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, 2012

 

OR

 

o

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES x NO o

 

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 o	Accelerated filer o
Non-Accelerated filer o	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 o 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 14, 2012
Common Stock, $0.0001 par value per share	14,001,463

 

 

CONMED HEALTHCARE MANAGEMENT, INC.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

 

	Page
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheets
June 30, 2012 and December 31, 2011	1
Consolidated Statements of Income
For the three and six months ended June 30, 2012 and 2011	2
Consolidated Statements of Cash Flows
For the six months ended June 30, 2012 and 2011	3
Consolidated Statements of Shareholders’ Equity
For the six months ended June 30, 2012	4
Notes to Consolidated Financial Statements	5
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	23
ITEM 4. CONTROLS AND PROCEDURES	23

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS	25
ITEM 1A. RISK FACTORS	25
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	25
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	25
ITEM 4. MINE SAFETY DISCLOSURES	25
ITEM 5. OTHER INFORMATION	25
ITEM 6. EXHIBITS	25
SIGNATURES	26

 

 

PART 1. FINANCIAL INFORMATION

 

ITEM 1.      FINANCIAL STATEMENTS

 

CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED BALANCE SHEETS

 

		June 30, 2012				December 31,
		(unaudited)				2011
ASSETS
CURRENT ASSETS
Cash and cash equivalents		$	17,452,061			$	16,445,938
Accounts receivable			3,452,734				3,069,622
Prepaid expenses			685,699				1,215,841
Taxes receivable			173,307				—
Deferred taxes			260,000				240,000
Total current assets			22,023,801				20,971,401
PROPERTY AND EQUIPMENT, NET			989,222				732,152
DEFERRED TAXES			956,000				1,085,000
OTHER ASSETS
Service contracts acquired, net			87,000				129,500
Non-compete agreements, net			148,001				106,222
Goodwill			6,349,705				6,263,705
Deposits			118,792				56,275
Total other assets			6,703,498				6,555,702
		$	30,672,521			$	29,344,255
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable		$	1,322,899			$	1,291,951
Accrued expenses			6,137,041				4,628,827
Taxes payable			—				532,780
Deferred revenue			441,575				600,895
Notes payable			—				832,102
Total current liabilities			7,901,515				7,886,555
DERIVATIVE FINANCIAL INSTRUMENTS			133,253				2,162,536
SHAREHOLDERS’ EQUITY
Preferred stock, no par value; authorized 5,000,000 shares; zero shares issued and outstanding as of June 30, 2012 and December 31, 2011			—				—
Common stock, $0.0001 par value, authorized 40,000,000 shares; issued and outstanding 13,959,315 and 13,132,481 shares as of June 30, 2012 and December 31, 2011, respectively			1,396				1,313
Additional paid-in capital			40,458,919				37,609,607
Accumulated deficit			(17,822,562	)			(18,315,756	)
Total shareholders' equity			22,637,753				19,295,164
		$	30,672,521			$	29,344,255

 

See Notes to Unaudited Financial Statements

 

 

CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

		For the Six				For the Six				For the Three				For the Three
		Months Ended				Months Ended				Months Ended				Months Ended
		June 30, 2012				June 30, 2011				June 30, 2012				June 30, 2011
Service contract revenue		$	38,594,436			$	32,967,885			$	19,655,220			$	16,656,792
HEALTHCARE EXPENSES:
Salaries, wages and employee benefits			21,678,278				18,750,281				10,702,623				9,454,312
Medical expenses			8,645,862				6,891,916				4,711,239				3,472,272
Other operating expenses			1,512,048				1,319,716				660,936				712,785
Total healthcare expenses			31,836,188				26,961,913				16,074,798				13,639,369
Gross profit			6,758,248				6,005,972				3,580,422				3,017,423
Selling and administrative expenses			5,240,802				4,858,807				2,724,067				2,830,841
Depreciation and amortization			262,811				332,526				138,973				160,055
Total operating expenses			5,503,613				5,191,333				2,863,040				2,990,896
Operating income			1,254,635				814,639				717,382				26,527
OTHER INCOME (EXPENSE)
Interest income			48,003				52,244				23,498				23,714
Interest (expense)			(6,457	)			—				(2,540	)			—
(Loss) on fair value of derivatives			(307,987	)			(355,467	)			(2,663	)			(225,723	)
Total other income (expense)			(266,441	)			(303,223	)			18,295				(202,009	)
Income (loss) before income taxes			988,194				511,416				735,677				(175,482	)
Income tax expense (benefit)			495,000				257,000				376,000				(36,000	)
Net income (loss)		$	493,194			$	254,416			$	359,677			$	(139,482	)
EARNINGS (LOSS) PER COMMON SHARE
Basic		$	0.04			$	0.02			$	0.03			$	(0.01	)
Diluted		$	0.03			$	0.02			$	0.02			$	(0.01	)
WEIGHTED-AVERAGE SHARES OUTSTANDING
Basic			13,776,231				12,890,680				13,930,194				12,941,704
Diluted			14,429,663				14,375,739				14,601,081				12,941,704

 

See Notes to Unaudited Financial Statements

 

 

CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

		For the Six				For the Six
		Months Ended				Months Ended
		June 30, 2012				June 30, 2011
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	493,194			$	254,416
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation			185,589				153,191
Amortization of service contracts and non-compete agreements			77,222				179,335
Amortization of long-term customer agreement			87,500				87,500
Restricted stock compensation			143,000				—
Stock-based compensation			285,581				211,332
Loss on fair value of derivatives			307,987				355,467
Gain on disposal of property and equipment			(24,042	)			—
Deferred income taxes			109,000				70,000
Changes in working capital components
(Increase) in accounts receivable			(383,112	)			(339,084	)
Decrease in prepaid expenses			530,142				592,137
(Increase) decrease in deposits			(62,517	)			201
Increase in accounts payable			30,948				736,345
Increase (decrease) in accrued expenses			1,508,214				(34,634	)
(Decrease) in income taxes payable			(706,087	)			(505,379	)
(Decrease) in deferred revenue			(159,320	)			(445,634	)
Net cash provided by operating activities			2,423,299				1,315,193
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment			(418,617	)			(221,323	)
Business combination			(250,000	)			—
Net cash (used in) investing activities			(668,617	)			(221,323	)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable			(832,102	)			—
Proceeds from exercise of warrants and stock options			83,543				260,836
Net cash provided by (used in) financing activities			(748,559	)			260,836
Net increase in cash and cash equivalents			1,006,123				1,354,706
CASH AND CASH EQUIVALENTS
Beginning			16,445,938				13,270,089
Ending		$	17,452,061			$	14,624,795
NON-CASH INVESTING AND FINANCING ACTIVITIES WERE AS FOLLOWS:
Reclassification of warrants from derivative financial instruments to additional paid-in capital upon exercise, at fair value.		$	2,337,270			$	185,905
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash payments for interest			6,457				—
Income taxes paid		$	1,092,088			$	692,379

 

See Notes to Unaudited Financial Statements

 

 

CONMED HEALTHCARE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

 

		Preferred				Common				Additional Paid-				Accumulated
		Stock				Stock				in Capital				Deficit				Total
Balance at December 31, 2011		$	—			$	1,313			$	37,609,607			$	(18,315,756	)		$	19,295,164
Net Income			—				—				—				493,194				493,194
Restricted stock expense			—				5				142,995				—				143,000
Stock option expense			—				—				285,581				—				285,581
Exercise of warrants and stock options			—				78				2,420,736				—				2,420,814
Balance at June 30, 2012		$	—			$	1,396			$	40,458,919			$	(17,822,562	)		$	22,637,753

 

See Notes to Unaudited Financial Statements

 

 

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, 2011 filed with the SEC on March 2, 2012.

