PSYCHIATRIC SOLUTIONS, INC.

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Hgxrw0cWMFa6mzH6g7P1E5dgDLIzXFF+PxoaUHiOcWxBIf4ZruaPxcGNlOcqAqJN PLTGI0OeEiBOUrAeourQ5w== 0000950144-04-011555.txt : 20041124 0000950144-04-011555.hdr.sgml : 20041124 20041124134747 ACCESSION NUMBER: 0000950144-04-011555 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20041123 ITEM INFORMATION: Other Events ITEM INFORMATION: Financial Statements and Exhibits FILED AS OF DATE: 20041124 DATE AS OF CHANGE: 20041124 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PSYCHIATRIC SOLUTIONS INC CENTRAL INDEX KEY: 0000829608 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SPECIALTY OUTPATIENT FACILITIES, NEC [8093] IRS NUMBER: 232491707 STATE OF INCORPORATION: DE FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-20488 FILM NUMBER: 041166435 BUSINESS ADDRESS: STREET 1: 113 SEABOARD LANE STREET 2: SUITE C-100 CITY: FRANKLIN STATE: TN ZIP: 37067 BUSINESS PHONE: 615-312-5700 MAIL ADDRESS: STREET 1: 113 SEABOARD LANE STREET 2: SUITE C-100 CITY: FRANKLIN STATE: TN ZIP: 37067 FORMER COMPANY: FORMER CONFORMED NAME: PMR CORP DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: ZARON CAPITAL INC DATE OF NAME CHANGE: 19891116 8-K 1 g92119e8vk.htm PSYCHIATRIC SOLUTIONS, INC. - FORM 8-K PSYCHIATRIC SOLUTIONS, INC. - FORM 8-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

______________________________

FORM 8-K

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

Date of report (Date of earliest event reported): November 24, 2004 (November 24, 2004)

Psychiatric Solutions, Inc.

(Exact Name of Registrant as Specified in Its Charter)


Delaware	0-20488	23-2491707
(State or Other Jurisdiction of Incorporation)	(Commission File Number)	(IRS Employer Identification No.)

840 Crescent Centre Drive, Suite 460, Franklin, Tennessee 37067
(Address of Principal Executive Offices)

(615) 312-5700
(Registrant’s Telephone Number, including Area Code)

Not Applicable
(Former Name or Former Address, if Changed Since Last Report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (See General Instruction A.2. below):


o		Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)


o		Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)


o		Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))


o		Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

TABLE OF CONTENTS


	Item 8.01. Other Events.
	Item 9.01. Financial Statements and Exhibits.
SIGNATURES
EX-23.1 CONSENT OF ERNST & YOUNG LLP
EX-99.1 RE-ISSUED FORM 10-K - ITEM 6
EX-99.2 RE-ISSUED FORM 10-K - ITEM 7
EX-99.3 RE-ISSUED FORM 10-K - ITEM 8

Item 8.01. Other Events.

Psychiatric Solutions, Inc. (the “Company”) is re-issuing in an updated format its historical financial statements in connection with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“SFAS No. 144”). During the nine month period ended September 30, 2004, the Company exited three of its contracts to manage state-owned facilities in Florida; in compliance with SFAS No. 144, the Company has reported the operations of such contracts, net of applicable income taxes, as discontinued operations for each period presented in its quarterly report for the quarter and nine month period ended September 30, 2004 (including the comparable periods of the prior year). Under Securities and Exchange Commission (“SEC”) requirements, the same reclassification to discontinued operations that is required by SFAS No. 144 is also required for previously issued financial statements for each of the three years shown in the Company’s last annual report on Form 10-K, if those financial statements are incorporated by reference in subsequent filings with the SEC made under the Securities Act of 1933, as amended, even though those financial statements relate to periods prior to the date the contracts were exited. This reclassification has no effect on the Company’s reported net income available to common shareholders.

