Conmed Healthcare Management (CMHM) 10-Q 2010 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2010
OR
¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934.
For the transition period from                  to

Commission File Number:

0-27554

Conmed Healthcare Management, Inc.

(Exact name of registrant as specified in its charter)

Delaware	42-1297992
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

7250 Parkway Dr., Suite 400 Hanover, MD	21076
(Address of principal executive offices)	(Zip Code)

(410) 567-5520

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed 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.

YES x     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 ¨     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. (Check one):

Large Accelerated filer ¨	Accelerated filer ¨
Non-Accelerated filer ¨	Smaller reporting company x
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨     NO x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:

	Number of Shares Outstanding
Class	August 16, 2010
Common Stock, $0.0001 par value per share	12,632,593

 

CONMED HEALTHCARE MANAGEMENT, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

	Page
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets June 30, 2010 and December 31, 2009	1
Consolidated Statements of Operations For the three and six months ended June 30, 2010 and 2009	2
Consolidated Statements of Cash Flows For the six months ended June 30, 2010 and 2009	3
Consolidated Statements of Shareholders’ Equity For the six months ended June 30, 2010	4
Notes to Consolidated Financial Statements	5
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	18
ITEM 4(T). CONTROLS AND PROCEDURES	18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	19
ITEM 1A. RISK FACTORS	19
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	19
ITEM 4. RESERVED	19
ITEM 5. OTHER INFORMATION	19
ITEM 6. EXHIBITS	19
SIGNATURES	20

i

PART 1.  FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED BALANCE SHEETS

	June 30, 2010 (unaudited)			December 31, 2009
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	12,068,889		$	11,056,143
Accounts receivable		2,490,069			2,278,074
Prepaid expenses		517,936			865,261
Deferred taxes		111,000			102,000
Total current assets		15,187,894			14,301,478
PROPERTY AND EQUIPMENT, NET		626,950			605,578
DEFERRED TAXES		1,377,000			1,381,000
OTHER ASSETS
Service contracts acquired, net		709,000			984,000
Non-compete agreements, net		355,228			436,667
Goodwill		6,263,705			6,263,705
Deposits		11,549			11,549
Total other assets		7,339,482			7,695,921
	$	24,531,326		$	23,983,977
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable	$	2,709,100		$	1,489,498
Accrued expenses		3,535,433			4,146,940
Taxes payable		313,103			550,000
Deferred revenue		215,476			1,018,645
Total current liabilities		6,773,112			7,205,083
DERIVATIVE FINANCIAL INSTRUMENTS		1,346,829			1,299,450
SHAREHOLDERS’ EQUITY
Preferred stock, no par value; authorized 5,000,000 shares; issued and outstanding zero shares as of June 30, 2010 and December 31, 2009		—			—
Common stock, $0.0001 par value, authorized 40,000,000 shares; issued and outstanding 12,630,822 and 12,629,572 shares as of June 30, 2010 and December 31, 2009, respectively		1,263			1,263
Additional paid-in capital		38,136,149			37,829,900
Accumulated deficit		(21,726,027	)		(22,351,719	)
Total shareholders' equity		16,411,385			15,479,444
	$	24,531,326		$	23,983,977

See Notes to Unaudited Financial Statements

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CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

	For the Six Months Ended June 30, 2010			For the Six Months Ended June 30, 2009			For the Three Months Ended June 30, 2010			For the Three Months Ended June 30, 2009
Service contract revenue	$	29,490,123		$	25,131,993		$	14,738,152		$	12,712,751
HEALTHCARE EXPENSES:
Salaries, wages and employee benefits		16,705,809			14,238,095			8,490,509			7,250,241
Medical expenses		6,011,743			4,763,396			2,872,001			2,381,463
Other operating expenses		941,528			863,830			446,815			479,625
Total healthcare expenses		23,659,080			19,865,321			11,809,325			10,111,329
Gross profit		5,831,043			5,266,672			2,928,827			2,601,422
Selling and administrative expenses		3,990,333			3,759,723			1,987,202			1,944,196
Depreciation and amortization		599,699			1,240,559			280,170			605,738
Total operating expenses		4,590,032			5,000,282			2,267,372			2,549,934
Operating income		1,241,011			266,390			661,455			51,488
OTHER INCOME (EXPENSE)
Interest income		45,360			44,580			27,291			15,952
Interest (expense)		—			(7,173	)		—			(1,967	)
(Loss) on fair value of derivatives		(47,379	)		(2,444,273	)		(3,695	)		(2,445,139	)
Total other income (expense)		(2,019	)		(2,406,866	)		23,596			(2,431,154	)
Income (loss) before income taxes		1,238,992			(2,140,476	)		685,051			(2,379,666	)
Income tax expense		613,300			153,000			343,000			32,000
Net income (loss)	$	625,692		$	(2,293,476	)	$	342,051		$	(2,411,666	)
EARNINGS (LOSS) PER COMMON SHARE
Basic	$	0.05		$	(0.18	)	$	0.03		$	(0.19	)
Diluted	$	0.04		$	(0.18	)	$	0.02		$	(0.19	)
WEIGHTED-AVERAGE SHARES OUTSTANDING
Basic		12,630,115			12,516,285			12,630,657			12,560,155
Diluted		14,242,733			12,516,285			14,280,367			12,560,155

See Notes to Unaudited Financial Statements

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CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	For the Six Months Ended June 30, 2010			For the Six Months Ended June 30, 2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	625,692		$	(2,293,476	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities
Depreciation		140,920			90,559
Amortization		458,779			1,150,000
Stock-based compensation		303,937			324,269
Loss on fair value of derivatives		47,379			2,444,273
Deferred income taxes		(5,000	)		—
Changes in working capital components
(Increase) decrease in accounts receivable		(211,995	)		518,196
(Increase) decrease in prepaid expenses		347,325			(82,225	)
Increase in accounts payable		1,219,602			560,167
(Decrease) in accrued expenses		(611,507	)		(212,988	)
(Decrease) in income taxes payable		(236,897	)		(360,140	)
(Decrease) in deferred revenue		(803,169	)		(346,228	)
Net cash provided by operating activities		1,275,066			1,792,407
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment		(117,364	)		(210,117	)
Stock Purchase of CMHS, LLC		—			(9,161	)
Asset purchase		(147,268	)		—
Net cash (used in) investing activities		(264,632	)		(219,278	)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on line of credit		—			(100,000	)
Payments on loans		—			(36,186	)
Proceeds from exercise of stock options		2,312			12,000
Net cash provided by (used in) financing activities		2,312			(124,186	)
Net increase in cash and cash equivalents		1,012,746			1,448,943
CASH AND CASH EQUIVALENTS
Beginning		11,056,143			7,472,140
Ending	$	12,068,889		$	8,921,083
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash payments for interest	$	—		$	7,173
Income taxes paid		855,197			513,140

