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 September 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 October 31, 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

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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 September 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 Operations
For the Six Months Ended September 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.

5

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

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

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MED DIVERSIFIED, INC.
Notes to Condensed Consolidated Financial Statements
September 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
renegotiate its existing financing agreements with National Century Financial
Enterprises ("NCFE") obtain alternative funding sources, 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
September 30, 2002, the Company had negative working capital from continuing
operations of $189.0 million (excluding $10.3

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million negative working capital of discontinued operations). Cash and cash
equivalents at September 30, 2002 was $8.7 million.

The Company's relationship with NCFE, the Company's primary lender, has
recently become uncertain. On November 18, 2002 NCFE filed for protection
under Title 11 of the United States Code (the "Bankruptcy Code"). Recently,
the Company has experienced funding from NCFE that has been unpredictable in
timing and amount. This has created cash shortages which have resulted in our
inability to meet all vendor obligations as they became due. The Company is
exploring alternatives to secure additional funding and continues to work
with NCFE on a resolution to these matters. If the Company and NCFE are
unable to negotiate an agreement regarding NCFE's current liens on the
Company's unpurchased and future accounts receivable, the Company may be
forced to seek protection under the Bankruptcy Code. In connection with these
difficulties, we have filed a lawsuit against Lance K. Paulsen, Hal Pate, NPF
VI, Inc., NPF XII, Inc., Bank One NA, Trustee and JP Morgan Chase & Co.,
Trustee in Federal Court in Massachusetts, Civil Action No. 02-12214NG.

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 PIP amounts and all
audit liabilities relative to Medicare audits for periods through February 28,
2001. The balance due recorded as of September 30, 2002 is $52.2 million. The
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, the TLCS financing agreement with 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.

On November 11, 2002 the Company's majority owned subsidiary TLCS filed a
voluntary petition for relief under chapter 11 of title 11 of the United
States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for
the Eastern District of New York (the "Bankruptcy Court") Case No. 02-88020.
TLCS remains in possession of their assets and properties, and continues to
operate their business as "debtor-in-possession" pursuant to sections 1107(a)
and 1108 of the Bankruptcy Code.

Effective July 15, 2002 the Company was delisted from the AMEX. Further, the
Company's stock was trading at between $0.06 to $0.25 per share during October
and November 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 and
Frank Magliochetti, our CEO, were indirect shareholders 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):

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4) JOINT VENTURES AND MINORITY INTEREST

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 also provides various management services for each of the joint ventures
under Administrative Service Agreements, which range for periods from one to
five years. 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. Minority interest of
$447 thousand and $433 thousand at September 30, 2002 and 2001, respectively,
represents the outside ownership in the Company's eighty percent owned joint
venture.

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

5) FINANCING ARRANGEMENTS

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

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

On August 14, 2002 the Company refinanced $70 million of debentures with PIBL.
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 $68.6 million of the

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outstanding balance will be reported as long-term debt on the consolidated
balance sheet at September 30, 2002.

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.

Also 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.

As previously stated in our Form 10-Q for the quarter ending June 30, 2002,
we have recently been advised by counsel for PIBL that there may be material
defaults committed by us under the Amendment Agreement. These include NCFE's
failure to operationalize American Reimbursement, LLC's collections and the
fact that our subsidiary, Tender Loving Care Health Care Services, Inc., has
filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code.

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, (in thousands):

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

7) STOCK, WARRANTS AND STOCK OPTIONS

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
Trestle 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

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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.

On August 30, 2002 in conjunction with the resolution of a contractual dispute
between TegRx and the Company, the Company agreed to issue stock options to
TegRx to purchase 3 million shares of the Company's common stock at an exercise
price of $0.10 per share. The options expire on August 30, 2012. These stock
options are valued at $650 thousand based on the Black-Scholes valuation model.
TegRx is an entity majority owned by the Company's Chairman and Chief Executive
Officer. All amounts related to this settlement were expensed in the period
ended March 31, 2002.

