Item 2. Management’s Discussion and Analysis of Financial Statements and Results of Operations
This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are based on management’s beliefs and assumptions and on information currently available to them. For this purpose, any statement contained in this report that is not a statement of historical fact may be deemed to be forward-looking, including statements about our revenue, spending, cash flow, products, new customer acquisitions, trends, actions, intentions, plans, strategies and objectives. Without limiting the foregoing, words such as “may,” “hope,” “will,” “expect,” “believe,” “anticipate,” “estimate,” “project,” “intend,” “budget,” “plan,” “forecast,” “predict,” “could,” “should,” or “continue” or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainty, and actual results may differ materially depending on a variety of factors, many of which are not within our control. These factors include but are not limited to economic conditions generally and in the industry in which we and our customers participate; the impacts of the Covid-19 pandemic and our ability to react to those impacts; cost reduction efforts by our existing and prospective customers; competition within our industry, including competition from much larger competitors; business combinations; legislative requirements or changes which could render our services less competitive or obsolete; our failure to successfully develop new services and/or products or to anticipate current or prospective customers’ needs; our ability to retain existing customers and to attract new customers; price increases; employee limitations; and delays, reductions, or cancellations of contracts we have previously entered.
Forward-looking statements are predictions and not guarantees of future performance or events. Forward-looking statements are based on current industry, financial and economic information, which we have assessed but which, by its nature, is dynamic and subject to rapid and possibly abrupt changes. Our actual results could differ materially from those stated or implied by such forward-looking statements due to risks and uncertainties associated with our business. We hereby qualify all our forward-looking statements by these cautionary statements. These forward-looking statements speak only as of their dates and should not be relied upon. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise (other than pursuant to reporting obligations imposed on registrants pursuant to the Exchange Act) to reflect subsequent events or circumstances.
The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes contained elsewhere in this report and in our other filings with the Commission.
Throughout this quarterly report on Form 10-Q, unless the context indicates otherwise, the terms, “we,” “us,” “our” or “the Company” refer to Pacific Health Care Organization, Inc., (“PHCO”) and our wholly-owned subsidiaries Medex Healthcare, Inc. (“Medex”), Industrial Resolutions Coalition, Inc. (“IRC”), Medex Managed Care, Inc. (“MMC”), Medex Medical Management, Inc. (“MMM”), Medex Legal Support, Inc., (“MLS”) and Pacific Medical Holding Company, Inc. (“PMHC”).
Overview
We incorporated under the laws of the state of Utah in April 1970, under the name Clear Air, Inc. We changed our name to Pacific Health Care Organization, Inc., in January 2001. In February 2001, we acquired Medex Healthcare, Inc. (“Medex”), a California corporation organized in March 1994, in a share for share exchange. Medex is in the business of managing and administering both Health Care Organizations (“HCOs”) and Medical Provider Networks (“MPNs”) in the state of California. In August 2001, we formed Industrial Resolutions Coalition, Inc. (“IRC”), a California corporation, as a wholly-owned subsidiary of PHCO. IRC oversees and manages the Company’s Workers’ Compensation Carve-Outs services. In June 2010, we acquired Medex Legal Support, Inc. (“MLS”), a Nevada corporation incorporated in September 2009. MLS offers lien representation services and Medicare Set-aside (“MSA”) services. In February 2012, we incorporated Medex Medical Management, Inc., (“MMM”) in the state of Nevada, as a wholly owned subsidiary of the Company. MMM is responsible for overseeing and managing medical case management services. In March 2011, we incorporated Medex Managed Care, Inc. (“MMC”) in the state of Nevada, as a wholly owned subsidiary of the Company. MMC oversees and manages the Company’s utilization review and bill review services. In October 2018, we incorporated Pacific Medical Holding Company, Inc. (“PMHC”) to act as a holding company for future potential acquisitions.
Business of the Company
We are workers’ compensation cost containment specialists providing a range of services principally to California employees and claims administrators. Our business objective is to deliver value to our clients that reduces their workers’ compensation related medical claims expense in a manner that will assure that injured employees receive high quality healthcare that allows them to recover from injury and return to gainful employment without undue delay. According to studies conducted by auditing bodies on behalf of the California Division of Workers’ Compensation, (“DWC”) the two most significant cost drivers for workers’ compensation are claims frequency and medical treatment costs.
Our clients include self-administered employers, insurers, third party administrators, municipalities and others. Our principal clients are in the State of California where the high cost of workers’ compensation insurance is a critical problem for employers. We have processed medical bill reviews in 25 states. Our provider networks are composed of experts in treating worker injuries.