See Notes to Unaudited Financial Statements

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CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

	Preferred Stock		Common Stock		Additional Paid-in Capital		Accumulated Deficit			Total
Balance at December 31, 2009	$	—	$	1,263	$	37,829,900	$	(22,351,719	)	$	15,479,444
Net Income		—		—		—		625,692			625,692
Stock option expense		—		—		303,937		—			303,937
Exercise of stock options		—		—		2,312		—			2,312
Balance at June 30, 2010	$	—	$	1,263	$	38,136,149	$	(21,726,027	)	$	16,411,385

See Notes to Unaudited Financial Statements

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CONMED HEALTHCARE MANAGEMENT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Conmed Healthcare Management, Inc. (together with its consolidated subsidiaries, “Conmed”, the “Company”, “we”, “us”, or “our”, unless otherwise specified or the context otherwise requires) contained herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim reporting requirements of Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, the financial information and disclosures normally included in the financial statements prepared annually in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. Readers of this report should, therefore, refer to the consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 25, 2010.

In the opinion of management, all adjustments (consisting of normal and recurring adjustments) which are considered necessary to fairly present our financial position and our results of operations as of and for these periods have been made.

Our interim results of operations for the three and six months ended June 30, 2010 are not necessarily indicative of the results of operations to be expected for a full year.

In January 2010, we purchased approximately $45,000 and $102,000 of fixed assets and intangible assets, respectively, from a small mobile imaging company to expand the base of services that we provide to our customers, as such services were previously subcontracted.  This acquisition did not have a material impact on our financial position or results of operations and therefore additional proforma information has not been presented.

NOTE 2. New Accounting Standards

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements.  The update provides amendments to FASB Accounting Standards Codification 820-10, Fair Value, which requires entities to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers.  In addition, the update requires entities to present separately information about purchases, sales, issuances and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3).  The disclosures related to Level 1 and Level 2 fair value measurements became effective for us in 2010 and the disclosures related to Level 3 fair value measurements are effective for us in 2011.  The update requires new disclosures and will have no impact on our consolidated financial position, results of operations or cash flows.

NOTE 3. Common Stock Options

The Board of Directors has adopted, and our stockholders have approved, the 2007 Stock Option Plan, as amended (the “2007 Plan”). On May 25, 2010, the 2007 Plan was amended to increase the total number of shares available from 2,350,000 to 3,100,000.  The 2007 Plan provides for the grant of incentive stock options, nonqualified stock options and restricted stock units. The 2007 Plan is administered by the independent members of the Board of Directors, which has the authority and discretion to determine: the persons to whom the options will be granted; when the options will be granted; the number of shares subject to each option; the price at which the shares subject to each option may be purchased; and when each option will become exercisable. The options generally vest over three to four years and expire no later than ten years from the date of grant.

During the six months ended June 30, 2010 and 2009, we recorded stock-based compensation expense net of reversals for forfeited options totaling $303,937 and $324,269, respectively, and during the three months ended June 30, 2010 and 2009, we recorded stock-based compensation expense net of reversals for forfeited options totaling $144,506 and $165,000, respectively.

During the six months ended June 30, 2010, options were granted to purchase 116,000 shares of common stock at an average exercise price of $3.18 per share and an average grant date fair value of $2.14 per share.  Additionally, during the six months ended June 30, 2010, options to purchase 26,479 shares of common stock were forfeited, options to purchase 1,250 shares of common stock were cancelled, options to purchase 1,250 shares of common stock were exercised at an average exercise price of $1.85 per share and, as of June 30, 2010, 992,562 shares remain available for grant.

 

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As of June 30, 2010, stock-based compensation expense not yet recognized in income totaled $760,681, which is expected to be recognized over a weighted-average remaining period of 1.13 years.

NOTE 4. Common Stock Warrants

Pre-Acquisition Warrants

In connection with the acquisition of Conmed, Inc. on January 26, 2007, we issued warrants to purchase an aggregate of 250,000 shares of common stock to warrant holders of the Company’s predecessor exercisable at $0.30 per share.  The warrants vested immediately and expire October 23, 2010.

Investor Warrants

In connection with the acquisition of Conmed, Inc. on January 26, 2007, we issued to investors warrants to purchase an aggregate of 1,500,000 shares of common stock, exercisable at $0.30 per share and warrants to purchase an aggregate of 500,000 shares of common stock, exercisable at $2.50 per share.  The warrants vested immediately and expire March 13, 2012.

Placement Agent Warrants

In connection with the acquisition of Conmed, Inc. on January 26, 2007, we issued to Maxim Group LLC, our exclusive placement agent, a warrant to purchase 300,000 shares of common stock, exercisable at $2.75 per share.  The warrants vested immediately and expire January 26, 2012.

Consultant Warrants

In connection with the purchase of all of the assets of Emergency Medicine Documentation Consultants, P.C., a provider of medical services in northwest Oregon, in 2008, we issued warrants to two consultants to purchase an aggregate of 80,000 shares of common stock at an exercise price of $1.85 per share. The warrants vested immediately and expire February 28, 2013.

