ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 30, 2002

NOTE 1—BASIS OF PRESENTATION

     The accompanying consolidated balance sheet as of June 30, 2002, consolidated statements of operations for the three and six months ended June 30, 2002 and 2001, and consolidated statements of cash flows for the six months ended June 30, 2002 and 2001 have been prepared by Anchor Pacific Underwriters, Inc. (unless otherwise noted, “the Company,” “Anchor Pacific,” “Anchor,” “we,” “APU,” “us,” or “our,” refers to Anchor Pacific Underwriters, Inc.) and have not been audited. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United Sates of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. These consolidated financial statements, in our opinion, include all adjustments necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows for all periods presented. The consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our annual Report on Form 10-K filed for the year ended December 31, 2001, which provides further information regarding our significant accounting policies and other financial and operating information. Interim operating results are not necessarily indicative of operating results for the full year or any other future period.

     The consolidated financial statements include the accounts of APU and its wholly owned subsidiaries, Ward Benefits Administrators & Insurance Services, Inc. (“WBAIS”), formerly known as Harden & Company Insurance Services, Inc., Harden & Company of Arizona (“Harden-AZ”) and Spectrum Managed Care of California, Inc. (“Spectrum CA”). Commencing in mid-2000 WBAIS and Harden-AZ operated under the common business name “Ward Benefits Administrators” (WBAIS and Harden-AZ may collectively be referred to as “WBA” or the “WBA companies”). All significant intercompany accounts and transactions have been eliminated.

     The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

     At June 30, 2002, the Company had negative working capital of $6,822,620 and a deficiency in assets of $6,150,634. The Company is in violation of the terms of substantially all of its debt provisions. In 2001, the Company received financing from its majority shareholder, Ward North America Holding, Inc. (“WNAH”). Management has been notified by WNAH that it does not intend to provide any further financing in support of the Company’s operations. Effective January 1, 2002, the Company discontinued WBA companies’ plan administration business (Note 9); therefore there is no financial activity for these operations in the 2002 results. The Company’s consolidated financial statements have been reclassified to reflect the discontinuation of WBA’s operations in 2001. Accordingly, the revenues and operating and other expenses of WBA have been reported as “Discontinued Operations” in the six months ended June 30, 2001.

     Management is attempting to develop a plan to restructure Anchor’s debt, raise additional working capital, and continue to operate Spectrum CA, the Company’s managed care subsidiary (Note 4). The assets and business of Anchor and Spectrum CA are encumbered by collateral security interests granted for loans made by Anchor’s commercial bank and Legion Insurance Company (“Legion”). The loan by Legion is currently in default. Neither Anchor nor Spectrum CA has capital resources sufficient to cure the loan default and, as a result, their assets could be subjected to foreclosure by Legion. Anchor and Spectrum CA also owe significant sums to other unsecured creditors and lenders, including the Novaeon, Inc. bankruptcy estate and WNAH and its subsidiaries including Ward North America, Inc. (“WNA”). In the event a secured creditor of Anchor or Spectrum CA commences legal action to collect its debt or enforce its security interests, it is foreseeable that Anchor, and/or Spectrum CA would file for Chapter 11 bankruptcy protection to preserve their assets and ongoing operations.

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      One financing alternative under consideration by Anchor contemplates funds to be provided by WNAH. WNAH, however, is currently prohibited under its Securities Purchase Agreement with Anchor from acquiring additional Anchor equity unless it first makes a tender offer to buy all the shares of Anchor’s common stock not then owned by WNAH, or its affiliates, at a purchase price equal to the greater of: (i) $.080 per share (as adjusted for stock splits, combinations or dividends with respect to such shares) or (ii) the price per share determined by assuming the value of Anchor to be equal to Anchor’s earnings before income taxes (“EBIT”) for the 12 full calendar months preceding the month in which the offer is made, multiplied by six (6) and divided by the number of shares outstanding of the Company on a fully diluted basis. This contractual restriction expires in March 2003. Any equity refinancing proposal involving funds to be provided by WNAH would likely be contingent upon WNAH successfully completing its own private equity offering which commenced in April 2002 and the approval by a majority of Anchor’s disinterested common shareholders. There can be no assurance that a commitment from WNAH to provide additional funds to Anchor will be obtained or, if such an agreement is reached, that WNAH will be successful in its own efforts to raise additional working capital or that such a plan would be acceptable to Anchor’s common shareholders.

