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 our 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; 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”) and Medex Legal Support, Inc., (“MLS”).
Overview
We are workers’ compensation cost containment specialists. 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 core service focuses on the reduction of medical treatment costs by enabling our client/employers to share the control over the medical treatment process. This control is obtained by participation in one of our medical treatment networks. We hold several valuable government-issued licenses to operate medical treatment networks. Through Medex we hold two of the total of nine licenses issued by the State of California to establish and manage a Health Care Organization (“HCO”) within the state of California. We also hold approvals issued by the State of California to act as a Medical Provider Network (“MPN”). Our HCO and MPN programs provide our client/employers with provider networks within which the client/employer has some ability to direct the administration of the claim. This is designed to decrease the incidence of fraudulent claims and disability awards and ensure injured employees receive the necessary back-to-work rehabilitation and training they need. We also offer a Nurse Case Management program that keeps medical treatment claims progressing to a resolution and assures treatment plans are aligned from a medical perspective. Nurse 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
Our clients include self-administered employers, insurers, third party administrators, municipalities and others. Our principal clients are located in the State of California where the high cost of workers’ compensation insurance is a critical problem for employers. Our networks have contracted with approximately 3,900 individual medical providers and clinics, as well as hospitals, pharmacies, rehabilitation centers and other ancillary services enabling our networks to provide comprehensive medical services throughout California. Our provider networks are composed of experts in treating worker injuries.
Beyond the core services we provide to facilitate client/employers involvement in employee medical treatment claims administration and patient treatment options, we also provide to our HCO and MPN clients a number of claims-related services that bring efficiencies to claim processing and management that further reduce the overall burden of workers’ compensation claims resolution. These services include various back office type functions that assure cost efficiency and accuracy in claim processing, claim reimbursement and claim dispute resolution.
Recent Developments
MPN Enrollment Count
Changes to the MPN regulations in August 2014 eliminated the notice requirements to employees covered under an MPN program. This change eliminated the need for our MPN clients to submit employee rosters for MPN notice mailings. As a result, over the past several years, many of our MPN client/employers have stopped sending us employee rosters which we have historically used to determine employee/enrollee headcount information. Enough of our MPN client/employers have stopped submitting to us such information that we can no longer accurately track the overall number of MPN participants. Therefore, beginning in the first quarter 2017, we ceased tracking the overall number of MPN participants of all client/employers in our MPN program.
HCO Enrollment Count
Historically, the HCO employee/enrollee headcount was directly related to the amount of revenue generated by HCO clients. We were, however, at risk of losing several clients under this pricing model. To remain competitive in the marketplace, we developed a new pricing model, which includes both a fixed monthly flat rate pricing option that is negotiated per client and/or a per claim incurred pricing model. Under the per claim model, our client/employers do not incur this cost as an out of pocket cost, but rather apply the cost directly to the insured or self-insured claim. As a result of moving from our fixed fee per number of employee/enrollees per customer model, beginning in the first quarter 2017 we have discontinued reporting the direct relationship between the number of HCO employee/enrollees and total HCO revenues because that historical relationship has become distorted as a result of the implementation of our new pricing model. This change in our pricing model had no significant impact to our current level of HCO revenues and we expect the same level of impact over the remaining months of 2017.
