UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-Q





(Mark
One)




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





For the
quarterly period ended June 30, 2009





OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
      EXCHANGE ACT OF 1934.





For the
transition period
from                 
to





Commission
File Number:


0-27554





Conmed
Healthcare Management, Inc.


(Exact
name of registrant as specified in its charter)




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




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




(410) 567-5520(Registrant’s
      telephone number, including area code)




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


YES x
    NO  ̈





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


YES  ̈
    NO  ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





Large Accelerated filer  ̈
                Accelerated filer  ̈Non-Accelerated filer  ̈
                Smaller reporting company x


(Do not
check if a smaller reporting company)





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


YES  ̈
    NO x




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




Number of Shares OutstandingClass
                        
                        August 12, 2009Common Stock, $0.0001 par value per share
                        
                        12,601,429





CONMED
HEALTHCARE MANAGEMENT, INC.





TABLE
OF CONTENTS





PART I. FINANCIAL
INFORMATION


PageITEM
      1. FINANCIAL STATEMENTS (UNAUDITED)Consolidated
      Balance SheetsJune
      30, 2009 and December 31, 2008
                          
                          1Consolidated
      Statements of OperationsFor
      the three and six months ended June 30, 2009 and 2008
                          
                          2Consolidated
      Statements of Cash FlowsFor
      the six months ended June 30, 2009 and 2008
                          
                          3Consolidated
      Statements of Shareholders’ EquityFor
      the six months ended June 30, 2009
                          
                          4Notes
      to Consolidated Financial Statements
                          
                          5ITEM
      2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS
                          
                          13ITEM
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
    RISK
                          
                          22ITEM
      4(T). CONTROLS AND PROCEDURES
                          
                          22




PART
II.OTHER
INFORMATION




ITEM
      1. LEGAL PROCEEDINGS
                  
                  23ITEM
      1A. RISK FACTORS
                  
                  23ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
    PROCEEDS
                  
                  23ITEM
      3. DEFAULTS UPON SENIOR SECURITIES
                  
                  23ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
                  
                  23ITEM
      5. OTHER INFORMATION
                  
                  23ITEM
      6. EXHIBITS
                  
                  23SIGNATURES
                  
                  24


i




PART
1.  FINANCIAL INFORMATION




ITEM
      1.
            FINANCIAL
      STATEMENTS




CONMED
HEALTHCARE MANAGEMENT, INC.


CONSOLIDATED
BALANCE SHEETS


June 30, 2009
                  
                  
                  December 31,(unaudited)
                  
                  
                  2008ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                  
                  $
                  8,921,083
                  
                  
                  $
                  7,472,140Accounts
      receivable
                  
                  
                  1,857,387
                  
                  
                  
                  2,375,583Prepaid
      expenses
                  
                  
                  373,824
                  
                  
                  
                  291,599Total
      current assets
                  
                  
                  11,152,294
                  
                  
                  
                  10,139,322PROPERTY
      AND EQUIPMENT, NET
                  
                  
                  648,862
                  
                  
                  
                  529,304DEFERRED
      TAXES
                  
                  
                  645,000
                  
                  
                  
                  645,000OTHER
      ASSETSService
      contracts acquired, net
                  
                  
                  1,047,000
                  
                  
                  
                  2,004,000Non-compete
      agreements, net
                  
                  
                  628,667
                  
                  
                  
                  821,667Goodwill
                  
                  
                  6,263,705
                  
                  
                  
                  6,254,544Deposits
                  
                  
                  15,408
                  
                  
                  
                  15,408Total
      other assets
                  
                  
                  7,954,780
                  
                  
                  
                  9,095,619$
                  20,400,936
                  
                  
                  $
                  20,409,245LIABILITIES
      AND SHAREHOLDERS’ EQUITYCURRENT
      LIABILITIESAccounts
      payable
                  
                  $
                  1,640,426
                  
                  
                  $
                  1,080,259Accrued
      expenses
                  
                  
                  2,997,761
                  
                  
                  
                  3,210,749Taxes
      payable
                  
                  
                  72,240
                  
                  
                  
                  432,380Deferred
      revenue
                  
                  
                  215,506
                  
                  
                  
                  561,734Notes
      payable, current portion
                  
                  
                  34,042
                  
                  
                  
                  170,228Total
      current liabilities
                  
                  
                  4,959,975
                  
                  
                  
                  5,455,350NOTES
      PAYABLE, LONG-TERM
                  
                  
                  35,000
                  
                  
                  
                  35,000DERIVATIVE
      FINANCIAL INSTRUMENTS
                  
                  
                  4,817,102
                  
                  
                  
                  —SHAREHOLDERS’
      EQUITYPreferred
      stock, no par value; authorized 5,000,000 shares; issued and outstanding
      zero shares as of June 30, 2009 and December 31, 2008
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, $0.0001 par value, authorized 40,000,000 shares; issued and
      outstanding 12,601,429 and 12,457,539 shares as of June 30, 2009 and
      December 31, 2008, respectively
                  
                  
                  1,260
                  
                  
                  
                  1,246Additional
      paid-in capital
                  
                  
                  35,205,648
                  
                  
                  
                  36,875,610Retained
      (deficit)
                  
                  
                  (24,618,049
                  )
                  
                  
                  (21,957,961
                  )Total
      shareholders' equity
                  
                  
                  10,588,859
                  
                  
                  
                  14,918,895$
                  20,400,936
                  
                  
                  $
                  20,409,245


See
Notes to unaudited Financial Statements


Page - 1
-


CONMED
HEALTHCARE MANAGEMENT, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS (UNAUDITED)





For
      the Six
                  Months
      Ended
                  June
      30, 2009
                
                
                For
      the Six
                  Months
      Ended
                  June
      30, 2008
                
                
                For
      the Three
                  Months
      Ended
                  June
      30, 2009
                
                
                For
      the Three
                  Months
      Ended
                  June
      30, 2008Service
      contract revenue
                
                $
                25,131,993
                
                
                $
                16,831,113
                
                
                $
                12,712,751
                
                
                $
                8,994,863HEALTHCARE
      EXPENSES:Salaries,
      wages and employee benefits
                
                
                14,238,095
                
                
                
                8,719,760
                
                
                
                7,250,241
                
                
                
                4,605,733Medical
      expenses
                
                
                4,763,396
                
                
                
                4,659,923
                
                
                
                2,381,463
                
                
                
                2,643,335Other
      operating expenses
                
                
                863,830
                
                
                
                487,704
                
                
                
                479,625
                
                
                
                254,269Total
      healthcare expenses
                
                
                19,865,321
                
                
                
                13,867,387
                
                
                
                10,111,329
                
                
                
                7,503,337Gross
      profit
                
                
                5,266,672
                
                
                
                2,963,726
                
                
                
                2,601,422
                
                
                
                1,491,526Selling
      and administrative expenses
                
                
                3,759,723
                
                
                
                3,084,421
                
                
                
                1,944,196
                
                
                
                1,495,409Depreciation
      and amortization
                
                
                1,240,559
                
                
                
                1,029,575
                
                
                
                605,738
                
                
                
                530,126Total
      operating expenses
                
                
                5,000,282
                
                
                
                4,113,996
                
                
                
                2,549,934
                
                
                
                2,025,535Operating
      income (loss)
                
                
                266,390
                
                
                
                (1,150,270
                )
                
                
                51,488
                
                
                
                (534,009
                )OTHER
      INCOME (EXPENSE)Interest
      income
                
                
                44,580
                
                
                
                107,150
                
                
                
                15,952
                
                
                
                41,253Interest
      (expense)
                
                
                (7,173
                )
                
                
                (3,194
                )
                
                
                (1,967
                )
                
                
                (1,504
                )Change
      in fair value of derivatives
                
                
                (2,444,273
                )
                
                
                —
                
                
                
                (2,445,139
                )
                
                
                —Total
      other income (expense)
                
                
                (2,406,866
                )
                
                
                103,956
                
                
                
                (2,431,154
                )
                
                
                39,749(Loss)
      before income taxes
                
                
                (2,140,476
                )
                
                
                (1,046,314
                )
                
                
                (2,379,666
                )
                
                
                (494,260
                )Income
      tax (expense)
                
                
                (153,000
                )
                
                
                —
                
                
                
                (32,000
                )
                
                
                —Net
      (loss)
                
                $
                (2,293,476
                )
                
                $
                (1,046,314
                )
                
                $
                (2,411,666
                )
                
                $
                (494,260
                )(LOSS)
      PER COMMON SHAREBasic
      and diluted
                
                $
                (0.18
                )
                
                $
                (0.09
                )
                
                
                (0.19
                )
                
                
                (0.04
                )WEIGHTED-AVERAGE
      SHARES OUTSTANDINGBasic
      and diluted
                
                
                12,516,285
                
                
                
                12,006,848
                
                
                
                12,560,155
                
                
                
                12,024,222


See
Notes to unaudited Financial Statements


Page - 2
-




CONMED
HEALTHCARE MANAGEMENT, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)




For the Six Months
                  
                  
                  For the Six MonthsEnded June 30,
                  
                  
                  Ended June 30,2009
                  
                  
                  2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      (loss)
                  
                  $
                  (2,293,476
                  )
                  
                  $
                  (1,046,314
                  )Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDepreciation
                  
                  
                  90,559
                  
                  
                  
                  39,575Amortization
                  
                  
                  1,150,000
                  
                  
                  
                  990,000Stock-based
      compensation
                  
                  
                  324,269
                  
                  
                  
                  263,246Loss
      on disposal of property
                  
                  
                  —
                  
                  
                  
                  2,257Change
      in fair value of derivatives
                  
                  
                  2,444,273
                  
                  
                  
                  —Changes
      in working capital componentsDecrease
      (increase) in accounts receivable
                  
                  
                  518,196
                  
                  
                  
                  (158,182
                  )(Increase)
      in prepaid expenses
                  
                  
                  (82,225
                  )
                  
                  
                  (327,955
                  )Decrease
      in deposits
                  
                  
                  —
                  
                  
                  
                  45,000Increase
      in accounts payable
                  
                  
                  560,167
                  
                  
                  
                  159,956Increase
      (decrease) in accrued expenses
                  
                  
                  (212,988
                  )
                  
                  
                  1,027,433(Decrease)
      in income taxes payable
                  
                  
                  (360,140
                  )
                  
                  
                  —(Decrease)
      in deferred revenue
                  
                  
                  (346,228
                  )
                  
                  
                  (326,828
                  )Net
      cash provided by operating activities
                  
                  
                  1,792,407
                  
                  
                  
                  668,188CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of property and equipment
                  
                  
                  (210,117
                  )
                  
                  
                  (271,397
                  )Asset
      Purchase from EMDC, P.C.
                  