Summary

The following table summarizes the warrant activity for the six months ended June 30, 2010:

	Pre- Acquisition Warrants		Investor Warrants @ $0.30 per share		Investor Warrants @ $2.50 per share		Placement Agent Warrants		Consultant Warrants		Total
Exercise price	$	0.30	$	0.30	$	2.50	$	2.75	$	1.85	$	1.32
Warrants outstanding as of December 31, 2009		223,000		813,000		496,667		300,000		80,000		1,912,667
Warrants exercised		—		—		—		—		—		—
Warrants outstanding as of June 30, 2010		223,000		813,000		496,667		300,000		80,000		1,912,667

The following table summarizes the warrant activity for the six months ended June 30, 2009:

	Pre- Acquisition Warrants		Investor Warrants @ $0.30 per share		Investor Warrants @ $2.50 per share		Placement Agent Warrants		Consultant Warrants		Total
Exercise price	$	0.30	$	0.30	$	2.50	$	2.75	$	1.85	$	1.25
Warrants outstanding as of December 31, 2008		225,000		980,000		500,000		300,000		80,000		2,085,000
Warrants exercised		—		157,000		—		—		—		157,000
Warrants outstanding as of June 30, 2009		225,000		823,000		500,000		300,000		80,000		1,928,000

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NOTE 5. Fair Value of Warrants

As a result of adopting derivative accounting for warrants, effective January 1, 2009, 1,705,000 of our then issued and outstanding common stock purchase warrants previously treated as equity were no longer afforded equity treatment.  These common stock purchase warrants do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the Black-Scholes option pricing model and all changes in the fair value of these warrants are recognized currently in earnings until such time as the warrants are exercised, amended or expire.

Investor Warrants @ $0.30 per share

Black-Scholes assumptions	June 30, 2010			December 31, 2009
Expected life (years)		1.5			1.5
Expected volatility		64.32	%		79.59	%
Risk-free interest rate		1.2	%		1.4	%
Expected dividend yield		0.0	%		0.0	%

Investor Warrants @ $2.50 per share

Black-Scholes assumptions	June 30, 2010			December 31, 2009
Expected life (years)		1.5			1.5
Expected volatility		64.32	%		79.59	%
Risk-free interest rate		1.2	%		1.4	%
Expected dividend yield		0.0	%		0.0	%

The following tables summarize the warrant activity subject to fair value accounting for the six months ended June 30, 2010:

	Investor Warrants @ $0.30 per share		Investor Warrants @ $2.50 per share		Total
Warrants outstanding subject to fair value accounting as of December 31, 2009		221,430		496,667		718,097
Warrants exercised		—		—		—
Warrants amended		—		—		—
Warrants outstanding subject to fair value accounting as of June 30, 2010		221,430		496,667		718,097

	Investor Warrants @ $0.30 per share		Investor Warrants @ $2.50 per share			Total
Fair value of warrants outstanding as of December 31, 2009	$	615,280	$	684,170		$	1,299,450
Realized loss on warrants		—		—			—
Unrealized (gain) loss on warrants		50,250		(2,871	)		47,379
Fair value of warrants transferred to equity upon amendment		—		—			—
Fair value of warrants exercised		—		—			—
Fair value of warrants outstanding as of June 30, 2010	$	665,530	$	681,299		$	1,346,829

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The following tables summarize the warrant activity subject to fair value accounting for the three months ended June 30, 2010:

	Investor Warrants @ $0.30 per share		Investor Warrants @ $2.50 per share		Total
Warrants outstanding subject to fair value accounting as of March 31, 2010		221,430		496,667		718,097
Warrants exercised		—		—		—
Warrants amended		—		—		—
Warrants outstanding subject to fair value accounting as of June 30, 2010		221,430		496,667		718,097

	Investor Warrants @ $0.30 per share		Investor Warrants @ $2.50 per share			Total
Fair value of warrants outstanding as of March 31, 2010	$	643,787	$	699,347		$	1,343,134
Realized loss on warrants		—		—			—
Unrealized (gain) loss on warrants		21,743		(18,048	)		3,695
Fair value of warrants transferred to equity upon amendment		—		—			—
Fair value of warrants exercised		—		—			—
Fair value of warrants outstanding as of June 30, 2010	$	665,530	$	681,299		$	1,346,829

As of June 30, 2010, we had outstanding warrants to purchase an aggregate of 1,912,667 shares of common stock, of which warrants to purchase 718,097 shares of common stock were subject to derivative accounting for warrants, at an average exercise price of $1.82, and we have reserved shares of our common stock for issuance in connection with the potential exercise thereof.

NOTE 6. Fair Value Measurements

The Company is required to disclose the fair value measurements required by the fair value measurement guidance.  The derivative financial instruments recorded at fair value in the balance sheets as of June 30, 2010 and December 31, 2009 are categorized based upon the level of judgment associated with the inputs used to measure their fair value.

The following tables summarize the financial liabilities measured at fair value on a recurring basis segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

	As of June 30, 2010
	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Derivative financial instruments	$	1,346,829	$	—	$	—	$	1,346,829

	As of December 31, 2009
	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant Unobservable inputs (Level 3)
Derivative financial instruments	$	1,299,450	$	—	$	—	$	1,299,450

 

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Equity-linked financial instruments consist of stock warrants issued by the Company that contain a strike price adjustment feature.  In accordance with derivative accounting for warrants, we calculated the fair value of warrants using the Black-Scholes option pricing model and the assumptions used are described in Note 5, “Fair Value of Warrants”.  During the six months ended June 30, 2010 and 2009, we recognized a $47,379 and a $2,352,625 unrealized loss, respectively, related to the change in fair value of the financial instruments which is included in Other Income (Expense) on the Statement of Operations.

The following table reflects the activity for liabilities measured at fair value using Level 3 inputs for the six months ended June 30:

	2010		2009
Balance as of January 1	$	1,299,450	$	2,766,150
Transfers into level 3		—		—
Transfers out of level 3		—		—
Sales of equity-linked financial instruments		—		(393,321	)
Realized loss related to the change in fair value		—		91,648
Unrealized loss related to the change in fair value		47,379		2,352,625
Balance as of June 30	$	1,346,829	$	4,817,102

NOTE 7. Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per-share:

	For the Six Months Ended June 30, 2010		For the Six Months Ended June 30, 2009			For the Three Months Ended June 30, 2010		For the Three Months Ended June 30, 2009
Numerator for basic and diluted earnings per share:
Net income (loss)	$	625,692	$	(2,293,476	)	$	342,051	$	(2,411,666	)
Denominator:
Weighted-average basic shares outstanding		12,630,115		12,516,285			12,630,657		12,560,155
Assumed conversion of dilutive securities
Stock options		472,405		—			502,486		—
Warrants		1,140,213		—			1,147,224		—
Potentially dilutive common shares		1,612,618		—			1,649,710		—
Denominator for diluted earnings per share – Adjusted weighted average shares		14,242,733		12,516,285			14,280,367		12,560,155
Earnings (loss) per common share:
Basic	$	0.05	$	(0.18	)	$	0.03	$	(0.19	)
Diluted	$	0.04	$	(0.18	)	$	0.02	$	(0.19	)

Common stock warrants and options outstanding totaling 224,000 and 3,974,167 shares, respectively, are not included in diluted earnings per common share for the six months ended June 30, 2010 and 2009, respectively, as they would have an antidilutive effect on earnings per common share.

