UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM            10-Q

(Mark            One)

 

xQuarterly Report pursuant to Section 13            or 15(d) of the Securities Exchange Act of 1934

 

|   | For the quarterly period ended: August 31, 2007                            or |
|--------|-------------------------------------------------------------------------------|

 

oTransition report pursuant to Section 13            or 15(d) of the Securities Exchange Act of 1934

 

|   | For the transition period from ______________ to                            _______________ |
|--------|---------------------------------------------------------------------------------------------|

 

Commission file number:0-11411

 

| QMed, Inc.                                                                                                    |
|---------------------------------------------------------------------------------------------------------------|
| (Exact name of registrant as specified in its                            charter)                             |
|                                                                                                          |
| Delaware                                                                                                      | 22-2468665 |
| (State or other jurisdiction of incorporation or                            organization)                     | (I.R.S. Employer Identification No.) |
|                                                                                                          |   |
| 25 Christopher Way, Eatontown, New                            Jersey                                          | 07724 |
| (Address of principal executive offices)                                                                      | (Zip Code) |
|                                                                                                          |
| (732) 544-5544                                                                                                |
| (Registrant’s telephone number, including area                            code)                         |
|                                                                                                          |
| N/A                                                                                                           |
| (Former name, former address and former fiscal year, if                            changed since last report) |

 

 

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. YesxNoo

 

Indicate by check mark whether the registrant is a large accelerated            filer, an accelerated filer, or a non-accelerated filer. See definition of            “accelerated filer and large accelerated filer” in Rule 12b-2 of the            Exchange Act.

 

Large            accelerated fileroAccelerated filerxNon-accelerated filero

 

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

YesoNox

 

The            number of shares of the registrant’s common stock outstanding on October 3, 2007:            17,051,765.

 

----

 

QMED,            INC. AND SUBSIDIARIES 

FORM            10-Q

 

For            the Quarter Ended August 31, 2007

 

INDEX

 

|           |                  |                                                                                          | Page                                                                                                                                            |
|----------------|-----------------------|------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| Part I.   | Financial Information |                                                                                                                   |
|           | Item 1.          | Financial Statements                                                                                                   |                                                                                                                                            |
|           |                  |                                                                                                                   | Condensed Consolidated Balance Sheets as of August 31,                            2007 and November 30, 2006                                    | 1 |
|           |                  |                                                                                                                   | Condensed Consolidated Statements of Operations for the                            Three and Nine Months Ended August 31, 2007 and 2006         | 2 |
|           |                  |                                                                                                                   | Condensed Consolidated Statements of Comprehensive Loss                            for the Three and Nine Months Ended August 31, 2007 and 2006 | 3 |
|           |                  |                                                                                                                   | Condensed Consolidated Statements of Stockholders’                            Equity for the Nine Months Ended August 31, 2007            | 4 |
|           |                  |                                                                                                                   | Condensed Consolidated Statements of Cash Flows for the                            Nine Months Ended August 31, 2007 and 2006                   | 5 |
|           |                  |                                                                                                                   | Notes to Condensed Consolidated Financial                            Statements                                                                 | 6 |
|           | Item 2.          | Management’s Discussion and Analysis of Financial                            Condition and Results of Operations | 20                                                                                                                                              |
|           | Item 3.          | Quantitative and Qualitative Disclosures About Market                            Risk                                  | 28                                                                                                                                              |
|           | Item 4.          | Controls and Procedures                                                                                                | 28                                                                                                                                              |
| Part II   | Other Information     |                                                                                                                   |
|           | Item 1.          | Legal Proceedings                                                                                                      | 29                                                                                                                                              |
|           | Item 2.          | Unregistered Sales of Equity Securities and Use of                            Proceeds                                 | 29                                                                                                                                              |
|           | Item 3.          | Defaults Upon Senior Securities                                                                                        | 29                                                                                                                                              |
|           | Item 4.          | Submission of Matters to a Vote of Security                            Holders                                         | 29                                                                                                                                              |
|           | Item 5.          | Other Information                                                                                                      | 29                                                                                                                                              |
|           | Item 6.          | Exhibits                                                                                                               | 29                                                                                                                                              |
| Signature      |                  |
| Certifications |                  |

 

----

 

**Part            I.**

**Item            1. Financial Statements**

QMED,            INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

|                                                                                                                                                                                                                                                                                                                                                                                       |   | **August 31,****2007**                                                                                                     |   | **November 30,****2006**                                                                                                   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------|
| ASSETS                                                                                                                                                                                                                                                                                                                                                                                     |   | **(unaudited)**                                                                                                            |   |                                                                                                                       |
| Current assets                                                                                                                                                                                                                                                                                                                                                                             |   |                                                                                                                       |   |                                                                                                                       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                                                  | $      | 2,411,562                                                                                                                  | $      | 3,039,695                                                                                                                  |
| Investments                                                                                                                                                                                                                                                                                                                                                                                |   | 4,011,933                                                                                                                  |   | 10,867,815                                                                                                                 |
| Accounts receivable, net of allowances of $49,910 and                            $59,505,    respectively                                                                                                                                                                                                                                                              |   |  

2,627,358                                                                                                          |   |  

2,005,485                                                                                                          |
| Inventory, net of reserve                                                                                                                                                                                                                                                                                                                                                                  |   | 13,278                                                                                                                     |   | 36,631                                                                                                                     |
| Prepaid commissions                                                                                                                                                                                                                                                                                                                                                                        |   | 457,045                                                                                                                    |   | -                                                                                                                          |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                                                                  |   | 510,435                                                                                                                    |   | 301,282                                                                                                                    |
|                                                                                                                                                                                                                                                                                                                                                                                       |   | 10,031,611                                                                                                                 |   | 16,250,908                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |
| Restricted cash and cash equivalents,                            non-current                                                                                                                                                                                                                                                                                                               |   | 2,975,081                                                                                                                  |   | 705,881                                                                                                                    |
| Property and equipment, net of accumulated                            depreciation                                                                                                                                                                                                                                                                                                         |   | 762,453                                                                                                                    |   | 989,329                                                                                                                    |
| Product software development costs, net                                                                                                                                                                                                                                                                                                                                                    |   | 1,970,885                                                                                                                  |   | 2,104,788                                                                                                                  |
| Acquired intangibles, net                                                                                                                                                                                                                                                                                                                                                                  |   | 462,675                                                                                                                    |   | 587,027                                                                                                                    |
| Other assets                                                                                                                                                                                                                                                                                                                                                                               |   | 142,513                                                                                                                    |   | 149,202                                                                                                                    |
| Investment in joint ventures                                                                                                                                                                                                                                                                                                                                                               |   | 19,050                                                                                                                     |   | 23,703                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                       | $      | 16,364,268                                                                                                                 | $      | 20,810,838                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                                                                                                                 |   |                                                                                                                       |   |                                                                                                                       |
| Current liabilities                                                                                                                                                                                                                                                                                                                                                                        |   |                                                                                                                       |   |                                                                                                                       |
| Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                                                                                      | $      | 2,410,285                                                                                                                  | $      | 2,827,223                                                                                                                  |
| Medical claims payable                                                                                                                                                                                                                                                                                                                                                                     |   | 7,570,729                                                                                                                  |   | 364,830                                                                                                                    |
| Leases payable, current portion                                                                                                                                                                                                                                                                                                                                                            |   | 20,142                                                                                                                     |   | 65,881                                                                                                                     |
| Accrued salaries and commissions                                                                                                                                                                                                                                                                                                                                                           |   | 558,796                                                                                                                    |   | 446,740                                                                                                                    |
| Fees reimbursable to health plans                                                                                                                                                                                                                                                                                                                                                          |   | 7,825                                                                                                                      |   | 47,005                                                                                                                     |
| Contract billings in excess of revenue                                                                                                                                                                                                                                                                                                                                                     |   | 1,564,667                                                                                                                  |   | 1,396,423                                                                                                                  |
| Deferred revenue                                                                                                                                                                                                                                                                                                                                                                           |   | 528,960                                                                                                                    |   | 16,583                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                       |   | 12,661,404                                                                                                                 |   | 5,164,685                                                                                                                  |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |
| Leases payable – long term                                                                                                                                                                                                                                                                                                                                                           |   | -                                                                                                                          |   | 11,645                                                                                                                     |
| Accrued severance payable, long term                                                                                                                                                                                                                                                                                                                                                       |   | 313,589                                                                                                                    |   | 619,643                                                                                                                    |
|                                                                                                                                                                                                                                                                                                                                                                                       |   | 12,974,993                                                                                                                 |   | 5,795,973                                                                                                                  |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |
| Commitments and Contingencies                                                                                                                                                                                                                                                                                                                                                              |   |                                                                                                                       |   |                                                                                                                       |
|  

                             

Stockholders’ equity

Common stock $.001 par value; 40,000,000 shares                            authorized;      17,013,056 and                            16,858,539 shares issued and 16,991,056 and      16,836,539                            outstanding, respectively |   |  

                             

                             

                             

17,013 |   |  

                             

                             

                             

16,859 |
| Paid-in capital                                                                                                                                                                                                                                                                                                                                                                            |   | 54,885,049                                                                                                                 |   | 53,433,095                                                                                                                 |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                                                        |   | (51,423,068)                                                                                                               |   | (38,354,696)                                                                                                               |
| Accumulated other comprehensive loss      Unrealized loss on                            securities available for sale                                                                                                                                                                                                                                        |   |  

(14,094)                                                                                                           |   |  

(4,768)                                                                                                            |
|                                                                                                                                                                                                                                                                                                                                                                                       |   | 3,464,900                                                                                                                  |   | 15,090,490                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |
| Less treasury stock at cost, 22,000 common                            shares                                                                                                                                                                                                                                                                                                               |   | (75,625)                                                                                                                   |   | (75,625)                                                                                                                   |
| Total stockholders’ equity                                                                                                                                                                                                                                                                                                                                                           |   | 3,389,275                                                                                                                  |   | 15,014,865                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                       | $      | 16,364,268                                                                                                                 | $      | 20,810,838                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |
|                                                                                                                                                                                                                                                                                                                                                                                       |   |                                                                                                                       |   |                                                                                                                       |

 

See            Accompanying Notes to Condensed Consolidated Financial Statements

 

1

 

----

 

QMED,            INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

|                                          | **For the Three**

**Months Ended**

**August 31,**

**2007** | **For the Three**

**Months Ended**

**August 31,**

**2006** | **For the Nine**

**Months Ended**

**August 31,**

**2007** | **For the Nine**

**Months Ended**

**August 31,**

**2006** |
|-----------------------------------------------|---------------------------------------------------------------|---------------------------------------------------------------|--------------------------------------------------------------|--------------------------------------------------------------|
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Revenue                                       | $                                                             | 10,781,247                                               | $                                                            | 2,202,270                                               | $ | 26,574,368  | $ | 7,306,588  |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Cost of revenue                               |                                                          | 15,430,886                                               |                                                         | 1,371,709                                               |   | 28,741,667  |   | 4,951,164  |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Gross (loss) margin                           |                                                          | (4,649,639)                                                   |                                                         | 830,561                                                 |   | (2,167,299) |   | 2,355,424  |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Selling, general and

administrative expenses |  

                                                 |  

4,079,495                                        |  

                                                |  

4,025,951                                       |  

                              |  

12,125,123  |  

                              |  

11,099,815  |
| Research and development expenses             |                                                          | 604,031                                                  |                                                         | 298,836                                                 |   | 1,553,086  |   | 1,180,866  |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Loss from operations                          |                                                          | (9,333,165)                                                   |                                                         | (3,494,226)                                                  |   | (15,845,508) |   | (9,925,257) |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Interest expense                              |                                                          | (5,903)                                                       |                                                         | (4,337)                                                      |   | (20,844) |   | (15,146) |
| Interest income                               |                                                          | 137,307                                                  |                                                         | 201,833                                                 |   | 458,682  |   | 577,152  |
| Loss in operations of

joint ventures         |                                                          |  

-                                                |                                                         |  

(18,927)                                             |   |  

(24,973) |   |  

(57,365) |
| Other income                                  |                                                          | -                                                        |                                                         | -                                                       |   | 2,375,400  |   | 450,000  |
| Loss before income tax

provision             |                                                          |  

(9,201,761)                                           |                                                         |  

(3,315,657)                                          |   |  

(13,057,243) |   |  

(8,970,616) |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Benefit (provision) for income taxes          |                                                          | 362                                                      |                                                         | (1,744)                                                      |   | (11,129) |   | 45,670  |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Net loss                                      | $                                                             | (9,201,399)                                                   | $                                                            | (3,317,401)                                                  | $ | (13,068,372) | $ | (8,924,946) |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Basic and diluted loss per share              |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Weighted average shares outstanding           |                                                          | 16,989,180                                               |                                                         | 16,823,885                                              |   | 16,953,750  |   | 16,804,457  |
| Basic and diluted loss per share              | $                                                             | (.54)                                                         | $                                                            | (.20)                                                        | $ | (.77) | $ | (.53) |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
|                                          |                                                          |                                                          |                                                         |                                                         |   |   |   |   |

 

 

See            Accompanying Notes to Condensed Consolidated Financial Statements

 

2

 

----

 

QMED,            INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

 