                  
                  —
                  
                  
                  
                  (245,762
                  )Stock
      Purchase of CMHS, LLC
                  
                  
                  (9,161
                  )
                  
                  
                  —Net
      cash used in investing activities
                  
                  
                  (219,278
                  )
                  
                  
                  (517,159
                  )CASH
      FLOWS FROM FINANCING ACTIVITIESPayments
      on line of credit
                  
                  
                  (100,000
                  )
                  
                  
                  —Payments
      on loans
                  
                  
                  (36,186
                  )
                  
                  
                  (35,930
                  )Proceeds
      from exercise of warrants
                  
                  
                  12,000
                  
                  
                  
                  —Net
      cash used in financing activities
                  
                  
                  (124,186
                  )
                  
                  
                  (35,930
                  )Net
      increase in cash and cash equivalents
                  
                  
                  1,448,943
                  
                  
                  
                  115,099CASH
      AND CASH EQUIVALENTSBeginning
                  
                  
                  7,472,140
                  
                  
                  
                  7,136,720Ending
                  
                  $
                  8,921,083
                  
                  
                  $
                  7,251,819NON-CASH
      INVESTING AND FINANCING ACTIVITIES WERE AS FOLLOWS:Stock
      (81,081 Shares) for Asset Purchase from EMDC, P.C.
                  
                  
                  —
                  
                  
                  
                  150,000Promissory
      Note payable to EMDC, P.C. for Asset Purchase
                  
                  
                  —
                  
                  
                  
                  132,275Warrants
      (80,000 Shares) for Asset Purchase from EMDC, P.C.
                  
                  
                  —
                  
                  
                  
                  50,013$
                  —
                  
                  
                  $
                  332,288SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONCash
      payments for interest
                  
                  $
                  7,173
                  
                  
                  $
                  3,194Income
      taxes paid
                  
                  
                  513,140
                  
                  
                  
                  —




See
Notes to unaudited Financial Statements


Page - 3
-


CONMED
HEALTHCARE MANAGEMENT, INC.


CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)





Preferred
                    
                    
                    Common
                    
                    
                    Additional Paid-in
                    
                    
                    AccumulatedStock
                    
                    
                    Stock
                    
                    
                    Capital
                    
                    
                    Deficit
                    
                    
                    TotalBalance
      at December 31, 2008
                    
                    $
                    —
                    
                    
                    $
                    1,246
                    
                    
                    $
                    36,875,610
                    
                    
                    $
                    (21,957,961
                    )
                    
                    $
                    14,918,895Cumulative
      effect of change in accounting principleJanuary
      1, 2009 reclassification of embedded feature of equity-linked financial
      instrument to derivative liability
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (2,399,538
                    )
                    
                    
                    (366,612
                    )
                    
                    
                    (2,766,150
                    )Net
      Income
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (2,293,476
                    )
                    
                    
                    (2,293,476
                    )Stock
      option expense
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    324,269
                    
                    
                    
                    —
                    
                    
                    
                    324,269Exercise
      of warrants
                    
                    
                    —
                    
                    
                    
                    14
                    
                    
                    
                    405,307
                    
                    
                    
                    —
                    
                    
                    
                    405,321Balance
      at June 30, 2009
                    
                    $
                    —
                    
                    
                    $
                    1,260
                    
                    
                    $
                    35,205,648
                    
                    
                    $
                    (24,618,049
                    )
                    
                    $
                    10,588,859


See
Notes to unaudited Financial Statements


Page - 4
-


CONMED
HEALTHCARE MANAGEMENT, INC.




NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS




NOTE
      1.
            Nature
      of Business




Nature
of Business


Prior to
January 26, 2007, Conmed Healthcare Management, Inc. (together with its
consolidated subsidiaries, “we”, “us”, “our” or the Company, unless otherwise
specified or the context otherwise requires) was classified as a public shell,
had no ongoing operations, minimal operating expenses, no employees and operated
under the name Pace Health Management Systems, Inc. (“Pace”).





On
January 26, 2007, the Company acquired Conmed, Inc. (“Conmed, Inc.”) a provider
of correctional healthcare services (the “Acquisition”). Conmed, Inc. was formed
as a corporation on June 10, 1987 in the State of Maryland for the purpose of
providing healthcare services exclusively to county detention centers located in
Maryland. As Conmed, Inc. developed, it accepted more contracts for additional
services including mental health, pharmacy and out-of-facility healthcare
expenses. In 2000, Conmed, Inc. served more than 50% of the county detention
healthcare services market in Maryland. In 2003, Conmed, Inc. elected to seek
contracts outside of Maryland.





As a
result of the Acquisition, Conmed, Inc. is a wholly-owned subsidiary of the
Company and the business of Conmed, Inc. is now our primary business. On March
13, 2007, the Company changed its name to Conmed Healthcare Management, Inc. As
of June 30, 2009, we were in contract with, and currently providing medical
services in thirty-three counties in six states including:  Arizona,
Kansas, Maryland, Oregon, Virginia and Washington.




NOTE
      2.
            Significant
      Accounting Policies




The
accompanying unaudited consolidated financial statements contained herein have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (the “SEC”) for interim reporting requirements of Form 10-Q
and Rule 8-03 of Regulation S-X. Accordingly, the financial information and
disclosures normally included in the financial statements prepared annually in
accordance with accounting principles generally accepted in the United States of
America (“GAAP”) have been condensed or omitted. Readers of this report should,
therefore, refer to the consolidated financial statements and notes included in
Amendment No. 1 to our Annual Report on Form 10-K/A for the year ended December
31, 2008, filed with the Securities and Exchange Commission on July 14,
2009.





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





Our
interim results of operations for the three and six months ended June 30, 2009
are not necessarily indicative of the results of operations to be expected for a
full year.





A summary
of the Company's significant accounting policies is as follows:





Acquisitions


Acquisitions
are recorded based on Financial Accounting Standards Board (“FASB”) Statement of
Financial Accounting Standards (“SFAS”) No. 141(Revised), Business Combinations (“SFAS
141R”), using the purchase method. Under purchase accounting, assets
acquired, liabilities assumed, and any noncontrolling interest in the acquiree
should be stated on the financial statements at “fair value” (see definition in
Fair Value of Financial Instruments section below), with limited exceptions, as
of the acquisition date.  SFAS 141R requires that intangible assets be
recognized as assets apart from goodwill if they meet one of two criteria, (1)
the contractual-legal criterion, or (2) the separability
criterion.  SFAS 141R also requires disclosure of the primary reasons
for business combination and the allocation of the purchase price paid to the
assets acquired and the liabilities assumed by major balance sheet caption.
Goodwill is to be recognized as a residual. If the acquisition-date fair value
exceeds the consideration transferred, a gain is to be recognized. The statement
generally requires that acquisition costs be expensed as incurred. SFAS 141R is
effective for business combinations for which the acquisition date is on or
after January 1, 2009.


Page - 5
-


Service
Contracts Acquired


There are
material costs in obtaining a customer list, especially customers with recurring
revenue streams. The value of service contracts acquired is represented by the
future revenue streams, therefore, the income approach is the most applicable
fair value measurement approach to value these assets. The operating income
streams of service contracts acquired are calculated based on the net present
value of estimated earnings. Operating income streams are estimated on a
contract by contract basis and an overall cost factor is used to estimate
management expenses.  Service contracts acquired are amortized over
the life of each individual contract.





Non-Compete
Agreements


Non-compete
agreements are generally acquired as part of our acquisition
agreements.  Key considerations in estimating the value of non-compete
agreements include consideration of the potential losses resulting from such
competition, the enforceability of the terms of the agreement, and the
likelihood of competition in the absence of the agreement. Non-compete
agreements are amortized over the lives of the agreements.





Goodwill


We record
as goodwill the excess of purchase price over the fair value of the identifiable
net assets acquired.  SFAS No. 142, Goodwill and Other Intangible
Assets, prescribes a two-step process for impairment testing of goodwill,
which is performed annually, as well as when an event triggering impairment may
have occurred. The first step tests for impairment, while the second step, if
necessary, measures the impairment. There have been no indicators of impairment
for any of the goodwill. We have elected to perform our annual analysis during
the fourth quarter of each fiscal year.





Fair
Value of Financial Instruments


Financial
instruments include cash, receivables, accounts payable, accrued expenses,
deferred revenue and long-term debt. We believe the fair value of each of these
instruments approximates their carrying value in the balance sheet as of the
balance sheet date. The fair value of current assets and current liabilities is
estimated to approximate carrying value due to the short-term nature of these
instruments. The fair value of the long-term debt is estimated based on
anticipated interest rates which we believe would currently be available to us
for similar issues of debt, taking into account our current credit risk and the
other market factors.  The same assumptions are used to record
financial instruments acquired through acquisition at fair value.





