UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2011

o TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from _________________ to ________________

COMMISSION FILE NUMBER: 333-163076
 
PHYHEALTH CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
26-1772160
(State or other jurisdiction of
incorporation or organization)
  
(IRS Employer 
Identification No.)

700 South Royal Poinciana Boulevard -- Suite 506
Miami, Florida 33166
(Address of principal executive offices)
 
(305) 779-1760
  (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 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.    x      Yes    ¨      No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  ¨ Yes      x No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer   o Accelerated filer o
Non-accelerated filer o Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨ Yes      x No

The number of outstanding shares of the registrant's common stock, par value $.0001, was 11,011,572 as of November 7, 2011. 
 


 
 

 
 
TABLE OF CONTENTS
 
     
Page #
       
PART 1
FINANCIAL INFORMATION:
   
       
ITEM 1
FINANCIAL STATEMENTS:
 
3
       
 
Phyhealth Corporation Consolidated Financial Statements for the Nine Months Ended September 30, 2011 and 2010.
 
3
       
ITEM  2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
19
       
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
23
       
ITEM 4.
CONTROLS AND PROCEDURES
 
23
       
PART II
OTHER INFORMATION:
   
       
ITEM 1
LEGAL PROCEEDINGS
 
24
       
ITEM 2
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
24
       
ITEM 3
DEFAULTS UPON SENIOR SECURITIES
 
24
       
ITEM 4
REMOVED AND RESERVED
 
24
       
ITEM 5
OTHER INFORMATION
 
24
       
ITEM 6
EXHIBITS
 
24
       
 
Signatures
 
25

 
2

 
 
PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS




 

 
Phyhealth Corporation

Consolidated Financial Statements

For the nine months ended September 30, 2011 and 2010





 
 
 
3

 

Phyhealth Corporation and Subsidiaries
 
Index to Consolidated Financial Statements

   
Page
 
       
Consolidated Balance Sheets
    5  
         
Consolidated Statements of Operations and Comprehensive Loss – Unaudited
    6  
         
Consolidated Statements of Changes in Equity (Deficit) – Unaudited
    7  
         
Consolidated Statements of Cash Flows – Unaudited
    8  
         
Notes to Consolidated Financial Statements – Unaudited
    9  



 
 
4

 


Phyhealth Corporation and Subsidiaries
Consolidated Balance Sheets

   
September 30, 2011
   
December 31, 2010
 
ASSETS
 
(unaudited)
       
Current assets:
           
Cash
  $ 8,986     $ 112,087  
Patient accounts receivable, net
    76,563       -  
Current portion of convertible note receivable
    -       23,052  
Marketable equity securities
    6,900       556,950  
Surplus notes and interest receivable due from related party
    -       362,251  
Due from related party
    -       21,997  
Other current assets
    7,000       4,500  
Total current assets
    99,449       1,080,837  
                 
Convertible note receivable, net of current portion, net of $40,000 allowance
    -       576,948  
Non-marketable equity securities
    -       77,500  
Furniture, equipment and leasehold improvements, net
    217,464       46,755  
Website costs, net
    1,505       2,839  
Other assets
    11,608       2,533  
Total assets
  $ 330,026     $ 1,787,412  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
               
Current liabilities:
               
Accounts payable and accrued liabilities
  $ 122,164     $ 26,889  
Accrued payroll liabilities
    100,229       36,647  
Note payable to related party
    50,000       50,000  
Convertible note payable to related party, net of $49,723 discount
    150,277       -  
Current portion of capital leases
    70,399       16,735  
Margin loan, secured by marketable equity securities
    -       137,609  
Total current liabilities
    493,069       267,880  
                 
Capital leases, net of current portion
    117,175       18,257  
Total Liabilities
    610,244       286,137  
                 
Contingencies & Commitments (Note 6, 8 and 9)
               
                 
EQUITY (DEFICIT):
               
Phyhealth Corporation stockholders' equity (deficit):
               
Common stock, $0.0001 par value, 40,000,000 authorized, 7,582,032 and
               
 6,604,312 issued and outstanding at September 30, 2011 and December 31, 2010
    757       660  
Preferred stock, 10,000,000 authorized, $0.0001 par value,
               
Series A convertible preferred stock, 5,000,000 designated, 3,240,008
               
    shares issued and outstanding at September 30, 2011 and December 31, 2010
    324       324  
Series B convertible preferred stock, 5,000,000 designated, 612,489 and 622,332
               
   shares outstanding at September 30, 2011 and December 31, 2010, respectively
    61       62  
Additional paid-in capital
    2,284,662       2,144,278  
Accumulated deficit
    (2,395,115 )     (635,688 )
Accumulated other comprehensive income -unrealized gain (loss) on marketable equity securities
    (98,100 )     62,066  
Total Phyhealth Corporation stockholders' equity (deficit)
    (207,411 )     1,571,702  
Noncontrolling interest
    (72,807 )     (70,427 )
Total equity (deficit)
    (280,218 )     1,501,275  
Total liabilities and equity (deficit)
  $ 330,026     $ 1,787,412  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
5

 

Phyhealth Corporation and Subsidiaries
Consolidated Statements of Operations and Comprehensive Loss - Unaudited
 
   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Sleep care service revenue, net
  $ 125,510     $ -     $ 309,773     $ -  
                                 
Operating expenses:
                               
Officer and directors compensation
    89,831       -       278,577       -  
Consulting and professional fees
    134,881       -       349,568       -  
Sleep center operating expense
    222,283       -       410,701       -  
Bad debt expense
    -       -       29,918       -  
General and administration
    138,179       9,706       381,895       20,679  
Total operating expense
    585,174       9,706       1,450,659       20,679  
Loss from operations
    (459,664 )     (9,706 )     (1,140,886 )     (20,679 )
                                 
Other income (expenses):
                               
Interest expense
    (44,496 )     -       (50,622 )     -  
Gain on settlement of note receivable
    -       -       60,624       -  
Impairment of securities
    (772,000 )     -       (772,000 )     -  
Realized gain on sale of securities
    -       -       141,077       -  
                                 
Net loss
    (1,276,160 )     (9,706 )     (1,761,807 )     (20,679 )
Add: net loss attributable to noncontrolling interest
    16       -       2,380       -  
Net loss attributable to Phyhealth Corporation and Subsidiaries
  $ (1,276,144 )   $ (9,706 )   $ (1,759,427 )   $ (20,679 )
Net loss per share - basic and diluted
  $ (0.18 )   $ (9.71 )   $ (0.26 )   $ (20.68 )
                                 
Weighted average shares outstanding - basic and diluted
    7,224,336       1,000       6,882,965       1,000  
                                 
Net loss
  $ (1,276,160 )   $ (9,706 )   $ (1,761,807 )   $ (20,679 )
Unrealized investment holding loss
    (14,725 )     -       (109,089 )     -  
Less: reclassification adjustment for (gains) losses included in net loss
    90,000       -       (51,077 )     -  
Comprehensive loss
    (1,200,885 )     (9,706 )     (1,921,973 )     (20,679 )
Net loss attributable to noncontrolling interest
    16       -       2,380       -  
Comprehensive loss attributable to Phyhealth Corporation and Subsidiaries
  $ (1,200,869 )   $ (9,706 )   $ (1,919,593 )   $ (20,679 )
   