 

|                                                     | **For the Three**

**Months Ended**

**August 31,**

**2007** | **For the Three**

**Months Ended**

**August 31,**

**2006** | **For the Nine**

**Months Ended**

**August 31,**

**2007** | **For the Nine**

**Months Ended**

**August 31,**

**2006** |
|----------------------------------------------------------|---------------------------------------------------------------|---------------------------------------------------------------|--------------------------------------------------------------|--------------------------------------------------------------|
|                                                     |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Net loss                                                 | $                                                             | (9,201,399)                                                   | $                                                            | (3,317,401)                                                  | $ | (13,068,372) | $ | (8,924,946) |
|                                                     |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Other comprehensive income                               |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Unrealized (loss) gain on securities

available for sale |  

                                                 |  

(10,637)                                              |  

                                                |  

(1,424)                                              |   |  

(9,326) |  

                              |  

16,737  |
|                                                     |                                                          |                                                          |                                                         |                                                         |   |   |   |   |
| Comprehensive loss                                       | $                                                             | (9,212,036)                                                   | $                                                            | (3,318,825)                                                  | $ | (13,077,698) | $ | (8,908,209) |

 

 

 

See            Accompanying Notes to Condensed Consolidated Financial Statements

3

 

----

 

QMED,            INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’            EQUITY

For            the Nine Months Ended August 31, 2007

(Unaudited)

 

|                                                                                                                                                                                      | **Common Stock**                                                               |                                       | **Paid-in**                                                                    |  

                              | **Accumulated** |                                                                           | **Accumulated Other Comprehensive** |  

                              | **Common Stock Held in Treasury** |   |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------|--------------------------------------------|--------------------------------------------------------------------------------|--------------------------------------------|-----------------|--------------------------------------------------------------------------------|-------------------------------------|--------------------------------------------|-----------------------------------|--------|------------|
|                                                                                                                                                                                      | **Shares**                                                                     |                                       | **Amount**                                                                     |                                       | **Capital**     |                                                                           | **Deficit**                         |                                       | **Loss**                          |   | **Shares** |   | **Amount** |   | **Total** |
|  

Balance –                              November 30, 2006                                                                                                          |  

16,858,539                                                             |  

                              |  

$  16,859                                                    |                                       |  

$       |  

53,433,095                                                             |                                |  

$                                  |  

(38,354,696)              |   |  

$  |  

(4,768) |   |  

22,000 |  

                              |  

$(75,625) |   |  

$ |  

15,014,865  |
|                                                                                                                                                                                      |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |                              |   |       |   |   |   |   |   |   |   |   |
| Exercise of stock options                               and warrants                                                                                                            |  

137,941                                                                |                                       |  

137                                                                    |                                       |            |  

381,867                                                                |                                |                                       |                              |   |       |   |   |   |   |   |   |   |  

382,004  |
|                                                                                                                                                                                      |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |                              |   |       |   |   |   |   |   |   |   |   |
| Stock compensation in                               connection with the                               Directors Equity Plan                                           |  

16,576                                                                 |                                       |  

17                                                                     |                                       |            |  

69,075                                                                 |                                |                                       |                              |   |       |   |   |   |   |   |   |   |  

69,092  |
|                                                                                                                                                                                      |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |                              |   |       |   |   |   |   |   |   |   |   |
| Share-based employee                              compensation expense                                                                                                          |                                                                           |                                       |                                                                           |                                       |            |  

1,001,012                                                              |                                |                                       |                              |   |       |   |   |   |   |   |   |   |  

1,001,012  |
|                                                                                                                                                                                      |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |                              |   |       |   |   |   |   |   |   |   |   |
| Net loss for the                              nine months ended                              August 31, 2007                                                          |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |  

(13,068,372)              |   |       |   |   |   |   |   |   |   | (13,068,372) |
|                                                                                                                                                                                      |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |                              |   |       |   |   |   |   |   |   |   |   |
| Change in unrealized                               holding loss on                              securities available                               for sale |  

                             

                              |                                       |  

                             

                              |                                       |            |  

                             

                              |                                |                                       |                              |   |       |  

                             

(9,326) |   |  

                             

                              |   |  

                             

                              |   |   |  

                             

(9,326) |
|                                                                                                                                                                                      |                                                                           |                                       |                                                                           |                                       |            |                                                                           |                                |                                       |                              |   |       |   |   |   |   |   |   |   |   |
| Balance –                              August 31, 2007                                                                                                                    | 17,013,056                                                                     |                                       | $  17,013                                                            |                                       | $               | 54,885,049                                                                     |                                | $                                          | (51,423,068)                      |   | $          | (14,094) |   | 22,000 |   | $(75,625) |   | $ | 3,389,275  |

 

 

See            Accompanying Notes to Condensed Consolidated Financial Statements

 

4

 

----

 

QMED,            INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

|                                                                                                                                                                                                    | **For the Nine**

**Months Ended**

**August 31, 2007** | **For the Nine**

**Months Ended**

**August 31, 2006** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------|---------------------------------------------------------|
| Cash flows from operating activities:                                                                                                                                                                   |                                                    |                                                    |   |   |
| Net loss                                                                                                                                                                                                | $                                                       | (13,068,372)                                            | $ | (8,924,946) |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |
| Adjustments to reconcile net loss to net cash (used in)                            provided by operating activities:                                                                                    |                                                    |                                                    |   |   |
| Loss in operations of joint ventures                                                                                                                                                                    |                                                    | 24,973                                             |   | 57,365  |
| Depreciation and amortization                                                                                                                                                                           |                                                    | 881,203                                            |   | 605,343  |
| Provision for loss on accounts receivable                                                                                                                                                               |                                                    | 34,214                                             |   | 9,283  |
| Provision for slow-moving inventory                                                                                                                                                                     |                                                    | 11,859                                             |   | -  |
| Stock compensation expense                                                                                                                                                                              |                                                    | 69,092                                             |   | 34,802  |
| Share-based employee compensation expense                                                                                                                                                               |                                                    | 1,001,012                                          |   | 1,300,367  |
| Amortization of non-employee stock options                                                                                                                                                              |                                                    | -                                                  |   | 83,063  |
| Amortization of bond discounts and premiums                                                                                                                                                             |                                                    | 518                                                |   | (43,193) |
| (Increase) decrease in                                                                                                                                                                                  |                                                    |                                                    |   |   |
| Accounts Receivable                                                                                                                                                                                     |                                                    | (656,087)                                               |   | 1,424,068  |
| Inventory                                                                                                                                                                                               |                                                    | 11,494                                             |   | 657  |
| Prepaid expenses and other current assets                                                                                                                                                               |                                                    | (666,198)                                               |   | (4,702) |
| Increase (decrease) in                                                                                                                                                                                  |                                                    |                                                    |   |   |
| Accounts payable and accrued liabilities                                                                                                                                                                |                                                    | (650,117)                                               |   | 302,212  |
| Medical claims payable                                                                                                                                                                                  |                                                    | 7,205,899                                          |   | 165,755  |
| Contract billings in excess of revenues and                            deferred                                           revenue |                                                    |  

680,621                                    |   |  

766,395  |
| Other, net                                                                                                                                                                                              |                                                    | -                                                  |   | (67,966) |
| Total adjustments                                                                                                                                                                                       |                                                    | 7,948,483                                          |   | 4,633,449  |
| Net cash used in operating activities                                                                                                                                                                   |                                                    | (5,119,889)                                             |   | (4,291,497) |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |
| Cash flows from investing activities:                                                                                                                                                                   |                                                    |                                                    |   |   |
| Proceeds from sale of securities available for                            sale                                                                                                                          |                                                    | 7,838,974                                          |   | 8,085,001  |
| Purchases of securities available for sale                                                                                                                                                              |                                                    | (992,936)                                               |   | (3,157,620) |
| Increase in restricted cash and cash equivalents –                            long term                                                                                                           |                                                    | (2,269,200)                                             |   | (705,881) |
| Capital expenditures                                                                                                                                                                                    |                                                    | (63,833)                                                |   | (278,194) |
| Product software development expenditures                                                                                                                                                               |                                                    | (325,550)                                               |   | (920,294) |
| Investment in joint venture                                                                                                                                                                             |                                                    | (20,319)                                                |   | (75,442) |
| Net cash provided by investing activities                                                                                                                                                               |                                                    | 4,167,136                                          |   | 2,947,570  |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |
| Cash flows from financing activities:                                                                                                                                                                   |                                                    |                                                    |   |   |
| Payments for capital leases                                                                                                                                                                             |                                                    | (57,384)                                                |   | (109,241) |
| Proceeds from exercise of stock options                                                                                                                                                                 |                                                    | 382,004                                            |   | 128,318  |
| Net cash provided by financing activities                                                                                                                                                               |                                                    | 324,620                                            |   | 19,077  |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |
| Net increase in cash and cash equivalents                                                                                                                                                               |                                                    | (628,133)                                               |   | (1,324,850) |
| Cash and cash equivalents at beginning of                            period                                                                                                                             |                                                    | 3,039,695                                          |   | 4,051,046  |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |
| Cash and cash equivalents at end of period                                                                                                                                                              | $                                                       | 2,411,562                                          | $ | 2,726,196  |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |
| Supplemental disclosure of cash flow                            information:                                                                                                                            |                                                    |                                                    |   |   |
| Cash paid during the period for:                                                                                                                                                                        |                                                    |                                                    |   |   |
| Interest                                                                                                                                                                                                | $                                                       | 6,786                                              | $ | 15,146  |
| Income taxes                                                                                                                                                                                            |                                                    | 12,349                                             |   | 111,939  |
|                                                                                                                                                                                                    |                                                    |                                                    |   |   |

 

See            Accompanying Notes to Condensed Consolidated Financial Statements

 

5

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1            –Interim Financial Reporting

 

The            accompanying unaudited condensed consolidated financial statements of QMed, Inc. and            its subsidiaries (the “Company”) have been prepared in accordance with            generally accepted accounting principles for interim financial information.            Accordingly, these financial statements do not include all of the information and            footnotes required by generally accepted accounting principles. In the opinion of            management, all adjustments (consisting of normal recurring accruals) considered            necessary for a fair presentation have been included. Operating results for the three            and nine month period ended August 31, 2007 are not necessarily indicative of the            results that may be expected for the current fiscal year ending November 30, 2007.            These condensed consolidated financials statements include the accounts of QMed, Inc.,            its wholly owned subsidiaries; Interactive Heart Management Corp. (“IHMC”);            QMedCare, Inc., its wholly owned subsidiaries; QMedCare of New Jersey, Inc., and            Positive Directions, Inc. (formerly Forward Health, Inc.). These condensed consolidated            financial statements should be read in conjunction with the financial statements and            footnotes thereto included in the Company’s Annual Report on Form 10-K for the            year ended November 30, 2006.

 

Going Concern

 

The            accompanying condensed financial statements have been prepared assuming that the            Company continues as a going concern that contemplates the realization of assets and            satisfaction of liabilities in the normal course of business. However, the ability of            the Company to continue as a going concern will be dependent upon its ability to raise            additional capital or obtain other sources of financing in the immediate future            necessary to meet its obligations and continue operations.

 

During the nine months ended August 31, 2007, the Company incurred net            losses totaling $13,068,372, had net cash used in operating activities of $5,119,889 as            of August 31, 2007. These factors raise substantial doubt as to the Company’s            ability to continue as a going concern. The financial statements do not include any            adjustments that might result from this uncertainty. If the Company is unable to raise            additional capital or obtain other sources of financing to meet its working capital            requirements, it may have to curtail its business sharply or cease business            altogether.

 

Management’s plan is to raise additional capital through a variety            of fund raising methods and to pursue all available financing alternatives as necessary            to fund operations. The Company needs to raise additional funds in the immediate future            in order to continue its operations. Whereas the Company has been successful in the            past in raising capital, no assurance can be given that these sources of financing will            continue to be available to the Company and/or that demand for the Company’s            equity/debt instruments will be sufficient to meet its capital needs. The financial            statements do not include any adjustments relating to the recoverability and            classification of liabilities that might be necessary should the Company be unable to            continue as a going concern.

 

To            the extent that the Company raises additional capital through the sale of equity or            convertible debt securities, the issuance of such securities may result in dilution to            existing stockholders. If additional funds are raised through the issuance of debt            securities, these securities may have rights, preferences and privileges senior to            holders of common stock and the terms of such debt could impose restrictions on the            Company’s operations.

 

Note 2            –Summary of Significant Accounting            Policies

Managed Care Services – Revenue Recognition

The            Company’s captive insurance company, LakeShore Captive Insurance Company, entered            into an agreement with DAKOTACARE (a South Dakota Health Maintenance Organization            (“HMO”)) in 2005 whereby the captive insurance company assumes 100% of the            risk associated with the operations of a Special Needs Plan (“SNP”) in            South Dakota. The initial term of the agreement is for 5 years and contains provisions            for automatic one year renewals unless a non-renewal notice is provided within 120 days            of expiration. In addition, on January 1, 2007, QMedCare of New Jersey, Inc. commenced            operations of its SNP in New Jersey, which is a risk-bearing HMO plan. The SNPs offer            comprehensive health care coverage and prescription drug benefits for chronically ill            and dual eligible Medicare beneficiaries. In return for provision of care to plan(s)            members, the Company receives a fixed monthly member premium and a Medicare            risk-adjusted premium, which is based upon the diagnoses of the enrolled member as            captured by claims data from the prior year.

 

6

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note            2 –Summary of Significant Accounting Policies –            (continued)

Managed Care Services – Revenue Recognition –            (continued)

 

The            Company records revenue from health care premiums received in the month that enrollees            are entitled to coverage. Revenue for the Managed Care segment totaled approximately            $9,934,000 and $439,000 for the three months ended August 31, 2007 and 2006,            respectively. Revenue for the Managed Care segment totaled approximately $22,758,000            and $877,000 for the nine months ended August 31, 2007 and 2006, respectively. For the            three and nine months ended August 31, 2007, revenue derived from this segment was            approximately 92% and 86% of total revenue, respectively.