      The continuation of the Company as a going concern is dependent on the successful implementation of a refinancing plan and the retention of Spectrum CA’s managed care operations. Any such refinancing plan will likely require Anchor’s debt to be restructured or all or portions of it converted to Anchor equity securities. Any such plan will also likely require the Company to raise substantial additional working capital. There can be no assurance that such a plan will be developed and successfully implemented.

      On July 25, 2002, Congress passed the Sarbanes-Oxley Act of 2002 (the “Act”), which was subsequently signed into law by President Bush on July 30, 2002. The Act requires compliance with a substantial number of new rules and regulations applicable to companies that are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In addition, the Act mandates that a substantial number of additional rules and regulations be enacted by the Securities and Exchange Commission in the ensuing months. Anchor is working to understand and implement the standards of compliance under the various new rules and regulations to which it is now subject under the Act. Anchor is also working to understand and prepare for those new rules and regulations which are anticipated to become effective in the near future. Anchor has concluded that the costs and resources necessary to effectuate compliance with all such rules and regulations mandated by the Act may exceed the resources currently available to the Company and reasonably expected to be available to the Company in the future. Because it is unlikely that the Company will be able to become and remain compliant with all of the new rules and regulations currently mandated by the Act, as well as those new rules and regulations expected to be fully enacted during 2003, the Company is considering alternatives that would relieve the Company from compliance with the Act. Such alternatives may include a termination of the Company’s registration with the Securities and Exchange Commission under Section 12(g) of the Exchange Act.

     On April 1, 2002, Legion, a shareholder of WNAH, was placed into voluntary rehabilitation by the Commonwealth Court of Pennsylvania. Beginning on April 1, 2002, Legion operated in run-off under the control of the Insurance Commissioner of the Commonwealth of Pennsylvania as Rehabilitator. Legion has not written any new insurance policies since going into rehabilitation. On September 3, 2002, the Insurance Commissioner of the Commonwealth of Pennsylvania petitioned the Pennsylvania Court to order Legion into liquidation. Should the Court issue an order of liquidation, as part of the liquidation process, all outstanding claims on Legion programs will be managed by various state guaranty associations. Management is evaluating the likely impact of Legion’s liquidation on the Company’s future results including the possibility of a substantial loss of revenue to Spectrum CA. For the three months ended June 30, 2002, the Company has recognized $706,261 of revenue from Legion. For the six months ended June 30, 2002, the Company has recognized $1.2 million of revenue from Legion. The Company had an accounts receivable balance due from Legion programs of $369,515 at June 30, 2002. When Legion went into rehabilitation on April 1, 2002, the State of Pennsylvania placed a moratorium on all vendor payments for amounts owed prior to April 1, 2002. Spectrum CA had an accounts receivable balance of $99,696 due from Legion at April 1, 2002. Spectrum CA has recorded an allowance for doubtful accounts for the entire account receivable balance owed by Legion before April 1, 2002.

      On July 19, 2002, WBAIS made a general assignment of assets for the benefit of creditors to facilitate a workout of its debt under an arrangement that is similar to a Chapter 7 bankruptcy liquidation. The assignee, San

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Diego Credit Association (“SDCA”), has rights under California state law similar to those of a federal bankruptcy trustee, including the right to take possession of a debtor’s assets, recover avoidable transfers of property for the benefit of all creditors, pursue and compromise claims on behalf of the debtor, and administer the equitable distribution of the debtor’s assets among its creditors. As a result of the assignment, WBAIS’s former assets are no longer controlled by WBAIS or the Company and cannot be used by either WBAIS’s or the Company’s board of directors to satisfy the liabilities of WBAIS. Therefore, the Company will deconsolidate WBAIS effective July 19, 2002, which will result in the recognition of a deferred gain in the amount of $2,876,720. Such deferred gain represents the difference between the carrying values of WBAIS’s assets of $444,450 and liabilities of $6,094,359, net of intercompany liabilities due to the Company of $2,773,189, as of July 19, 2002. Because the gain will not be assured until WAIS is liquidated, the Company will recognize the deferred gain when the liquidation of WBAIS is complete. The Company does not have an estimate as to when it will recognize this gain.