NOTE 8. Income Tax Matters

Our effective tax rate was 49.5% during the six months ended June 30, 2010, which differs from the expected tax rate of 39.0% primarily due to permanent differences related to stock-based compensation and derivatives related to warrants.  The change in our effective tax rate from prior periods is primarily due to the relation of our taxable income relative to pre-tax income.  We recorded income tax expense of $613,300 and $153,000 for the six months ended June 30, 2010 and 2009, respectively.  We recorded income tax expense of $343,000 and $32,000 for the three months ended June 30, 2010 and 2009, respectively.

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

Information included in this section and elsewhere in this Quarterly Report on Form 10-Q contains forward-looking statements regarding the business, operations and financial condition of Conmed Healthcare Management, Inc. (together with its consolidated subsidiaries, the “Company”, “we”, “us”, or “our” unless otherwise specified or the context otherwise requires) within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). This information may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from our future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, and other statements that are not historical facts, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend," “plan,” “potential” or "project" or the negative of these words or other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be incorrect, and there can be no assurance that these projections included in these forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. We caution you not to place undue reliance on these forward-looking statements. Such forward-looking statements relate only to events as of the date on which the statements are made. These forward-looking statements involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond the Company's control) including, without limitation, the Company's ability to increase revenue and to continue to obtain new contracts; the incurrence of start-up costs associated with new contracts; contract renewals and extensions; inflation exceeding the Company’s projection of the inflation rate of cost of services under multi-year contracts; the ability to obtain bonds; decreases in occupancy levels or disturbances at detention centers; malpractice litigation; the ability to utilize third party administrators for out-of-facility care; compliance with laws and government regulations, including those relating to healthcare; investigation and auditing of our contracts by government agencies; competition; termination of contracts due to lack of government appropriations; material adverse changes in economic and industry conditions in the healthcare market; negative publicity regarding the provision of correctional healthcare services; dependence on key personnel and the ability to hire skilled personnel; influence of certain stockholders; increases in healthcare costs; insurance; completion and integration of future acquisitions; public company obligations; limited liability of directors and officers; the Company’s ability to meet the NYSE Amex continued listing standards; and stock price volatility. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, even if experience or future changes make it clear that any projected results or events expressed or implied therein will not be realized. You are advised, however, to consult any further disclosures we make in future public statements and press releases. More detailed information about us and the risk factors that may affect the realization of forward-looking statements is set forth in our filings with the Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 25, 2010. Investors and security holders are urged to read this document free of charge on the SEC's web site at www.sec.gov.

General

We provide healthcare services to county and municipal detention centers across the United States. As a result of the Supreme Court decision in Estelle v. Gamble (1976), all individuals held against their will are required to be provided with community standard healthcare. Under this requirement, correctional institutions are required to provide healthcare services for their inmates. We are a specialist in the provision of these services, having provided correctional healthcare services since 1984.  We began providing correctional healthcare services in the State of Maryland, and currently serve county and municipal correctional facilities in thirty-eight counties in seven states:  Arizona, Kansas, Maryland, Oklahoma, Oregon, Virginia and Washington. Our services have expanded to include mental health, pharmacy and out-of-facility healthcare services.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements. These condensed consolidated financial statements have been prepared following the requirements of accounting principles generally accepted in the United States (“GAAP”) for interim periods and require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition and related medical expense accruals and amortization and potential impairment of intangible assets and goodwill and stock-based compensation expense. As these are condensed consolidated financial statements, one should also read expanded information about our critical accounting policies and estimates provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 25, 2010. There have been no material changes to our critical accounting policies and estimates from the information provided in our Form 10-K for the year ended December 31, 2009.

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Recently Adopted Accounting Standards

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements.  The update provides amendments to FASB Accounting Standards Codification 820-10, Fair Value, which requires entities to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers.  In addition, the update requires entities to present separately information about purchases, sales, issuances and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3).  The disclosures related to Level 1 and Level 2 fair value measurements became effective for us in 2010 and the disclosures related to Level 3 fair value measurements are effective for us in 2011.  The update requires new disclosures and will have no impact on our consolidated financial position, results of operations or cash flows.

Results of Operations

Three Months Ended June 30, 2010 compared to Three Months Ended June 30, 2009

The following discussion of financial results is derived from unaudited financial statements for the three months ended June 30, 2010 and 2009.

	Three Months Ended June 30, 2010						Three Months Ended June 30, 2009
	Amount			% of  Revenue			Amount			% of  Revenue
Service contract revenue	$	14,738,152			100.0	%	$	12,712,751			100.0	%
HEALTHCARE EXPENSES:
Salaries, wages and employee benefits		8,490,509			57.6	%		7,250,241			57.0	%
Medical expenses		2,872,001			19.5	%		2,381,463			18.7	%
Other operating expenses		446,815			3.0	%		479,625			3.8	%
Total healthcare expenses		11,809,325			80.1	%		10,111,329			79.5	%
Gross profit		2,928,827			19.9	%		2,601,422			20.5	%
OPERATING EXPENSES:
Selling and administrative expenses		1,987,202			13.5	%		1,944,196			15.3	%
Depreciation and amortization		280,170			1.9	%		605,738			4.8	%
Total operating expenses		2,267,372			15.4	%		2,549,934			20.1	%
Operating income		661,455			4.5	%		51,488			0.4	%
OTHER INCOME (EXPENSE)
Interest income		27,291			0.2	%		15,952			0.1	%
Interest expense		—			0.0	%		(1,967	)		0.0	%
(Loss) on fair value of derivatives		(3,695	)		(0.0	)%		(2,445,139	)		(19.2	)%
Total other income (expense)		23,596			0.2	%		(2,431,154	)		(19.1	)%
Income (loss) before income taxes		685,051			4.6	%		(2,379,666	)		(18.7	)%
Income tax expense		343,000			2.3	%		32,000			0.3	%
Net income (loss)	$	342,051			2.3	%	$	(2,411,666	)		(19.0	)%