On September 9, 2002, the Company issued 1.25 million shares of restricted
common stock to a former employee as part of a legal settlement. The shares were
valued at approximately $288 thousand based on the closing price of the
Company's common stock on September 9, 2002. All amounts related to this
settlement were expensed in the period ended March 31, 2002.

During the six months ended September 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. Also during the six months ended September 30, 2002, employees exercised
stock options to purchase 600 thousand shares of the Company's common stock at
an exercise price of $0.001 per share.

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 September 30, 2002 and 2001, options and warrants to purchase
approximately 64.0 million and 47.7 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 September 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 certain options and warrants to acquire 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 September 30, 2002 and March 31, 2002, respectively. (In thousands):

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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 and six months ended September 30, 2002,
approximately 82.3% and 82.0%, respectively of the sales from these segments
were reimbursable by Medicare and Medicaid.

During the three and six months ended September 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. 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

12

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.

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. We are currently behind on
such payments. If we do not become current, then the Remaining Plaintiffs may
enforce judgment against us for the remaining amount.

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 was filed
on November 1, 2002.

Hoskin International, Ltd. and Cappello Capital Corp.

On October 30, 2001, we filed a demand for arbitration with the American
Arbitration Association ("AAA") against Hoskin International, Ltd. ("Hoskin")
and Cappello (collectively, "Respondents") (AAA CASE NO. 50T 168 00515 1),
alleging that Respondents fraudulently induced us to enter into a "Common Stock
Purchase Agreement" and to issue warrants through various misstatements of
material facts and failed to disclose facts that the Respondents had a duty
to disclose. This matter is before an administrator assigned to the case
through the San Francisco branch of the AAA.

On December 28, 2001, Hoskin filed a response to our demand in which it
denied our allegations and asserted a counterclaim alleging that we are
liable for breach of the Common Stock Purchase Agreement and warrants based
on our alleged failure to use best efforts to cause the registration
statement for the warrants to become effective at a time when the warrants
could have been exercised at a profit.

On January 2, 2002, Cappello filed a motion to stay arbitration before the
AAA as to Cappello on the grounds that Cappello was not a party to the
arbitration clause contained in the Common Stock Purchase Agreement, and that
our claims against Cappello should be resolved in the Cappello Action in Los
Angeles (as described above under "Legal Proceedings: Cappello Capital
Corp."). The Court granted Cappello's motion on January 28, 2002. We
dismissed, without prejudice, the claims asserted against Cappello in the AAA
arbitration. Arbitration of the Hoskin matter is scheduled for late October,
2002. We settled this matter in early November for $75 thousand.

Illumea (Asia)

As disclosed in our Annual Report on Form 10-K for the year ending March 31,
2002, on April 2, 2002 the Company settled these matters, under the terms of
the settlement we were required to (i) pay $300 thousand; (ii) issue 700
thousand shares of our common stock (shares issued July 11, 2002); and (iii)
file a registration statement, on Form S-1, registering the 700 thousand
shares. As of October 25, 2002, the Company has not filed the required
registration statement. 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 was filed on Monday, November 4,
and the hearing was on November 18.

Calvin Carrera

In June 2002, Plaintiff Calvin Carrera filed suit against e-Medsoft.com
("e-Med") and nine others individually (Calvin M. Carrera v. Med Diversified,
Inc.: et al., Superior Court for the State of California for the County of
Los Angeles). On or about September 16, 2002, the parties agreed to arbitrate
the matter, with the named defendant being limited to Med Diversified, Inc.
(Calvin Carrera v. Med Diversified, Inc., American Arbitration Association,
Ref. No. 72 166 00929 02 TRPE).

Plaintiff brought nine causes of action, which included claims for breach of
contract, fraud and deceit, negligent misrepresentation, state securities
fraud, nonpayment of wages, and late payments on accrued benefits.

Plaintiff alleges that we owe him general compensatory, and punitive damages
in amounts above the minimum jurisdictional limits of the court. Plaintiff
also alleges that we owe him $833,662.50 for unpaid wages and $26,843 for
"waiting time" unpaid vacation penalties.