 

Generally, pharmacy benefits under Medicare Advantage (“MA”)            plans (collectively referred to as “Part D plans”) may vary in terms of            coverage levels and out-of-pocket costs for beneficiary premiums, deductibles and            co-insurance. However, all Part D plans must offer either “standard            coverage” or its actuarial equivalent (with out-of-pocket threshold and            deductible amounts that do not exceed those of standard coverage). These “defined            standard” benefits represent the minimum level of benefits mandated by Congress.            In addition to defined standard plans, the Company offers prescription drug plans            containing benefits in excess of the standard coverage limits as part of the monthly            premium.

 

The            monthly payment for Part D received from the Centers for Medicare and Medicaid            Services, or CMS, generally represents the Company’s actuarially certified bid            amount for providing prescription drug insurance coverage. However, our CMS payment is            subject to 1) plan liability risk corridors and 2) low income cost sharing in order for            the Company and CMS to share the risk associated with financing the ultimate costs of            our Part D benefit. Since the Company participates in the Flexible Capitation            Reinsurance Demonstrations, there will not be reconciliation items for the Federal            Reinsurance component of the Part D Reconciliation.

 

The            amount of revenue payable to a plan by CMS is subject to adjustment, positive or            negative, based upon the application of risk corridors that compare a plan’s            revenue targeted in their bids (“target amount’) to actual prescription            drug costs. Variances exceeding certain thresholds may result in CMS making additional            payments to the Company or require the Company to refund to CMS a portion of the            premiums received. Actual prescription drug costs subject to risk sharing with CMS are            limited to the costs that are, or would have been, incurred under the CMS            “defined standard” benefit plan (“allowable risk corridor            costs”). Included in the accounts payable and accrued expenses is an estimate of            this adjustment totaling approximately $318,000.

 

The            Company recognizes pharmacy benefit costs as incurred. The Company has subcontracted            the pharmacy claims administration to a third party pharmacy benefit            manager.

 

The            Company also entered into a services agreement with DAKOTACARE, a large health            maintenance organization, to administer the SNP in South Dakota and New Jersey. In            accordance with the agreement, the Company records revenue on a monthly basis as            services are rendered.

 

Managed Care Services - Medical Claims Payable

 

The cost            of health care services is accrued in the period the services are            provided to enrolled members: the accrued cost for health care services            is based in part on estimates for services and other health care costs that have            been incurred but not yet reported or paid (IBNP). IBNP is classifiedas “medical claims payable” on the condensed consolidated            balance sheet. The Company’s estimates are initially based upon an independent            actuarial model of expected costs. As the plan matures, the Company will develop these            estimates using standard actuarial methods which may include, among other factors, the            average interval between the dates services are rendered and the date claims are paid,            denied claims activity, disputed claims activity, expected health care cost inflation,            utilization, seasonality patterns and changes in membership.

 

A large            portion of medical claims are not submitted to the Company until after the end of the            quarter in which services are rendered by providers to the Company’s members.            Accordingly, the Company uses an extensive degree of judgment in the process of            estimating its medical claims payable and as a result, considerable variability and            uncertainty is inherent in such estimates, and the adequacy of such estimates is highly            sensitive to changes in assumed completion factors and the assumed health care cost            trend rate. For each reporting period, the Company recognizes its best            estimate

 

7

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note            2 –Summary of Significant Accounting Policies –            (continued)

Managed Care Services - Medical Claims Payable –            (continued)

 

of            medical claims payable considering the potential volatility in assumed completion            factors and health care cost trend rates, as well as other factors.

 

The            Company’s management believes the estimate of medical claims payable is            reasonable and adequate to cover its obligations at August 31, 2007; however,            actual claim payments may differ from this estimate. A worsening (or improvement) of            our health care cost trend rates or changes in medical claims payment patterns from            those that were assumed in estimating medical claims payable at August 31, 2007            would cause this estimate to change in the near term, and such a change could be            material. The estimate for submitted claims and IBNP claims liabilities are made on an            accrual basis and adjusted in future periods as required. Adjustments to prior period            estimates or financial results, if any, are included in current operations.

 

Managed Care Services – Broker Commissions

 

Broker commissions related to the SNPs are paid at the time of            enrollment and amortized on a straight-line basis over twelve months beginning with the            effective date of coverage. Commissions are adjusted for subsequent disenrollments            during the period. As a result, the unamortized balance of the commission payments are            classified as prepaid on the balance sheet.

 

Disease Management – Revenue Recognition

 

The            Company enters into contractual arrangements with health plans and government agencies            to provide disease management services. Fees under the Company’s health plan            contracts are generally determined by multiplying a contractually negotiated rate per            health plan member per month (“PMPM”) by the number of health plan members            covered by the Company’s services during the month. The PMPM rates usually differ            between contracts due to the various types of health plan product groups (e.g. PPO,            HMO, Medicare Advantage). These contracts are generally for terms of one to three years            with provisions for subsequent renewal, and typically provide for a small portion of            the Company’s fees may be “performance-based”. The Company bills its            customers each month for the entire amount of the fees contractually due based on            previous month’s membership, which always includes the amount, if any that may be            subject to refund for member retroactivity and a shortfall in performance. The Company            adjusts or defers revenue for contracts where it believes performance is short of            contractual obligations. Adjustments for shortfalls in performance targets under the            terms of the contract or other factors affecting revenue recognition are accrued on an            estimated basis in the period the services are provided and are adjusted in future            periods when final settlement is determined. The Company reviews these estimates            periodically and makes adjustments, as interim information is available.

 

Under performance based arrangements, the ability to make estimates at            interim periods can be challenging due to the inherent nature of the medical claims            process and the claims lag time associated with it. In most cases, paid claims data is            not available until up to six months after claims are incurred. Although interim data            measurement is indicative of performance objectives, actual results could differ from            those estimates. As of August 31, 2007, based on information and data available, the            Company has deferred approximately $1,565,000 of revenue, which may be subject to            refund. This deferral has been reflected as contract billings in excess of revenues on            the balance sheet.

 

Note            3 –Impairment of Intangible Assets

 

In            accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the            Company is required to review intangible assets for impairment on an annual basis or            more frequently whenever events or circumstances indicate that the carrying value may            not be recoverable.

 

The            Company amortizes other identifiable intangible assets, such as acquired technologies            and other intangibles, on the straight-line method over their estimated useful lives,            except for trade names, which have an indefinite life and are not subject to            amortization. The Company reviews intangible assets not subject to amortization on an            annual basis or more frequently whenever events or circumstances indicate that the            assets might be impaired. The Company also assesses the

 

8

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note            3 –Impairment of Intangible Assets –            (continued)

 

potential impairment of intangible assets subject to amortization            whenever events or changes in circumstances indicate that the carrying values may not            be recoverable.

 

If            the Company determines that the carrying value of other identifiable intangible assets            may not be recoverable, the Company would calculate any impairment using an estimate of            the asset’s fair value based on the projected net cash flows expected to result            from that asset, including eventual disposition.

 

Note            4 –Use of Estimates

 

The            preparation of financial statements in conformity with generally accepted accounting            principles in the United States of America requires management to make estimates and            assumptions that affect the reported amounts of assets and liabilities and disclosure            of deferral, contingent assets and liabilities at the date of the financial statements,            and the reported amounts of revenue and expenses during the reporting period. Actual            results could differ from those estimates.

 

Note            5 –Investments in Securities

 

Investment in securities treated as available-for-sale as of August 31,            2007 and November 30, 2006 were as follows:

 

 

| **2007**                  |   | **Cost**  |   | **Market**

**Value** |   | **Unrealized**

**Gain (Loss)** |
|---------------------------|--------|-----------|--------|-----------------------|--------|---------------------------------|
|                      |   |      |   |                  |   |                            |
| Corporate debt securities | $      | 4,026,027 | $      | 4,011,933             | $      | (14,094)                        |
|                      |   |      |   |                  |   |                            |

 

 

 

 

 

| **2006**                  |   | **Cost**   |   | **Market**

**Value** |   | **Unrealized**

**Gain (Loss)** |
|---------------------------|--------|------------|--------|-----------------------|--------|---------------------------------|
|                      |   |       |   |                  |   |                            |
| Corporate debt securities | $      | 10,872,583 | $      | 10,867,815            | $      | (4,768)                         |
|                      |   |       |   |                  |   |                            |
|                      |   |       |   |                  |   |                            |

 

 

 

 

 

Note            6 –Accounts Receivable

 

Accounts receivable primarily represent fees and insurance premiums            receivable that are contractually due in the ordinary course of providing a service,            net of contractual adjustments and the allowance for doubtful accounts.

 

Note 7            –Inventory

 

Inventories, consisting of finished units and raw materials, are stated            at the lower of cost (determined on a moving weighted average method) or market.            Inventories consist of the following:

 

|                              |   | **August 31,**

**2007**

**(Unaudited)** |   | **November 30,**

**2006** |
|-----------------------------------|--------|-------------------------------------------|--------|----------------------------|
|                              |   |                                      |   |                       |
| Raw materials (component parts)   | $      | 116,112                              | $      | 114,225               |
| Finished units                    |   | 20,085                               |   | 33,466                |
| Total inventory                   | $      | 136,197                              | $      | 147,691               |
| Reserve for slow moving inventory |   | (122,919)                                 |   | (111,060)                  |
| Net inventory                     | $      | 13,278                               | $      | 36,631                |

 

 

9

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 8            –Product Software Development Costs

 

During the three months ended August 31, 2007 and 2006, the Company            capitalized approximately $18,000 and $428,000, respectively, in product software            development costs. During the nine months ended August 31, 2007 and 2006, the Company            capitalized approximately $326,000 and $920,000, respectively. These costs are being            amortized over a two to five-year useful life.

 

During the three months ended August 31, 2007 and 2006, amortization            expense related to product software development costs was approximately $161,000 and            $86,000, respectively. During the nine months ended August 31, 2007 and 2006            amortization expense related to product software development costs was approximately            $459,000 and $185,000, respectively. Accumulated amortization was $1,360,837 and            $804,745 at August 31, 2007 and 2006, respectively. Estimated amortization expense is            $159,000 for the remainder of fiscal year 2007, $596,000 for fiscal year 2008, $555,000            for fiscal year 2009, $367,000 for fiscal year 2010, $260,000 for fiscal year 2011 and            $34,000 thereafter.

 

Note 9            –Restricted Cash and Cash Equivalents

 

In            December 2005, the Company established a $250,000 letter of credit with Wachovia Bank,            N.A. to establish the appropriate capital required for the Company’s captive            insurance company in South Carolina. The letter of credit is collateralized by cash and            expires on December 31, 2007. These funds were classified as non-current assets as the            cash was not available for current operations and the Company had intent on extending            the letter of credit at the time of expiration. In May 2007, the letter of credit was            released by the State of South Carolina and accordingly, the funds are classified as            current assets as the cash is available for current operations. The funds are currently            invested in a money market account.

 

In            May 2006, the Company received approval of their application to obtain a license to            operate as a Health Maintenance Organization within the State of New Jersey from the            Department of Banking and Insurance. In accordance with statutory requirements, the            Company was required to establish an administrative reserve in the amount of            approximately $456,000. These funds are classified as noncurrent assets as the cash is            not available for current operations. The funds are currently invested in certificates            of deposit. In June 2007, these funds were increased to $474,000 in accordance with            statutory requirements.

 

In            December 2006, the Company funded an additional $2.5 million representing an insolvency            reserve established for QMedCare of New Jersey, Inc. as required by the State of New            Jersey Department of Banking and Insurance. These funds are classified as noncurrent            assets as the cash is not available for current operations. The funds are held in trust            currently invested in certificates of deposit.

 

Note 10            –Acquired Intangibles

 

In            April 2005, the Company acquired all of the outstanding common stock of Positive            Directions, Inc. (formerly Forward Health, Inc.). Positive Directions had developed a            weight management program but had not yet commenced significant operations. In            accordance with SFAS No. 141 “Business Combinations,” this transaction was            accounted for as a purchase of assets as defined by EITF Issue No. 98-3            “Determining Whether a Nonmonetary Transaction Involves Receipt of Productive            Assets or of a Business” rather than a business combination. Accordingly, no            goodwill was recorded from this acquisition, as consideration in excess of the fair            value of identified assets was allocated pro-rata to the identified intangible assets.            The aggregate purchase price was $500,000, which consisted of $200,000 in cash and            $300,000 of common stock. In addition, transaction costs were approximately $30,000. As            additional consideration under the purchase agreement, the company would be obligated            to release an additional 60,709 shares of common stock upon certain targets being            achieved in 2006. The targets for 2006 were not achieved and as a result, the Company            has no obligation to release these shares. Pursuant to FAS No. 141 the direct costs to            acquire Positive Directions have been allocated to the assets acquired based upon an            independent appraisal and the contingent consideration will be recorded if and when it            becomes due and payable.