 The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
6

 

Phyhealth Corporation and Subsidiaries
Consolidated Statements of Changes in Equity (Deficit) - Unaudited
For the nine months ended September 30, 2011
 
                                                   
Accumulated
   
Phyhealth
Corporation
             
   
Series A
   
Series B
               
Additional
         
Other
   
Stockholders'
   
Non-
   
Total
 
   
Preferred Stock
   
Preferred Stock
   
Common Stock
   
Paid-in
   
Retained
   
Comprehensive
   
Equity
   
Controlling
   
Equity
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
Income (Loss)
   
(Deficit)
   
Interest
   
(Deficit)
 
                                                                         
Balance- December 31, 2010
    3,240,008     $ 324       622,332     $ 62       6,604,312     $ 660     $ 2,144,278     $ (635,688 )   $ 62,066     $ 1,571,702     $ (70,427 )   $ 1,501,275  
                                                                                                 
Conversion of preferred shares to common shares
    -       -       (9,843 )     (1 )     393,720       39       (38 )     -       -       -       -       -  
                                                                                                 
Issuance of stock for services
    -       -       -       -       84,000       8       52,972       -       -       52,980       -       52,980  
                                                                                                 
Issuance of shares under convertible debt agreement with related party
    -       -       -       -       500,000       50       38,838       -       -       38,888       -       38,888  
                                                                                                 
Beneficial conversion feature
    -       -       -       -       -               48,612       -       -       48,612       -       48,612  
                                                                                                 
Unrealized loss on marketable equity securities
    -       -       -       -       -       -       -       -       (160,166 )     (160,166 )     -       (160,166 )
                                                                                                 
Net loss for nine months ended September 30, 2011
    -       -       -       -       -       -       -       (1,759,427 )     -       (1,759,427 )     (2,380 )     (1,761,807 )
                                                                                                 
Balance- September 30, 2011
    3,240,008     $ 324       612,489     $ 61       7,582,032     $ 757     $ 2,284,662     $ (2,395,115 )   $ (98,100 )   $ (207,411 )   $ (72,807 )   $ (280,218 )
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.

 
7

 
 
Phyhealth Corporation and Subsidiaries
Consolidated Statements of Cash Flows - Unaudited
 
   
Nine months ended
 
   
September 30,
 
   
2011
   
2010
 
Cash from operating activities:
           
Net loss attributable to Phyhealth Corporation and Subsidiaries
  $ (1,759,427 )   $ (20,679 )
Adjustments to reconcile net loss to net cash used in (provide by) operating activities:
               
Net loss attributable to noncontrolling interests
    (2,380 )     -  
Gain on sale of equity securities
    (141,077 )     -  
Impairment of securities
    772,000          
Gain on sale of surplus note receivable
    (60,624 )        
Stock issued for services
    52,980          
Bad debt expense
    29,918       -  
Depreciation and amortization
    29,250       -  
Amortization of debt discount to interst expense
    37,777          
Changes in operating assets and liabilities:
               
   Accounts receivable, net
    (76,563 )     -  
   Other current assets
    (2,500 )     -  
   Other assets
    (9,075 )     -  
   Accounts payable and accrued liabilities
    98,931       273  
   Accrued payroll liabilities
    63,582       -  
   Due to/from related party
    (7,921 )     20,889  
Net cash (used in) provided by operating activities
    (975,129 )     483  
                 
Cash flows from investing activities:
               
   Proceeds from sale of marketable securities
    436,462       -  
   Purchase of furniture and equipment
    (29,819 )     -  
   Proceeds from surplus note receivable
    422,875          
Net cash provided by investing activities
    829,518       -  
                 
Cash flows from financing activities:
               
  Repayment of margin loan
    (137,609 )     -  
  Proceeds from convertible note payable from related party
    200,000          
  Repayment of capital lease
    (19,881 )     -  
Net cash provided in financing activities
    42,510       -  
                 
Net increase (decrease) in cash
    (103,101 )     483  
Cash, beginning of period
    112,087       -  
Cash, end of period
  $ 8,986     $ 483  
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest paid
  $ 5,479     $ -  
Cash paid for income taxes paid
  $ -     $ -  
Unrealized loss on investments
  $ 109,089     $ -  
Equipment purchased under capital lease
  $ 168,806     $ -  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
8

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010
 
1.   BASIS OF PRESENTATION, ORGANIZATION, PRINCIPLE OF CONSOLIDATION AND NATURE OF BUSINESS AND CURRENT OPERATIONS, AND GOING CONCERN

Basis of Presentation – The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the United States Securities and Exchange Commission for interim financial information. Accordingly, they do not include all the information and footnotes necessary for a comprehensive presentation of consolidated financial position and results of operations.  It is management's opinion, however, that all material adjustments (consisting of normal recurring adjustments) have been made which are necessary for a fair consolidated financial statement presentation. The results for the interim period are not necessarily indicative of the results to be expected for the year.  For further information, refer to the audited consolidated financial statements and footnotes of the company for the years ending December 31, 2010 and 2009.

Organization – Phyhealth Corporation (“Company,” “Phyhealth” or “Parent”) was formed in the state of Delaware on January 18, 2008 and was originally a wholly-owned subsidiary of Physicians Healthcare Management Group, Inc. (PHYH).  Prior to November 10, 2010, the Company was dormant and was created to receive the operating assets and liabilities of PHYH (“Predecessor”) under a spin-off (Spin-off) which occurred on November 10, 2010, as described below.  Any references to “the Company” below may refer to the Company or its predecessor.

The operations of PHYH that were the subject of the Spin-off have been in the development stage up to and through the date of the Spin-off, and continues to be in the development stage through December 31, 2010.  During the nine months ended September 30, 2011, the Company recognized the first revenue from operations and is no longer in the development stage.

Principles of Consolidation - The consolidated financial statements include the accounts of Phyhealth Corporation which is a Delaware corporation and includes its wholly-owned and majority-owned subsidiaries as described below.  All material intercompany balances and transactions have been eliminated in consolidation.

Subsidiaries – As part of the Spin-off described below, Phyhealth acquired PHYH’s ownership interest in the following subsidiaries:

Phyhealth Underwriters, Inc . - On July 1, 2005, Phyhealth Underwriters, Inc. (Underwriters) was incorporated in the state of Illinois.  On December 12, 2005 it was redomesticated by incorporating in Nevada.  It was originally owned equal between two partners.  On February, 27, 2009 the Company purchased an additional 42.5% (1,062 shares) of the common stock of Phyhealth Underwriters, Inc. (Underwriters) for a total of 92.5% ownership from its joint venture partner, Atlas Insurance Management (Atlas).  Underwriters was created to act as the legally required Attorney-in-fact for risk retention groups such as the one formed by the Company and Atlas named “Physhield Insurance Exchange, a Risk Retention Group” (Physhield), a Nevada domiciled Association Captive.  Underwriters was the Attorney-in fact for Physhield, but Physhield was liquidated between April and June of 2011 as described below.