As of November 19, 2002, this matter is still pending and no settlement
agreement has been reached.

Lex Reddy

On June 7, 2002, Plaintiff Lex Reddy filed suit against e-Medsoft.com and
Chartwell Diversified Services, Inc. (Lex Reddy v. e-Medsoft.com d/b/a/ Med
Diversified, Inc.; Chartwell Diversified Services, Inc.; DOES 1 through 10
inclusive, Superior Court of the State of California for the County of San
Bernadino, Victorville District, Case No. VCVVS 027100).

Reddy alleges that on or about October 20, 2002, e-Med and he entered into an
oral contract by which e-Med would pay Reddy $175,000 for services performed.
Reddy argues that he performed all of the services and e-Med partially
performed--paying approximately $20,000. Reddy claims that he was assured by
e-Med that he would receive the remainder of the money. Reddy claims that he
performed all of the conditions of the oral agreement, but has not received
the remainder of what he feels is owed. The second cause of action is for
common counts to all defendants, in which Reddy argues that he is still owed
$155,000 by the defendants.

On July 19, 2002, we filed a cross-complaint against Lex Reddy for breach of
fiduciary duty. We allege that Reddy agreed to act as an officer of the
company, and he breached his corporate fiduciary duties by not acting in the
best interests of the company. We alleged that as a result of Reddy's breach,
we were deprived of Reddy's management loyalty, and as a result, suffered
damages in excess of one million dollars. As of November 19, 2002, this
matter is still pending and no settlement agreement has been reached.

11) RECENT ACCOUNTING PRONOUNCMENTS

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.

* Included in Other assets.

13

Total amortization expense for intangible assets was $207 thousand and $405
thousand for the three and six months ended September 30, 2002, respectively.
The annual amortization expense expected for the years 2003 through 2008 is
as follows (in thousands):

2003 $802
2004 792
2005 792
2006 792
2007 792
2008 774
------
$4,744
======

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.

In July 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH
EXIT OR DISPOSAL ACTIVITIES, which addresses the recognition, measurement, and
reporting of costs associated with exit or disposal activities, and supercedes
Emerging Issues Task Force (EITF) Issue No. 94-3, LIABILITY RECOGNITION FOR
CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY
(INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING). The principal difference
between SFAS 146 and EITF 94-3 relates to the requirements for recognition of a
liability for a cost associated with an exit or disposal activity. SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity, including those related to employee termination benefits and
obligations under operating leases and other contracts, be recognized when the
liability is incurred, and not necessarily the date of an entity's commitment to
an exit plan, as under EITF 94-3. SFAS 146 also establishes that the initial
measurement of a liability recognized under SFAS 146 be based on fair value. The
provisions of SFAS 146 are effective for exit or disposal activities that are
initiated after December 31, 2002, with early application encouraged. The
company expects to adopt SFAS 146, effective January 1, 2003. For exit or
disposal activities initiated prior to December 31, 2002, the Company plans to
follow the accounting guidelines outlined in EITF 94-3.

In April 2002, FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS
No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt." As a result, gains and losses from extinguishments of debt should be
classified as extraordinary items only if they meet the criteria in Accounting
Principles Board Opinion No. 30 ("APB No. 30"). SFAS No. 44, "Accounting for
Intangible Assets of Motor Carriers," was issued to establish accounting
requirements for the effects of transition to the provisions of the Motor
Carrier Act of 1980. Because those transitions have been completed, SFAS No. 44
is no longer necessary. SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements," amended SFAS No. 4, and is no longer necessary
because SFAS No. 4 has been rescinded. SFAS No. 145 amends SFAS No. 13,
"Accounting for Leases," to eliminate an inconsistency between the required
accounting for sale-leaseback transactions and the required accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The provisions of SFAS No. 145 related to the
recision of SFAS No. 4 will be applied in fiscal year beginning after May 15,
2002. The provisions of SFAS No. 145 related to SFAS No. 13 will be effective
for transactions occurring after May 15, 2002, with early application
encouraged. All other provisions of SFAS No. 145 are effective for financial
statements issued on or after May 15, 2002, with early application encouraged.