 

10

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note            10 –Acquired Intangibles –            (continued)

 

In            October 2005, the Company acquired all of the assets of Disease Management            Technologies, Inc. (“DMT”). DMT had developed a website for a weight            management program that will complement Positive Direction’s existing weight            management program but had not yet commenced significant operations. In accordance with            SFAS No. 141 “Business Combinations,” this transaction was accounted for as            a purchase of assets as defined by EITF Issue No. 98-3 “Determining Whether a            Non-monetary Transaction Involves Receipt of Productive Assets or of a Business”            rather than a business combination. Accordingly, no goodwill was recorded from this            acquisition, as consideration in excess of the fair value of identified assets was            allocated pro-rata to the identified intangible assets. The aggregate purchase price            was $302,000, which consisted of $250,000 in cash and $52,000 of common stock. In            addition, transaction costs were approximately $42,000. As additional consideration            under the purchase agreement, the company would be obligated to issue an additional            87,664 shares of common stock upon certain targets being achieved in 2006. The targets            for 2006 were not achieved and as a result, the Company has no obligation to release            these shares. Pursuant to FAS No. 141 the direct costs to acquire DMT have been            allocated to the assets acquired based upon an independent appraisal and the contingent            consideration will be recorded if and when it becomes due and payable.

 

The            following table summarizes the estimated fair value of the assets acquired and their            balances as of August 31, 2007:

 

|                    |   | Original FairValue |   | AccumulatedAmortization |   | Net BookValue | Useful Lifein                            Years |
|-------------------------|--------|--------------------|--------|-------------------------|--------|---------------|------------------------------------------------|
| Positive Directions:    |   |               |   |                    |   |          |                                           |
| Covenant not to compete | $      | 483,363            | $      | (229,597)               | $      | 253,766       | 5                                              |
| Acquired technology     |   | 46,307             |   | (21,996)                |   | 24,311        | 5                                              |
|                    |   |               |   |                    |   |          |                                           |
| DMT:                    |   |               |   |                    |   |          |                                           |
| Software and contents   |   | 299,348            |   | (114,750)               |   | 184,598       | 5                                              |
| Assembled workforce     |   | 45,117             |   | (45,117)                |   | -             | -                                              |
|                    | $      | 874,135            | $      | (411,460)               | $      | 462,675       |                                           |

 

During the three months ended August 31, 2007, amortization expense            related to the covenant not to compete, acquired technology, and software and contents            was $24,168, $2,315, and $14,967, respectively. During the three months ended August            31, 2006, amortization expense related to the covenant not to compete, acquired            technology, software and contents, and assembled workforce was $24,169, $2,315, $14,967            and $2,820, respectively. During the nine months ended August 31, 2007, amortization            expense related to the covenant not to compete, acquired technology and software and            contents was $72,504, $6,945, and $44,902, respectively. During the nine months ended            August 31, 2006, amortization expense related to the covenant not to compete, acquired            technology, software and contents, and assembled workforce was $72,505, $6,946, $44,902            and $8,460, respectively. Estimated amortization expense is $41,000 for the remainder            of fiscal year 2007, $166,000 for fiscal years 2008 and 2009, and $90,000 for the            fiscal year thereafter.

 

Note 11            –Investment in Joint Ventures

 

The            Company has a 33.33% interest in HealthSuite Partners, LLC (“HSP”). The            management agreement provides for profits and losses to be allocated based on the            Company’s 33.33% interest. As of August 31, 2007, the Company has recorded losses            to date of approximately $254,000 bringing its investment in this joint venture to            approximately $19,000. This joint venture is not a variable interest entity and            therefore is not required to be consolidated under the provisions of FIN 46R. As of            August 31, 2007, approximately $655,000 is due from this joint venture, which is            included in accounts receivable. The collection of this receivable is subject to            achieving certain contractual performance guarantees.

 

11

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 12            –Accounts Payable and Accrued Expenses

 

Accounts payable and accrued expenses include the following:

 

|                                                                        |                                       | **August 31,**

**2007**

**(Unaudited)** |                                       | **November 30, 2006** |
|-----------------------------------------------------------------------------|--------------------------------------------|-------------------------------------------|--------------------------------------------|-----------------------|
|                                                                        |                                       |                                      |                                       |                  |
| Accounts payable trade                                                      | $                                          | 752,882                                   | $                                          | 1,378,999             |
| Insurance premiums payable                                                  |                                       | 152,293                                   |                                       | 79,124                |
| Professional fees payable                                                   |                                       | 501,880                                   |                                       | 609,553               |
| Accrued severance payable, current                                          |                                       | 324,365                                   |                                       | 323,776               |
| Other accrued expenses – none in

excess of 5% of current liabilities |  

                              |  

678,865                           |  

                              |  

435,771       |
|                                                                        | $                                          | 2,410,285                                 | $                                          | 2,827,223             |

 

Note 13            –Medical Claims Payable

 

The            following table represents a roll-forward of our medical claims reserve inclusive of            our incurred but not reported or paid (IBNP) reserve as of the period            indicated:

 

|                                                                             |             |         |                                                                                                     |   | **For the Nine**    |
|----------------------------------------------------------------------------------|------------------|--------------|----------------------------------------------------------------------------------------------------------|--------|---------------------|
|                                                                             |             |         |                                                                                                     |   | **Months Ended**    |
|                                                                             |             |         |                                                                                                     |   | **August 31, 2007** |
|                                                                             |             |         |                                                                                                     |   |                |
| IBNP as of December 1, 2006                                                      |             |         | $               364,830  |
|                                                                             |             |         |                                                                                                     |   |                |
| Health care claim expenses incurred during the                            period | 25,896,407  |
|                                                                             |             |         |                                                                                                     |   |                |
| Health care claims paid during the period                                        |             | (18,690,508) |
|                                                                             |             |         |                                                                                                     |   |                |
| IBNP as of August 31, 2007                                                       |             |         | $            7,570,729                  |
|                                                                             |             |         |                                                                                                     |   |                |

 

Included in the health care claim expenses incurred during the period is            a provision for the IBNP reserve. The IBNP reserve for the SNP in South Dakota was            estimated utilizing an independent actuarial analysis performed at November 30, 2006.            For 2007, with the significant increase in enrollment in the South Dakota SNP and the            commencement of the QMedCare of New Jersey, Inc. SNP, the Company’s estimates for            the nine months ended August 31, 2007 are based upon an independent actuarial model of            expected costs.

 

Note            14 –Fees Reimbursable to Health Plans

 

Health plans utilizing the disease management program of the Company pay            participating physicians, fees for their services related to use of the program. Such            fees are additional costs to the health plan, which in some cases are deducted from            fees paid to the Company. As of August 31, 2007 and November 30, 2006, there were            $7,825 and $47,005 outstanding under these provisions, respectively.

 

Note 15            –Accrued Severance Payable

 

On            November 28, 2006, the Company incurred certain obligations under the terms of the            employment agreement related to separation of service of its former CEO. These            obligations consist of: (i) three times last base salary, to be paid in three equal            annual installments, with the first installment to be paid no later than thirty (30)            days after

 

12

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 15            –Accrued Severance Payable –            (continued)

 

November 28, 2006 (the “Payment Date”), and thereafter, the            second and third installments on each of the next two annualanniversaries of the payment date; (ii) immediate vesting of all            options; and (iii) continued coverage, at the Company’s expense for a period of            36 months from November 28, 2006 under all executive health plans in which the            Executive participates as of November 28, 2006. As of August 31, 2007, the Company has            a liability of $637,954, representing the present value of these obligations using an            interest rate of 4%, of which $324,365 is included within accounts payable and accrued            expenses and $313,589 is classified as long term.

 

Note            16 –Income Taxes

 

The            Company has cumulative pre-tax losses through the period ended August 31, 2007 for            financial reporting purposes. Recognition of deferred tax assets will require            generation of future taxable income. Given the recent non-renewal of disease management            contracts and the costs associated with the new business segments, there can be no            assurance that the Company will generate earnings in future years. Therefore, the            Company established a 100% valuation allowance on its deferred tax assets.

 

Note 17            –Business Segment Information

 

The            Company presents segment information in accordance with SFAS No. 131,            “Disclosures about Segments of an Enterprise and Related Information,”            which established reporting and disclosure standards for an enterprise’s            operating segments. Operating segments are defined as components of an enterprise for            which separate financial information is available and regularly reviewed by the            Company’s senior management.

 

The            Company has decided to incorporate the health and wellness programs of Positive            Directions, Inc. as part of its disease management offerings. As a result, the Company            is currently organized into two business units, disease-management services and            specialty managed care services, which are considered reportable segments. The segments            are managed separately and the Company evaluates performance on operating profits of            the respective segments. The Company supports these segments with shared human            resources, financial, clinical, sales and marketing, operations and information            technology resources. The accounting policies of the operating segments are            substantially consistent with those applied in the condensed consolidated financial            statements. Income (loss) before income taxes by operating segment excludes general            corporate expenses.

 

Summarized financial information by operating segment for three and nine            months ended August 31, 2007 and 2006 is as follows:

 
|                                                     | Three Months Ended August 31,                        2007 |
|-----------------------------------------------------|-----------------------------------------------------------|
||
| Revenue                                             |                                                      |   | $ | 846,860 |   | $ | 9,934,387 |   | $ | - |   | $ | - |   | $ | 10,781,247 |   |   |   |   |
| Revenue - related                    parties        |                                                      |   |   | 757,500 |   |   | - |   |   | - |   |   | (757,500 | ) |   | - |   |
| Cost of revenue/medical                    expenses |                                                      |   |   | 748,490 |   |   | 14,514,670 |   |   | - |   |   | - |   |   | 15,263,160 |   |
| Cost of revenue -                    reinsurance    |                                                      |   |   | - |   |   | 167,726 |   |   | - |   |   | - |   |   | 167,726 |   |
| General operating                    expenses       |                                                      |   |   | 1,889,311 |   |   | 2,403,056 |   |   | 1,017,256 |   |   | (757,500 | ) |   | 4,552,122 |   |
| Loss before income                    taxes         |                                                      |   |   | (1,033,441 | ) |   | (7,151,064 | ) |   | (1,017,256 | ) |   | - |   |   | (9,201,761 | ) |
| Depreciation and                    amortization    |                                                      |   |   | 212,068 |   |   | 5,163 |   |   | 82,462 |   |   | - |   |   | 299,693 |   |
| Expenditures for                    long-lived      |                                                      |   |
|   assets                                  |                                                      |   |   | 17,929 |   |   | - |   |   | 1,200 |   |   | - |   |   | 19,129 |   |

 

 

13

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 17            –Business Segment Information –            (continued)

 
|                                                     | Three Months Ended August 31,                        2006 |
|-----------------------------------------------------|-----------------------------------------------------------|
||
| Revenue                                             |                                                      |   | $ | 1,763,429 |   | $ | 438,841 |   | $ | - |   | $ | - |   | $ | 2,202,270 |   |
| Revenue - related                    parties        |                                                      |   |   | 31,500 |   |   | - |   |   | - |   |   | (31,500 | ) |   | - |   |
| Cost of revenue/medical                    expenses |                                                      |   |   | 1,000,037 |   |   | 371,672 |   |   | - |   |   | - |   |   | 1,371,709 |   |
| General operating                    expenses       |                                                      |   |   | 1,616,485 |   |   | 1,160,192 |   |   | 1,401,041 |   |   | (31,500 | ) |   | 4,146,218 |   |
| Loss before income                    taxes         |                                                      |   |   | (821,593 | ) |   | (1,093,023 | ) |   | (1,401,041 | ) |   | - |   |   | (3,315,657 | ) |
| Depreciation and                    amortization    |                                                      |   |   | 156,183 |   |   | 1,981 |   |   | 71,463 |   |   | - |   |   | 229,627 |   |
| Expenditures for                    long-lived      |                                                      |   |
|   assets                                  |                                                      |   |   | 545,407 |   |   | 9,341 |   |   | 54,786 |   |   | - |   |   | 609,534 |   |

 

 
|                                                      | Nine Months Ended August 31,                        2007 |
|------------------------------------------------------|----------------------------------------------------------|
||
| Revenue                                              |                                                     |   | $ | 3,816,533 |   | $ | 22,757,835 |   | $ | - |   | $ | - |   | $ | 26,574,368 |   |
| Revenue - related                    parties         |                                                     |   |   | 1,718,820 |   |   | - |   |   | - |   |   | (1,718,820 | ) |   | - |   |
| Cost of revenue/medical                    expenses  |                                                     |   |   | 2,471,207 |   |   | 25,896,407 |   |   | - |   |   | - |   |   | 28,367,614 |   |
| Cost of revenue -                    reinsurance     |                                                     |   |   | - |   |   | 374,053 |   |   | - |   |   | - |   |   | 374,053 |   |
| General operating                    expenses        |                                                     |   |   | 5,326,845 |   |   | 6,540,535 |   |   | 3,116,384 |   |   | (1,718,820 | ) |   | 13,264,944 |   |
| Settlement                    proceeds               |                                                     |   |   | 2,375,000 |   |   | - |   |   | - |   |   | - |   |   | 2,375,000 |   |
| Income (loss) before                    income taxes |                                                     |   |   | 112,301 |   |   | (10,053,159 | ) |   | (3,116,384 | ) |   | - |   |   | (13,057,243 | ) |
| Depreciation and                    amortization     |                                                     |   |   | 618,352 |   |   | 14,196 |   |   | 248,655 |   |   | - |   |   | 881,202 |   |
| Expenditures for                    long-lived       |                                                     |   |
|   assets                                   |                                                     |   |   | 322,350 |   |   | 16,575 |   |   | 50,458 |   |   | - |   |   | 389,383 |   |
| Identifiable                    assets               |                                                     |   |   | 5,297,256 |   |   | 7,544,134 |   |   | 16,098,895 |   |   | (12,576,017 | ) |   | 16,364,268 |   |

 

 
|                                                     | Nine Months Ended August 31,                        2006 |
|-----------------------------------------------------|----------------------------------------------------------|
||
| Revenue                                             |                                                     |   | $ | 6,429,662 |   | $ | 876,926 |   | $ | - |   | $ | - |   | $ | 7,306,588 |   |
| Revenue - related                    parties        |                                                     |   |   | 60,120 |   |   | - |   |   | - |   |   | (60,120 | ) |   | - |   |
| Cost of revenue/medical                    expenses |                                                     |   |   | 4,208,461 |   |   | 742,703 |   |   | - |   |   | - |   |   | 4,951,164 |   |
| General operating                    expenses       |                                                     |   |   | 6,123,831 |   |   | 3,001,826 |   |   | 2,260,503 |   |   | (60,120 | ) |   | 11,326,040 |   |
| Loss before income                    taxes         |                                                     |   |   | (3,842,510 | ) |   | (2,867,603 | ) |   | (2,260,503 | ) |   | - |   |   | (8,970,616 | ) |
| Depreciation and                    amortization    |                                                     |   |   | 397,356 |   |   | 2,423 |   |   | 205,564 |   |   | - |   |   | 605,343 |   |
| Expenditures for                    long-lived      |                                                     |   |
|   assets                                  |                                                     |   |   | 1,054,119 |   |   | 44,476 |   |   | 99,893 |   |   | - |   |   | 1,198,488 |   |
| Identifiable                    assets              |                                                     |   |   | 10,133,849 |   |   | 3,849,176 |   |   | 14,672,593 |   |   | (4,310,282 | ) |   | 24,345,336 |   |

 

Related            party revenue represents an agreement entered into by QMedCare Dakota, LLC with QMed            Inc. for disease management services in connection with the administration of the SNP            in South Dakota and New Jersey.

