SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



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FORM 10-Q

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

|                                               |  |                         |  |        
|---------------------------------------------- |  | ----------------------- |  | -------
|For the quarterly period ended: March 31, 2001 |  | Commission File Number: |  | 1-12238

MHM SERVICES, INC.
(Exact name of Registrant as specified in its charter)

|                                                        |  |                    
|------------------------------------------------------- |  | -------------------
|Delaware                                                |  | 52-1223048         
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|(State or other jurisdiction of                         |  | (I.R.S. Employer   
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|incorporation or organization)                          |  | Identification No.)
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|8605 Westwood Center Drive, Suite 400, Vienna, Virginia |  | 22182              
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|(Address of principal executive offices)                |  | (Zip Code)         

Registrants telephone number, including area code: (703) 749-4600

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 requirement for the past 90 days. Yes X No

As of May 15, 2001, there were 30,645 shares of Common Stock, par value $.01
per share, outstanding.

1



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MHM SERVICES, INC., AND SUBSIDIARIES
Quarter Ended March 31, 2001

INDEX

|        |  |                                                                                                             |  |        |      | 
|------- |  | ----------------------------------------------------------------------------------------------------------- |  | ------ | ---- | 
|        |  |                                                                                                             |  | Page  
|        |  |                                                                                                             |  | Number
|PART I  |  | FINANCIAL INFORMATION                                                                                      
|       
|       
|       
|       
|        |  | Item 1. Financial Statements                                                                               
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Operations-                                                           
|        |  | Three and Six Months Ended March 31, 2001 and 2000 (Unaudited)                                              |  |        | 4    | 
|       
|       
|       
|       
|        |  | Condensed Consolidated Balance Sheets                                                                      
|        |  | March 31, 2001 (Unaudited) and September 30, 2000                                                           |  |        | 5    | 
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Cash Flows                                                            
|        |  | Six Months Ended March 31, 2001 and 2000 (Unaudited)                                                        |  |        | 6    | 
|       
|       
|       
|       
|        |  | Notes to Condensed Consolidated Financial                                                                  
|        |  | Statements (Unaudited)                                                                                      |  |        | 7-10 | 
|       
|       
|       
|       
|        |  | Item 2.  Managements Discussion and Analysis of
Financial Condition and              Results of Operations |  | 10-17  |     
|       
|       
|       
|       
|PART II |  | OTHER INFORMATION                                                                                          
|       
|       
|       
|       
|        |  | Item 1.  Legal Proceedings                                                                                  |  | 18     |     
|       
|       
|       
|       
|        |  | Item 2.  Changes in Securities and Use of Proceeds                                                          |  | 18     |     
|       
|       
|       
|       
|        |  | Item 3.  Defaults Upon Senior Securities                                                                    |  | 18     |     
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|       
|       
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|        |  | Item 4.  Submission of Matters to Vote of Security Holders                                                  |  | 18     |     
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|        |  | Item 5.  Other Information                                                                                  |  | 18     |     
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|       
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|        |  | Item 6.  Exhibits and Reports on Form 8-K                                                                   |  | 18     |     

2



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MHM SERVICES, INC., AND SUBSIDIARIES
Quarter Ended March 31, 2001

|        |  |  |  |                       |  | 
|------- |  |  |  | --------------------- |  | 
|PART I. |  |  |  | FINANCIAL INFORMATION

|        |  |  |  |                      |  | 
|------- |  |  |  | -------------------- |  | 
|Item 1. |  |  |  | Financial Statements