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

14

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 September 30, 2002, we had negative working capital of $189.0
million (excluding $10.3 million of negative working capital from discontinued
operations) and accumulated deficit of $640 million and a deficit stockholders'
equity of $218 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 $160.3
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, we are
also dependent upon NCFE to provide us financing for current operations under
our Sales and Subservicing Agreements. On November 18, 2002 NCFE filed for
protection under the Bankruptcy Code. NCFE has not performed its obligations
under these commitments and our relationship has become uncertain. We have
experienced funding that is unpredictable in timing and amount. These cash
shortages have resulted in our inability to meet all vendor obligations as
they become due. If NCFE fails to meet these commitments in the immediate
future, it will materially adversely affect our operations. Further, if we
are unable to obtain immediate alternative financing sources, we may be
required to seek protection under the Bankruptcy Code or cease further
operating activities. Because of NCFE's failure to honor its commitments
under the Sales and Subservicing Agreements, on November 11, 2002 TLCS filed
a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in
the United States Bankruptcy Court for the Eastern District of New York.

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 and six months
ended September 30, 2002 and 2001. In addition, we have included in the
comparisons below the unaudited pro forma financial information for the three
and six months ended September 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.

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

15

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 and six months ended September 30, 2002 (in
thousands):

16

As noted above, Chartwell's income from operations under management for the
three and six months ended September 30, 2002 totaled $887 thousand and $1.8
million, respectively.

*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 and six months ended September 30,
2002, which includes unconsolidated joint ventures as well as Chartwell
subsidiary revenue, is $43.7 million and $87.0 million, respectively.

NET SALES

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

Net sales in the distance medicine solutions segment decreased by approximately
65% and 73% in the three and six months ended September 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

17

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 and six months ended September 30, 2002, 2001
and Proforma 2001 are summarized as follows (in thousands):

PrimeRx, including Network, revenues decreased in the three and six months ended
September 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 increased in the three and six months ended
September 30, 2002 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 $2.5 million and $4.8 million in the
three and six months ended September 30, 2002 due to the closing of non
profitable locations, decreased patient referrals and other competitive factors.

Resource pharmacy revenues increased approximately $486 thousand and $1.0
million in the three and six months ended September 30, 2002 compared to 2001 as
a result of increased sales efforts for existing and new customers.

Home health revenues increased from $9.1 million in the three and six months
ended September 30, 2001 to $81.9 million and $165.5 million during the three
and six months ended September 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 $3.0 million and $6.7 million increase in revenues in the
three and six months ended September 30, 2002 due to increased patient
admissions for Medicare services.

COSTS AND EXPENSES

Cost of Sales

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

18

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

Distance Medicine Solutions cost of sales declined in the three and six months
ended September 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 and six months ended September 30, 2002
decreased compared with comparable prior year periods due to the higher
percentage of Chartwell Pharmacy services which operate at a higher gross
margin, as well as favorable vendor pricing associated with our Chartwell
revenues. On a comparative 2001 proforma basis, absent one-time inventory
charges, 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 $754 thousand and $13.3 million for the three
and six months ended September 30, 2002 compared to comparable prior year
periods. The increase is attributed to our $70 million debenture financing
and existing debt acquired in the Chartwell and TLCS acquisitions.

19

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. 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 September 30, 2002 and
March 31, 2002 (in thousands):

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 September 30, 2002, we had negative working capital of $189.0
million (excluding $10.3 million of negative working capital from discontinued
operations) and accumulated deficit of $640 million and a deficit stockholders'
equity of $218 million.

In addition, we have consistently used cash in operations, including cash
used in operating activities of $25.2 million and $7.1 million in the six
months ended September 30, 2002 and 2001, respectively. As of September 30,
2002, the current portion of our long-term debt and related party debt was
$160.3 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 September 30, 2003
without other sources of funds.