 

14

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 18            –Share-Based Compensation

 

The            Company has shareholder-approved stock incentive plans for employees. Effective            December 1, 2005, we adopted SFAS No. 123(R), “Share-Based Payment,” using            the modified prospective transition method. Under the modified prospective transition            method, recognized compensation cost includes: 1) compensation cost for all share-based            payments granted prior to, but not yet vested as of, December 1, 2005, based on the            grant date fair value estimated in accordance with the original provisions of Statement            123; and 2) compensation cost for all share-based payments granted on or after December            1, 2005, based on the grant date fair value estimated in accordance with Statement            123(R). In accordance with the modified prospective method, we have not restated prior            period results.

 

For            the three months ended August 31, 2007, we recognized share-based compensation cost of            $263,886, which consisted of $31,305 in cost of services, $212,936 in selling, general            and administrative expenses and $19,645 in research and development. For the three            months ended August 31, 2006, we recognized share-based compensation cost of $353,739,            which consisted of $7,105 in cost of services, $356,257 in selling, general and            administrative expenses and ($9,623) in research and development.

 

For            the nine months ended August 31, 2007, we recognized share-based compensation cost of            $1,001,012, which consisted of $87,165 in cost of services, $855,560 in selling,            general and administrative expenses and $58,287 in research and development. For the            nine months ended August 31, 2006, we recognized share-based compensation cost of            $1,300,367, which consisted of $137,150 in cost of services, $1,101,867 in selling,            general and administrative expenses and $61,350 in research and development. The            Company did not capitalize any share-based compensation cost.

 

As a            result of adopting Statement 123(R), loss before income taxes and net loss for the            three months ended August 31, 2007 and 2006 totaling $263,886 and $353,739,            respectively, were lower than if the Company had continued to account for share-based            compensation under APB 25. As a result of adopting Statement 123(R), loss before income            taxes and net loss for the nine months ended August 31, 2007 and 2006 totaling            $1,001,012 and $1,300,367, respectively, were lower than if the Company had continued            to account for share-based compensation under APB 25. The effect of adopting Statement            123(R) on basic and diluted earnings per share was $.02 for the three months ended            August 31, 2007 and 2006, respectively, and $.06 and $.08 for the nine months ended            August, 31, 2007 and 2006, respectively.

 

Prior to adopting Statement 123(R), we presented the tax benefit of            stock option exercises as operating cash flows. Statement 123(R) requires that tax            benefits resulting from tax deductions in excess of the compensation cost recognized            for those options be classified as financing cash flows.

 

Statement 123(R) also requires companies to calculate an initial            “pool” of excess tax benefits available at the adoption date to absorb any            tax deficiencies that may be recognized under Statement 123(R). The pool includes the            net excess tax benefits that would have been recognized if the company had adopted            Statement 123 for recognition purposes on its effective date.

 

The            Company has elected to calculate the pool of excess tax benefits under the alternative            transition method described in FASB Staff Position (“FSP”) No. FAS            123(R)-3, “Transition Election Related to Accounting for Tax Effects of            Share-Based Payment Awards,” which also specifies the method we must use to            calculate excess tax benefits reported on the statement of cash flows. The Company is            in a net operating loss position; therefore, no excess tax benefits from share-based            payment arrangements have been recognized for the three and nine months ended August            31, 2007.        

 

Potentially dilutive options and warrants to purchase 771,807 and            959,738 shares of the common stock were outstanding for the three months ending August            31, 2007 and 2006, respectively, but were not included in the computation of diluted            loss per share because the effect of their inclusion would have been anti-dilutive.            Potentially dilutive options and warrants to purchase 953,017 and 1,494,583 shares of            the common stock were outstanding for the nine months ending August 31, 2007 and 2006,            respectively, but were not included in the computation of diluted loss per share            because the effect of their inclusion would have been anti-dilutive. Additionally,            options to purchase 1,163,887 and 885,696 shares of common stock were outstanding as of            August 31, 2007 and 2006, respectively, but  were also not  included in the            computation of diluted  loss per  share  for the

 

15

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 18            –Share-Based Compensation –            (continued)

 

three months ended August 31, 2007 and 2006 and options to purchase            1,011,220 and 661,488 shares of common stock were outstanding as of August 31, 2007 and            2006, respectively, but were also not included in the computation of diluted loss per            share for the nine months ended August 31, 2007 and 2006 because the option exercise            price was greater than the average market price of the common shares.

 

As            noted above, the Company has shareholder-approved stock incentive plans for employees            under which we have granted non-qualified and incentive stock options. Options granted            under these plans must be at a price per share not less than the fair market value per            share of common stock on the date the option is granted. The options generally vest            over a three-year period and expire ten years from the date of grant. Certain option            and share awards provide for accelerated vesting upon a change in control or normal or            early retirement (as defined in the plans). At the Company’s annual shareholder            meeting on April 28, 2006, the amendment to the 1999 Equity Incentive Plan to increase            the number of shares reserved for issuance under such plan from 2,000,000 to 3,000,000            and to ensure compliance with Section 409A of the Internal Revenue Code was approved.            At August 31, 2007, we have reserved approximately 1,146,000 shares for future equity            grants.

 

As            of August 31, 2007, there was $1.9 million of total unrecognized compensation cost            related to non-vested share-based compensation arrangements granted under the stock            incentive plans. That cost is expected to be recognized over a weighted-average period            of 1.9 years.

 

Stock Options 

 

For            the three and nine months ended August 31, 2007 and 2006, the Company based expected            volatility on both historical volatility and implied volatility on the Company’s            stock. The expected term of options granted represents the period of time that options            granted are expected to be outstanding. The Company used historical data to estimate            expected option exercise and post-vesting employment termination behavior. The Company            utilized the risk-free interest rate for periods equal to the expected term of the            option based upon the U.S. Treasury yield curve in effect at the time of the grant. The            Company has no intention of declaring any dividends for the foreseeable            future.

 

The            following table shows the weighted average grant date fair values and the weighted            average assumptions the Company used to develop the fair value estimates under each of            the option valuation models for three and nine months ended August 31, 2007 and            2006:

 

|                       | Three Months Ended |    | Nine Months Ended |
|----------------------------|--------------------|---------|-------------------|
|                       | August 31,         |    | August 31,        |
|                       | 2007               | 2006    |              | 2007 | 2006 |
| Weighted average grant -   |               |    |              |   |   |
| date fair value of options | $1.94              | — |              | $2.54 | $4.65 |
|                       |               |    |              |   |   |
| Assumptions:               |               |    |              |   |   |
| Expected volatility        | 67.18%             | — |              | 66.96% | 64.1% |
| Expected dividends         | —            | — |              | — | — |
| Expected term (in years)   | 4.0                | — |              | 4.0 | 4.0 |
| Risk-free rate             | 4.8%               | — |              | 4.6% | 4.4% |

 

 

16

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 18            –Share-Based Compensation –            (continued)

Stock Options – (continued)

 

A            summary of option activity as of August 31, 2007 and changes during the three months            then ended is presented below:

 

| Options                          | Shares    |   | WeightedAverageExercise Price | WeightedAverageRemainingContractual Term | AggregateIntrinsicValue |
|----------------------------------|-----------|--------|-------------------------------|------------------------------------------|-------------------------|
| Outstanding at December 1, 2006  | 2,022,983 |   | $7.43                         |                                     |                    |
| Granted                          | 515,000   |   | 5.46                          |                                     |                    |
| Exercised                        | (127,274) |   | 2.75                          |                                     |                    |
| Forfeited or expired             | (35,866)  |   | 10.14                         |                                     |                    |
|                             |      |   |                          |                                     |                    |
| Outstanding at February 28, 2007 | 2,374,843 |   | $7.22                         |                                     |                    |
| Granted                          | 104,000   |   | 4.43                          |                                     |                    |
| Exercised                        | (10,667)  |   | 3.00                          |                                     |                    |
| Forfeited or expired             | (319,663) |   | 7.93                          |                                     |                    |
|                             |      |   |                          |                                     |                    |
| Outstanding at May 31, 2007      | 2,148,513 |   | $6.97                         |                                     |                    |
| Granted                          | 30,000    |   | 3.55                          |                                     |                    |
| Exercised                        | 0         |   | 0.00                          |                                     |                    |
| Forfeited or expired             | (82,618)  |   | 7.62                          |                                     |                    |
|                             |      |   |                          |                                     |                    |
| Outstanding at August 31, 2007   | 2,095,895 |   | $6.89                         |                                     |                    |
|                             |      |   |                          |                                     |                    |
| Exercisable at August 31, 2007   | 1,218,586 |   |  

$7.26                 | 5.0                                      | $4,439                  |
|                             |      |   |                          |                                     |                    |

 

The            total intrinsic value, which represents the difference between the underlying            stock’s market price and the option’s exercise price, of options exercised            during the three months ended August 31, 2007 and 2006 was $0 and $8,800, respectively.            The total intrinsic value, which represents the difference between the underlying            stock’s market price and the option’s exercise price, of options exercised            during the nine months ended August 31, 2007 and 2006 was $265,049 and $71,287,            respectively. The total fair value of options vested during the three and nine months            ended August 31, 2007 was $15,714 and $1,193,331, respectively.

 

Cash            received from option and warrant exercises under all share-based payment arrangements            for the nine months ended August 31, 2007 and 2006 was $382,004 and $128,318,            respectively. No tax benefit was realized from option exercises of the share-based            payment arrangements for the three and nine months ended August 31, 2007 and            2006.

 

As            of August 31, 2007, the Company also has 1,672,522 stock warrants outstanding at a            weighted average exercise price of $1.85. As of December 1, 2005, the adoption date of            Statement 123(R), these warrants were exercisable; therefore, no expense has been            recognized in the current period. The warrants expire in November 2007.

 

Note            19 –Sale of Intellectual Property

 

On            May 22, 2006, the Company entered into an agreement to amend a certain patent license            agreement with a third party resulting in the sale of the patent for $450,000. The            Company received the proceeds from the sale on May 26, 2006. Accordingly, the proceeds            from the transaction were recorded within other income.

 

Note 20            –Commitments and Contingencies

 

Litigation

 

The            action against Healthcare First, a division of Gallagher Insurance Services, Inc., and            of Arthur J. Gallagher & Co. (“HCF”), described in prior filings, and            pending in the Superior Court of New Jersey, Law Division, Monmouth County has been            resolved. Following a mediation process, the matter was resolved on terms including a            payment to the Company of $400,000, which was received in June 2007.

             

17

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 20            –Commitments and Contingencies –            (continued)

|   | Litigation – (continued) |
|--------|--------------------------------|

 

On            November 21, 2005, the Company brought an arbitration proceeding against Alere Medical            Incorporated (“Alere”), seeking damages and an award for unjust enrichment,            on allegations that Alere materially misled and misrepresented to the Company, its            intentions to enter into long-term agreements with the Company for the provision of            disease management services.

             

In            the arbitration, Alere counterclaimed, asserting that, under a seventh agreement            between the parties, there was no obligation to enter into a long term agreement, and            thus, claimed Alere, the Company’s claims were not well founded and Alere is            allegedly entitled to damages for breach of the duty of good faith and fair dealing, as            well as its attorneys’ fees. Alere also filed a lawsuit in state court, in the            Second Judicial District Court of Nevada, Washoe County, seeking essentially the same            relief.

 

Following extensive discovery, these matters were mediated, and both the            arbitration and the litigation were resolved during December, 2006. As part of the            resolution, in December 2006, the Company received a payment totaling $1,975,000            bringing these matters to a conclusion.

 

The            Company is subject to claims and legal proceedings covering a wide range of matters            that arise in the ordinary course of business. Although management of the Company            cannot predict the ultimate outcome of these legal proceedings with certainty, it            believes that their ultimate resolution, including any additional amounts we may be            required to pay, will not have a material effect on the financial            statements.

