MED DIVERSIFIED INC - 10-Q Quarterly Report

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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2002

Commission File Number: 1-15587

MED DIVERSIFIED, INC.
(Exact name of small business issuer as specified in its charter)

Nevada 84-1037630
(State of other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

200 Brickstone Square, Suite 403
Andover, MA 01810

978-323-2500
(Issuer's telephone number)
MED DIVERSIFIED, INC.
200 Brickstone Square, Suite 403
Andover, MA 01810

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

As of September 30, 2002, 148,661,526 shares of common stock, $.001 par value
per share, were outstanding.

Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]

INDEX

2

MED DIVERSIFIED, INC.
Condensed Consolidated Balance Sheets
(in thousands)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

3

MED DIVERSIFIED, INC.
Condensed Consolidated Statements of Operations
For the Three Months Ended June 30, 2002 and 2001
(in thousands, except for per share information)
(Unaudited)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

4

MED DIVERSIFIED, INC.
Condensed Consolidated Statements of Cash Flows
Three Months Ended June 30, 2002 and 2001
(in thousands)
(Unaudited)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

5

MED DIVERSIFIED, INC.
Notes to Condensed Consolidated Financial Statements
June 30, 2002
(Unaudited)

1) NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
POLICIES

NATURE OF OPERATIONS

Med Diversified, Inc. ("the Company") is a diversified healthcare company that
provides home healthcare and alternate site healthcare, skilled nursing, and
pharmacy management and distribution services to more than 175 thousand patients
in 37 states. All products and services are provided through a national network
of Company owned and franchise locations.

BASIS OF PRESENTATION

The condensed consolidated financial statements included herein have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed financial statements should be read in conjunction
with the financial statements and the notes thereto included in the Company's
latest annual report on Form 10-K.

The condensed consolidated financial statements, in the opinion of management,
include all adjustments (consisting of normal recurring adjustments) necessary
to present fairly the Company's financial position and the results of
operations. These results are not necessarily indicative of the results to be
expected for the entire year.

SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies followed by the Company in preparing its
financial statements are set forth in Note 2 to the financial statements
included in its Form 10-K for the year ended March 31, 2002. The Company has
made no changes to these policies during this quarter.

The Company recognizes revenue on the accrual basis as the related services are
provided to customers. The Company's earnings process is completed as each hour
of service or home care visit is rendered. Revenues are recorded net of
contractual or other allowances to which customers are entitled. Employees
assigned to particular customers may be changed at the customer's request or at
the Company's initiation. In addition, for financial reporting purposes, a
provision for uncollectible and doubtful accounts is provided for amounts billed
to customers which may ultimately be uncollectible due to billing errors,
documentation disputes or the customer's inability to pay.

Due to the Company's recent acquisitions (see Note 3), a portion of the
Company's service revenues are derived under a form of franchising pursuant to a
license agreement under which independent companies or contractors represent the
Company within a designated territory. These licensees assign Company personnel
including registered nurses, therapists and home health aides to service the
Company's clients using the Company's trade names and service marks. The Company
pays and distributes the payroll for the direct service personnel who are all
employees of the Company, administers all payroll withholdings and payments,
bills the customers and receives and processes the accounts receivable. The
licensees are responsible for providing an office and paying related expenses
for administration including rent, utilities and costs for administrative
personnel.

The Company owns all necessary health care related permits and licenses and,
where required, certificates of need for operation of license offices. The
revenues generated by the licensees along with the related accounts receivable
belong to the Company. The revenues and related direct costs are included in the
Company's consolidated service revenues and operating costs.

The Company pays a distribution or commission to the licensees based on a
defined formula of gross profit generated. Generally, the Company pays the
licensees 60% of the gross profit attributable to the operations of the
franchise. There is no payment to the licensees based solely on revenues.

2) GOING CONCERN

The accompanying condensed consolidated financial statements have been prepared
on the basis that the Company will continue as a going concern, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. The Company's ability to continue to operate as a
going concern is dependent on its ability to restructure payments on existing
debt or raise additional capital through issuance of additional equity
securities. There is no guarantee that funding will be available on terms
acceptable to the Company.

The Company continues to experience losses from continuing operations. At June
30, 2002, the Company had negative working capital from continuing operations of
$177.0 million (excluding $10.3 million negative working capital of discontinued
operations). Cash and cash equivalents at June 30, 2002 was $10.6 million.

Tender Loving Care Health Care Services ("TLCS"), a subsidiary of the
Company, has a repayment agreement ("the Agreement") with the Federal Centers
for Medicare and Medicaid Services ("CMS") (formerly the Federal Health Care
Financing Administration) for the repayment of all excess Periodic Interim
Payment ("PIP") amounts and all audit liabilities relative to Medicare audits
for periods through February 28, 2001. The balance due recorded as of June
30, 2002 is $52.2 million. The

6

Agreement provides for aggregate monthly payments of principal and interest
through May 2005. The required monthly payments are $1 million through November
2002, $1.5 million from December 2002 through May 2004 and $1.75 million from
June 2004 through April 2005. Any remaining liabilities as of May 2005 for
periods covered by the Agreement will then be paid in a balloon payment, the
amount of which is to be determined no later than March 1, 2005. Any
overpayments or audit liabilities that are successfully appealed by the Company
will be subtracted from the total amounts owed. Interest is accrued from the
date of each assessment at the government rate of interest (currently at 13.75%
per annum). United Government Services LLC ("UGS"), a fiscal intermediary for
CMS, collects amounts due under the repayment plan by offsetting against current
remittances due to the Company. Based on this repayment plan the Company will
pay, excluding interest, $14 million through March 2003, $20.5 million through
March 2004 and a balloon payment of $21.5 million in the period ended March
2005.

Additionally, a TLCS financing agreement with National Century Financial
Enterprises ("NCFE") contains certain covenants under which TLCS was
technically in breach. TLCS has obtained all necessary waivers from NCFE on
those covenants through December 31, 2002. If NCFE does not continue to make
purchases of accounts receivables, TLCS would not have sufficient cash to
support its current level of operations.

In addition, the Company's relationship with our primary lender, NCFE, has
recently become uncertain. The Company has experienced funding that is
unpredictable in timing and amount. These cash shortages have recently
resulted in our inability to meet certain obligations as they became due. The
Company is exploring alternatives to secure additional funding and is
exploring all available, legal and other appropriate means to rectify this
uncertainty with NCFE including and not limited to selling assets. Management
cannot estimate the outcome or resolution to this funding matter. Any
continued disruption in funding will have an adverse impact in our operations
and financial condition.

Effective July 15, 2002 the Company was delisted from the American Stock
Exchange ("AMEX"). Our Common Stock is currently trading on the pink sheets
under the symbol "MDDV.PK". Further, the Company's stock was trading at
between $0.04 to $0.30 per share during August and September 2002. These
factors may affect the Company's ability to obtain equity or debt financing.

3) BUSINESS COMBINATIONS

ACQUISITIONS FOR THE FISCAL YEAR ENDING MARCH 31, 2002

Acquisitions

On August 6, 2001, the Company acquired Chartwell Diversified Services, Inc.
("Chartwell"). Donald Ayers, a member of the Company's board of directors was an
indirect shareholder of Chartwell.

On October 19, 2001, the Company signed a definitive merger agreement to acquire
TLCS, a publicly traded Company, headquartered in Lake Success, New York. The
Company finalized the legal merger with TLCS and a wholly owned subsidiary of
ours on February 14, 2002. In connection with the Merger, each share of TLCS
stock owned by us was canceled and retired. TLCS' stock is no longer registered
and is no longer publicly traded. We have acquired and cancelled 14.5 million or
99.3% of the outstanding TLCS shares.

The Company accounted for the TLCS and Chartwell acquisition's under the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 141,
BUSINESS COMBINATIONS. Accordingly, Chartwell's assets and liabilities were
recorded at their initial estimated fair market value, less certain adjustments,
as of the date of the Chartwell acquisition.