 

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, 2012 are not necessarily indicative of the results of operations to be expected for a full year.

 

NOTE 2.

Equity Compensation

 

The Board of Directors has adopted, and our stockholders have approved, the 2007 Stock Option Plan, as amended (the “2007 Plan”). On May 24, 2012, the 2007 Plan was amended to increase the total number of shares available from 3,100,000 to 4,100,000. The 2007 Plan provides for the grant of up to 4,100,000 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, 2012 and 2011, we recorded stock-based compensation expense totaling $285,581 and $211,332, respectively. During the six months ended June 30, 2012 and 2011, we recorded restricted stock compensation expense totaling $143,000 and $0, respectively.

 

During the three months ended June 30, 2012 and 2011, we recorded stock-based compensation expense totaling $144,769 and $106,503, respectively. During the three months ended June 30, 2012 and 2011, we recorded restricted stock compensation expense totaling $65,441 and $0, respectively.

 

During the six months ended June 30, 2012, options were granted to purchase 60,500 shares of common stock at an average exercise price of $3.58 per share and an average grant date fair value of $2.17 per share. During the six months ended June 30, 2012, 50,000 restricted stock units (“RSU”) were granted at an average grant date fair value of $2.86 per share which vested on May 24, 2012 and were exchanged for 50,000 shares of common stock on that date. Additionally, during the six months ended June 30, 2012, options to purchase 18,015 shares of common stock were forfeited, options to purchase 21,931 shares of common stock were cancelled and options to purchase 27,553 shares of common stock were exercised at an average exercise price of $2.22 per share. As of June 30, 2012, 1,164,570 shares remain available for grant under the 2007 Plan.

 

As of June 30, 2012, stock-based compensation expense not yet recognized in income totaled $1,368,333, which is expected to be recognized over a weighted-average remaining period of 2.86 years.

 

 

NOTE 3.

Common Stock Warrants

 

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 expired on March 13, 2012. All 1,027,333 of these warrants outstanding on January 1, 2012 were exercised prior to expiration. Of the 773,000 outstanding warrants exercisable at $0.30 per share, 747,070 were exercised on a net share basis and 25,930 were exercised for cash generating proceeds of $7,779 to the Company. Of the 254,333 outstanding warrants exercisable at $2.50 per share, 248,500 were exercised on a net share basis and 5,833 were exercised for cash generating proceeds of $14,583 to the Company.

 

Placement Agent Warrant

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 warrant vested immediately and expired on January 26, 2012. All 15,750 of these warrants outstanding on January 1, 2012 were exercised on a net share basis prior to expiration.

 

Consultant Warrant @ $3.72 per share

In connection with a consulting agreement dated July 24, 2007, we issued to a consultant a warrant to purchase 20,000 shares of common stock at an exercise price of $3.72 per share expiring July 24, 2011. The warrant vested over one year and was contingent upon the continued service to the Company of the warrant holder. These warrants expired on July 24, 2011.

 

Consultant Warrants @ $1.85 per share

In connection with the purchase in 2008 of all of the assets of Emergency Medicine Documentation Consultants, P.C., a provider of medical services in northwest Oregon, 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. These warrants were exercised on a net share basis on July 18, 2012.

 

Summary

The following table summarizes the warrant activity for the six months ended June 30, 2012:

 

		Investor				Investor								Consultant
		Warrants				Warrants				Placement				Warrants
		@$0.30				@$2.50				Agent				@$1.85
		per share				per share				Warrant				per share				Total
Exercise price		$	0.30			$	2.50			$	2.75			$	1.85			$	1.85
Warrants outstanding as of December 31, 2011			773,000				254,333				15,750				80,000				1,123,083
Warrants exercised			773,000				254,333				15,750				—				1,043,083
Warrants outstanding as of June 30, 2012			—				—				—				80,000				80,000

 

The following table summarizes the warrant activity for the six months ended June 30, 2011:

 

		Investor				Investor								Consultant				Consultant
		Warrants				Warrants				Placement				Warrant @				Warrants
		@$0.30				@$2.50				Agent				$3.72 per				@$1.85per
		per share				per share				Warrant				share				share				Total
Exercise price		$	0.30			$	2.50			$	2.75			$	3.72			$	1.85			$	1.21
Warrants outstanding as of December 31, 2010			813,000				496,667				300,000				20,000				80,000				1,709,667
Warrants exercised			40,000				50,667				284,250				—				—				374,917
Warrants outstanding as of June 30, 2011			773,000				446,000				15,750				20,000				80,000				1,334,750

 

 

NOTE 4.

Fair Value of Warrants

 

As a result of adopting derivative accounting for certain warrants which contain an exercise price adjustment feature 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 were recorded as a liability based on fair value estimates. During the years ended December 31, 2010 and 2009, warrants to purchase 90,000 and 814,570 shares of common stock, respectively, were amended to remove the provisions that resulted in the liability treatment and were treated as equity. During the year ended December 31 2011, 771,020 of our previously issued, amended and outstanding common stock purchase warrants were amended a second time in connection with the previously terminated merger agreement to have a cash settlement feature and, as a result, were no longer afforded equity treatment. This resulted in a reclassification from equity to liability of $2,513,391 in 2011 compared to a $282,670 reclassification of liability to equity in 2010 reflecting the first warrant amendment. 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 in earnings until such time as the warrants are exercised, amended or expire.