 

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Summary

Net revenue from medical services provided primarily to correctional institutions for the three months ended June 30, 2010 and 2009, was $14,738,152 and $12,712,751, respectively, which represents an increase of $2,025,401 or 15.9%. Net income was $342,051 or 2.3% of revenue compared to a net loss of $2,411,666 or (19.0)% of revenue for the three months ended June 30, 2010 and 2009, respectively, which represented an increase in net income of $2,753,717.

Revenue

The addition of service contracts signed with new jurisdictions since April 1, 2009 accounted for $1,597,509 or 78.9% of the increase in revenue for the three months ended June 30, 2010 compared to the same period for the prior year. These jurisdictions are as follows: Clark County, WA; Coos County, OR; Creek County, OK; Garrett County, MD; Kittitas County, WA; Pima County (Juvenile), AZ; and Washington County, MD. Revenue improvement totaling $328,369, or 16.2% of the increase, resulted primarily from expansion of the services provided under a number of our existing contracts in which we were providing services prior to April 1, 2009. Price increases related to existing service requirements totaled $277,937 or 13.7% of the revenue increase. The increase in revenue was partially offset by $(178,414), or (8.8)% of revenue, which was the result of decreases in other volume related activities, primarily associated with lower inmate populations at certain facilities partially offset by an increase in stop/loss reimbursements due to higher out of facility medical expenditures in excess of stop/loss limits which are billed back to the client.

Healthcare Expenses

Salaries and employee benefits

Salaries and employee benefits for healthcare employees were $8,490,509 or 57.6% of revenue for the three months ended June 30, 2010, compared to $7,250,241 or 57.0% of revenue for the three months ended June 30, 2009. The increase in spending for salaries and employee benefits of $1,240,268 or 17.1% is due primarily to the addition of new healthcare employees resulting from new business. Approximately 81.2% of the increase is related to new healthcare employees required to support the staffing requirements for our new medical service contracts as detailed above. Additional services related to previously existing medical service contracts, as well as cost-of-living and wage and benefit adjustments for existing employees accounted for the remainder of the increase. The increase in salaries and employee benefits as a percentage of revenue is due to a change in the mix of expense for salaries and benefits. Several of our new medical service contracts have a higher proportion of staffing services compared to our previously existing contracts and as a result these new contracts increased the mix of salaries and employee benefits as a percentage of total revenue.

Medical expenses

Medical expenses for the three months ended June 30, 2010 and 2009 were $2,872,001, or 19.5% of revenue, and $2,381,463, or 18.7% of revenue, respectively, which represented an increase of $490,538 or 20.6%. The increase in spending for medical expenses in absolute dollars primarily reflects increases related to new contracts for medical services. The increase in spending as a percentage of revenue results, in part, from increases in pharmacy expenses and out of facility hospital expenses which were higher than the prior year due to an increase in inmate hospitalization days in the second quarter of 2010 compared to the second quarter of 2009.

Other operating expenses

Other operating expenses were $446,815, or 3.0% of revenue, for the three months ended June 30, 2010, compared to $479,625, or 3.8% of revenue, for the three months ended June 30, 2009. The decrease of $32,810 in spending is primarily related to a decrease in spending for employment advertising, recruiting expense, and legal fees, which was partially offset by an increase in professional liability insurance expense as a result of the new service contracts.

Operating Expenses

Selling and administrative expenses

Selling and administrative expenses for the three months ended June 30, 2010 and 2009 were $1,987,202, or 13.5% of revenue, and $1,944,196, or 15.3% of revenue, respectively. The increased expenditure of $43,006 primarily reflects an increased investment in additional management and administrative personnel required to support new contracts and services added since April 1, 2009, as well as increases in consulting fees, recruiting expense and travel expenses, which were partially offset by decreases in accounting fees, legal fees, rent expense and stock-based compensation.  The reduction in spending as a percentage of revenue resulted from improved economies of scale as selling and administrative expenses continue to grow at a slower pace than revenue.  Stock-based compensation for the three months ended June 30, 2010 and 2009 was $144,506 and $165,000, respectively.

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Depreciation and amortization

Depreciation and amortization primarily reflects the amortization of intangible assets related to the acquisition of Conmed, Inc. in January 2007, the purchase of medical service contracts from Emergency Medicine Documentation Consultants, P.C. (“EMDC”) in February 2008 and the acquisition of Correctional Mental Health Services, LLC (“CMHS”) in November 2008. Amortization of service contracts acquired was $139,000, or 0.9% of revenue, for the three months ended June 30, 2010, compared to $463,000, or 3.6% of revenue, for the three months ended June 30, 2009. The decrease primarily reflects a decrease in amortization expense as certain individual service contracts acquired have become fully amortized.  Amortization of non-compete agreements was $69,668, or 0.5% of revenue, for the three months ended June 30, 2010, compared to $96,000, or 0.8% of revenue, for the three months ended June 30, 2009. Depreciation expense increased to $71,502 for the three months ended June 30, 2010 compared to $46,738 for the prior year period due primarily to capital expenditures associated with purchases of vehicles, medical equipment and computers at various facilities.

Interest income

Interest income was $27,291 for the three months ended June 30, 2010 compared to $15,952 for the same period in 2009. Higher average cash balances and increased short-term interest rates during the three months ended June 30, 2010 account for the increased interest income compared to the same period in 2009.

Interest expense

Interest expense for the three months ended June 30, 2010 decreased to $0 compared to $1,967 in the same period in 2009.