Effective
January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements
(“SFAS 157”). In February 2008, the FASB issued FASB Staff Position No. FAS
157-2, Effective Date of FASB
Statement No. 157, which provides a one year deferral of the effective
date of SFAS 157 for non-financial assets and non-financial liabilities, except
those that are recognized or disclosed in the financial statements at fair value
at least annually. Therefore, we have adopted the provisions of SFAS 157 with
respect to its financial assets and liabilities only. SFAS 157 defines fair
value, establishes a framework for measuring fair value under generally accepted
accounting principles and enhances disclosures about fair value measurements.
Fair value is defined under SFAS 157 as the exchange price that would be
received for an asset or paid to transfer a liability (an exit price) in the
principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date. Valuation
techniques used to measure fair value under SFAS 157 must maximize the use of
observable inputs and minimize the use of unobservable inputs. The standard
describes a fair value hierarchy based on three levels of inputs, of which the
first two are considered observable and the last unobservable, that may be used
to measure fair value, which are the following:




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




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




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





The
adoption of SFAS 157 did not have a material impact on our financial
statements.  Details related to our adoption of this standard are
discussed in Note 6, “Fair Value Measurements”.


Page - 6
-


Revenue
Recognition


Our
principal source of revenue is contracts to provide medical assistance to county
and municipal correctional facilities. Deferred revenue represents amounts that
may be paid in advance of delivery under these contracts.





Most of
our contracts call for a fixed monthly fee. In addition, most contracts have
incremental charges based on the average daily population (“ADP”) of the
correctional facility or a contractual fee adjustment based on the ADP. Revenues
from contracts are recognized ratably for fixed fees, or monthly for contracts
with variable charges based on ADP. We have one contract that partially operates
on a cost plus basis. The timing of each payment varies per contract. Credit
terms are not more than 30 days from the date of invoice.





Certain
contracts provide for monthly fee adjustments to reflect any missed hours of
work required under terms of the contract. In addition, we may incur liquidated
damages related to specific performance measurements required under the contract
that we have failed to meet. Reductions in monthly fees resulting from staffing
adjustments and liquidated damages are recorded by us as reductions to
revenue.





Certain
contracts include “stop/loss” limits, which create a ceiling to our financial
responsibility for an individual inmate's care or a maximum amount in the
aggregate for certain categories of medical expenses, whereby we are protected
from catastrophic medical losses. In circumstances where a stop/loss is reached,
we are reimbursed for any costs incurred over the predetermined stop/loss
amount. Any reimbursement received by us is recorded as revenue.





Accrued
Medical Claims Liability


Medical
expenses include the costs associated with medical services provided by off-site
medical providers; pharmacy, laboratory and radiology fees; professional and
general liability insurance as well as other generally related medical expenses.
The cost of medical services provided, administered or contracted for are
recognized in the period in which they are provided based in part on estimates
for unbilled medical services rendered through the balance sheet date. The
Company estimates an accrual for unbilled medical services using available
utilization data including hospitalization, one-day surgeries, physician visits
and emergency room and ambulance visits and other related costs, which are
estimated. Additionally, Company personnel review certain inpatient hospital
stays and other high cost medical procedures and expenses in order to attempt to
identify costs in excess of the historical average rates. Once identified,
reserves are determined which take into consideration the specific facts
available at that time.





Actual
payments and future reserve requirements will differ from the Company’s current
estimates. The differences could be material if significant adverse fluctuations
occur in the healthcare cost structure or the Company’s future claims
experience. Changes in estimates of claims resulting from such fluctuations and
differences between estimates and actual claims payments are recognized in the
period in which the estimates are changed or the payments are made.





Stock
Compensation


Effective
January 1, 2006, we adopted SFAS No. 123 (Revised), Shared-Based Payments(“SFAS
123R”), using the modified prospective transition method. Prior to that date, we
accounted for stock option awards under Accounting Principles Board Opinion No.
25. In accordance with SFAS 123R, compensation expense for stock-based awards is
recorded over the vesting period at the fair value of the award at the time of
grant. The recording of such compensation began on January 1, 2006 for shares
not yet vested as of that date and for all new grants subsequent to that date.
The exercise price of options granted under our incentive plans is equal to the
fair market value of the underlying stock at the grant date. We assume no
projected forfeitures on stock-based compensation, since actual historical
forfeiture rates on our stock-based incentive awards have been
negligible.





Fair
Value of Derivative Financial Instruments


Effective
January 1, 2009, we adopted Emerging Issues Task Force (“EITF”) Issue No. 07-5,
Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock (“EITF 07-5”). Details related to our adoption of this
standard and its impact on our financial position and results of operations are
discussed in Note 5, “Fair Value of Warrants”. EITF 07-5 is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early application was not
permitted. Paragraph 11(a) of SFAS No. 133, Accounting for Derivatives and
Hedging Activities (“SFAS 133”) specifies that a contract that would otherwise
meet the definition of a derivative but is both (a) indexed to the
Company’s own stock and (b) classified in stockholders’ equity in the
statement of financial position would not be considered a derivative financial
instrument. EITF 07-5 provides a new two-step model to be applied in determining
whether a financial instrument or an embedded feature is indexed to an issuer’s
own stock and thus able to qualify for the SFAS 133 paragraph 11(a) scope
exception.  The first step evaluates the instrument’s contingent
exercise provisions, if any and the second step evaluates the instrument’s
settlement provisions.


Page - 7
-


Income
Taxes


Deferred
taxes are provided on a liability method whereby deferred tax assets are
recognized for deductible temporary differences and operating loss carryforwards
and deferred tax liabilities are recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts of assets
and liabilities and their tax basis. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be
realized.





Recently
Adopted Accounting Standards


Effective
January 1, 2009, we adopted SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements(“SFAS 160”) and it did not have a
material impact on our financial position or results of operations. SFAS 160
requires companies to report ownership interest in subsidiaries held by other
parties (minority interest) to be clearly identified, labeled and presented in
the consolidated statement of financial condition separately within the equity
section. The amount of consolidated net income attributable to the parent
company and to the noncontrolling interest is to be clearly identified and
presented on the face of the consolidated statement of income. SFAS 160 became
effective beginning January 1, 2009.





Effective
with the quarter ended June 30, 2009, we adopted FSP FAS 107-1 and APB 28-1,
Interim Disclosures about Fair
Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”) and it did
not have a material impact on our financial position or results of
operations.  FSP FAS 107-1 and APB 28-1 require disclosures about fair
value of financial instruments in interim and annual financial
statements.  FSP FAS 107-1 and APB 28-1 became effective for periods
ending after June 15, 2009.





Effective
with the quarter ended June 30, 2009, we adopted SFAS No. 165, Subsequent Events (“SFAS
165”) and it did not have a material impact on our financial position or results
of operations.  SFAS 165 establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued.





New
Accounting Pronouncements


In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of SFAS No. 162 (“SFAS 168”).  Under SFAS 168, the
FASB Accounting Standards Codification (“Codification”) will become the source
of authoritative U.S. GAAP recognized by the FASB to be applied by
nongovernmental entities.  Rules and interpretive releases of the SEC
under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants.  On the effective date of SFAS 168, the
Codification will supersede all then-existing non-SEC accounting and reporting
standards.  All other non-grandfathered non-SEC accounting literature
not included in the Codification will become non-authoritative.  SFAS
168 is effective for financial statements issued for interim and annual periods
ending after September 15, 2009.  In the FASB’s view, the issuance of
SFAS 168 and the Codification will not change GAAP, except for those nonpublic
nongovernmental entities that must now apply the American Institute of Certified
Public Accountants Technical Inquiry Service Section 5100, “Revenue
Recognition”, paragraphs 38-76.  The Company does not expect that the
adoption of SFAS 168 will have a material impact on our financial position or
results of operations.




NOTE
      3.
            Common
      Stock Options




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





During
the six months ended June 30, 2009 and 2008, we recorded stock-based
compensation expense net of reversals for forfeited options totaling $324,269
and $263,246, respectively and during the three months ended June 30, 2009 and
2008 we recorded stock-based compensation expense net of reversals for forfeited
options totaling $165,000 and 143,192, respectively.





During
the six months ended June 30, 2009, the Board of Directors authorized options to
purchase 41,000 shares of common stock at an average exercise price of $2.54 per
share.  Additionally, during the six months ended June 30, 2009,
options to purchase 8,000 shares of common stock were forfeited and as of June
30, 2009, 303,833 shares remain available for grant.


Page - 8
-




NOTE
      4.
            Earnings
      Per Share




The
following table sets forth the computation of basic and diluted (loss)
per-share:





For the Six
                  
                  
                  For the Six
                  
                  
                  For the Three
                  
                  
                  For the ThreeMonths Ended
                  
                  
                  Months Ended
                  
                  
                  Months Ended
                  
                  
                  Months EndedJune 30, 2009
                  
                  
                  June 30, 2008
                  
                  
                  June 30, 2009
                  
                  
                  June 30, 2008Numerator
      for basic and diluted earnings pershare:Net
      (loss)
                  
                  $
                  (2,293,476
                  )
                  
                  $
                  (1,046,314
                  )
                  
                  
                  (2,411,666
                  )
                  
                  
                  (494,260
                  )Denominator:Weighted-average
      basic shares outstanding
                  
                  
                  12,516,285
                  
                  
                  
                  12,006,848
                  
                  
                  
                  12,560,155
                  
                  
                  
                  12,024,222(Loss)
      per common share:Basic
      and diluted
                  
                  $
                  (0.18
                  )
                  
                  $
                  (0.09
                  )
                  
                  
                  (0.19
                  )
                  
                  
                  (0.04
                  )





Common
stock warrants and options outstanding totaling 3,974,167 and 4,337,417 shares,
respectively, are not included in diluted earnings per common share for the
three and six months ended June 30, 2009 and 2008, respectively, as they would
have an antidilutive effect upon earnings per common share.




NOTE
      5.
            Fair
      Value of Warrants




As a
result of adopting EITF 07-5, effective January 1, 2009, 1,705,000 of our issued
and outstanding common stock purchase warrants previously treated as equity
pursuant to the derivative treatment exemption were no longer afforded equity
treatment as follows.  These common stock purchase warrants do not
trade in an active securities market, and as such, we estimate the fair value of
these warrants using the Black-Scholes option pricing model and all changes in
the fair value of these warrants will be recognized currently in earnings until
such time as the warrants are exercised or expire.