 

Investor Warrants @ $0.30 per share

 

Black-Scholes assumptions		June 30, 2012				December 31, 2011
Expected life (years)			—				0.2
Expected volatility			—				84.15	%
Risk-free interest rate			—				0.1	%
Expected dividend yield			—				0.0	%

 

Investor Warrants @ $2.50 per share

 

Black-Scholes assumptions		June 30, 2012				December 31, 2011
Expected life (years)			—				0.2
Expected volatility			—				84.15	%
Risk-free interest rate			—				0.1	%
Expected dividend yield			—				0.0	%

 

Placement Warrant @ $2.75 per share

 

Black-Scholes assumptions		June 30, 2012				December 31, 2011
Expected life (years)			—				0.1
Expected volatility			—				26.83	%
Risk-free interest rate			—				0.1	%
Expected dividend yield			—				0.0	%

 

Consultant Warrants @ $1.85 per share

 

Black-Scholes assumptions		June 30, 2012				December 31, 2011
Expected life (years)			0.7				1.2
Expected volatility			48.64	%			58.65	%
Risk-free interest rate			0.2	%			0.1	%
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, 2012:

 

										Placement
		Investor				Investor				Agent				Consultant
		Warrants @				Warrants @				Warrants @				Warrants @
		$0.30 per				$2.50 per				$2.75 per				$1.85 per
		share				share				share				share				Total
Warrants outstanding subject to fair value accounting as of December 31, 2011			773,000				254,333				9,450				80,000				1,116,783
Warrants exercised			773,000				254,333				9,450				—				1,036,783
Warrants outstanding subject to fair value accounting as of June 30, 2012			—				—				—				80,000				80,000

 

										Placement
		Investor				Investor				Agent				Consultant
		Warrants @				Warrants @				Warrants @				Warrants @
		$0.30 per				$2.50 per				$2.75 per				$1.85 per
		share				share				share				share				Total
Fair value of warrants outstanding as of December 31, 2011		$	1,924,826			$	144,090			$	947			$	92,673			$	2,162,536
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			219,847				47,532				28				—				267,407
Unrealized loss on warrants			—				—				—				40,580				40,580
Fair value of exercised warrants transferred to equity			(2,144,673	)			(191,622	)			(975	)			—				(2,337,270	)
Fair value of warrants outstanding as of June 30, 2012		$	—			$	—			$	—			$	133,253			$	133,253

 

The following tables summarize the warrant activity subject to fair value accounting for the six months ended June 30, 2011:

 

		Investor				Investor
		Warrants @				Warrants @
		$0.30 per				$2.50 per
		share				share				Total
Warrants outstanding subject to fair value accounting as of December 31, 2010			131,430				496,667				628,097
Warrants exercised			40,000				50,667				90,667
Warrants amended			—				—				—
Warrants outstanding subject to fair value accounting as of June 30, 2011			91,430				446,000				537,430

 

 

		Investor				Investor
		Warrants @				Warrants @
		$0.30 per				$2.50 per
		share				share				Total
Fair value of warrants outstanding as of December 31, 2010		$	361,537			$	331,159			$	692,696
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			20,382				21,707				42,089
Unrealized loss on warrants			54,812				258,566				313,378
Fair value of exercised warrants transferred to equity			(130,414	)			(55,491	)			(185,905	)
Fair value of warrants outstanding as of June 30, 2011		$	306,317			$	555,941			$	862,258

 

The following tables summarize the warrant activity subject to fair value accounting for the three months ended June 30, 2012:

 

										Placement
		Investor				Investor				Agent				Consultant
		Warrants @				Warrants @				Warrants @				Warrants @
		$0.30 per				$2.50 per				$2.75 per				$1.85 per
		share				share				share				share				Total
Warrants outstanding subject to fair value accounting as of March 31, 2012			—				—				—				80,000				80,000
Warrants exercised			—				—				—				—				—
Warrants outstanding subject to fair value accounting as of June 30, 2012			—				—				—				80,000				80,000

 

										Placement
		Investor				Investor				Agent				Consultant
		Warrants @				Warrants @				Warrants @				Warrants @
		$0.30 per				$2.50 per				$2.75 per				$1.85 per
		share				share				share				share				Total
Fair value of warrants outstanding as of March 31, 2012		$	—			$	—			$	—			$	130,590			$	130,590
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			—				—				—				—				—
Unrealized loss on warrants			—				—				—				2,663				2,663
Fair value of exercised warrants transferred to equity			—				—				—				—				—
Fair value of warrants outstanding as of June 30, 2012		$	—			$	—			$	—			$	133,253			$	133,253

 

 

The following tables summarize the warrant activity subject to fair value accounting for the three months ended June 30, 2011:

 

		Investor				Investor
		Warrants @				Warrants @
		$0.30 per				$2.50 per
		share				share				Total
Warrants outstanding subject to fair value accounting as of March 31, 2011			131,430				490,000				621,430
Warrants exercised			40,000				44,000				84,000
Warrants amended			—				—				—
Warrants outstanding subject to fair value accounting as of June 30, 2011			91,430				446,000				537,430

 

		Investor				Investor
		Warrants @				Warrants @
		$0.30 per				$2.50 per
		share				share				Total
Fair value of warrants outstanding as of March 31, 2011		$	390,423			$	426,920			$	817,343
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			20,382				21,056				41,438
Unrealized loss on warrants			25,926				158,359				184,285
Fair value of exercised warrants transferred to equity			(130,414	)			(50,394	)			(180,808	)
Fair value of warrants outstanding as of June 30, 2011		$	306,317			$	555,941			$	862,258

 

As of June 30, 2012, we had outstanding warrants to purchase an aggregate of 80,000 shares of common stock, all of which were subject to derivative accounting for warrants, at an average exercise price of $1.85, and we have reserved shares of our common stock for issuance in connection with the potential exercise thereof.

 

NOTE 5.

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, 2012 and December 31, 2011 are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The guidance describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value as follows:

 

·

Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

·

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

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, 2012

Quoted prices in

Significant

active markets for

Significant other

Unobservable

identical assets

observable inputs

inputs

Total

(Level 1)

(Level 2)

(Level 3)

Derivative financial instruments

$

133,253

$

—

$

—

$

133,253

 

As of December 31, 2011

Quoted prices in

Significant

active markets for

Significant other

Unobservable

identical assets

observable inputs

nputs

Total

(Level 1)

(Level 2)

(Level 3)

Derivative financial instruments

$

2,162,536

$

—

$

—

$

2,162,536

 

Equity-linked financial instruments consist of stock warrants issued by the Company that contain an exercise price adjustment feature or a cash settlement 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 4, “Fair Value of Warrants”. Any gains and losses related to the change in fair value of the financial instruments are included in other income (expense) on the Statements of Income.

 

During the six months ended June 30, 2012, certain warrants were exercised and, as a result, the fair value of $2,337,270 was transferred from a liability and into equity and we recognized a $267,407 realized loss related to the exercise of these warrants. We also recognized a $40,580 unrealized loss related to the change in fair value of the warrants outstanding at June 30, 2012.

 

During the six months ended June 30, 2011, certain warrants were exercised and, as a result, the fair value of $185,905 was transferred from a liability and into equity and we recognized a $42,089 realized loss related to the exercise of these warrants. We also recognized a $313,378 unrealized loss related to the change in fair value of the warrants outstanding at June 30, 2011.

 

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

 

		2012				2011
Fair value of warrants outstanding as of January 1		$	2,162,536			$	692,696
Fair value of exercised warrants transferred to equity			(2,337,270	)			(185,905	)
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			267,407				42,089
Unrealized loss on warrants			40,580				313,378
Fair value of warrants outstanding as of June 30		$	133,253			$	862,258

 

Financial instruments include cash and cash equivalents (level 1), accounts receivable (level 2), accounts payable (level 2), accrued expenses (level 2), deferred revenue (level 2), and derivative financial instruments (level 3). The fair value of current assets and current liabilities is estimated to approximate carrying value due to the short-term nature of these instruments. The fair value of derivative financial instruments is estimated using the Black-Scholes option pricing model.