 

Statutory Reserves

 

New Jersey

The            Company maintains an administrative statutory reserve and a minimum net worth as            required by the State of New Jersey Department of Banking and Insurance. Accordingly,            the Company deposited funds of approximately $456,000 for the administrative reserve            and contributed capital to meet its minimum net worth requirements. In June 2007, these            funds were increased to $474,000 in accordance with statutory requirements.

 

In            December 2006, the Company funded an additional $2.5 million representing an insolvency            reserve established for QMedCare of New Jersey, Inc. as required by the State of New            Jersey Department of Banking and Insurance. These funds will be classified as            noncurrent assets as the cash is not available for current operations. The funds are            held in trust and are currently invested in certificates of deposit.

 

South Carolina

The            Company has committed to maintain a minimum 10 to 1 premium to capital ratio in order            to operate the captive insurance company. This capital reserve is required by the South            Carolina Department of Insurance. As of August 31, 2007, the Company was not in            compliance with this requirement. Should the Company obtain additional financing, this            requirement will be funded.

 

Guaranty

 

New Jersey

The            Company has provided the State of New Jersey Department of Banking and Insurance with a            capital and surplus guaranty dated May 10, 2006 whereby the Company has guaranteed that            QMedCare of New Jersey, Inc. will have and maintain capital and surplus at a minimum            amount as required by law or such additional surplus as required by the Commissioner of            Banking and Insurance of the State of New Jersey. The guaranty also requires that these            capital and surplus funds are maintained in assets under the investment laws governing            health maintenance organizations in the State of New Jersey. At August 31, 2007,            QMedCare of New Jersey, Inc. was in full compliance with its capital and surplus            obligations.

 

18

 

----

 

QMED,            INC. AND SUBSIDIARIES

NOTES            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Note 20            –Commitments and Contingencies –            (continued)

|   | Guaranty – (continued) |
|--------|------------------------------|

 

Government Contracts

The            Company’s Managed Care business, which accounted for approximately 92% and 86% of            our total revenues for the three and nine months ended August 31, 2007, respectively,            primarily consisted of products covered under Medicare Advantage contracts with the            federal government. These contracts are renewed generally for a one-year term each            January 1, unless CMS notifies the Company or DAKOTACARE of its decision not to renew            by August of the contract year, or the Company OR DAKOTACARE notifies CMS of its            decision not to renew in June through August of the contract year depending on the            results of the final bid submission. For the year beginning January 1, 2007, we            have entered into a Medicare Advantage contract with CMS for New Jersey.

 

Sales Guarantees

Typically, the Company’s fees or incentives are higher in            contracts with increased financial risk such as those contracts with performance-based            fees or guarantees against cost increases. The failure to achieve targeted cost            reductions could, in certain cases, render a contract unprofitable and could have a            material negative impact on the Company’s results of operations.

 

Leases

In            March 2007, the Company executed a five-year extension of its lease for its corporate            office space under similar terms of the original lease.

 

Major Customers

In a            letter dated October 4, 2006, the Company was notified by HealthSuite Partners, a joint            venture with Alere Medical, Airlogix and the Company, that the HealthSuite Partners            contract with HealthPartners, a Minnesota managed care organization, would not be            extended beyond April 5, 2007.

 

19

 

----

 

**Item 2. Management’s Discussion and Analysis of Financial            Condition and Results of Operations**

 

Management’s Discussion and Analysis of Financial Condition and            Results of Operations contain forward-looking statements, which are based upon current            expectations and involve a number of risks and uncertainties. In order for us to            utilize the “safe harbor” provisions of the Private Securities Litigation            Reform Act of 1995, investors are hereby cautioned that these statements may be            affected by the important factors, among others, set forth below, and consequently,            actual operations and results may differ materially from those expressed in these            forward-looking statements. The Company is facing risk factors in connection with the            operations of its Managed Care segment. These risk factors may include, but not be            limited, to the following:

 

|   | **•** | our ability to obtain adequate financing to provide the                            capital required to support current and future operations and                            financing or insurance to support our performance in these                            operations; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the risks inherent in starting a new venture including                            the incurring of significant start-up expenses, the time and number of                            enrollees in the Special Needs Plans, and the ability to achieve                            profitable operations; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the legislation providing for Special Needs Plans                            expires at the end of 2008 and must be renewed in order for SNPs to                            continue beyond 2008, if not renewed, the SNP will convert to a                            traditional Medicare Advantage Plan; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to renew and/or maintain our SNP agreement                            under existing terms or restructure this contract on terms that would                            not have a material negative impact on our results of                            operations; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to maintain certain levels of equity                            (referred to as surplus) that may be required by state                            regulations; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to maintain the Risk-Based Capital ratio                            (RBC ratio) as defined and utilized by the National Association of                            Insurance Commissioners (NAIC) to identify weakly capitalized companies                            by comparing each company’s adjusted surplus to its required                            surplus (RBC ratio); |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to reasonably estimate appropriate medical                            claims reserves and related benefit expenses; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to manage health care costs; |
|--------|------------|------------------------------------------|

|   | **•** | our ability to maintain regulatory compliance associated                            with governmental supervisory agencies including state health,                            insurance, managed care and securities departments which have the                            authority to grant, suspend, and revoke licenses to transact business,                            regulate many aspects of the products and services offered, assess                            fines, penalties and/or sanctions, monitor our solvency and reserve                            adequacy and regulate our investment activities on the basis of                            quality, diversification and other quantitative criteria; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to adequately protect member health related                            and other sensitive information; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to be competitive, set prices and renew                            business as pricing and underwriting regulations by states limit the                            Company’s and other health insurers’ flexibility to their                            underwriting and rating practices; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to operate, achieve and maintain                            profitability as the federal government determines our                            premiums; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the ability to maintain and develop existing and new                            contracts with providers, hospitals and other health care                            systems; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to attract, retain and provide support to                            internal sales personnel and third party brokers and                            consultants; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the impact on medical costs of health benefits provider                            fraud that is not prevented or detected; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the impact of financial loss from inadequate insurance                            coverage due to unavailability of insurance and reinsurance at                            affordable prices; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to monitor the performance of independent                            third parties for outsourced services that our operations are subject                            to their performance. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Some            additional factors include:

 

|   | **•** | our ability to renew and/or maintain contracts with our                            customers under existing terms or restructure these contracts on terms                            that would not have a material negative impact on our results of                            operations; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to execute new contracts for health plan                            disease management services; |
|--------|------------|--------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to effect estimated cost savings and                            clinical outcome improvements under health plan disease management                            contracts and reach mutual agreement with customers with respect to                            cost savings, or to effect such savings and improvements within the                            timeframes contemplated by us; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the ability of our health plan customers to provide                            timely, complete and accurate data that is essential to the operation                            and measurement of our performance under the terms of our health plan                            contracts, and our accurate analysis of such data; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to effectively integrate new technologies                            into our care management information technology platform; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|

 

20

 

----

 

|   | **•** | unusual and unforeseen patterns of healthcare                            utilization by individuals within the health plans with chronic                            conditions, including coronary artery disease (“CAD”),                            stroke, heart failure (“HF”), hypertension, hyperlipidemia                            and the cardiovascular complications of diabetes with which we have                            executed disease management contracts; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the impact of the introduction of new                            technologies; |
|--------|------------|--------------------------------------------------------------------------------|

|   | **•** | the ability of the health plans to maintain the number                            of covered lives enrolled in the plans during the terms of the                            agreements between the health plans and us; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to attract and/or retain and effectively                            manage the employees required to implement our agreements with health                            plan organizations; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the impact of future state and federal healthcare                            legislation and regulations on our business; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the financial health of our customers and their                            willingness to purchase our services; |
|--------|------------|------------------------------------------------------------------------------------------------------------------|

|   | **•** | the impact of litigation or arbitration; |
|--------|------------|------------------------------------------|

|   | **•** | our ability to accurately estimate our performance and                            revenue recognition under the terms of our contracts; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to develop new products and deliver outcomes                            on those products; |
|--------|------------|--------------------------------------------------------------------------------------------------------|

|   | **•** | our ability to implement our strategy within expected                            cost estimates; |
|--------|------------|--------------------------------------------------------------------------------------------------|

|   | **•** | general economic conditions |
|--------|------------|-----------------------------|

 

**Overview**

 

We            manage, own and operate Medicare Advantage Special Needs Plans for chronically ill            Medicare and dual-eligible beneficiaries. We also provide disease management services            to health plans and to the federal government through its Medicare program. Our            services provide Care Managment Solutions to assist health plans and government            organizations in managing the cost and care of diabetes, cardiovascular disease,            coronary artery disease (“CAD”), congestive heart failure            (“CHF”), chronic obstructive pulmonary disease (COPD), stroke, weight and            obesity and all associated co-morbid conditions. By leveraging our innovative clinical            practices and proprietary analytical technology, our model improves patient outcomes,            reduces practice variation, and measures quality.

 

**Recent Developments**

 

*Managed Care Segment*

 

In            December 2004, we formed QMedCare, Inc. as a wholly owned subsidiary of QMed, Inc. This            organization acts as a management company that operates a series of specialty            Managed Care products serving high-risk and dual eligible Medicare            beneficiaries. The first of these products was offered in South Dakota, beginning            January 2006, as a Special Needs Plan (“SNP”) for chronically ill Medicare            recipients. QMedCare Inc., specifically formed QMedCare Dakota, LLC to administer this            Plan for DAKOTACARE, a health maintenance organization in South Dakota. The SNP is            being marketed as HeartLinePlus and is providing exclusive health coverage for CAD,            heart failure and stroke patients.

 

LakeShore Captive Insurance Company, a wholly owned subsidiary of            QMedCare, Inc., entered into an agreement with DAKOTACARE (a South Dakota HMO) in June            2005 whereby the captive insurance company assumes 100% of the risk associated with the            operations of DAKOTACARE’s HeartLinePlus SNP. The initial term of the agreement            is for 5 years and contains provisions for automatic one year renewals unless a            non-renewal notice is provided within 120 days of expiration.

 

The            Company formed QMedCare of New Jersey, Inc. on January 17, 2006 in order to fulfill its            previously announced intention and filed an application for a wholly owned SNP in New            Jersey. On May 18, 2006, the Company received approval of its application from the            State of New Jersey, Department of Banking and Insurance (DOBI) and has a license to            operate as an HMO within the State.

 

In            September 2006, the Company executed a contract with CMS to operate its SNP in New            Jersey, and DAKOTACARE executed two contracts, which are comprised of a renewal of the            HeartLinePlus program for 2007 and a new SNP for dual eligibles. Dual eligibles are            individuals that are eligible for both Medicare and Medicaid programs.

 

In            March 2007, the Company submitted an expansion application to add an additional disease            state for its two chronic SNPs in New Jersey and South Dakota.

 

21

 

----

 

*Positive Directions, Inc. (formerly Health e Monitoring,            Inc.)*

 

Positive Directions, Inc. is a wholly owned subsidiary of QMed, Inc. In            May of 2005, QMed, Inc. acquired Positive Directions, Inc., (formerly Health e            Monitoring, Inc.), a privately owned firm offering a program for healthy weight and            lifestyle management. In October 2005, QMed, Inc. acquired all of the assets of Disease            Management Technologies, Inc. (“DMT”). DMT has developed a website for a            health and wellness program.

 

Its            program focuses on the role of wellness and prevention to establish healthy lifestyle            habits, dietary and nutrition education, exercise regimens and behavioral            modifications. Since the direction of this program will be primarily focused on our            care coordination programs for our SNP initiatives, we expect that minimal revenue will            be derived from third parties.

 

**Recently Issued Accounting Pronouncements**

 

In            February 2007, the FASB issued Statement of Financial Accounting Standards No. 159,            “The Fair Value Option for Financial Assets and Liabilities,” or SFAS 159.            SFAS 159 allows an option to report selected financial assets and liabilities at fair            value and establishes presentation and disclosure requirements. We are required to            adopt SFAS 159 in the first quarter of 2008. We currently are evaluating the provisions            of SFAS 159 and do not expect the adoption of SFAS 159 to have a material impact on our            financial position or results of operations.

 

**Critical Accounting Estimates**

 

Our            accounting policies are described in Note 2 of the condensed consolidated financial            statements included in this Report on Form 10-Q for the nine months ended August 31,            2007. The condensed consolidated financial statements are prepared in accordance with            accounting principles generally accepted in the United States of America, which            requires management to make estimates and assumptions that affect the reported amounts            of assets and liabilities and disclosure of contingent assets and liabilities at the            date of the financial statements and the reported amounts of revenues and expenses            during the reporting period. Actual results could differ from those            estimates.

 

We            consider the following policies to be the most critical in understanding the judgments            involved in preparing the financial statements and the uncertainties that could impact            our results of operations, financial condition and cash flows.

 

**Revenue Recognition**

 

Premiums 

 

For            our SNP plans, we record revenue from health care premiums received in the month that            enrollees are entitled to coverage.

 

Managed Care Services

 

The            Company’s captive insurance company entered into an agreement with DAKOTACARE in            2005 whereby the captive insurance company assumes 100% of the risk associated with the            operations of a Special Needs Plan (“SNP”) in South Dakota. The initial            term of the agreement is for 5 years and contains provisions of automatic one year            renewals unless a non-renewal notice is provided within 120 days of expiration. In            addition, on January 1, 2007, QMedCare of New Jersey, Inc., a licensed HMO in NJ,             commenced operations of its SNP. In May 2007, a SNP for dual eligibles commenced            operation in South Dakota. The SNPs offer comprehensive health care coverage            and prescription drug benefits for chronically ill and dual eligible Medicare            recipients. We receive a fixed monthly member premium and a Medicare risk-adjusted            premium, which is based upon the diagnoses of the enrolled member as captured by claims            data from the prior year.