Florida Physicians - On November 29, 2007, the Company filed with the state of Florida to create a limited liability company named Florida Physicians, LLC (Florida Physicians).  Phyhealth is the managing member of Florida Physicians, which in turn is the immediate parent of Phyhealth Plan Corporation as described below.

Phyhealth Plan Corporation - On September 4, 2007 the Company filed with the state of Florida to create Phyhealth Plan Corporation (Plancorp).   There were 10 million, no par, shares authorized upon filing.  This wholly owned subsidiary of Florida Physicians was created to operate as a healthcare maintenance organization (HMO).  Management expects to submit an application for an HMO operating certificate when it raises the necessary funds to support operations.
 
 
9

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010
 
Phyhealth Sleep Care Corporation - On September 29, 2010, Phyhealth Sleep Care Corporation (Phyhealth Sleep Care) was incorporated in the state of Delaware in order to own and operate sleep care facilities.  Currently, they have centers in operation in Colorado and Virginia.
 
Debt Discount – The Company amortizes debt discount incurred in loans and notes payable over the term of the loan on the interest method of accounting.

Nature of Business and Current Operations
 
Although the Company’s insurance related business is not yet active, the Company will continue to develop and market products to physicians and physician groups around its  community health plan model that is designed to operatein partnership with participating physicians and other healthcare providers.  The Company’s community health plans are structured to integrate all the financial and reimbursement components of healthcare delivery; align the financial incentives of all participants; and empower physicians to assume end-to-end management of healthcare for their patients. The Phyhealth community health plan model is built on the foundation of the physician-patient relationship and rewards physicians for proactively providing the preventative care necessary to keep their patients healthy and for closely managing the ongoing care necessary for patients who suffer from chronic disorders to stabilize their health status.

The Company previously formed Physhield Insurance Exchange, a Risk Retention Group to offer a medical malpractice liability insurance program for physicians and physician groups marketed through its subsidiary, Phyhealth Underwriters, Inc. (Underwriters).  Underwriters served as the attorney-in-fact (management company) for Physhield.  However, because Physhield had not written any business since its inception, the Company suspended Physhield’s operations in order to recover the capital invested in Physhield to meet the Company’s capital needs for developing additional sleep centers and for corporate expenses.
 
The Company intends to expand its product offerings to include ownership and operation of local healthcare facilities and other products  and services designed to support its goal to increase physicians’ income, reduce their expenses and add to their net worth.  Part of this plan was initiated in October 2010 when the Company incorporated a wholly owned subsidiary named Phyhealth Sleep Care Corporation (Sleep Care) and entered into an agreement with an individual operator to open a series of sleep care centers over the next year.  In November 2010 Sleep Care initiated the development of a 2 bed diagnostic sleep center in Longmont, Colorado and purchased the assets and assumed certain liabilities of an existing 2 bed diagnostic sleep care center in Denver, Colorado.    In January 2011, the Denver facility was expanded to 4 beds.  In June 2011 Sleep Care opened a 4 bed diagnostic sleep center in Virginia.
 
In August 2011, the Company terminated its agreement with the individual operator and assumed direct management control of the Sleep Care operations.  This action was necessary primarily because the individual operator had not completed the profitable sleep care acquisitions contemplated by the Agreement.  In addition, the sleep centers that were developed were accumulating unanticipated operating losses under the management control of the individual operator. The Company plans to continue developing and growing its sleep care business through expanding its successful existing sleep centers, building new profitable centers in attractive markets and acquiring profitable sleep centers that complement its current operations.

Phyhealth’s community health plan model, including the ownership and operation of local healthcare facilities in partnership with healthcare providersis designed to provide high quality, affordable healthcare and insurance coverage to the broadest segment of patients in the community.  The Company’s operations are designed to take advantage of and fully comply with the new PPACA regulations, but remain able to adapt to a changing regulatory climate as uncertainty builds around the feasibility of fully implementing major provisions of the PPACA on its original timetable.
 
 
 
10

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010

Going Concern - The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company and its ability to meet its ongoing obligations. The Company has a net loss of $1,759,427 and net cash used in operations of $975,129 for nine months ended September 30, 2011 and a negative working capital, stockholders’ deficit and an accumulated deficit of $393,620, $207,411 and $2,395,115, respectively, at September 30, 2011.  These factors raise substantial doubt about the ability of the Company to continue as a going concern for a reasonable period of time.  However, the operations of Phyhealth Sleep Care started generating revenue in the nine months ended September 30, 2011.

These conditions, as well as the conditions noted below, were considered when evaluating the Company’s liquidity and its ability to meet its ongoing obligations. These unaudited consolidated financial statements do not include any adjustments to reflect the possible future effect on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of these uncertainties.

Management plans to fund the needed cash flow by obtaining additional financing for the company.  While management believes that this plan will provide the cash flow necessary to continue as a going concern, no assurances can be made that its plan will be successful.

Use of Estimates in Financial Statements - The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates during the period covered by these consolidated financial statements include the useful life of furniture, equipment and leasehold improvements, the allowance for contractual discounts and doubtful accounts, the impairment of long lived assets, valuation of securities, the allocation of service expenses to Underwriters, the valuation of stock and options issued for services, and the valuation allowance on deferred tax assets.

Revenues, Patient Accounts Receivable and Allowances – For the Company’s Sleep Care operations, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered, the sales price to the patient is fixed or determinable, and collectability is reasonably assured. The Company recognizes revenues in the period in which services are performed and billed to the patient or third party insurer. Patient accounts receivable primarily consist of amounts due from third party insurers and patients. Amounts the Company receives for treatment of patients is generally covered by third party insurers such as health maintenance organizations, preferred provider organizations and other private insurers and are generally less than the Company’s established billing rates. Accordingly, the revenues and related patient accounts receivable reported in the Company’s consolidated financial statements are recorded at the net amount expected to be received.
 
The Company derives a significant portion of its revenues from third party insurers that receive discounts from our standard charges. The Company must estimate the total amount of these discounts to prepare its consolidated financial statements. The various managed care contracts under which these discounts must be calculated are complex and are subject to interpretation and adjustment. The Company estimates the allowance for contractual discounts on a payer-specific basis given its interpretation of the applicable regulations or contract terms. These interpretations sometimes result in payments that differ from the Company’s estimates. Additionally, updated regulations and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management. Changes in estimates related to the allowance for contractual discounts affect revenues reported in the Company’s consolidated statements of operations in the period of the change.
 
Management may record estimates for doubtful accounts, which may be sustained in the collection of these receivables. Although estimates with respect to realization of the receivables are based on management’s knowledge of current events, the Company’s collection history, and actions it may undertake in the future, actual collections may ultimately differ substantially from these estimates. Receivables are written off when all legal actions have been exhausted.
 