 

 

NOTE 6.

Earnings Per Share

 

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

 

		For the Six				For the Six				For the Three				For the Three
		Months Ended				Months Ended				Months Ended				Months Ended
		June 30, 2012				June 30, 2011				June 30, 2012				June 30, 2011
Numerator for basic and diluted earnings per share:
Net income (loss)		$	493,194			$	254,416			$	359,677			$	(139,482	)
Denominator:
Weighted-average basic shares outstanding			13,776,231				12,890,680				13,930,194				12,941,704
Assumed conversion of dilutive securities
Stock options			587,643				589,440				612,355				—
Restricted stock			30,795				—				22,580				—
Warrants			34,994				895,619				35,952				—
Potentially dilutive common shares			653,432				1,485,059				670,887				—
Denominator for diluted earnings per share – Adjusted weighted average shares			14,429,663				14,375,739				14,601,081				12,941,704
Earnings (loss) per common share:
Basic		$	0.04			$	0.02			$	0.03			$	(0.01	)
Diluted		$	0.03			$	0.02			$	0.02			$	(0.01	)

 

Common stock warrants and options outstanding totaling 1,031,970 and 645,000 shares, respectively, are not included in diluted earnings per common share for the six months ended June 30, 2012 and 2011, respectively, as they would have an antidilutive effect on earnings per common share.

 

NOTE 7.

Professional Liability Litigation

 

From time to time, the Company is party to legal proceedings in the ordinary course of business, including claims of professional negligence based on services performed by our employees and independent medical providers, including physicians, physician assistants, nurse practitioners and nurses providing treatments at the various facilities.

 

The Company evaluates each medical malpractice claim or similar contingent liability to determine the likelihood and amount of estimated claims as follows:

 

·

In the event the Company determines it is probable that the Company will incur a loss arising from the claim and the amount can be reasonably estimated, a liability is established to satisfy the claim including an estimate of related legal fees. A receivable is then established to recognize the anticipated insurance recoveries at the same time that it recognized the liability, measured on the same basis as the liability, subject to the need for a valuation allowance for uncollectible accounts.

 

·

In the event the Company determines it is not probable that the Company will incur a loss arising from the claim or the amount cannot be reasonably estimated, no liability is established to satisfy the claim and legal fees related to the claim are expensed as incurred.

 

These accruals are adjusted periodically as assessments change or additional information becomes available.

 

The amounts accrued for contingencies deemed probable are included in accrued expenses and total $115,000 and $0 as of June 30, 2012 and December 31, 2011, respectively. The amounts recorded for insurance recoveries are included in accounts receivable and total $65,000 and $0 as of June 30, 2012 and December 31, 2011, respectively.

 

 

NOTE 8.

Income Tax Matters

 

Our effective tax rate was 50.1% and 50.2% during the six months ended June 30, 2012 and 2011, respectively, which differs from the expected tax rate of 40.0%, primarily due to permanent differences related to stock-based compensation, derivatives related to warrants and Merger-related expenses. The change in our effective tax rate from prior periods is primarily due to permanent differences related to higher stock-based compensation and non-deductible Merger-related expenses and lower losses on derivatives related to warrants. We recorded income tax expense of $495,000 and $257,000 for the six months ended June 30, 2012 and 2011, respectively. We recorded income tax expense of $376,000 and an income tax benefit of $36,000 for the three months ended June 30, 2012 and 2011, respectively.

 

NOTE 9.

Subsequent Event

 

On July 16, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Correct Care Solutions, LLC, a Kansas limited liability company (“Parent”), and Hanover Merger Sub, Inc., a Delaware corporation and a wholly-owned direct subsidiary of Parent (“Purchaser”). Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, on July 30, 2012, Purchaser commenced a tender offer (the “Offer”) to purchase all the issued and outstanding shares (the “Shares”) of the Company’s common stock, par value $.0001 per share, at a purchase price of $3.95 per Share, net to the seller in cash, without interest thereon and less any applicable withholding taxes (the “Offer Price”). Pursuant to the Merger Agreement, following the closing of the Offer, and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Purchaser will be merged with and into the Company (the “Merger”), with the Company surviving as a wholly-owned direct subsidiary of Parent. In the Merger, each Share issued and outstanding immediately prior to the effective time of the Merger (the “Effective Time”), other than (i) Shares owned by Parent, Purchaser or any other direct or indirect wholly-owned subsidiary of Parent (including as a result of an exercise of the Top-Up Option (as defined in the Merger Agreement) by Purchaser) and Shares owned by the Company or any direct or indirect wholly-owned subsidiary of the Company, and in each case not held on behalf of third parties, and (ii) Shares owned by stockholders who validly exercise appraisal rights under Delaware law with respect to such Shares, will be automatically canceled and converted into the right to receive the Offer Price, without interest thereon and less any applicable withholding taxes. Pursuant to the Merger Agreement, each outstanding option to purchase Shares will become fully vested and exercisable immediately prior to, and then shall be cancelled at, the Effective Time, with each holder thereof receiving an amount in cash equal to the excess, if any, of the Offer Price over the exercise price thereof multiplied by the number of Shares subject to such option.

 

Consummation of the Offer is subject to several customary closing conditions, including that there shall have been validly tendered and not withdrawn that number of Shares which, when added to the Shares already owned by Parent or any of its subsidiaries, would represent at least 90% of the outstanding Shares at such time.

 

 

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; contract renewals and extensions; the incurrence of start-up costs associated with new contracts; 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; influences 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; stock price volatility; and uncertainties related to the acquisition of the Company by Correct Care Solutions, LLC, including the timing of the tender offer and merger, how many of our stockholders will tender their stock in the offer, the possibility that competing offers will be made, the possibility that various closing conditions for the tender offer or merger may not be satisfied or waived, the effects of disruption from the tender offer or merger making it more difficult to maintain relationships with employees, customers, other business partners or governmental entities, unexpected costs or expenses resulting from the tender offer or merger, litigation or adverse judgments relating to the tender offer or merger, unexpected costs or expenses resulting from the tender offer or merger, other risks relating to the tender offer or merger and any changes in general economic and/or industry-specific conditions. 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, 2011 filed with the SEC on March 2, 2012. 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 forty-seven counties in ten states: Arizona, Kansas, Kentucky, Maryland, New Jersey, Oregon, Tennessee, Texas, Virginia and Washington. Our services have expanded to include mental health, pharmacy and out-of-facility healthcare services.

 

 

Recent Development

On July 16, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Correct Care Solutions, LLC, a Kansas limited liability company (“Parent”), and Hanover Merger Sub, Inc., a Delaware corporation and a wholly-owned direct subsidiary of Parent (“Purchaser”). Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, on July 30, 2012, Purchaser commenced a tender offer (the “Offer”) to purchase all the issued and outstanding shares (the “Shares”) of the Company’s common stock, par value $.0001 per share, at a purchase price of $3.95 per Share, net to the seller in cash, without interest thereon and less any applicable withholding taxes. Pursuant to the Merger Agreement, following the closing of the Offer, and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Purchaser will be merged with and into the Company, with the Company surviving as a wholly-owned direct subsidiary of Parent. See Note 9, “Subsequent Event”, for additional information.