Pre-Acquisition
Warrants @ $0.30 per share


On
October 24, 2005, Pace issued 37,500 warrants to purchase common stock, as
adjusted for the 1 for 20 reverse stock split. Of these warrants, 30,000 were
issued to John Pappajohn, Pace's sole director and acting chairman, and the
remaining 7,500 warrants were issued to his designees. The warrants were issued
as compensation for past services rendered and all warrants were immediately
vested. The warrants had an exercise price of $10.00, which exceeded the market
price of Pace's common stock at the time of issuance. The value of the warrants
was separately estimated at $0.20 per share or $10,000 based on the
Black-Scholes valuation of the call option associated with a five-year warrant.
As part of the negotiations for the private placement of $15,000,000 of units of
Series B Convertible Preferred Stock and warrants completed on January 26, 2007
(the “Private Placement), Mr. Pappajohn relinquished the 30,000 warrants that
were issued to him, and the remaining 7,500 warrants issued to his designees
were adjusted to 250,000 warrants to purchase common stock exercisable at $0.30
per share, expiring October 23, 2010.





Black-Scholes assumptions
                  
                  June 30, 2009
                  
                  
                  January 1, 2009Expected
      life (years)
                  
                  
                  0.7
                  
                  
                  
                  0.9Expected
      volatility
                  
                  
                  85.74
                  %
                  
                  
                  82.51
                  %Risk-free
      interest rate
                  
                  
                  1.2
                  %
                  
                  
                  0.8
                  %Expected
      dividend yield
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %





As of
January 1, 2009, we had outstanding warrants to purchase an aggregate of 225,000
shares of common stock.  During the six months ended June 30, 2009, no
warrants were exercised and as of June 30, 2009, we had outstanding warrants to
purchase an aggregate of 225,000 shares of common stock.


Page - 9
-


Investor
Warrants @ $0.30 per share


In
connection with the Private Placement, each investor received a warrant to
purchase up to a number of shares of common stock equal to 25% of such
investor's subscription amount, divided by the conversion price of the Series B
Convertible Preferred Stock, with an exercise price equal to $0.30. As a result,
we issued to investors warrants to purchase an aggregate of 1,500,000 shares of
common stock, exercisable at $0.30 per share, expiring March 13,
2012.





Black-Scholes assumptions
                  
                  June 30, 2009
                  
                  
                  January 1, 2009Expected
      life (years)
                  
                  
                  1.8
                  
                  
                  
                  2.0Expected
      volatility
                  
                  
                  85.74
                  %
                  
                  
                  82.51
                  %Risk-free
      interest rate
                  
                  
                  1.8
                  %
                  
                  
                  1.1
                  %Expected
      dividend yield
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %





As of
January 1, 2009, we had outstanding warrants to purchase an aggregate of 980,000
shares of common stock.  During the six months ended June 30, 2009,
warrants to purchase 40,000 shares of common stock were exercised for cash and
warrants to purchase 117,000 shares of common stock were exercised by cashless
exercise and as a result, a total of 143,890 shares of common stock were
issued.  As of June 30, 2009, we had outstanding warrants to purchase
an aggregate of 823,000 shares of common stock.





Investor
Warrants @ $2.50 per share


In
connection with the Private Placement, each investor received a warrant to
purchase up to a number of shares of common stock equal to 8.3% of such
investor's subscription amount, divided by the conversion price of the Series B
Convertible Preferred Stock, with an exercise price equal to $2.50 per share. As
a result, we issued to investors warrants to purchase an aggregate of 500,000
shares of common stock, exercisable at $2.50 per share, expiring March 13,
2012.





Black-Scholes assumptions
                  
                  June 30, 2009
                  
                  
                  January 1, 2009Expected
      life (years)
                  
                  
                  1.8
                  
                  
                  
                  2.0Expected
      volatility
                  
                  
                  85.74
                  %
                  
                  
                  82.51
                  %Risk-free
      interest rate
                  
                  
                  1.8
                  %
                  
                  
                  1.1
                  %Expected
      dividend yield
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %





As of
January 1, 2009, we had outstanding warrants to purchase an aggregate of 500,000
shares of common stock.  During the six months ended June 30, 2009, no
warrants were exercised and as of June 30, 2009, we had outstanding warrants to
purchase an aggregate of 500,000 shares of common stock.





Summary


On
January 1, 2009, in connection with our adoption of EITF 07-5, we reclassified
from additional paid-in capital, as a cumulative effect adjustment, $366,612 to
beginning retained earnings and $2,399,538 to a long-term warrant liability to
recognize the fair value of such warrants on such date.





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





Investor
                          
                          
                          InvestorPre-
                          
                          
                          Warrants@
                          
                          
                          Warrants@Acquisition
                          
                          
                          $0.30per
                          
                          
                          $2.50perWarrants
                          
                          
                          share
                          
                          
                          share
                          
                          
                          TotalShares
      outstanding as of January 1, 2009
                          
                          
                          225,000
                          
                          
                          
                          980,000
                          
                          
                          
                          500,000
                          
                          
                          
                          1,705,000Shares
      exercised
                          
                          
                          -
                          
                          
                          
                          157,000
                          
                          
                          
                          -
                          
                          
                          
                          157,000Fair
      value of shares exercised
                          
                          $
                          -
                          
                          
                          $
                          393,321
                          
                          
                          $
                          -
                          
                          
                          $
                          393,321Realized
      loss on shares exercised
                          
                          $
                          -
                          
                          
                          $
                          91,648
                          
                          
                          $
                          -
                          
                          
                          $
                          91,648Shares
      outstanding as of June 30, 2009
                          
                          
                          225,000
                          
                          
                          
                          823,000
                          
                          
                          
                          500,000
                          
                          
                          
                          1,548,000Unrealized
      loss on shares outstanding as of June 30, 2009
                          
                          $
                          371,056
                          
                          
                          $
                          1,351,927
                          
                          
                          $
                          629,642
                          
                          
                          $
                          2,352,625Fair
      value of shares outstanding as of June 30, 2009
                          
                          $
                          799,277
                          
                          
                          $
                          2,932,954
                          
                          
                          $
                          1,084,871
                          
                          
                          $
                          4,817,102


Page - 10
-


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





Investor
                        
                        
                        InvestorPre-
                        
                        
                        Warrants@
                        
                        
                        Warrants@Acquisition
                        
                        
                        $0.30per
                        
                        
                        $2.50perWarrants
                        
                        
                        share
                        
                        
                        share
                        
                        
                        TotalShares
      outstanding as of March 31, 2009
                        
                        
                        225,000
                        
                        
                        
                        960,000
                        
                        
                        
                        500,000
                        
                        
                        
                        1,685,000Shares
      exercised
                        
                        
                        -
                        
                        
                        
                        137,000
                        
                        
                        
                        -
                        
                        
                        
                        137,000Fair
      value of shares exercised
                        
                        $
                        -
                        
                        
                        $
                        354,397
                        
                        
                        $
                        -
                        
                        
                        $
                        354,397Realized
      loss on shares exercised
                        
                        $
                        -
                        
                        
                        $
                        91,146
                        
                        
                        $
                        -
                        
                        
                        $
                        91,146Shares
      outstanding as of June 30, 2009
                        
                        
                        225,000
                        
                        
                        
                        823,000
                        
                        
                        
                        500,000
                        
                        
                        
                        1,548,000Unrealized
      loss on shares outstanding as of June 30, 2009
                        
                        $
                        371,144
                        
                        
                        $
                        1,351,531
                        
                        
                        $
                        631,318
                        
                        
                        $
                        2,353,993Fair
      value of shares outstanding as of June 30, 2009
                        
                        $
                        799,277
                        
                        
                        $
                        2,932,954
                        
                        
                        $
                        1,084,871
                        
                        
                        $
                        4,817,102





As of
June 30, 2009, we have outstanding warrants to purchase an aggregate of
1,928,000 shares of common stock at an average exercise price of $1.32 and have
reserved shares of our common stock for issuance in connection with the
potential exercise thereof.




NOTE
      6.
            Fair
      Value Measurements




As a
result of the adoption of EITF 07-5, the Company is also required to disclose
the fair value measurements required by SFAS 157.  The derivative
financial instruments recorded at fair value in the balance sheet as of June 30,
2009 are categorized based upon the level of judgment associated with the inputs
used to measure their fair value.





The
following table summarizes the financial liabilities measured at fair value on a
recurring basis as of June 30, 2009, segregated by the level of valuation inputs
within the fair value hierarchy utilized to measure fair value:





Quoted
      prices in
                
                
                
                
                
                Significantactive
      markets for
                
                
                Significant
      other
                
                
                Unobservableidentical
      assets
                
                
                observable
      inputs
                
                
                inputsTotal
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Derivative
      financial instruments
                
                $
                4,817,102
                
                
                $
                —
                
                
                $
                —
                
                
                $
                4,817,102





Equity-linked
financial instruments consist of stock warrants issued by the Company that
contain a strike price adjustment feature.  In accordance with EITF
07-5, we calculated the fair value of warrants using the Black-Scholes option
pricing model and the assumptions used are described in Note 5, “Fair Value of
Warrants”.  During the six months ended June 30, 2009, we recognized a
$2,352,625 unrealized loss and a $91,648 realized loss related to the change in
fair value of the financial instruments which is included in Other Income on the
Statement of Operations.


Page - 11
-





The
following table reflects the activity for liabilities measured at fair value
using Level 3 inputs for the six months ended June 30, 2009:





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




NOTE
      7.
            Income
      Tax Matters




Our
effective tax rate differs from the expected tax rate primarily due to permanent
differences related to stock-based compensation and derivatives related to
warrants.  The change in our effective tax rate from prior periods is
primarily due to the relation of our taxable income relative to pre-tax income
and the ability to effectively determine our annualized effective tax
rate.  For the six months ended June 30, 2009, we recorded income tax
expense of $153,000 and for the three months ended June 30, 2009, we recorded
income tax expense of $32,000.  Management continues to apply a
valuation allowance against certain deferred tax assets because of a limited
history of taxable income, the long-term nature of the deferred tax asset and
certain limitations regarding the utilization of the net operating loss
carryforwards. The Company’s ability to utilize its net operating loss
carryforwards and research and development credit is currently limited due to
limitations on change of control under Section 382 of the Internal Revenue Code.
Accordingly, we have fully reserved for the net operating loss carryforwards and
research and development credit as we do not expect to derive any future benefit
from them.




