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 December 31, 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

Indicate by check mark 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 / /

Indicate by check mark whether the issuer is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).

Yes / / No /X/

Indicate by check mark whether the issuer has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange
Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.

Yes /X/ No / /

As of January 31, 2003, 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.
(Debtor-In-Possession as of November 27, 2002)
Condensed Consolidated Balance Sheets
(in thousands)

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

3

MED DIVERSIFIED, INC.
(Debtor-In-Possession as of November 27, 2002)
Condensed Consolidated Statements of Operations
For the Three Months Ended December 31, 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.
(Debtor-In-Possession as of November 27, 2002)
Condensed Consolidated Statements of Operations
For the Nine Months Ended December 31, 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.
(Debtor-In-Possession as of November 27, 2002)
Condensed Consolidated Statements of Cash Flows
Nine Months Ended December 31, 2002 and 2001
(in thousands)
(Unaudited)

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

6

MED DIVERSIFIED, INC.
(Debtor-In-Possession as of November 27, 2002)
Notes to Condensed Consolidated Financial Statements
December 31, 2002
(Unaudited)

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

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.

On November 27, 2002 (the "Petition Date") we and five of our domestic,
wholly-owned subsidiaries, Chartwell Diversified Services, Inc. ("Chartwell"),
Chartwell Community Services, Inc. ("CCS"), Chartwell Care Givers, Inc. ("CCG"),
Resource Pharmacy, Inc. ("Resource"), and Trestle Corporation ("Trestle")
(collectively, the "Med Debtors"), filed voluntary petitions in the United
States Bankruptcy Court for the Eastern District of New York (the "Bankruptcy
Court") under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy
Code"). The reorganization cases are being jointly administered under the
caption "In re Med Diversified, Inc., et al., Case No. 8-02-88564." The Med
Debtors continue to operate their businesses as debtors-in-possession, subject
to the jurisdiction of the Bankruptcy Court and in accordance with the
applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court
while a plan of reorganization is formulated (see Note 3). As a
debtor-in-possession, we are authorized to operate our business, but may not
engage in transactions outside the ordinary course of business without the
approval of the Bankruptcy Court.

On November 8, 2002, our majority-owned subsidiary, Tender Loving Care Health
Care Services, Inc. ("TLCS") along with nineteen of TLCS' subsidiaries
(collectively, with the Med Debtors, the "Debtors"), filed voluntary petitions
in the United States Bankruptcy Court for the Eastern District of New York under
the Bankruptcy Code. The reorganization cases are being jointly administered
under the caption "In re Tender Loving Care Health Care Services, Inc., et al.,
Case No. 02-88020." TLCS continues to operate its business as a
debtor-in-possession, subject to the jurisdiction of the Bankruptcy Court and in
accordance with the applicable provisions of the Bankruptcy Code and orders of
the Bankruptcy Court while a plan of reorganization is formulated (see Note 3).
As a debtor-in-possession, TLCS is authorized to operate its business, but may
not engage in transactions outside the ordinary course of business without the
approval of the Bankruptcy Court.

Immediately prior to TLCS's Chapter 11 filing, James Happ was appointed to the
board of TLCS and named CEO of TLCS. Mr. Happ is no longer President of Med
Diversified. Day-to-day management of TLCS operations and management of TLCS in
connection with its reorganization have been supervised to date by Mr. Happ. We
have appointed Robert Cataldo as an additional board member to TLCS (with the
agreement of TLCS management), subject to any applicable regulatory approval.
Mr. Cataldo has over 30 years experience managing healthcare companies, as well
as over 40 years of extensive corporate management and restructuring experience.

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 our Annual
Report on Form 10-K for the fiscal year ended March 31, 2002.

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.

The accompanying condensed consolidated financial statements have been prepared
on a going concern basis, which assumes continuity of operations and realization
of assets and settlement of liabilities and commitments in the ordinary course
of business. The financial statements do not include any adjustments reflecting
the possible future effects on the recoverability and classification of assets
or the amount and classification of liabilities that may result from the outcome
of uncertainties discussed herein.

The accompanying condensed consolidated financial statements have also been
presented in conformity with the American Institute of Certified Public
Accountants (the "AICPA") Statement of Position (SOP) 90-7, FINANCIAL
REPORTING BY ENTITIES IN REORGANIZATION UNDER THE BANKRUPTCY CODE. The
statement requires a segregation of liabilities subject to compromise by the
Bankruptcy Court as of the Petition Date and identification of all
transactions and events that are directly associated with the reorganization
of the Company. Pursuant to SOP 90-7, pre-petition liabilities are reported
on the basis of the expected amounts of such allowed claims, as opposed to
the amounts for which claims may be

7

settled. Under a confirmed final plan of reorganization, those claims may be
settled at amounts substantially less than their allowed amounts.

SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies we followed in preparing our financial
statements are set forth in Note 2 to the financial statements included in our
Annual Report Form 10-K for the year ended March 31, 2002. We have made no
changes to these policies during this quarter, except as noted above.

We recognize revenue on the accrual basis as the related services are provided
to customers. Our 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.

A portion of our service revenues are derived under a form of franchising
pursuant to a license agreement under which independent companies or contractors
represent us within a designated territory. These licensees assign personnel
including registered nurses, therapists and home health aides to service our
clients using our trade names and service marks. We pay and distribute the
payroll for the direct service personnel who are all our employees, administer
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. We own all necessary
healthcare-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 us. The revenues and
related direct costs are included in our consolidated service revenues and
operating costs. We pay a distribution or commission to the licensees based on a
defined formula of gross profit generated. Generally, we pay the licensees 60%
of the gross profit attributable to the operations of the franchise.

Management is in the process of testing goodwill for impairment as outlined in
the Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"). Based
upon the results of such testing, management believes that a potentially
significant impairment of our $89.4 million goodwill exists. Because the Debtors
are operating under Chapter 11 of the Bankruptcy Code, the fair value of our
liabilities will be impacted by the settlement pursuant to plans of
reorganization set forth in the Bankruptcy Court. As a result, the amount of the
goodwill impairment charge, if any, will consider, among other things, the final
disposition of our pre-petition liabilities and the provisions of "fresh-start"
reporting included in SOP 90-7 (see Note 13 on this Form 10-Q).

2) GOING CONCERN

Our recent operating losses, liquidity issues and the bankruptcy proceeding
raise substantial doubt about our ability to continue as a going concern. Our
ability to continue as a going concern and the appropriateness of using the
going concern basis of accounting depends upon, among other things, the ability
to comply with the terms of our debtor-in-possession financing arrangement with
Sun Capital Healthcare, Inc. ("Sun Capital"), confirmation of a plan of
reorganization, success of future operations after such confirmation and the
ability to generate sufficient cash from operations and financing sources to
meet obligations.

3) PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

EVENTS LEADING TO BANKRUPTCY

As has been previously disclosed in our public filings, we had, up until
October 2002, been long dependent on National Century Financial Enterprises,
Inc. ("NCFE") to provide us financing for current operations under various
Sales and Subservicing Agreements. In or around October, NCFE began to suffer
financial difficulties after an ongoing audit revealed financial inaccuracies
in NCFE's accounting. During the week of October 14, 2002, we submitted
receivables for sale to NCFE under the terms of the Sales and Subservicing
Agreements, but did not receive funding from NCFE for those sales. NCFE never
resumed funding after that point, resulting in a breach of their obligations
under the various Sales and Subservicing Agreements. Nevertheless, through
the end of October, NCFE continued to assure us that funding would resume and
we acted in reliance on those assurances. The resulting cash shortages caused
us to fail to meet certain vendor obligations when they became due and caused
us eventually to default on certain obligations to Private Investment Bank,
Ltd. ("PIBL"). NCFE continued to fail to meet its funding obligations, having
a materially adverse effect on our operations. This caused our subsidiary,
TLCS, to file for bankruptcy protection on November 8, 2002 in the United
States Bankruptcy Court for the Eastern District of New York. During this
period, NCFE interpreted the terms of the Sales and Subservicing Agreements
to mean that they had a security interest in any accounts receivable of ours,
even if we had not submitted such accounts to them for sale. We disagree with
this interpretation. We believe that, at most, NCFE had a security interest
in future accounts receivable only to the extent that they might have been
owed servicing fees. Their continued intransigence regarding their
interpretation inhibited out ability to arrange for alternate sources of
financing because few lenders would be willing to finance us if they were
unable to take an undisputed first priority security interest in our accounts
receviable. NCFE and certain of its affiliates filed for bankruptcy
protection on November 18, 2002 in the Southern District of Ohio. In NCFE's
proceeding and in other venues prior to the filing of the NCFE bankruptcy,
NCFE's counsel sought temporary restraining orders restricting our ability to
access cash held by NCFE and cash that we collected on our own account.
Because of immediate cash needs and in order to obtain the ability to access
necessary cash and move forward with a new financing partner, we filed for
bankruptcy on November 27, 2002.

REORGANIZATION

8

As noted previously, the Debtors are operating their businesses as
debtors-in-possession, subject to the jurisdiction of the Bankruptcy Court and
in accordance with the applicable provisions of the Bankruptcy Code and orders
of the Bankruptcy Court while a plan of reorganization is formulated. As such,
the Debtors are authorized to operate their business, but may not engage in
transactions outside the ordinary course of business without the approval of the
Bankruptcy Court.

Soon after the Chapter 11 filings, the Debtors began notifying all known or
potential creditors, in an effort to identify and quantify all pre-petition
claims against them. As a result of the Debtors' filings, substantially all of
their indebtedness and lease obligations went into technical default. The
Chapter 11 filings, however, automatically stayed or enjoined the continuation
of any judicial or administrative proceedings or other actions against the
Debtors or their property to recover on, collect or secure a claim arising prior
to the Petition Date, subject to certain exceptions under the Bankruptcy Code.
For example, those creditor actions that seek to obtain property, or those that
seek to create, perfect or enforce any lien against property of the Debtors, or
those that seek to exercise rights or remedies with respect to a pre-petition
claim, are enjoined. Such claims may proceed only if the Bankruptcy Court grants
relief from the automatic stay. Under the Bankruptcy Code, actions to collect
pre-petition indebtedness, as well as most other pending litigation, are stayed
and other contractual obligations against the Debtors generally may not be
enforced, absent an order of the Bankruptcy Court.

At hearings held on December 2, 2002, December 9, 2002, and December 20, 2002
the Bankruptcy Court granted the Med Debtors' motions to stabilize their
operations and business relationships with customers, vendors, employees and
others. The Court granted the Med Debtors authority to, among other things: (a)
pay pre-petition and post-petition employee wages, salaries, benefits, and other
employee obligations; (b) pay vendors and other providers in the ordinary course
of business for goods and services received from and after the Petition Date,
and other similar agreements. The Bankruptcy Court also gave interim and final
approval for use of cash collateral. The Court also approved a
Debtor-In-Possession Master Purchase and Sale Agreement ("DIP Facility") with
Sun Capital. This secured debtor-in-possession financing arrangement was
approved for the payment of certain permitted pre-petition claims, working
capital needs and other general corporate purposes.

On November 12, 2002, the Bankruptcy Court granted TLCS the authority to: a)
maintain and continue to use its existing bank accounts without interruption and
in the ordinary course of business; b) continue to use existing business forms,
including checks and other documents; and c) collect and utilize cash collateral
on an interim basis pending further hearings before the Bankruptcy Court. Since
November 12, 2002, TLCS has maintained the authority to use cash collateral and
continued to operate its business in the ordinary course. It has taken
affirmative steps to stabilize its business and preserve assets for the benefit
of its creditors. Within its rights under the applicable provisions of the
Bankruptcy Code, TLCS has eliminated certain unnecessary or burdensome
obligations under various leases and contracts.