(Loss) on fair value of derivatives

As a result of adopting derivative accounting for warrants effective January 1, 2009, 1,705,000 of our then issued and outstanding common stock purchase warrants previously treated as equity were no longer afforded equity treatment and as a result they are now recorded as a liability based on fair value estimates.  These common stock purchase warrants do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the Black-Scholes option pricing model and all changes in the fair value of these warrants will be recognized currently in earnings until such time as the warrants are exercised, amended or expire.

During the three months ended June 30, 2010 and 2009, we recognized a $3,695 and a $2,353,993 unrealized loss, respectively.  The decreased expense of $2,350,298 was primarily the result of our stock price increasing $0.10 during the three months ended June 30, 2010 compared to a $1.65 increase in stock price during the three months ended June 30, 2009.  Additionally, there were 829,903 fewer warrants subject to fair value accounting during the three months ended June 30, 2010 compared to the three months ended June 30, 2009, primarily due to the amendment of certain warrant agreements to remove the provisions that resulted in liability treatment subsequent to June 30, 2009.

During the three months ended June 30, 2010, no warrants were exercised.  As of June 30, 2010, we had outstanding warrants subject to derivative accounting to purchase an aggregate of 718,097 shares of common stock.  During the three months ended June 30, 2009, warrants to purchase 20,000 shares of common stock were exercised generating $6,000 of net proceeds and warrants to purchase 117,000 shares of common stock were exercised by cashless exercise and as a result, a total of 123,890 shares of common stock were issued.  As of June 30, 2009, we had outstanding warrants subject to derivative accounting to purchase an aggregate of 1,548,000 shares of common stock.

The following table summarizes the change in fair value for the three months ended June 30:

	2010		2009
Fair value of warrants outstanding as of March 31	$	1,343,134	$	2,726,360
Realized loss on warrants		—		91,146
Unrealized loss on warrants		3,695		2,353,993
Fair value of warrants exercised		—		(354,397	)
Fair value of warrants outstanding as of June 30	$	1,346,829	$	4,817,102

See Note 5, “Fair Value of Warrants”, for additional information on the warrant activity subject to fair value accounting for the three months ended June 30, 2010.

Income tax expense

Our effective tax rate was 50.1% during the three months ended June 30, 2010 which differs from the expected tax rate of 39.0% primarily due to permanent differences related to stock-based compensation and derivatives related to warrants.  The change in our effective tax rate from prior periods is primarily due to the relation of our taxable income relative to pre-tax income.  We recorded income tax expense of $343,000 and $32,000 for the three months ended June 30, 2010 and 2009, respectively.

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Six Months Ended June 30, 2010 compared to Six Months Ended June 30, 2009

The following discussion of financial results is derived from unaudited financial statements for the six months ended June 30, 2010 and 2009.

	Six Months Ended June 30, 2010						Six Months Ended June 30, 2009
	Amount			% of Revenue			Amount			% of Revenue
Service contract revenue	$	29,490,123			100.0	%	$	25,131,993			100.0	%
HEALTHCARE EXPENSES:
Salaries, wages and employee benefits		16,705,809			56.6	%		14,238,095			56.7	%
Medical expenses		6,011,743			20.4	%		4,763,396			19.0	%
Other operating expenses		941,528			3.2	%		863,830			3.4	%
Total healthcare expenses		23,659,080			80.2	%		19,865,321			79.0	%
Gross profit		5,831,043			19.8	%		5,266,672			21.0	%
OPERATING EXPENSES:
Selling and administrative expenses		3,990,333			13.5	%		3,759,723			15.0	%
Depreciation and amortization		599,699			2.0	%		1,240,559			4.9	%
Total operating expenses		4,590,032			15.6	%		5,000,282			19.9	%
Operating income		1,241,011			4.2	%		266,390			1.1	%
OTHER INCOME (EXPENSE)
Interest income		45,360			0.2	%		44,580			0.2	%
Interest expense		—			0.0	%		(7,173	)		(0.0	)%
(Loss) on fair value of derivatives		(47,379	)		(0.2	)%		(2,444,273	)		(9.7	)%
Total other income (expense)		(2,019	)		(0.0	)%		(2,406,866	)		(9.6	)%
Income (loss) before income taxes		1,238,992			4.2	%		(2,140,476	)		(8.5	)%
Income tax expense		613,300			2.1	%		153,000			0.6	%
Net income (loss)	$	625,692			2.1	%	$	(2,293,476	)		(9.1	)%

Summary

Net revenue from medical services provided primarily to correctional institutions for the six months ended June 30, 2010 and 2009, was $29,490,123 and $25,131,993, respectively, which represents an increase of $4,358,130 or 17.3%. Net income was $625,692 or 2.1% of revenue compared to a net loss of $2,293,476 or (9.1)% of revenue for the six months ended June 30, 2010 and 2009, respectively, which represented an increase in net income of $2,919,168.

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Revenue

The addition of service contracts signed with new jurisdictions since January 1, 2009 accounted for $3,125,353, or 71.7% of the increase in revenue, for the six months ended June 30, 2010 compared to the same period for the prior year. These jurisdictions are as follows: Clark County, WA; Coos County, OR; Creek County, OK; Garrett County, MD; Kittitas County, WA; Pima County (Juvenile), AZ; Washington County, MD; and Western Virginia Regional Jail, VA. Revenue improvement totaling $757,328, or 17.4% of the increase, resulted primarily from expansion of the services provided under a number of our existing contracts in which we were providing services prior to January 1, 2009. Price increases related to existing service requirements totaled $623,804, or 14.3% of the revenue increase. The increase in revenue was partially offset by $(148,355), or (3.4)% of revenue, which was the result of decreases in other volume related activities, primarily associated with lower inmate populations at certain facilities partially offset by an increase in stop/loss reimbursements due to higher out of facility medical expenditures in excess of stop/loss limits which are billed back to clients.

Healthcare Expenses

Salaries and employee benefits

Salaries and employee benefits for healthcare employees were $16,705,809, or 56.6% of revenue, for the six months ended June 30, 2010, compared to $14,238,095, or 56.7% of revenue, for the six months ended June 30, 2009. The increase in spending for salaries and employee benefits of $2,467,714, or 17.3%, is due primarily to the addition of new healthcare employees resulting from new business. Approximately 78.5% of the increase related to new healthcare employees required to support the staffing requirements for our new medical service contracts as detailed above. Additional services related to previously existing medical service contracts, as well as cost-of-living and wage and benefit adjustments for existing employees accounted for the remainder of the increase.