Results of Operations
The following represents selected components of our consolidated results of operations, for the three-month period ended March 31, 2017 and 2016, respectively, together with changes from period-to-period:
|
|
For three months ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
Amount Change
|
|
|
% Change
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
HCO fees
|
|
$
|
302,569
|
|
|
$
|
395,081
|
|
|
$
|
(92,512
|
)
|
|
|
(23
|
%)
|
MPN fees
|
|
|
138,281
|
|
|
|
141,358
|
|
|
|
(3,077
|
)
|
|
|
(2
|
%)
|
NCM fees
|
|
|
587,236
|
|
|
|
288,736
|
|
|
|
298,500
|
|
|
|
103
|
%
|
UR fees
|
|
|
237,045
|
|
|
|
166,966
|
|
|
|
70,079
|
|
|
|
42
|
%
|
MBR fees
|
|
|
156,778
|
|
|
|
204,972
|
|
|
|
(48,194
|
)
|
|
|
(24
|
%)
|
Other
|
|
|
119,347
|
|
|
|
112,048
|
|
|
|
7,299
|
|
|
|
7
|
%
|
Total revenues
|
|
|
1,541,256
|
|
|
|
1,309,161
|
|
|
|
232,095
|
|
|
|
18
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
19,827
|
|
|
|
21,763
|
|
|
|
(1,936
|
)
|
|
|
(9
|
%)
|
Bad debt provision
|
|
|
(3,250
|
)
|
|
|
4,500
|
|
|
|
(7,750
|
)
|
|
|
(172
|
%)
|
Consulting fees
|
|
|
77,260
|
|
|
|
101,532
|
|
|
|
(24,272
|
)
|
|
|
(24
|
%)
|
Salaries and wages
|
|
|
588,657
|
|
|
|
575,111
|
|
|
|
13,546
|
|
|
|
2
|
%
|
Professional fees
|
|
|
82,084
|
|
|
|
70,492
|
|
|
|
11,592
|
|
|
|
16
|
%
|
Insurance
|
|
|
87,275
|
|
|
|
78,304
|
|
|
|
8,971
|
|
|
|
11
|
%
|
Outsource service fees
|
|
|
112,748
|
|
|
|
86,228
|
|
|
|
26,520
|
|
|
|
31
|
%
|
Data maintenance
|
|
|
34,619
|
|
|
|
56,496
|
|
|
|
(21,877
|
)
|
|
|
(39
|
%)
|
General and administrative
|
|
|
161,388
|
|
|
|
150,108
|
|
|
|
11,280
|
|
|
|
8
|
%
|
Total expenses
|
|
|
1,160,608
|
|
|
|
1,144,534
|
|
|
|
16,074
|
|
|
|
1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
380,648
|
|
|
|
164,627
|
|
|
|
216,021
|
|
|
|
131
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0
|
%
|
Total other expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes
|
|
|
380,648
|
|
|
|
164,627
|
|
|
|
216,021
|
|
|
|
131
|
%
|
Income tax provision
|
|
|
158,391
|
|
|
|
68,501
|
|
|
|
89,890
|
|
|
|
131
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
222,257
|
|
|
$
|
96,126
|
|
|
$
|
126,131
|
|
|
|
131
|
%
|
Revenue
Total revenues during the three-month period ended March 31, 2017, increased 18% to $1,541,256 compared to $1,309,161 during the three-month period ended March 31, 2016.
During the first quarter 2017, nurse case management, utilization review and other revenues increased 42%, 103% and 7% respectively, while HCO, MPN and medical bill review revenue decreased by 23%, 2% and 24%, respectively. Other revenues consisted of revenues derived primarily from network claims repricing services, lien representation services, legal support services, workers’ compensation carve out revenues and Medicare set aside revenues.
HCO fees
During the three-month periods ended March 31, 2017 and 2016, HCO fee revenues were $302,569 and $395,081 respectively. The 23% decrease in HCO revenue was primarily attributable to revenues derived from initial notification and mailing fees from a new HCO customer in the three-month period ended March 31, 2016 of $84,453 compared to $25,734 in 2017. The loss of one client in second quarter of 2016, together with lower revenues from three other existing customers during the three-month period ended March 31, 2017, also contributed to this decrease. As previously noted above in our Recent Development section, effective January 1, 2017, we discontinued reporting the direct relationship between the number of HCO employees and total HCO revenues which now has become distorted resulting from the implementation of our new pricing model.
MPN fees
MPN fee revenue for the three-month periods ended March 31, 2017 and 2016, was $138,281 and $141,358, respectively, a decrease of 2%.
NCM fees
During the three months ended March 31, 2017 and 2016, nurse case management revenue was $587,236 and $288,736, respectively. The increase in nurse case management revenue of $298,500 was primarily the result of adding new customers during the second quarter of 2016 and increases in revenues from existing customers during the fourth quarter of 2016. We expect nurse case management revenue to continue to moderately increase during fiscal 2017.
UR fees
During the three-month periods ended March 31, 2017 and 2016, utilization review revenue was $237,045 and $166,966, respectively. The increase of $70,079 in the 2017 period was attributable to adding new clients in the second and fourth quarters of fiscal 2016. Utilization review can provide a safeguard against unnecessary and inappropriate medical treatment from the perspective of medical necessity, quality of care, appropriateness of decision-making, etc. Through our skilled staff and automated review system, we are able to deliver utilization review services that cut overhead costs for the self-insured clients, insurance companies and the public entities we service.
MBR fees
During the three-month period ended March 31, 2017, medical bill review revenue decreased $48,194 to $156,778 when compared to the same period a year earlier. This decrease of $48,194 was mainly caused by processing fewer hospital claims from existing customers. 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 rebundling, 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.
Other
Other fees consist of revenue derived from network access and claims repricing, lien representation, legal support services, Medicare set aside and worker’s compensation carve-outs services. Other fee revenue for three-month periods ended March 31, 2017 and 2016, was $119,347 and $112,048, respectively.