The Debtors intend to develop a plan or plans of reorganization through
negotiations with their respective key creditor constituencies. A substantial
portion of all pre-petition liabilities are subject to settlement under such a
plan of reorganization to be voted upon by the Debtors' creditors, and approved
by the Bankruptcy Court. No assurance can be given regarding the timing of such
a plan, the likelihood that such a plan will be developed, or the terms on which
such a plan may be conditioned.

Although the Debtors expect to file a reorganization plan that provides
emergence from Chapter 11 during 2003 or 2004, there can be no assurances that a
plan of reorganization will be proposed by the Debtors, or approved by the
requisite creditors, or confirmed by the Bankruptcy Court, or that any such plan
will be consummated.

The Debtors have the exclusive right to file a plan of reorganization during the
120 days after the Petition Date until March 27, 2003. If the Debtors choose to
file a plan of reorganization, they then have an additional 60 days in which to
obtain the required acceptances of the plan. The Bankruptcy Court, for cause,
may extend these time periods. If the requisite number of impaired creditors and
equity holders does not approve the plan, and the Debtors' 120-day exclusivity
period lapses, any party in interest subsequently may file a plan of
reorganization for any of the Debtors. The Med Debtors intend to move for an
additional 60-day extension of their exclusive periods, seeking to extend the
exclusive period to file their plans until May 26, 2003. TLCS has filed for an
extension of the exclusivity period and the Bankruptcy Court has approved such
extension until May 7, 2003.

A plan of reorganization is deemed accepted by holders of claims against the
equity interests in the Debtors if (i) at least one-half in number and
two-thirds in dollar amount of claims actually voting in each impaired class of
claims have voted to accept the plan; and (ii) at least two-thirds in amount of
equity interests actually voting in each impaired class of equity interests have
voted to accept the plan.

The Bankruptcy Court may confirm a plan of reorganization notwithstanding the
non-acceptance of the plan by an impaired class of creditors or equity holders
if certain requirements of the Bankruptcy Code are met. For example, if a class
of claims or equity interests does not receive or retain any property under the
plan, such claims or interests are deemed to have voted to reject the plan. The
precise requirements and evidentiary showing for confirming a plan
notwithstanding its rejection by one or more impaired classes of claims or
equity interests, depends upon a number of factors. Such factors include the
status and seniority of the claims or equity interest in the rejecting class
(i.e., secured claims

9

or unsecured claims, subordinated or senior claims, preferred or common stock).
Generally, with respect to common stock interests, a plan may be "crammed down"
if the proponent of the plan demonstrates that (i) the common stock holders are
receiving the value of their common stock interests or no class junior to the
common stock is receiving or retaining property under the plan and (ii) no class
of claims or interests senior to the common stock is being paid more than in
full.

As required by the Bankruptcy Code, the United States Trustee has appointed
official committees of unsecured creditors for TLCS, the Company and CCG (the
"Official Committees"). The Official Committees, through their legal
representatives, have a right to be heard on all matters that come before the
Bankruptcy Court. There can be no assurances that the Official Committees will
support the Debtors' positions in the reorganization cases or the plan of
reorganization once proposed. Disagreements between the Debtors and the Official
Committees could protract the reorganization cases, negatively impacting the
Debtors' ability to operate during their Chapter 11 cases, thus, possibly
delaying the Debtors' emergence from Chapter 11.

On December 22, 2002, TLCS filed, and on January 13, 2003, the Med Debtors filed
with the Bankruptcy Court schedules and statements of financial affairs setting
forth, among other things, the assets and liabilities of the Debtors, subject to
the assumptions contained in certain notes filed in connection therewith. All of
the schedules are subject to further amendment or modification. The deadline for
filing proofs of claim against the Med Debtors with the Bankruptcy Court is
expected to be set for on or about April 21, 2003, with limited exceptions for
governmental entities. Differences between amounts scheduled by the Debtors and
claims by creditors will be investigated and resolved in connection with the
claims resolution process. That process has commenced, and in light of the
number of the Debtors' creditors, may take considerable time to complete.
Accordingly, the ultimate number and amount of allowed claims is not presently
known and, because the settlement terms of such allowed claims are subject to a
confirmed plan of reorganization, the ultimate distribution with respect to
allowed claims is not presently ascertainable.

The potential adverse publicity associated with the Chapter 11 filings and the
resulting uncertainty regarding our future may hinder our ongoing business
activities and our ability to operate, fund, and execute our business plan. Such
potential negative publicity may impair relations with existing and potential
customers, negatively impact our ability to attract and retain key employees,
limit our ability to obtain trade credit and impair present and future
relationships with vendors and service providers.

As a result of the Chapter 11 filings, the realization of assets and the
liquidation of liabilities are subject to uncertainty. While operating as
debtors-in-possession under the protection of the Bankruptcy Code, and while
subject to Bankruptcy Court approval or otherwise as permitted in the normal
course of business, the Debtors may sell or otherwise dispose of assets and
liquidate or settle liabilities for amounts other than those reflected in the
condensed consolidated financial statements. Further, a plan of reorganization
could materially change the amounts and classifications reported in the
consolidated historical financial statements, which do not give effect to any
adjustments to the carrying value of assets or amounts of liabilities that might
be necessary as a consequence of confirmation of a plan of reorganization.

Under the priority scheme established by the Bankruptcy Code, unless creditors
agree otherwise, pre-petition liabilities and post-petition liabilities must be
satisfied in full before shareholders are entitled to receive any distribution
or retain any property under a plan. The ultimate recovery to creditors and/or
common shareholders, if any, will not be determined until confirmation of a plan
or plans of reorganization. No assurance can be given as to what values, if any,
will be ascribed in the Chapter 11 cases to each of these constituencies, or
what types or amounts of distributions, if any, they will receive. A plan of
reorganization could result in holders of our common stock receiving no
distribution on account of their interests and cancellation of their existing
stock. The value of the common stock is highly speculative. We urge that
appropriate caution be exercised with respect to existing and future investments
in any liabilities and/or securities of the Company or the other Debtors.

LIABILITIES SUBJECT TO COMPROMISE

"Liabilities subject to compromise" refers to liabilities incurred prior to the
commencement of the Chapter 11 filings. These liabilities, consisting primarily
of related-party and long-term debt, certain accounts payable and accrued
liabilities, represent our estimate of known or potential pre-petition claims to
be resolved in connection with the Chapter 11 filings.

Under the Bankruptcy Code, the Debtors may assume, assume and assign, or reject
executory contracts and unexpired leases, including leases of real and personal
property, subject to the approval of the Bankruptcy Court and certain other
conditions. Rejection constitutes a court-authorized breach of the lease or
contract in question and, subject to certain exceptions, relieves the Debtors of
their future obligations under such lease or contract, but creates a deemed
pre-petition claim for damages caused by such breach or rejection. Parties whose
contracts or leases are rejected may file claims against the rejecting Debtor
for damages. Generally, the assumption of an executory contract or unexpired
lease requires the Debtors to cure all prior defaults under such executory
contract or unexpired lease, including all pre-petition arrearages, and to
provide adequate assurance of future performance. In this regard, we expect that
liabilities subject to compromise and resolution in the Chapter 11 case will
arise in the future as a result of claims for damages created by the Debtors'
rejection of various

10

executory contracts and unexpired leases. Conversely, we would expect that the
assumption of certain executory contracts and unexpired leases might convert
liabilities shown as subject to compromise, into liabilities not subject to
compromise.

A summary of the principal categories of claims classified as liabilities
subject to compromise at December 31, 2002 are as follows (unaudited, in
thousands):

Long Term Debt

Borrowings under credit facility $ 125,377
Notes payable related to acquisitions 3,059
Term notes 28,679
Debentures held by related party 12,500
Debentures 57,300
Other notes payable 16,275

---------
Total Debt 243,190

Due to government agencies 51,924
Related party liabilities 2,400
Capital lease obligations 3,613
Accounts Payable 17,999
Accrued salaries and related benefits costs 15,211
Accrued interest 3,540
Other accrued liabilities 37,602
---------
Total liabilities 132,289
---------
Total Debt and Liabilities Subject to Compromise $ 375,479
=========

Approximately $257.6 million in liabilities subject to compromise would have
been classified as current liabilities if the Chapter 11 petitions had not been
filed. Filing a petition generally causes the payment of unsecured or
undersecured liabilities to be prohibited before the plan is confirmed. The
Chapter 11 reorganization ending in confirmation of a plan typically takes
more than one year or one operating cycle, if longer. Therefore, we have
classified all debt and liabilities subject to compromise as long term.

In accordance with SOP 90-7, we have discontinued accruing interest relating to
certain debt currently classified as liabilities subject to compromise effective
November 27, 2002. Contractual interest for the three and nine month periods
ended December 31, 2002 was $6.7 million and $26.8 million, respectively, which
is $1.5 million in excess of interest included in the accompanying financial
statements.

DIVESTITURE

The Bankruptcy Code provides a mechanism by which the Debtors may abandon
property if it is no longer beneficial to the estates and its retention serves
no purpose in effectuating the goals of the Bankruptcy Code. Abandonment
constitutes a court-authorized divestiture of all of the Debtors' interests in
the property. Abandonment gives rise to potential claims against the Debtors.

Due to the uncertain nature of many of the potential rejection and abandonment
related claims, we are unable to project the magnitude of such claims with any
degree of certainty at this time.

DEBTOR FINANCIALS

A condensed combined balance sheet at December 31, 2002 and a condensed combined
statement of operations for the three and nine months ended December 31, 2002
for the Debtors are as follows (unaudited, in thousands):

CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 2002

ASSETS
Current assets
Cash & cash equivalents $ 6,766
Accounts receivable, net 45,218
Other Current Assets 5,031
----------
57,015
----------

Non-Current Assts
Property and equipment, net 14,765
Goodwill, net 82,302
Intangibles and other assets, net 11,366
----------
108,433
----------

Total Assets $ 165,448
==========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities
Accounts payable and accrued expense $ 16,540

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Long Term Liabilities
Liabilities subject to compromise 375,479
Other Liabilities 3,087
----------
378,566

Stockholders deficit
Common shares 149
Paid in capital 427,027
Stock subscriptions (4,400)
Common stock options 528
Deferred Compensation (110)
Accumulated deficit (651,483)
Accumulated comprehensive income (3)
Less: treasury shares, at cost (1,366)
----------

(229,658)
----------

TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 165,448
==========

CONDENSED COMBINED STATEMENT OF OPERATIONS

4) BUSINESS COMBINATIONS

ACQUISITIONS FOR THE FISCAL YEAR ENDED MARCH 31, 2002

Acquisitions

On August 6, 2001, we acquired Chartwell. Donald Ayers, a member of our board of
directors, was an indirect shareholder of Chartwell at the time of the
acquisition.

On October 19, 2001, we signed a definitive merger agreement to acquire TLCS, a
publicly traded company, headquartered in Lake Success, New York. We 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.

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

12

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):

5) JOINT VENTURES AND MINORITY INTEREST

As a result of the Chartwell merger in August 2001, we have investments in eight
(8) 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. We also provide
various management services for each of the joint ventures under Administrative
Service Agreements, which range for periods from one to five years. Our
ownership in the joint ventures includes: one with 80% interest which is
consolidated, one with 45% interest and six with 50% interest accounted for on
the equity basis of accounting. Minority interest of $443 thousand at December
31, 2002 and 2001, represents the outside ownership in our 80%-owned joint
venture.