The following pro forma information gives effect to the acquisition of TLCS and
Chartwell as if such transaction had occurred at April 1, 2001 (unaudited, in
thousands except per share amounts):

4) JOINT VENTURES

As a result of the Chartwell merger, in August 2001, the Company has investments
in nine (9) joint ventures with various healthcare providers that provide home
care services, including high-tech infusion therapy, nursing, clinical
respiratory services, and durable medical equipment to home care patients. The
Company's ownership in the joint ventures includes: one with 80% interest which
is consolidated, one with 45% interest and seven with 50% interest accounted for
on the equity basis of accounting. In addition, the Company provides various
management services for each of the joint ventures under Administrative Service
Agreements, which range for periods from one to five years.

7

A condensed balance sheet at June 30, 2002 and a condensed statement of
operations of the joint ventures accounted for on the equity method for the 3
months ended June 30, 2002 are as follows (in thousands):

5) FINANCING ARRANGEMENTS

Indebtedness at June 30, 2002 and March 31, 2002 consists of the following, (in
thousands):

On June 28, 2002, the Company amended a $4.0 million Promissory Note and Stock
Pledge Agreement with NCFE to extend the due date to June 30, 2003. The
principal amount on the Promissory Note has been increased to $4.4 million to
include interest accrued from the inception of the note through June 28, 2002.
The amended Promissory Note carries an interest rate of 14% per annum with
interest payments beginning in August 2002.

On June 28, 2002, the Company entered into two Promissory Notes with NCFE, each
in the amount of $2.5 million. The Promissory Notes carry an interest rate of
8.5% per annum with interest payments beginning in July 2002. Principal is due
and payable upon the occurrence of a sale of Company assets with proceeds in
excess of $5.0 million or a public offering of stock by any of the Subsidiaries
of the Company or July 28, 2003, whichever is earlier.

CONVERTIBLE DEBENTURES AND DEBENTURES ISSUED TO PRIVATE INVESTMENT BANK LTD
("PIBL") OR ITS AFFILIATES

In December 2001, we entered into a series of five (5) short form convertible
debentures with PIBL. The short form debentures provided for an aggregate of up
to $85.0 million in financing as summarized below:

8

Each of the debentures provides for the following terms: (a) a stated interest
rate of seven percent (7%) per annum, payable at maturity, (b) a maturity date
of June 28, 2002 (refinanced August 2002, See Note 12 Subsequent Events) and (c)
collateral in the form of our U.S. Government Medical gross accounts receivable
in the amount of approximately one hundred forty percent (140%) of the total
amount funded. Debentures 1 and 2 provide that such debentures are convertible
at the option of PIBL at any time after January 1, 2002 by PIBL or its designee,
for the number of shares of our common stock pledged as collateral under each
debenture. We may pre-pay these obligations in full without penalty at any time
prior to maturity or Conversion. Debentures 3, 4 and 5 can be pre-paid prior to
maturity, without penalty, upon giving PIBL written notice 14 days in advance of
payment, but in any case not before March 31, 2002. This financing replaces and
supercedes our September 5, 2001 financing arrangement with SFSL.

On December 28, 2001, debentures 1 and 2 were funded for a total of $40 million
and accordingly, the above-referenced shares in the aggregate amount of 13.2
million shares were pledged to PIBL as collateral for the repayment of
debentures 1 and 2 and are issuable at the discretion of PIBL in satisfaction of
these debentures. In connection with the funding of debentures 1 and 2, we
entered into a Commission Agreement with SFSL pursuant to which, as
consideration for arranging the financing, we provided SFSL with a commission of
$680,000 and 2 million shares of our common stock. The proceeds of debentures 1
and 2 were used to retire certain of our outstanding debentures with SFSL with a
maturity date of December 20, 2001.

On December 28, 2001, debentures 3, 4 and 5 were funded for a total of $30
million. In connection with funding of debentures 3, 4 and 5, we entered into a
Commission Agreement pursuant to which, as consideration for arranging for the
financing, we provided SFSL with a commission of $2.7 million, 3 million shares
of our common stock and a warrant to purchase an additional 2 million shares of
our common stock at a purchase price of $4.20 per share. Additionally, 10
million shares of our common stock were pledged to SFSL as collateral for the
January 4, 2002 funding with SFSL. SFSL has the unilateral right to purchase
bondholder position for the conversion rights of the 10 million shares at $3.00
per share.

6) DISCONTINUED OPERATIONS

The results of discontinued operations presented herein reflect the operations
of our wholly owned subsidiary, e-Net Technology Ltd. ("e-Net"). On June 15,
2001, e-Net voluntarily filed for receivership. In accordance with EITF 95-18,
ACCOUNTING AND REPORTING FOR A DISCONTINUED BUSINESS SEGMENT WHEN THE
MEASUREMENT DATE OCCURS AFTER THE BALANCE SHEET DATE BUT BEFORE THE ISSUANCE OF
FINANCIAL STATEMENTS, the Company reflected the discontinued operations in the
fiscal year ended March 31, 2001. The Company estimated the net realizable value
of the assets of the discontinued operations and recorded a write down of $6.4
million in fiscal 2001.

The net sales, expenses, net assets and net liabilities of e-Net have been
included in the Company's condensed consolidated financial statements under
discontinued operations, since these operations represented 100 percent of the
Company's product business segment and contributed less than 1 percent to any
other business segment. The financial information included herein provides the
components comprising the results from discontinued operations (in thousands):

The following is a condensed balance sheet for e-Net at June 30, 2002 and March
31, 2002 (in thousands):

9

7) STOCK, WARRANTS AND STOCK OPTIONS

On April 2, 2002, the Company entered into a settlement agreement with a
former shareholder of Illumea corporation. Under the terms of the settlement
agreement the company agreed to issue 700 thousand shares of the Company's
restricted common stock valued at approximately $665 thousand based on the
closing price of the Company's stock on April 2, 2002, the shares were issued
on July 11, 2002. All amounts related to this settlement, approximately $995
thousand, including $300 thousand in cash, were recorded and expensed in the
period ended March 31, 2002.

On April 5, 2002 and June 11, 2002, the Company issued 316 thousand unrestricted
shares of common stock and 1 million shares of restricted common stock,
respectively, and a warrant to purchase 1.5 million shares of common stock at
$1.50 per share to Cappello Capital Corporation in conjunction with the
settlement of a lawsuit in March 2002. All amounts related to the settlement,
approximately $2.1 million, were recorded and expensed in the period ended March
31, 2002.

During the three months ended June 30, 2002, the Company granted stock options
to employees to purchase 820 thousand shares of the Company's stock at $0.68 per
share. These options were granted in accordance with the Company's stock option
plans with exercise prices based on the market price of the Company's stock at
the time of grant. The Board of Directors has approved these grants.

8) BASIC AND FULLY DILUTED LOSS PER SHARE

In accordance with SFAS No. 128, COMPUTATION OF EARNINGS PER SHARE, basic
earnings per share is computed by dividing the net earnings available to common
stockholders for the period by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed by
dividing the net earnings for the period by the weighted average number of
common and common equivalent shares outstanding during the period.

Common equivalent shares, consisting of incremental common shares issuable upon
the exercise of stock options and warrants are excluded from the diluted
earnings per share calculation if their effect is anti-dilutive. A summary of
the shares used to compute net loss per share is as follows (in thousands):

As of June 30, 2002 and 2001, options and warrants to purchase approximately
56.4 million and 20.0 million shares of common stock were outstanding,
respectively. The common stock equivalents that were anti-dilutive were excluded
from the computation of diluted loss per share for the three months ended June
30, 2002 and 2001 as such options and warrants were anti-dilutive. In accordance
with SFAS No. 128, Earnings Per Share, the Company has included options and
warrants to acquire 916 thousand shares in basic earnings per share because they
are issuable for little or no cash consideration. These shares have been removed
from diluted earnings per share because they are anti-dilutive.