This Report on Form 8-K updates Items 6, 7 and 8 of the Company’s 2003 Form 10-K to reflect the contracts that were exited during the nine month period ended September 30, 2004 as discontinued operations. The re-issued consolidated financial statements also include Note 18 for events subsequent to December 31, 2003. All other items of the Form 10-K remain unchanged. No attempt has been made to update matters in the Form 10-K except to the extent expressly provided above.

Item 9.01. Financial Statements and Exhibits.

(a) Not applicable.

(b) Not applicable.


23.1		Consent of Independent Registered Public Accounting Firm

99.1		Re-issued Form 10-K, Item 6. — Selected Financial Data

99.2		Re-issued Form 10-K, Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations

99.3		Re-issued Form 10-K, Item 8. — Financial Statements and Supplementary Data

SIGNATURES

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

PSYCHIATRIC SOLUTIONS, INC.

By: /s/ Jack E. Polson
Jack E. Polson
Chief Accounting Officer

Date: November 24, 2004

EX-23.1 2 g92119exv23w1.txt EX-23.1 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the Registration Statement on Form S-8 (Registration No. 333-118529) and in the Registration Statement on Form S-3 (Registration No. 333-111679) of our report dated March 3, 2004, except for Note 4, as to which the date is November 22, 2004, with respect to the consolidated financial statements of Psychiatric Solutions, Inc. included in this current report on Form 8-K for the year ended December 31, 2003. /s/ Ernst & Young LLP November 22, 2004 Nashville, Tennessee EX-99.1 3 g92119exv99w1.txt EX-99.1 RE-ISSUED FORM 10-K - ITEM 6 EXHIBIT 99.1 ITEM 6. SELECTED FINANCIAL DATA. The selected financial data presented below for the years ended December 31, 2003, 2002 and 2001, and at December 31, 2003 and December 31, 2002, are derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected financial data for the years ended December 31, 2000 and 1999, and at December 31, 2001, 2000 and 1999, are derived from our audited consolidated financial statements not included herein. The selected financial data presented below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. PSYCHIATRIC SOLUTIONS, INC. SELECTED FINANCIAL DATA AS OF AND FOR THE YEARS ENDED DECEMBER 31,

See Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements describing the reclassification from continuing operations to discontinued operations of three contracts to manage state-owned facilities in Florida assumed in 2003 with the acquisition of Ramsay Youth Services, Inc. and exited during 2004. PSYCHIATRIC SOLUTIONS, INC. SELECTED FINANCIAL DATA (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31,