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 $160.3
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

20

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, we are
also dependent upon NCFE to provide us financing for current operations under
our Sales and Subservicing Agreements. NCFE has not performed its obligations
under these commitments and our relationship has become uncertain. We have
experienced funding that is unpredictable in timing and amount. These cash
shortages have resulted in our inability to meet all vendor obligations as they
become due. If NCFE fails to meet these commitments in the immediate future, it
will materially adversely affect our operations and we may be required to cease
further operating activities. Because of NCFE's failure to honor its commitments
under the Sales and Subservicing Agreements, on November 11, 2002 TLCS filed a
voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the
United States Bankruptcy Court for the Eastern District of New York.

We are also dependent upon NCFE to provide us financing for current
operations under our Sales and Subservicing Agreements. NCFE has not
performed its obligations under these commitments in accordance with the
terms of the agreements providing for such obligations. If NCFE fails to meet
these commitments in the immediate future, it will materially adversely
affect our operations and we may be required to cease further operating
activities. If the Company and NCFE are unable to negotiate an agreement
regarding NCFE's current liens on the Company's unpurchased and future
accounts receivable, the Company may be forced to seek protection under the
Bankruptcy Code.

In order for us to continue our operations, we must be successful in obtaining
additional funding through implementing the following steps:

1. Resolve our funding issues with NCFE and/or seek alternative funding
sources.

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 September 30, 2003.

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

4. Successfully manage our voluntary bankruptcy filing at TLCS.

As noted above, 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.

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.

ITEM 3. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Based on his
evaluation as of a date within 90 days prior to the filing date of this
Quarterly Report on Form 10-Q, our principal executive officer and principal
financial officer has concluded that our disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934 are effective to ensure that information required to be disclosed by us in
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.

(b) Changes in internal controls. There were no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

21

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.

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. We are currently behind on
such payments. If we do not become current, then the Remaining Plaintiffs may
enforce judgment against us for the remaining amount.

Illumea (Asia)

As of April 2, 2002, we settled these matters. Under the terms of the
settlement, we were required to (i) pay $300 thousand, (ii) issue 700 thousand
shares of our common stock (shares issued July 11, 2002) and (iii) file a
registration statement, on Form S-1, registering the 700 thousand shares. As of
October 25, 2002, we have not filed the registration statement as set forth 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 was filed
on November 1, 2002.

Hoskin International, Ltd. and Cappello Capital Corp.

On October 30, 2001, we filed a demand for arbitration with the American
Arbitration Association ("AAA") against Hoskin International, Ltd. ("Hoskin")
and Cappello (collectively, "Respondents") (AAA CASE NO. 50T 168 00515 1),
alleging that Respondents fraudulently induced us to enter into a "Common Stock
Purchase Agreement" and to issue warrants through various misstatements of
material facts and failed to disclose facts that the Respondents had a duty
to disclose. This matter is before an administrator assigned to the case
through the San Francisco branch of the AAA.

On December 28, 2001, Hoskin filed a response to our demand in which it
denied our allegations and asserted a counterclaim alleging that we are
liable for breach of the Common Stock Purchase Agreement and warrants based
on our alleged failure to use best efforts to cause the registration
statement for the warrants to become effective at a time when the warrants
could have been exercised at a profit.

On January 2, 2002, Cappello filed a motion to stay arbitration before the
AAA as to Cappello on the grounds that Cappello was not a party to the
arbitration clause contained in the Common Stock Purchase Agreement, and that
our claims against Cappello should be resolved in the Cappello Action in Los
Angeles (as described above under "Legal Proceedings: Cappello Capital
Corp."). The Court granted Cappello's motion on January 28, 2002. We
dismissed, without prejudice, the claims asserted against Cappello in the AAA
arbitration. Arbitration of the Hoskin matter is scheduled for late October,
2002. We settled this matter in early November for $75,000.