      The following unaudited pro forma balance sheet presents the consolidated balance sheet of the Company as of July 31, 2002 after the deconsolidation of WBAIS:

      SDCA provided the creditors with written notice of the assignment and the amount of each creditor’s debt reflected in the companies’ books and records. Creditors of Harden AZ received notice and are eligible to participate in distributions on the same basis as creditors of WBAIS. Creditors desiring to participate in distributions will be required to file claims with SDCA by December 11, 2002. In the meantime, SDCA will investigate and pursue the recovery of any avoidable transfers of funds and property by WBAIS to unaffiliated third parties. All recovery claims against Anchor, WNAH and its subsidiary, WNA have been settled and compromised as described below. SDCA, as the assignee of all the companies’ assets, will be entitled to receive all sums payable to WBAIS by third-parties and take possession of and liquidate WBAIS’s remaining tangible and intangible assets.

     Anchor is the single largest WBAIS creditor with an aggregate creditor claim of approximately $2.8 million. Anchor, however, was the recipient of avoidable debt repayments by WBAIS during the twelve months preceding the general assignment. On July 19, 2002, Anchor and SDCA entered into a Settlement Agreement wherein Anchor agreed to the partial subordination of its rights as a creditor to receive distributions of assets from SDCA in exchange for the release of all claims and rights of SDCA to recover avoidable transfers of funds by WBAIS to Anchor occurring within twelve months of the general assignment. The Settlement Agreement provides that Anchor will receive no distributions until WBAIS’s creditors other than Anchor and its affiliates

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receive an aggregate amount of approximately $119,000. Thereafter, Anchor will participate in distributions on a pro rata basis with all other creditors.

NOTE 2—REVENUE RECOGNITION

Continuing Operations

      Revenue from continuing operations consists of service fees for managed care services performed by Spectrum CA including telephonic medical case management and field medical case management. Such services are performed under various fee arrangements, including flat fees for specified procedures and on an hourly fee basis. Fee income is recognized when services are rendered.

Discontinued Operations

     Third-party administrative services were provided through WBA. Revenue consisted primarily of fees charged for the administration of fully insured and self-insured health plans. Fee income was recognized when services were rendered.

NOTE 3—RECENT ACCOUNTING PRONOUNCEMENTS

      In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 changes the accounting for goodwill and certain intangible assets from an amortization method to an impairment-only approach. The amortization of goodwill, including goodwill recorded in past business combinations, ceased when the Company adopted SFAS No. 142 on January 1, 2002. In connection with the adoption of the SFAS No. 142, the Company was required to complete the initial step of a transitional impairment assessment within six months of adoption, and complete the final step of the transitional impairment test by the end of the year. The Company completed this transitional impairment test and deemed that no impairment loss was necessary. Any subsequent impairment losses will be reflected in operating income in the income statement. The effect of no longer amortizing goodwill in accordance with SFAS No. 142 for all periods presented is as follows:

			Three Months Ended							Six Months Ended
			June 30, 2002			June 30, 2001				June 30, 2002			June 30, 2001
Reported income (loss) from continuing operations			$	68,464		$	(207,523	)		$	31,426		$	(358,616	)
	Add back goodwill amortization			—			13,687				—			27,374
Adjusted income (loss) from continuing operations			$	68,464		$	(193,836	)		$	31,426		$	(331,242	)
Basic and diluted net income (loss) from continuing operations per share:
	Reported income (loss) from continuing    operations		$	0.01		$	(0.04	)			0.01		$	(0.08	)
	Goodwill amortization			—			—				—			0.01
Adjusted basic and diluted net income (loss) from continuing operations per share			$	0.01		$	(0.04	)		$	0.01		$	(0.07	)

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          In November 2001, the Emerging Issues Task Force (EITF) issued Topic No. D-103 relating to the accounting for reimbursements received for out-of-pocket expenses. In accordance with Topic No. D-103, reimbursements received for out-of-pocket expenses incurred should be characterized as revenue in the statement of operations. The Company has received minimal reimbursements for out-of-pocket expenses. The Company historically accounted for such reimbursements as revenue and recorded the out-of-pocket expense as reduction of revenue. The Company adopted Topic No. D-103 effective January 1, 2002. The adoption of this EITF Issue had no effect on the Company’s consolidated results of operations, financial position, or cash flows.