(1) Refer to the notes to the consolidated financial statements regarding the non-amortization provisions of goodwill for transactions completed subsequent to June 30, 2001 and effective for fiscal years ending after December 15, 2001. (2) Refer to the notes to the consolidated financial statements regarding our adoption of Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). As a result of our adoption of SFAS 145, we have reclassified certain losses on refinancing of long-term debt previously reported as an extraordinary item to a component of income from continuing operations. EX-99.2 4 g92119exv99w2.txt EX-99.2 RE-ISSUED FORM 10-K - ITEM 7 EXHIBIT 99.2 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read in conjunction with the selected financial data and the accompanying consolidated financial statements and related notes thereto included in this Annual Report on Form 10-K. OVERVIEW Psychiatric Solutions completed a number of significant transactions in 2003. Through acquisitions, we increased our inpatient facility operations nearly fivefold to 24 inpatient facilities and 3,128 licensed beds at December 31, 2003 from five inpatient facilities and 699 licensed beds at December 31, 2002. We also raised capital through offerings of our common stock, series A convertible preferred stock and debt securities, as well as borrowings from our credit facility. As a result, we ended 2003 with nearly $45 million in cash, $67 million in working capital and $150 million in fixed assets, all significant increases from our 2002 levels. We believe these developments position us as a leading provider of inpatient behavioral health care services in the United States. We also believe that our singular focus on the provision of behavioral health care services allows us to operate more efficiently and provide higher quality care than our competitors. Our business is characterized by diversified sources of revenue, stable cash flows and low capital expenditure requirements. Our business strategy is to acquire inpatient behavioral health care facilities and improve operating results within new and existing inpatient facilities and our other inpatient behavioral health care operations. We completed our first significant acquisition in 2000 when we acquired Sunrise Behavioral Health, Ltd. and its inpatient behavioral health care management contracts. We continued implementing our acquisition strategy in 2001 with the acquisition of four inpatient behavioral health care facilities. In 2002, we acquired one inpatient behavioral health care facility and merged with PMR, a public company and operator of inpatient behavioral health care management contracts. 2003 marked our largest acquisitions to date with the purchase of six inpatient behavioral health care facilities from The Brown Schools and the acquisition of Ramsay, an operator of 11 owned or leased inpatient behavioral health care facilities and ten contracts to manage inpatient behavioral health care facilities for certain state governmental agencies. We strive to improve the operating results of new and existing inpatient behavioral health care operations by providing the highest quality service, expanding referral networks and marketing initiatives and meeting increased demand for our services by expanding our services and developing new services. We also improve operating results by optimizing staffing ratios, controlling contract labor costs and reducing supply costs through group purchasing. During 2003, we increased our revenue from owned and leased inpatient facilities by approximately 9% as compared to our 2002 revenue from owned and leased inpatient facilities through same-facility growth. Same-facility growth also produced gains in owned and leased inpatient facility admissions and patient days of approximately 4% and 7%, respectively, in 2003 as compared to 2002. Same-facility growth refers to the comparison of the five inpatient facilities owned during 2002 with the comparable period in 2003. We owned four inpatient facilities throughout 2002 and acquired a fifth inpatient facility on July 1, 2002. RECENT ACQUISITIONS On March 1, 2004, we acquired two inpatient psychiatric facilities from Brentwood Behavioral Health for $28 million cash with an earn-out of up to $5 million contingent upon future financial results. The facilities, which have an aggregate of 311 licensed beds, are located in Shreveport, Louisiana and Jackson, Mississippi. On November 1, 2003, we acquired the 109-bed Alliance Health Center located in Meridian, Mississippi. Alliance Health Center is a licensed acute care hospital that provides psychiatric care for children, adolescents and adults. In addition, a 60-bed residential treatment center is under construction and is scheduled to open during the second quarter of 2004. On June 30, 2003, we consummated the acquisition of Ramsay, a public company that traded on the Nasdaq SmallCap Market under the symbol "RYOU," for approximately $81.3 million, consisting of $56.2 million in cash, or $5.00 per share, $22.3 million in net assumed debt that was repaid in connection with the acquisition and $2.8 million in fees and expenses. We financed the acquisition of Ramsay with proceeds from the issuance of $150 million in 10 5/8% senior subordinated notes and an issuance of $12.5 million of our series A convertible preferred stock. The 11 owned or leased inpatient behavioral health care facilities we acquired from Ramsay, which have an aggregate of 1,292 beds, are located primarily in the Southeastern region of the United States with locations also in Michigan, Missouri and Utah. In the acquisition, we also assumed 10 contracts to manage inpatient behavioral health care facilities for government agencies in Florida, Georgia and Puerto Rico. In April 2003, we consummated the acquisition of six inpatient behavioral health care facilities from The Brown Schools for $63.0 million in cash. The six inpatient facilities, which have an aggregate of 895 licensed beds, are located in Austin, San Antonio and San Marcos, Texas; Charlottesville, Virginia; Colorado Springs, Colorado; and Tulsa, Oklahoma. The Brown Schools offer a full continuum of care for troubled adolescents and adults. We financed the acquisition of The Brown Schools with proceeds from the private placement of $12.5 million of our series A convertible preferred stock and an increase in funding under our credit facility. Acquiring inpatient behavioral health care facilities is a key part of our business strategy. Because we have grown through acquisitions accounted for as purchases, it is difficult to make meaningful comparisons between our financial statements for the fiscal 1 periods presented. SOURCES OF REVENUE PATIENT SERVICE REVENUE Patient service revenue is generated by our inpatient facilities as a result of services provided to patients within the inpatient behavioral health care facility setting. Patient service revenue is reported on an accrual basis in the period in which services are rendered, at established rates, regardless of whether collection in full is expected. Patient service revenue includes amounts estimated by management to be reimbursable by Medicare and Medicaid under provisions of cost or prospective reimbursement formulas in effect. Amounts received are generally less than the established billing rates of the inpatient facilities and the differences are reported as deductions from patient service revenue at the time the service is rendered. For the year ended December 31, 2003, patient service revenue comprised approximately 78.4% of our total revenue. MANAGEMENT CONTRACT REVENUE Management contract revenue is earned by our inpatient management contract division. The inpatient management contract division receives contractually determined management fees from hospitals and clinics for providing psychiatric unit management and development services as well as management fees for managing inpatient behavioral health care facilities for government agencies. For the year ended December 31, 2003, management contract revenue comprised approximately 21.6% of our total revenue. RESULTS OF OPERATIONS The following table illustrates our consolidated results of operations for the years ended December 31, 2003, 2002 and 2001 (dollars in thousands).

YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 Revenue. Revenue from continuing operations was $284.9 million for the year ended December 31, 2003 compared to $113.9 million for the year ended December 31, 2002, an increase of $171.0 million or 150.1%. Revenue from our owned and leased inpatient facilities segment accounted for $223.3 million of the 2003 results compared to $81.9 million of the 2002 results, an increase of $141.4 million or 172.5%. The increase in revenues from our owned and leased inpatient facilities segment relates primarily to revenues of $14.9 million during the first six months of 2003 for Riveredge Hospital, $57.3 million during 2003 for The Brown Schools and $59.6 million for the owned and leased inpatient facilities acquired from Ramsay. The remainder of the increase in revenues from owned and leased inpatient facilities is primarily attributable to growth in admissions and patient days of 4.1% and 7.0%, respectively, on a same-facility basis. Revenue from our inpatient management contracts segment accounted for $61.6 million of the 2003 results compared to $32.0 million of the 2002 results, an increase of $29.6 million or 92.5%. The increase in revenues from our inpatient management contracts segment relates primarily to revenues of $13.6 million from inpatient management contracts acquired from PMR in August 2002, $13.8 million for Ramsay's inpatient management contracts and growth of approximately $3.4 million in our contract to provide case management services in and around Nashville, Tennessee. This growth was offset by a reduction in the number of inpatient unit management contracts from 48 at December 31, 2002 to 42 at December 31, 2003, impacting 2 revenues by approximately $1.2 million. Salaries, wage, and employee benefits. Salaries, wages and employee benefits ("SWB") expense was $147.1 million for the year ended December 31, 2003, or 51.6% of revenue, compared to $62.3 million for the year ended December 31, 2002, or 54.7% of revenue,.SWB expense for our owned and leased inpatient facilities segment was $122.5 million in 2003, or 54.9% of revenue from this segment. Same-facility SWB expense for our owned and leased inpatient facilities segment was $48.2 million in 2003, or 53.9% of same-facility revenue, compared to $47.0 million in 2002, or 57.4% of revenue from this segment. This decrease in SWB expense as a percentage of revenue from our owned and leased inpatient facilities segment on a same-facility basis, as compared to 2002, primarily relates to efforts to maintain staffing levels on higher volumes. SWB expense for our inpatient management contracts segment was $21.1 million in 2003, or 34.2% of revenue from this segment. Same-facility SWB expense for our inpatient management contracts segment was $12.0 million in 2003, or 35.2% of same-facility revenue from this segment, compared to $13.2 million in 2002, or 41.2% of revenue from this segment. This decrease in SWB expense as a percentage of revenue from our inpatient management contracts segment on a same-facility basis, as compared to 2002, primarily relates to our acquisition from PMR of a contract to provide case management services in and around Nashville, Tennessee. We incur little SWB expense to provide these services because primarily all the costs to provide these services are recorded in other operating expenses because the actual services provided are subcontracted. SWB expense for our corporate office was $3.5 million for 2003 compared to $2.1 million for 2002 as the result of the hiring of additional staff necessary to manage the inpatient facilities and inpatient management contracts acquired during 2002 and 2003. Professional fees. Professional fees were $32.5 million for the year ended December 31, 2003, or 11.4% of revenue, compared to $14.4 million for the year ended December 31, 2002, or 12.6% of revenue. Professional fees for our owned and leased inpatient facilities segment were $26.3 million in 2003, or 11.8% of revenue from this segment. Same-facility professional fees for our owned and leased inpatient facilities segment were $10.8 million in 2003, or 12.1% of