3



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MHM SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |           |       | 
|-------------------------------------------------- | ------------------------------------------------------------------------------------- | -------- | --------- | ---------------------------- | ------ | -------------------------- | --------- | --------- | ----- | ---- | ---------- | --------- | ------ | - | --------- | --------- | ----- | 
|                                                   |                                                                                       |          |           | Three Months Ended March 31, |        | Six Months Ended March 31,
|                                                   |                                                                                       |          |           |                              |        |                           
|                                                   |                                                                                       |          |           | 2001                         |        | 2000                       |           | 2001      |       | 2000
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |     
|Net Revenues                                       |                                                                                       | $        | 6,065,000 |                              |        |                            | 4,739,000 |           |       | $    | 11,640,000 |           |        |   | 9,423,000 |          
|                                                  
|                                                  
|                                                  
|                                                  
|Costs and expenses:                               
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Operating                                                                             |          |           | 4,746,000                    |        |                            |           | 3,669,000 |       |      |            | 9,043,000 |        |   |           | 7,193,000 |      
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | General and administrative                                                            |          |           | 1,138,000                    |        |                            |           | 912,000   |       |      |            | 2,221,000 |        |   |           | 1,844,000 |      
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Provision for bad debts                                                               |          |           | 23,000                       |        |                            |           | 29,000    |       |      |            | 52,000    |        |   |           | 104,000   |      
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Depreciation and amortization                                                         |          |           | 10,000                       |        |                            |           | 25,000    |       |      |            | 20,000    |        |   |           | 48,000    |      
|                                                  
|                                                  
|                                                  
|                                                  
|Other (credits) charges:                          
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Interest expense                                                                      |          |           |                             |        |                            |           | 36,000    |       |      |            | 23,000    |        |   |           | 72,000    |      
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Loss on disposal of assets                                                            |          |           |                             |        |                            |           |          |       |      |            |          |        |   |           | 5,000     |      
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Other- principally cost report settlements
on previously sold freestanding facilities |          |           | (275,000                     | )      |                            |           | (100,000  | )     |      |            | (289,000  | )      |   |           | (181,000  | )    
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|Income before gain on dissolution
and income taxes |                                                                                       |          | 423,000   |                              |        |                            | 168,000   |           |       |      | 570,000    |           |        |   | 338,000   |          
|                                                  
|                                                  
|                                                  
|                                                  
|Gain on dissolution of Extended Care
Services      |                                                                                       |          |          |                              |        |                            |          |           |       |      | (261,000   | )         |        |   |          |          
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|Income before income taxes                         |                                                                                       |          | 423,000   |                              |        |                            | 168,000   |           |       |      | 831,000    |           |        |   | 338,000   |          
|                                                  
|                                                  
|                                                  
|                                                  
|Income tax expense (benefit)                       |                                                                                       |          | 170,000   |                              |        |                            | (11,000   | )         |       |      | 313,000    |           |        |   | 3,000     |          
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|Net income                                         |                                                                                       | $        | 253,000   |                              |        | $                          | 179,000   |           |       | $    | 518,000    |           |        | $ | 335,000   |          
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|Earnings per common share:                        
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                                                       | -basic   |           | $                            | 8.26   |                            |           | $         | 24.56 |      |            | $         | 16.90  |   |           | $         | 45.97 | 
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|                                                   |                                                                                       | -diluted |           | $                            | 8.10   |                            |           | $         | 20.14 |      |            | $         | 16.58  |   |           | $         | 37.35 | 
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|Weighted average shares outstanding:              
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                                                                       | -basic   |           |                              | 30,645 |                            |           |           | 7,287 |      |            |           | 30,645 |   |           |           | 7,287 | 
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          
|                                                   |                                                                                       | -diluted |           |                              | 31,241 |                            |           |           | 8,889 |      |            |           | 31,241 |   |           |           | 8,970 | 
|                                                   |                                                                                       |          |           |                              |        |                            |           |           |       |      |            |           |        |   |           |          