          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,” and an amendment of that statement, SFAS No. 64, “Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements.” SFAS No. 145 requires the accounting for gains and losses from extinguishment of debt to be classified as extraordinary items only if they meet the criteria in APB Opinion No. 30. This portion of SFAS No.145 is effective for financial statements with fiscal years beginning after May 15, 2002. SFAS No. 145 also rescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers.” SFAS No. 145 amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between 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, such as change from a capital lease to an operating lease. This portion of SFAS No. 145 is effective for transactions occurring after May 15, 2002. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions, effective for financial statements with fiscal years beginning after May 15, 2002. The adoption of SFAS No. 145 will not have a material effect on its consolidated results of operations, financial position or cash flows.

          In June 2002, the FASB issued SFAS No. 146, “Accounting for cost associated with exit or disposal activities” which is effective for exit or disposal activities that are initiated after December 31, 2002. SFAS No. 146 addresses financial accounting and reporting for cost associated with exit or disposal activities and nullifies EITF issue No. 96-3, “Liability recognition for certain employee termination benefits and other cost to exit an activity (including certain cost incurred in a restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liabilities are incurred. This statement also established that fair value is the objective for initial measurement of the liability. The Company does not expect that the adoption of SFAS No. 146 will have a material impact on its financial statements.

NOTE 4—ACQUISITION

          In January 2001, Anchor entered the managed care service business by purchasing substantially all of the assets and business of Novaeon, Inc. (“Novaeon” and the “Novaeon Assets”) from Novaeon’s Chapter 11 bankruptcy estate. APU subsequently transferred the Novaeon assets to a newly created subsidiary, Spectrum CA.

         The purchase price of the Novaeon Assets was payable at the closing by a cash down payment of $1,500,000 and delivery of Anchor’s contingent promissory note (the “Novaeon Note”) in the principal amount of $3,500,000, that was subsequently reduced to $500,000 as a result of the revenue contingency provision. The Novaeon Note was due on April 30, 2002. Anchor failed to make the payment on April 30, 2002 and has negotiated amended payment terms with the Novaeon bankruptcy estate pursuant to a forbearance agreement. The forbearance agreement required an initial payment of $97,926 in principal and interest by May 31, 2002 and the remaining principal and interest of $457,353, plus 8% interest, to be paid in 12 monthly installments of $39,784 beginning July 1, 2002 until June 1, 2003. The balance of principal and interest at June 30, 2002 was $457,353. The balance at October 31, 2002 was $308,935.

         Anchor accounted for the Novaeon acquisition using the purchase method of accounting. The tangible assets and goodwill recorded at acquisition were $1,477,000 and $547,000, respectively, taking into consideration the reduction in purchase price described above. The assets acquired included $320,000 of fixed

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assets, $950,000 of accounts receivable and $207,000 of unbilled service revenue. The fixed assets acquired are being depreciated over their remaining useful life of three to ten years in accordance with the Company’s depreciation policy. Goodwill is no longer being amortized in accordance with SFAS No. 142.

          In order to finance the Novaeon acquisition and provide working capital for its new managed care service business, Anchor obtained a secured convertible loan from Legion in the amount of $2,000,000 (the “Legion Loan”) due on the amended due date of December 31, 2001. Anchor used $1,500,000 of the Legion Loan proceeds for the required down payment. The balance of the proceeds was later transferred to Anchor to pay back part of the line of credit and short-term borrowings with WNAH. The note evidencing the Legion Loan (the “Legion Note”) provided for its automatic redemption in exchange for the issuance of Anchor equity securities upon the completion by the Company of an equity offering by June 30, 2001 resulting in gross proceeds of at least $3,000,000. The repayment of the Legion Loan is secured by a security interest in favor of Legion encumbering all the Novaeon Assets pursuant to the terms of a Security Agreement between the parties dated January 12, 2001.

         The Legion Loan was obtained through the cooperation and assistance of WNAH. As a condition of making the Legion Loan, Legion required WNAH to enter into a Note Purchase Agreement dated January 12, 2001 (the “Legion Note Purchase Agreement”). The Legion Note Purchase Agreement granted Legion the option to cause WNAH to purchase the Legion Note from Legion in the event Anchor failed to complete an equity offering by June 30, 2001. The consideration for the purchase of the Legion Note under the Legion Note Purchase Agreement is the issuance of WNAH common stock having an aggregate value of $2,000,000 (plus the sum of unpaid interest under the Legion Note) at an agreed value of $4 per share.