Calvin Carrera

In June 2002, Plaintiff Calvin Carrera filed suit against e-Medsoft.com
("e-Med") and nine others individually (Calvin M. Carrera v. Med Diversified,
Inc.: et al., Superior Court for the State of California for the County of
Los Angeles). On or about September 16, 2002, the parties agreed to arbitrate
the matter, with the named defendant being limited to Med Diversified, Inc.
(Calvin Carrera v. Med Diversified, Inc., American Arbitration Association,
Ref. No. 72 166 00929 02 TRPE).

Plaintiff brought nine causes of action, which included claims for breach of
contract, fraud and deceit, negligent misrepresentation, state securities
fraud, nonpayment of wages, and late payments on accrued benefits.

Plaintiff alleges that we owe him general compensatory, and punitive damages
in amounts above the minimum jurisdictional limits of the court. Plaintiff
also alleges that we owe him $833,662.50 for unpaid wages and $26,843 for
"waiting time" unpaid vacation penalties.

As of November 19, 2002, this matter is still pending and no settlement
agreement has been reached.

Lex Reddy

On June 7, 2002, Plaintiff Lex Reddy filed suit against e-Medsoft.com and
Chartwell Diversified Services, Inc. (Lex Reddy v. e-Medsoft.com d/b/a/ Med
Diversified, Inc.; Chartwell Diversified Services, Inc.; DOES 1 through 10
inclusive, Superior Court of the State of California for the County of San
Bernadino, Victorville District, Case No. VCVVS 027100).

Reddy alleges that on or about October 20, 2002, e-Med and he entered into an
oral contract by which e-Med would pay Reddy $175,000 for services performed.
Reddy argues that he performed all of the services and e-Med partially
performed--paying approximately $20,000. Reddy claims that he was assured by
e-Med that he would receive the remainder of the money. Reddy claims that he
performed all of the conditions of the oral agreement, but has not received
the remainder of what he feels is owed. The second cause of action is for
common counts to all defendants, in which Reddy argues that he is still owed
$155,000 by the defendants.

On July 19, 2002, we filed a cross-complaint against Lex Reddy for breach of
fiduciary duty. We allege that Reddy agreed to act as an officer of the
company, and he breached his corporate fiduciary duties by not acting in the
best interests of the company. We alleged that as a result of Reddy's breach,
we were deprived of Reddy's management loyalty, and as a result, suffered
damages in excess of one million dollars. As of November 19, 2002, this
matter is still pending and no settlement agreement has been reached.

ITEM 2. CHANGES IN SECURITIES.

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

On August 30, 2002 in conjunction with the resolution of a contractual
dispute between TegRx and the Company, the Company agreed to issue stock
options to TegRx to purchase 3 million shares of the Company's common stock
at an exercise price of $0.10 per share. The options expire on August 30,
2012. These stock options are valued at $650 thousand based on the
Black-Scholes valuation model. TegRx is an entity majority owned by the
Company's Chairman and Chief Executive Officer. All amounts related to this
settlement were expensed in the period ended March 31, 2002.

On September 9, 2002, the Company issued 1.25 million shares of restricted
common stock to a former employee as part of a legal settlement. The shares were
valued at approximately $288 thousand based on the closing price of the
Company's common stock on September 9, 2002. All amounts related to this
settlement were expensed in the period ended March 31, 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) EXHIBIT INDEX

22

Exhibit
NUMBER DESCRIPTION OF DOCUMENT
- ------ -----------------------

99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

(b) REPORTS ON FORM 8-K.

We filed a Form 8-K dated October 25, 2002 reporting under Item 5 the issuance
of a press release concerning our management team.

23

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 19, 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)

24

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;

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;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Dated: November 19, 2002 By: /s/ Frank P. Magliochetti, Jr.
---------------------------------
Name: Frank P. Magliochetti, Jr.
Title: Chief Executive Officer

CERTIFICATION

I, James A. Shanahan, 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;

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;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Dated: November 19, 2002 By: /s/ James A. Shanahan
-------------------------------------
Name: James A. Shanahan
Title: Vice President of Finance
and Accounting,
Corporate Controller
(Principal Accounting Officer)