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

4



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MHM SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |               |   |           |  | 
|--------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------- | -------------------------- | ------------------------------------ | - | ----------- | --------- | ------------- | - | --------- |  | 
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   | (Unaudited) |           | September 30,
|Assets                      |                                                                                                                                                                                                                                          | March 31, 2001                                  |                            | 2000                                
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|Current assets:            
|                           
|                           
|                           
|                           
|                            | Cash and cash equivalents                                                                                                                                                                                                                |                                                 | $                          | 52,000                               |   |             |           | 211,000       |  
|                           
|                           
|                           
|                           
|                            | Accounts receivable, net                                                                                                                                                                                                                 |                                                 |                            | 1,728,000                            |   |             |           | 1,479,000     |  
|                           
|                           
|                           
|                           
|                            | Prepaid expenses                                                                                                                                                                                                                         |                                                 |                            | 255,000                              |   |             |           | 347,000       |  
|                           
|                           
|                           
|                           
|                            | Other current assets                                                                                                                                                                                                                     |                                                 |                            | 163,000                              |   |             |           | 267,000       |  
|                           
|                           
|                           
|                           
|                            | Deferred income taxes                                                                                                                                                                                                                    |                                                 |                            | 550,000                              |   |             |           | 251,000       |  
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|                            |                                                                                                                                                                                                                                          |                                                 | Total currrent assets      |                                      |   | 2,748,000   |           |               |   | 2,555,000 | 
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|                           
|Property and equipment, net |                                                                                                                                                                                                                                          |                                                 | 140,000                    |                                      |   |             | 85,000    |              
|                           
|                           
|                           
|                           
|Restricted cash             |                                                                                                                                                                                                                                          |                                                 | 297,000                    |                                      |   |             | 275,000   |              
|                           
|                           
|                           
|                           
|Other assets                |                                                                                                                                                                                                                                          |                                                 | 106,000                    |                                      |   |             | 106,000   |              
|                           
|                           
|                           
|                           
|Deferred income taxes       |                                                                                                                                                                                                                                          |                                                 | 3,036,000                  |                                      |   |             | 3,645,000 |              
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|                            |                                                                                                                                                                                                                                          | $                                               | 6,327,000                  |                                      |   |             | 6,666,000 |              
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|                            |                                                                                                                                                                                                                                          |                                                 |                            | Liabilities and Stockholders Equity
|                           
|                           
|                           
|                           
|Current liabilities:       
|                           
|                           
|                           
|                           
|                            | Accounts payable                                                                                                                                                                                                                         |                                                 | $                          | 548,000                              |   |             |           | 454,000       |  
|                           
|                           
|                           
|                           
|                            | Accrued payroll and related expenses                                                                                                                                                                                                     |                                                 |                            | 1,009,000                            |   |             |           | 977,000       |  
|                           
|                           
|                           
|                           
|                            | Estimated third-party payor settlements                                                                                                                                                                                                  |                                                 |                            | 27,000                               |   |             |           | 106,000       |  
|                           
|                           
|                           
|                           
|                            | Other accrued expenses                                                                                                                                                                                                                   |                                                 |                            | 796,000                              |   |             |           | 1,675,000     |  
|                           
|                           
|                           
|                           
|                            | Notes payable                                                                                                                                                                                                                            |                                                 |                            | 72,000                               |   |             |           | 170,000       |  
|                           
|                           
|                           
|                           
|                            | Current maturities of long-term debt                                                                                                                                                                                                     |                                                 |                            |                                     |   |             |           | 67,000        |  
|                           
|                           
|                           
|                           
|                            | Deferred income taxes                                                                                                                                                                                                                    |                                                 |                            | 98,000                               |   |             |           | 143,000       |  
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|                            |                                                                                                                                                                                                                                          |                                                 | Total currrent liabilities |                                      |   | 2,550,000   |           |               |   | 3,592,000 | 
|                           
|                           
|                           
|                           
|Long-term debt              |                                                                                                                                                                                                                                          |                                                 |                           |                                      |   |             | 1,400,000 |              
|                           
|                           
|                           
|                           
|Stockholders equity:      
|                           
|                           
|                           
|                           
|                            | Preferred stock ($0.01 par value; authorized: 100,000 and                                                                                                                                                                                |                                                 |                            |                                      |   |             |           |               |  
|                            | and 5,000,000 at March 31, 2001 and September 30, 2000,                                                                                                                                                                                  |                                                 |                            |                                      |   |             |           |               |  
|                            |                                                                                                                                                                                                                                          | respectively; no shares issued and outstanding) |                            |                                      |  |             |           |               |  |          
|                           
|                           
|                           
|                           
|                            | Common stock ($0.01 par value; authorized: 200,000 and
    15,000,000 at March 31, 2001 and September 30, 2000,
     respectively; issued and outstanding: 30,645 and 7,266 
    at March 31, 2001 and September 30, 2000, respectively) |                                                 |                            |                                     |   |             |           |              |  
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |               |  
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |               |  
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |               |  
|                           
|                           
|                           
|                           
|                            | Additional paid-in capital                                                                                                                                                                                                               |                                                 |                            | 43,714,000                           |   |             |           | 42,100,000    |  
|                           
|                           
|                           
|                           
|                            | Accumulated deficit                                                                                                                                                                                                                      |                                                 |                            | (39,903,000                          | ) |             |           | (40,421,000   | )
|                           
|                           
|                           
|                           
|                            | Treasury stock                                                                                                                                                                                                                           |                                                 |                            | (34,000                              | ) |             |           | (5,000        | )
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|                            |                                                                                                                                                                                                                                          |                                                 | Total stockholders equity |                                      |   | 3,777,000   |           |               |   | 1,674,000 | 
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              
|                            |                                                                                                                                                                                                                                          | $                                               | 6,327,000                  |                                      |   |             | 6,666,000 |              
|                            |                                                                                                                                                                                                                                          |                                                 |                            |                                      |   |             |           |              

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5



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MHM SERVICES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

|                                                                                 |  |                                                                     |            |                            |         |      |          |   |        | 
|-------------------------------------------------------------------------------- |  | ------------------------------------------------------------------- | ---------- | -------------------------- | ------- | ---- | -------- | - | ------ | 
|                                                                                 |  |                                                                     |            | Six Months Ended March 31,
|                                                                                 |  |                                                                     |            |                           
|                                                                                 |  |                                                                     |            | 2001                       |         | 2000
|                                                                                 |  |                                                                     |            |                            |         |     
|Cash flows from operating activities                                            
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Net income                                                                       |  | $                                                                   | 518,000    |                            |         | $    | 335,000  |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Adjustments to reconcile net income to net cash
provided by operating activities |  |                                                                     | (492,000   | )                          |         |      | (200,000 | )
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|Net cash provided by operating activities                                        |  |                                                                     | 26,000     |                            |         |      | 135,000  |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flows from investing activities                                            
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Capital expenditures                                                             |  |                                                                     | (76,000    | )                          |         |      | (16,000  | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Change in restricted cash                                                        |  |                                                                     | (22,000    | )                          |         |      |         |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Collections on note receivable                                                   |  |                                                                     |           |                            |         |      | 40,000   |  
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|Net cash (used in) provided by investing activities                              |  |                                                                     | (98,000    | )                          |         |      | 24,000   |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flows from financing activities                                            
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Proceeds from Shareholders Rights Offering, net                                 |  |                                                                     | 1,612,000  |                            |         |      |         |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Borrowings                                                                       |  |                                                                     | 106,000    |                            |         |      | 300,000  |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Debt repayments                                                                  |  |                                                                     | (1,671,000 | )                          |         |      | (343,000 | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Repurchase of stock warrants                                                     |  |                                                                     | (105,000   | )                          |         |      |         |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Purchase of treasury stock                                                       |  |                                                                     | (29,000    | )                          |         |      |         |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Change in cash overdrafts                                                        |  |                                                                     |           |                            |         |      | (24,000  | )
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Net cash used in financing activities                                            |  |                                                                     | (87,000    | )                          |         |      | (67,000  | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|(Decrease) increase in cash and cash equivalents                                 |  |                                                                     | (159,000   | )                          |         |      | 92,000   |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash and cash equivalents                                                       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |  | Beginning balance                                                   |            |                            | 211,000 |      |          |   | 6,000  | 
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|                                                                                 |  | Ending balance                                                      |            | $                          | 52,000  |      |          | $ | 98,000 | 
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|Supplemental disclosure of cash flow information:                               
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |  | Interest paid                                                       |            | $                          | 20,000  |      |          | $ | 77,000 | 
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |  | Income taxes paid                                                   |            |                            | 236,000 |      |          |   | 78,000 | 
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|Supplemental disclosure of non-cash investing and financing activities:         
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |  | Issuance of stock warrants-to obtain financing from
Bank of America |            | $                          | 1,000   |      |          | $ | 86,000 | 
|                                                                                 |  |                                                                     |            |                            |         |      |          |  
|                                                                                 | 