Medical expenses

Medical expenses for the six months ended June 30, 2010 and 2009 were $6,011,743, or 20.4% of revenue, and $4,763,396, or 19.0% of revenue, respectively, which represented an increase of $1,248,347, or 26.2%. The increase in spending for medical expenses in absolute dollars primarily reflects increased medical and pharmacy services related to new contracts. The increase in spending as a percentage of revenue results, in part, from increases in pharmacy expenses and out of facility hospital expenses which were higher than the prior year as a result of an increase in hospitalization days in the first six months of 2010.

Other operating expenses

Other operating expenses were $941,528, or 3.2% of revenue, for the six months ended June 30, 2010, compared to $863,830, or 3.4% of revenue, for the six months ended June 30, 2009. The increase of $77,698 in spending is primarily related to the increase in the number of inmates served as a result of the new service contracts and reflects increased spending for consulting fees, professional liability insurance, office supplies and travel expenses partially offset by a reduction in employment advertising.

Operating Expenses

Selling and administrative expenses

Selling and administrative expenses for the six months ended June 30, 2010 and 2009 were $3,990,333, or 13.5% of revenue, and $3,759,723, or 15.0% of revenue, respectively. The increased expenditure of $230,610 primarily reflects an increased investment in additional management and administrative personnel required to support new contracts and services added since January 1, 2009, as well as increases in consulting fees, recruiting expense and travel expenses, which were partially offset by decreases in accounting fees, legal fees, rent expense and stock-based compensation. The reduction in spending as a percentage of revenue reflects improved economies of scale as selling and administrative expenses continue to grow at a slower pace than revenue. Stock-based compensation for the six months ended June 30, 2010 and 2009 was $303,937 and $324,269, respectively. 

Depreciation and amortization

Depreciation and amortization primarily reflects the amortization of intangible assets related to the acquisition of Conmed, Inc. in January 2007, the purchase of medical service contracts from EMDC in February 2008 and the acquisition of CMHS in November 2008. Amortization of service contracts acquired was $292,000, or 1.0% of revenue, for the six months ended June 30, 2010, compared to $957,000, or 3.8% of revenue, for the six months ended June 30, 2009. The decrease primarily reflects a decrease in amortization expense as certain individual service contracts acquired have become fully amortized.  Amortization of non-compete agreements was $166,779, or 0.6% of revenue, for the six months ended June 30, 2010, compared to $193,000, or 0.8% of revenue, for the six months ended June 30, 2009. Depreciation expense increased to $140,920 for the six months ended June 30, 2010 compared to $90,559 for the prior year period due primarily to capital expenditures associated with vehicle purchases as well as purchases of medical equipment and computers at various facilities.

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Interest income

Interest income was $45,360 for the six months ended June 30, 2010 compared to $44,580 for the same period in 2009. Average cash balances were higher during the six months ended June 30, 2010 compared to the six months ended June 30, 2009, however the marginally higher interest income in 2010 reflects reduced short-term interest rates during the period.

Interest expense

Interest expense for the six months ended June 30, 2010 decreased to $0 compared to $7,173 in the same period in 2009.

(Loss) on fair value of derivatives

As a result of adopting derivative accounting for warrants effective January 1, 2009, 1,705,000 of our then issued and outstanding common stock purchase warrants previously treated as equity were no longer afforded equity treatment and as a result they are now recorded as a liability based on fair value estimates.  These common stock purchase warrants do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the Black-Scholes option pricing model and all changes in the fair value of these warrants will be recognized currently in earnings until such time as the warrants are exercised, amended or expire.

During the six months ended June 30, 2010 and 2009, we recognized a $47,379 and a $2,352,625 unrealized loss, respectively.  The decreased expense of $2,305,246 was primarily the result of our stock price increasing $0.23 during the six months ended June 30, 2010 compared to a $1.65 stock price increase during the six months ended June 30, 2009.  Additionally, there were 829,903 fewer warrants subject to fair value accounting during the six months ended June 30, 2010 compared to the six months ended June 30, 2009, primarily due to the amendment of certain warrant agreements to remove the provisions that resulted in liability treatment subsequent to June 30, 2009.

During the six months ended June 30, 2010, no warrants were exercised.  As of June 30, 2010, we had outstanding warrants subject to derivative accounting to purchase an aggregate of 718,097 shares of common stock.  During the six months ended June 30, 2009, warrants to purchase 40,000 shares of common stock were exercised generating $12,000 of net proceeds and warrants to purchase 117,000 shares of common stock were exercised by cashless exercise and as a result, a total of 143,890 shares of common stock were issued.  As of June 30, 2009, we had outstanding warrants subject to derivative accounting to purchase an aggregate of 1,548,000 shares of common stock.

The following table summarizes the change in fair value for the six months ended June 30:

	2010		2009
Fair value of warrants outstanding as of January 1	$	1,299,450	$	2,766,150
Realized loss on warrants		—		91,648
Unrealized loss on warrants		47,379		2,352,625
Fair value of warrants exercised		—		(393,321	)
Fair value of warrants outstanding as of June 30	$	1,346,829	$	4,817,102

See Note 5, “Fair Value of Warrants”, for additional information on the warrant activity subject to fair value accounting for the six months ended June 30, 2010.

Income tax expense

Our effective tax rate was 49.5% during the six months ended June 30, 2010 which differs from the expected tax rate of 39.0% primarily due to permanent differences related to stock-based compensation and derivatives related to warrants.  The change in our effective tax rate from prior periods is primarily due to the relation of our taxable income relative to pre-tax income.  We recorded income tax expense of $613,300 and $153,000 for the six months ended June 30, 2010 and 2009, respectively.

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Liquidity and Capital Resources

Financing is generally provided by funds generated from our operating activities.

Cash Flow for the six months ended June 30, 2010 compared to the six months ended June 30, 2009

Cash as of June 30, 2010 and June 30, 2009 was $12,068,889 and $8,921,083, respectively.  We believe that our existing cash balances and anticipated cash flows from future operations will be sufficient to meet our normal operating requirements and liquidity needs for at least the next twelve months.

