,908 |   | $ | 0.65 |   |
|                             |   |                    |   |                                       |   |   |   |   |   |
| Exercisable at end of year       |   | 955,372                 |   | $                                          | 0.69   |   | 1,226,110 |   | $ | 0.83 |   |

 

| **Range of  Exercise Price** |   | **Number of  Shares  Outstanding** |   | **Weighted  Average  Remaining  Contractual Life  in Years** |   | **Weighted  Average  Exercise Price** |   |
|------------------------------|--------|------------------------------------|--------|--------------------------------------------------------------|--------|---------------------------------------|--------|
| $0.50 –  $1.03          |   | 934,022                            |   | 7.4                                                          |   | $                                     | 0.65   |   |
| $2.75                        |   | 21,350                             |   | 4.0                                                          |   | $                                     | 2.75   |   |
|                         |   | 955,372                            |   |                                                         |   |                                  |   |

 

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The fair value of each option grant is estimated on the date of grantusing the Black Scholes Option Pricing Model with the following assumptions in2002 and 2001: weighted average risk-free interest rate of 5.1 and 5.5 percent;respectively, a weighted average volatility of 161.3 and 154.2 percent;respectively, an expected life of 5 and 7 years, respectively; and no expecteddividend yield. Under the fair value provisions of SFAS 123, the pro formaimpact to Net Loss and EPS is as follows:

 
|         |   |        |   | **2002** |       | **2001** |   |
|--------------|--------|-------------|--------|----------|------------|----------|--------|
| Net Loss:    |   | As Reported |   | $        | (3,565,492 | )        | $      | (2,436,347 | ) |
|         |   | Pro Forma   |   | $        | (3,701,406 | )        | $      | (2,539,484 | ) |
| Basic EPS:   |   | As Reported |   | $        | (0.17      | )        | $      | (0.11 | ) |
|         |   | Pro Forma   |   | $        | (0.17      | )        | $      | (0.12 | ) |
| Diluted EPS: |   | As Reported |   | $        | (0.17      | )        | $      | (0.11 | ) |
|         |   | Pro Forma   |   | $        | (0.17      | )        | $      | (0.12 | ) |

 

m.            Rental Operations

 

The Company leases a portion of its building to unrelated parties underlease terms expiring from 2005 through 2006. Management allocates certain costsincurred to rental operations based on a ratio of square footage leased to the totalsquare footage of the respective building. The results of rental operations for the years ended September 30, 2002and 2001 are as follows (see Note 10):

 
|                |   | **2002** |    | **2001** |   |
|---------------------|--------|----------|---------|----------|--------|
|                |   |     |    |     |   |
| Rental income       |   | $        | 210,244 |     | $      | 236,953 |   |
| Utilities and other |   | (117,800 | )       | (152,810 | )      |
|                |   |     |    |     |   |
|                |   | $        | 92,444  |     | $      | 84,143 |   |

 

n.              Recent Accounting Pronouncements

 

In June 2001, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standard (SFAS) No. 141, “BusinessCombinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.”  SFAS No. 141 addresses financial accountingand reporting for business combinations and is effective for all businesscombinations after June 30, 2001. The Company will apply the provisions of SFASNo. 141 for any business combinations entered into beginning July 1, 2001.  SFAS No. 142 addresses financial accountingand reporting for acquired goodwill and other intangible assets and iseffective for the Company’s fiscal year beginning October 1, 2002.  SFAS No. 142 eliminates the amortization ofintangible assets with indefinite lives such as goodwill, and requires anannual impairment test of such tangibles. In fiscal year 2002, the Companyrecorded $528,960 in amortization expense related to Goodwill. In fiscal year 2003,the Company’s adoption of this accounting pronouncement resulted in animpairment of $1,576,328 of goodwill associated with its temporary staffingbusiness segment. This impairment was recorded in the first quarter of fiscalyear 2003.

 

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In June 2001, the FASB issued SFAS No. 143, “Accounting for AssetRetirement Obligations.” SFAS No. 143 addresses the recognition and measurementof obligations associated with the retirement of tangible long-livedassets.  SFAS No. 143 applies to legalobligations associated with the retirement of long-lived assets resulting fromthe acquisition, construction, development or the normal operation of along-lived asset. SFAS No. 143 required that the fair value of an assetretirement obligation be recognized as a liability in the period in which it isincurred. The asset retirement obligation is to be capitalized as part of thecarrying amount of the long-lived asset and the expense is to be recognizedover the estimated useful life of the long-lived asset. SFAS No. 143 iseffective June 15, 2002, with early adoption permitted. The Company adoptedSFAS No. 143 effective October 1, 2002, which did not have a material impact onthe Company’s financial position or results of operations.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses the financial accounting and reporting for theimpairment of long-lived assets and for long-lived assets to be disposed of andis effective for fiscal years beginning after December 15, 2001.  This statement supersedes SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto Be Disposed Of;” however, it retains the fundamental provisions of SFAS No.121 for (i) recognition and measurement of the impairment of long-lived assetsto be held and used and (ii) measurement of long-lived assets to be disposed ofby sale.  This statement also supersedesthe accounting and reporting provisions of APB Opinion No. 30, “Reporting theResults of Operations – Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions” for the disposal of a segment of a business.  The adoption of SFAS No. 144 did not have amaterial impact on the Company’s financial position or results of operations(see also Note 13, “Subsequent Events”).