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS

6



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MHM Services, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
March 31, 2001

NOTE 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The condensed consolidated balance sheet as of March 31, 2001, the
condensed consolidated statements of operations for the three and six-month
periods ended March 31, 2001 and 2000, and the condensed consolidated
statements of cash flows for the six-month periods ended March 31, 2001 and
2000 have been prepared by the Company, without audit. In the opinion of
management, all material adjustments (consisting only of normal, recurring
adjustments) necessary to present fairly the condensed consolidated financial
position, results of operations and cash flows as of March 31, 2001, and for
all periods presented, have been made.

Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted. These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended
September 30, 2000. The results of operations for the period ended March 31,
2001 are not necessarily indicative of the operating results for the full year.

NOTE 2. DISSOLUTION OF EXTENDED CARE SERVICES

On August 25, 1999, the Companys wholly owned subsidiary, MHM Extended
Care Services, Inc, (Extended Care Services), filed a Certificate of
Dissolution with the Secretary of State of the State of Delaware. Subsequent
to the filing, Extended Care Services informed all known and foreseeable
creditors about its intent to dissolve and prepared a dissolution plan for
which to pay its outstanding creditors.

On October 30, 2000, the Delaware Court of Chancery approved Extended Care
Services dissolution plan to distribute its remaining total assets, on a
pro-rata basis, to its external creditors. The dissolution of Extended Care
Services became effective on November 30, 2000, which was the first business
day after which creditors could file an appeal of the final order and judgment
issued by the Delaware Court of Chancery.

On December 8, 2000, Extended Care Services distributed total assets of
approximately $178,000, on a pro-rata basis, to its creditors who had claims
that totaled approximately $439,000. As such, a net gain on dissolution of
$261,000 was recorded during the quarter ended December 31, 2000.

7



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NOTE 3. SHAREHOLDERS RIGHTS OFFERING

On November 20, 2000, the Company raised $1,612,000, net of offering
expenses of approximately $100,000, in investment capital as a result of a
Shareholders Rights Offering (the Offering). Each stockholder, based on a
record date of September 29, 2000, was given the right to purchase four new
shares of the Companys common stock for each share of common stock the
stockholder held on the record date, and the pro-rata right to purchase shares
which other stockholders declined to purchase. As a result of the Offering,
the Company issued 23,779 shares of common stock at $72 per share.

Effective November 15, 2000, as a measure to counter the dilutive effect
of the Offering on current stock option holders, the Board of Directors
approved an increase in the number of authorized options from 1,000 options to
4,656 options. This change raised the option pool from 13% of total
outstanding shares of the Company prior to the Offering to 15% of the
outstanding shares of the Company subsequent to the Offering. The Companys
shareholders at the Annual Stockholders Meeting held March 1, 2001 ratified
this amendment.

Effective November 15, 2000, the Company granted 2,906 stock options to
its employees and Board members in order to offset the dilutive effects of the
Offering to option holders.

NOTE 4. DEBT

In October 1997, the Company obtained an unsecured $500,000 line of credit
from Bank of America. This line of credit was required in order to meet cash
demands, and there were no other reasonable sources for financing. Michael S.
Pinkert, Chairman and Chief Executive Officer, personally guaranteed the line
of credit. William P. Ferretti, Director and Lee Calligaro, former Vice
President and General Counsel, each indemnified Mr. Pinkert on his guarantee to
the extent of $100,000. In consideration of the risks assumed in connection
with the guarantee and indemnification, the Company granted 180 warrants to
purchase common stock of the Company at a price of $755 per share. The
warrants were issued as follows, Mr. Pinkert 108 warrants, Mr. Ferretti and
Calligaro 36 warrants each. In addition, for each month there was an
outstanding balance on the line of credit, the Company issued additional
warrants to purchase shares of the Companys common stock at $755 per share.
The Company granted warrants for the number of shares as are equal in value (at
a price of $755 per share) to one and one-half percent of the average loan
balance that was outstanding at the end of each month, based on the guarantors
and indemnitors pro-rata share.

In fiscal 1999, Mr. Pinkert, Mr. Ferretti, and Mr. Calligaro, guarantor
and indemnitors of the original line of credit of $500,000, who earned warrants
of 210, 70, and 70, respectively, during the period that this obligation was
outstanding, were granted
a reduction in their warrant exercise purchase price to $50 per share to
purchase the Companys common stock with previously earned warrants.