Impact of Covid-19 on our Business
In late 2019 the novel coronavirus, Covid-19, was identified. By February 2020, the virus had spread to many countries around the world, including the United States. By late February, authorities in the United States began advising American businesses to prepare for the effects of the outbreak. On March 20, 2020, the governor of California issued a stay-at-home order except for essential services, such as grocery stores, gas stations and banks. In mid-March 2020 we implemented our disaster recovery and business plan addressing how our business operations would be performed by our employees working remotely. As a result, since late March 2020 nearly 100% of our employees have been working remotely and performing approximately 95% of our typical business functions, with the primary exceptions being certain manual, non-critical functions.
Even though we have been able to transition our work force and work flow to address the restrictions designed to “flatten the curve” of the Covid-19 pandemic, the extent of the long-term adverse effect of the Covid-19 pandemic on the economy, our industry and our results of operations and financial condition is unknown and largely dependent on future developments, most of which, including the severity and duration of this pandemic, are beyond our control.
Revenue for our services is derived from our employer customers’ employee counts and workers’ workplace injuries. Several of our employer customers, including some of our largest customers, have had to suspend or significantly modify their operations during the stay-at-home order issued by the governor of California. This stay-at-home order has been extended until July 15, 2020, although certain industries are being allowed to open with restrictions in place.
The governor of California has declared that any employee that becomes ill with Covid-19 will be assumed to have contracted the disease in the workplace if the worker worked any time during the fourteen-day period prior to the onset of the illness. This automatic assumption that the disease was contracted in the workplace effectively places the cost of employee medical care for Covid-19 treatment on employers.
The Actuary Committee of the California Workers’ Compensation Insurance Rating Bureau is presently attempting to assess the impact of the Covid-19 pandemic on future claims frequency and costs in relation to historically traditional claims frequency during times of severe economic downturn. They are especially focused on post-termination claims, work-at-home arrangements, and the Covid-19 presumption.
For the first two and one-half months of the quarter ended March 31, 2020, the Covid-19 outbreak did not have a significant impact on our business. We began to experience some slowdown in claims in the last two weeks of March, which has continued into the second quarter of 2020. At this time, however, we cannot predict if, how or when our employer customers will be allowed to reopen/ramp up their operations, and when reopened/ramped up, whether those operations, employee counts and workplace injuries will be the same or less than they were before the outbreak of the Covid-19 pandemic. We anticipate that reductions in employee counts and workplace injuries will negatively impact our revenues and have an adverse impact on our results of operations and liquidity position.
While we have taken steps to render our business functions remotely, to deploy these measures effectively and to do our best to ensure data security, there is no guarantee the measures we have taken will be completely effective, that our productivity will not be impacted, or that we will not encounter some of the common risks associated with a remote workforce, including employees accessing company data and systems remotely. As discussed in greater detail in Item 1A Risk Factors of our Annual Report on Form 10-K, our business could be materially and adversely affected by the potential interruptions to our business operations arising from the Covid-19 outbreak.
Results of Operations
The following represents selected components of our consolidated results of operations, for the three-month periods ended March 31, 2020 and 2019, respectively, together with changes from period-to-period:
|
|
For three months ended March 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
Amount of Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HCO
|
|
$
|
326,665
|
|
|
$
|
370,342
|
|
|
$
|
(43,677
|
)
|
|
|
(12
|
%)
|
MPN
|
|
|
120,749
|
|
|
|
123,865
|
|
|
|
(3,116
|
)
|
|
|
(3
|
%)
|
Utilization review
|
|
|
296,055
|
|
|
|
292,683
|
|
|
|
3,372
|
|
|
|
1
|
%
|
Medical bill review
|
|
|
83,079
|
|
|
|
134,997
|
|
|
|
(51,918
|
)
|
|
|
(38
|
%)
|
Medical case management
|
|
|
677,212
|
|
|
|
781,614
|
|
|
|
(104,402
|
)
|
|
|
(13
|
%)
|
Other
|
|
|
49,149
|
|
|
|
79,937
|
|
|
|
(30,788
|
)
|
|
|
(39
|
%)
|
Total revenues
|
|
|
1,552,909
|
|
|
|
1,783,438
|