 

In April 2002, the FASB issued No. SFAS 145, “Rescission of FASBStatements 4, 44, and 64, Amendment of FASB Statement 13, and TechnicalCorrections.”  SFAS No. 145 rescindsSFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and SFASNo. 64, “Extinguishment of Debt Made to Satisfy Sinking-FundRequirements.”  Accordingly, a gain orloss from a debt extinguishment should not be classified as an extraordinaryitem unless it meets the criteria for extraordinary item classification in APBOpinion 30, “Reporting the Results of Operations — Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual, andInfrequently Occurring Events and Transactions.”  SFAS No. 145 also rescinds SFAS No. 44, “Accounting forIntangible Assets of Motor Carriers,” because transition to the Motor CarrierAct of 1980 is complete and intrastate operating rights have beenderegulated.  SFAS No. 145 is effectivefor financial statements issued on or after May 15, 2002.  The implementation of this standard did nothave a material effect upon the Company’s financial statements.

 

In June 2002, the FASB approved for issuance SFAS No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities.”  This Statement provides financial accountingand reporting guidance for costs associated with exit or disposal activitiesand nullifies EITF Issue 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring).” SFAS No. 146 is effective for exit or disposal activities initiated afterDecember 31, 2002.  Previously issuedfinancial

 

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statements should not be restated. The provisions of EITF Issue 94-3 continue to apply for an exit activityinitiated under an exit plan that met the criteria in EITF Issue 94-3 beforethe Statement’s initial application. The implementation of this statement did not have a material effect uponthe Company’s financial statements.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure”, an amendment of FASB Statement No.123.  The disclosure requirements ofStatement 123, “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.

 

The amendments to the disclosure and transition provisions of Statement123 are effective for fiscal years ending after December 15, 2002.  Calendar year-end entities are required toinclude the new disclosures in their 2002 financial statements.  The disclosure requirement for interimfinancial information is effective for interim periods beginning after December15, 2002.  Management does not intend totransition to the fair value method of accounting for stock options andbelieves implementation of this standard will not have a material effect uponthe Company’s financial statements except to include the additional requireddisclosures.

 

The FASB issued Interpretation No. 45, “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others,” – an interpretation of FASB Nos. 5, 57 and 107 andrescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at theinception of a guarantee, a liability for the fair value of the obligationundertaken in issuing the guarantee. The initial recognition and measurement provisions of thisInterpretation are applicable on a prospective basis to guarantees issued ormodified after December 31, 2002. Implementation of these provisions of the Interpretation is not expectedto have a material impact on the Company’s consolidated financial statements.  The disclosure requirements of theInterpretation are effective for financial statements of interim or annualperiods ended after December 15, 2002, and have been adopted in theaccompanying consolidated financial statements for September 30, 2002 (see Note10 (d)).

 

The FASB has issued Interpretation No. (FIN) 46, “Consolidation ofVariable Interest Entities” – an interpretation of Accounting Research Bulletin(“ARB”) No. 51.  This Interpretationdefines a

 

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variable interest entity and provides that if a business enterprise hasa controlling 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 the businessenterprise.  Furthermore, the Boardindicates that the voting interest approach of ARB No. 51 is not effective inidentifying controlling financial interests in entities that are notcontrollable through voting interest or in which the equity investors do notbear the residual economic risk.  ThisInterpretation applies immediately to variable interest entities created afterJanuary 31, 2003, and to variable interest entities in which an enterpriseobtains an interest after that date.  Asa result of the issuance of FASB Staff Position FIN 46-6 “Effective Date ofFASB Interpretation No. 46, Consolidation of Variable Interest Entities,” FIN46 applies at the end of the interim or annual period ending after December 15,2003, to variable interest entities in which an enterprise holds a variableinterest that it acquired before February 1, 2003.  Management believes the implementation of this Interpretationwill not have a material effect upon the Company’s financial statements.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity.”This Statement establishes standards for how an issuer classifies and measurescertain financial instruments with characteristics of both liabilities andequity. It requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances). ThisStatement is effective for financial instruments entered into or modified afterMay 31, 2003, and otherwise is effective at the beginning of the first interimperiod beginning after June 15, 2003. The adoption of this statement will nothave a material impact on our financial condition or results from operations.

 

o.              Reclassification

 

Certain amounts in the accompanying 2001 consolidated financialstatements have been reclassified to conform to the presentation used in 2002.