At September 30, 2011, patient accounts receivable were presented net of an allowance for contractual discounts and an allowance for bad debts of $131,249 and $10,937, respectively.
 
 
11

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010
 
Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company.
 
In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.”  The amendments in this Update affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments in this Update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.    This disclosure is effective for the Company’s financial statements ending December 31, 2011.  Management doesn’t believe that this ASU will have a material impact on its financial statements.
 
2. CONVERTIBLE NOTE RECEIVABLE AND INVESTMENTS IN SECURITIES

Investments made by the Company were made in debt and equity securities of companies.   The investments at September 30, 2011 are as follows:

Convertible Note Receivable:

Convertible Note from AccessKey IP, Inc. (AccessKey) – In November 10, 2010 Spin-off, the Company received 1) an AccessKey note receivable with a face value of $640,000, and 2) warrants to purchase 75 million shares of AccessKey common stock at a total exercise price of $100, with an expiration date of December 31, 2013 (see non-marketable securities below).  Of the $640,000 face value on the note receivable, $300,000 is convertible at the holder’s option into AccessKey common stock at a 50% discount to the market as computed under the provisions within the note.  The Company has evaluated the collectibility of note, and because of the 50% conversion discount, the Company’s risk of loss is substantially mitigated such that the note can always be converted into a minimum of $600,000 worth of AccessKey common stock.  Therefore, prior to November 10, 2010, management established a $40,000 reserve for the portion of the investment at risk to loss.  Management has re-evaluated this security as of September 30, 2011 and due to the increased uncertainty that the Company can realize any of its investment in AccessKey in the open market due to trading restrictions, a 100% reserve has been recorded on this investment resulting in a charge to operations of $600,000 in September 2011.  It has a carrying value of $0 as of September 30, 2011.
 
In addition, the $300,000 portion of the note receivable that is subject to conversion into AccessKey’s common stock was evaluated to see if it met the definition of a derivative asset as described by Statement of Financial Accounting Standards Codification (ASC) section 815 “Derivative and Hedging.”  It was determined that the note did not meet the definition of a derivative because there was no provision for net settlement and because it was determine that the shares were not easily convertible to cash due to the selling restriction of more than 31 days on the stock.
 
Marketable Equity Securities :

AccessKey Common Stock – As described above, the Company received 15 million shares of AccessKey common stock in the November 10, 2010 Spin-off.  Based on the market value of these shares and the uncertainty described above, at September 30, 2011, the Company recorded an impairment loss of $94,500 in September 2011 to value these securities at zero.  This loss included a reclassification from accumulated other comprehensive loss in equity of $90,000 into expense.  An unrealized loss of $0 and $4,200 is reflected in the unaudited consolidated statements of operations and comprehensive income (loss) for the nine and three months ended September 30, 2011, respectively.  There was no unrealized gain or loss reflected in the unaudited consolidated statements of operations and comprehensive income (loss) for the nine and three months ended September 30, 2010.  The fair value of these securities as of September 30, 2011 reflected in the accompanying unaudited consolidated balance sheet is $0.
 
 
12

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010

ZST Digital Networks, Inc. Common Stock – In the November 10, 2010 Spin-off, the Company received 75,000 shares of common stock in ZST Digital Networks, Inc. (ZST Digital), a Chinese supplier of optical and digital network equipment, listed as ZSTN on NASDAQ.

During the nine and three months ended September 30, 2011, the Company sold shares of ZST Digital common stock with a market value of $440,699 and $13,212, respectively, receiving proceeds after selling costs of $436,462 and $12,918, respectively, and realizing a gain of $141,077 and a loss of $6,778, respectively.  There were no sales during the nine and three months ended September 30, 2010.  All shares of this stock was sold as of September 30, 2011 and all gains and losses have been realized.

Bio-Matrix Scientific Group, Inc. (Bio-Matrix) Common Stock – In the November 10, 2010 Spin-off, the Company received 1,150,000 common shares and 25,000 of non-convertible preferred shares of Bio-Matrix Scientific Group (Bio-Matrix).  Bio-Matrix is an OTCBB company listed as BMSN.  This investment in common stock is classified as available for sale by management and presented as short-term because the shares are expected to be sold in the next twelve months.   The preferred shares are non-marketable and valued at zero cost (see below).  There is a possibility that the Company could receive an additional 150,000 shares of Bio-Matrix common stock that Bio-Matrix issued to another entity under the original PHYH purchase agreement as compensation for a business transaction that never materialized.  Since that transaction never materialized, the Company believes that they should receive the shares of Bio-Matrix common stock issued to that entity.  However, those shares have not been recognized in these consolidated financial statements nor included in the fair value disclosure herein, because it is not reasonably assured that they will receive those shares.

Based on the OTC market price of the stock currently held by the Company, an unrealized loss of $27,600 and $13,225 is reflected in the comprehensive income (loss) portion of the unaudited consolidated statements of operations and comprehensive income (loss) for the nine and three months ended September 30, 2011, respectively, and is included in the accumulated other comprehensive income – unrealized gain (loss) on marketable equity securities on the balance sheet which totals $98,100 for this security as of September 30, 2011.  There is no unrealized gain or loss reflected in the unaudited consolidated statements of operations and comprehensive income (loss) for the nine and three months ended September 30, 2010. The fair value of these securities as of September 30, 2011 reflected in the accompanying unaudited consolidated balance sheet is $6,900.

Non-Marketable Securities:

AccessKey warrants – As described above, the Company recorded warrants to purchase 75 million shares of AccessKey common stock.  These warrants are considered non-marketable and accounted for at cost less any impairment since there is no readily determinable market value.  These warrants were recorded at the $77,500 at the time of the Spin-off and were subsequently evaluated for other than temporary impairment.  Management has re-evaluated this security as of September 30, 2011 and due to the increased uncertainty that the Company can realize any of its investment in AccessKey in the open market due to trading restrictions, a 100% reserve has been recorded on these warrants and $77,500 has been charged to impairment expense in September 2011.  It has a carrying value of $0 as of September 30, 2011.

Bio-Matrix Scientific Group, Inc. (Bio-Matrix) Preferred Stock – As described above the Company acquired 25,000 shares of non-convertible preferred stock in Bio-Matrix.  These shares were recorded at a zero cost basis.

Common stock - MLH Investments, Inc (MLH) – On November 10, 2010 the Company acquired PHYH’s interest in 100,000 restricted common shares of Wound Management Technologies, Inc. (WNDM) common stock that was provided to PHYH as a result of a previous loan made to MLH.  The Company also received a put option requiring MLH to purchase 75,000 shares of the WNDM stock at $3.00 per share upon notice by the Company between September 15, 2009 and October 15, 2009.  Although the original loan was repaid, MLH and WNDM have refused to honor the terms of these other instruments and have not issued the 100,000 shares of WNDM common stock to the Company and have not paid the $225,000 due upon the Company’s exercise of the Put Option. The Company believes the terms are legally enforceable and has filed a lawsuit against MLH Investments, its Chairman, WNDM and other parties.  However, the Company has not recorded the stock in these financial statements since a positive outcome to this dispute cannot be reasonably assured.
 