A condensed balance sheet at December 31, 2002 and a condensed statement of
operations of the joint ventures accounted for on the equity method for the nine
months ended December 31, 2002 are as follows (unaudited, in thousands):

CONDENSED COMBINED BALANCE SHEET

Current assets $ 24,414
Non current assets 5,743
----------

$ 30,157
==========

Current liabilities 6,815

Non current liabilities 584

Members equity:
Company 11,980
Other members 10,778
----------

$ 30,157
==========

CONDENSED COMBINED STATEMENT OF OPERATIONS

Revenues $ 54,680
Expenses 47,145
----------
7,535

Net income allocated to
other members (4,243)
----------

Net income $ 3,292
==========

6) FINANCING ARRANGEMENTS

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

TERM NOTES

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On October 28, 2002, our subsidiaries, Chartwell, CCS, CCG and TLCS, entered
into an Assumption and Release Agreement with a subsidiary of NCFE. NCFE had
previously assumed notes payable to HMA by certain subsidiaries of Chartwell.
We assigned these obligations to TLCS in exchange for the negation of
approximately $16 million of inter-company debt owed by TLCS to us and/or
CDSI. Under the terms of the agreement, TLCS assumed the three unsecured term
notes totaling $28.7 million thereby assuming the obligations of Chartwell,
CCS and CCG under the original terms of the notes.

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

On August 14, 2002 we refinanced $70 million of debentures with PIBL. To secure
the extension, we 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. We 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 our
Chairman and Chief Executive Officer. The TegCo debt is subordinate to the PIBL
debentures and is due on June 29, 2004. As a result of the Chapter 11 filing,
approximately $68.6 million of the outstanding balance is included in
liabilities subject to compromise on the condensed consolidated balance sheet at
December 31, 2002.

As a result of NCFE's collapse and our filing and TLCS' filing for bankruptcy,
we are in default of our obligations to PIBL, although the obligations are
treated for accounting purposes as liabilities subject to compromise. PIBL had
notified us prior to November 27, 2002 that they were accelerating our $57.5
million obligation to them because PIBL claimed various events of default
under the amended debentures.

OTHER NOTES PAYABLE

On June 28, 2002, we amended a $4 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, we 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 our subsidiaries, or by
July 28, 2003, whichever is earlier. Each obligation to NCFE is included for
accounting purposes as a liability subject to compromise.

7) 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 Emerging
Issues Task Force 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. We 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 our condensed consolidated financial statements under discontinued
operations (unaudited, in thousands):

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

14

Stockholder's deficit ............... (8,908) (8,908)
---------- ----------
$ 2,314 $ 2,314
========== ==========

8) STOCK, WARRANTS AND STOCK OPTIONS

On April 2, 2002, we entered into a settlement agreement with a former
shareholder of Illumea Corporation, our subsidiary now called Trestle. Under the
terms of the settlement agreement, we agreed to issue 700 thousand shares of
restricted common stock valued at approximately $665 thousand based on the
closing price of such 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, we 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 connection with the settlement of a lawsuit
in March 2002 (See Note 12). 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 Pharmacy Management Company, Inc. ("TegRx") and the Company, we
agreed to issue stock options to TegRx to purchase 3 million shares of 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 our Chairman and Chief
Executive Officer. All amounts related to this settlement were expensed in the
period ended March 31, 2002.

On September 9, 2002, we 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 our common stock on
September 9, 2002. All amounts related to this settlement were expensed in the
period ended March 31, 2002.

During the nine months ended December 31, 2002, we granted stock options to
employees to purchase 820 thousand shares of stock at $0.68 per share and 2.5
million shares of stock at $0.13 per share. These options were granted in
accordance with our stock option plans with exercise prices based on the
market price of our stock at the time of grant. The Board of Directors has
approved these grants. Also during the nine months ended December 31, 2002,
employees exercised stock options to purchase 600 thousand shares of common
stock at an exercise price of $0.001 per share.

9) 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 (unaudited, in
thousands):

As of December 31, 2002 and 2001, options and warrants to purchase approximately
65.6 million and 55.0 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 and nine months
ended December 31, 2002 and 2001 as such options and warrants were
anti-dilutive. In accordance with SFAS No. 128, we have 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.

10) REORGANIZATION ITEMS

15

Reorganization items consist of income, expense and other cost directly related
to our reorganization since the Chapter 11 Filings. We have incurred, and will
continue to incur, significant costs associated with the reorganization. The
amount of these costs, which are being expensed as incurred, are expected to
significantly and adversely affect the results of operations.

Reorganization items included in the statements of operations for the three and
nine months ended December 31, 2002 consist of the following (in thousands):

Professional fees $ 773
Unamortized market premium on term notes - net (721)
Other reorganization costs 222
Unamortized financing fees 25
Trustee filing fees 38

------
$ 337
======

11) SEGMENT INFORMATION

We derive our 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 our Annual
Report on Form 10-K for the year ended March 31, 2002. We evaluate performance
based on operating earnings of our respective business segments; as such, there
is no separately identifiable statements of operations data below operating
loss.

Our 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 thousands):

16

Three Months Ended December 31, 2001
Net Sales .......................................... $ 912 $ 16,357 $ 37,943 $ -- $ 55,212
Operating (Loss)/Income Before
Depreciation and Amortization ...................... (1,922) 1,458 (3,279) (6,125) (9,868)
Depreciation and Amortization ...................... 1,224 1,236 714 399 3,573
Operating Income (Loss) ............................ (3,146) 222 (3,993) (6,524) (13,441)
Capital Expenditures ............................... 14 649 148 42 853
Total Assets as of March 31, 2002 .................. 1,485 32,291 67,130 111,934 212,840
-----------------------------------------------------------

Our U.S. sales from our 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 nine months ended December 31, 2002, approximately - 82.5%
and 82.1%, respectively, of the sales from these segments were reimbursable by
Medicare and Medicaid.

During the three and nine months ended December 31, 2001, our U.S. operations
from our 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 our total sales.

12) 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. In connection with our
filing for bankruptcy protection, all of the litigation noted below, if it was
not settled prior to the our filing for bankruptcy, has been automatically
stayed under bankruptcy law, meaning, where we are a defendant, that no adverse
party may take any action in the context of such litigation unless such party
obtains relief from the automatic stay. Where we are the plaintiff, we may
pursue such litigation at our option. 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.

These matters are organized below as follows: 1) Litigation from events
arising prior to our merger with Chartwell in August 2001; 2) Litigation from
events arising after our merger with Chartwell in August 2001; 3) TLCS
litigation; and, 4) Chartwell litigation.

LITIGATION FROM EVENTS ARISING PRIOR TO OUR MERGER WITH CHARTWELL IN AUGUST
2001

PRIMERX.COM/NETWORK PHARMACEUTICALS, INC.

Our relationship with PrimeRx.com ("PrimeRx"), Network Pharmaceuticals, Inc.
("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 meet 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)
release 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.

17

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.

Due to our filing for bankruptcy protection, Network is an unsecured creditor of
ours. Any action by them to enforce the terms of the settlement is subject to
the automatic stay enforced under the Bankruptcy Code.

VIDIMEDIX CORPORATION

On or about September 15, 2000, certain former securities holders of VidiMedix
Corporation ("VidiMedix") filed a petition against us arising from 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 6.0 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 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.

Due to our filing for bankruptcy protection, the Remaining Plaintiffs are
unsecured creditor of ours. Any action by them to enforce the terms of the
settlement is subject to the automatic stay under the Bankruptcy Code.

SUTRO NASD ARBITRATION NO. 1

As disclosed in our Annual Report on Form 10-K for the year ended March 31,
2001, and as updated in our Annual Report on Form 10-K for the year ended March
31, 2002, a dispute between Sutro & Co. ("Sutro"), and us has been arbitrated
before the National Association of Securities Dealers. On October 22, 2001, we
agreed to settle the matter and Sutro NASD Arbitration No. 2 described below for
1.6 million shares of our common stock. We delivered a stock certificate for 1.3
million shares of our common stock representing shares due Sutro from an
exercise of our warrants in June and August 2000. These shares met all
requirements of Rule 144(k) of the Securities Act of 1933 and were delivered to
Sutro without restriction. We also delivered a stock certificate for 300
thousand shares of our common stock with a value of $720 thousand at the time of
issuance. We agreed to register these shares in our next registration statement
filing with the SEC. If based on the closing price of our common stock two days
prior to the effective date of the registration statement, the market value of
the 300 thousand shares is less then $720 thousand, then we are obligated to
issue an additional number of shares such that the market value of the sum of
the shares is as nearly as possible equal to $720 thousand. Based on the closing
price of our common stock at June 30, 2002, we would be obligated to issue an
additional 3.3 million shares. As a result of this settlement, we expensed $3.7
million as of March 31, 2002.

SUTRO NASD ARBITRATION NO. 2

An investor in the Company sued Sutro for failing to honor commitments and
failures to act in accordance with its fiduciary duties. This matter was being
arbitrated before the National Association of Securities Dealers.

As part of the Sutro No. 1 NASD arbitration settlement described above, on
October 22, 2001, we agreed to settle the matter.

CAPPELLO CAPITAL CORP.

On November 16, 2001, we filed a complaint against Cappello Capital Corp.
("Cappello") (Med Diversified v. Cappello Capital Corp., Los Angeles Superior
Court Case No. SC 069391 (the "Cappello Action")), alleging that Cappello was
liable for fraud for inducing us to enter into an exclusive financial advisor
engagement agreement ("Engagement Agreement"), by misrepresenting to us that
Cappello had significant sources of capital ready and willing to invest in us
when such was not true. In the complaint, we sought

18

compensatory and punitive damages, as well as rescission of the Engagement
Agreement. We dismissed the case without prejudice on March 1, 2002, and settled
the case and all claims relating thereto as of March 25, 2002. We have fulfilled
all of our obligations under this settlement.

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 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
office 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. We settled the
matter with Hoskin in November 2002.

Due to our filing for bankruptcy protection, Hoskin is an unsecured creditor of
ours. Any action by Hoskin to enforce the terms of the settlement is subject to
the automatic stay under the Bankruptcy Code.

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, the "Defendants")
arising out of our acquisition of Illumea (Illumea (Asia), Ltd., et al. v.
Illumea Corporation and Andrew Borsanyi). All of the plaintiffs 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, 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 and (iii) file a registration statement, on Form S-1,
registering the 700 thousand shares. As of October 31, 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. We filed an opposition
to this motion, and the court approved the motion pending the presentation of
evidence. This matter is subject to the automatic stay under the Bankruptcy
Code.

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 us, PrimeRx,
Chartwell 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.

19

SAN DIEGO ASSET MANAGEMENT, INC.

On October 24, 2001, we filed a complaint against San Diego Asset Management,
Inc. ("SDAM") (Med Diversified v. San Diego Asset Management Inc., Los Angeles
Superior Court Case No. BC 260285 (the "2001 SDAM Action")) arising out of an
agreement whereby we were to sell shares of our common stock that could be
purchased for $83 million for 90% of the market price of our common stock to
SDAM. We agreed to prepare a certificate for 15 million restricted shares of our
common stock as a commission (the "Certificate"), as well as pay $3 million in
cash as commission to SDAM. We delivered the Certificate but SDAM did not
deliver the $83 million. In the lawsuit, we sought a temporary restraining
order, preliminary injunction and permanent injunction ordering SDAM to return
the Certificate to us. Pursuant to the Court's order dated November 6, 2001, the
Certificate was returned to us and cancelled. We dismissed the 2001 SDAM Action
without prejudice on November 13, 2001.