 

3.               Acquisition and Goodwill

 

On August 14, 2000, Cypress Financial Services, Inc. completed thepurchase of all of the outstanding stock of Orange County Professional Service,Inc. (“OCPS”).  OCPS became a subsidiaryof Cypress 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.

 

4.               Related Party Transactions

 

As part of Mr. Manny Occiano’s originalemployment agreement, Mr. Occiano is eligible to participate in the managementbonus pool to be established by the Board of Directors and is entitled, during1999 only, to quarterly advances of $22,500 to be credited against the

 

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management bonus when earned.  Mr. Occiano received four such advancesamounting to $90,000.  This amount is tobe credited against future management bonuses when earned.   Mr. Occiano also received a loan of$100,000 to purchase 66,000 shares of common stock on the open market.  The loan is secured by a pledge of thecommon stock acquired.

 

In conjunction with the acquisition of OCPS, on August 14, 2000 theCompany issued $3,675,000 of secured convertible promissory notes toshareholders and officers of OCPS, who were employees or officers of theCompany as of September 30, 2002.  Allof these notes bear interest at the rate of 8 percent per annum. Of thesenotes, a total of $3,503,500 mature in January 2003 and the remaining notematures in August 2003, at which time the unpaid principal balances and allaccrued and unpaid interest are due. The balance of these notes at September 30, 2002 was $3,647,430.  At the option of the holder, the notes areconvertible into common stock at $0.735 per share. Certain of these notes wereamended and/or retired as part of various transactions that were executed in2003. See Note 13, “Subsequent Events” for additional information regardingthese matters.

 

A convertible note payable to an individual (related party) for$143,930 of principal and interest was outstanding at September 30, 2002, andis due in monthly installments of $13,613 through August 2003.  Interest on the note is payable at 8 percentper annum.  At the option of the holder,any unpaid principal balance may be converted into the Company’s common stockat $.0735 per share.

 

On September 28, 2001, the Company entered into a revolving line ofcredit agreement with two officers of the Company.  The agreement permits borrowings up to $350,000 at the bankreference (5.25% at September 30, 2002) rate plus one percent.  The line of credit is unsecured and expireson January 2, 2003.  At September 30,2002 we owed $350,000 on this line of credit. On January 2, 2003, we entered into an amendment with these officers inwhich the maturity date was extended to January 2, 2004. This agreement wasamended in June 2003. Please see Note 13, “Subsequent Events” for more information regarding this amendment.

 

On July 22, 2002, the Company entered into a $100,000 note payable withits majority stockholder, FBR Financial Services Partners, L.P. (FBR) The notebears interest at the bank reference rate (5.25% at September 30, 2002) plusone percent and is payable on demand, but is subordinate to a note from anofficer of the Company.  The note isunsecured.

 

On September 19, 2002, the Company entered into a $1,000,000convertible note payable (“Note”) with its majority shareholder, FBR.  The note bears interest at 12 percent perannum and is payable on demand, but is subordinate to a note from an officer ofthe Company.   The note is convertibleinto the Company’s common stock concurrently or at any time following an equityfinancing of common stock (“Financing”) at a conversion price equal toeighty-five percent (85%) of the price per share at which the common stock issold in the Financing.  The Companycomputed the intrinsic value of the beneficial conversion feature attributableto the convertible note to be $176,471, which will be charged to expense at thetime of a Financing.  This agreement wasamended in August 2003.  Please see thefollowing paragraph for more information regarding this amendment.

 

On August 29, 2003, the aforementioned $100,000 unsecured note payableand the $1,000,000 convertible note payable including combined accrued interestof $120,325 were amended and restated into a new $1,220,325 secured convertiblepromissory note.  The significantamendments to the previous notes include the following:

 

•                  The maturitydate was extended to September 1, 2005

 

F-20

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

 

•                  All or anyportion of the unpaid principal balance and any accrued but unpaid interestoutstanding under this Note may be converted into fully paid and nonassessableshares of capital stock of the Company (the “Stock”) concurrently upon or atany 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.

 

On August 13, 2003, the Company executed the relevant documents underwhich FBR agreed to provide the Company a $500,000 unsecured note. The proceedsof this note were used for working capital purposes.  On August 29, 2003, the Company executed the relevant documentsunder which FBR agreed to provide the Company a $1,000,000 convertiblenote.  The proceeds for 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, the aforementioned $500,000 unsecured note and the$1,000,000 convertible note including combined accrued interest of $2,000 wereamended and restated into a new $1,502,000 secured convertible promissorynote.  The significant amendments to theprevious notes include the following:

 

•                  The maturitydate was extended to September 1, 2005 with all outstanding principal andaccrued interest 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 rateson the notes were changed to the prime rate charged by the Company’s lender(5.5% at December 31, 2003) plus 4% per annum payable on the maturity date.