 
13

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010

Note Receivable and Warrants from Bottled Water Media (BWM) - On November 10, 2010 the Company acquired PHYH’s interest in a note receivable of $250,000 in BWM in the form of a secured original issue discount promissory note with a face value of $287,500, including interest, with a maturity date of December 29, 2009, collateralized by the intellectual property of BWM and the Chief Executive Officer’s personal guarantee. Part of the compensation to the Company includes warrants to purchase 7% of the BWM’s common stock and 7% of the BWM’s preferred stock for $200,000, which expires on December 29, 2012.  Since BWM is a privately held development stage company with no revenues or sales contracts and no indicators of common stock value, the warrant received was valued at zero for accounting purposes and no interest or loan fee income was recognized.  Since the warrants are accounted for at cost for this non-marketable security, there is no change in recorded value as of September 30, 2011.  BWM has the right to repurchase 50% of the Warrants from the Company for $500,000.  The Company is also entitled to future advertising through BWM at BWM’s cost for a period of 24 months not to exceed $250,000 or 25% of BWM’s annual revenues.

Since BWM is in default on this note receivable, default interest rates of 27% started to accrue, the warrant to purchase 7% of BWM’s common stock and preferred stock increased to 20% and the exercise price was reduced to $100.  BWM is in the process of raising funds that, if successful, all or a portion of the funds raised will be used to pay this debt.    While the Company’s management remains hopeful that they will be repaid their investment and earnings from this note receivable, due to the uncertainty of BWM’s ability to raise funds and BWM’s lack of established operations, the Company has maintained a 100% reserve that was established prior to the November 10, 2010 acquisition of this investment in BWM and no interest income is being accrued on the note receivable.
 
3.  FAIR VALUE MEASUREMENTS
 
Marketable Equity Securities
 
As of September 30, 2011 the Company’s investments in marketable equity securities are based on the September, 2011 stock price as reflected in the OTC markets, reduced by a discount factor if those shares have selling restrictions.  These marketable equity securities are summarized as follows:
 
   
Equity Securities Cost
   
Aggregate Unrealized
Gains (Loss)
   
Equity Securities Aggregated Fair Value
 
Marketable Equity Securities-Available for Sale:
                 
                   
  Bio-Matrix Scientific Group, Inc.
    105,000       (98,100 )     6,900  
                         
Total Marketable Equity Securities-Available for Sale
  $ 105,000     $ (98,100 )   $ 6,900  
 
The unrealized gains (losses) are presented in the comprehensive income (loss) portion of the unaudited consolidated statements of operations and comprehensive income (loss) and is included in the accumulated other comprehensive income – unrealized gain (loss) on marketable equity securities on the balance sheet.  .
 
The levels of the fair value measurements for marketable equity securities are summarized as follows:
 
   
Fair Value Measurements Using:
 
   
Quoted Prices
 in Active
Markets
(Level 1)
   
Significant Other Observable
 Inputs
(Level 2)
   
Significant
Unobservable
 Inputs
(Level 3)
 
Marketable Equity Securities – December 31, 2010
  $ 34,500     $ -     $ -  
                         
Sale of equity securities
    -       -       -  
                         
Total unrealized gains (losses)
                       
   Included in other comprehensive income
    (27,600 )     -       -  
                         
Marketable Equity Securities – September 30, 2011
  $ 6,900     $ -     $ -  

 
14

 

Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010
 
4. RELATED PARTIES

Underwriters is the attorney in fact for Physhield (see Note 1) and the Parent company has received the surplus note in the November 10, 2010 Spin-off.  Between April and June 2011 Physhield was liquidated.  The Company received $422,875 in cash on the surplus note receivable which had a face value of $600,000 (book value of $313,924) plus $48,327 of accrued interest, thus realizing a gain of $60,624.  Physhield also owed the Company $252,874 of accrued interest, $87,358 for a start-up loan and $619,646 of shared expenses, for a total of $959,878.  These amounts were not collected upon the liquidation of Physhield but had been fully reserved and therefore did not result in any additional loss to the Company.

The Company has contracted with NextPath Partners, LLC (NextPath) to provide full-time marketing and related services for $7,500 per month to support the introduction and sales of Physhield’s medical malpractice products, particularly in Maryland and the District of Columbia.  Services include website development and maintenance, product development, communications, direct marketing to physicians and the development of marketing materials to support Physhield’s Managing General Agent, Palumbo Insurance Associates.  NextPath has also been engaged by the Company to provide substantially the same full-time marketing services to Phyhealth Sleep Care Corporation.  NextPath will not receive additional compensation for the services for Sleep Care over and above the $7,500 per month contracted amount. NextPath is owned and operated by the spouse of the President and CEO of the Company.  NextPath has more than twenty years executive management experience in target marketing for a Fortune 500 media corporation and complies with the Company’s Related Parties Policy.  Based on a mutual agreement, NextPath did not receive cash for services in February or March of 2011 and only collected $2,500 of cash in April 2011.  Consequently, they were only paid $35,000 and $10,000 for the nine and three months ended September 30, 2011, respectively.   However, the Company accrued $32,500 for unpaid services that were paid in the form of the Company’s common stock subsequent to the September 30, 2011 financial statements.  There were no fees paid for the nine and three months ended September 30, 2010.

5.  CONVERTIBLE NOTE PAYABLE – RELATED PARTY

On August 9, 2011, the Company executed a convertible note payable with its President/Chief Executive Officer/Chairman of the Board (CEO), whereby the Company would draw down loans from the CEO up to four times at increments of at least $25,000, for a total maximum of $100,000.  The CEO advanced all $100,000 on this note in August 2011 under three draws.  The note earns 12% interest per annum, payable on the maturity date of November 9, 2011, plus 250,000 shares of the Company’s common stock payable and issued on August 9, 2011.  The CEO has the option to convert the note and accrued interest at $0.28 per share, unless the note is in default, at which time the conversion rate changes to $.14 per share.  The Company has subsequently defaulted on this note.

The 250,000 shares of common stock issued with the debt and initial $25,000 draw were recorded at their relative fair value of $19,444 with a corresponding debt discount.  Additionally, a beneficial conversion value of $5,556 was recorded as a debt discount and additional paid-in capital. Both discounts are being amortized to interest expense over the term of the note.  The subsequent draws, totaling $75,000, caused additional beneficial conversion values of $18,750 to be recorded and to be amortized over the remaining term of the loan.  There is also a contingent beneficial conversion value due to the default of the Company that totals $56,250.  This contingent beneficial conversion value was recorded as of the date of the default on the note thereby causing a decrease in the conversion price of the note to $.14 per share.
 