         In conjunction with the Legion Note Purchase Agreement, Anchor and WNAH entered into an assignment and assumption agreement dated January 12, 2001 in which Anchor agreed that in the event that (i) Anchor failed to complete a $3,000,000 equity offering by June 30, 2001 and (ii) Legion exercised its option to cause WNAH to purchase the Legion Note under the Legion Note Purchase Agreement, WNAH, as the transferee holder of the Legion Note, would have the right to acquire all of the equity securities of Spectrum CA from Anchor in exchange for the cancellation and release of all Anchor’s repayment obligations under the Legion Note and the assumption by WNAH of all Anchor’s repayment obligations to Novaeon’s bankruptcy estate under the Novaeon Note.

         Anchor was unable to complete a $3,000,000 equity offering or repay the Legion Note by June 30, 2001 as contemplated at the time of the Novaeon acquisition. The Legion Note was subsequently amended by the parties to extend the maturity date to December 31, 2001. The Legion Note Purchase Agreement was also amended by Legion and WNAH to extend its term to coincide with the amended maturity date under the Legion Note. The term of the amended Legion Note Purchase Agreement lapsed on December 31, 2001. The Legion Note has not been repaid by Anchor. Anchor has had discussions with Legion regarding the extension or amendment of the Legion Note. There can be no assurance that amended terms favorable to Anchor will result from these efforts.

         Legion was placed into Rehabilitation by court order under Pennsylvania insurance law on April 1, 2002. As of that date, the Pennsylvania Insurance Commissioner assumed possession and control of all Legion’s assets and business to protect the interests of Legion’s policyholders. Anchor is seeking to conduct negotiations with the Pennsylvania Insurance Commissioner regarding an extension of the Legion Note’s maturity and the amendment of other terms. On September 3, 2002, the Insurance Commissioner of the Commonwealth of Pennsylvania petitioned the Pennsylvania Court to order Legion into liquidation. If Legion is approved for liquidation, then Legion will be dissolved. The Company is uncertain of the impact of Legion’s prospective liquidation on its negotiations with the Pennsylvania Insurance Commissioner.

         The following table presents the unaudited pro forma results from continuing operations assuming we had acquired Novaeon at the beginning of fiscal 2001. The pro forma results from continuing operations are not necessarily indicative of the results of operations which actually would have resulted had the purchase been in effect at the beginning of the year or of future results.

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NOTE 5—TERM BANK LOAN

          On September 30, 1999, the Company entered into a term loan (“Secured Bank Loan”) of $931,485 with Comerica Bank (“the Bank”), combining the balances owing on an existing term loan and a $250,000 bank loan. The basic terms of this Secured Bank Loan are (a) monthly interest payments equal to bank’s prime rate, plus 2.5% (b) a maturity date of October 7, 2002 and (c) monthly principal payments in installments of $16,500 which began on November 7, 1999. The Secured Bank Loan is secured by certain receivables, property and equipment, and other assets. The loan agreement with the Bank contains certain restrictive covenants that, among other things, require Anchor to maintain certain levels of net worth and cash flow (as defined), and prohibits the payment of dividends. Anchor was not in compliance with these covenants at June 30, 2002.

         The balance of the Secured Bank Loan was $217,986 as of June 30, 2002. The Company made additional principal payments as consideration under that certain Forbearance Agreement and Amendment to Promissory Note and Conditional Consent to Subsidiary Transactions dated January 2, 2002 executed between Anchor and the Bank (the “Forbearance Agreement”). The Forbearance Agreement amended the repayment terms of the Secured Bank Loan making it payable in monthly amortized installments of principal in the amount of $20,000, plus applicable interest for that month, with a balloon payment of $257,986 due on October 5, 2002. The Forbearance Agreement also evidenced the Bank’s forbearance of Anchor’s financial covenant defaults under the Secured Bank Loan until January 31, 2002 and the Bank’s consent to the cessation and wind down of WBAIS’s business. As a condition of its forbearance, the Bank sought and obtained the execution and delivery of an Unconditional Guaranty of the Secured Bank Loan by WNAH. The repayment of the Secured Bank Loan is further secured by a blanket security interest in favor of the Bank encumbering the assets of Anchor and its subsidiaries.