NOTE
      8.
            Subsequent
      Events




Subsequent
events have been evaluated through August 12, 2009, the date financial
statements are filed with the Securities and Exchange
Commission.  Through that date, there were no events requiring
disclosure.


Page - 12
-




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




Information included in this section
and elsewhere in this Quarterly Report on Form 10-Q contains forward-looking
statements regarding the business, operations and financial condition of Conmed
Healthcare Management, Inc. (together with its consolidated subsidiaries, the
“Company”, “we”, “us”, or “our” unless otherwise specified or the context
otherwise requires) within the meaning of Section 27A of the Securities Act of
1933, as amended and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). This information may involve known and unknown
risks, uncertainties and other factors which may cause our actual results,
performance or achievements to be materially different from our future results,
performance or achievements expressed or implied by any forward-looking
statements. Forward-looking statements, which involve assumptions and describe
our future plans, strategies and expectations, and other statements that are not
historical facts, are generally identifiable by use of the words "may," "will,"
"should," "expect," "anticipate," "estimate," "believe," "intend," “plan,”
“potential” or "project" or the negative of these words or other variations on
these words or comparable terminology. These forward-looking statements are
based on assumptions that may be incorrect, and there can be no assurance that
these projections included in these forward-looking statements will come to
pass. Our actual results could differ materially from those expressed or implied
by the forward-looking statements as a result of various factors. We caution you
not to place undue reliance on these forward-looking statements. Such
forward-looking statements relate only to events as of the date on which the
statements are made. We undertake no obligation to update any forward-looking
statements, whether as a result of new information, future events or otherwise,
even if experience or future changes make it clear that any projected results or
events expressed or implied therein will not be realized. You are advised,
however, to consult any further disclosures we make in future public statements
and press releases.More detailed information about us
and the risk factors that may affect the realization of forward-looking
statements is set forth in our filings with the Securities and Exchange
Commission (the “SEC”), including Amendment No. 1 to our Annual Report on Form
10-K/A for the year ended December 31, 2008, filed with the SEC on July 14,
2009. Investors and security holders are urged to read this document free of
charge on the SEC's web site at www.sec.gov.




General




Prior to
January 26, 2007, the Company was classified as a shell company and had no
ongoing operations, minimal operating expenses, no employees and operated under
the name Pace Healthcare Management Systems, Inc.





On
January 26, 2007, we acquired Conmed, Inc., a provider of correctional
healthcare services since 1984 (the “Acquisition”). Conmed, Inc. was formed as a
corporation on June 10, 1987 in the State of Maryland for the purpose of
providing healthcare services exclusively to county detention centers located in
Maryland. As Conmed, Inc. developed, it accepted more contracts for additional
services including pharmacy and out-of-facility healthcare expenses. In 2000,
Conmed, Inc. served more than 50% of the county detention healthcare services
market in Maryland. In 2003, Conmed, Inc. elected to seek contracts outside of
Maryland and by December 2006, it had secured contracts in four (4) states. In
January 2007, Conmed, Inc. was in contract with and serviced 18 detention
centers and facilities at the county level in the United States. As a result of
the Acquisition, Conmed, Inc. is a wholly-owned subsidiary of the Company and
the business of Conmed, Inc. is now our primary business. As of June 30, 2009
the Company was servicing detention facilities in thirty-three (33) counties and
six (6) states. Our services have expanded to include the mental health
offerings of our new wholly-owned subsidiary Correctional Mental Health
Services, LLC (“CMHS”).




Critical
Accounting Policies




The
discussion and analysis of our financial condition and results of operations are
based upon our condensed financial statements. These condensed financial
statements have been prepared following the requirements of accounting
principles generally accepted in the United States (“GAAP”) for interim periods
and require us to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to revenue recognition and related medical
expense accruals and amortization and potential impairment of intangible assets
and goodwill and stock-based compensation expense. As these are condensed
financial statements, one should also read expanded information about our
critical accounting policies and estimates provided in Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”,
included in Amendment No. 1 to our Annual Report on Form 10-K/A for the year
ended December 31, 2008, filed with the SEC on July 14, 2009. There have been no
material changes to our critical accounting policies and estimates from the
information provided in our Form 10-K/A for the year ended December 31,
2008.


Page - 13
-




Recently
Adopted Accounting Standards




Effective
January 1, 2009, we adopted Statement of Financial Accounting Standards (“SFAS”)
No. 141(Revised), Business
Combinations (“SFAS 141R”) and it did not have a material impact on our
financial position or results of operations. SFAS 141R replaces the original
SFAS No. 141. This statement applies to all transactions in which an entity
obtains control of one or more businesses. SFAS 141R requires an acquirer to
recognize the assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree at their fair values, with limited exceptions, as of
the acquisition date. Goodwill is to be recognized as a residual. If the
acquisition-date fair value exceeds the consideration transferred, a gain is to
be recognized. The statement generally requires that acquisition costs be
expensed. SFAS 141R became effective for business combinations for which the
acquisition date is on or after January 1, 2009.





Effective
January 1, 2009, we adopted SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements(“SFAS 160”) and it did not have a
material impact on our financial position or results of operations. SFAS 160
requires companies to report ownership interest in subsidiaries held by other
parties (minority interest) to be clearly identified, labeled and presented in
the consolidated statement of financial condition separately within the equity
section. The amount of consolidated net income attributable to the parent
company and to the noncontrolling interest is to be clearly identified and
presented on the face of the consolidated statement of income. SFAS 160 became
effective beginning January 1, 2009.





Effective
January 1, 2009, we adopted Emerging Issues Task Force (“EITF”) Issue No. 07-5,
Determining Whether an
Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock
(“EITF 07-5”).  Details related to our adoption of this standard and
its impact on our financial position and results of operations are discussed in
more detail elsewhere in this Management’s Discussion and Analysis of Financial
Condition and Results of Operations and in the accompanying Notes to the
Unaudited Condensed Consolidated Financial Statements.





Effective
with the quarter ended June 30, 2009, we adopted FSP FAS 107-1 and APB 28-1,
Interim Disclosures about Fair
Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”) and it did
not have a material impact on our financial position or results of
operations.  FSP FAS 107-1 and APB 28-1 require disclosures about fair
value of financial instruments in interim and annual financial
statements.  FSP FAS 107-1 and APB 28-1 became effective for periods
ending after June 15, 2009.





Effective
with the quarter ended June 30, 2009, we adopted SFAS No. 165, Subsequent Events (“SFAS
165”) and it did not have a material impact on our financial position or results
of operations.  SFAS 165 establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued.




New
Accounting Pronouncements




In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of SFAS No. 162 (“SFAS 168”).  Under SFAS 168, the
FASB Accounting Standards Codification (“Codification”) will become the source
of authoritative U.S. GAAP recognized by the FASB to be applied by
nongovernmental entities.  Rules and interpretive releases of the SEC
under authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants.  On the effective date of SFAS 168, the
Codification will supersede all then-existing non-SEC accounting and reporting
standards.  All other non-grandfathered non-SEC accounting literature
not included in the Codification will become non-authoritative.  SFAS
168 is effective for financial statements issued for interim and annual periods
ending after September 15, 2009.  In the FASB’s view, the issuance of
SFAS 168 and the Codification will not change GAAP, except for those nonpublic
nongovernmental entities that must now apply the American Institute of Certified
Public Accountants Technical Inquiry Service Section 5100, “Revenue
Recognition”, paragraphs 38-76.  The Company does not expect that the
adoption of SFAS 168 will have a material impact on our financial position or
results of operations.


Page - 14
-




Results
of Operations




Three
Months Ended June 30, 2009 compared to Three Months Ended June 30,
2008


The
following discussion of financial results below is derived from unaudited
financial statements for the three months ended June 30, 2009 and
2008.





Three
      Months Ended
                  June
      30, 2009
                
                
                Three
      Months Ended
                  June
      30, 2008Amount
                
                
                %
      of
                  Revenue
                
                
                Amount
                
                
                %
      of
                  RevenueService
      contract revenue
                
                $
                12,712,751
                
                
                
                100.0
                %
                
                $
                8,994,863
                
                
                
                100.0
                %HEALTHCARE
      EXPENSES:Salaries,
      wages and employee benefits
                
                
                7,250,241
                
                
                
                57.0
                %
                
                
                4,605,733
                
                
                
                51.2
                %Medical
      expenses
                
                
                2,381,463
                
                
                
                18.7
                %
                
                
                2,643,335
                
                
                
                29.4
                %Other
      operating expenses
                
                
                479,625
                
                
                
                3.8
                %
                
                
                254,269
                
                
                
                2.8
                %Total
      healthcare expenses
                
                
                10,111,329
                
                
                
                79.5
                %
                
                
                7,503,337
                
                
                
                83.4
                %Gross
      profit
                
                
                2,601,422
                
                
                
                20.5
                %
                
                
                1,491,526
                
                
                
                16.6
                %OPERATING
      EXPENSES:Selling,
      general & administrative expenses
                
                
                1,944,196
                
                
                
                15.3
                %
                
                
                1,495,409
                
                
                
                16.6
                %Depreciation
      and amortization
                
                
                605,738
                
                
                
                4.8
                %
                
                
                530,126
                
                
                
                5.9
                %Total
      operating expenses
                
                
                2,549,934
                
                
                
                20.1
                %
                
                
                2,025,535
                
                
                
                22.5
                %Operating
      income (loss)
                
                
                51,488
                
                
                
                0.4
                %
                
                
                (534,009
                )
                
                
                (5.9
                )%OTHER
      INCOME (EXPENSE)Interest
      income
                
                
                15,952
                
                
                
                0.1
                %
                
                
                41,253
                
                
                
                0.5
                %Interest
      expense
                
                
                (1,967
                )
                
                
                0.0
                %
                
                
                (1,504
                )
                
                
                0.0
                %Change
      in fair value of derivatives
                
                
                (2,445,139
                )
                
                
                (19.2
                )%
                
                
                —
                
                
                
                0.0
                %Total
      other income (expense)
                
                
                (2,431,154
                )
                
                
                (19.1
                )%
                
                
                39,749
                
                
                
                0.4
                %(Loss)
      before income taxes
                
                
                (2,379,666
                )
                
                
                (18.7
                )%
                
                
                (494,260
                )
                
                
                (5.5
                )%Income
      tax expense
                
                
                32,000
                
                
                
                0.3
                %
                
                
                —
                
                
                
                0.0
                %Net
      (loss)
                
                $
                (2,411,666
                )
                
                
                (19.0
                )%
                
                $
                (494,260
                )
                
                
                (5.5
                )%





Revenues


Net
revenue from medical services provided primarily to correctional institutions
for the three months ended June 30, 2009 and 2008, was $12,712,751 and
$8,994,863, respectively, which represents an increase of $3,717,888 or 41.3%.
Net loss was $2,411,666 or 19.0% of revenue compared to a net loss of $494,260
or 5.5% of revenue for the three months ended June 30, 2009 and 2008,
respectively, which represented an increased loss of $1,917,406.