On February 1, 2002, we filed for Arbitration with the National Association of
Securities Dealers (the "NASD Arbitration") against SDAM and its principals,
Wendy Feldman Purner and Daniel Feldman (collectively, "Respondents") (NASD CASE
NO. 02 00650), alleging that Respondents fraudulently induced us to enter into a
Securities Purchase Agreement through various misstatements of material fact
and, alternatively, that Respondents breached the Securities Purchase Agreement.
On March 13, 2002, following objections to jurisdiction, we dismissed without
prejudice the claims asserted against Daniel Feldman in the arbitration. The
remaining Respondents have not yet responded to our claims and no arbitrator has
yet been selected.

On February 5, 2002, we filed a complaint against SDAM and its principals, Wendy
Feldman Purner and Daniel Feldman, (Med Diversified, Inc. v. San Diego Asset
Management, Inc., Wendy Feldman Purner and Daniel Feldman, Los Angeles, Superior
Court Case No. BC 267635 (the "2002 SDAM Action")), alleging that they, in the
second half of 2001, fraudulently induced us to enter into a Debenture Agreement
through various misstatements of material fact and, alternatively, that they
breached the Debenture Agreement.

On February 28, 2002, we amended our complaint in the 2002 SDAM Action to add as
defendants E*Trade Securities, Inc. and E*Trade Group, Inc. and to add, as
against SDAM, Wendy Feldman Purner and Daniel Feldman, the claims asserted in
the NASD Arbitration. No discovery has been propounded as of October 24, 2002.
On May 3, 2002, we dismissed E*Trade from the 2002 SDAM Action without
prejudice. On May 6, 2002, we dismissed Daniel Feldman from the 2002 SDAM Action
without prejudice.

On May 9, 2002, SDAM filed a cross-complaint against us. SDAM alleges that on or
about August 2001, we entered into an agreement with SDAM to sell it 5 million
shares of our common stock and that SDAM paid us $2 million, but have not
received any stock. After we demurred to SDAM's cross-complaint, SDAM filed an
amended cross complaint July 3, 2002. These matters were in discovery. Due to
our filing for bankruptcy protection, this matter is subject to the automatic
stay under the Bankruptcy Code.

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 were 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. Due to our filing for bankruptcy protection and UAIPA's bankruptcy
proceedings, this matter is subject to the automatic stay in both cases.

LITIGATION FROM EVENTS ARISING AFTER OUR MERGER WITH CHARTWELL IN AUGUST 2001

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 (Med Diversified, Inc. v. Addus
Healthcare, Inc., et al., U.S. District Court, Central District of California,
Case No. CV 02-3911 AHM (JTLX)). 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

20

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, stating that they never intended to complete the transaction but
planned to use the pendency of the transaction to obtain concessions from us.
Additionally, there is a claim for breach of contract. We seek compensatory
damages of approximately $10 million per claim, plus punitive damages, along
with the equitable relief previously described and attorneys' fees.

Addus has filed a counterclaim against us, alleging 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. Addus has sought compensatory
damages in excess of $4 million, a declaratory judgment that it is entitled to
retain the $7.5 million deposit, for general and special damages. We dispute
these claims vigorously and believe they are without merit. On July 9, 2002, we
filed a reply to the counterclaim. This matter has been transferred to the
Northern District of Illinois. On October 11, 2002, we filed an Amended
Complaint. We received Addus' answer to that complaint. A status conference is
scheduled for early March 2003. We intend to pursue this litigation and remove
the automatic stay.

LANCE POULSEN, HAL POTE, NPF VI, NPF XII, BANK ONE, JP MORGAN CHASE & CO.

In November 2002, we filed a complaint, along with our subsidiary Chartwell
Diversified Services, Inc. and OrthoRehab, Inc. ("OrthoRehab"), against two
principals of NCFE, Lance K. Poulsen ("Poulsen") and Hal Pote ("Pote"), two
legal designees of NCFE, NPF VI, Inc., NPF XII, Inc., and two banking
organizations, Bank One NA, Trustee ("Bank One"), and JP Morgan Chase & Co.,
Trustee ("JP Morgan") (Med Diversified, Inc.; Chartwell Diversified Services,
Inc.; and OrthoRehab, Inc. v. Lance K. Poulsen; Hal Pote; NPF VI, Inc.; NPF XII,
Inc.; Bank One NA, Trustee and JP Morgan Chase & Co., Trustee, U.S. District
Court District of Massachusetts, Civil Action No. 02-12214 NG). We contend that
Poulsen and Pote made false representations to us about NCFE's ability to fund
us, as well as NCFE's financial condition. In reliance, we entered into
contractual relationships for financing with NCFE and its affiliates. We believe
that NCFE's liquidity problems and the nature of the "ponzi scheme" which NCFE
engaged, was known for some time prior to NCFE's breach of the Sales and
Subservicing Agreements by certain of its principals and independent board
members. Had we known, we would not have continued these financing arrangements
and would have searched for alternate financing. Because of NCFE's eventual
financing difficulties, we were harmed as a result. We also contend that at the
time Poulsen and Pote assured us that NCFE would provide funding to us, they
were conspiring to conceal from us the true status of NCFE's business and
financial condition.

Further, we contend that Poulsen and Pote demanded that NPF VI and NPF XII
withhold funding, completely depriving us of all necessary monies from which we
operate our business. We also believe that Bank One and JP Morgan caused NPF VI
and NPF XII to withhold funds, which were guaranteed under contractual
agreements. We also contend that NPF VI and NPF XII breached their contracts
with Chartwell and OrthoRehab in refusing to honor their funding commitments.

We seek monetary damages to be proven at trial. As NCFE is in bankruptcy
(meaning actions against it are subject to an automatic stay), we are
investigating our alternatives in pursuing this litigation against all named
defendants.

TLCS LITIGATION

PRIVATE INVESTMENT BANK LIMITED

On January 29, 2003, TLCS and its nineteen subsidiaries commenced an adversary
proceeding against Private Investment Bank Limited ("PIBL") by the filing of a
complaint (the "PIBL Complaint") in the Bankruptcy Court where the TLCS Chapter
11 case is currently pending. In connection with the TLCS Chapter 11 cases, PIBL
has asserted certain security and other interests in the assets of TLCS and its
subsidiaries. The PIBL Complaint seeks to avoid and recover those certain
security and other interests asserted by PIBL against the assets of TLCS and its
subsidiaries as either preferential or fraudulent transfers. As of the date of
this disclosure, PIBL has not yet answered the PIBL Complaint and joined issue
in the action.

H.L.N. CORPORATION

H.L.N. Corporation, Frontlines Homecare, Inc., E.T.H.L., Inc., Phoenix Homelife
Nursing, Inc., and Pacific Rim Health Care Services, Inc., former licensees
(franchisees) of TLCS for the territory comprising certain counties in and
around Los Angeles, California, and their holding company, instituted an action
against TLCS subsidiaries, Staff Builders, Inc., Staff Builders International,
Inc. and Staff Builders Services, Inc., and certain executive officers of TLCS.
Plaintiffs filed a First and Second Amended Complaint in the Central District on
January 8, 1999 and September 1, 1999, respectively, to challenge the
termination of the four franchise agreements between TLCS and certain of the
named plaintiffs (H.L.N. Corporation, et al. v. TLCS Subsidiaries, et al.). The
Plaintiffs are seeking damages for violations of California franchise laws,
breach of contract, fraud and deceit, unfair trade

21

practices, claims under the RICO, negligence, intentional interference with
contractual rights, declaratory and injunctive relief and a request for an
accounting. The Plaintiffs have not specified the amount of damages they are
seeking. Pursuant to a Motion of Summary Judgment, the court granted all of the
individual Defendants' Motions for Summary Judgment, dismissing all causes of
action against these individuals. In addition, the court dismissed the RICO,
fraud, negligence, California franchise investment law and implied covenant of
good faith and fair dealing claims. The only remaining triable issues in the
case are those relating to breach of contract, unfair business practices and
wrongful termination under the California franchise law. Trial is scheduled for
August 2003. Due to TLCS' filing for bankruptcy protection, this matter is
subject to the automatic stay under the Bankruptcy Code.

CHARTWELL LITIGATION

CRAVEY

Warren Willard Cravey ("Cravey"), now deceased, was a client of CCS.

CCS provided care to Cravey via its community-based alternatives program. On
October 1, 2001, Lorene Emma Barros, Individually and as Executive to the Estate
of Warren Willard Cravey, Deceased, Cheryl Lynn Sloniger, Londa Sylvia Cravey,
Lorna Christine Tillman, and Warren Willard Cravey, II ("Plaintiffs") filed a
lawsuit against Concepts of Care II, Inc., Chartwell Community Services, Inc.
f/k/a Concepts of Care, Infusion Management Systems, Inc. d/b/a Concepts of
Care, HomeCare Concepts of America, Inc. d/b/a Concepts of Care, Mollie
Primrose, and Mollie Gay Jordy ("Defendants"). (Case No. 23096, pending in the
District Court of Jasper County, Texas.) Plaintiffs in the above-referenced
cause are the children of Cravey.

Plaintiffs claim that Defendants were negligent in their care of Cravey.
Plaintiffs allege against CCS claims for negligence, negligence per se, gross
negligence and breach of fiduciary duty. Pursuant to the theory of respondeat
superior, Plaintiffs also assert that CCS is liable for the alleged negligence
of its former employee, Defendant Mollie Primrose, in her care of Cravey.
Plaintiffs also assert against CCS a claim for punitive damages, alleging CCS'
conduct was grossly negligent and/or malicious. CCS denies and is vigorously
defending all claims.

All parties to the suit are currently actively engaged in discovery. As of the
date hereof, there have been no motions for summary judgment or any other
dispositive motions filed by any party. Though a jury trial has been demanded,
this case is not presently set for trial. Due to our filing for bankruptcy
protection, this matter is subject to the automatic stay under the Bankruptcy
Code.

MEDICAL SPECIALTIES DISTRIBUTORS INC.

In July 2001, Medical Specialties, Inc. ("Medical Specialties") sued our
subsidiary, Chartwell, in superior court in Massachusetts (Medical Specialties
Distributors Inc. v. Chartwell Diversified Services, Inc., et al., Bristol
County Superior Court (Massachusetts) Civil Action No. BRCV2001-00845. This
claim alleges failure to pay for the purchase of healthcare products and
equipment rentals totaling approximately $2 million. The case is currently in
discovery. Under the terms of the purchase of certain assets by Chartwell, we
assumed certain assets while not assuming certain liabilities and were
indemnified by Home Medical of America, Inc. ("HMA") for any actions that might
arise from such non-assumed liabilities. We had been informed previously by HMA
that it would assume the defense of this matter. As of the date hereof, we have
not been informed that HMA has actually assumed such defense. We continue to
request of HMA that it assume this defense, and have retained counsel to handle
this defense in the meantime. We believe that this case has no merit. Due to our
defendant subsidiaries filing for bankruptcy protection, this matter is subject
to the automatic stay under the Bankruptcy Code.

TRI-COUNTY HOME HEALTH, INC.

In March of 2002, Tri-County Home Health, Inc. ("Tri-County") and other
plaintiffs filed suit against CCS and Chartwell and Shay Fields (Tri County Home
Health, Inc. et al. v. Chartwell Community Services, Inc., Chartwell Diversified
Services, Inc. and Shay Field, 365th JDC, Hardin County TX, Case No. 42108).
Tri-County claims that the Defendants breached a contract for the sale of the
long term care portion of Tri-County's operations. They have also alleged fraud,
tortious interference, material misrepresentation and unfair dealings. They seek
damages in excess of $1 million. Chartwell answered the complaint and believes
that the claims are without merit. Due to our filing for bankruptcy protection,
this matter is subject to the automatic stay under the Bankruptcy Code.