 

•                  All or anyportion of the unpaid principal balance and any accrued but unpaid interestoutstanding under this Note may be converted into fully paid and nonassessableshares of capital stock of the Company (the “Stock”) concurrently upon or atany 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.

 

F-21

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

 

On August 29, 2003, the Company entered into an Exchange Agreement withRussell and Suzette Mohrmann and their affiliate, Hospital Employee Labor Pool,a California corporation, or HELP, pursuant to which the transfer wasconsummated. See Note 13, “Subsequent Events” for more information regardingthis agreement.

 

5.               Property and Equipment

 

Property and equipment consists of the following at September 30, 2002:

 
| Land                               |   | $          | 866,575   |   |
|------------------------------------|--------|------------|-----------|--------|
| Building                           |   | 1,540,577  |      |
| Furniture, fixtures and equipment  |   | 2,472,035  |      |
|                               |   |       |      |
|                               |   | 4,879,187  |      |
| Less—Accumulated depreciation |   | (1,631,914 | )         |
|                               |   |       |      |
|                               |   | $          | 3,247,273 |   |

 

Depreciation expense for the years ended September 30, 2002 and 2001totaled $452,228 and $346,788, respectively. At September 30, 2002, the costand accumulated amortization of equipment under capital leases was $534,321 and$324,983, respectively.

 

6.               Intangible Assets

 

Intangible assets consists of the following at September 30, 2002:

 
| Goodwill                           |   | $          | 10,773,940 |   |
|------------------------------------|--------|------------|------------|--------|
| Less—Accumulated amortization |   | (1,152,261 | )          |
|                               |   |       |       |
|                               |   | $          | 9,621,679  |   |

 

7.               Lines of Credit

 

The Company has a line of credit with a bank, which permits borrowingsup to a maximum of $300,000 at the bank’s reference rate of prime plus twopercent (6.75 percent at September 30, 2002). The line of credit expires on May 1, 2003.  At September 30, 2002, borrowings onthe line totaled $50,294.  Borrowingsare secured by substantially all the assets of OCPS, including accountsreceivable and equipment, as well as guaranteed by the prior owner of OCPS, whoare employees of the Company. All outstanding principal and interest related tothis borrowing were paid in full in May, 2003.

 

On November 19, 2001, the Company entered into a secured line of creditwith a bank, which provides for borrowings up to $1,000,000 at the bank’sreference rate plus five percent (9.75

 

F-22

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percent at September 30, 2002). The line expires on January 20, 2003which was subsequently extended to February 20, 2003. At September 30, 2002 theborrowings on the line totaled $394,540. All outstanding principal and interestowed under this borrowing were paid in full in February 2003.

 

8.               MortgageNote Payable

 

The Company has a mortgage note payable to a bank in the amount of$2,886,894, collateralized by land and a building, due in monthly payments of$25,984, bearing interest at an interest rate based on the yield of the U.S.Five Year Treasury Swap Rate (“the Index”) plus 2.5 percent and no cap.  Said rate will be fixed for five years andadjusted on the first business day of each five-year anniversary date of thepromissory note dated December 19, 2000 through January 2021, at which time theentire principal balance becomes due and payable.  At September 30, 2002, the interest rate was 8.4%. Alloutstanding principal and interest owed under this note was paid in May 2003 aspart of the Sale and Leaseback transaction that the Company consummated at thattime.  See Note 13, “Subsequent Events”for more information on this transaction. The Sale and Leaseback transactionwas accounted for as a financing transaction. Accordingly, the future scheduledmaturities after September 2002, as disclosed below, reflect the amounts dueunder the Lease Agreement.

 

Future scheduled maturities of the Lease Agreement at September 30, areas follows:

 
| Fiscal Years Ending September 30, |   |      |      |
|-----------------------------------|--------|-----------|-----------|
| 2003                              |   | $         | 233,727   |   |
| 2004                              |   | 647,244   |      |
| 2005                              |   | 647,244   |      |
| 2006                              |   | 647,244   |      |
| 2007                              |   | 647,244   |      |
| Thereafter                        |   | 4,962,204 |      |
| Total                             |   | $         | 7,784,907 |   |

 

9.               CapitalTransactions

 

a.                                       SeriesA Convertible, Redeemable Preferred Stock

 

On September 30, 1996, the Company converted the balance of notesissued in connection 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 anti-dilutionprovisions. 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$2.00 per share over common shareholders.

 

F-23

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b.                                      CommonStock

 

On May 30, 2000, the Company sold 15,000,000 shares of its common stockto FBR Financial Services Partners, L.P. for $7,500,000 (FBR), representing69.8 percent of the outstanding common stock of the Company on a fully dilutedbasis.  Offering costs related to thistransaction were $446,856.