|
|
|
(230,529
|
)
|
|
|
(13
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
17,231
|
|
|
|
18,884
|
|
|
|
(1,653
|
)
|
|
|
(9
|
%)
|
Bad debt provision
|
|
|
101
|
|
|
|
-
|
|
|
|
101
|
|
|
|
-
|
%
|
Consulting fees
|
|
|
75,693
|
|
|
|
79,635
|
|
|
|
(3,942
|
)
|
|
|
(5
|
%)
|
Salaries and wages
|
|
|
745,989
|
|
|
|
753,705
|
|
|
|
(7,716
|
)
|
|
|
(1
|
%)
|
Professional fees
|
|
|
87,226
|
|
|
|
77,965
|
|
|
|
9,261
|
|
|
|
12
|
%
|
Insurance
|
|
|
94,793
|
|
|
|
73,383
|
|
|
|
21,410
|
|
|
|
29
|
%
|
Outsource service fees
|
|
|
106,114
|
|
|
|
124,809
|
|
|
|
(18,695
|
)
|
|
|
(15
|
%)
|
Data maintenance
|
|
|
39,728
|
|
|
|
10,300
|
|
|
|
29,428
|
|
|
|
286
|
%
|
General and administrative
|
|
|
214,853
|
|
|
|
207,435
|
|
|
|
7,418
|
|
|
|
4
|
%
|
Total expenses
|
|
|
1,381,728
|
|
|
|
1,346,116
|
|
|
|
35,612
|
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
171,181
|
|
|
|
437,322
|
|
|
|
(266,141
|
)
|
|
|
(61
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes
|
|
|
171,181
|
|
|
|
437,322
|
|
|
|
(266,141
|
)
|
|
|
(61
|
%)
|
Income tax provision
|
|
|
(48,053
|
)
|
|
|
(122,759
|
)
|
|
|
74,706
|
|
|
|
(61
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
123,128
|
|
|
$
|
314,563
|
|
|
$
|
(191,435
|
)
|
|
|
(61
|
%)
|
Revenue
HCO
During the three-month periods ended March 31, 2020 and 2019, HCO fee revenues were $326,665 and $370,342 respectively. The 12% decrease in HCO revenue was primarily attributable to the loss of two customers, a decrease in the number of HCO notifications for existing customers due to employee reductions made by our customers and revenue from HCO employee notifications that was recognized in the first quarter in 2019 being shifted to the second quarter in 2020. These decreases were partially offset by an increase in the number of claims, renegotiation of certain deliverables to an existing customer and the addition of a new customer. HCO revenue is generated largely from fees charged to our employer customers for access to our HCO networks, per claim fees, notification fees and fees for other ancillary services the employer customers using our HCO networks may select. HCO notifications are mailed out annually and handed out by the employer for all new hires during the month. We prepare the mailings no earlier than three months prior to the end of the previous year’s enrollment so that our employers are able to prepare their employee rosters. Delays in the employer providing accurate and timely employee rosters can delay the notification process causing changes to when we record the revenues.
MPN
MPN fee revenue for the three-month periods ended March 31, 2020 and 2019, was $120,749 and $123,865, respectively, a decrease of 3% resulting from fewer claims reported by customers. Like HCO revenue, MPN revenue is generated largely from fees charged to our employer customers for access to our MPN networks, per claim fees and fees for other ancillary services the employer customers using our MPN networks may select. Unlike the HCO, MPNs do not require annual notifications, but only require a notice to be given to an injured worker at the time the employer is notified by the injured worker that an injury occurred.
Utilization review
During the three-month periods ended March 31, 2020 and 2019, utilization review revenue was $296,055 and $292,683, respectively. The increase of 1% in the 2020 period was primarily attributable to existing employer customers adding utilization review services to the suite of services they hire us to perform and an increase in the number of utilization reviews performed for existing employer customers who were already utilizing our utilization review services. These increases were partially offset by the loss of two customers. Our employer customers retain us to review proposals for treatment. Utilization review can provide a safeguard against unnecessary and inappropriate medical treatment from the perspective of medical necessity, quality of care, and appropriateness of decision-making.
Medical bill review
During the three-month period ended March 31, 2020, medical bill review revenue decreased 38% to $83,079 from $134,997 during the same period a year earlier. This decrease was due to a decrease in the volume of hospital bills reviewed and the completion of a project of a backlog of bills for an existing customer. This decrease was partially offset by an existing customer adding medical bill review services to the existing suite of services we provide for them. Medical bill review involves analyzing medical provider services and equipment billing to ascertain proper reimbursement. Such services include, but are not limited to, coding review and re-bundling, confirming that the services are customary and reasonable, fee schedule compliance, out-of-network bill review, pharmacy review, and preferred provider organization repricing arrangements. These services can result in significant network savings.