13) 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.

22

* Included in Other assets.

Total amortization expense for intangible assets was $198 thousand and $604
thousand for the three and nine months ended December 31, 2002, respectively.
The annual amortization expense expected is as follows:

As of March 31, 2002, the net carrying value of the Company's goodwill
totaled $89.4 million. No amortization expense was recorded for the three and
nine months ended December 31, 2002 as a result of the Company's adoption of
SFAS No. 142. Amortization of goodwill for the three and nine months ended
December 31, 2001 amounted to $422 thousand and $1.3 million, respectively.
The following unaudited pro forma information summarizes the effect of
excluding goodwill amortization expense retroactive to April 1, 2001. Pro
forma results are in thousands of dollars, except per share data:

THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
2001 2001

Reported net loss from
continuing operations $ (25,652) $ (109,443)
--------- ----------
Add back: goodwill
amortization 422 1,248

Adjusted net loss from
continuing operations $ (25,230) $ (108,195)
========= ==========
Basic Earnings per share:
Reported net loss from
continuing operations $ (0.26) $ (1.24)
Goodwill amortization -- 0.01

Adjusted net loss from
continuing operations $ (0.26) $ (1.23)
========= ==========
Earnings per share - basic
and diluted:

Reported net loss from
continuing operations $ (0.28) $ (1.28)
Goodwill amortization -- 0.02
--------- ----------
Adjusted net loss from
continuing operations $ (0.28) $ (1.26)
========= ==========

Management is in the process of testing goodwill for impairment using the
two-step process prescribed by SFAS No. 142. The first step is a screen for
potential impairment and the second step measures the amount of impairment, if
any. In performing the first step during the third quarter of fiscal 2003,
management utilized estimates of the enterprise value of the Company as of
January 1, 2002 and compared such enterprise value estimates to the carrying
value of the Company's corresponding net assets as of that date. Based on the
results of such test, management believes that a potentially significant
impairment of the Company's $89.4 million goodwill exists. However, determining
the amount of such impairment, which constitutes the second step of the process
described in SFAS No. 142, requires management to identify the implied fair
value of the Company's goodwill. Because the Debtors are operating under Chapter
11 of the Bankruptcy Code, the fair value of the Company's liabilities will be
impacted by the settlement pursuant to a plan or plans of reorganization set
forth by the Debtors' Chapter 11 trustee or another interested party in the
bankruptcy proceedings and, ultimately, on decisions of the Bankruptcy Court. As
a result, the amount of the goodwill impairment charge, if any, will consider,
among other things, the Company's enterprise value and management's best
estimates regarding the final disposition of the Company's pre-petition
liabilities in accordance with SOP 90-7 and the provisions of "fresh-start"
reporting included therein.

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

23

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.

ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES

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 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. We expect to adopt SFAS 146, effective January 1,
2003. For exit or disposal activities initiated prior to December 31, 2002,
we plan to follow the accounting guidelines outlined in EITF 94-3.

RESCISSION OF FASB STATEMENTS NO. 4, 44 AND 64, AMENDMENT OF FASB STATEMENT NO.
13, AND TECHNICAL CORRECTIONS

In April 2002, the 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 are in effect for transactions occurring after
May 15, 2002. Due to our recent bankruptcy filing, Management has not
determined the impact of adopting SFAS No. 145 on our consolidated financial
statements.

ACCOUNTING FOR STOCK BASED COMPENSATION - TRANSITION AND DISCLOSURE

In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION-TRANSITION AND DISCLOSURE, SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of account
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. The amendments to SFAS No. 123 provided for under SFAS No.
148 are effective for financial statements for fiscal years ending after
December 15, 2002. However, certain provisions of SFAS No. 148 relating to
interim financial statements are effective for the Company's fourth quarter
beginning January 1, 2003.

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
our 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 strategies, and of healthcare
industry trends. Management's forward-looking statements further assume that the
Company will be able to successfully develop and execute on its strategic
relationships and obtain approval for a plan of reorganization under the terms
of the Bankruptcy Code. 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 our products, changing technology, competition in the health-care
market, government regulation of health care, general economic conditions,
availability of

24

capital, the outcome of pending litigation, our ability to successfully
reorganize under the Bankruptcy Code 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 our expectations. Some important factors that could cause
our actual results to differ materially from those projected in such
forward-looking statements are discussed in our Annual Report on Form 10-K for
the year ended March 31, 2002.

OVERVIEW

Part I, Item 2 of this report should be read in conjunction with Part II, Item 7
of our Annual Report on Form 10-K for the year ended March 31, 2002. The
information contained herein is not a comprehensive discussion and analysis of
our financial condition and results of operations, but rather updates
disclosures made in the aforementioned filing.

On November 27, 2002, we and five of our domestic, wholly-owned subsidiaries,
Chartwell, CCS, CCG, Resource, and Trestle, filed voluntary petitions in the
United States Bankruptcy Court for the Eastern District of New York under
Chapter 11 of Title 11 of the Bankruptcy Code. The reorganization cases are
being jointly administered under the caption "In re Med Diversified, Inc., et
al., Case No. 8-02-88564." The Med Debtors continue to operate their businesses
as debtors-in-possession, subject to the jurisdiction of the Bankruptcy Court
and in accordance with the applicable provisions of the Bankruptcy Code and
orders of the Bankruptcy Court while a plan of reorganization is formulated (see
Note 3). As a debtor-in-possession, we are authorized to operate our business,
but may not engage in transactions outside its ordinary course of business
without the approval of the Bankruptcy Court.

On November 8, 2002, our majority-owned subsidiary, TLCS along with nineteen of
TLCS' subsidiaries, filed voluntary petitions in the United States Bankruptcy
Court for the Eastern District of New York under Chapter 11 of the Bankruptcy
Code. The reorganization cases are being jointly administered under the caption
"In re Tender Loving Care Health Care Services, Inc., et al., Case No.
02-88020." TLCS continues to operate its business as a debtor-in-possession,
subject to the jurisdiction of the Bankruptcy Court and in accordance with the
applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court
while a plan of reorganization is formulated (see Note 3). As a
debtor-in-possession, TLCS is authorized to operate its business, but may not
engage in transactions outside its ordinary course of business without the
approval of the Bankruptcy Court.

As a result of the filings, we are now periodically required to file various
documents with, and provide certain information to, the Bankruptcy Court,
including statements of financial affairs, schedules of assets and liabilities,
and monthly operating reports in forms prescribed by the Bankruptcy Code, as
well as certain financial information on an unconsolidated basis.

Such materials will be prepared according to requirements of the Bankruptcy
Code. While they accurately provide then-current information required under the
Bankruptcy Code, they are nonetheless unconsolidated, unaudited, and are
prepared in a format different from that used in our consolidated financial
statements filed under the securities laws. Accordingly, we believe that the
substance and format of such materials do not allow meaningful comparison with
our regular publicly disclosed consolidated financial statements.

Moreover, the materials filed with the Bankruptcy Court are not prepared for the
purpose of providing a basis for an investment decision relating to our or other
Debtors' stock or debt or for comparison with other financial information filed
with the SEC.

Most of the Debtors' filings with the Court are available to the public at the
offices of the Clerk of the Bankruptcy Court or the Bankruptcy Court's website
(www.nyeb.uscourts.gov) or may be obtained through private document retrieval
services. We undertake no obligation to make any further public announcement
with respect to the documents filed with the Court or any matters referred to
therein.

CHAPTER 11 REORGANIZATION

As noted previously, the Debtors are operating their businesses as
debtors-in-possession, subject to the jurisdiction of the Bankruptcy Court and
in accordance with the applicable provisions of the Bankruptcy Code and orders
of the Bankruptcy Court while a plan of reorganization is formulated. As such,
the Debtors are authorized to operate their business, but may not engage in
transactions outside the ordinary course of business without the approval of the
Bankruptcy Court.

Soon after the Chapter 11 filings, the Debtors began notifying all known or
potential creditors, in an effort to identify and quantify all pre-petition
claims against them. As a result of the Debtors' filings, substantially all of
their indebtedness and lease obligations went into technical default. The
Chapter 11 filings, however, automatically stayed or enjoined the continuation
of any judicial or administrative proceedings or other actions against the
Debtors or their property to recover on, collect or secure a claim arising prior
to the Petition Date, subject to certain exceptions under the Bankruptcy Code.
For example, those creditor actions that seek to obtain property, or those that
seek to create, perfect or enforce any lien against property of the Debtors, or
those that seek to exercise rights or remedies with respect to a pre-petition
claim, are enjoined. Such claims may proceed only if the Bankruptcy Court grants
relief from the automatic stay. Under the Bankruptcy Code, actions to collect

25

pre-petition indebtedness, as well as most other pending litigation, are stayed
and other contractual obligations against the Debtors generally may not be
enforced, absent an order of the Bankruptcy Court.

At hearings held on December 2, 2002, December 9, 2002, and December 20, 2002
the Bankruptcy Court granted the Med Debtors' motions to stabilize their
operations and business relationships with customers, vendors, employees and
others. The Court granted the Med Debtors authority to, among other things: (a)
pay pre-petition and post-petition employee wages, salaries, benefits, and other
employee obligations; (b) pay vendors and other providers in the ordinary course
of business for goods and services received from and after the Petition Date,
and other similar agreements. The Bankruptcy Court also gave interim and final
approval for use of cash collateral. The Court also approved a
Debtor-In-Possession Master Purchase and Sale Agreement ("DIP Facility") with
Sun Capital. This secured debtor-in-possession financing arrangement was
approved for the payment of certain permitted pre-petition claims, working
capital needs and other general corporate purposes.

On November 12, 2002, the Bankruptcy Court granted TLCS the authority to: a)
maintain and continue to use its existing bank accounts without interruption and
in the ordinary course of business; b) continue to use existing business forms,
including checks and other documents; and c) collect and utilize cash collateral
on an interim basis pending further hearings before the Bankruptcy Court. Since
November 12, 2002, TLCS has maintained the authority to use cash collateral and
continued to operate its business in the ordinary course. It has taken
affirmative steps to stabilize its business and preserve assets for the benefit
of its creditors. Within its rights under the applicable provisions of the
Bankruptcy Code, TLCS has eliminated certain unnecessary or burdensome
obligations under various leases and contracts.

The Debtors intend to develop a plan or plans of reorganization through
negotiations with their respective key creditor constituencies. A substantial
portion of all pre-petition liabilities are subject to settlement under such a
plan of reorganization to be voted upon by the Debtors' creditors, and approved
by the Bankruptcy Court. No assurance can be given regarding the timing of such
a plan, the likelihood that such a plan will be developed, or the terms on which
such a plan may be conditioned.

Although the Debtors expect to file a reorganization plan that provides
emergence from Chapter 11 during 2003 or 2004, there can be no assurances that a
plan of reorganization will be proposed by the Debtors, or approved by the
requisite creditors, or confirmed by the Bankruptcy Court, or that any such plan
will be consummated.