 

We            also entered into an agreement with DAKOTACARE, a health maintenance organization, to            administer the SNP in South Dakota and New Jersey. In accordance with the agreement, we            record revenue on a monthly basis as services are rendered.

 

The            Company’s Managed Care business, which accounted for approximately 92% and 86% of            our total revenues for the three and nine months ended August 31, 2007, respectively,            primarily consisted of products covered under Medicare Advantage contracts with the            federal government.

 

22

 

----

 

Disease Management Services

 

We            enter into contractual arrangements with health plans and government agencies to            provide disease management services. Fees under our health plan contracts are generally            determined by multiplying a contractually negotiated rate per health plan member per            month (“PMPM”) by the number of health plan members covered by our services            during the month. The PMPM rates usually differ among contracts due to the various            types of health plan product groups (e.g. PPO, HMO, and Medicare Advantage) that we            interact with. These contracts are generally for terms of one to three years with            provisions for subsequent renewal, and typically provide that a small portion of our            fees may be “performance-based.” We bill our customers each month for the            entire amount of the fees contractually due based on previous months membership, which            always includes the amount, if any that may be at risk due to retroactive member            terminations or a shortfall in performance. We adjust or defer revenue for contracts            where we believe performance is short of contractual obligations. We recognize revenue,            in accordance with SEC Staff Accounting Bulletins No. 101 and No. 104, as follows: 1.)            we recognize the fixed portion of our monthly fee as revenue during the period we            perform the services; 2.) we recognize the performance – based portion of the            monthly fees based on indicators of performance to date in the contract year; and 3.)            we recognize previously recorded deferred revenue upon final settlement of the contract            measurement year. Adjustments for shortfalls in performance targets under the terms of            the contracts or other factors affecting revenue recognition are accrued on an            estimated basis in the period the services are provided and are adjusted in future            periods when final settlement is determined. We review these estimates periodically and            make adjustments, as interim information is available.

 

The            settlement process under a contract, which includes the settlement of any            performance-based fees and involves reconciliation of health-care claims and clinical            data, is generally not completed until after the end of the contract year. Data            reconciliation differences between the Company and the customer can arise due to health            plan data deficiencies, omissions and/or data discrepancies, for which the Company            negotiates with the customer until agreement is reached with respect to identified            issues.

 

**Medical Claims Payable**

 

The cost            of health care provided is accrued in the period it is dispensed to the enrolled            members, based in part on estimates for services and other health care costs that have            been incurred but not yet reported or paid (IBNP), and are classifiedas “medical claims payable” on the condensed consolidated            balance sheet. Our estimates are initially based upon an independent actuarial model of            expected costs. As the plan matures, we will develop these estimates using standard            actuarial methods which may include, among other factors, the average interval between            the dates services are rendered and the date claims are paid, denied claims activity,            disputed claims activity, expected health care cost inflation, utilization, seasonality            patterns and changes in membership.

 

A            large portion of medical claims are not submitted to us by the providers until after            the end of the reporting period in which services have been rendered.            Accordingly, we use an extensive degree of judgment in the process of estimating our            medical claims payable and as a result, considerable variability and uncertainty is            inherent in such estimates, and the adequacy of such estimates is highly sensitive to            changes in assumed completion factors and the assumed health care cost trend rate. For            each reporting period, we recognize our best estimate of medical claims payable            considering the potential volatility in assumed completion factors and health care cost            trend rates, as well as other factors. We believe our estimate of medical claims            payable is reasonable and adequate to cover its obligations at August 31, 2007;            however, actual claim payments may differ from this estimate. A worsening (or            improvement) of our health care cost trend rates or changes in medical claims payment            patterns from those that were assumed in estimating medical claims payable at            August 31, 2007 would cause these estimates to change in the near term, and such a            change could be material. The estimates for submitted claims and IBNP claims            liabilities are made on an accrual basis and adjusted in future periods as required.            Adjustments to prior period estimates or financial results, if any, are included in            current operations.

 

**Impairment of Intangible Assets**

 

In            accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the            Company is required to review intangible assets for impairment on an annual basis or            more frequently whenever events or circumstances indicate that the carrying value may            not be recoverable.

 

The            Company amortizes other identifiable intangible assets, such as acquired technologies            and other intangibles, on the straight-line method over their estimated useful lives,            except for trade names, which have an indefinite life and are not subject to            amortization. The Company reviews intangible assets not subject to

 

23

 

----

 

amortization on an annual basis or more frequently whenever events or            circumstances indicate that the assets might be impaired. The Company also assesses the            potential impairment of intangible assets subject to amortization whenever events or            changes in circumstances indicate that the carrying values may not be            recoverable.

 

If            the Company determines that the carrying value of other identifiable intangible assets            may not be recoverable, the Company calculates any impairment using an estimate of the            asset’s fair value based on the projected net cash flows expected to result from            that asset, including eventual disposition.

 

Future events could cause the Company to conclude that impairment            indicators exist and that acquired intangible assets are impaired. Any resulting            impairment loss could have a material adverse impact on our financial condition and            results of operations.

 

**Share-Based Compensation**

 

On            December 1, 2005, we adopted SFAS No. 123(R), which requires the measurement            and recognition of compensation expense for all share-based payment awards based on            estimated fair values at the date of grant. Determining the fair value of share-based            awards at the grant date requires judgment in developing assumptions, which involve a            number of variables. These variables include, but are not limited to, the expected            stock price volatility over the term of the awards, and expected stock option exercise            behavior. In addition, we also use judgment in estimating the number of share-based            awards that are expected to be forfeited.

 

**Results of Operations**

 

The            following table presents the percentage of total revenues for the periods indicated and            changes from period to period of certain items included in our Condensed Consolidated            Statements of Operations.

 

 

|                                                         | **For the Three Months****Ended August 31,** |   | **For the Nine Months****Ended August 31,** |                | **For the****Three****Months****Ended****August 31,** |                                       | **For the****Nine****Months****Ended****August 31,** |
|--------------------------------------------------------------|----------------------------------------------|--------|---------------------------------------------|---------------------|-------------------------------------------------------|--------------------------------------------|------------------------------------------------------|
|                                                         |  

**2007**                             |   |  

**2006**                            |                |  

**2007**                                      |                                       |  

**2006**                                     |   | **2007 vs. 2006** |   | **2007 vs. 2006** |
|                                                         |                                         |   |                                        |                |                                                  |                                       |                                                 |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                      | 100.0                                   | %      |                                        | 100.0          | %                                                     |                                       | 100.0                                           | % |   | 100.0  | % |   | 389.6  | % |   | 263.7  | % |
| Cost of revenue                                              | 143.1                                   |   |                                        | 62.3           |                                                  |                                       | 108.2                                           |   |   | 67.8  |   |   | 1024.9  |   |   | 480.5  |   |
| Gross (loss) margin                                          | (43.1)                                       |   |                                        | 37.7           |                                                  |                                       | (8.2)                                                |   |   | 32.2  |   |   | (659.8) |   |   | (192.0) |   |
| Selling                            general andadministrative |  

37.8                            |   |                                        |  

182.8  |                                                  |                                       |  

45.6                                    |   |   |  

151.9  |   |   |  

1.3  |   |   |  

9.2  |   |
| Research anddevelopment                                      |  

5.6                             |   |                                        |  

13.6   |                                                  |                                       |  

5.8                                     |   |   |  

16.2  |   |   |  

102.1  |   |   |  

31.5  |   |
| Loss from operations                                         | (86.6)                                       |   |                                        | (158.7)             |                                                  |                                       | (59.6)                                               |   |   | (135.8) |   |   | 167.1  |   |   | 59.6  |   |
| Interest expense                                             | (0.1)                                        |   |                                        | (0.2)               |                                                  |                                       | (0.1)                                                |   |   | (0.2) |   |   | 36.1  |   |   | 37.6  |   |
| Interest income, net                                         | 1.3                                     |   |                                        | 9.2            |                                                  |                                       | 1.7                                             |   |   | 7.9  |   |   | (32.0) |   |   | (20.5) |   |
| Loss on operations ofjoint venture                           |  

-                               |   |                                        |  

(0.9)       |                                                  |                                       |  

(0.1)                                        |   |   |  

(0.9) |   |   |  

(100.0) |   |   |  

(56.5) |   |
| Other income                                                 | -                                       |   |                                        | -              |                                                  |                                       | 8.9                                             |   |   | 6.2  |   |   | -  |   |   | 427.9  |   |
| Loss before tax benefit(provision)                           |  

(85.3)                               |   |                                        |  

(150.6)     |                                                  |                                       |  

(49.1)                                       |   |   |  

(122.8) |   |   |  

177.5  |   |   |  

45.6  |   |
| Income tax (provision)benefit                                |  

-                               |   |                                        |  

(0.1)       |                                                  |  

                              |  

-                                       |   |   |  

(0.6) |   |   |  

*  |   |   |  

*  |   |
| Net loss                                                     | (85.3)                                       |   |                                        | (150.7)             |                                                  |                                       | (49.2)                                               |   |   | (122.2) |   |   | 177.4  |   |   | 46.4  |   |

 

* Not            meaningful

 

24

 

----

 

**Three Months Ended August 31, 2007 Compared to Three Months Ended            August 31, 2006**

 

Revenue for the three months ended August 31, 2007 increased            approximately $8.6 million as compared to the three months ended August 31, 2006. This            increase is attributable to an increase of approximately $9.5 million in premium and            service revenue related to increased enrollment in the South Dakota Special Needs Plan            (SNP) project and the commencement of operations of the QMedCare SNP in New Jersey on            January 1, 2007. This increase was offset by a decrease of approximately $907,000 in            disease management services revenue. The decrease was primarily attributable to a            decrease of approximately $1.2 million related to the expiration of two contracts            offset by an increase of approximately $300,000 primarily related to the commencement            of a new contract during the first quarter of fiscal 2007.

 

Cost            of revenue for the three months ended August 31, 2007 increased by approximately $14.1            million as compared to the three months ended August 31, 2006. This increase was            attributable to an increase of approximately $14.1 million related to the medical            claims associated with the SNP projects. Included in this $14.1 million is an estimate            of IBNP, which represents 34% of this increase. This increase was offset by: (i) the            decrease of approximately $91,000 related to the outsourcing of certain call center            services for our disease management programs; and (ii) a decrease of approximately            $407,000 of labor costs associated with the reduction in workforce and operating costs            related to the non-renewal of two disease management contracts.

 

Gross margin for the three months ended August 31, 2007 decreased to            (43.1%) from 37.7% for the three months ended August 31, 2006. This decrease represents            the net increase in cost of revenue over revenue.

 

Selling, general and administrative expenses for the three months ended            August 31, 2007 increased by approximately $54,000 over the three months ended August            31, 2006. The increase was attributable to (i) an increase of approximately $17,000 in            salaries and related costs for the operations of the managed care business; (ii) an            increase of approximately $477,000 associated with the operations of the SNP for costs            related to claims processing, broker commissions, reinsurance premiums, registration            services and office space; (iii) an increase in depreciation and amortization of            approximately $75,000 primarily related to capitalized product software development            costs; (iv) an increase of approximately $39,000 in professional fees primarily            attributable to the SNP projects; (v) an increase of approximately $26,000 in software            licensing fees related to the operations of the managed care business; (vi) an increase            of approximately $17,000 in premium tax related to our captive insurance company for            HeartLine Plus; (viii) an increase of $38,000 in personnel recruiting costs; and (ix)            an increase of approximately $20,000 in rent and utilities. This increase was offset by            (i) a reduction of approximately $61,000 in advertising and promotion expenses related            to more cost effective marketing for HeartLine Plus and QMedCare SNPs; (ii) a decrease            of approximately $47,000 in travel expenses; (iii) a decrease of approximately $180,000            in compensation costs associated with SFAS No. 123(R) “Share Based Payment”            and; (iv) a decrease of approximately $361,000 in legal expenses primarily related to            the settlement with Alere in the first quarter of 2007.

 

Research and development expenses for the three months ended August 31,            2007 increased approximately $305,000 or 102% over the three months ended August 31,            2006. Our accounting policy is to capitalize certain software development costs during            development and amortize them upon implementation. Subsequent to implementation any            further costs (i.e. maintenance costs) are expensed as incurred. The increase in            expenses is primarily attributable to (i) an increase of approximately $48,000 in            salaries and related costs associated with new hires and a reduction in capitalization            of salaries for product software development; (ii) an increase of approximately            $229,000 in consulting fees associated with special projects; and (iii) an increase of            approximately $29,000 in compensation costs associated with the adoption of SFAS No.            123(R) “Share Based Payment”. During the three months ended August 31,            2007, there was a decrease of approximately $410,000 in capitalization of costs, which            include salaries and consultant fees, incurred for product software development as            compared to the three months ended August 31, 2006. We continue to focus our efforts on            the development of new, advanced software programs to assist in the identification and            evaluation of patients who are at risk for developing various disease conditions. These            programs incorporate telecommunications, data management, and security and information            technology. We intend to continue to improve and expand the capabilities of all of our            technologies since it has a direct impact on our ability to manage our Medical Expense            Ratio (MER).

 

Interest income for the three months ended August 31, 1007 was            approximately $137,000 as compared to $202,000 for the three months ended August 31,            2006. This decrease is attributable to the reduction in funds available for            investment.