9) SEGMENT INFORMATION

The Company derives its net sales from three operating segments: (1)Home
Health Services comprised of skilled nursing care and attendant care services
in the home, (2) Pharmacy Services comprised of pharmaceutical management and
distribution services and (3) Internet based transaction and information
services comprised of our Distance Medicine and Medical e-Business products.

The accounting policies of the segments are the same as those described in the
summary of significant accounting policies which are contained in the Company's
March 31, 2002 Annual Report on Form 10-K. The Company evaluates performance
based on operating earnings of the respective business segments; as such there
is no separately identifiable statements of operations data below operating
loss.

The Company's financial information by business segment is summarized as follows
(in thousands). The "Other" column includes corporate related items and other
expenses not allocated to reportable segments. In addition, assets included in
the Other column includes $2.3 million in assets from discontinued operations as
of June 30, 2002 and March 31, 2002, respectively. (In thousands):

10

The Company's U.S. sales from its pharmacy services and home health services
segments are paid through third party payors including Medicare, Medicaid and
commercial insurance companies, as well as directly from institutions and
patients. During the three months ended June 30, 2002, approximately 81% of the
sales from these segments were reimbursable by Medicare and Medicaid.

During the three months ended June 30, 2001, the Company's U.S. operations from
its distance medicine segment had one customer whose sales, on an individual
basis, represented over 5 percent of distance medicine operations' net sales for
an aggregate of 28.6 percent. This customer, NCFE a related party, represented
less than 5 percent of the Company's total sales.

10) CONTINGENCIES AND LEGAL MATTERS

We are party to routine litigation involving various aspects of our business. In
addition, we have been and continue to be involved in litigation regarding
several of our acquisitions and strategic relationships. Except as described
below, none of such pending litigation, in our opinion, will have a material
adverse impact on our consolidated financial condition, results of operations,
or businesses.

PrimeRx.com/Network Pharmaceuticals, Inc.

Our relationship with PrimeRx.com ("PrimeRx"), Network and the principal
stockholders of PrimeRx has been a troubled one characterized by numerous
disputes and litigation. On March 26, 2001, we entered into a Settlement
Agreement and Mutual Releases (the "March 2001 Settlement Agreement") with
PrimeRx, Network, PrimeMed Pharmacy Services, Inc. ("PrimeMed"), another
subsidiary of PrimeRx and the shareholders of PrimeRx. On or about July 16,
2001, Network filed a complaint against us and our strategic partner, NCFE
(NETWORK PHARMACEUTICALS, INC., A NEVADA CORPORATION; NCFE; AND DOES 1 THROUGH
25, INCLUSIVE, SUPERIOR COURT OF THE STATE OF CALIFORNIA FOR THE COUNTY OF LOS
ANGELES (CENTRAL DISTRICT) (CASE NO. BC 254258). This suit alleged breach of the
March 2001 Settlement Agreement.

On or about September 26, 2001, this matter was ordered to arbitration
through the American Arbitration Association (the "AAA"). On or about
September 28, 2001, Network formally filed its claim with the AAA claiming
damages of over $10 million. In addition, on or about October 19, 2001,
Network filed documents seeking a court order allowing Network to attach up
to $14 million of our assets pending resolution of this action. Network's
request for attachment was denied.

On or about November 6, 2001, we filed documents with the AAA denying the
allegations raised by Network and counterclaiming against Network and its
alleged co-conspirators, Prem Reddy, Richard Hayes, Prime A Investments, LLC,
PrimeMed, PrimeRx and Doe Defendants for over $120 million.

As of July 1, 2002, we entered into a settlement agreement with Network,
PrimeRx and its principal shareholders (the "Network Settlement"). Under the
terms of the Network Settlement, provided we met the obligations set forth
therein, each of us, NCFE, and one of NCFE's subsidiaries on the one hand,
and the cross-defendants (which include Network and certain alleged
co-conspirators) released one another from all claims related to the subject
matter of this litigation. This release does not cover certain employment
compensation disputes that one of the principal shareholders of PrimeRx has
against us and does not release any parties other than NCFE, the NCFE
subsidiary and us.

Our obligations under the Network Settlement include: (i) a payment of $2.5
million we made on July 1, 2002; (ii) a payment of $2.5 million by wire
transfer by August 1, 2003; (iii) a transfer of shares of PrimeRx that we had
held, which transfer was made prior to July 1, 2002; (iv) returning all of
PrimeRx's, Network's and their affiliates' equipment by July 15, 2002 along
with an inventory of such equipment that indicates whether any equipment has
been previously sold by us; (v) monthly payments commencing July 15 in
connection with certain guaranties of leased equipment made by a principal
shareholder of PrimeRx; and, (vi) a dismissal of our cross-complaint with
prejudice in the arbitration proceedings. Amounts pertaining to this
settlement were expensed and recorded as of March 31, 2002.

VidiMedix Corporation

On or about September 15, 2000, certain former securities holders of
VidiMedix Corporation ("VidiMedix") filed a petition against us arising out of
our acquisition of VidiMedix (MONCRIEF, ET AL. V. E-MEDSOFT.COM AND VIDIMEDIX
ACQUISITION CORPORATION, HARRIS COUNTY (TEXAS) COURT, NO. 200047334 (the "Texas
Action")). The petition was amended on or about May 24, 2001 and amended again,
on or about August 15, 2001. Plaintiffs Jana Davis Wells and Tom Davis, III
("Remaining Plaintiffs") filed a Third Amended Original Petition on or about
December 26, 2001.

Plaintiffs claimed that we owe them either 6 million shares of common stock
or liquidated damages of $8.9 million and exemplary damages of at least $24
million. We settled those disputes with all but two former VidiMedix
shareholders, the Remaining Plaintiffs.

On May 3, 2001, we filed a lawsuit against the plaintiffs and others in
California Superior Court for the County of Los Angeles (E-MEDSOFT.COM V.
MONCRIEF, ET AL., CASE NO. BC249782 (the "California Action")). On or about
October 19, 2001, defendants caused the case to be transferred to the United
States District Court for the Central District of California based on
diversity of citizenship between the defendants and us, the case is now known
as CASE NO. EDCV 01-00803-VAP (SGLX). We settled those disputes with all but
two former VidiMedix shareholders. The terms of the settlement required us to
pay approximately $4.1 million in a combination of cash and common stock. The
Remaining Plaintiffs are the only remaining plaintiffs in the Texas Action
and the only remaining defendants in the California Action.

As of July 31, 2002, we reached a settlement with the Remaining Plaintiffs.
Settlement terms included a mutual release from the Texas Action and for us
to dismiss the California action with prejudice and monetary payments to the
remaining plaintiffs over a seven-month period.

11

Illumea (Asia)

On December 13, 2000, Illumea (Asia), Ltd. ("IAL"), Nathalie j.v.d.
Doornmalen, David Chung Shing Wu, George K.K. Tong, Edna Liu, Yee Mau Chen,
Norman Yuen Tsing Tao, Jeffrey Sun, Boris Luchterhand, Carol Andretta, Kin
Yu, Kathryn Ma, Alan Munro, Yonanda j.v.d. Doornmalen, Hunter Vest, Ltd.,
Eltrinic Enterprises, Ltd. and True Will Investments filed a First Amended
Complaint against Illumea Corporation ("Illumea") and Andrew Borsanyi
(collectively "Defendants") arising out of our acquisition of Illumea
(ILLUMEA (ASIA), LTD., ET AL. V. ILLUMEA CORPORATION AND ANDREW BORSANYI).
All of the plaintiffs except IAL and Nathalie Doornmalen thereafter dismissed
their claims without prejudice. As a result, only IAL and Doornmalen remained
as plaintiffs.