 

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

 

c.               Warrants

 

On February 12, 1999, the Company issued a warrant to Batchelder &Partners, Inc. to purchase up to 400,000 shares of the Company’s common stockin connection with their agreement to act as the Company’s non-exclusivefinancial advisor. This warrant is subject to specific exercise prices rangingfrom $1.75 to $4.75 with a weighted average exercise price of $3.06.Additionally, this warrant is subject to vesting provisions whereas 100,000shares vested immediately and the balance vests if and when certain definedtargets are achieved based upon the Company’s enterprise value, asdefined.  The next 50,000 warrants vestupon an enterprise value of $17.29 million.   The warrant is exercisable until November 13, 2005.

 

The fair value of the warrant was estimated to be $415,000 on the dateof grant using the Black-Scholes Option Pricing model with the followingassumptions: weighted average risk-free interest rate of 4.5 percent; aweighted average volatility of 86.9 percent; an expected life of 6.75 years;and no expected dividend yield. This amount will be recognized in the incomestatement during the period the services are deemed to have been provided.During the year ended September 30, 1999, the Company recognized advisory feesof $100,000 relating to this warrant and no expense has been recognized for anyperiod since then. Any remaining expense will be recognized in future periodsif and when various conditions to vesting have been met.

 

10.         Commitments and Contingencies

 

a.                                       Lessee - TheCompany leases certain office space and equipment under non-cancelableoperating and capital leases that expire at various times through fiscal2006.  Future annual minimum leasepayments, in the aggregate, under operating and capital leases atSeptember 30, 2002 are as follows:

 
| **Year Ending September 30**               |   | **Operating** |   | **Capital** |    |
|--------------------------------------------|--------|---------------|--------|-------------|---------|
|                                       |   |          |   |        |    |
| 2003                                       |   | $             | 42,750 |        | $       | 117,618 |   |
| 2004                                       |   | 19,186        |   | 102,557     |    |
| 2005                                       |   | —        |   | 41,294      |    |
| 2006                                       |   | —        |   | 16,013      |    |
|                                       |   |          |   |        |    |
| Total minimum lease payments               |   | $             | 61,936 |        | $       | 277,482 |   |
|                                       |   |          |   |        |    |
| Less – Amounts representing interest  |   |          |   | 57,834      |    |
|                                       |   |          |   |        |    |
| Present value of capital lease obligations |   |          |   | 219,648     |    |
| Less – current portion                |   |          |   | 87,343      |    |
|                                       |   |          |   |        |    |
|                                       |   |          |   | $           | 132,305 |   |

 

F-24

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Rent expense under all operating leases totaled $66,433 in 2002 and$28,272 in 2001.

 

b.              Lessor - Asdiscussed in Note 1, the Company sub-leases a portion of its building tounrelated entities under operating leases which expire at various times throughfiscal 2005. The Company leases to several tenants on a month-to-month basis.Future annual collections of rental income under non-cancelable operatingleases as of September 30, 2002 are scheduled as follows:

 
| Years Ending September 30, |   |   |    |
|----------------------------|--------|--------|---------|
|                       |   |   |    |
| 2003                       |   | $      | 62,470  |   |
| 2004                       |   | 54,378 |    |
| 2005                       |   | 61,819 |    |
|                       |   |   |    |
|                       |   | $      | 178,667 |   |

 

c.               Employment Agreements

 

On May 30, 2000, the Company entered into a three-year employmentagreement with the Chief Executive Officer. On August 14, 2000, the Company entered into a two-year and a three-yearemployment agreement with two of its Vice Presidents.  On January 2, 2001, the Company entered into a three-yearemployment agreement with its Chief Financial Officer.  The agreements provide for annual salaries,paid vacations and other related benefits. The minimum annual compensation pursuant to such agreements, excludingprovisions for fringe benefits (e.g., vacations, etc.), will be approximately$710,417 and $66,667 in fiscal years 2003 and 2004, respectively. Theseemployment contracts were amended in 2003. See Note 13, “Subsequent Events” forsubsequent changes to these contracts.

 

d.              Guarantees

 

The Company indemnifies all directors and officers of the Company andany person who may have been identified by the Board of Directors.  The Company is obligated, among otherthings, to indemnify the directors and officers of the Company againstliabilities arising from their actions in their capacity as directors and executiveofficers.  The obligation has no maximumand extends into perpetuity.  TheCompany carries Directors and Officers (D&O) insurance of $1,000,000 forthe benefit of such persons.  Management expects such insurance wouldcover any costs that might be incurred under the indemnification agreements.