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In June 1999, the Company renegotiated the line of credit to a maximum
borrowing capacity of $1,300,000. Mr. Pinkert personally guaranteed the entire
line of credit. For his guaranty in June 1999, the Company granted an
additional 180 warrants to purchase stock of the Company at $50 per share.
Mr. Ferretti, John Silverman, Jacob Shipon, Directors, and Mr. Calligaro
indemnified Mr. Pinkert on his guarantee to the extent of $550,000. For their
indemnifications, the Company granted to each indemnitor on a pro-rata basis
according to their individual indemnification, a total of 198 warrants to
purchase stock of the Company at $50 per share. As a fee to the guarantor and
indemnitors for the ongoing risks represented by the guarantee and
indemnification obligations, for each month during which the guarantee and
indemnification obligations were outstanding, warrants for the number of shares
as are equal in value (at a price of $50 per share) to one and one-half percent
of the average loan balance which is outstanding during the month became
issuable.

Effective May 31, 2000, the Company converted the line of credit of
$1,300,000 to a promissory note due on May 31, 2002. The warrant obligations
described in the paragraphs above to Mr. Pinkert and the others as indemnitors
of Mr. Pinkert terminated when the line of credit was converted to a promissory
note. The note has a revolving feature that allows the Company to borrow,
repay and re-borrow up to the maximum aggregate amount. On July 13, 2000, with
no changes in the original terms, the Company increased the borrowing capacity
on the note to $1,800,000. Mr. Pinkert and Dr. Shipon personally guaranteed
this note in the amount of $1,300,000 and $500,000, respectively. For their
guarantees, the Company granted Mr. Pinkert an additional 180 warrants, and to
Dr. Shipon 126 warrants, to purchase the Companys common stock at $50 per
share. As compensation to Mr. Pinkert and Dr. Shipon for the ongoing risks
represented by their guarantees, for each month the note was outstanding,
warrants for the number of shares of common stock as are equal in value (at a
price of $50 per share) to one and one-half percent of the average loan balance
that is outstanding during the month became issuable.

On November 22, 2000, the Company utilized a portion of the proceeds
received in the Offering to repay the outstanding balance on the note. The
note was subsequently cancelled.

Expenses totaling approximately $1,000 were recorded during the six-month
period ended March 31, 2001 in connection with the issuance of
all warrants in such period for guarantees of the promissory note for
which the warrants were issued and indemnification associated with
such guarantees.

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NOTE 5. STOCKHOLDERS EQUITY

Effective March 16, 2001, the Companys Certificate of Incorporation was
amended to reduce the number of authorized preferred shares from 5,000,000 to
100,000 and to reduce the number of common shares from 15,000,000 to 200,000.

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

This report contains forward-looking statements. Forward-looking
statements relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
may, will, should, expects, plans, anticipates, could,
believes, estimates, predicts, potential, or continue or the negative
of these terms or other similar words. These statements are only predictions.
The outcome of the events described in these forward-looking statements is
subject to certain risks. Actual results could differ materially. We
acknowledge our risks include, but are not limited to, winning new correctional
services contracts, and the realization of future revenues under existing
contracts. Also, we acknowledge there are risks and uncertainties which may
cause actual future activities and results of our operations to be materially
different from that suggested in this report, including, among others, that we
will not have adequate cash flow to continue to fund ongoing operations and the
on-going risk of industry consolidation, acquisitions and competition.

The following discussion addresses the financial condition of MHM
Services, Inc. and subsidiaries as of March 31, 2001 and the results of
operations for the three and six month periods then ended compared with the
same period last year. Our discussion should be read in conjunction with the
Managements Discussion and Analysis section (pages 13-18) for the fiscal year
ended September 30, 2000 included in our Annual Report on Form 10-K.

GENERAL

We were originally incorporated in Virginia in 1981 and in 1994
reincorporated in Delaware. Since we were formed, we have provided mental
health services, initially in general, substance abuse and psychiatric
hospitals and then in nursing homes and correctional facilities. Today, we
principally focus on the correctional services market.

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DESCRIPTION OF BUSINESS

We currently provide mental health services at over 100 correctional
facilities encompassing over 85,000 inmates through statewide contracts with
the Departments of Corrections of the States of Georgia and Tennessee, a
subcontract covering a womens correctional facility in Florida, a subcontract
covering a jail in Mississippi, a subcontract covering the Alabama Department
of Corrections, and contracts with the Departments of Juvenile Justice of the
States of Georgia and Florida. Also, under a contract with the Georgia
Department of Medical Assistance, we provide mental health services to all of
the states Medicaid patients residing in over 300 nursing
homes. We formed MHM Correctional Services, Inc. (Correctional
Services) in 1997 and in the fourth quarter of 1997 that
entity secured contracts with the Tennessee and Georgia Departments of
Correction to provide behavioral health services on a capitated basis to the
inmates of those states correctional facilities.