Doornmalen, a former Illumea shareholder, alleges that she consented to our
acquisition of Illumea based on the allegedly false representation that we
would hire her. She also alleges that defendants made defamatory statements
about her. Doornmalen asserts claims for securities fraud under 15 U.S.C.
Section 78j(b) and Rule 10b-5, "conspiracy," breach of contract, fraud, false
promise, defamation, and violation of California Business & Professions Code
Section 17200 ("Section 17200"). IAL alleges that Illumea breached an agency
agreement between IAL and Illumea and engaged in fraud in connection with the
agency relationship. IAL asserts claims for breach of contract and fraud.
Collectively, plaintiffs seek compensatory damages, disgorgement under
Section 17200 and attorneys' fees.

We filed a counterclaim against IAL and Doornmalen on March 26, 2001,
alleging breach of contract, breach of fiduciary duty and fraud. We allege
that IAL and Doornmalen refused to repay Illumea for providing funding and
equipment to IAL and that Doornmalen failed to disclose certain material
issues in connection with the merger between Illumea and us.

As of April 2, 2002 these matters have been settled, under the terms of the
settlement we were required to (i) pay $300 thousand; (ii) issue 700 thousand
shares of our common stock; and (iii) file a registration statement, on Form
S-1, registering the 700 thousand shares. As of October 31, 2002, the Company
has not filed the required registration statement as set for the in the
Settlement Agreement. We have been notified that Nathalie Doornmalen has
filed a motion to enforce the Settlement Agreement in the Illumea (Asia),
Ltd. matter. The opposition to this motion is due on Monday, November 4, and
the hearing is on November 18.

Trebor O. Corporation

On June 29, 2001, Trebor O. Corporation, a California corporation, doing
business as Western Pharmacy Services ("Trebor O."), and its principal Robert
Okum, filed an action in Los Angeles County Superior Court against the
Company, PrimeRx, Chartwell Diversified Services and various individuals
(TREBOR O. CORPORATION D.B.A. WESTERN PHARMACY SERVICES AND ROBERT OKUM V.
E-MEDSOFT.COM, PRIMERX, CHARTWELL DIVERSIFIED SERVICES AND VARIOUS
INDIVIDUALS, LOS ANGELES SUPERIOR COURT CASE NO. BC 253387). The plaintiffs
assert claims for breach of contract, promissory estoppel, misrepresentation,
breach of confidentiality, and tortious interference, and seek more than $5
million in compensatory damages, on the theory that we entered into a letter
of intent to purchase Trebor O, but then refused to complete the transaction.
We have settled this lawsuit as of July 2002. Settlement terms include
dismissal of Trebor O's suit against us and a payment by us to Trebor O.

Addus Healthcare

On or about April 24, 2002, we filed a complaint against Addus Healthcare,
Inc. ("Addus"), and its major shareholders, W. Andrew Wright, Mark S. Heaney,
Courtney E. Panzer, and James A. Wright. We contend that Addus has been
unable to perform its obligations under a certain stock purchase agreement
relating to our acquisition of Addus. We allege that Addus breached the
warranties and representations it gave regarding its financial condition, and
Addus has been unable to obtain the consent of necessary third parties to
assign some relevant contracts. We believe that Addus has breached the
agreement in other ways, as well. Additionally, we allege that the defendants
have misappropriated our deposit.

The complaint demands the imposition of a constructive trust for the
converted funds; and an injunction against the defendants' disposing of or
liquidating the $7.5 million deposit. Our complaint further alleges fraud on
behalf of the defendants, in the sense that they never intended to complete
the transaction but planned to use the pendency of the transaction to obtain
concessions from us. Finally, there is a claim for breach of contract. We
seek compensatory damages of $10 million per claim, plus punitive damages,
along with the equitable relief previously described and attorney's fees.

Addus has filed a counterclaim against us. They allege that we (1)
fraudulently induced them to enter into the agreement, (2) negligently
misrepresented certain aspects of our business, (3) breached the terms of the
agreement by not closing the transaction and not having available funds to
close the transaction, and (4) breached certain other confidentiality
agreements. They have sought compensatory damages in excess of $4 million, a
declaratory judgment that they are entitled to retain the $7.5 million
deposit, for general and special damages and attorney's fees. We dispute
these claims vigorously and believe they are without merit. On July 9, we
filed a reply to the counterclaim. This matter is currently in discovery and
has been transferred to the Northern District of Illinois. On October 11,
2002 we filed an Amended Complaint. Addus' answer to that complaint is due on
November 1, 2002.

University Affiliates

In January 2002, we filed a Complaint against University Affiliates IPA
("UAIPA") and its president, Sam Romeo, who at the time was also a member of
our board of directors, for breach of contract, fraud, and, as to Mr. Romeo,
breach of fiduciary duty arising out of a May 2, 2000 agreement between UAIPA
and us. Under the agreement, during the quarter ended June 2000, we advanced
$2 million to UAIPA for the purpose of creating a joint venture intended to
combine UAIPA's supposed healthcare management expertise with Internet
healthcare management systems in an effort to develop new business
opportunities. As of the filing of the suit, the companies had not proceeded
with the joint venture. According to the original agreement, if a formal
joint venture agreement was not entered into between UAIPA and us by July 1,
2000, UAIPA would guarantee payment of $2.5 million on or before July 1,
2001. The $2.5 million has not been paid. We seek payment of this amount,
plus any profits from the business opportunities that were to be transferred
to the joint venture, and punitive damages.

On March 4, 2002, UAIPA served a cross-complaint against us, Sanga E-Health,
LLC, TSI Technologies, LLC, Mitchell Stein, and John F. Andrews alleging
breach of various contracts, breach of the implied covenant of good faith and
fair dealing, declaratory relief, promissory estoppel, fraud, negligent
misrepresentation, unjust enrichment, quantum meruit, conversion, money had
and received, breach of fiduciary duty, interference with prospective
business advantage and unfair business practices, seeking damages in the
aggregate of approximately $11 million plus punitive damages. The court
denied our motion to compel arbitration on May 8, 2002. We subsequently filed
a cross-complaint against UAIPA and Sam Romeo regarding their failure to
adhere to the May 2, 2000 agreement. No trial date has been set and UAIPA is
currently in bankruptcy proceedings.

11) ADOPTION OF NEW ACCOUNTING STANDARDS

On April 1, 2002, we adopted the provisions of SFAS No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS. Under the provisions of SFAS No. 142, intangible assets with
indefinite lives and goodwill are no longer amortized but are subject to annual
impairment tests. Separable intangible assets with finite lives continue to be
amortized over their useful lives. We have not yet determined the impact, if
any, of adopting the goodwill impairment provisions of SFAS No. 142.

* Included in Other assets.

12

Total amortization expense for intangible assets was $207 thousand for the three
months ended June 30, 2002. The annual amortization expense expected for the
years 2003 through 2008 is as follows:

ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS

On April 1, 2002, we adopted the provisions of SFAS No. 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144 requires that
long-lived assets to be disposed of by sale, including those of discontinued
operations, be measured at the lower of carrying amount or fair value less cost
to sell, whether reported in continuing operations or in discontinued
operations. Under these rules, discontinued operations will no longer be
measured at net realizable value or include amounts for operating losses that
have not yet been incurred. SFAS No. 144 also broadens the reporting of
discontinued operations to include all components of an entity with operations
that can be distinguished from the rest of the entity and that will be
eliminated from the ongoing operations of the entity in a disposal transaction.
The adoption of SFAS No. 144 has no impact on our current operations.

12) SUBSEQUENT EVENTS

The following is a discussion of significant events subsequent to June 30, 2002.

AMERICAN STOCK EXCHANGE

On June 28, 2002, the Company announced that it had withdrawn its appeal of the
AMEX delisting determination and that AMEX consented to the Company's request to
voluntarily delist the Company's common stock on the AMEX effective at the close
of trading on July 15, 2002. Beginning on July 16, 2002, the Company's common
stock is quoted on the "Pink Sheets".