Medical case management
During the three months ended March 31, 2020 and 2019, medical case management revenue was $677,212 and $781,614, respectively. This decrease was primarily the result of a decrease in the number and amount of time spent on claims managed with existing customers, partially offset by certain existing customers expanding the suite of services they hire us to provide to include medical case management services. Medical case management keeps medical treatment claims progressing to a resolution and assures treatment plans are aligned from a medical perspective. Medical oversight is a collaborative process that assesses plans, implements, coordinates, monitors and evaluates the options and services required to meet an injured worker’s health needs. Medical case managers act as an ombudsperson between the injured worker, claims adjuster, medical providers and attorneys to achieve optimal results for injured workers and employer/clients.
Other
Other fees consist of revenue derived from network access, lien representation, legal support services, Medicare-set-aside and workers’ compensation carve-outs services. Other fee revenue for three-month periods ended March 31, 2020 and 2019, was $49,149 and $79,937, respectively. The decrease was due to fewer claims accessing our network and fewer Medicare-set-asides processed.
Expenses
Total expenses for the three months ended March 31, 2020 and 2019, were $1,381,728 and $1,346,116, respectively. The 3% increase was primarily due to increases in bad debt provision, professional fees, insurance, data maintenance and general and administrative, partially offset by decreases in depreciation, consulting fees, salaries and wages, and outsource service fees.
Depreciation
During the three-month period ended March 31, 2020, we recorded depreciation expense of $17,231 compared to $18,884 during the comparable 2019 period. The decrease in depreciation was due to equipment that had fully depreciated prior to the quarter ended March 31, 2020.
Bad debt
During the three-month period ended March 31, 2020, we recorded bad debt provisions of $101 compared to $0 during the comparable 2019 period. The increase in bad debt provision was due to the writing off bad debt of existing customers.
Consulting fees
Consulting fees decreased from $79,636 during the three months ended March 31, 2019, to $75,693 during the three months ended March 31, 2020. This decrease was the result of terminating a consultant.
Salaries and wages
During the three-month period ended March 31, 2020, salaries and wages decreased 1% to $745,989 compared to $753,705 during the same period in 2019. Salaries and wages were lower during the first quarter 2020 because we had one fewer full-time employee during that quarter.
Professional fees
For the three months ended March 31, 2020, we incurred professional fees of $87,226 compared to $77,965 during the three months ended March 31, 2019. The increase in professional fees was mainly the result of higher fees paid to our medical consultants and legal fees, which was partially offset by decreased professional fees paid for accounting and medical case management services.
Insurance
During the three-month period ended March 31, 2020, we incurred insurance expenses of $94,793, a 29% increase over the same three-month period in 2019. The increase in insurance expense was primarily attributable to increases in our group health insurance premiums. We expect insurance expenses will continue to increase during 2020.
Outsource service fees
Outsource service fees consist of costs incurred by our subsidiaries in outsourcing general administrative tasks, utilization review, medical bill review and medical case management services, and typically tends to increase and decrease in correspondence with increases and decreases in demand for those services. We incurred $106,114 and $124,809 in outsource service fees during the three-month periods ended March 2020 and 2019, respectively. The 15% decrease was the result of a decrease in volume from our customers that required outsource services for Medicare-set-asides, medical case management and utilization review. We anticipate our outsource service fees will continue to move correspondingly with the levels of client claims.
Data maintenance
During the three-month period ended March 31, 2020 and 2019, data maintenance fees were $39,728 and $10,300, respectively. The increase of 286% was primarily the result of recording the costs of notification associated with a customer’s annual HCO renotifications during the three-month period ended March 31, 2020 when compared to the same period in 2019.
General and administrative
During the three-month period ended March 31, 2020, general and administrative expenses increased 4% compared to the three-month period ended March 31, 2019. This increase was primarily attributable to increases in dues and subscriptions, licenses and permits, and telephone, partially offset by decreases in auto expenses, IT enhancements, equipment and repairs.
Income from Operations
Income from operations decreased 61% during the three-month period ended March 31, 2020 when compared to the same period in 2019, as the result of the 13% decrease in revenue and 3% increase in expenses.
Income Tax Provision
We realized income before taxes of $171,181 and $437,322 during the three-month periods ended March 31, 2020 and 2019, respectively. The decrease in income from operations resulted in a decrease in income tax provision of 61%.