         In the second quarter of 2002, the Company made a principal payment of $100,000 in addition to the scheduled monthly payments of $20,000. In August 2002, the Company obtained an amendment to the Secured Bank Loan extending the maturity date to April 1, 2003. The amendment includes changes to certain financial covenants, including the elimination of maintaining certain levels of net worth and the addition of maintaining monthly profitability. The balance of the Secured Bank Loan was $137,985 as of October 31, 2002.

NOTE 6—CONVERTIBLE DEBENTURES

Series B Convertible Debentures

      During 1998, Anchor raised $215,000 from five members of the Board of Directors and other qualified investors by offering 10% Convertible Subordinated Debentures Series B (the “Series B Debentures”). The basic terms of the Series B Debentures were (a) 10% interest, payable semi-annually in arrears (b) two year maturity (c) conversion price of $0.50 per share (d) ”Piggyback” registration rights for three years (e) for each $5,000 of Series B Debentures acquired, an investor received a five-year warrant to acquire 2,000 shares of Anchor common stock at an exercise price of $0.50 per share; and (f) subordination provisions that subordinate the Series B Debentures to Anchor’s “Senior Debt” (as defined in the Series B Debentures). In early 1999, Anchor raised an additional $50,000 and redeemed one debenture for $15,000. On March 15, 2000, Anchor redeemed $130,000 of the Series B Debentures. In late 2000, Anchor redeemed $45,000 of the outstanding Series B Debentures. At June 30, 2002, Anchor was in default on the outstanding balance of $75,000 in Series B debentures, which has been classified as current in the accompanying balance sheet as of June 30, 2002. Accrued interest due on the Series B Debentures was $1,875 at June 30, 2002.

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Series D Convertible Debentures

         During 1999, Anchor raised $244,000 from other qualified investors by offering 10% Convertible Subordinated Debentures, Series D (the “Series D Debentures”). The basic terms of the Series D Debentures were (a) 10% interest, payable semi-annually in arrears (b) two year maturity (c) conversion price of $0.50 per share (d) ”Piggyback” registration rights for three years (e) for each $5,000 of Series D Debentures acquired, an investor received a five year warrant to acquire 3,000 shares of Anchor common stock at an exercise price of $0.50 per share and (f) subordination provisions that subordinates the Series D Debentures to Anchor’s “Senior Debt” (as defined). In December 2001, Anchor redeemed $9,000 of the outstanding Series D Debentures. At June 30, 2002, Anchor was in default on the entire $235,000 in Series D Debentures, which have been classified as current in the accompanying balance sheet as of June 30, 2002. Accrued interest due on the Series D Debentures was $5,875 at June 30, 2002.

Series E Convertible Debentures

         In late 1999, Anchor raised $400,000 from WNAH by offering 10% Convertible Subordinated Debentures, Series E (the “Series E Debentures”). The basic terms of the Series E Debentures were (a) 10% interest, payable semi-annually in arrears (b) two year maturity (c) conversion price of $0.50 per share (d) ”Piggyback” registration rights for three years (e) for each $5,000 of Series E Debentures acquired, WNAH received a five year warrant to acquire 3,000 shares of Anchor common stock at an exercise price of $0.50 per share and (f) subordination provisions that subordinates the Series E Debentures to Anchor’s “Senior Debt” (as defined). The Series E Debentures are superior to all other debentures of the Company, including without limitation those Series B and D debentures, and shall constitute “Senior Debt” for purposes of those debentures. During 2000, Anchor raised an additional $100,000 from WNAH through the Series E offering, subject to the terms and provisions described above, bringing the total outstanding Series E debentures to $500,000. At June 30, 2002, Anchor was in default on the entire $500,000 in Series E Debentures, which have been classified as current in the accompanying balance sheet as of June 30, 2002. Accrued interest due on the Series E Debentures was $126,667 at June 30, 2002.