NETWORK AND VIDIMEDIX SETTLEMENTS

As more fully discussed in Note 10, the Company entered into settlement
agreements with Network, PrimeRx and its principal shareholders and the
plaintiffs in the Vidimedix matter.

SECURITIES AND EXCHANGE COMMISSION INQUIRY

On July 26, 2002, our Board of Directors received a letter from KPMG pursuant to
which KPMG resigned from its position as our independent auditors. Refer to the
Company's Form 8-K/A filed August 19, 2002.

As a result of KPMG's letter dated July 26, 2002 communicating alleged illegal
acts as well as their resignation, the Securities and Exchange Commission
("SEC") has initiated an informal inquiry. As of the date of this Form 10-Q
filing, we have had preliminary discussions with the SEC, although we have not
been informed of and are not aware of any conclusions the SEC has reached
related to their inquiry. We also are not aware of whether the informal inquiry
will result in a formal investigation by the SEC.

FINANCING ARRANGEMENTS

On August 14, 2002 the Company refinanced $70 million of debentures with
Private Investment Bank Limited ("PIBL"), see Note 5. To secure the
extension, the Company paid $12.5 million to reduce the principal balance
with additional principal reduction payments over the term as follows; $100
thousand per month through July 2003, $400 thousand per month through January
2004 and $600 thousand per month through May 2004, $25 million on July 31,
2003 and the balance of $26.5 million due on June 28, 2004. Interest at a
rate of 7% per annum is to be paid quarterly. The Company also paid $2.5
million in accrued interest due as of June 28, 2002. The $12.5 million
principal reduction payment was funded by TEGCO Investments LLC ("TegCo"), an
entity which is majority owned by the Company's CEO. The TegCo debt is
subordinate to the PIBL debentures and is due on June 29, 2004. Additionally,
as a result of this refinancing approximately $68.9 million of the
outstanding balance will be reported as long-term debt on the consolidated
balance sheet at June 30, 2002. As of October 31, 2002, we have been notified
by PIBL's counsel that they believe there have been certain technical
breaches by us under the terms of this refinancing. We are actively
addressing these issues.

As previously disclosed in our Form 10-K for the fiscal year ending March 31,
2002, counsel for PIBL has notified us through counsel that they believe there
are certain technical breaches under the terms of the Amended Agreement. These
alleged breaches include 1) a failure to redirect certain collections of aged
accounts receivable purchased by American Reimbursement, LLC ("ARL") to PIBL; 2)
failure to maintain an independent member of ARL; 3) a shortfall in a quarterly
interest payment of approximately $14,000; and 4) our failure to provide
definitive financial statements for the quarter ending June 30, 2002. With
respect to the alleged failure to redirect payments for ARL, NCFE, acting as the
servicer of the accounts receivable purchased by ARL under certain purchase
agreements, is unwilling and/or unable to comply with the terms of those
agreements. We are exploring numerous options, legal and otherwise, to bring
NCFE into compliance with such agreements. We are actively seeking a replacement
for the independent member, which withdrew from ARL when its principal member
joined our Board of Directors. Our calculation of the quarterly interest payment
(which payment amounted to over $1 million) differed from PIBL's calculation,
and we are working to resolve this discrepancy. The filing of this Form 10-Q
enables us to provide the definitive financial statements PIBL seeks.

13

ITEM 2
MED DIVERSIFIED, INC.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Statements in this Report that relate to management's expectations, intentions
or beliefs concerning future plans, expectations, events and performance are
"forward-looking" within the meaning of the federal securities laws. Forward
looking statements do not relate strictly to historical or current facts and may
be identified by their use of words like "plan", "believe", "expect", "will",
"anticipate", "estimate" and other words of similar meaning. These
forward-looking statements include assumptions, beliefs and opinions relating to
the Company's business and growth strategy based upon management's
interpretation and analysis of its own contractual and legal rights, of
management's ability to satisfy industry and consumer needs with its
technologies, of healthcare industry trends, and of management's ability to
successfully develop, implement, market and/or sell its network transaction
processing services, software programs, clinical and financial transaction
services, and e-commerce systems to its clientele. Management's forward-looking
statements further assume that the Company will be able to successfully develop
and execute on its strategic relationships. Actual results or events could
differ materially from those anticipated in the forward-looking statements due
to a variety of factors, in addition to those set out above, including, without
limitation, acceptance by customers of the Company's products, changing
technology, competition in the health-care market, government regulation of
health care, the Company's limited operating history, general economic
conditions, availability of capital, the outcome of pending litigation and other
factors. Investors should not rely on forward looking statements because they
are subject to a variety of risks, uncertainties, and other factors that could
cause actual results to differ materially from the Company's expectations. Some
important factors that could cause our actual results to differ materially from
those projected in such forward-looking statements are discussed in the March
31, 2002 Form 10-K.

OVERVIEW

There are significant uncertainties about our ability to continue as a going
concern. We have suffered recurring losses from operations and have consistently
had negative working capital from continuing operations and lower than needed
levels of cash. On June 30, 2002, we had negative working capital of $177.0
million (excluding $10.3 million of negative working capital from discontinued
operations) and accumulated deficit of $628.8 million and a deficit
stockholders' equity of $208.6 million. During fiscal years ended March 31, 2002
and 2001, net losses from continuing operations included asset impairment
charges of $175.1 million and $201 million, respectively. These charges reduced
assets from continuing operations and our stockholders' equity.

In August 2002 we refinanced, with the existing lender, debentures totaling $70
million. Terms of the refinance included a $12.5 million principal reduction and
an extension of the due date to June 28, 2004. However, we must also extend,
refinance, or raise cash to meet our obligations with respect to the $148.6
million of indebtedness that is due under contractual arrangement over the next
12 months. While we are confident of our ability to arrange extensions, we have
not commenced serious discussions with the creditors of this indebtedness and we
cannot assure that we will be successful in doing so on terms and conditions
that are acceptable. If we are not successful in obtaining additional funding or
extending our short-term obligations, we may not be able to continue as a going
concern.

In addition to extending our short-term indebtedness, our principal focus will
be to generate positive cash flow from our continuing operations primarily from
our business units. We will continue to eliminate redundancies at all staff
levels and locations consistent with this objective. Our current plan indicates
that these efforts will yield positive cash flow sometime during the first
quarter of fiscal 2004, reduce operating losses throughout the year and generate
positive earnings sometime during the fourth quarter of 2004. However, our
earnings analysis has not considered any additional write-downs or impairments
of our intangible assets that may be required. Any such write-downs could have a
material adverse effect on our results of operations and stockholders' equity,
however are not expected to impact our cash flows from operations.

RESULTS OF OPERATIONS

Results of Continuing Operations:

The results of operations presented herein reflect the unaudited consolidated
net sales and expenses from continuing operations for the three months ended
June 30, 2002 and 2001. In addition, we have included in the comparisons below
the unaudited pro forma financial information for the three months ended June
30, 2001 ["Proforma 2001"] to include the acquisitions of Chartwell and TLCS as
if these transactions occurred on April 1, 2001. For more detailed information
regarding the pro forma effects of these mergers SEE Forms 8-K/A filed February
11, 2002 and February 20, 2002.

14

Information presented in the table below is unaudited (in thousands):

The following table summarizes the operations for Chartwell and subsidiaries and
the statements of operations of non-majority joint ventures, which are managed
by Chartwell for the three months ended June 30, 2002 (in thousands):

As noted above, Chartwell's income from operations under management for the
three months ended June 30, 2002 totaled $906 thousand.