 

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, 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, 2011 filed with the SEC on March 2, 2012. 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, 2011.

 

 

Results of Operations

 

Three Months Ended June 30, 2012 compared to Three Months Ended June 30, 2011

The following discussion of financial results is derived from unaudited financial statements for the three months ended June 30, 2012 and 2011.

 

		Three Months Ended								Three Months Ended
		June 30, 2012								June 30, 2011
		Amount				% of Revenue				Amount				% of Revenue
Service contract revenue		$	19,655,220				100.0	%		$	16,656,792				100.0	%
HEALTHCARE EXPENSES:
Salaries, wages and employee benefits			10,702,623				54.5	%			9,454,312				56.8	%
Medical expenses			4,711,239				24.0	%			3,472,272				20.8	%
Other operating expenses			660,936				3.4	%			712,785				4.3	%
Total healthcare expenses			16,074,798				81.8	%			13,639,369				81.9	%
Gross profit			3,580,422				18.2	%			3,017,423				18.1	%
OPERATING EXPENSES:
Selling and administrative expenses			2,724,067				13.9	%			2,830,841				17.0	%
Depreciation and amortization			138,973				0.7	%			160,055				1.0	%
Total operating expenses			2,863,040				14.6	%			2,990,896				18.0	%
Operating income			717,382				3.6	%			26,527				0.2	%
OTHER INCOME (EXPENSE)
Interest income			23,498				0.1	%			23,714				0.1	%
Interest (expense)			(2,540	)			(0.0	)%			—				0.0	%
(Loss) on fair value of derivatives			(2,663	)			(0.0	)%			(225,723	)			(1.4	)%
Total other income (expense)			18,295				0.1	%			(202,009	)			(1.2	)%
Income (loss) before income taxes			735,677				3.7	%			(175,482	)			(1.1	)%
Income tax expense (benefit)			376,000				1.9	%			(36,000	)			(0.2	)%
Net income (loss)		$	359,677				1.8	%		$	(139,482	)			(0.8	)%

 

Summary

Net revenue from medical services provided primarily to correctional institutions for the three months ended June 30, 2012 and 2011, was $19,655,220 and $16,656,792, respectively, which represents an increase of $2,998,429 or 18.0%. Net income was $359,677, or 1.8% of revenue, compared to a net loss of $139,482, or 0.8% of revenue, for the three months ended June 30, 2012 and 2011, respectively, which represented an increase in net income of $499,159.

 

 

Revenue

The addition of service contracts signed with new jurisdictions since April 1, 2011 accounted for $2,477,028 or 81.6% of the increase in revenue for the three months ended June 30, 2012 compared to the same period for the prior year. These jurisdictions are as follows: Galveston County, TX; Gray County, TX; Marion County, KY; Ocean County, NJ; Oldham County, TX; Newport News, VA; Randall County, TX; and Worcester County, MD. Revenue improvement totaling $182,828, or 6.1% of the increase over the prior year period, 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, 2011. Price increases related to existing service requirements accounted for $259,947, or 8.7% of the increase compared to the prior year period. The remainder of revenue improvement, $108,625 or 3.6% of the increase, was the result of other volume related activities, primarily associated with 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 and was partially offset by revenue declines related to business decisions to exit specific less profitable markets.

 

Healthcare Expenses

Salaries and employee benefits

Salaries and employee benefits for healthcare employees were $10,702,623, or 54.5% of revenue, for the three months ended June 30, 2012, compared to $9,454,312, or 56.8% of revenue, for the three months ended June 30, 2011, an increase of $1,248,311, or 13.2%, due primarily to the addition of healthcare employees servicing the new medical service contracts. Approximately $1,412,121, or 113.1%, of the increase is related to new healthcare employees required to support the staffing requirements for our new medical service contracts as detailed above. Partially offsetting the increase related to new service contracts was a decrease in salaries and benefits at existing facilities of $163,810, or 13.1%, primarily related to a decline in cost related to the self insured employee health benefit programs.

 

Medical expenses

Medical expenses for the three months ended June 30, 2012 and 2011 were $4,711,239, or 24.0% of revenue, and $3,472,272, or 20.8% of revenue, respectively, which represented an increase of $1,238,967, or 35.7%. Approximately 53.6% of the increase in spending for medical expenses in absolute dollars is related to medical services for new contracts both in- and out-of-facility as well as pharmacy services. The remainder of the increase is related to increases in medical expenses at existing facilities in which we were providing services prior to April 1, 2011. Out-of-facility expenses increased by approximately 66.5% at existing facilities and were primarily due to inpatient hospitalization expenses at Baltimore, Virginia Beach, and Loudoun counties. Pharmacy expenses at existing facilities increased by 3.7% and the increase was partially offset by favorable price negotiations with certain pharmacy vendors. In-facility medical expenses increased by approximately 12.5% at existing facilities.

 

Other operating expenses

Other operating expenses were $660,936, or 3.4% of revenue, for the three months ended June 30, 2012, compared to $712,785, or 4.3% of revenue, for the three months ended June 30, 2011. The decrease of $51,849 in spending is primarily related to a $24,665 decrease in legal fees, a $36,430 decrease in professional liability insurance and an $8,630 decrease in office supplies partially offset by a $7,745 increase in equipment rental and a $7,295 increase in information systems expense.

 

Gross Profit

Gross profit increased to $3,580,422 for the three months ended June 30, 2012 compared to $3,017,423 for the three months ended June 30, 2011, primarily reflecting the increased revenue related to the new medical service contracts. Gross margin as a percentage of revenue increased to 18.2% for the three months ended June 30, 2012 from 18.1% for the three months ended June 30, 2011. Gross profit for the three months ended June 30, 2012 at existing contracts in which we were providing services prior to April 1, 2011 was 19.3%. Gross profit for the three months ended June 30, 2012 for new contracts added since April 1, 2011 was 10.4%.

 

Operating Expenses

Selling and administrative expenses

Selling and administrative expenses for the three months ended June 30, 2012 and 2011 were $2,724,067, or 13.9% of revenue, and $2,830,841, or 17.0% of revenue, respectively. The decreased expenditure of $106,774 primarily results from a $320,455 decrease in business taxes related to a non-recurring sales tax accrual and a $90,549 decrease in Merger-related expense from the prior year’s quarter. Partially offsetting the above was increased investment in additional management and administrative personnel required to support new contracts and services added since April 1, 2011 coupled with a $20,250 increase in business development fees and an $18,792 increase in meeting expense. Stock-based compensation for the three months ended June 30, 2012 and 2011 was $144,769 and $106,503, respectively. Restricted stock compensation for the three months ended June 30, 2012 and 2011 was $65,441 and $0, respectively.