 
15

 
 
Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010

On August 26, 2011, the Company executed a second 12% convertible note payable with its President/Chief Executive Officer/Chairman of the Board (CEO), with the exact same terms as described above, maturing November 26, 2011.  The 250,000 shares of common stock issued with the debt and initial $25,000 draw were recorded at their relative fair value of $19,444 with a corresponding debt discount.  Additionally, a beneficial conversion value of $5,556 was recorded as a debt discount and additional paid-in capital. Both discounts are being amortized to interest expense over the term of the note.  The subsequent draws, totaling $75,000, caused additional beneficial conversion values of $18,750 to be recorded and amortized over the remaining term of the loan.  There is also a contingent beneficial conversion value of $56,250 that will be recorded only if the Company defaults on the note thereby causing a decrease in the conversion price of the note to $.14 per share.

Interest expense was recorded as a result of the amortization of debt discount from the two convertible notes payable totaling $37,777 for the nine and three months ended September 30, 2011.

6.   CAPITAL LEASES

The Company entered into a capital lease on January 14, 2011 for $85,928 of sleep care medical equipment for location opened in Denver, Colorado.  The lease requires the Company to pay monthly principal and interest payments of $3,218 per month for 30 months starting in July 2011 and ending December 2013.  The lease has an implicit interest rate of 6.6%.

The Company entered into a capital lease on May 1, 2011 for $82,878 of sleep care medical equipment for location opened in Virginia.  The lease requires the Company to pay monthly principal and interest payments of $2,808 per month for 36 months starting in September 2011 and ending August 2014.  The lease has an implicit interest rate of approximately 11.4%.

The Company also has a capital lease on the sleep care medical equipment for its Longmont, Colorado location that requires the Company to pay monthly principal and interest payments of $1,287 per month through August 2013.  The lease has an implicit interest rate of 14.2%.

Total minimum lease payments under all capital leases are summarized as follows:

Year ended September 30 :
     
2012
  $ 84,958  
2013
    86,479  
2014
    40,542  
         
  Total minimum lease payment
    211,979  
Interest portion of minimum lease payments
    (24,405 )
Present value of minimum lease payments
    187,574  
Less: current portion of capital leases
    (70,399 )
Capital leases, net of current portion
  $ 117,175  

7.  EQUITY

In accordance with the rights of the series B shareholders, two Series B shareholders converted a total of 9,843 Series B preferred shares into 393,720 common shares.

Management issued 84,000 shares of the Company’s common stock in exchanges for legal and consulting services.  The stock and the related services were valued at $20,980 based on the common stock’s market value at the date the shares were issued.

Under a six month consulting agreement dated July 1, 2011, the Company is recognizing expense for 250,000 common shares on a prorata basis using the average trading price for each reporting period.   The Company recognized $32,000 as of September 30, 2011.  The shares were issued in October 2011 (See Note 10).
 
 
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Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010
 
The Company issued the President and CEO 500,000 shares of its common stock in accordance with a convertible debt agreement as described in the Note 5 above.
 
8. OPERATING LEASE COMMITMENT

In April 2011, the Company extended their current lease commitment for their headquarters in Miami Springs, Florida.  Rental payments under this lease are $3,460 per month in 2011 and increase each year by 4% through May 2014.

The Company opened a Sleep Center in Culpeper, Virginia in May 2011.  Part of opening that center was signing a three year facility lease with lease payments of $2,500 per month through April 2014 with a 3% annual increase in the rental payments.

They also signed a three year lease starting in July 2011 and ending June 30, 2014, with monthly lease payments of $2,950 with a 3% escalation clause, plus common area maintenance payments of $493 per month.

The minimum lease payments under these leases are as follows:

Year ended September 30,
 
Amount
 
2012
  $ 114,305  
2013
    117,743  
2014
    89,057  
   Total
    321,106  

9.  LITIGATION

One of the Company’s investors has initiated litigation claiming that the August 2008 conversion of their convertible debentures into Series B Preferred shares should be voided since they believe their Investment Advisor also represented the Company at that time.  The investment advisor and the Company deny that there was any conflict of interest or wrongdoing in this conversion.

If the conversion is declared to be void, the investor seeks judgment on the convertible debenture, in an amount of approximately $263,000.  The management team believes this case is without merit and has asked legal counsel to vigorously contest this matter.  Legal counsel filed a motion to dismiss this case.  The plaintiff filed an amended complaint. After discovery, legal counsel plans on filing a motion for summary judgment, as it sees no factual basis for the complaint. The Company’s management believes it will successfully defend this claim and does not believe that the outcome of this litigation will have a material impact to the Company’s consolidated financial statements.  No liability has been recorded in the Company’s consolidated financial records regarding this litigation.

 
17

 

Phyhealth Corporation and Subsidiaries
Notes to Consolidated Financial Statements – Unaudited
For the nine months ended September 30, 2011 and 2010
 
10.  SUBSEQUENT EVENT

On October 6, 2011, the Company executed a convertible note payable with the spouse of its President/Chief Executive Officer/Chairman of the Board (CEO), whereby the Company would draw down loans up to four times at increments of at least $25,000, for a total maximum of $100,000.  The CEO advanced all $100,000 on this note in October 2011 under two draws.  The note earns 12% interest per annum, payable on the maturity date of January 6, 2012, plus 500,000 shares of the Company’s common stock payable and issued on October 6, 2011.  The holder has the option to convert the note and accrued interest of $0.0664 per share, unless the note is in default, at which time the conversion rate will change to $0.0415 per share.

The 500,000 shares of common stock issued with the debt and initial $50,000 draw were recorded at their relative fair value of $35,714 with a corresponding debt discount.  Additionally, a beneficial conversion value of $14,286 was recorded as a debt discount and additional paid-in capital. Both discounts are being amortized to interest expense over the term of the note.  The subsequent draw of $50,000 caused additional beneficial conversion values of $8,300 to be recorded and to be amortized over the remaining term of the loan.  There is also a contingent beneficial conversion value due to the default of the Company that totals $30,000.  This contingent beneficial conversion value was recorded as of the date of the default on the note thereby causing a decrease in the conversion price of the note to $0.0415 per share.

On October 17, 2011 the Company issued 250,000 shares of its common stock to a provider of Investor/Public Relations service under a six month contract, dated July 1, 2011.  The measurement date was reached on the issue date and the unearned portion of the shares was recorded as a prepaid asset to be recognized over the remainder of the term (see Note 7).

On October 7, 2011, an officer and shareholder converted 275,539 shares of series A preferred stock into 275,539 shares of the Company’s common stock.

On October 21, 2011, the Company replaced two executives’ stock options to purchase a total of 800,000 common shares with a strike price of $0.15 per share with an equal number of the Company’s common shares.  The Company valued the options given up using a Black-Scholes model with the Company’s volatility rate of 214%, at an interest rate of 1.65%, and no dividends.  The value of the options under the Black Scholes model equaled the value of the shares issued; thus, no compensation expense was recorded.

On October 25, 2011, five individuals that were owed a total of $133,132 by the Company accepted 1,604,001 shares of the Company’s common stock in lieu of cash.  The value of the stock was based on the market price of $0.083 per share at the date the shares were issued.

 
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ITEM  2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements.

The purpose of this discussion is to provide an understanding of the financial results and condition of Phyhealth Corporation (Company) and to also describe the plans for future growth and expansion.