Approximately
$3,468,999 or 93.3% of the increase in revenue for the three months ended June
30, 2009 compared to the same period for the prior year resulted from the
addition of contracts signed with new jurisdictions since March 31, 2008:
Caroline County, MD; Chesapeake City, VA; Douglas County, OR; Pima County, AZ;
and Western Virginia Regional Jail, VA.  Revenues also increased as a
result of the acquisition of CMHS on November 4, 2008. Revenue improvement
totaling approximately $266,572, or 7.2% of the increase, resulted primarily
from expansion of the services provided under a number of our existing contracts
in which we were providing services prior to 2008. Price increases related to
existing service requirements totaled approximately $318,674 or 8.6% of the
revenue increase. Partially offsetting the above were decreases in other volume
related activities totaling $336,357, or 9.1% of revenue, primarily associated
with a decrease in stop/loss reimbursements due to reduced out of facility
medical expenditures in excess of stop/loss limits billed back to
counties.


Page - 15
-


Healthcare
Expenses


Salaries
and employee benefits


Salaries
and employee benefits for healthcare employees were $7,250,241 or 57.0% of
revenue for the three month period ended June 30, 2009, compared to $4,605,733
or 51.2% of revenue for the three months ended June 30, 2008. The increase in
spending for salaries and employee benefits of $2,644,508 or 57.4% is due to the
addition of new healthcare employees required to support the increased staffing
requirements resulting primarily from our new medical service contracts and
expansions under some of our existing agreements. The primary factors causing
the increase in salaries and employee benefits as a percentage of revenue was
the addition of new service contracts with Caroline County, MD, Pima County, AZ,
and Western Virginia Regional Jail, VA, which primarily provide staffing
services. As a result, these contracts increased the mix of salaries and
employee benefits as a percentage of total revenue.  Salaries and
employee benefits also increased as a result of the acquisition of CMHS on
November 4, 2008.  Additionally, the services provided by CMHS to
Conmed prior to the acquisition of CMHS on November 4, 2008 were being recorded
as independent contractor medical expenses totaling approximately
$219,000.  Since the acquisition, those expenses are now primarily
recorded as salaries and employee benefits.





Medical
expenses


Medical
expenses for the three months ended June 30, 2009 and 2008 were $2,381,463 or
18.7% of revenue and $2,643,335 or 29.4% of revenue, respectively, which
represented a decrease of $261,872 or 9.9%. The decrease in spending for medical
expenses in absolute dollars reflects decreases for medical services out of
facility which were partially offset by increased expenditures for pharmacy and
radiology services. The reduction in spending as a percentage of revenue results
from the favorable mix factor generated from the new primarily staffing services
contracts in 2008 in Caroline County, MD ,Pima County, AZ, and Western Virginia
Regional Jail, VA, and decreased spending for hospitalization and other out of
facility inmate medical visits primarily in Baltimore County, MD, Loudoun
County, VA and Frederick County, MD, partially offset by the addition of
pharmacy services in Calvert County, MD, Douglas County, OR and Pima County,
AZ.  Additionally, the services provided by CMHS to Conmed prior to
the acquisition of CMHS on November 4, 2008 were being recorded as independent
contractor medical expenses totaling approximately $219,000.  Since
the acquisition, those expenses are now primarily recorded as salaries and
employee benefits.





Other
operating expenses


Other
operating expenses were $479,625, or 3.8% of revenue, for the three months ended
June 30, 2009, compared to $254,269, or 2.8% of revenue, for the three months
ended June 30, 2008. The increase of $225,356 in spending is primarily related
to the increase in the number of inmates served as a result of the new service
contracts and reflects increased spending for employment advertising and
recruiting, professional liability insurance, office supplies and travel
expenses.





Operating
Expenses


Selling,
general and administrative expenses


Selling,
general and administrative expenses for the three months ended June 30, 2009 and
2008 were $1,944,196 or 15.3% of revenue and $1,495,409 or 16.6% of revenue,
respectively. The increased expenditures of $448,787 primarily reflects an
increased investment in additional management and administrative personnel
required to support additional new contracts and services added in 2008, as well
as to sustain the Company during anticipated future growth and increased legal
expenses. Stock based compensation for the three months ended June 30, 2009 and
2008 was $165,000 and $143,192, respectively.





Depreciation
and amortization


Depreciation
and amortization primarily reflects the amortization of intangible assets
related to the acquisition of Conmed, Inc. in January 2007, the purchase of
medical service contracts from Emergency Medicine Documentation Consultants,
P.C. (“EMDC”) in February 2008 and the acquisition of CMHS in November 2008.
Amortization of service contracts acquired was $463,000, or 3.6% of revenue, for
the three months ended June 30, 2009, compared to $422,000, or 4.7% of revenue,
for the three months ended June 30, 2008. The increase primarily reflects
additional amortization expense for service contracts acquired in the CMHS
acquisition in November 2008 partially offset by a decrease in amortization
expense related to the Conmed, Inc. acquisition as certain individual contracts
acquired have become fully amortized. Amortization of non-compete agreements was
$96,000, or 0.8% of revenue, for the three months ended June 30, 2009, compared
to $82,000, or 0.9% of revenue, for the three months ended June 30, 2008. The
increase primarily reflects an additional non-compete agreement related to the
acquisition of CMHS. Depreciation expense increased to $46,738 for the three
months ended June 30, 2009 compared to $26,126 for the prior year period due
primarily to capital expenditures associated with the new corporate office in
Hanover, Maryland, a new corporate accounting system, and computer equipment in
our Pima County, AZ facility.


Page - 16
-


Interest
income


Interest
income was $15,952 for the three months ended June 30, 2009 compared to $41,253
for the same period in 2008. Cash balances in the second quarter of 2009 were
higher compared to the second quarter of 2008, however the lower interest income
reflects reduced short-term interest rates during the period.





Interest
expense


Interest
expense for the second quarter increased to $1,967 in 2009 compared to $1,504 in
the same period in 2008.





Change
in fair value of derivatives


As a
result of adopting EITF 07-5 effective January 1, 2009, 1,705,000 of our issued
and outstanding common stock purchase warrants previously treated as equity
pursuant to the derivative treatment exemption were no longer afforded equity
treatment and as a result they are now being recorded as a liability based on
fair value estimates.  These common stock purchase warrants do not
trade in an active securities market, and as such, we estimate the fair value of
these warrants using the Black-Scholes option pricing model and all changes in
the fair value of these warrants will be recognized currently in earnings until
such time as the warrants are exercised or expire.  As such, on
January 1, 2009, we reclassified from additional paid-in capital, as a
cumulative effect adjustment, $366,612 to beginning retained earnings and
$2,399,538 to a long-term warrant liability to recognize the fair value of such
warrants on such date.





During
the three months ended June 30, 2009, warrants to purchase 20,000 shares of
common stock were exercised generating $6,000 of net proceeds and warrants to
purchase 117,000 shares of common stock were exercised by cashless exercise and
as a result, a total of 123,890 shares of common stock were issued.





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





Pre-
                  Acquisition
                  Warrants
                
                
                Investor
                  Warrants@
                  $0.30per
                  share
                
                
                Investor
                  Warrants@
                  $2.50per
                  share
                
                
                TotalShares
      outstanding as of March 31, 2009
                
                
                225,000
                
                
                
                960,000
                
                
                
                500,000
                
                
                
                1,685,000Shares
      exercised
                
                
                -
                
                
                
                137,000
                
                
                
                -
                
                
                
                137,000Fair
      value of shares exercised
                
                $
                -
                
                
                $
                354,397
                
                
                $
                -
                
                
                $
                354,397Realized
      loss on shares exercised
                
                $
                -
                
                
                $
                91,146
                
                
                $
                -
                
                
                $
                91,146Shares
      outstanding as of June 30, 2009
                
                
                225,000
                
                
                
                823,000
                
                
                
                500,000
                
                
                
                1,548,000Unrealized
      loss on shares outstanding as of June 30, 2009
                
                $
                371,144
                
                
                $
                1,351,531
                
                
                $
                631,318
                
                
                $
                2,353,993Fair
      value of shares outstanding as of June 30, 2009
                
                $
                799,277
                
                
                $
                2,932,954
                
                
                $
                1,084,871
                
                
                $
                4,817,102





Income
tax expense


Our
effective tax rate differs from the expected tax rate primarily due to permanent
differences related to stock-based compensation and derivatives related to
warrants.  The change in our effective tax rate from prior periods is
primarily due to the relation of our taxable income relative to pre-tax income
and the ability to effectively determine our annualized effective tax
rate.  For the three months ended June 30, 2009, we recorded income
tax expense of $32,000.  Management continues to apply a valuation
allowance against certain deferred tax assets because of a limited history of
taxable income, the long-term nature of the deferred tax asset and certain
limitations regarding the utilization of the net operating loss carryforwards.
The Company’s ability to utilize its net operating loss carryforwards and
research and development credit is currently limited due to limitations on
change of control under Section 382 (“Section 382”) of the Internal Revenue Code
(“IRC”). Accordingly, we have fully reserved for the net operating loss
carryforwards and research and development credit as we do not expect to derive
any future benefit from them.