 

 

Depreciation and amortization

Depreciation and amortization primarily reflects the amortization of intangible assets related to the acquisition of Conmed, Inc. in January 2007 and the acquisition of Correctional Mental Health Services, LLC (“CMHS”) in November 2008. Amortization of service contracts acquired was $20,600, or 0.1% of revenue, for the three months ended June 30, 2012, compared to $57,000, or 0.3% of revenue, for the three months ended June 30, 2011. 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 $18,000, or 0.1% of revenue, for the three months ended June 30, 2012, compared to $24,667, or 0.1% of revenue, for the three months ended June 30, 2011. Depreciation expense increased to $100,373 for the three months ended June 30, 2012 compared to $78,388 for the prior year period due primarily to capital expenditures associated with purchases of computers and software related to electronic medical records systems and medical equipment.

 

Interest income

Interest income was $23,498 for the three months ended June 30, 2012 compared to $23,714 for the same period in 2011. Reduced short-term interest rates partially offset by higher average cash balances during the three months ended June 30, 2012 account for the decreased interest income compared to the same period in 2011.

 

(Loss) on fair value of derivatives

During the three months ended June 30, 2012 and 2011, we recognized a realized loss of $0 and $41,438, respectively, related to warrants subject to derivative accounting treatment that were exercised and transferred to equity treatment. The realized loss is the difference between the fair value at the date of exercise and the fair value at the beginning of each year. In addition, during the three months ended June 30, 2012 and 2011, we recorded an unrealized loss of $2,663 and $184,285, respectively. The unrealized loss is the difference between the fair value of warrants remaining at the end of each period and the fair value of those same warrants at the beginning of the each year. The decrease of $181,622 was primarily the result of the decreased number of warrants subject to the derivative accounting treatment due to the exercise of all but 80,000 of the outstanding warrants and by the smaller increase in our stock price of $0.06 during the three months ended June 30, 2012, compared to a $0.38 stock price increase during the three months ended June 30, 2011.

 

During the three months ended June 30, 2012, no warrants subject to derivative accounting treatment were exercised. As of June 30, 2012, we had outstanding warrants to purchase an aggregate of 80,000 shares of common stock that remain subject to derivative accounting. During the three months ended June 30, 2011, warrants to purchase 30,667 shares of common stock were exercised generating $76,668 of net proceeds and warrants to purchase 53,333 shares of common stock were exercised by cashless exercise and as a result, a total of 41,081 shares of common stock were issued.

 

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

 

		2012				2011
Fair value of warrants outstanding as of March 31		$	130,590			$	817,343
Fair value of exercised warrants transferred to equity			—				(180,808	)
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			—				41,438
Unrealized loss on warrants			2,663				184,285
Fair value of warrants outstanding as of June 30		$	133,253			$	862,258

 

See Note 4, “Fair Value of Warrants”, for additional information on the warrant activity subject to fair value accounting for the three months ended June 30, 2012.

 

Income tax expense

Our effective tax rate was 51.1% and 50.2% during the three months ended June 30, 2012 and 2011, respectively, which differs from the expected tax rate of 40.0%, primarily due to permanent differences related to stock-based compensation, derivatives related to warrants and Merger-related expenses. The change in our effective tax rate from prior periods is primarily due to permanent differences related to higher stock-based compensation and non-deductible Merger-related expenses and lower losses on derivatives related to warrants. We recorded income tax expense of $376,000 and an income tax benefit of $36,000 for the three months ended June 30, 2012 and 2011, respectively.

 

 

Six Months Ended June 30, 2012 compared to Six Months Ended June 30, 2011

The following discussion of financial results is derived from unaudited financial statements for the six months ended June 30, 2012 and 2011.

 

		Six Months Ended								Six Months Ended
		June 30, 2012								June 30, 2011
		Amount				% of Revenue				Amount				% of Revenue
Service contract revenue		$	38,594,436				100.0	%		$	32,967,885				100.0	%
HEALTHCARE EXPENSES:
Salaries, wages and employee benefits			21,678,278				56.2	%			18,750,281				56.9	%
Medical expenses			8,645,862				22.4	%			6,891,916				20.9	%
Other operating expenses			1,512,048				3.9	%			1,319,716				4.0	%
Total healthcare expenses			31,836,188				82.5	%			26,961,913				81.8	%
Gross profit			6,758,248				17.5	%			6,005,972				18.2	%
OPERATING EXPENSES:
Selling and administrative expenses			5,240,802				13.6	%			4,858,807				14.7	%
Depreciation and amortization			262,811				0.7	%			332,526				1.0	%
Total operating expenses			5,503,613				14.3	%			5,191,333				15.7	%
Operating income			1,254,635				3.3	%			814,639				2.5	%
OTHER INCOME (EXPENSE)
Interest income			48,003				0.1	%			52,244				0.2	%
Interest (expense)			(6,457	)			(0.0	)%			—				0.0	%
(Loss) on fair value of derivatives			(307,987	)			(0.8	)%			(355,467	)			(1.1	)%
Total other income (expense)			(266,441	)			(0.7	)%			(303,223	)			(0.9	)%
Income before income taxes			988,194				2.6	%			511,416				1.6	%
Income tax expense			495,000				1.3	%			257,000				0.8	%
Net income		$	493,194				1.3	%		$	254,416				0.8	%

 

Summary

Net revenue from medical services provided primarily to correctional institutions for the six months ended June 30, 2012 and 2011, was $38,594,436 and $32,967,885, respectively, which represents an increase of $5,626,551 or 17.1%. Net income was $493,194, or 1.3% of revenue, compared to net income of $254,416, or 0.8% of revenue, for the six months ended June 30, 2012 and 2011, respectively, which represented an increase in net income of $238,778.

 

 

Revenue

The addition of service contracts signed with new jurisdictions since January 1, 2011 accounted for $4,915,056 or 87.4% of the increase in revenue for the six months ended June 30, 2012 compared to the same period for the prior year. These jurisdictions are as follows: Alexandria, VA; Galveston County, TX; Gray County, TX; Haywood County, TN; Marion County, KY; Ocean County, NJ; Oldham County, TX; Newport News, VA; Randall County, TX; and Worcester County, MD. Revenue improvement totaling $270,975, or 4.6% of the increase over the prior year period, 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, 2011. Price increases related to existing service requirements accounted for $544,780, or 9.7% of the increase compared to the prior year period. Also, partially offsetting the revenue increases above were decreases in other volume related activities totaling $104,260 primarily associated with revenue declines related to business decisions to exit specific less profitable markets, which were partially offset by an increase in revenue associated with higher inmate populations at certain facilities.

 

Healthcare Expenses

Salaries and employee benefits

Salaries and employee benefits for healthcare employees were $21,678,278, or 56.2% of revenue, for the six months ended June 30, 2012, compared to $18,750,281, or 56.9% of revenue, for the six months ended June 30, 2011. The increase in spending for salaries and employee benefits of $2,927,997, or 15.6%, is due primarily to the addition of new healthcare employees resulting from new business. Approximately 97.3% 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.