Expenses
Total expenses for the three months ended March 31, 2017 and 2016, were $1,160,608 and $1,144,534, respectively. The increase of $16,074 was the result of increases in salaries and wages, professional fees, insurance, outsource service fees and general and administrative expense, partially offset by decreases in depreciation, bad debt, consulting fees and data maintenance expense.
Depreciation
During the three-month period ended March 31, 2017, we recorded depreciation expense of $19,827 compared to $21,763 during the comparable 2016 period. The decrease in depreciation was primarily attributable to certain fixed assets being fully depreciated during the fourth quarter of 2016.
Bad Debt
During the three-month period ended March 31, 2017, bad debt provision decreased by $7,750 compared to the three-month period ended March 31, 2016. This reduction of $7,750 was primarily the result of receiving payments of previously designated potential bad debts receivables from a customer during the first quarter of 2017. At March 31, 2017 and 2016, our allowances for bad debt balances were $60,900 and $64,150, respectively.
Consulting Fees
During the three months ended March 31, 2017, consulting fees decreased to $77,260 from $101,532 during the three months ended March 31, 2016. This decrease of $24,272 was mainly the result of a 10% reduction in fees paid to two consultants commencing in June 2016 and converting a consultant to an employee in March 2016.
Salaries and Wages
During the three-month period ended March 31, 2017, salaries and wages increased 2% to $588,657 compared to $575,111 during the same period in 2016. This increase was primarily the result of additional staffing in nurse case management and higher levels of commissions partially offset by salary reductions of 10% by several senior executives in June 2016. The Company employed 38 and 36 full-time employees as of March 31, 2017 and 2016, respectively.
Professional Fees
For the three months ended March 31, 2017, we incurred professional fees of $82,084, compared to $70,492 during the three months ended March 31, 2016. The $11,592 increase in professional fees was primarily the result of higher professional fees paid for nurse case management services resulting from increased numbers of cases processed.
Insurance
During the three-month period ended March 31, 2017, we incurred insurance expenses of $87,275, an 11% increase over the same three-month period in 2016. The increase in insurance expense was primarily attributed to higher workers compensation and director and officer’s insurance premiums during the first three months of 2017 compared to 2016. We do not expect current insurance fees to increase materially over the remaining months of 2017.
Outsource Service Fees
Outsource service fees consist of costs incurred by our subsidiaries in outsourcing utilization review, medical bill review and nurse case management services, and typically tends to increase and decrease in correspondence with increases and decreases in demand for those services. We incurred $112,748 and $86,228 in outsource service fees during the three-month periods ended March 2017 and 2016, respectively. The increase of $26,520 was primarily the result of increases in outsource services required for utilization review and nurse case management. We anticipate our outsource service fees will continue to move in correspondence with the level of utilization review, medical bill review and certain nurse case management services we provide in the future.
Data Maintenance
During the three-month period ended March 31, 2017 and 2016, data maintenance fees were $34,619 and $56,496, respectively. The decrease of $21,877 was primarily the result of recording notification fees associated with the addition of a major HCO customer in the first quarter 2016, with a lower level of notification fees recorded for this same customer during the three-month period ended March 31, 2017.
General and Administrative
During the three-month period ended March 31, 2017, general and administrative expenses increased 8% to $161,388 when compared to the three-month period ended March 31, 2016. This increase of $11,280 was primarily attributable to increases in IT enhancement, office rent, miscellaneous expense, and travel expense, partially offset by decreases in office supplies and vacation expenses. We do not expect current levels of general and administrative expenses to materially increase during the remaining months of 2017.
Income from Operations
As a result of the 18% increase in total revenue during the three-month period ended March 31, 2017, which was partially offset by the 1% increase in total expenses, our income from operations increased by 131% when compared to the same quarter 2016.
Income Tax Provision
Because we realized income before taxes of $380,648 and $164,627 during the three-month periods ended March 31, 2017 and 2016 respectively, we realized an $89,890, or 131%, increase in our income tax provision.
Net Income
During the three-month period ended March 31, 2017, total revenues of $1,541,256 was 18% higher when compared to the same period in 2016. This increase in total revenues was partially offset by a 1% increase in total expenses, resulting in a 131% increase in income from operations compared to the three months ended March 31, 2016. Correspondingly, we realized net income of $222,257 for the three-month period ended March 31, 2017, also a 131% increase compared to the three-month period ended March 31, 2016.