*Chartwell's ownership in the joint ventures ranges from 45% to 50%. As a result
of the Chartwell merger the Company has investments in nine (9) joint ventures
with various health care providers that provide home care services, including
high-tech infusion therapy, nursing, clinical respiratory services, and durable
medical equipment to home care patients. The Company's ownership in the joint
ventures includes: one with 80 percent interest which is consolidated, one with
45 percent interest and seven with 50 percent interest accounted for on the
equity basis of accounting. Total Chartwell revenue under management for the
three months ended June 30, 2002, which includes unconsolidated joint ventures
as well as Chartwell subsidiary revenue, is $43.4 million.

NET SALES

Net sales for the three months ended June 30, 2002, 2001 and Proforma 2001 are
summarized as follows (in thousands):

15

Net sales in the distance medicine solutions segment decreased by approximately
76% in the three months ended June 30, 2002 as compared to the comparable period
of the prior year. These decreases resulted primarily from the Company's efforts
at focusing on more profitable products, lower consulting revenues during the
respective periods, and the Company's decision to abandon products that were not
considered likely to be profitable in the future.

Pharmacy revenues for the three months ended June 30, 2002, 2001 and Proforma
2001 are summarized as follows (in thousands):

PrimeRx, including Network, revenues decreased in the three months ended June
30, 2002 compared to comparable period in 2001 as a result of the Company's
decision to not consolidate Network subsequent to August 1, 2001 and the
Company's decision to dispose of unprofitable pharmacy operations of PrimeRx in
the first and second quarters of fiscal 2002.

Chartwell pharmacy revenues of $10.6 million in the three months ended June 30,
2002 increased over comparable prior year period as a result of the August 6,
2001 acquisition of Chartwell. Compared with Proforma 2001, Chartwell pharmacy
revenues decreased approximately $2.3 million or 18% due to decreased patient
referrals and other competitive factors.

Resource pharmacy revenues increased approximately $548 thousand in the three
months ended June 30, 2002 compared to 2001 as a result of increased sales
efforts for existing and new customers.

Home health revenues increased from $0 in the three months ended June 30, 2001
to $83.6 million during the three months ended June 30, 2002. These increases
were a result of home health revenues generated as a result of the Chartwell and
TLCS acquisitions on August 6, 2001 and November 28, 2001, respectively. A
comparative proforma analysis indicates a $3.8 million or 4.8% increase in
revenues due to increased patient admissions for Medicare services.

COSTS AND EXPENSES

Cost of Sales

Cost of sales for the three months ended June 30, 2002, 2001 and Proforma 2001
are summarized as follows (in thousands):

Cost of sales as a percentage of sales for the three months ended June 30, 2002,
2001 and Proforma 2001 are summarized as follows:

16

Distance Medicine Solutions cost of sales declined in the three months ended
June 30, 2002 compared to the same periods in 2001 as a result of a decrease in
sales of products which have a significantly lower gross margin than consulting
services.

Pharmacy cost of sales in the three months ended June 30, 2002 decreased with
the same periods in 2001 because of favorable vendor pricing associated with our
Chartwell revenues. The gross margin on Chartwell revenues is higher than those
on Network and other pharmacy operations in 2001.

Home health cost of sales represents the direct costs of providing services to
patients, including provider wages, cost of medical supplies and the cost of
contracted services.

OTHER INCOME (EXPENSE)

Interest expense has increased to a net expense of $12.8 million for the three
months ended June 30, 2002 compared to $317 thousand for the three months ended
June 30, 2001. The increase is attributed to our $70 million debenture financing
and existing debt acquired in the Chartwell and TLCS acquisitions.

Results of Discontinued Operations:

The results of discontinued operations presented herein reflect the operations
of our wholly owned subsidiary, e-Net Technology Ltd. ("e-Net"). On June 15,
2001, e-Net voluntarily filed for receivership. In accordance with EITF 95-18,
ACCOUNTING AND REPORTING FOR A DISCONTINUED BUSINESS SEGMENT WHEN THE
MEASUREMENT DATE OCCURS AFTER THE BALANCE SHEET DATE BUT BEFORE THE ISSUANCE OF
FINANCIAL STATEMENTS, the Company reflected the discontinued operations in the
fiscal year ended March 31, 2001. The Company estimated the net realizable value
of the assets of the discontinued operations and recorded a write down of $6.4
million in fiscal 2001.

The net sales, expenses, net assets and net liabilities of e-Net have been
included in the Company's condensed consolidated financial statements under
discontinued operations, since these operations represented 100 percent of the
Company's product business segment and contributed less than 1 percent to any
other business segment. The financial information included herein provides the
components comprising the results from discontinued operations (in thousands):

The following is a condensed balance sheet for e-Net at June 30, 2002 and March
31, 2002 (in thousands):

17

LIQUIDITY

There are significant uncertainties about our ability to continue as a going
concern. We have suffered recurring losses from operations and have consistently
had negative working capital from continuing operations and lower than needed
levels of cash. On June 30, 2002, we had negative working capital of $177.0
million (excluding $10.3 million of negative working capital from discontinued
operations) and accumulated deficit of $628.8 million and a deficit
stockholders' equity of $208.6 million.

In addition, we have consistently used cash in operations, including cash used
in operating activities of $13.8 million and $5.7 million in the three months
ended June 30, 2002 and 2001, respectively. As of June 30, 2002, the current
portion of our long-term debt and related party debt was $148.6 million. As a
result, we have relied upon funding through loans from private investors, sales
of equity securities, and various credit facilities. These sources of funding
have often included terms that are less favorable than our management desires.
However, our need of funds to meet current operating needs, as well as funds
necessary for acquisitions has required us to enter into such less favorable
agreements. We have projected that we cannot meet our current cash operating
needs through June 30, 2003 without other sources of funds.

The TLCS financing agreement contains certain covenants under which TLCS is
currently in breach. TLCS has obtained all necessary waivers from the financing
facility on those covenants through December 31, 2002. If the financing facility
does not continue to make purchases of accounts receivables, TLCS would not have
sufficient cash to support its current level of operations. Furthermore, TLCS
has approximately $52.2 million in Medicare and Medicaid liabilities that are
payable over the next four years.

In addition, the Company's relationship with our primary lender, NCFE, has
recently become uncertain. The Company has experienced funding that is
unpredictable in timing and amount. These cash shortages have recently
resulted in our inability to meet certain obligations as they became due. The
Company is exploring alternatives to secure additional funding and is
exploring all available legal and other appropriate means to rectify this
uncertainty with NCFE. Management cannot estimate the outcome or resolution
to this funding matter. Any continued disruption in funding will have an
adverse impact in our operations and financial condition.

Although the Company has entered into agreements to provide funding, the sale of
common stock relative to the fundings is contingent upon many performance
targets that we have not demonstrated that we can meet. Therefore, we cannot
depend on these financing facilities to provide us the required funding to meet
our operational needs. In order for us to continue our operations, we must be
successful in obtaining additional funding through implementing the following
steps:

1. Implement our business strategy.

2. Obtain additional funding either in the form of equity or debt
financing to support our operating cash requirements as well as cash
required for acquisitions through June 30, 2003.

3. Continue to integrate Chartwell and TLCS operations with ours to take
advantage of cost savings and potential generation of future sales to
provide sources of additional funds.

4. Renegotiate TLCS Financing Agreement with NCFE to ensure cash is
available.

If we are not successful in obtaining the funding or resolving the matters
referred to above, and we do not obtain other sources of funding to replace
these commitments, we may not be able to fund our operations or support our
capital needs and business strategy beyond June 30, 2003. Accordingly, our
ability to continue as a going concern is in question.

Our independent auditors stated in their "Report of Independent Accountants" on
our consolidated financial statements as of and for the years ended March 31,
2002 and 2001 that there is substantial doubt about our ability to continue as a
going concern.

If we decide to enter into any other business ventures that would require
additional cash, we will need to raise additional funds by selling debt or
equity securities, by entering into strategic relationships, or through other
arrangements.