 

Medical expenses

Medical expenses for the six months ended June 30, 2012 and 2011 were $8,645,862, or 22.4% of revenue, and $6,891,916, or 20.9% of revenue, respectively, which represented an increase of $1,753,946, or 25.4%. Approximately 60.5% of the increase in spending for medical expenses in absolute dollars primarily reflects increases related to medical services for new contracts both in- and out-of-facility as well as pharmacy services. The remainder of the increase is related to increases in medical expenses at existing facilities in which we were providing services prior to January 1, 2011. Out-of-facility expenses increased by approximately 19.4% at existing facilities, primarily due to inpatient hospitalization expenses at Baltimore, Harford, and Loudoun counties. Pharmacy expenses at existing facilities increased by 19.4% and in-facility expenses increased by 8.7%.

 

Other operating expenses

Other operating expenses were $1,512,048, or 3.9% of revenue, for the six months ended June 30, 2012, compared to $1,319,716, or 4.0% of revenue, for the six months ended June 30, 2011. The increase of $192,332 in spending is primarily related to a $112,233 increase in legal fees, a $68,078 increase in travel expenses and a $33,399 increase in information systems expenses partially offset by a $56,198 reduction in professional liability insurance and a $14,983 reduction in education expenses.

 

Gross Profit

Gross profit increased to $6,758,248 for the six months ended June 30, 2012 compared to $6,005,972 for the six months ended June 30, 2011, reflecting the higher volume. However, gross margin as a percentage of revenue declined to 17.5% for the six months ended June 30, 2012 from 18.2% for the six months ended June 30, 2011 due to lower initial margins associated with the new contract wins. Gross profit for the six months ended June 30, 2012 at existing contracts in which we were providing services prior to January 1, 2011 was 19.6%. Gross profit for the six months ended June 30, 2012 for new contracts added since January 1, 2011 was 10.8%.

 

Operating Expenses

Selling and administrative expenses

Selling and administrative expenses for the six months ended June 30, 2012 and 2011 were $5,240,802, or 13.6% of revenue, and $4,858,807, or 14.7% of revenue, respectively. The increased expenditure of $381,995 primarily reflects an increased investment in additional management and administrative personnel required to support new contracts and services added since January 1, 2011 coupled with a $51,696 increase in board expenses, and a $27,575 increase in business development fees which were partially offset by a $278,977 reduction in business taxes which were due to a non-recurring sales tax accrual from the prior year’s period, a $51,795 decrease in Merger-related expense, a $49,142 decrease in legal fees, and a $33,059 reduction in travel expenses. Stock-based compensation for the six months ended June 30, 2012 and 2011 was $285,581 and $211,332, respectively. Restricted stock compensation for the six months ended June 30, 2012 and 2011 was $143,000 and $0, respectively.

 

 

Depreciation and amortization

Depreciation and amortization primarily reflects the amortization of intangible assets related to the acquisition of Conmed, Inc. in January 2007 and the acquisition of Correctional Mental Health Services, LLC (“CMHS”) in November 2008. Amortization of service contracts acquired was $39,000, or 0.1% of revenue, for the six months ended June 30, 2012, compared to $118,000, or 0.4% of revenue, for the six months ended June 30, 2011. 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 $38,222, or 0.1% of revenue, for the six months ended June 30, 2012, compared to $61,335, or 0.2% of revenue, for the six months ended June 30, 2011. Depreciation expense increased to $185,589 for the six months ended June 30, 2012 compared to $153,191 for the prior year period due primarily to capital expenditures associated with purchases of vehicles, computers and software related to electronic medical records systems and medical equipment.

 

Interest income

Interest income was $48,003 for the six months ended June 30, 2012 compared to $52,244 for the same period in 2011. Reduced short-term interest rates partially offset by higher average cash balances during the six months ended June 30, 2012 account for the decreased interest income compared to the same period in 2011.

 

(Loss) on fair value of derivatives

During the six months ended June 30, 2012 and 2011, we recognized a realized loss of $267,407 and $42,089, respectively, related to warrants subject to derivative accounting treatment that were exercised and transferred to equity treatment. The realized loss is the difference between the fair value at the date of exercise and the fair value at the beginning of each year. In addition, during the six months ended June 30, 2012 and 2011, we recorded an unrealized loss of $40,580 and $313,378, respectively. The unrealized loss is the difference between the fair value of warrants remaining at the end of each period and the fair value of those same warrants at the beginning of the each year. The decrease of $272,798 was primarily the result of the decreased number of warrants subject to the derivative accounting treatment due to the exercise of all but 80,000 of the outstanding warrants partially offset by the increase in our stock price of $0.70 during the six months ended June 30, 2012, compared to a $0.60 stock price increase during the six months ended June 30, 2011.

 

During the six months ended June 30, 2012, 31,763 warrants subject to derivative accounting treatment were exercised generating $22,362 of cash receipts and warrants subject to derivative accounting treatment totaling 1,005,020 shares of common stock were exercised by cashless exercise resulting in the issue of 717,297 shares of common stock. As a result, a total of 749,060 shares of common stock were issued related to the exercise of warrants subject to derivative accounting treatment. The fair value of the exercised warrants transferred to equity was $2,337,270 which was estimated using the Black-Scholes option pricing model on each exercise date. As of June 30, 2012, we had outstanding warrants to purchase an aggregate of 80,000 shares of common stock that remain subject to derivative accounting.

 

During the six months ended June 30, 2011, 37,334 warrants subject to derivative accounting treatment were exercised generating $93,335 of cash receipts and warrants subject to derivative accounting treatment totaling 53,333 shares of common stock were exercised by cashless exercise resulting in the issue of 41,081 shares of common stock. As a result, a total of 78,415 shares of common stock were issued related to the exercise of warrants subject to derivative accounting treatment.

 

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

 

		2012				2011
Fair value of warrants outstanding as of January 1		$	2,162,536			$	692,696
Fair value of exercised warrants transferred to equity			(2,337,270	)			(185,905	)
Realized loss on warrants exercised or reclassified to equity treatment upon amendment			267,407				42,089
Unrealized loss on warrants			40,580				313,378
Fair value of warrants outstanding as of June 30		$	133,253			$	862,258

 

See Note 4, “Fair Value of Warrants”, for additional information on the warrant activity subject to fair value accounting for the six months ended June 30, 2012.

 

 

Income tax expense

 

Our effective tax rate was 50.1% and 50.2% during the six months ended June 30, 2012 and 2011, respectively, which differs from the expected tax rate of 40.0%, primarily due to permanent differences related to stock-based compensation, derivatives related to warrants and Merger-related expenses. The change in our effective tax rate from prior periods is primarily due to permanent differences related to higher stock-based compensation and non-deductible Merger-related expenses and lower losses on derivatives related to warrants. We recorded income tax expense of $495,000 and $257,000 for the six months ended June 30, 2012 and 2011, respectively.