Page - 17
-


Six
Months Ended June 30, 2009 compared to Six Months Ended June 30,
2008


The
following discussion of financial results below is derived from unaudited
financial statements for the six months ended June 30, 2009 and
2008.





Six
      Months Ended
                  June
      30, 2009
                
                
                Six
      Months Ended
                  June
      30, 2008Amount
                
                
                %
      of
                  Revenue
                
                
                Amount
                
                
                %
      of
                  RevenueService
      contract revenue
                
                $
                25,131,993
                
                
                
                100.0
                %
                
                $
                16,831,113
                
                
                
                100.0
                %HEALTHCARE
      EXPENSES:Salaries,
      wages and employee benefits
                
                
                14,238,095
                
                
                
                56.7
                %
                
                
                8,719,760
                
                
                
                51.8
                %Medical
      expenses
                
                
                4,763,396
                
                
                
                19.0
                %
                
                
                4,659,923
                
                
                
                27.7
                %Other
      operating expenses
                
                
                863,830
                
                
                
                3.4
                %
                
                
                487,704
                
                
                
                2.9
                %Total
      healthcare expenses
                
                
                19,865,321
                
                
                
                79.0
                %
                
                
                13,867,387
                
                
                
                82.4
                %Gross
      profit
                
                
                5,266,672
                
                
                
                21.0
                %
                
                
                2,963,726
                
                
                
                17.6
                %OPERATING
      EXPENSES:Selling,
      general & administrative expenses
                
                
                3,759,723
                
                
                
                15.0
                %
                
                
                3,084,421
                
                
                
                18.3
                %Depreciation
      and amortization
                
                
                1,240,559
                
                
                
                4.9
                %
                
                
                1,029,575
                
                
                
                6.1
                %Total
      operating expenses
                
                
                5,000,282
                
                
                
                19.9
                %
                
                
                4,113,996
                
                
                
                24.4
                %Operating
      income (loss)
                
                
                266,390
                
                
                
                1.1
                %
                
                
                (1,150,270
                )
                
                
                (6.8
                )%OTHER
      INCOME (EXPENSE)Interest
      income
                
                
                44,580
                
                
                
                0.2
                %
                
                
                107,150
                
                
                
                0.6
                %Interest
      expense
                
                
                (7,173
                )
                
                
                0.0
                %
                
                
                (3,194
                )
                
                
                0.0
                %Change
      in fair value of derivatives
                
                
                (2,444,273
                )
                
                
                (9.7
                )%
                
                
                —
                
                
                
                0.0
                %Total
      other income (expense)
                
                
                (2,406,866
                )
                
                
                (9.6
                )%
                
                
                103,956
                
                
                
                0.6
                %(Loss)
      before income taxes
                
                
                (2,140,476
                )
                
                
                (8.5
                )%
                
                
                (1,046,314
                )
                
                
                (6.2
                )%Income
      tax expense
                
                
                153,000
                
                
                
                0.6
                %
                
                
                —
                
                
                
                0.0
                %Net
      (loss)
                
                $
                (2,293,476
                )
                
                
                (9.1
                )%
                
                $
                (1,046,314
                )
                
                
                (6.2
                )%





Revenues


Net
revenue from medical services provided primarily to correctional institutions
for the six months ended June 30, 2009 and 2008, was $25,131,993 and
$16,831,113, respectively, which represents an increase of $8,300,880 or 49.3%.
Net loss was $2,293,476 or 9.1% of revenue compared to a net loss of $1,046,314
or 6.2% of revenue for the six months ended June 30, 2009 and 2008,
respectively, which represented an increased loss of $1,247,162.





Approximately
$7,628,984 or 91.9% of the increase in revenue for the six months ended June 30,
2009 compared to the same period for the prior year resulted from the addition
of new contracts since December 31, 2007: Caroline County, MD; Chesapeake City,
VA; Douglas County, OR; Pima County, AZ; and Western Virginia Regional Jail,
VA.  Revenues also increased as a result of the contracts in Oregon
acquired when we purchased all of the assets of EMDC in February 2008 plus the
revenue generated from the acquisition of CMHS on November 4, 2008. Revenue
improvement totaling approximately $462,429, or 5.6% of the increase, resulted
primarily from expansion of the services provided under a number of our existing
contracts in which we were providing services prior to 2008. Price increases
related to existing service requirements totaled approximately $662,619 or 8.0%
of the revenue increase. Partially offsetting the above were decreases in other
volume related activities totaling $453,152, or 5.5% of revenue, primarily
associated with a decrease in stop/loss reimbursements due to reduced out of
facility medical expenditures in excess of stop/loss limits billed back to
counties.


Page - 18
-


Healthcare
Expenses


Salaries
and employee benefits


Salaries
and employee benefits for healthcare employees were $14,238,095 or 56.7% of
revenue for the six month period ended June 30, 2009, compared to $8,719,760 or
51.8% of revenue for the six months ended June 30, 2008. The increase in
spending for salaries and employee benefits of $5,518,335 or 63.3% is due to the
addition of new healthcare employees required to support the increased staffing
requirements resulting primarily from our new medical service contracts and
expansions in some of our existing agreements. The primary factors causing the
increase in salaries and employee benefits as a percentage of revenue was the
addition of new service contracts with Caroline County, MD , Pima County, AZ,
and Western Virginia Regional Jail, VA, which primarily provide staffing
services. As a result, these contracts increased the mix of salaries and
employee benefits as a percentage of total revenue.  Salaries and
employee benefits also increased as a result of the acquisition of CMHS on
November 4, 2008.  Additionally, the services provided by CMHS to
Conmed prior to the acquisition of CMHS on November 4, 2008 were being recorded
as independent contractor medical expenses totaling approximately
$439,000.  Since the acquisition, those expenses are now primarily
recorded as employee salaries and benefits.





Medical
expenses


Medical
expenses for the six months ended June 30, 2009 and 2008 were $4,763,396 or
19.0% of revenue and $4,659,923 or 27.7% of revenue, respectively, which
represented an increase of $103,473 or 2.2%. The increase in spending for
medical expenses in absolute dollars reflects increased expenditures for
pharmacy services, a portion of which were offset by reductions in out of
facility medical services expense. The reduction in spending as a percentage of
revenue results from the favorable mix factor generated from the new primarily
staffing services contracts in 2008 in Caroline County, MD , Pima County, AZ,
and Roanake County, VA and decreased spending for hospitalization and other out
of facility inmate medical visits primarily in Baltimore County, MD, Loudoun
County, VA and Frederick County, MD, partially offset by the addition of
pharmacy services in Calvert County, MD, Douglas County, OR and Pima County,
AZ.  Additionally, the services provided by CMHS to Conmed prior to
the acquisition of CMHS on November 4, 2008 were being recorded as independent
contractor medical expenses totaling approximately $439,000.  Since
the acquisition, those expenses are now primarily recorded as employee salaries
and benefits.





Other
operating expenses


Other
operating expenses were $863,830, or 3.4% of revenue, for the six months ended
June 30, 2009, compared to $487,704, or 2.9% of revenue, for the six months
ended June 30, 2008. The increase of $376,126 is directly related to the
increase in the number of inmates served as a result of the new service
contracts and reflects increased spending for employment advertising and
recruiting, professional liability insurance, office supplies and travel
expenses.





Operating
Expenses


Selling,
general and administrative expenses


Selling,
general and administrative expenses for the six months ended June 30, 2009 and
2008 were $3,759,723 or 15.0% of revenue and $3,084,421 or 18.3% of revenue,
respectively. The increased expenditures of $675,302 reflects an increased
investment in additional management and administrative personnel required to
support additional new contracts and services added in 2008, as well as to
sustain the Company during anticipated future growth and increased legal
expenses. Stock based compensation for the six months ended June 30, 2009 and
2008 was $324,269 and $263,247, respectively.





Depreciation
and amortization


Depreciation
and amortization primarily reflects the amortization of intangible assets
related to the acquisition of Conmed, Inc. in January 2007, the purchase of
medical service contracts from EMDC in February 2008 and the acquisition of CMHS
in November 2008. Amortization of service contracts acquired was $957,000, or
3.8% of revenue, for the six months ended June 30, 2009, compared to $836,000,
or 5.0% of revenue, for the six months ended June 30, 2008. The increase
primarily reflects additional amortization expense for service contracts
acquired in the CMHS acquisition in November 2008 partially offset by a decrease
in amortization expense related to the Conmed, Inc. acquisition as certain
individual contracts acquired have become fully amortized. Amortization of
non-compete agreements was $193,000, or 0.8% of revenue, for the six months
ended June 30, 2009, compared to $154,000, or 0.9% of revenue, for the six
months ended June 30, 2008. The increase primarily reflects an additional
non-compete agreement related to the acquisition of CMHS. Depreciation expense
increased to $90,559 for the six months ended June 30, 2009 compared to $39,575
for the prior year period due primarily to capital expenditures associated with
the new corporate office in Hanover, Maryland, a new corporate accounting
system, and computer equipment in our Pima County, AZ facility.


Page - 19
-


Interest
income


Interest
income was $44,580 for the six months ended June 30, 2009 compared to $107,150
for the same period in 2008. Cash balances in the first six months of 2009 were
higher compared to the first six months of 2008, however the lower interest
income reflects reduced short-term interest rates during the
period.





Interest
expense


Interest
expense for the first six months increased to $7,173 in 2009 compared to $3,194
in the same period in 2008.