Net Income
During the three-month period ended March 31, 2020, net income was $123,128 compared to $314,563 for the same period in 2019. As discussed above, this decrease in net income was primarily due to a decrease in income from operations and an increase in expenses.
Liquidity and Capital Resources
As of March 31, 2020, we had cash on hand of $8,489,281 compared to $8,104,164 as of December 31, 2019. The $385,117 increase was primarily the result of net cash provided by our operating activities, partially offset by cash used in investing activities. Net cash provided by our operating activities was the result of realizing net income coupled with increases in accounts payable, accrued expenses, income tax payable, and unearned revenue and decreases in accounts receivable, receivable – other, partially offset by decreased deferred rent expense and increased in prepaid expense.
We used $19,637 in investing activities to purchase computers, furniture and equipment.
In late April and early May 2020, we received three Payment Protection Program loans for PHCO, MMC and MMM in the amounts of $133,400, $59,600, and $267,700 respectively.
To date, we have not laid off or otherwise reduced our workforce as a result of Covid-19. As noted above, we have taken advantage of and may in the future avail ourselves of federal, state or local government programs to protect our workforce as management and our board of directors determine to be in the best interest of the Company and our shareholders.
Historically, we have generally realized positive cash flows from operating activities, which coupled with positive reserves of cash on hand have been used to fund our operating expenses and obligations. Management currently believes that absent any unanticipated Covid-19 impact, including, but not limited to a significant longer-term downturn in the economy or the loss of several major customers within a condensed time period, cash on hand and anticipated revenues from operations will be sufficient to cover our operating expenses over the next twelve months.
As the impact of the Covid-19 pandemic continues to play out throughout our industry and the broader economy, we believe our strong cash position, could allow us to identify and capitalize on potential opportunities to expand our business either through the acquisition of existing businesses that may have insufficient resources to overcome the impacts of the pandemic, including, expansion into the insurance industry or through the creation of new lines of business. Depending upon the nature of the opportunities we identify, such acquisitions or expansion could require greater capital resources than we currently possess. Should we need additional capital resources, we could seek to obtain such through debt and/or equity financing. We do not currently possess an institutional source of financing and there is no assurance that we could be successful in obtaining equity or debt financing when needed on favorable terms, or at all. We could also use shares of our capital stock as consideration for a business acquisition transaction, but there is also no assurance that there would be significant market interest in our capital stock.
Cash Flow
During the three months ended March 31, 2020, cash was primarily used to fund operations. We had a net increase in cash of $385,117 during the three months ended March 31, 2020, compared to a net increase of $295,667 during the three months ended March 31, 2019. See below for additional information.
|
|
For the three months ended March 31,
|
|
|
|
2020
(unaudited)
|
|
|
2019
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
404,754
|
|
|
$
|
297,951
|
|
Net cash used in investing activities
|
|
|
(19,637
|
)
|
|
|
(2,284
|
)
|
Net cash used in financing activities
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash
|
|
$
|
385,117
|
|
|
$
|
295,667
|
|
During the three months ended March 31, 2020 and 2019, net cash provided by operating activities was $404,754 and $297,951, respectively. As discussed herein, we realized net income of $123,128 during the three months ended March 31, 2020, compared to net income of $314,563 during the three months ended March 31, 2019. The increase of $106,803 in cash flow from operating activities was primarily the result of decreases in net income, bad debt provision, accounts receivable, receivable – other, deferred rent expense, and increases in prepaid expenses, accounts payable, accrued expenses, income tax payable, and unearned revenue.
Net cash used in investing activities was $19,637 and $2,284 during the three-month periods ended March 31, 2020 and 2019, respectively. Net cash used in investing activities was higher by $17,353 during the three-month period ended March 31, 2020, because of an increase in expenditures for computers, furniture, and equipment.
Contractual Obligations and Contingencies
Smaller reporting companies are not required to provide this information.
Off-Balance Sheet Financing Arrangements
As of March 31, 2020, we had no off-balance sheet financing arrangements.
Inflation
We experience pricing pressures in the form of competitive prices. Insurance carriers and third-party administrators often try to take our clients by offering bundled claims administration services with their own managed care services at a lower rate. We are also impacted by rising costs for certain inflation-sensitive operating expenses such as labor and employee benefits and facility leases. We believe that these impacts are material to our revenues or net income. Some of our clients are public entities which contract with us at a fixed price for the term of the contract. Increases in labor and employee benefits can reduce our profit margin over the term of these contracts.
Critical Accounting Policies and Estimates
See Note 1 to our condensed consolidated financial statements included elsewhere in this report.