The Debtors have the exclusive right to file a plan of reorganization during the
120 days after the Petition Date until March 27, 2003. If the Debtors choose to
file a plan of reorganization, they then have an additional 60 days in which to
obtain the required acceptances of the plan. The Bankruptcy Court, for cause,
may extend these time periods. If the requisite number of impaired creditors and
equity holders does not approve the plan, and the Debtors' 120-day exclusivity
period lapses, any party in interest subsequently may file a plan of
reorganization for any of the Debtors. The Med Debtors intend to move for an
additional 60-day extension of their exclusive periods, seeking to extend the
exclusive period to file their plans until May 26, 2003. TLCS has filed for an
extension of the exclusivity period and the Bankruptcy Court has approved such
extension. The extension is until May 7, 2003.

A plan of reorganization is deemed accepted by holders of claims against the
equity interests in the Debtors if (i) at least one-half in number and
two-thirds in dollar amount of claims actually voting in each impaired class of
claims have voted to accept the plan; and (ii) at least two-thirds in amount of
equity interests actually voting in each impaired class of equity interests have
voted to accept the plan.

The Bankruptcy Court may confirm a plan of reorganization notwithstanding the
non-acceptance of the plan by an impaired class of creditors or equity holders
if certain requirements of the Bankruptcy Code are met. For example, if a class
of claims or equity interests does not receive or retain any property under the
plan, such claims or interests are deemed to have voted to reject the plan. The
precise requirements and evidentiary showing for confirming a plan
notwithstanding its rejection by one or more impaired classes of claims or
equity interests, depends upon a number of factors. Such factors include the
status and seniority of the claims or equity interest in the rejecting class
(i.e., secured claims or unsecured claims, subordinated or senior claims,
preferred or common stock). Generally, with respect to common-stock interests, a
plan may be "crammed down" if the proponent of the plan demonstrates that (i)
the common stock holders are receiving the value of their common stock interests
or no class junior to the common stock is receiving or retaining property under
the plan and (ii) no class of claims or interests senior to the common stock is
being paid more than in full.

Going forward, our principal focus will be to generate positive cash flow from
our continuing operations primarily from our business units. We plan to continue
to eliminate redundancies at all staff levels and locations consistent with this
objective.

We had, until October 2002, depended on NCFE to provide us financing for current
operations under our Sales and Subservicing Agreements. Cash shortages caused by
NCFE's collapse resulted in our inability to meet all vendor obligations as they
became due. Because of NCFE's failure to honor its commitments under the Sales
and Subservicing Agreements, TLCS filed for Chapter 11 protection on November 8,
2002 and we and certain of our subsidiaries, including CCG, CCS, Chartwell,
Trestle and Resource, filed for Chapter 11 protection on November 27, 2002.

26

We believe that due to NCFE's actions over the past two years, in its
allegedly willful and knowing misconduct, caused us and our subsidiaries to
falter. We believe an appropriate remedy to be either a complete forgiveness
of any indebtedness owed by us to NCFE or recharacterization of our debt to
them as equity and/or equitably subordinated, in whole or in part, to the
claims of general unsecured creditors. As has been previously disclosed, NCFE
and its principals own over 30% of our outstanding common stock. NCFE has
also provided funding to us beyond that contemplated by the various Sales and
Subservicing Agreements we had with them. Further, Lance Poulsen, NCFE's CEO,
commented in a press release issued by us in February 2002, that NCFE stood
behind us in terms of financial commitment. Because of these facts,
management has believed that NCFE's conduct in overfundings and with respect
to our Company generally has resembled that of a stakeholder rather than a
senior lender. Likewise, certain of NCFE's actions in connection with its
dealings with us may give rise to equitable subordination claims by us.
However, there can be no assurances that we will bring such an action or that
such an action, or claims made in such an action, will be successful.

We are authorized under the Bankruptcy Code to act as a "debtor-in-possession"
during the course of our case. Being a debtor-in-possession means that current
management, the board of directors, and the shareholders remain in place during
the pendency of the case or until such time as an examiner or trustee is
appointed. No trustee or examiner has been appointed in our case, although it is
possible that one might be appointed at a future time.

In connection with being a debtor-in-possession, we have obtained financing from
Sun Capital. By order of the Bankruptcy Court dated December 23, 2002, Sun
Capital has been approved to act as our source for outside financing in order
for us to make up potential gaps in our cash flow during the course of our
bankruptcy.

On December 24, 2002, we and certain of our subsidiaries in bankruptcy,
including Chartwell, CCG, CCS and Resource, entered into a Master Purchase and
Sale Agreement with Sun Capital. Under this agreement, certain of our
subsidiaries can sell accounts receivable to Sun Capital. After such sale, Sun
Capital factors the receivables and submits an advance to the subsidiary selling
the receivable. The advance is net of offsets based on a history of collections
for the receivable or receivables submitted and a contractually permitted
reserve amount. The receivables (in addition to other receivables not sold to
Sun Capital but forwarded to Sun Capital in order to provide adequate
collateral) then are sent to lockbox accounts controlled by Sun Capital. Sun
Capital collects the receivables and provides a reconciliation of them to show
which receivables have been collected and which have not. We pay at a daily
percentage rate of .0075% for each day a receivable remains uncollected, which
is equivalent to an annual percentage rate of 27%.

As of the date hereof, we have sold approximately $5.0 million worth of
receivables to Sun Capital. On January 3, 2003, Sun Capital advanced us $3.4
million based on such receivables.

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 nine months
ended December 31, 2002 and 2001. In addition, we have included in the
comparisons below the unaudited pro forma financial information for the three
and nine months ended December 31, 2001 ("Proforma 2001") to include our
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 tables 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 and nine months ended December 31, 2002 (unaudited,
in thousands):

As noted above, Chartwell's income from operations under management for the
three and nine months ended December 31, 2002 totaled $1.5 million and $3.3
million, respectively.

*Chartwell's ownership in the joint ventures ranges from 45% to 50%. As a result
of the Chartwell merger, we have investments in eight 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. Our ownership in the joint ventures
includes: one with 80 percent interest which is consolidated, one with 45
percent interest and six with 50 percent interest accounted for on the equity
basis of accounting. Total Chartwell revenue under management for the three
months and nine months ended December 31, 2002, which includes unconsolidated
joint ventures as well as Chartwell subsidiary revenue, was $42.2 and $129.2
million, respectively.

NET SALES

Net sales for the three and nine months ended December 31, 2002, 2001 and
Proforma 2001 are summarized as follows (unaudited, in thousands):

28

Net sales in the distance medicine solutions segment decreased by approximately
25.8% and 63.1% in the three and nine months ended December 31, 2002 as compared
to the comparable period of the prior year. These decreases resulted primarily
from our efforts to focus on more profitable products, lower consulting revenues
during the respective periods, and our decision to abandon products that were
not considered likely to be profitable in the future.

Pharmacy revenues for the three and nine months ended December 31, 2002, 2001
and Proforma 2001 are summarized as follows (unaudited, in thousands):

PrimeRx, including Network, revenues decreased in the nine months ended
December 31, 2002 compared to comparable period in 2001 as a result of our
decision to not consolidate Network subsequent to August 1, 2001 and our
decision to dispose of unprofitable pharmacy operations of PrimeRx in the first
and second quarters of fiscal 2002.

Chartwell pharmacy revenues decreased in the three months ended December 31,
2002 over comparable prior year period due to the closing of non profitable
locations, decreased patient referrals and other competitive factors.

29

Chartwell pharmacy revenues increased in nine months ended December 31, 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 $3.6 million and $9.7 million in the three and nine months ended
December 31, 2002, respectively, due to the closing of non profitable locations,
decreased patient referrals and other competitive factors.

Resource's pharmacy revenues increased approximately $296 thousand and $1.3
million in the three and nine months ended December 31, 2002, respectively,
compared to 2001 as a result of increased sales efforts for existing and new
customers.

Home health revenues increased from $37.9 million and $47.0 million,
respectively, to $76.1 million and $241.6 million during the three and nine
months ended December 31, 2001 and December 31, 2002. These increases were
principally 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 $3.7 million and $10.8
million increase in revenues in the three and nine months ended December 31,
2002, respectively, due to increased patient admissions for Medicare services.

COSTS AND EXPENSES

COST OF SALES

Cost of sales for the three and nine months ended December 31, 2002, 2001 and
Proforma 2001 are summarized as follows (unaudited, in thousands):

Cost of sales as a percentage of sales for the three and nine months ended
December 31, 2002, 2001 and Proforma 2001 are summarized as follows:

Distance Medicine Solutions cost of sales declined in nine months ended December
31, 2002 compared to the same periods in 2001 as a result of a decrease in sales
of products that have a significantly lower gross margin than consulting
services.

Pharmacy cost of sales in the three and nine months ended December 31, 2002
decreased as compared to 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.

Due to management's restructuring process since August 2001, we believe that
the profit margins for our businesses have shown significant improvement
since that time. The benefit of these restructuring activities, both at TLCS
and Chartwell, is evidenced by examining the cost of sales set forth in our
segmentation for the three month ending period as projected for 2001 of 63.4%
in the home health sector and the actual percentage of 56.7%. As stated in
our business plan, our focus has been to restructure these costs continually.

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 decreased $8.7 million for the three months ended December
31, 2002 as compared to the comparable period in 2001. The decrease is
attributed to the amortization of $3.3 million in deferred financing fees and
interest on preferred stock of $3.5 million in 2001. In addition, we have in
accordance with SOP 90-7, discontinued accruing $1.5 million of interest
related to our unsecured debt.

Interest expense increased $4.3 million for the nine months ended December
31, 2002 as compared to the comparable period in 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. 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, we reflected the
discontinued operations in the fiscal year ended March 31, 2001. We 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 our condensed consolidated financial statements under discontinued
operations. The financial information included herein provides the components
comprising the results from discontinued operations (unaudited, in thousands):

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

31

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 December 31, 2002, we had an accumulated deficit of $645.0
million and a deficit stockholders' equity of $223.2 million.

In addition, we have consistently used cash in operations, including cash used
in operating activities of $29.8 million and $37.1 million in the nine months
ended December 31, 2002 and 2001, respectively.

We are authorized under the Bankruptcy Code to act as a debtor in possession
during the course of our bankruptcy case. Being a debtor in possession means
that current management, the board of directors and the shareholders remain in
place during the pendency of the case or until such time as an examiner or
trustee is appointed. No trustee or examiner has been appointed in our case,
although it is possible that one might be appointed at a future time.

In connection with being a debtor in possession, we obtained financing from Sun
Capital. By order of the bankruptcy court dated December 23, 2002, Sun Capital
has been approved to act as our source for outside financing in order for us to
make up potential gaps in our cash flow during the course of our bankruptcy.

We and certain of our subsidiaries in bankruptcy, including CCG, CCS, Chartwell
and Resource, entered into a Master Purchase and Sale Agreement with Sun
Capital. Under this agreement, certain of our subsidiaries can sell accounts
receivable to Sun Capital. After such sale, Sun Capital factors the receivables
and submits an advance to the subsidiary selling the receivable. The advance is
net of offsets based on a history of collections for the receivable or
receivable submitted and a contractually permitted reserve amount. The
receivables (in addition to other receivables not sold to Sun Capital but
forwarded to Sun Capital in order to provide adequate collateral) then are sent
to lockbox accounts controlled by Sun Capital. Sun Capital collects the
receivables and provides a reconciliation of them to show which receivables have
been collected and which have not. We pay at a daily percentage rate of .0075%
for each day a receivable remains uncollected, which is equivalent to an annual
percentage rate of 27%.

To date, we have sold approximately $5.0 million worth of receivables to Sun
Capital. On January 3, 2003, Sun Capital advanced us $3.4 million based on such
receivables.

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.

Going forward, our principal focus will be to generate positive cash flow from
our continuing operations primarily from our business units. We plan to continue
to eliminate redundancies at all staff levels and locations consistent with this
objective.