In the correctional services
market we generally provide our services under what are known as capitation arrangements.
Capitation means we are paid a fixed fee for each inmate eligible for our
services. For that fixed fee, we are required to provide all psychiatric and
psychological services, as well as any psychotropic drugs (i.e., medications
prescribed for mental illness), which are needed by any eligible inmates.
However, we are not responsible for providing inpatient hospitalization that is
provided outside the correctional facilities. In order to limit and control our
risk, the exact level of care we are required to provide for the inmate
population is established by each contract.

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We had previously provided
on-site extended care services outside the correctional services
market through our
subsidiary, MHM Extended Care Services, Inc. In 1998, we decided to wind down
the operations of this subsidiary and eventually dissolve its operations.
Because our correctional services subsidiary was already operating in
Georgia, MHM Extended Care Services Inc. did not seek to effect a renewal of the contract it
maintained to provide on-site mental health services to residents of nursing
homes in Georgia under a contract with the Georgia Department of Medical
Assistance. Since we were aware of the opportunity under this contract, and
because Correctional Services was already operating in Georgia under its
contract with the Georgia Department of Corrections, Correctional Services
sought to procure a contract with the Georgia Department of Medical Assistance
in place of our Extended Care Services subsidiary which was then involved in
dissolution proceedings before the Delaware courts. In May 1999, through a
competitive bid process, we were awarded a one-year contract
beginning July 1, 1999 with three successive options to renew this contract for
additional terms of up to one year each. On July 1, 2000, this contract was
renewed for another year.

When we decided to discontinue the operations of Extended Care Services,
Extended Care Services outstanding liabilities exceeded its total assets. In
August 1999, Extended Care Services initiated dissolution proceedings under the
Delaware General Corporate Law. By November 30, 2000, these dissolution
proceedings became final. Accordingly, on December 8, 2000, Extended Care
Services distributed total assets of approximately $178,000, on a pro-rata
basis, to its creditors who had claims that totaled approximately $439,000.

Financial Position  March 31, 2001 Compared to September 30, 2000

Our stockholders equity increased to $3,777,000 at March 31, 2001 from
$1,674,000 at September 30, 2000. Net proceeds of $1,612,000 received from our
Shareholders Rights Offering and net income of $518,000 for the six months
ended March 31, 2001 were the primary factors which increased our stockholders
equity. Our current assets were $2,748,000 at March 31, 2001 as compared to
$2,555,000 at September 30, 2000. The increase is primarily attributed to an
increase in accounts receivable as a result of additional contracts in our
correctional services business for the six-month period ended March 31, 2001.
Noncurrent assets were $3,579,000 at March 31, 2001 as compared to $4,111,000
at September 30, 2000. The decrease is primarily attributable to the
utilization of our deferred income tax asset to reduce the amount of income tax
expense payable as of March 31, 2001 as a result of the operating income
generated during the six month period ended March 31, 2001. Total current
liabilities were $2,550,000 at March 31, 2001 as compared to $3,592,000 at
September 30, 2000. As a result of the improved operations for the six-month
period ended March 31, 2001, and the compromise of liabilities associated with the dissolution proceedings
of our subsidiary, Extended Care Services, during the quarter ended December
31, 2000, we were able to reduce our current liabilities by $1,042,000.

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As a result of payments we made in connection with the dissolution of
Extended Care Services our cash balance decreased from $211,000 at September
30, 2000 to $52,000 at March 31, 2001.

Six Months Ended March 31, 2001 Compared to Six Months Ended March 31, 2000

Net revenues for the six-month period ended March 31, 2001 were
$11,640,000, an increase of 24% as compared to $9,423,000 for the six-month
period ended March 31, 2000. The increase is the result of the growth in our
correctional services business due to additional contracts.

Operating expenses for the six-month period ended March 31, 2001 were
$9,043,000, or 78% of net revenues, as compared to $7,193,000, or 76% of net
revenues for the six-month period ended March 31, 2000. Operating expenses
increased by 26% over the prior years six-month period due primarily to
continuing operations of several new correctional services contracts added
during the third and fourth quarter of fiscal year 2000 and start-up costs
associated with a new contract added during the second quarter of fiscal year
2001.

General and administrative expenses for the six-month period ended March
31, 2001 were $2,221,000, or 19% of net revenues as compared to $1,844,000, or
20% of net revenues for the six-month period ended March 31, 2000.
Correctional Services had general and administrative expenses of $905,000 for
the quarter ended March 31, 2001 as compared to $683,000 for the six-month
period ended March 31, 2000. The increase was as a result of expanding services at the regional level to provide clients with
additional support and the award of certain new correctional services
contracts during the third and fourth quarters of fiscal year 2000 and the
second quarter of fiscal year 2001. Corporate general and administrative
expenses were $1,312,000 for the six-month period ended March 31, 2001 as
compared to $1,150,000 for the six-month period ended March 31, 2000.
Corporate general and administrative expenses increased primarily due to
corporate marketing and development initiatives. The dissolved Extended Care
Services operations had general and administrative expenses of $4,000 from the
wind down of operations for the six-month period ended March 31, 2001 as
compared to $11,000 for the six-month period ended March 31, 2000.