Cash Flows from Operating Activities

Cash flow from operations for the six months ended June 30, 2010 totaled $1,275,066, reflecting a net income of $625,692 plus $946,015 in adjustments for non-cash expenses such as amortization of $458,779, stock-based compensation of $303,937 and other non-cash expenses of $183,299.  Changes in working capital components used $296,641, reflective of an increase in accounts receivable of $211,995 and decreases in accrued expenses of $611,057, deferred revenue of $803,169 and income taxes payable of $236,897 partially offset by an increase in accounts payable of $1,219,602 and a decrease in prepaid expenses of $347,325.  The increase in accounts receivable resulted primarily from new medical service contracts added in 2010.  The decrease in accrued expenses resulted primarily from the receipt of medical expense invoices that are now recorded in accounts payable, a decrease in accrued wages covering one less day as compared to the six months ended December 31, 2009 and a reduction in corporate accrued expenses.  Deferred revenue decreased primarily as a result of a reduction in advance customer payments due to their fiscal year ending June 30, 2010 which prohibits them from making advance payments for services pertaining to the next fiscal year.  The decrease in income taxes payable resulted primarily from the payment of scheduled estimated taxes partially offset by accruals of estimated taxes payable.  The increase in accounts payable was primarily from the receipt of medical expense invoices previously recorded in accrued expenses as well as the timing of vendor payments in relation to quarter end.  The decrease in prepaid expenses resulted primarily from a reduction in prepaid professional liability insurance.  We prepaid our primary annual professional liability insurance policy in October 2009 and we expense the prepaid amounts ratably from the annual policy period of October through September.

Cash flow from operations for the six months ended June 30, 2009 totaled $1,792,407.  The net loss of $2,293,476 was offset by $4,009,101 in adjustments for non-cash expenses such as the change in fair value of derivatives of $2,444,273, amortization of $1,150,000 and stock-based compensation of $324,269.  Changes in working capital components generated an additional $76,782, reflective of an increase in accounts payable of $560,167 and a decrease in accounts receivable of $518,196 partially offset by decreases in income taxes payable of $360,140, deferred revenue of $346,228 and accrued expenses of $212,988.  The increase in accounts payable resulted primarily from the timing of vendor payments in relation to quarter end.  The decrease in accounts receivable resulted primarily from the receipt of customer payments prior to quarter end that typically are received the following week.  The decrease in income taxes payable resulted primarily from estimated tax payments in excess of the increase in liability as well as the increased revenue and related expenses.  The decrease in deferred revenue resulted primarily from a reduction in advance customer payments due to their fiscal year ending June 30, 2009 which prohibits them from making advance payments for services pertaining to the next fiscal year.  The decrease in accrued expenses resulted primarily from the decrease in medical expenses for the quarter ended June 30, 2009.

Cash Flows from Investing Activities

Cash flow from investing activities for the six months ended June 30, 2010 used $264,632.  Purchases of property and equipment used $117,364 primarily for purchases of vehicles, computers and medical equipment.  The purchase of all of the assets of a small mobile imaging company used $147,268.

Cash flow from investing activities for the six months ended June 30, 2009 used $219,278, primarily for purchases of vehicles, computers and medical equipment.

Cash Flows from Financing Activities

Cash flow from financing activities for the six months ended June 30, 2010 generated cash of $2,312 related to the proceeds from the exercise of stock options.

Cash flow from financing activities for the six months ended June 30, 2009 used cash of $124,186.  Payments on the line of credit were $100,000 and payments on loans were $36,186 which was partially offset by proceeds from warrant exercises of $12,000.

Loans

As of June 30, 2010, we had no outstanding loans.

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Off Balance Sheet Arrangements

We are required to provide performance and payment guarantee bonds to county governments under certain contracts. As of June 30, 2010, we have three performance bonds totaling $8,112,680 and two payment bonds for $2,855,537, totaling $10,968,217. The surety issuing the bonds has recourse against our assets in the event the surety is required to honor the bonds.

Contractual Obligations

The following table presents our expected cash requirements for contractual obligations outstanding as of June 30, 2010:

	Total		Current		2 – 3 Years		4 – 5 Years		Thereafter
Equipment Leases	$	132,379	$	53,881	$	67,112	$	11,386	$	—
Automobile Leases		25,187		22,792		2,395		—		—
Office Space Leased		382,886		150,719		232,167		—		—
Total Contractual Cash Obligations	$	540,452	$	227,392	$	301,674	$	11,386	$	—

Effects of Inflation

We do not believe that inflation and changing prices over the past three years have had a significant impact on our revenue or results of operations.

Potential Future Service Contract Revenue

As of June 30, 2010, we have entered into 61 agreements with county governments to provide medical and healthcare services primarily to county and municipal correctional facilities. Most of these contracts are for multiple years and include option renewal periods which are, in all cases, at the county's option. The original terms of the contracts are from one to nine years. These medical and mental healthcare service contracts have potential future service contract revenue of $182 million as of June 30, 2010, with a weighted-average term of 3.8 years, of which approximately $58 million relates to the initial contract period and approximately $124 million relates to the option renewal periods.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information in this Item is not required to be provided by Smaller Reporting Companies pursuant to Regulation S-K.

ITEM 4(T). CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective such that the information required to be disclosed by us in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.

Changes in Internal Control over Financial Reporting. During the most recently completed fiscal quarter, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II.  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There are no material changes in the legal proceedings pending against us.

ITEM 1A. RISK FACTORS

The information in this Item is not required to be provided by Smaller Reporting Companies.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. RESERVED

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

31.1 Section 302 Certification of Principal Executive Officer

31.2 Section 302 Certification of Principal Financial Officer

32.1 Section 906 Certification of Principal Executive Officer

32.2 Section 906 Certification of Principal Financial Officer

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SIGNATURES

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

	Conmed Healthcare Management, Inc.
August 16, 2010
	By /s/ Richard W. Turner
	Richard W. Turner, Ph.D.
	Chairman and Chief Executive Officer
	(principal executive officer)

August 16, 2010
	By /s/ Thomas W. Fry
	Thomas W. Fry
	Chief Financial Officer and Secretary
	(principal financial officer and principal accounting officer)

 

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