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

1. Maintain our arrangement with Sun Capital as our source for
debtor-in-possession financing.

2. 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.

3. Successfully manage the reorganization of TLCS and the Med Debtors.

4. Prepare, file and obtain approval of plans of reorganization for the
Med Debtors.

Other factors, including those risk factors identified in our Annual Report
on Form 10-K for the year ended March 31, 2002, could adversely affect our
ability to obtain additional funding.

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 September 30, 2003. Accordingly, our
ability to continue as a going concern is in question.

32

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.

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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET/PRICE RISK

We are exposed to market risk in the normal course of business operations. We
face competition and must offer our products and services at prices that the
market will bear. Management believes that we are well positioned with our mix
of products and services to take advantage of future price increases for these
products and services. However, should the prices for our products decline, this
could adversely affect our future profitability and competitiveness.

INTEREST RATE RISK

Our debt portfolio as of December 31, 2002 is composed entirely of fixed and
variable rate debt denominated in United States currency. Changes in interest
rates have different impacts on the fixed and variable rate portions of our debt
portfolio. A change in interest rate on the variable portion of the debt
portfolio impacts the interest incurred and cash flows but does not impact the
net financial instrument position. If interest rates significantly increase, we
could incur additional interest expenses, which would negatively affect our cash
flow and future profitability.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Based on an 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
each 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) Any changes in internal controls due to bankruptcy proceeding. 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.

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. In connection with our
filing for bankruptcy protection, all of the litigation noted below, if it was
not settled prior to the our filing for bankruptcy, has been automatically
stayed under bankruptcy law, meaning, where we are a defendant, that no adverse
party may take any action in the context of such litigation unless such party
obtains relief from the automatic stay. Where we are the plaintiff, we may
pursue such litigation at our option. 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.

These matters are organized below as follows: 1) Litigation from events
arising prior to our merger with Chartwell in August 2001; 2) Litigation from
events arising after our merger with Chartwell in August 2001; 3) TLCS
litigation; and, 4) Chartwell litigation.

LITIGATION FROM EVENTS ARISING PRIOR TO OUR MERGER WITH CHARTWELL IN AUGUST
2001

PRIMERX.COM/NETWORK PHARMACEUTICALS, INC.

Our relationship with PrimeRx.com ("PrimeRx"), Network Pharmaceuticals, Inc.
("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

33

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 meet 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)
release 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.

Due to our filing for bankruptcy protection, Network is an unsecured creditor of
ours. Any action by them to enforce the terms of the settlement is subject to
the automatic stay enforced under the Bankruptcy Code.

VIDIMEDIX CORPORATION

On or about September 15, 2000, certain former securities holders of VidiMedix
Corporation ("VidiMedix") filed a petition against us arising from 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 6.0 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 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.

Due to our filing for bankruptcy protection, the Remaining Plaintiffs are
unsecured creditor of ours. Any action by them to enforce the terms of the
settlement is subject to the automatic stay under the Bankruptcy Code.

SUTRO NASD ARBITRATION NO. 1

As disclosed in our Annual Report on Form 10-K for the year ended March 31,
2001, and as updated in our Annual Report on Form 10-K for the year ended March
31, 2002, a dispute between Sutro & Co. ("Sutro"), and us has been arbitrated
before the National Association of Securities Dealers. On October 22, 2001, we
agreed to settle the matter and Sutro NASD Arbitration No. 2 described below for
1.6 million shares of our common stock. We delivered a stock certificate for 1.3
million shares of our common stock representing shares due Sutro from an
exercise of our warrants in June and August 2000. These shares met all
requirements of Rule 144(k) of the Securities Act of 1933 and were delivered to
Sutro without restriction. We also delivered a stock certificate for 300
thousand shares of our common stock with a value of $720 thousand at the time of
issuance. We agreed to register these shares in our next registration statement
filing with the SEC. If based on the closing price of our common stock two days
prior to the effective date of the registration statement, the market value of
the 300 thousand shares is less then $720 thousand, then we are obligated to
issue an additional number of shares such that the

34

market value of the sum of the shares is as nearly as possible equal to $720
thousand. Based on the closing price of our common stock at June 30, 2002, we
would be obligated to issue an additional 3.3 million shares. As a result of
this settlement, we expensed $3.7 million as of March 31, 2002.

SUTRO NASD ARBITRATION NO. 2

An investor in the Company sued Sutro for failing to honor commitments and
failures to act in accordance with its fiduciary duties. This matter was being
arbitrated before the National Association of Securities Dealers.

As part of the Sutro No. 1 NASD arbitration settlement described above, on
October 22, 2001, we agreed to settle the matter.

CAPPELLO CAPITAL CORP.

On November 16, 2001, we filed a complaint against Cappello Capital Corp.
("Cappello") (Med Diversified v. Cappello Capital Corp., Los Angeles Superior
Court Case No. SC 069391 (the "Cappello Action")), alleging that Cappello was
liable for fraud for inducing us to enter into an exclusive financial advisor
engagement agreement ("Engagement Agreement"), by misrepresenting to us that
Cappello had significant sources of capital ready and willing to invest in us
when such was not true. In the complaint, we sought compensatory and punitive
damages, as well as rescission of the Engagement Agreement. We dismissed the
case without prejudice on March 1, 2002, and settled the case and all claims
relating thereto as of March 25, 2002. We have fulfilled all of our obligations
under this settlement.

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 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
office 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. We settled the
matter with Hoskin in November 2002.

Due to our filing for bankruptcy protection, Hoskin is an unsecured creditor of
ours. Any action by Hoskin to enforce the terms of the settlement is subject to
the automatic stay under the Bankruptcy Code.

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, the "Defendants")
arising out of our acquisition of Illumea (Illumea (Asia), Ltd., et al. v.
Illumea Corporation and Andrew Borsanyi). All of the plaintiffs 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.

35

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 and (iii) file a registration statement, on Form S-1,
registering the 700 thousand shares. As of October 31, 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. We filed an opposition
to this motion, and the court approved the motion pending the presentation of
evidence. This matter is subject to the automatic stay under the Bankruptcy
Code.

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 us, PrimeRx,
Chartwell 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.

SAN DIEGO ASSET MANAGEMENT, INC.

On October 24, 2001, we filed a complaint against San Diego Asset Management,
Inc. ("SDAM") (Med Diversified v. San Diego Asset Management Inc., Los Angeles
Superior Court Case No. BC 260285 (the "2001 SDAM Action")) arising out of an
agreement whereby we were to sell shares of our common stock that could be
purchased for $83 million for 90% of the market price of our common stock to
SDAM. We agreed to prepare a certificate for 15 million restricted shares of our
common stock as a commission (the "Certificate"), as well as pay $3 million in
cash as commission to SDAM. We delivered the Certificate but SDAM did not
deliver the $83 million. In the lawsuit, we sought a temporary restraining
order, preliminary injunction and permanent injunction ordering SDAM to return
the Certificate to us. Pursuant to the Court's order dated November 6, 2001, the
Certificate was returned to us and cancelled. We dismissed the 2001 SDAM Action
without prejudice on November 13, 2001.

On February 1, 2002, we filed for Arbitration with the National Association of
Securities Dealers (the "NASD Arbitration") against SDAM and its principals,
Wendy Feldman Purner and Daniel Feldman (collectively, "Respondents") (NASD CASE
NO. 02 00650), alleging that Respondents fraudulently induced us to enter into a
Securities Purchase Agreement through various misstatements of material fact
and, alternatively, that Respondents breached the Securities Purchase Agreement.
On March 13, 2002, following objections to jurisdiction, we dismissed without
prejudice the claims asserted against Daniel Feldman in the arbitration. The
remaining Respondents have not yet responded to our claims and no arbitrator has
yet been selected.

On February 5, 2002, we filed a complaint against SDAM and its principals, Wendy
Feldman Purner and Daniel Feldman, (Med Diversified, Inc. v. San Diego Asset
Management, Inc., Wendy Feldman Purner and Daniel Feldman, Los Angeles, Superior
Court Case No. BC 267635 (the "2002 SDAM Action")), alleging that they, in the
second half of 2001, fraudulently induced us to enter into a Debenture Agreement
through various misstatements of material fact and, alternatively, that they
breached the Debenture Agreement.

On February 28, 2002, we amended our complaint in the 2002 SDAM Action to add as
defendants E*Trade Securities, Inc. and E*Trade Group, Inc. and to add, as
against SDAM, Wendy Feldman Purner and Daniel Feldman, the claims asserted in
the NASD Arbitration. No discovery has been propounded as of October 24, 2002.
On May 3, 2002, we dismissed E*Trade from the 2002 SDAM Action without
prejudice. On May 6, 2002, we dismissed Daniel Feldman from the 2002 SDAM Action
without prejudice.

On May 9, 2002, SDAM filed a cross-complaint against us. SDAM alleges that on or
about August 2001, we entered into an agreement with SDAM to sell it 5 million
shares of our common stock and that SDAM paid us $2 million, but have not
received any stock. After we demurred to SDAM's cross-complaint, SDAM filed an
amended cross complaint July 3, 2002. These matters were in discovery. Due to
our filing for bankruptcy protection, this matter is subject to the automatic
stay under the Bankruptcy Code.

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 were 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.

36

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. Due to our filing for bankruptcy protection and UAIPA's bankruptcy
proceedings, this matter is subject to the automatic stay in both cases.

LITIGATION FROM EVENTS ARISING AFTER OUR MERGER WITH CHARTWELL IN AUGUST 2001

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 (Med Diversified, Inc. v. Addus
Healthcare, Inc., et al., U.S. District Court, Central District of California,
Case No. CV 02-3911 AHM (JTLX)). 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, stating that they never intended to complete the transaction but
planned to use the pendency of the transaction to obtain concessions from us.
Additionally, there is a claim for breach of contract. We seek compensatory
damages of approximately $10 million per claim, plus punitive damages, along
with the equitable relief previously described and attorneys' fees.

Addus has filed a counterclaim against us, alleging 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. Addus has sought compensatory
damages in excess of $4 million, a declaratory judgment that it is entitled to
retain the $7.5 million deposit, for general and special damages. We dispute
these claims vigorously and believe they are without merit. On July 9, 2002, we
filed a reply to the counterclaim. This matter has been transferred to the
Northern District of Illinois. On October 11, 2002, we filed an Amended
Complaint. We received Addus' answer to that complaint. A status conference is
scheduled for early March 2003. We intend to pursue this litigation and remove
the automatic stay.

LANCE POULSEN, HAL POTE, NPF VI, NPF XII, BANK ONE, JP MORGAN CHASE & CO.

In November 2002, we filed a complaint, along with our subsidiary Chartwell
Diversified Services, Inc. and OrthoRehab, Inc. ("OrthoRehab"), against two
principals of NCFE, Lance K. Poulsen ("Poulsen") and Hal Pote ("Pote"), two
legal designees of NCFE, NPF VI, Inc., NPF XII, Inc., and two banking
organizations, Bank One NA, Trustee ("Bank One"), and JP Morgan Chase & Co.,
Trustee ("JP Morgan") (Med Diversified, Inc.; Chartwell Diversified Services,
Inc.; and OrthoRehab, Inc. v. Lance K. Poulsen; Hal Pote; NPF VI, Inc.; NPF XII,
Inc.; Bank One NA, Trustee and JP Morgan Chase & Co., Trustee, U.S. District
Court District of Massachusetts, Civil Action No. 02-12214 NG). We contend that
Poulsen and Pote made false representations to us about NCFE's ability to fund
us, as well as NCFE's financial condition. In reliance, we entered into
contractual relationships for financing with NCFE and its affiliates. We believe
that NCFE's liquidity problems and the nature of the "ponzi scheme" which NCFE
engaged, was known for some time prior to NCFE's breach of the Sales and
Subservicing Agreements by certain of its principals and independent board
members. Had we known, we would not have continued these financing arrangements
and would have searched for alternate financing. Because of NCFE's eventual
financing difficulties, we were harmed as a result. We also contend that at the
time Poulsen and Pote assured us that NCFE would provide funding to us, they
were conspiring to conceal from us the true status of NCFE's business and
financial condition.