 

Liquidity and Capital Resources

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

 

Cash Flow for the six months ended June 30, 2012 compared to the six months ended June 30, 2011

Cash as of June 30, 2012 and June 30, 2011 was $17,452,061 and $14,624,795, 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, 2012 totaled $2,423,299, reflecting a net income of $493,194 plus $1,171,837 in adjustments for non-cash expenses such as amortization of intangible assets of $77,222, amortization of long-term customer agreement of $87,500, stock-based compensation of $285,581, restricted stock compensation of $143,000, change in fair value of warrants of $307,987, depreciation of $185,589, gain on the disposal of property of $24,042 and deferred income taxes of $109,000. Changes in working capital components provided $758,268, reflective of a decrease in prepaid expenses of $530,142 and increases in accrued expenses of $1,508,214 and accounts payable of $30,948, partially offset by an increase in accounts receivable of $383,112 and deposits of $62,517 as well as decreases in deferred revenue of $159,320 and income taxes payable of $706,087. The increase in accounts payable was primarily due to the timing of vendor payments in relation to quarter end. The increase in accrued expenses resulted primarily from increases in accrued medical expenses, accrued malpractice litigation expenses and accruals for employee benefits which was partially offset by a decrease in accrued bonus expense due to the payment of annual corporate bonuses in April 2012. 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 receivable resulted primarily from slower collection of receivables on certain existing medical service contracts resulting in an average 16.3 days sales outstanding as of June 30, 2012 compared to an average 15.5 days sales outstanding as of December 31, 2011. The decrease in prepaid expenses resulted primarily from a reduction in prepaid professional liability insurance. We prepaid our annual professional liability insurance policy premium in October 2011 and we expense the prepaid amounts ratably during the annual policy period of October through September. The increase in deposits resulted primarily from a bid deposit required for a request for proposal which will be refunded after award of the contract. Deferred revenue decreased primarily as a result of a reduction in advance customer payments due to their fiscal year ending June 30, 2012 which prohibits them from making advance payments for services pertaining to the next fiscal year.

 

Cash flow from operations for the six months ended June 30, 2011 totaled $1,315,193, reflecting a net income of $254,416 plus $1,056,825 in adjustments for non-cash expenses such as amortization of intangible assets of $179,335, amortization of long-term customer agreement of $87,500, stock-based compensation of $211,332, change in fair value of warrants of $355,467, depreciation of $153,191 and deferred income taxes of $70,000. Changes in working capital components generated an additional $3,952, reflecting a decrease in prepaid expenses of $592,137 and deposits of $201 as well as an increase in accounts payable of $736,345 partially offset by an increase in accounts receivable of $339,084 as well as a decrease in deferred revenue of $445,634, income taxes payable/receivable of $505,379 and accrued expenses of $34,634. The decrease in prepaid expenses resulted primarily from a reduction in prepaid professional liability insurance. We prepaid our annual professional liability insurance policy premium in October 2010 and we expense the prepaid amounts ratably during the annual policy period of October through September. The increase in accounts payable was primarily due to the addition of new service contracts, increased payables relating to the Merger and an increase in the payables that were previously reflected in accrued expenses. The increase in accounts receivable resulted primarily from faster collection of receivables on new medical service contracts added in 2010 which was partially offset by increased receivables for stop/loss reimbursements due to out of facility medical expenditures in excess of stop/loss limits related to new service contracts. The decrease in accrued expenses resulted primarily from a decrease in accrued wages covering one fewer day as compared to the accrual at December 31, 2010 which was partially offset by increases in accruals for Merger related expenses and a non-recurring sales tax accrual. The decrease in income taxes payable/receivable resulted primarily from the payment of scheduled estimated taxes partially offset by accruals of estimated taxes payable. Deferred revenue decreased primarily as a result of a reduction in advance customer payments due to their fiscal year ending June 30, 2011 which prohibits them from making advance payments for services pertaining to the next fiscal year.

 

 

Cash Flows from Investing Activities

Cash flow from investing activities for the six months ended June 30, 2012 used $668,617. Purchases of property and equipment used $418,617 primarily for purchases of vehicles, furniture related to the expansion of the corporate office, computers, software and medical equipment. The purchase of the assets of a small correctional healthcare company used $250,000.

 

Cash flow used in investing activities for the six months ended June 30, 2011 used $221,323 for purchases of property and equipment primarily for purchases of vehicles, computers, software and medical equipment.

 

Cash Flows from Financing Activities

Cash flow from financing activities for the six months ended June 30, 2012 used $748,559. Proceeds from the exercise of stock options and warrants provided $83,543 and the financing of certain business insurance policies required payments of $832,102.

 

Cash flow from financing activities for the six months ended June 30, 2011 generated cash of $260,836 related to the proceeds from the exercise of warrants and stock options.

 

Loans

As of June 30, 2012, we had no outstanding loans.

 

Off Balance Sheet Arrangements

We are required to provide performance and payment guarantee bonds to county governments under certain contracts. As of June 30, 2012, we have seven performance bonds totaling $6,515,677 and three payment bonds for $3,958,020, totaling $10,473,696. 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, 2012:

 

		Total				Current				2 – 3 Years				4 – 5 Years				Thereafter
Equipment leases			184,090				61,034				97,053				26,003				—
Automobile leases			129,489				62,422				67,067				—				—
Office Space leased			335,930				216,362				119,568				—				—
Total Contractual Cash Obligations		$	649,509			$	339,818			$	283,688			$	26,003			$	—

 

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, 2012, we have entered into 70 agreements with county and municipal 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 option of the county or municipality. The original terms of the contracts are from one to ten years. These medical and mental healthcare service contracts have potential future service contract revenue of $220 million as of June 30, 2012, with a weighted-average term of 4.1 years including option renewal periods, of which approximately $62 million relates to the initial contract period and approximately $158 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.

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.

 

 

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.

MINE SAFETY DISCLOSURES

No disclosure required pursuant to this Item.

 

ITEM 5.

OTHER INFORMATION

None

 

ITEM 6.

EXHIBITS

	2.1	Agreement and Plan of Merger, dated as of July 16, 2012, by and among Conmed Healthcare Management, Inc., Correct Care Solutions, LLC and Hanover Merger Sub, Inc. (incorporated by reference to the Company’s Current Report on Form 8-K filed on July 18, 2012).
	10.1	Amendment No. 4 to the 2007 Stock Option Plan (incorporated by reference to the Company’s Current Report on Form 8-K filed on May 30, 2012). *
	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
	101	Financial Statements from the quarterly report on Form 10-Q of the Company for the quarter ended June 30, 2012, filed on August 14, 2012, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flows, (iv) the Consolidated Statements of Shareholders’ Equity and (v) the Notes to Consolidated Financial Statements tagged as blocks of text. (†)

 

*

Management contract or compensatory plan or arrangement.

 

(†) Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to liability of that Section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act, except as shall be expressly set forth by specific reference in such filing or document.

 

 

 

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 14, 2012
	By /s/ Richard W. Turner
	Richard W. Turner, Ph.D.
	Chairman and Chief Executive Officer
	(principal executive officer)
August 14, 2012
	By /s/ Thomas W. Fry
	Thomas W. Fry
	Chief Financial Officer and Secretary
	(principal financial officer and principal accounting officer)