NOTE 7—CONVERTIBLE LOAN FACILITY

         A $1,000,000 convertible loan facility (the “Convertible Loan”) was made available immediately following the closing of the purchase of the Series A Preferred shares by WNAH. The Convertible Loan is convertible, at WNAH’s option, into Series A Preferred shares, which are further convertible into a number of shares of common stock. These shares of common stock, when added to the shares of common stock issued or issuable pursuant to the Series E Debentures (not including the warrants accompanying the Series E Debentures) and other shares of Series A Preferred issued to WNAH, would constitute 73.5% of Anchor’s common stock on a fully-diluted basis following such conversion, assuming the maximum amount of $1,000,000 was borrowed and converted by Anchor pursuant to the Convertible Loan. During 2001, Anchor repaid $91,000 of the convertible loan facility to WNAH and borrowed an additional $90,000. As of June 30, 2002, Anchor was in default on the balance of $999,000, which has been classified as current in the accompanying balance sheet as of June 30, 2002. Accrued interest due on the Convertible Loan was $205,425 at June 30, 2002.

NOTE 8—COMPUTATION OF NET LOSS PER SHARE

        Basic net income (loss) per common share is presented in conformity with SFAS No. 128, “Earnings per Share,” for all periods presented. Basic net income (loss) per share is computed using the weighted-average number of outstanding shares of common stock.

         Diluted net income (loss) per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, rights to purchase common stock under outstanding options, warrants, and conversion rights, potential common shares from options and warrants to purchase common stock using the treasury method and from convertible debt and equity securities using the as-if converted basis. All common shares issuable under outstanding vested options, warrants, and conversion rights, have been excluded from the computation of diluted net income (loss) per share for the three and six months ended June 30, 2002 and 2001 because the effect would have been anti-dilutive.

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NOTE 9—DISCONTINUED OPERATIONS

         In late 2001, management determined WBAIS could not remain in business and service its customers beyond the first quarter of 2002 without an infusion of substantial additional working capital. WBAIS determined it was unlikely that sufficient working capital would be available to it in that time frame, if ever. Management concluded that WBAIS would have no choice but to abandon its service contract obligations and cease operations if an acceptable alternative was not found. In order to avoid the imminent breach of its remaining service agreements and preserve the value of its business for the benefit of WBAIS and its creditors, and its parent shareholder, WBAIS entered into an agreement with Loomis Benefits West, Inc. (“LBW”) dated January 1, 2002 (the “Commission Arrangement”).

         The Commission Arrangement provides for WBAIS and its affiliates to introduce benefit plan administration customers to LBW for a ten-year period commencing on January 1, 2002. In exchange for the referrals and the prospect of ongoing referrals, LBW agreed to pay WBAIS: (a) monthly “Base Revenue Commissions” equal to 4% of LBW’s “Base Gross Revenue” during 2002–2003 and 6% of LBW’s Base Gross Revenue during 2004–2011; and (b) quarterly “Business Development Consideration” in the amount of 10% of LBW’s “Gross Revenue” derived from “Referred Customers” during 2002–2011. “Gross Revenue” under the Commission Arrangement means commissions and administration fees earned by LBW on a cash basis less brokerage fees and commissions payable to other brokers, refunds, rebates, credits, etc. “Base Gross Revenue” is defined as “Gross Revenue” less “Gross Revenue” derived by LBW from “Referred Customers”. “Referred Customers” are defined as LBW customers that were not previously customers of WBAIS and that become customers of LBW after January 1, 2002 through the direct or indirect referral of WBAIS or an affiliate.

         The Commission Arrangement also requires WBAIS to indemnify LBW and its affiliates from future claims brought by its creditors and other claimants for claims relating to or arising from obligations or acts of WBAIS. In addition to the Commission Arrangement, WBAIS agreed to sell LBW a portion of its furniture located in its Portland, Oregon office and LBW agreed to reimburse WBAIS for certain employee compensation and benefits expenses paid by WBAIS in December 2001 and January 2002 .

         Pursuant to Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” the Company’s consolidated financial statements have been reclassified to reflect the discontinuing of WBA’s operations. Accordingly, revenues and operating and other expenses of WBA have been segregated in the consolidated statements of operations as discontinued operations.

         For the three and six months ended June 30, 2001, the following is summarized financial information for the discontinued operations:

          Loss on disposal of discontinued business during phase-out period includes estimated costs associated with the wind down of WBAIS and estimated referral fees from LBW as determined at December 31, 2001. The costs include future office lease and operating lease obligations of approximately $428,000, fixed asset write-downs of $42,000 and other operating costs of approximately $40,000. The referral fees included in the loss are estimated at $50,000 for 2002. In the six months ended June 30, 2002, the accrual for costs estimated during the phase out period increased $145,000. WBAIS received approximately $12,000 in commissions from Loomis, $41,000 in collections from accounts receivables previously written off, $100,000 in liquidated trust funds and recognized $8,000 in expenses previously accrued.