Further, we contend that Poulsen and Pote demanded that NPF VI and NPF XII
withhold funding, completely depriving us of all necessary monies from which we
operate our business. We also believe that Bank One and JP Morgan caused NPF VI
and NPF XII to withhold funds, which were guaranteed under contractual
agreements. We also contend that NPF VI and NPF XII breached their contracts
with Chartwell and OrthoRehab in refusing to honor their funding commitments.

We seek monetary damages to be proven at trial. As NCFE is in bankruptcy
(meaning actions against it are subject to an automatic stay), we are
investigating our alternatives in pursuing this litigation against all named
defendants.

TLCS LITIGATION

PRIVATE INVESTMENT BANK LIMITED

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On January 29, 2003, TLCS and its nineteen subsidiaries commenced an adversary
proceeding against Private Investment Bank Limited ("PIBL") by the filing of a
complaint (the "PIBL Complaint") in the Bankruptcy Court where the TLCS Chapter
11 case is currently pending. In connection with the TLCS Chapter 11 cases, PIBL
has asserted certain security and other interests in the assets of TLCS and its
subsidiaries. The PIBL Complaint seeks to avoid and recover those certain
security and other interests asserted by PIBL against the assets of TLCS and its
subsidiaries as either preferential or fraudulent transfers. As of the date of
this disclosure, PIBL has not yet answered the PIBL Complaint and joined issue
in the action.

H.L.N. CORPORATION

H.L.N. Corporation, Frontlines Homecare, Inc., E.T.H.L., Inc., Phoenix Homelife
Nursing, Inc., and Pacific Rim Health Care Services, Inc., former licensees
(franchisees) of TLCS for the territory comprising certain counties in and
around Los Angeles, California, and their holding company, instituted an action
against TLCS subsidiaries, Staff Builders, Inc., Staff Builders International,
Inc. and Staff Builders Services, Inc., and certain executive officers of TLCS.
Plaintiffs filed a First and Second Amended Complaint in the Central District on
January 8, 1999 and September 1, 1999, respectively, to challenge the
termination of the four franchise agreements between TLCS and certain of the
named plaintiffs (H.L.N. Corporation, et al. v. TLCS Subsidiaries, et al.). The
Plaintiffs are seeking damages for violations of California franchise laws,
breach of contract, fraud and deceit, unfair trade practices, claims under the
RICO, negligence, intentional interference with contractual rights, declaratory
and injunctive relief and a request for an accounting. The Plaintiffs have not
specified the amount of damages they are seeking. Pursuant to a Motion of
Summary Judgment, the court granted all of the individual Defendants' Motions
for Summary Judgment, dismissing all causes of action against these individuals.
In addition, the court dismissed the RICO, fraud, negligence, California
franchise investment law and implied covenant of good faith and fair dealing
claims. The only remaining triable issues in the case are those relating to
breach of contract, unfair business practices and wrongful termination under the
California franchise law. Trial is scheduled for August 2003. Due to TLCS'
filing for bankruptcy protection, this matter is subject to the automatic stay
under the Bankruptcy Code.

CHARTWELL LITIGATION

CRAVEY

Warren Willard Cravey ("Cravey"), now deceased, was a client of CCS.

CCS provided care to Cravey via its community-based alternatives program. On
October 1, 2001, Lorene Emma Barros, Individually and as Executive to the Estate
of Warren Willard Cravey, Deceased, Cheryl Lynn Sloniger, Londa Sylvia Cravey,
Lorna Christine Tillman, and Warren Willard Cravey, II ("Plaintiffs") filed a
lawsuit against Concepts of Care II, Inc., Chartwell Community Services, Inc.
f/k/a Concepts of Care, Infusion Management Systems, Inc. d/b/a Concepts of
Care, HomeCare Concepts of America, Inc. d/b/a Concepts of Care, Mollie
Primrose, and Mollie Gay Jordy ("Defendants"). (Case No. 23096, pending in the
District Court of Jasper County, Texas.) Plaintiffs in the above-referenced
cause are the children of Cravey.

Plaintiffs claim that Defendants were negligent in their care of Cravey.
Plaintiffs allege against CCS claims for negligence, negligence per se, gross
negligence and breach of fiduciary duty. Pursuant to the theory of respondeat
superior, Plaintiffs also assert that CCS is liable for the alleged negligence
of its former employee, Defendant Mollie Primrose, in her care of Cravey.
Plaintiffs also assert against CCS a claim for punitive damages, alleging CCS'
conduct was grossly negligent and/or malicious. CCS denies and is vigorously
defending all claims.

All parties to the suit are currently actively engaged in discovery. As of the
date of hereof, there have been no motions for summary judgment or any other
dispositive motions filed by any party. Though a jury trial has been demanded,
this case is not presently set for trial. Due to our filing for bankruptcy
protection, this matter is subject to the automatic stay under the Bankruptcy
Code.

MEDICAL SPECIALTIES DISTRIBUTORS INC.

In July 2001, Medical Specialties, Inc. ("Medical Specialties") sued our
subsidiary, Chartwell, in superior court in Massachusetts (Medical Specialties
Distributors Inc. v. Chartwell Diversified Services, Inc., et al., Bristol
County Superior Court (Massachusetts) Civil Action No. BRCV2001-00845. This
claim alleges failure to pay for the purchase of healthcare products and
equipment rentals totaling approximately $2 million. The case is currently in
discovery. Under the terms of the purchase of certain assets by Chartwell, we
assumed certain assets while not assuming certain liabilities and were
indemnified by Home Medical of America, Inc. ("HMA") for any actions that might
arise from such non-assumed liabilities. We had been informed previously by HMA
that it would assume the defense of this matter. As of the date hereof, we have
not been informed that HMA has actually assumed such defense. We continue to
request of HMA that it assume this defense, and have retained counsel to handle
this defense in the meantime. We believe that this case has no merit. Due to our
defendant subsidiaries filing for bankruptcy protection, this matter is subject
to the automatic stay under the Bankruptcy Code.

TRI-COUNTY HOME HEALTH, INC.

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In March of 2002, Tri-County Home Health, Inc. ("Tri-County") and other
plaintiffs filed suit against CCS and Chartwell and Shay Fields (Tri County Home
Health, Inc. et al. v. Chartwell Community Services, Inc., Chartwell Diversified
Services, Inc. and Shay Field, 365th JDC, Hardin County TX, Case No. 42108).
Tri-County claims that the Defendants breached a contract for the sale of the
long term care portion of Tri-County's operations. They have also alleged fraud,
tortious interference, material misrepresentation and unfair dealings. They seek
damages in excess of $1 million. Chartwell answered the complaint and believes
that the claims are without merit. Due to our filing for bankruptcy protection,
this matter is subject to the automatic stay under the Bankruptcy Code.

ITEM 2. CHANGES IN SECURITIES.

During the three months ended December 31, 2002, the Company had no transactions
involving the issuance of unregistered securities of its common stock.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

The Med Debtors made their Chapter 11 filings on November 27, 2002. As a result
of the filings, no principal or interest payments have been or will be made on
certain indebtedness incurred by the Med Debtors prior to November 27, 2002,
until a plan of reorganization defining the payment terms has been approved by
the Bankruptcy Court. Additional information regarding the Med Debtors' Chapter
11 filings is set forth elsewhere in this Form 10-Q, including Notes 1 and 3 to
the Condensed Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations."

TLCS made its Chapter 11 filings on November 8, 2002. As a result of the
filings, no principal or interest payments have been or will be made on certain
indebtedness incurred by the Med Debtors prior to November 8, 2002, until a plan
of reorganization defining the payment terms has been approved by the Bankruptcy
Court. Additional information regarding the Med Debtors' Chapter 11 filings is
set forth elsewhere in this Form 10-Q, including Notes 1 and 3 to the Condensed
Consolidated Financial Statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations."

We also received a letter from PIBL, which declared a notice of acceleration of
the $57.5 million of principal amount of Amended Debentures dated as of June 28,
2002 issued by us to PIBL in connection with the Amendment Agreement dated as of
June 28, 2002

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

(a) The Annual Meeting of Stockholders of the Company was held on
December 6, 2002.

(b) The results of the voting on the proposals considered at the
Annual Meeting of Stockholders were as follows:

1. Election of Directors

Frank P. Magliochetti, Jr., John F. Andrews, Donald H. Ayers,
Gregory J. Simms, and Richard J. Boudreau were each elected as a
Director of the Company for a one-year term expiring at the next
Annual Meeting of Stockholders. Mr. Boudreau did not stand for
re-election as he had previously resigned from the Board.

The voting results were as follows:

2. Ratification of Brown and Brown, LLP Independent Auditors for Fiscal
Year ending March 31, 2003

ITEM 5. OTHER INFORMATION.

None.

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

(a) EXHIBIT INDEX

39

(b) REPORTS ON FORM 8-K.

We filed a Form 8-K, dated October 25, 2002, reporting under Item 5 the addition
of James K. Happ as President of our Company.

We filed a Form 8-K, dated November 8, 2002, reporting under Item 3 that our
majority-owned subsidiary TLCS, filed a voluntary petition for relief under
Chapter 11 of Title 11 of the Bankrupcty Code in the United States Bankruptcy
Court for the Eastern District of New York.

We filed a Form 8-K, dated November 27, 2002, reporting under Item 3 that we
along with our subsidiaries, Chartwell, CCS, CCG, Resource, and Trestle, filed a
voluntary petition for relief under Chapter 11 of Title 11 of the Bankruptcy
Code in the United States Bankruptcy Court for the Eastern District of New York,
and reporting under Item 5 that we received a letter from PIBL, which declared a
notice of acceleration of the $57.5 million of principal amount of Amended
Debentures dated as of June 28, 2002 issued by us to PIBL in connection with the
Amendment Agreement dated as of June 28, 2002.

We filed a Form 8-K, dated December 13, 2002, reporting under Item 5 that Frank
P. Magliochetti, Jr., John Andrews, Don Ayers, and Gregory Simms have been
elected to serve on the Board of Directors by vote of our stockholders, and
reporting under Item 6 the resignation of Richard Boudreau from our Board of
Directors by letter dated November 20, 2002, and the resignation of John Andrews
from our Board of Directors by e-mail transmission dated December 13, 2002.

SIGNATURES

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: February 19, 2003 By: /s/ Frank P. Magliochetti
----------------------------------------
Frank P. Magliochetti
Chairman and Chief Executive Officer

By: /s/ James A. Shanahan
----------------------------------------
Date: February 19, 2003 James A. Shanahan
Vice President of Finance
and Accounting, Corporate Controller
(Principal Accounting Officer)

40

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: February 19, 2003 By: /s/ Frank P. Magliochetti, Jr.
-------------------------------------
Name: Frank P. Magliochetti, Jr.
Title: Chief Executive Officer

41

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: February 19, 2003 By: /s/ James A. Shanahan
-------------------------------------------
Name: James A. Shanahan
Title: Vice President of Finance and
Accounting, Corporate Controller
(Principal Accounting Officer)

42