 

25

 

----

 

**Nine            Months Ended August 31, 2007 Compared to Nine Months Ended August 31,            2006**

 

Revenue for the nine months ended August 31, 2007 increased            approximately $19.3 million as compared to the nine months ended August 31, 2006. This            increase is attributable to an increase of approximately $21.9 million in premium and            service revenue related to increased enrollment in the South Dakota Special Needs Plan            (SNP) projects and the commencement of operations of the QMedCare SNP in New Jersey on            January 1, 2007. This increase was offset by a decrease of approximately $2.6 million            in disease management services revenue. The decrease was primarily attributable to a            decrease of $3.6 million related to the expiration of four contracts offset by an            increase of approximately $900,000 primarily related to the commencement of a new            contract during the first quarter of fiscal 2007 and an increase of approximately            $100,000 related to existing contracts.

 

Cost            of revenue for the nine months ended August 31, 2007 increased by approximately $23.8            million as compared to the nine months ended August 31, 2006. This increase was            attributable to (ii) an increase of approximately $25.2 million related to the medical            claims associated with the SNP projects; and (ii) the increase of approximately            $181,000 primarily related to a purchase commitment. Included in the $25.2 million            increase in medical clains is an estimate of IBNP, which represents 30% of the amount.            This increase was offset by: (i) approximately $1.7 million of labor and related cost            reductions associated with the reduction in workforce and operating costs related to            the non-renewal of contracts and in efficiencies related to enhancements in our            programs; and (ii) an increase of approximately $311,000 in cost reductions related to            the outsourcing of certain call center services for our disease management            programs.

 

Gross margin for the nine months ended August 31, 2007 decreased to            (8.2%) from 32.2% for the nine months ended August 31, 2006. This decrease represents            the net increase in cost of revenue as compared to revenue.

 

Selling, general and administrative expenses for the nine months ended            August 31, 2007 increased by approximately $1.0 million over the nine months ended            August 31, 2006. The increase was attributable to (i) an increase of approximately            $591,000 in salaries related to additional new hires for the operations of the managed            care business; (ii) an increase of approximately $1.1 million associated with the            operations of the SNP for costs related to claims processing, broker commissions,            registration services and office space; (iii) an increase in depreciation and            amortization of approximately $297,000 primarily related to capitalized product            software development costs; (iv) an increase of approximately $181,000 in consulting            fees primarily related to the SNP projects; and (v) an increase of approximately            $83,000 in actuarial services primarily attributable to the SNP projects. These            increases were offset by (i) a decrease of approximately $402,000 in advertising and            promotion expenses related to primarily our second year of operation in South Dakota in            which our branding costs are substantially reduced for HeartLine Plus and we are just            starting to build QMedCare of New Jersey’s SNP; (ii) a decrease of approximately            $154,000 in travel and entertainment expenses related to the reduction of costs            incurred with respect to the development and/or launch activities associated with the            SNP and Positive Directions, Inc. in 2006; (iii) and a decrease of approximately            $205,000 in compensation costs associated with SFAS No. 123(R) “Share Based            Payment” (iv) a decrease of approximately $438,000 of legal fees primarily            related to the settlement agreement with Alere in the first quarter of 2007.

 

Research and development expenses for the nine months ended August 31,            2007 increased approximately $372,000 or 31.5% over the nine months ended August 31,            2006. Our accounting policy is to capitalize certain software development costs during            development and amortize them upon implementation. Subsequent to implementation any            further costs (i.e. maintenance costs) are expensed as incurred. The increase in            expenses is primarily attributable to: (i) an increase of approximately $169,000 in            salaries and related costs associated with new hires and a reduction in capitalization            of salaries for product software development; (ii) an increase of approximately            $275,000 in consulting fees associated with special projects and a decrease in            capitalization of software development costs as software is transitioned into            production. These increases were offset by: (i) a decrease of approximately $41,000 in            travel expenses; and (ii) a decrease of approximately $26,000 in personnel recruitment            costs. During the nine months ended August 31, 2007 there was a decrease of            approximately $594,000 in capitalization of costs, which include salaries and            consultant fees, incurred for development as compared to the nine months ended August            31, 2006. We continue to focus our efforts on the development of new, advanced software            programs to assist in the identification and evaluation of patients who are at risk for            developing various disease conditions. These programs incorporate state of the art            telecommunications, data management, and security and information technology. We intend            to continue to improve and expand the capabilities of all of our technologies since it            has a direct impact on our ability to manage our Medical Expense Ratio            (MER).

 

26

 

----

 

Interest income for the nine months ended August 31, 2007 was            approximately $459,000 as compared to $577,000 for the nine months ended August 31,            2006. This decrease is attributable to the reduction in funds available for            investment.

 

Other income for the nine months ended August 31, 2007 increased            approximately $1,925,000 as compared to the nine months ended August 31, 2006. The            increase represents the proceeds from the settlement agreement with Alere and            Healthcare First.

 

**Liquidity and Capital Resources**

 

To            date, our principal sources of working capital have been the proceeds from public and            private placements of securities. The working capital deficit was approximately            $2.6 million at August 31, 2007 as compared to approximately $11.1 million of working            capital at November 30, 2006 and ratios of current assets to current liabilities of            0.79:1 as of August 31, 2007 and 3.2:1 as of November 30, 2006. The working capital            decrease of approximately $13.7 million was primarily due to the net loss of            approximately $13.1 million resulting in cash used in operations of approximately $5.1            million along with an additional $2.5 million of cash classified as long term            restricted cash in order to establish a required insolvency reserve for QMedCare of New            Jersey, Inc.

 

The            accompanying condensed financial statements have been prepared assuming that the            Company continues as a going concern that contemplates the realization of assets and            satisfaction of liabilities in the normal course of business. However, the ability of            the Company to continue as a going concern will be dependent upon its ability to raise            additional capital or obtain other sources of financing in the immediate future            necessary to meet its obligations and continue operations.

 

During the nine months ended August 31, 2007, the Company incurred net            losses totaling $13,068,372, had net cash used in operating activities of $5,119,889 as            of August 31, 2007. These factors raise substantial doubt as to the Company’s            ability to continue as a going concern.The Company needs to            raise additional funds in the immediate future in order to continue its operations.            Whereas the Company has been successful in the past in raising capital, no assurance            can be given that these sources of financing will continue to be available to the            Company and/or that demand for the Company’s equity/debt instruments will be            sufficient to meet its capital needs. If the Company is unable to raise additional            capital or obtain other sources of financing to meet its working caital requirements,            it may have to curtail its business sharply or cease business altogether. The financial            statements do not include any adjustments relating to the recoverability and            classification of liabilities that might be necessary should the Company be unable to            continue as a going concern.

 

To            the extent that the Company raises additional capital through the sale of equity or            convertible debt securities, the issuance of such securities may result in dilution to            existing stockholders. If additional funds are raised through the issuance of debt            securities, these securities may have rights, preferences and privileges senior to            holders of common stock and the terms of such debt could impose restrictions on the            Company’s operations.

 

**Material Commitments**

 

The            following schedule summarizes our contractual cost obligation as of August 31, 2007 in            the periods indicated:

 

| ContractualObligations             | Payments Due by Period                                                                             |
|------------------------------------|----------------------------------------------------------------------------------------------------|
| Total                              | Less than 1year                                                                                    | 1-3 years | 4-5 years | After 5years |
| Long-Term Debt                     | $                - | $                - | $                - | $               - | $          - |
| Capital Lease Obligations          | 146,468                                                                                            | 65,008 | 77,172 | 4,288 | - |
| Operating Leases                   | 2,722,000                                                                                          | 580,000 | 1,569,000 | 573,000 | - |
| Unconditional Purchase Obligations | -                                                                                                  | - | - | - | - |
| Other Long-Term Obligations        | 1,563,233                                                                                          | 1,136,566 | 426,667 | - | - |
| Total Contractual Cash Obligations | $  4,431,701                                                                             | $  1,781,574 | $  2,072,839 | $    577,288 | $          - |

 

 

27

 

----

 

 

**Item            3. Quantitative and Qualitative Disclosures About Market Risk**

 

Our            exposure to market risk for changes in interest rates relates primarily to the            market-driven increase or decrease in interest rates, and the impact of those changes            on the Company’s ability to realize a return on invested or available funds. We            ensure the safety and preservation of our invested principal funds by limiting default            risk, market risk and reinvestment risk. We mitigate default risk by investing in short            term high-credit investment grade securities.

 

**Item** **4.            Evaluation of Disclosure Controls and Procedure**

 

We            have established disclosure controls and procedures to ensure that material information            relating to the Company, including its consolidated subsidiaries, is made known to the            officers who certify the Company’s financial reports and to other members of            senior management and the Board of Directors.

 

Based on their evaluation as of August 31, 2007, the principal executive            officer and principal financial officer of the Company have concluded that the            Company’s disclosure controls and procedures (as defined in Rules 13a-15(e)            and 15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that            the information required to be disclosed by the Company in the reports that it files or            submits under the Securities Exchange Act of 1934 is recorded, processed, summarized            and reported within the time periods specified in SEC rules and forms.

 

No            changes in the Company’s internal controls over financial reporting have occurred            during the quarterly period covered by this report that have materially affected, or            are reasonably likely to material affect the Company’s internal controls over            financial reporting.

 

28

 

----

 

**Part            II. Other Information**

 

|   | Item 1. | Legal Proceedings |
|--------|---------|-------------------|

The action against Healthcare First, a division of Gallagher Insurance            Services, Inc., and of Arthur J. Gallagher & Co. (“HCF”), described in            prior filings, and pending in the Superior Court of New Jersey, Law Division, Monmouth            County has been resolved. Following a mediation process, the matter was resolved on            terms including a payment to the Company of $400,000.

             

On November 21, 2005, the Company brought an arbitration proceeding            against Alere Medical Incorporated (“Alere”), seeking damages and an award            for unjust enrichment, on allegations that Alere materially misled and misrepresented            to the Company, its intentions to enter into long-term agreements with the Company for            the provision of disease management services.

             

In the arbitration, Alere counterclaimed, asserting that, under a            seventh agreement between the parties, there was no obligation to enter into a long            term agreement, and thus, claimed Alere, the Company’s claims were not well            founded and Alere is allegedly entitled to damages for breach of the duty of good faith            and fair dealing, as well as its attorneys’ fees. Alere also filed a lawsuit in            state court, in the Second Judicial District Court of Nevada, Washoe County, seeking            essentially the same relief.

             

Following extensive discovery, these matters were mediated, and both the            arbitration and the litigation were resolved during December 2006. As part of the            resolution, in December 2006, the Company received a payment totaling $1,975,000            bringing these matters to a conclusion.

             

The Company is subject to claims and legal proceedings covering a wide            range of matters that arise in the ordinary course of business. Although management of            the Company cannot predict the ultimate outcome of these legal proceedings with            certainty, it believes that their ultimate resolution, including any additional amounts            we may be required to pay, will not have a material effect on the financial            statements.

             

|   | Item 1A. | Risk Factors |
|--------|----------|--------------|

See Management’s Discussion and Analysis and Risk Factors            contained earlier in this report.

             

|   | Item 2. | Unregistered Sales of Equity Securities and Use of                            Proceeds |
|--------|---------|----------------------------------------------------------------------------------------|

|   | (a) Non applicable |
|--------|--------------------|

| . | (b) Non applicable |
|---|--------------------|

|   | (c) None |
|--------|----------|

 

|   | Item 3. | Defaults upon Senior Securities |
|--------|---------|---------------------------------|

|   | None. |
|--------|-------|

 

|   | Item 4. | Submission of Matters to a Vote of Security                            Holders |
|--------|---------|--------------------------------------------------------------------------------|

|   | None. |
|--------|-------|

 

|   | Item 5. | Other Information |
|--------|---------|-------------------|

|   | (a) | None |
|--------|-----|------|

|   | (b) | There have been no material changes to the procedures by                            which security holders may recommend nominees to the Company’s                            Board of Directors. |
|--------|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | Item 6. | Exhibits |
|--------|---------|----------|

|   | (a) | The following exhibits are filed as part of this                            report: |
|--------|-----|-------------------------------------------------------------------------------------|

|   | 31.1 | Certification of Chief Executive Officer of Periodic                            Report |
|--------|------|----------------------------------------------------------------------------------------|

pursuant to Rule 13a-14a and Rule 15d-14(a).

|   | 31.2 | Certification of Chief Financial Officer of Periodic                            Report |
|--------|------|----------------------------------------------------------------------------------------|

pursuant to Rule 13a-14a and Rule 15d-14(a).

|   | 32.1 | Certification of Chief Executive Officer and Chief                            Financial Officer pursuant to 18 U.S.C. |
|--------|------|-----------------------------------------------------------------------------------------------------------------------|

Section 1350.

 

29

 

----

 

SIGNATURES

 

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

 

|   | QMed, Inc. |
|--------|------------|

 

 

 

|   | By:/s/ Jane A.                            Murray |
|--------|--------------------------------------------------|

|   | Jane A. Murray |
|--------|----------------|

|   | Chief Executive Officer |
|--------|-------------------------|

 

 

|   | By:/s/ William T. Schmitt,                            Jr. |
|--------|-----------------------------------------------------------|

|   | William T. Schmitt, Jr. |
|--------|-------------------------|

|   | Senior Vice President, Chief Financial |
|--------|----------------------------------------|

|   | Officer and Treasurer |
|--------|-----------------------|

 

October            5, 2007

 

30