Liquidity and Capital Resources
As of March 31, 2017, we had cash on hand of $5,086,957 compared to $5,005,617 at December 31, 2016. The $81,340 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 depreciation, accrued expenses, income tax payable and deferred rent expense and partially offset by decreases in our bad debt, accounts payable, unearned revenues and increases in our accounts receivable and prepaid expense. We used $5,754 in investing activities for purchases of computers, furniture and equipment. Barring a significant downturn in the economy or the loss of major customers, we believe that cash on hand and anticipated revenues from operations will be sufficient to cover our operating expenses over the next twelve months.
We currently have planned certain capital expenditures during fiscal 2017 to support potential new customers’ software requirements. We do not expect these software expenditures to be material. We do not anticipate this will require us to seek outside sources of funding. We do, however, from time to time, investigate potential opportunities to expand our business either through the creation of new business lines or the acquisition of existing businesses. We have not identified any suitable opportunity at the current time. We could use cash or stock of our Company or some combination of both in any such expansion or acquisition. An expansion or acquisition of this sort may require greater capital resources than we possess. Should we need additional capital resources, we most likely would seek to obtain such through debt and/or equity financing. We do not currently possess an institutional source of financing. There is no assurance that we could be successful in obtaining equity or debt financing on favorable terms, or at all.
Ca
sh Flow
During the three months ended March 31, 2017, cash was primarily used to fund operations. We had a net increase in cash of $81,340 during the three months ended March 31, 2017, compared to a net increase of $592,261 during the three months ended March 31, 2016. See below for additional information.
|
|
For the three months ended March 31,
|
|
|
|
2017
(unaudited)
|
|
|
2016
(unaudited)
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
87,094
|
|
|
$
|
597,024
|
|
Net cash used in investing activities
|
|
|
(5,754
|
)
|
|
|
(3,535
|
)
|
Net cash used in financing activities
|
|
|
-
|
|
|
|
(1,228
|
)
|
|
|
|
|
|
|
|
|
|
Net increase in cash
|
|
$
|
81,340
|
|
|
$
|
592,261
|
|
During the three months ended March 31, 2017 and 2016, net cash provided by operating activities were $87,094 and $597,024, respectively. As discussed herein, we realized net income of $222,257 during the three months ended March 31, 2017, compared to net income of $96,126 during the three months ended March 31, 2016. The decrease of $509,930 in cash flow from operating activities was primarily the result of increases in depreciation, accounts receivable, bad debt and prepaid expense and decreases in prepaid expenses, accounts payable, deferred rent and deferred compensation, partially offset by increases in net income, accrued expense and income tax payable.
Net cash used in investing activities was $5,754 and $3,535 during the three-month periods ended March 31, 2017 and 2016, respectively. Net cash used in investing activities was higher by $2,219 during the three-month period ended March 31, 2017, because we purchased computers.
Net cash used in financing activities during the three-month period ended 2017 was lower by $1,228 when compared to the same period in 2016, as no cash dividends were paid in 2017.
Summary of Material Contractual Commitments
The following is a summary of our material contractual commitments as of March 31, 2017.
|
|
Payments Due By Period
|
|
|
|
Total
|
|
|
Less than 1 year
|
|
|
1-3 years
|
|
|
3-5 years
|
|
|
More than 5 years
|
|
Operating Leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Leases – Equipment
(1)
|
|
$
|
67,194
|
|
|
$
|
20,675
|
|
|
$
|
46,519
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Office Leases
(2)
|
|
$
|
1,280,684
|
|
|
|
230,595
|
|
|
|
507,346
|
|
|
|
542,743
|
|
|
|
-
|
|
Total Operating Leases
|
|
$
|
1,347,878
|
|
|
$
|
251,270
|
|
|
$
|
553,865
|
|
|
$
|
542,743
|
|
|
$
|
-
|
|
(1)
|
In March 2017, we entered into a 39 month operating lease for an office copy machine with scanner with monthly payment at $1,723, commencing in April 2017
|
(2)
|
On July 23, 2015, we entered into a 79 month lease to lease approximately 9,439 square feet of office space that commenced on September 28, 2015. This office space serves as our principal executive offices, as well as, the principal offices of our operating subsidiaries.
|
Off-Balance Sheet Financing Arrangements
As of March 31, 2017, we had no off-balance sheet financing arrangements.
Inflation
We experience pricing pressures in the form of competitive prices. We are also impacted by rising costs for certain inflation-sensitive operating expenses such as labor and employee benefits and facility leases. However, we generally do not believe these impacts are material to our revenues or net income.
Critical Accounting Policies and Estimates
See Note 1 to our condensed consolidated financial statements included elsewhere in this report.