 

F-25

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e.               Litigation

 

The Company is involved, from time to time, in litigation that isincidental to its collection business. The Company regularly initiates legalproceedings as a plaintiff in connection with its routine collectionactivities. In management’s opinion, none of these legal matters individuallywill have a material adverse effect on the Company’s financial position or theresults of its operations

 

f.                 Other

 

As discussed in Note 2, the practice of transferring funds collected onbehalf of certain California-based delinquent debt clients to operatingaccounts or delay in remitting funds might be deemed a breach of the Company’sobligations. In July 2003, the Company reported that it has discontinued thispractice and has taken steps to reduce the collections payable balance. TheCompany believes that a potential consequence of any such potential breach isthat certain of our California-based delinquent debt collection clients mayfeel damaged and may request compensation. To the extent the Company is unableto reach an agreement with entities that request compensation, such entitiesmay initiate legal efforts to pursue claims against the Company. In connectionwith the process to reduce the collections payable balance owed to certain ofthe Company’s California-based delinquent debt collection clients, the Companywill contact those clients and offer to pay interest to those of which assert aclaim as a result of the Company’s past practice.

 

We have provided copies of our reports on Form 8-K filed on July 10,2003 and August 15, 2003, respectively, to the Division of Enforcement of theSecurities and Exchange Commission. Since that time, the SEC has notified theCompany that it has begun an informal investigation involving the Company. TheCompany is cooperating with the SEC in this process.  No provision has been included in the consolidated financialstatements for the impact of an unfavorable outcome, if any, should occur.

 

11.         Income Taxes

 

The benefits for income taxes for the years ended September 30,2002 and 2001 are shown in the table below:

 
|              |   | **2002** |   | **2001** |   |
|-------------------|--------|----------|--------|----------|--------|
|              |   |     |   |     |   |
| Federal:          |   |     |   |     |   |
| Current           |   | $        | — |     | $      | — |   |
| Deferred          |   | —   |   | —   |   |
| State:            |   |     |   |     |   |
| Current           |   | —   |   | —   |   |
| Deferred          |   | —   |   | —   |   |
| Total tax benefit |   | $        | — |     | $      | — |   |

 

A reconciliation of the total tax benefit from the Federal statutoryrate of 34 percent is as follows:

 

F-26

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|                                                   |   | **2002** |   | **2001** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                   |   |     |   |     |   |
| Federal statutory tax rate                             |   | (34.0    | )%     | (34.0    | )%     |
| State income taxes, net of Federal income  tax benefit |   | (8.6     | )      | (8.6     | )      |
| Other                                                  |   | 6.0      |   | 1.2      |   |
| Valuation Allowance                                    |   | 36.6     |   | 41.4     |   |
| Actual tax benefit                                     |   | —   | %      | —   | %      |

 

Because certain items of income and expense are not recognized in thesame year in the Company’s financial statements as in its Federal andCalifornia tax returns, deferred assets and liabilities are created.  As of September 30, 2002, the accompanyingconsolidated balance sheet reflects no deferred tax assets. The net deferredtax assets as of September 30, 2002 are disclosed in the table below:

 
|                            |   | **2002**   |   | **2001**   |   |
|---------------------------------|--------|------------|--------|------------|--------|
|                            |   |       |   |       |   |
| Deferred tax assets:            |   |       |   |       |   |
| Allowance for doubtful accounts |   | $          | 71,616 |       | $      | 107,920 |   |
| Vacation accrual                |   | 56,832     |   | 60,469     |   |
| Net operating loss              |   | 2,686,004  |   | 1,671,602  |   |
| Warrants                        |   | 42,840     |   | 42,840     |   |
| Other                           |   | 40,808     |   | 31,772     |   |
| Total deferred tax assets       |   | 2,898,100  |   | 1,914,603  |   |
|                            |   |       |   |       |   |
| Deferred tax liabilities:       |   |       |   |       |   |
| Securitization                  |   | (673,420   | )      | (673,420   | )      |
| Other                           |   | (59,564    | )      | (39,716    | )      |
| Total deferred tax liabilities  |   | (732,984   | )      | (713,136   | )      |
|                            |   |       |   |       |   |
| Valuation allowance             |   | (2,165,116 | )      | (1,201,467 | )      |
| Net deferred tax asset          |   | $          | — |       | $      | — |   |

 

As of September 30, 2002, the Company had approximately $6.1 millionand $3.2 million of federal and state net operating carry forwards,respectively.  The federal amount isavailable to offset future taxable incomes which expire in various yearsthrough 2022.  The state amount has beendeferred by legislative action and will not be available for use for two yearsbeginning with the fiscal year ending September 30, 2003.

 

12.         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

 

F-27

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and are not identified by segments. Presently, the Company issegregated into four divisions, which are as follows:

 

*Physician Services* –

 

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.

 

*Reimbursement Solutions –*

 

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.

 

*Temporary Staffing –*

 

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. InAugust 2003, we entered into an Exchange Agreement with Russell and SuzetteMohrmann and their affiliate, Hospital Employee Labor Pool, a Californiacorporation, or HELP, pursuant to which there was a transfer of substantiallyall the assets related to our administrative and back office temporary staffingdivision. See Note 13, “Subsequent Events” for more information regarding thismatter.