Forward-Looking Statements
 
This Management’s Discussion and Analysis and other parts of this report contain forward-looking statements that involve risks and uncertainties, as well as current expectations and assumptions. From time to time, the Company may publish forward-looking statements, including those that are contained in this report, relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company’s business include, but are not limited to, its ability to maintain sufficient working capital, adverse changes in the economy, the ability to attract and maintain key personnel, its ability to identify or complete an acceptable merger or acquisition, and future results related to acquisition, merger or investment activities. The Company’s actual results could differ materially from those anticipated in these forward-looking statements, including those set forth elsewhere in this report. The Company assumes no obligation to update any such forward-looking statements.
 
Operational Overview:

The Company has been dormant during 2008, 2009 and most of 2010.  The Company was created to receive the business, operating assets and liabilities of Physician Healthcare Management Group, Inc. (PHMG) under a spin-off where shares of the Company are distributed to the stockholders of PHMG and both PHMG and the Company became independent publicly traded companies.  That spin-off occurred on November 10, 2010.

During the first nine months of 2011, the Company received its first revenues from services provided by its wholly owned subsidiary Phyhealth Sleep Care Corporation as more fully described below.  The receipt of these revenues means that the Company is no longer a “development stage enterprise” for financial accounting purposes.  Although several portions of the business plan are still to be implemented, it is now considered to be an operating entity.
 
 
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Although the Company’s insurance related business is not yet active, the Company will continue to develop and market products to physicians and physician groups around its  community health plan model that is designed to operatein partnership with participating physicians and other healthcare providers.  The Company’s community health plans are structured to integrate all the financial and reimbursement components of healthcare delivery; align the financial incentives of all participants; and empower physicians to assume end-to-end management of healthcare for their patients. The Phyhealth community health plan model is built on the foundation of the physician-patient relationship and rewards physicians for proactively providing the preventative care necessary to keep their patients healthy and for closely managing the ongoing care necessary for patients who suffer from chronic disorders to stabilize their health status.

The Company previously formed Physhield Insurance Exchange, a Risk Retention Group to offer a medical malpractice liability insurance program for physicians and physician groups marketed through its subsidiary, Phyhealth Underwriters, Inc. (Underwriters).  Underwriters served as the attorney-in-fact (management company) for Physhield.  However, because Physhield had not written any business since its inception, the Company suspended Physhield’s operations in order to recover the capital invested in Physhield to meet the Company’s capital needs for developing additional sleep centers and for corporate expenses.
 
The Company intends to expand its product offerings to include ownership and operation of local healthcare facilities and other products  and services designed to support its goal to increase physicians’ income, reduce their expenses and add to their net worth.  Part of this plan was initiated in October 2010 when the Company incorporated a wholly owned subsidiary named Phyhealth Sleep Care Corporation (Sleep Care) and entered into an agreement with an individual operator to open a series of sleep care centers over the next year.  In November 2010 Sleep Care initiated the development of a 2 bed diagnostic sleep center in Longmont, Colorado and purchased the assets and assumed certain liabilities of an existing 2 bed diagnostic sleep care center in Denver, Colorado.    In January 2011, the Denver facility was expanded to 4 beds.  In June 2011 Sleep Care opened a 4 bed diagnostic sleep center in Virginia.
 
In August 2011, the Company terminated its agreement with the individual operator and assumed direct management control of the Sleep Care operations.  This action was necessary primarily because the individual operator had not completed the profitable sleep care acquisitions contemplated by the Agreement.  In addition, the sleep centers that were developed were accumulating unanticipated operating losses under the management control of the individual operator. The Company plans to continue developing and growing its sleep care business through expanding its successful existing sleep centers, building new profitable centers in attractive markets and acquiring profitable sleep centers that complement its current operations.

Phyhealth’s community health plan model, including the ownership and operation of local healthcare facilities in partnership with healthcare providersis designed to provide high quality, affordable healthcare and insurance coverage to the broadest segment of patients in the community.  The Company’s operations are designed to take advantage of and fully comply with the new PPACA regulations, but remain able to adapt to a changing regulatory climate as uncertainty builds around the feasibility of fully implementing major provisions of the PPACA on its original timetable.
 
Results of Operations for the nine and three months ending September 30, 2011 compared to the nine and three months ending September 30, 2010

As described above, the Company had no operations prior to the spin-off on November 10, 2010.  Consequently, discussion will be limited to the nature of the revenues earned and expenses incurred in the nine and three months ended September 30, 2011.

Sleep care operations – nine and three months ended September 30, 2011:

The sleep care service revenue recognized for the nine and three months ended September 30, 2011 of $309,773 and $125,510, respectively, was through three branches in 1) Longmont, Colorado, 2) Denver, Colorado (opened in late January 2011) and 3) Culpeper, Virginia (operational late June 2011).

The sleep care operating expenses for the nine and three months ended September 30, 2011 of $410,701 and $222,283, respectively, includes $293,030 and $176,798, respectively, of medical professional fees incurred in the set-up of the two branches and the patient treatments once operations began.  These operating expenses also included rent expense of $86,624 and $40,153, respectively.  The increase in the rent expense for the three months ended September 30, 2011 was due to having rent for all three facilities for the entire three month period.

Corporate expenses – nine and three months ended September 30, 2011:

Officer and director compensation of $278,577 and $89,831 for the nine and three months ended September 30, 2011, respectively, was incurred in accordance with the employment contracts of the two executive officers of the Company.

Consulting and professional fees totaled $349,568 and $134,881 in the nine and three months ended September 30, 2011, respectively, and consisted mostly of legal, audit and accounting fees incurred in the completion of the Company’s Form 10K and Form 10Qs and other day to day operating matters.

Bad debt expense of $29,918 and $0 for the nine and three months ended September 30, 2011, respectively, was a result of recording the allowance for doubtful accounts for all costs due to the Company by Physhield.  Since the management team has liquidated Physhield, these costs will not be reimbursed.     

The Company’s general and administrative expenses totaling $381,895 and $138,179 for the nine and three months ended September 30, 2011, respectively, consists mostly of:

Expense Description
 
Nine months Ended
September 30, 2011
   
Three months Ended
September 30, 2011
 
Sleep Care business development
  $ 141,465     $ 52,011  
Travel
    42,881       11,190  
Rent
    36,609       14,032  
Depreciation
    29,250       12,647  
Marketing
    21,383       968  
Public company expense
    25,286       14,188  
 
 
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The majority of these expenses focused on the development of Sleep Care since they were establishing a new branch operation.

Liquidity and Capital Resources

The Company’s cash and liquidity resources have been provided by the assets received in the November 10, 2010 spin-off.  As of the date of the spin-off, the Company received $118,127 in cash and $1,061,000 of marketable equity securities and a surplus note receivable.  During the nine months ended September 30, 2011, management sold a portion of the marketable equity securities for $436,462 and liquidated the surplus note receivable for $422,875.  These funds have been used to fund the startup of Phyhealth Sleep Centers and to meet general corporate expenses.