We may be unable to raise any additional amounts on reasonable terms, or at all,
when needed. If we are unable to raise such additional funding, we would have to
curtail operations or merger and acquisition activities, which in turn would
have an adverse effect on our financial position and results of operations and
our ability to operate.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

We are party to routine litigation involving various aspects of our business.
In addition, we have been and continue to be involved in litigation regarding
several of our acquisitions and strategic relationships. Except as described
below, none of such pending litigation, in our opinion, could have a material
adverse impact on our consolidated financial condition, results of
operations, or businesses.

PrimeRx.com/Network Pharmaceuticals, Inc.

Our relationship with PrimeRx.com ("PrimeRx"), Network and the principal
stockholders of PrimeRx has been a troubled one characterized by numerous
disputes and litigation. On March 26, 2001, we entered into a Settlement
Agreement and Mutual Releases (the "March 2001 Settlement Agreement") with
PrimeRx, Network, PrimeMed Pharmacy Services, Inc. ("PrimeMed"), another
subsidiary of PrimeRx and the shareholders of PrimeRx. On or about July 16,
2001, Network filed a complaint against us and our strategic partner, NCFE
(NETWORK PHARMACEUTICALS, INC., A NEVADA CORPORATION; NCFE; AND DOES 1
THROUGH 25, INCLUSIVE, SUPERIOR COURT OF THE STATE OF CALIFORNIA FOR THE
COUNTY OF LOS ANGELES (CENTRAL DISTRICT) (CASE NO. BC 254258). This suit
alleged breach of the March 2001 Settlement Agreement.

On or about September 26, 2001, this matter was ordered to arbitration
through the American Arbitration Association (the "AAA"). On or about
September 28, 2001, Network formally filed its claim with the AAA claiming
damages of over $10 million. In addition, on or about October 19, 2001,
Network filed documents seeking a court order allowing Network to attach up
to $14 million of our assets pending resolution of this action. Network's
request for attachment was denied.

On or about November 6, 2001, we filed documents with the AAA denying the
allegations raised by Network and counterclaiming against Network and its
alleged co-conspirators, Prem Reddy, Richard Hayes, Prime A Investments, LLC,
PrimeMed, PrimeRx and Doe Defendants for over $120 million.

As of July 1, 2002, we entered into a settlement agreement with Network,
PrimeRx and its principal shareholders (the "Network Settlement"). Under the
terms of the Network Settlement, provided we met the obligations set forth
therein, each of us, NCFE, and one of NCFE's subsidiaries on the one hand,
and the cross-defendants (which include Network and certain alleged
co-conspirators) released one another from all claims related to the subject
matter of this litigation. This release does not cover certain employment
compensation disputes that one of the principal shareholders of PrimeRx has
against us and does not release any parties other than NCFE, the NCFE
subsidiary and us.

Our obligations under the Network Settlement include: (i) a payment of $2.5
million we made on July 1, 2002; (ii) a payment of $2.5 million by wire
transfer by August 1, 2003; (iii) a transfer of shares of PrimeRx that we had
held, which transfer was made prior to July 1, 2002; (iv) returning all of
PrimeRx's, Network's and their affiliates' equipment by July 15, 2002 along
with an inventory of such equipment that indicates whether any equipment has
been previously sold by us; (v) monthly payments commencing July 15 in
connection with certain guaranties of leased equipment made by a principal
shareholder of PrimeRx; and, (vi) a dismissal of our cross-complaint with
prejudice in the arbitration proceedings. Amounts pertaining to this
settlement were expensed and recorded as of March 31, 2002.

18

VidiMedix Corporation

On or about September 15, 2000, certain former securities holders of
VidiMedix Corporation ("VidiMedix") filed a petition against us arising out
of our acquisition of VidiMedix (MONCRIEF, ET AL. V. E-MEDSOFT.COM AND
VIDIMEDIX ACQUISITION CORPORATION, HARRIS COUNTY (TEXAS) COURT, NO. 200047334
(the "Texas Action")). The petition was amended on or about May 24, 2001 and
amended again, on or about August 15, 2001. Plaintiffs Jana Davis Wells and
Tom Davis, III ("Remaining Plaintiffs") filed a Third Amended Original
Petition on or about December 26, 2001.

Plaintiffs claimed that we owe them either 6 million shares of common stock
or liquidated damages of $8.9 million and exemplary damages of at least $24
million. We settled those disputes with all but two former VidiMedix
shareholders, the Remaining Plaintiffs.

On May 3, 2001, we filed a lawsuit against the plaintiffs and others in
California Superior Court for the County of Los Angeles (E-MEDSOFT.COM V.
MONCRIEF, ET AL., CASE NO. BC249782 (the "California Action")). On or about
October 19, 2001, defendants caused the case to be transferred to the United
States District Court for the Central District of California based on
diversity of citizenship between the defendants and us, the case is now known
as CASE NO. EDCV 01-00803-VAP (SGLX). We settled those disputes with all but
two former VidiMedix shareholders. The terms of the settlement required us to
pay approximately $4.1 million in a combination of cash and common stock. The
Remaining Plaintiffs are the only remaining plaintiffs in the Texas Action
and the only remaining defendants in the California Action.

As of July 31, 2002, we reached a settlement with the Remaining Plaintiffs.
Settlement terms included a mutual release from the Texas Action and for us
to dismiss the California action with prejudice and monetary payments to the
remaining plaintiffs over a seven-month period.

Illumea (Asia)

On December 13, 2000, Illumea (Asia), Ltd. ("IAL"), Nathalie j.v.d.
Doornmalen, David Chung Shing Wu, George K.K. Tong, Edna Liu, Yee Mau Chen,
Norman Yuen Tsing Tao, Jeffrey Sun, Boris Luchterhand, Carol Andretta, Kin
Yu, Kathryn Ma, Alan Munro, Yonanda j.v.d. Doornmalen, Hunter Vest, Ltd.,
Eltrinic Enterprises, Ltd. and True Will Investments filed a First Amended
Complaint against Illumea Corporation ("Illumea") and Andrew Borsanyi
(collectively "Defendants") arising out of our acquisition of Illumea
(ILLUMEA (ASIA), LTD., ET AL. V. ILLUMEA CORPORATION AND ANDREW BORSANYI).
All of the plaintiffs except IAL and Nathalie Doornmalen thereafter dismissed
their claims without prejudice. As a result, only IAL and Doornmalen remained
as plaintiffs.

Doornmalen, a former Illumea shareholder, alleges that she consented to our
acquisition of Illumea based on the allegedly false representation that we
would hire her. She also alleges that defendants made defamatory statements
about her. Doornmalen asserts claims for securities fraud under 15 U.S.C.
Section 78j(b) and Rule 10b-5, "conspiracy," breach of contract, fraud, false
promise, defamation, and violation of California Business & Professions Code
Section 17200 ("Section 17200"). IAL alleges that Illumea breached an agency
agreement between IAL and Illumea and engaged in fraud in connection with the
agency relationship. IAL asserts claims for breach of contract and fraud.
Collectively, plaintiffs seek compensatory damages, disgorgement under
Section 17200 and attorneys' fees.

We filed a counterclaim against IAL and Doornmalen on March 26, 2001,
alleging breach of contract, breach of fiduciary duty and fraud. We allege
that IAL and Doornmalen refused to repay Illumea for providing funding and
equipment to IAL and that Doornmalen failed to disclose certain material
issues in connection with the merger between Illumea and us.

As of April 2, 2002 these matters have been settled, under the terms of the
settlement we were required to (i) pay $300 thousand; (ii) issue 700 thousand
shares of our common stock; and (iii) file a registration statement, on Form
S-1, registering the 700 thousand shares. As of October 31, 2002, the Company
has not filed the required registration statement as set for the in the
Settlement Agreement. We have been notified that Nathalie Doornmalen has
filed a motion to enforce the Settlement Agreement in the Illumea (Asia),
Ltd. matter. The opposition to this motion is due on Monday, November 4, and
the hearing is on November 18.