 

Below is a summary statement of operations for the twelve months endedSeptember 30, 2002 and 2001. The accounting policies used in the disclosure ofbusiness segments are the same as those described in the summary of significantaccounting policies. Certain assumptions are made concerning the allocations ofcosts between segments that may influence relative results, most notably,allocations of various types of technology, legal, recruiting and trainingcosts. Management believes that the allocations utilized below are reasonableand consistent with the way it manages the business.

 

F-28

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The following table summarizes the results of our operating units forthe twelve months ended September 30, 2002 and 2001:

 

*For the twelvemonths ended September 30, 2002:*

 
|                                           |   | **Recovery** |      |   |   | **Physician  Services** |   |      |   | **Reimbursement  Solutions** |   |   |      | **Temporary  Staffing** |   |   |   | **Total**  |       |   |   |
|------------------------------------------------|--------|--------------|-----------|--------|--------|-------------------------|--------|-----------|--------|------------------------------|--------|--------|-----------|-------------------------|--------|--------|--------|------------|------------|--------|--------|
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Revenue                                        |   | $            | 5,076,778 |   | 100    | %                       | $      | 3,137,544 |   | 100                          | %      | $      | 3,530,896 |                    | 100    | %      | $      | 1,637,674  |       | 100    | %      | $ | 13,382,892 |   | 100 | % |
| Direct Labor                                   |   | 1,898,482    |      | 37     | %      | 1,654,391               |   | 53        | %      | 1,506,815                    |   | 43     | %         | 1,118,997               |   | 68     | %      | 6,178,685  |       | 46     | %      |
| Indirect Labor                                 |   | 863,844      |      | 17     | %      | 695,949                 |   | 22        | %      | 401,515                      |   | 11     | %         | 107,173                 |   | 7      | %      | 2,068,481  |       | 15     | %      |
| Other Expenses                                 |   | 750,599      |      | 15     | %      | 850,236                 |   | 27        | %      | 287,613                      |   | 8      | %         | 57,490                  |   | 3      | %      | 1,945,938  |       | 15     | %      |
| Total Expenses                                 |   | 3,512,925    |      | 69     | %      | 3,200,576               |   | 102       | %      | 2,195,943                    |   | 62     | %         | 1,283,660               |   | 78     | %      | 10,193,104 |       | 76     | %      |
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Operating income (loss)                        |   | $            | 1,563,853 |   | 31     | %                       | $      | (63,032   | )      | (2                           | )%     | $      | 1,334,953 |                    | 38     | %      | $      | 354,014    |       | 22     | %      | $ | 3,189,788 |   | 24 | % |
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Selling, general & administrative expenses |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | (5,093,529 | )          | (38    | )%     |
| Depreciation & amortization                |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | (995,759   | )          | (7     | )%     |
| Losses on portfolio receivables                |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | (70,667    | )          | 1      | %      |
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Loss from Operations                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | $          | (2,970,167 | )      | (22    | )% |

 

F-29

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*For the twelvemonths ended September 30, 2001:*

 
|                                           |   | **Recovery** |      |   |   | **Physician  Services** |   |      |   | **Reimbursement  Solutions** |   |   |      | **Temporary  Staffing** |   |   |   | **Total**  |       |   |   |
|------------------------------------------------|--------|--------------|-----------|--------|--------|-------------------------|--------|-----------|--------|------------------------------|--------|--------|-----------|-------------------------|--------|--------|--------|------------|------------|--------|--------|
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Revenue                                        |   | $            | 6,536,699 |   | 100    | %                       | $      | 2,672,615 |   | 100                          | %      | $      | 1,245,921 |                    | 100    | %      | $      | 3,703,509  |       | 100    | %      | $ | 14,158,744 |   | 100 | % |
| Direct Labor                                   |   | 2,254,317    |      | 34     | %      | 1,411,556               |   | 53        | %      | 558,286                      |   | 45     | %         | 2,710,560               |   | 73     | %      | 6,934,719  |       | 49     | %      |
| Indirect Labor                                 |   | 1,241,634    |      | 19     | %      | 595,613                 |   | 22        | %      | 193,689                      |   | 16     | %         | 127,558                 |   | 3      | %      | 2,158,494  |       | 15     | %      |
| Other Expenses                                 |   | 1,136,861    |      | 17     | %      | 813,339                 |   | 30        | %      | 160,173                      |   | 13     | %         | 56,363                  |   | 2      | %      | 2,166,736  |       | 15     | %      |
| Total Expenses                                 |   | 4,632,812    |      | 71     | %      | 2,820,508               |   | 106       | %      | 912,148                      |   | 73     | %         | 2,894,481               |   | 78     | %      | 11,259,949 |       | 80     | %      |
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Operating income (loss)                        |   | $            | 1,903,887 |   | 29     | %                       | $      | (147,893  | )      | (6                           | )%     | $      | 333,773   |                    | 27     | %      | $      | 809,028    |       | 22     | %      | $ | 2,898,795 |   | 20 | % |
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Selling, general & administrative expenses |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | (3,723,136 | )          | (26    | )%     |
| Depreciation & amortization                |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | (888,029   | )          | (6     | )%     |
| Losses on portfolio receivables                |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | (241,381   | )          | (2     | )%     |
|                                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   |       |       |   |   |
| Loss from Operations                           |   |         |      |   |   |                    |   |      |   |                         |   |   |      |                    |   |   |   | $          | (1,953,751 | )      | (14    | )% |

 

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13.         Subsequent Events

 

a.               Changes in Management EmploymentAgreements

 

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.