In August through November 2011, the President, Chief Executive Officer, and Chairman of the Board (CEO) and his spouse, loaned the Company $300,000, as bridge loans until other capital is raised.  These loans were evidenced by a three convertible notes payable with an interest rate of 12% and, if the CEO and his spouse choose to convert these loans to common stock, the conversion price will be 80% of the market price at the time of the loan.  Each of these loans mature 90 days after the effective date, which range from November 9, 2011 through January 6, 2012.

The Company is currently out of funds and is looking for additional financing in order to support the sleep care business as well as administrative expenses. However, there is no guarantee that additional capital can be raised, that current investments will provide adequate capital or that operations can produce enough cash flow to sustain the Company over the long-term.
 
Off-Balance Sheet Arrangements

None

Debt and Contractual Obligations

As a result of the spin-off on November 10, 2010, the Company assumed the two employment agreements, one with its President/Chief Executive Officer/Chairman of the Board (CEO), the other with its Vice President, Chief Operating Officer and Corporate Director (COO).  Both agreements are effective upon signing and expire on December 31, 2012.  The base salary of the two agreements total $270,000, with combined escalation clauses up to $900,000 if certain revenue, equity and profit milestones are met.

The Company also assumed a lease for its current corporate office space which was renewed in April 2011.  The revised lease extends through May 31, 2014 requiring monthly lease payments of $3,459 for the first year and annual increases of 4% for the succeeding years.

The Company is also obligated to make monthly lease payments for two sleep center facility in Culpeper, Virginia starting at $2,500 and $2,950 per month in 2011 and increase 3% each year plus common area maintenance.
 
 
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These minimum operating lease payments under all three facility leases total:

Year ended September 30 ,
 
Amount
 
2012
  $ 114,305  
2013
    117,743  
2014
    89,057  
Total
  $ 321,105  

The Company is also obligated to monthly payments under three year equipment capital leases through August 2014 as follows:
 
Year ended September 30 ,
 
Amount
 
2012
  $ 84,958  
2013
    86,479  
2014
    40,542  
Total
  $ 211,979  
 
Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. On an ongoing basis we re-evaluate our judgments and estimates including those related to bad debts, investments and income taxes. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. Our estimates are guided by observing the following critical accounting policies.

Patient Revenues :

The Company recognizes revenues in the period in which services are performed and billed to the patient or third party insurer. Amounts the Company receives for treatment of patients is generally covered by third party insurers and is generally less than the Company’s established billing rates. Accordingly, the revenues and related accounts receivable reported in the Company’s consolidated financial statements are recorded at the net amount expected to be received.

The Company derives a significant portion of its revenues from third party insurers that receive discounts from our standard charges. The Company must estimate the total amount of these discounts to prepare its consolidated financial statements. The various managed care contracts under which these discounts must be calculated are complex and are subject to interpretation and adjustment. The Company estimates the allowance for contractual discounts on a payor-specific basis given its interpretation of the applicable regulations or contract terms. These interpretations sometimes result in payments that differ from the Company’s estimates. Additionally, updated regulations and contract renegotiations occur frequently, necessitating regular review and assessment of the estimation process by management. Changes in estimates related to the allowance for contractual discounts affect revenues reported in the Company’s consolidated statements of operations in the period of the change.

Allowance for loans :

Phyhealth's predecessor loaned funds to several companies and have subsequently recorded a 100% allowance on those investments because the uncertainty regarding the investee’s ability to repay the loan.  However, if those investees are able to repay the loan it would create material expense recovery to the Company’s financial statements.  In one such investment, Phyhealth, as the successor, is entitled to 20% of the company for $100 and could gain much more than the original investment by having a 20% ownership interest in the company along with the intellectual property it possesses.
 
 
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Income taxes

Phyhealth accounts for income taxes using the liability method, which requires the determination of deferred tax assets and liabilities based on the differences between the financial and tax basis of assets and liabilities, using enacted tax rates in effect for the year in which differences are expected to reverse. Deferred tax assets are adjusted by a valuation allowance, if based on the weight of available evidence it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Currently 100% of the deferred tax asset is reserved.  If in fact Phyhealth does become profitable post spin-off, income will be charged to the statement of operations resulting from a reversal of that allowance.  That allowance totals approximately $2 million as of December 31, 2010.
 
Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company.
 
In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.”  The amendments in this Update affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments in this Update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists.    This disclosure is effective for the Company’s financial statements ending December 31, 2011.  Management doesn’t believe that this ASU will have a material impact on its financial statements.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not applicable.
 
ITEM 4.
CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures - Our management carried out an evaluation, with the participation of our Principal Executive Officer and Principal Financial Officer, required by Rule 13a-15 of the Securities Exchange Act of 1934 (Exchange Act) of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on their evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified under SEC rules and forms and is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


 
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PART II – OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS
 
One of the Company’s investors has initiated litigation against the predecessor company (PHMG) claiming that the August 2008 conversion of their convertible debentures into Series B Preferred shares should be voided since they believe their Investment Advisor also represented the Company at that time.  The investment advisor and the Company deny that there was any conflict of interest or wrongdoing in this conversion.

If the conversion is declared to be void, the investor seeks judgment on the convertible debenture, in an amount of approximately $263,000.  The management team believes this case is without merit and has asked legal counsel to vigorously contest this matter.  Legal counsel filed a motion to dismiss this case.  The plaintiff filed an amended complaint. After discovery, legal counsel plans on filing a motion for summary judgment, as it sees no factual basis for the complaint. The Company’s management believes it will successfully defend this claim and does not believe that the outcome of this litigation will have a material impact to the Company’s consolidated financial statements.  No liability has been recorded in the Company’s financial records regarding this litigation.
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Unregistered equity securities were sold during the third quarter.  See the associated financial statements as well as footnotes 7 and 10, the latter a subsequent event.  In the aggregate, these disclosures reflect numbers, dates and amounts respectively of debt settlement and/or in kind payment of shares for services.
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.
REMOVED AND RESERVED
 
ITEM 5.
OTHER INFORMATION
 
None.
 
ITEM 6.
EXHIBITS
 
Exhibit Number
 
Exhibit Description
     
31.1   Certification of Chief Executive Officer and Chief Financial Officer
     
32.1
 
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS **
 
XBRL INSTANCE DOCUMENT
     
101.SCH **
 
XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
     
101.CAL **
 
XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT
     
101.DEF **
 
XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT
     
101.LAB **
 
XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT
     
101.PRE **
 
XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT
 
** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
 
 
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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.
 
  PHYHEALTH CORPORATION  
       
Date: November 14 , 2011
By:
/s/Robert L Trinka  
    Robert L. Trinka,  
    Chairman, President, CEO,  
    Principal Executive Officer and Principal Financial  
       
       
Date: November 14 , 2011 By: /s/ Fidel Rodriguez  
    Fidel Rodriguez,  
    V.P./Chief Operating Officer,  
    Director and Treasurer  
 
 
25

 
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