Trebor O. Corporation

On June 29, 2001, Trebor O. Corporation, a California corporation, doing
business as Western Pharmacy Services ("Trebor O."), and its principal Robert
Okum, filed an action in Los Angeles County Superior Court against the
Company, PrimeRx, Chartwell Diversified Services and various individuals
(TREBOR O. CORPORATION D.B.A. WESTERN PHARMACY SERVICES AND ROBERT OKUM V.
E-MEDSOFT.COM, PRIMERX, CHARTWELL DIVERSIFIED SERVICES AND VARIOUS
INDIVIDUALS, LOS ANGELES SUPERIOR COURT CASE NO. BC 253387). The plaintiffs
assert claims for breach of contract, promissory estoppel, misrepresentation,
breach of confidentiality, and tortious interference, and seek more than $5
million in compensatory damages, on the theory that we entered into a letter
of intent to purchase Trebor O, but then refused to complete the transaction.
We have settled this lawsuit as of July 2002. Settlement terms include
dismissal of Trebor O's suit against us and a payment by us to Trebor O.

Addus Healthcare

On or about April 24, 2002, we filed a complaint against Addus Healthcare,
Inc. ("Addus"), and its major shareholders, W. Andrew Wright, Mark S. Heaney,
Courtney E. Panzer, and James A. Wright. We contend that Addus has been
unable to perform its obligations under a certain stock purchase agreement
relating to our acquisition of Addus. We allege that Addus breached the
warranties and representations it gave regarding its financial condition, and
Addus has been unable to obtain the consent of necessary third parties to
assign some relevant contracts. We believe that Addus has breached the
agreement in other ways, as well. Additionally, we allege that the defendants
have misappropriated our deposit.

The complaint demands the imposition of a constructive trust for the
converted funds; and an injunction against the defendants' disposing of or
liquidating the $7.5 million deposit. Our complaint further alleges fraud on
behalf of the defendants, in the sense that they never intended to complete
the transaction but planned to use the pendency of the transaction to obtain
concessions from us. Finally, there is a claim for breach of contract. We
seek compensatory damages of $10 million per claim, plus punitive damages,
along with the equitable relief previously described and attorney's fees.

Addus has filed a counterclaim against us. They allege that we (1)
fraudulently induced them to enter into the agreement, (2) negligently
misrepresented certain aspects of our business, (3) breached the terms of the
agreement by not closing the transaction and not having available funds to
close the transaction, and (4) breached certain other confidentiality
agreements. They have sought compensatory damages in excess of $4 million, a
declaratory judgment that they are entitled to retain the $7.5 million
deposit, for general and special damages and attorney's fees. We dispute
these claims vigorously and believe they are without merit. On July 9, we
filed a reply to the counterclaim. This matter is currently in discovery and
has been transferred to the Northern District of Illinois. On October 11,
2002 we filed an Amended Complaint. Addus' answer to that complaint is due on
November 1, 2002.

University Affiliates

In January 2002, we filed a Complaint against University Affiliates IPA
("UAIPA") and its president, Sam Romeo, who at the time was also a member of
our board of directors, for breach of contract, fraud, and, as to Mr. Romeo,
breach of fiduciary duty arising out of a May 2, 2000 agreement between UAIPA
and us. Under the agreement, during the quarter ended June 2000, we advanced
$2 million to UAIPA for the purpose of creating a joint venture intended to
combine UAIPA's supposed healthcare management expertise with Internet
healthcare management systems in an effort to develop new business
opportunities. As of the filing of the suit, the companies had not proceeded
with the joint venture. According to the original agreement, if a formal
joint venture agreement was not entered into between UAIPA and us by July 1,
2000, UAIPA would guarantee payment of $2.5 million on or before July 1,
2001. The $2.5 million has not been paid. We seek payment of this amount,
plus any profits from the business opportunities that were to be transferred
to the joint venture, and punitive damages.

On March 4, 2002, UAIPA served a cross-complaint against us, Sanga E-Health,
LLC, TSI Technologies, LLC, Mitchell Stein, and John F. Andrews alleging
breach of various contracts, breach of the implied covenant of good faith and
fair dealing, declaratory relief, promissory estoppel, fraud, negligent
misrepresentation, unjust enrichment, quantum meruit, conversion, money had
and received, breach of fiduciary duty, interference with prospective
business advantage and unfair business practices, seeking damages in the
aggregate of approximately $11 million plus punitive damages. The court
denied our motion to compel arbitration on May 8, 2002. We subsequently filed
a cross-complaint against UAIPA and Sam Romeo regarding their failure to
adhere to the May 2, 2000 agreement. No trial date has been set and UAIPA is
currently in bankruptcy proceedings.

ITEM 2. CHANGES IN SECURITIES.

During the three months ended June 30, 2002, the Company had two transactions
involving the issuance of unregistered securities of its common stock:

On April 2, 2002, the Company entered into a settlement agreement with a former
shareholder of Illumea Corporation, a subsidiary of the Company now called
Tresle Corporation. Under the terms of the settlement agreement the company
agreed to issue 700 thousand shares of the Company's restricted common stock
valued at approximately $665 thousand based on the closing price of the
Company's stock on April 2, 2002. The shares were issued in July 2002.

On June 11, 2002, the Company issued 1 million restricted shares of common
stock, valued at approximately $1.3 million, and a warrant to purchase 1.5
million shares of common stock at $1.50 per share, valued at $844 thousand based
on the Black-Scholes valuation model, to Cappello Capital Corporation in
conjunction with the settlement of a lawsuit in March 2002.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) EXHIBITS. None.

(b) REPORTS ON FORM 8-K.

19

We filed a Form 8-K dated April 12, 2002 reporting under Item 5 the formation
and Receivable Purchase Agreements by American Reimbursement LLC.

We filed a Form 8-K, dated June 4, 2002, reporting under Item 5 notification and
hearing to review its conformity with the listing requirements for the American
Stock Exchange.

We filed a Form 8-K, dated July 23, 2002, reporting under Item 5 the resignation
of our three independent members of our Board of Directors.

We filed a Form 8-K, dated August 2, 2002, reporting under Item 4 the
resignation of KPMG LLP as our independent auditors and under Item 5 the
resignation of our Chief Financial Officer.

We filed a Form 8-K, dated August 19, 2002, reporting under Item 5 the refinance
of $70 million debentures held by Private Investment Bank Limited.

We filed a Form 8-K/A, dated August 19, 2002, amending our 8-K dated August 2,
2002 and reporting under Item 4 the inclusion of an August 16, 2002 letter
written by KPMG LLP to the Securities and Exchange Commission.

We filed a Form 8-K, dated August 19, 2002, reporting under Item 4 the
appointment of Brown & Brown, LLP as our independent auditor.

We filed a Form 8-K, dated September 19, 2002, reporting under Item 5 the
appointment of two new members to our Board of Directors.

20

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

Med Diversified, Inc.

Date: November 5, 2002 By: /s/ Frank P. Magliochetti
----------------------------------------
Frank P. Magliochetti
Chairman and Chief Executive Officer

By: /s/ James A. Shanahan
----------------------------------------
James A. Shanahan
Vice President of Finance
and Accounting, Corporate Controller
(Principal Accounting Officer)

21

CERTIFICATION

I, Frank P. Magliochetti, Jr., certify that:

1. I have reviewed this quarterly report on Form 10-Q of Med Diversified,
Inc.;

2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.

Date: November 5, 2002 /s/ Frank P. Magliochetti, Jr.
------------------------------------
Frank P. Magliochetti, Jr.
Chief Executive Officer

22

CERTIFICATION

I, James A. Shanahan, certify that:

4. I have reviewed this quarterly report on Form 10-Q of Med Diversified,
Inc.;

5. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and

6. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.

Date: November 5, 2002 /s/ James A. Shanahan
--------------------------------------------
James A. Shanahan
Vice President of Finance and Accounting,
Corporate Controller, Principal Accounting
Officer

23