Our provision for bad debts for the six-month period ended March 31, 2001
decreased to $52,000 as compared to $104,000 for the six-month period ended
March 31, 2000. As a percentage of net revenues, the provision for bad debts
was 0.4% at March 31, 2001 and 1.1% at March 31, 2000, respectively. Our bad
debt provision primarily represents our best estimate of potential
uncollectible revenues for clients we serve under our contract with the Georgia
Department of Medical Assistance, who may not obtain the Medicaid coverage
required to reimburse us for certain services we have provided. Our bad debt
provision also estimates potential uncollectible revenues from
our modest correctional fee-for-service business.

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Depreciation and amortization expenses were $20,000 for the six-month
period ended March 31, 2001 as compared to $48,000 for the six-month period
ended March 31, 2000. Due to changes in technology, during the six-month
period ended March 31, 2000, we changed the estimated useful lives on certain
equipment which caused depreciation expense for the period ending March 31,
2000 to be higher than the period ending March 31, 2001.

Interest expense for the six-month period ended March 31, 2001 was $23,000
as compared to $72,000 for the six-month period ended March 31, 2000. Interest
expense for the period ending March 31, 2001 was primarily from
our promissory note with the bank and other short-term debt. With cash flow from our
operations and proceeds from our Shareholders Rights Offering, in November
2000, we repaid our promissory note that had an outstanding balance $1,400,000
as of September 30, 2000. As a result of this transaction, interest expense
for the six-month period ended March 31, 2001 decreased as compared to the
six-month period ended March 31, 2000.

We disposed of certain fixed assets deemed obsolete during the six-month
period ended March 31, 2000 that resulted in a loss on disposal of $5,000.

We recognized other income of $289,000 in the six-month period ended March
31, 2001. As the result of the reopening of the 1996 Medicare cost report for
a freestanding psychiatric hospital sold in fiscal year 1996, we received
$241,000 in additional reimbursement. Also, due to the Medicare reopening of
the 1997 and 1998 Medicare cost report for a freestanding psychiatric hospital
sold in fiscal year 1998, we recorded $23,000 in other income as a result of
changing the estimate of the liability to equal the notice of final settlement.
Other income from collections on accounts receivable from divested operations
was $1,000 for the six-month period ended March 31, 2001. Also, we had
interest income of $24,000 from interest earned on invested cash balances for
the six-month period ended March 31, 2001.

We recognized other income of $181,000 in the six-month period ended March
31, 2000. The sources of our other income were $91,000 for the settlement of
prior year cost reports from a freestanding hospital that had been sold,
$77,000 from the collection of accounts receivable previously reserved as
uncollectible as a result of the sale of our Extended Care Services operating
units and our former Hospital division, and $13,000 from interest income on invested cash
balances.

The dissolution of Extended Care Services became effective on November 30,
2000. As of September 30, 2000, Extended Care Services assets were $178,000
and its outstanding liabilities were $439,000. On December 8, 2000, Extended
Care Services paid all existing creditors as noted per the terms of its Plan of
Liquidation and Dissolution to resolve all of its outstanding liabilities. As
such, we recognized a net gain on dissolution of $261,000.

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Income tax expense for the six-month period ended March 31, 2001 was
$313,000 as compared to $3,000 for the six-month period ended March 31, 2000.
Income tax expense for the six months ended March 31, 2000 was impacted by the
utilization of deferred tax assets and the reduction in the valuation allowance
associated with such assets. In the fourth quarter of 2000, we eliminated our
valuation allowance on our deferred tax assets due to five consecutive quarters
of profitability. The 2001 effective tax rate is estimated to be approximately
40% of pretax income. The effective tax rate may be affected in future periods
by changes in our estimates with respect to, among other things, our deferred
tax assets.

As a result of the foregoing, we recognized net income of $518,000 for the
six-month period ended March 31, 2001, compared to net income of $335,000 for
the six-month period ended March 31, 2000.

Second Quarter 2001 Compared to Second Quarter 2000

Net revenues for the quarter ended March 31, 2001 were $6,065,000, an
increase of 28% as compared to $4,739,000 for the quarter ended March 31, 2000.
The increase is the result of the growth in our correctional services business
due to additional contracts.

Operating expenses for the quarter ended March 31, 2001 were $4,746,000,
or 78% of net revenues, as compared to $3,669,000, or 77% of net revenues for
the quarter ended March 31, 2000. Operating expenses increased
by 29% over the prior years quarter due primarily to the addition of new correctional services
contracts during the third and fourth quarter of fiscal year 2000 and the
start-up of a new contract in the second quarter of fiscal year 2001.

General and administrative expenses for the quarter ended March 31, 2001
were $1,138,000, or 19% of net revenues as compared to $912,000, or 19% of net
revenues for the quarter ended March 31, 2000. Correctional Services had
general and administrative expenses of $494,000 for the quarter ended March 31,
2001 as compared to $320,000 for the quarter ended March 31, 2000. The
increase was the result of expanding services at a
regional level to provide clients with additional support and the award of
certain new correctional services contracts during the third and fourth
quarters of fiscal year 2000 and the second quarter of fiscal year 2001.
Corporate general and administrative expenses were $644,000 for the quarter
ended March 31, 2001 as compared to $583,000 for the quarter ended March 31,
2000. Corporate general and administrative expenses increased primarily due to
corporate marketing and development initiatives. The dissolved Extended Care
Services operations had general and administrative expenses of $0 from the wind
down of operations for the quarter ended March 31, 2001 as compared to $9,000
for the quarter ended March 31, 2000.