Change
in fair value of derivatives


As a
result of adopting EITF 07-5 effective January 1, 2009, 1,705,000 of our issued
and outstanding common stock purchase warrants previously treated as equity
pursuant to the derivative treatment exemption were no longer afforded equity
treatment and as a result they are now being recorded as a liability based on
fair value estimates.  These common stock purchase warrants do not
trade in an active securities market, and as such, we estimate the fair value of
these warrants using the Black-Scholes option pricing model and all changes in
the fair value of these warrants will be recognized currently in earnings until
such time as the warrants are exercised or expire.  As such, on
January 1, 2009, we reclassified from additional paid-in capital, as a
cumulative effect adjustment, $366,612 to beginning retained earnings and
$2,399,538 to a long-term warrant liability to recognize the fair value of such
warrants on such date.





During
the six months ended June 30, 2009, warrants to purchase 40,000 shares of common
stock were exercised generating $12,000 of net proceeds and warrants to purchase
117,000 shares of common stock were exercised by cashless exercise and as a
result, a total of 143,890 shares of common stock were issued.





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





Pre-
                  Acquisition
                  Warrants
                
                
                Investor
                  Warrants@
                  $0.30per
                  share
                
                
                Investor
                  Warrants@
                  $2.50per
                  share
                
                
                TotalShares
      outstanding as of January 1, 2009
                
                
                225,000
                
                
                
                980,000
                
                
                
                500,000
                
                
                
                1,705,000Shares
      exercised
                
                
                -
                
                
                
                157,000
                
                
                
                -
                
                
                
                157,000Fair
      value of shares exercised
                
                $
                -
                
                
                $
                393,321
                
                
                $
                -
                
                
                $
                393,321Realized
      loss on shares exercised
                
                $
                -
                
                
                $
                91,648
                
                
                $
                -
                
                
                $
                91,648Shares
      outstanding as of June 30, 2009
                
                
                225,000
                
                
                
                823,000
                
                
                
                500,000
                
                
                
                1,548,000Unrealized
      loss on shares outstanding as of June 30, 2009
                
                $
                371,056
                
                
                $
                1,351,927
                
                
                $
                629,642
                
                
                $
                2,352,625Fair
      value of shares outstanding as of June 30, 2009
                
                $
                799,277
                
                
                $
                2,932,954
                
                
                $
                1,084,871
                
                
                $
                4,817,102





Income
tax expense


Our
effective tax rate differs from the expected tax rate primarily due to permanent
differences related to stock-based compensation and derivatives related to
warrants.  The change in our effective tax rate from prior periods is
primarily due to the relation of our taxable income relative to pre-tax income
and the ability to effectively determine our annualized effective tax
rate.  For the six months ended June 30, 2009, we recorded income tax
expense of $153,000.  Management continues to apply a valuation
allowance against certain deferred tax assets because of a limited history of
taxable income, the long-term nature of the deferred tax asset and certain
limitations regarding the utilization of the net operating loss carryforwards.
The Company’s ability to utilize its net operating loss carryforwards and
research and development credit is currently limited due to limitations on
change of control under Section 382 of the IRC. Accordingly, we have fully
reserved for the net operating loss carryforwards and research and development
credit as we do not expect to derive any future benefit from
them.


Page - 20
-




Liquidity
and Capital Resources




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





Cash as
of June 30, 2009 and June 30, 2008 was $8,921,083 and $7,251,819,
respectively.  We believe that our existing cash balances and
anticipated cash flows from future operations will be sufficient to meet our
normal operating requirements and liquidity needs for at least the next twelve
months.





Cash
flow for the six months ended June 30, 2009 compared to the six months ended
June 30, 2008


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





Cash flow
from operations for the six months ended June 30, 2008 totaled
$668,188.  The net loss of $1,046,314 was offset by $1,295,078 in
adjustments for non-cash expenses such as amortization of $990,000 and
stock-based compensation of $263,246.  Changes in working capital
components generated an additional $419,424 because of increases in accrued
expenses of $1,027,433 and accounts payable of $159,956 partially offset by an
increase in accounts receivable of $158,182 and prepaid expenses of $327,955 and
a decrease in deferred revenue of $326,828.  The increase in accrued
expenses, accounts payable and accounts receivable resulted primarily from the
increase in revenue and related expenses.  The increase in prepaid
expenses resulted primarily from annual insurance premiums paid during the
quarter.  The decrease in deferred revenue resulted primarily from a
reduction in advance customer payments due to their fiscal year ending June 30,
2008 which prohibits them from making advance payments for services pertaining
to the next fiscal year.





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





Cash flow
from investing activities for the six months ended June 30, 2008 used $517,159.
The asset purchase of EMDC service contracts used $245,762 and purchases of
computer and office equipment primarily related to the new corporate office in
Hanover, Maryland used $271,397.





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





Cash flow
from financing activities for the six months ended June 30, 2008 used cash of
$35,930 for payments on loans.





Loans


As of
June 30, 2009, we had a note outstanding for a vehicle in the amount of $1,319
and two short-term notes payable for $22,723 and $45,000,
respectively.





Off
Balance Sheet Arrangements


We are
required to provide performance and payment guarantee bonds to county
governments under certain contracts. As of June 30, 2009, we have three
performance bonds totaling $7,845,325 and two payment bonds for $2,785,281,
totaling $10,630,606. The surety issuing the bonds has recourse against our
assets in the event the surety is required to honor the bonds.


Page - 21
-


Contractual
Obligations


The
following table presents our expected cash requirements for contractual
obligations outstanding as of June 30, 2009:





Total
                
                
                Due as of
                  6/30/10
                
                
                Due as of
                  6/30/11
                  and
                  6/30/12
                
                
                Due as of
                  6/30/13
                  and
                  6/30/14
                
                
                Due
                  ThereafterAutomobile
      Loan
                
                $
                1,319
                
                
                $
                1,319
                
                
                $
                —
                
                
                $
                —
                
                
                $
                —Note
      Payable
                
                
                68,122
                
                
                
                43,122
                
                
                
                25,000
                
                
                
                —
                
                
                
                —Equipment
      Leases
                
                
                141,603
                
                
                
                57,862
                
                
                
                69,465
                
                
                
                14,276
                
                
                
                —Automobile
      Leases
                
                
                57,265
                
                
                
                32,078
                
                
                
                25,187
                
                
                
                —
                
                
                
                —Office
      Space Leased
                
                
                573,829
                
                
                
                198,279
                
                
                
                289,087
                
                
                
                86,463
                
                
                
                —Total
      Contractual Cash Obligations
                
                $
                842,138
                
                
                $
                332,660
                
                
                $
                408,739
                
                
                $
                100,739
                
                
                $
                —





Effects
of Inflation


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





Potential
Future Service Contract Revenue


As of
June 30, 2009, we have entered into 55 agreements with county governments to
provide medical and healthcare services primarily to county and municipal
correctional facilities. Most of these contracts are for multiple years and
include option renewal periods which are, in all cases, at the county's option.
The original terms of the contracts are from one to nine years. These medical
service contracts have potential future service contract revenue of $166 million
as of June 30, 2009, with a weighted-average term of 4.2 years, of which
approximately $22 million relates to the initial contract period and
approximately $144 million relates to the option renewal periods.




ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




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




ITEM
      4(T).
            CONTROLS
      AND PROCEDURES




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





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


Page - 22
-


PART
II.  OTHER INFORMATION




ITEM
      1.
            LEGAL
      PROCEEDINGS




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




ITEM
      1A.
            RISK
      FACTORS




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




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




None




ITEM
      3.
            DEFAULTS
      UPON SENIOR SECURITIES




None




ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS




The
Annual Meeting of our stockholders was held on May 28, 2009 to elect five
members of our board of directors and to ratify the appointment of McGladrey
& Pullen, LLP as our independent auditor for the fiscal year ending December
31, 2009.  All matters put before the stockholders were approved as
follows:





Proposal 1
                        
                        Election of Directors
                        
                        For
                        
                        
                        Withheld
                        
                        
                        AbstainJohn
      Pappajohn
                        
                        
                        8,077,260
                        
                        
                        
                        600,878
                        
                        
                        
                        100,698Richard
      W. Turner
                        
                        
                        8,069,299
                        
                        
                        
                        600,878
                        
                        
                        
                        100,698Edward
      B. Berger
                        
                        
                        8,678,118
                        
                        
                        
                        20
                        
                        
                        
                        100,698Terry
      E. Branstad
                        
                        
                        8,678,118
                        
                        
                        
                        20
                        
                        
                        
                        100,698John
      W. Colloton
                        
                        
                        8,678,118
                        
                        
                        
                        20
                        
                        
                        
                        100,698Proposal 2
                        
                        Ratification of Appointment of the Independent
      Auditor
                        
                        For
                        
                        
                        Against
                        
                        
                        Abstain8,166,478
                        
                        
                        
                        598,858
                        
                        
                        
                        13,500




ITEM
      5.
            OTHER
      INFORMATION




None




ITEM
      6.
            EXHIBITS




3.1
                Amended
      and Restated Bylaws (incorporated by reference to the Company’s Current
      Report on Form 8-K filed on June 3, 2009)10.1
                Amendment
      No.1 to the 2007 Stock Option Plan (incorporated by reference to the
      Company’s Current Report on Form 8-K filed on July 17,
    2009)31.1
                Section
      302 Certification of Principal Executive Officer31.2
                Section
      302 Certification of Principal Financial Officer32.1
                Section
      906 Certification of Principal Executive Officer32.2
                Section
      906 Certification of Principal Financial
Officer


Page - 23
-




SIGNATURES





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





Conmed
      Healthcare Management, Inc.August
      12, 2009By
      /s/ Richard W. TurnerRichard
      W. Turner, Ph.D.Chairman
      and Chief Executive Officer(principal
      executive officer)August
      12, 2009By
      /s/ Thomas W. FryThomas
      W. FryChief
      Financial Officer and Secretary(principal
      financial officer and principal accounting
  officer)


Page - 24
-