          The following is summarized assets and liabilities of WBAIS, excluding intercompany balances with Anchor and Spectrum CA.

          On July 19, 2002, WBAIS made a general assignment of assets for the benefit of creditors to facilitate a work-out of its debt under an arrangement that is similar to a Chapter 7 bankruptcy liquidation. As a result of the assignment, WBAIS’s former assets are no longer controlled by WBAIS or the Company and cannot be used by either WBAIS’s or the Company’s board of directors to satisfy the liabilities of WBAIS. Therefore, the Company will deconsolidate WBAIS effective July 19, 2002, which will result in the recognition of a deferred gain in the amount of $2,876,720. Such deferred gain represents the difference between the carrying values of WBAIS’s assets of $444,450 and liabilities of $6,094,359, net of intercompany liabilities due to the Company of $2,773,189, as of July 19, 2002. Because the gain will not be assured until WAIS is liquidated, the Company will recognize the deferred gain when the liquidation of WBAIS is complete. The Company does not have an estimate as to when it will recognize this gain. (Note 1)

NOTE 10—COMMITMENTS AND CONTINGENCIES

Anchor

          On May 15, 2002 Anchor and its majority shareholder, WNAH, settled litigation pending before the Superior Court of Contra Costa, California, Case Number COO-03258, with two of Anchor’s former executive officers and its former auditing firm. The litigation arose from various actions and events occurring in 1999 and 2000. Certain bifurcated claims ordered to arbitration by the court had previously resulted in a September 2001 arbitration award against Anchor in the approximate amount of $304,000 in favor of its former chief executive officer. Under the terms of a global settlement, Anchor and WNAH jointly agreed to pay Anchor’s former chief executive officer the sum of $365,000 with $240,000 of such amount being provided by their employee practices liability insurer. All causes of action plead against all corporate and individual defendants and cross-defendants were dismissed with prejudice under the settlement with no admission of fault or liability by any party.

         Management is not aware of any other litigation to which Anchor is currently a party or to which any property of Anchor is subject, which might materially adversely affect the financial condition or results of operations of Anchor.

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The WBA Companies

           Harden-AZ and WBAIS are defendants in a number of lawsuits seeking damages for alleged professional negligence or breach of contract in the performance of their employee benefit plan administration services. These matters are of a nature and type that typically arise from time to time in the normal course of business, and, except for claims that are strictly contractual in nature, are covered under professional liability policies effective during the years in which the alleged acts or omissions occurred. Although the pending professional negligence and employee liability claims against the WBA companies are, for the most part, covered by insurance, management is concerned that available cash resources in the future will be insufficient to satisfy the deductible payment obligations under the affected insurance policies, resulting in the termination of the policies by the insurers for breach of the insurance contracts. There can be no assurance that the companies will be able to maintain their insurance coverage in the future.

          WBAIS is a defendant in an administrative proceeding before the Oregon Bureau of Labor and Industries filed on March 1, 2001. The claimant in the matter was an employee of WBAIS who was involuntarily terminated in October 2000 for excessive absenteeism. The claimant alleges the termination was in violation of the federal Family Medical Leave Act, the Oregon Family Medical Leave Act and the Americans with Disabilities Act. The claim is covered under Anchor’s blanket employee practices liability insurance policy and its potential liability for defense and indemnity costs is limited to the policy’s per claim deductible of $50,000. Management is concerned that available cash resources in the future will be insufficient to satisfy the deductible payment obligations under the affected insurance policies, resulting in the termination of the policies by the insurers for breach of the insurance contracts.

          Following the July 19, 2002 general assignment for the benefit of creditors by WBAIS, the general assignee of WBAIS’s assets, San Diego Credit Association (SDCA) will have the sole authority to administer the current and future creditor claims and litigation involving the WBA companies.

Spectrum CA

           Management is not aware of any lawsuits to which Spectrum CA is currently a party or to which any property of Spectrum CA is subject which might materially adversely affect its financial condition or results of operations.

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