Our provision for bad debts for the quarter ended March 31, 2001 was
$23,000 as compared to $29,000 for quarter ended March 31, 2000. As a
percentage of net revenues, the provision for bad debts was 0.4% for the
quarter ended March 31, 2001 and 0.6% at March 31, 2000, respectively. Our bad debt provision primarily
represents our best estimate of potential uncollectible revenues for clients we
serve under our contract with the Georgia Department of Medical Assistance, who
may not obtain the Medicaid coverage required to reimburse us for certain
services we have provided. Our bad debt provision also estimates potential
uncollectible revenues from our modest correctional fee-for-service business.

15



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Depreciation and amortization expenses were $10,000 for the quarter ended
March 31, 2001 as compared to $25,000 for the quarter ended March 31, 2000.
Due to changes in technology, during the quarter ended March 31, 2000, we
changed the estimated useful lives on certain equipment, which caused
depreciation expense for the quarter ended March 31, 2000 to be higher than the
quarter ended March 31, 2001.

Interest expense for the quarter ended March 31, 2001 was $0 as compared
to $36,000 for the quarter March 31, 2000. During the first quarter ended
December 31, 2000, we repaid our promissory note which had an outstanding
balance $1,400,000 as of September 30, 2000 with cash flow from our operations
and proceeds from our Shareholders Rights Offering. As a result of this
transaction, we had no interest expense during the quarter.

We recognized other income of $275,000 during the quarter ended March 31,
2001 as compared to $100,000 for the quarter ended March 31, 2000. Other
income from settlements of cost reports of sold freestanding hospitals was
$264,000 for the quarter ended March 31, 2001 as compared to $89,000 for the
quarter ended March 31, 2000. Other income from collections on accounts
receivable from divested operations was $0 for the quarter ended March 31, 2001
as compared to $9,000 for the quarter ended March 31, 2000. Interest income on
invested cash balances was $11,000 for the quarter ended March 31, 2001 as
compared to $2,000 for the quarter ended March 31, 2000.

Income tax expense for the quarter ended March 31, 2001 was $170,000 as
compared to an income tax benefit of $11,000 for the quarter ended March 31,
2000. Income tax expense for the three months ended March 31, 2000 was
impacted by the utilization of deferred tax assets and the reduction in the
valuation allowance associated with such assets. In the fourth quarter of
2000, we eliminated our valuation allowance on our deferred tax assets due to
five consecutive quarters of profitability. The 2001 effective tax rate is
estimated to be approximately 40% of pretax income. The effective tax rate may
be affected in future periods by changes in our estimates with respect to,
among other things, our deferred tax assets.

As a result of the foregoing, we recognized net income of $253,000 for the
quarter ended March 31, 2001, compared to net income of $179,000 for the
quarter ended March 31, 2000.

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LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2001, we had stockholders equity of $3,777,000 and working capital of $198,000.

On October 30, 2000, the Delaware Court of Chancery approved Extended Care
Services dissolution plan, effective November 30, 2000, to distribute its
total remaining assets of approximately $178,000 on a pro-rata basis, to its
external creditors. Extended Care Services external liabilities were $439,000
on December 8, 2000, which was the date we distributed the remaining Extended
Care Services assets to the external creditors of Extended Care Services.

On November 20, 2000, as a result of a Shareholders Rights Offering, we
raised approximately $1,612,000, net of offering expenses, through the issuance
of 23,779 shares of our common stock at $72.00 per share to our existing
stockholders. We used a portion of the proceeds from this offering to
liquidate our promissory note with Bank of America. The remaining proceeds
were used as working capital.

As a result of the dissolution of Extended Care Services and investment
capital raised through a Shareholders Rights Offering, we have been able to
eliminate our previously reported working capital deficit. We believe our
future operating results will produce working capital to support
current operations. Our improved financial operating performance
should enable us to fund expansion by securing a working capital line
of credit.

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PART II    OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

We know of no new litigation, either pending or threatened, against the
Company which is likely to have a material adverse effect on our condensed
consolidated financial statements.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

Not applicable.

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

The Annual Meeting of Stockholders of MHM Services, Inc. was held on March
1, 2001. The following directors were elected at the meeting: (1) Michael S.
Pinkert, (2) Steven H. Wheeler, (3) William P. Ferretti, (4) John Silverman,
(5) Michael F. Sandler, and (6) Jacob A. Shipon, M.D. Also, our stockholders
voted to approve an increase in the number of our common stock shares to be
reserved for our stock option pool from 1,000 shares to 4,656 shares. Of the
18,399 shares voting on this matter, 17,458 shares voted for the change, 941
shares voted against the change, 2 shares abstained from the vote, and 13,105
shares did not vote on the matter. No other matter was voted upon at the
meeting.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a)   Exhibits

None

b)   Reports on Form 8-K

Not applicable.

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SIGNATURES

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

|                   |  |                                                                                                
|------------------ |  | -----------------------------------------------------------------------------------------------
|Dated May 15, 2001 |  | MHM Services, Inc.
/s/ CLEVELAND E. SLADE
Vice President, Chief
Financial Officer and Secretary

19