 

b.              Sale/Leaseback of Building

 

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 to collateralizethe letters of credit used as rent deposits related to the subsequent lease ofthe property equaled $1,352,361. The transaction will be accounted for as afinancing transaction. Accordingly, no gains or losses will be recorded by theCompany. All proceeds from this transaction will be recorded as a financingobligation. The Lease provides, among other things, all of the following:

 

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

 

• base rentof $53,937 per month for the first three years of the Lease, with annualadjustments thereafter based on an index, subject to minimum and maximum annualincreases

 

• a tenantimprovement allowance of $50,000;

 

• theCompany has responsibility for various costs, including those associated withmaintaining, insuring, repairing and replacing items on the property;

 

• securitydeposits in the form of two irrevocable letters of credits totaling $1,050,000,$400,000 of which is subject to release within twelve months upon satisfactionof specified conditions;

 

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

 

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

 

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c.               Dispositionof Segment

 

On August 29, 2003 the Company negotiated the disposition of itstemporary staffing segment (the “Staffing Business”), and 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. Pursuant to the terms of the ExchangeAgreement, HELP has acquired substantially all of the assets of the StaffingBusiness in exchange for: (1) the reduction of $1,900,000 of the indebtednessthat the Company owed to the Mohrmanns and their affiliates under various notesthat the Company had previously issued to them when the Company acquired anumber of businesses from them in 2000, (2) the modification of the terms onthe remaining $646,719 owed to the Mohrmanns, including the extension of theCompany’s payment obligation, with payments of $25,000 now being due each monthcommencing approximately September 1, 2004, the termination of the securityinterest held by the Mohrmanns and the subordination of their debt to theCompany’s other lenders.  The impact ofthis disposition, had it occurred at beginning of fiscal 2002, would be areduction in revenue of $1,637,674 and an increase in loss from operations of$354,014.

 

d.              Modifications to debtmaturities/renegotiation of debt instruments

 

On September 28, 2001, the Company entered into a revolving line ofcredit agreement with two officers of the Company.  The agreement permits borrowings up to $350,000 at the bankreference rate plus one percent.  Theline of credit is unsecured and expires on January 2, 2003.  At September 30, 2002 we owed $350,000 onthis line of credit.  In connection withthe Disposition of Segment discussed in Note 13 (c.) above, the maturity datewas extended to June 15, 2004.

 

In connection with the transfer of all of the assets of the staffingbusiness, the Company further amended and restated the terms of the promissorynote originally issued to these officers. In September 2001, the officers personally borrowed funds from a commercialbank and then loaned the proceeds to us. The Company agreed to make interest payments to their commercial lenderto the same extent the officers were required to make payments under theircommercial bank loan, which interest payments would be credited against thenote the Company had issued.  In June2003, the terms of the officers’ commercial bank loan were modified to requiremonthly payments of principal in the amount of $25,000 plus all accrued butunpaid interest.  Accordingly, theCompany modified the terms of its promissory note in favor of the officers toprovide for the same payment terms, which payments shall be paid directly by usto the commercial lender and shall be credited against the amended and restatednote.

 

e.               New financing

 

On February 11, 2003, the Company entered into a Business FinancingAgreement (“Financing Agreement”) with Bridge Bank. The Company may borrow upto $2,500,000 under the conditions set forth in the Financing Agreement and theoutstanding balance of principal and accrued interest under this FinancingAgreement was $418,913 at December 31, 2003. The maximum amount we can borrow iscontingent on and collateralized by qualified invoices, which will fluctuatefrom time to time depending on our business volume.  As of December 31, 2003 we have borrowed the maximum amountavailable under this line.  Part of theproceeds of this Financing Agreement was used to pay all outstandingprincipal and interest under the Company’s Line of Credit Agreement, whichexpired in January 2003. The obligations under the Financing Agreement aresecured by first priority liens in all of the Company’s assets and the assetsof its subsidiaries pursuant to the terms and conditions of securityagreements. The obligations are also guaranteed by the subsidiaries under theterms and conditions of guaranties.

 

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 usedfor working capital. The agreement, which bears interest at prime plus 4%,requires the Company to make 12 monthly principal and interest payments of$22,444 through February 2005. The obligation is guaranteed by FBR.

 

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