revenue from this segment, compared to $10.3 million in 2002, or 12.6% of revenue from this segment. This decrease in professional fees for our owned and leased inpatient facilities segment as a percentage of revenue on a same-facility basis, as compared to 2002, was primarily the result of efforts within our owned and leased inpatient facilities segment to reduce our reliance on contract labor. Professional fees for our inpatient management contracts segment were $4.3 million in 2003, or 7.0% of revenue from this segment. Same-facility professional fees for our inpatient management contracts segment were $3.6 million in 2003, or 10.6% of revenue from this segment, compared to $3.5 million in 2002, or 11.1% of revenue from this segment. Professional fees for our corporate office were approximately $1.8 million in 2003 compared to approximately $500,000 in 2002. The increase in professional fees in our corporate office relates to accounting, legal and other services required to meet the needs of a public company and achieving our acquisition strategy. Supplies. Supplies expense was $16.4 million for the year ended December 31, 2003, or 5.8% of revenue, compared to $5.3 million for the year ended December 31, 2002, or 4.7% of revenue. Supplies expense for our owned and leased inpatient facilities segment was $15.3 million in 2003, or 6.8% of revenue from this segment. Same-facility supplies expense for our owned and leased inpatient facilities segment was $5.9 million in 2003, or 6.6% of revenue from this segment, compared to $5.3 million in 2002, or 6.4% of revenue from this segment. Supplies expense for our inpatient management contracts segment was $1.0 million in 2003, or 1.7% of revenue from this segment, compared to $40,000 in 2002, or less than 1% of revenue from this segment. Supplies expense at our owned and leased inpatient facilities segment has historically comprised the majority of our supplies expense as a whole; however, our inpatient management contracts segment began to utilize supplies to a larger extent due to the assumption of inpatient management contracts from Ramsay. Supplies expense for our corporate office consists of office supplies and are negligible to supplies expense overall. Provision for bad debts. The provision for bad debts was $6.3 million for the year ended December 31, 2003, or 2.2% of revenue, compared to $3.7 million for the year ended December 31, 2002, or 3.2% of revenue. The provision for bad debts at our owned and leased inpatient facilities segment comprises the majority of our provision for bad debts as a whole. The reduction in provision for bad debts as a percentage of revenue was driven by the acquisition of inpatient facilities from The Brown Schools and Ramsay, which have fewer self-pay accounts. Other operating expenses. Other operating expenses were approximately $47.9 million for the year ended December 31, 2003, or 16.8% of revenue, compared to $16.0 million for the year ended December 31, 2002, or 14.1% of revenue. Other operating expenses for our owned and leased inpatient facilities segment were $21.7 million in 2003, or 9.7% of revenue from this segment. Same-facility other operating expenses for our owned and leased inpatient facilities segment were $7.9 million in 2003, or 8.8% of revenue from this segment, compared to $6.6 million in 2002, or 8.0% of revenue from this segment. This increase in other operating expenses for our owned and leased inpatient facilities segment as a percentage of revenue on a same-facility basis, as compared to 2002, relates primarily to increased insurance costs in 2003. Other operating expenses for our inpatient management contracts segment were $24.2 million in 2003, or 39.3% of revenue from this segment. Same-facility other operating expenses for our inpatient management contracts segment was $11.1 million in 2003, or 32.6% of revenue from this segment, compared to $7.9 million in 2002, or 24.8% of revenue from this segment. This increase in other operating expenses for our inpatient management contracts segment as a percentage of revenue from this segment on a same-facility basis, as compared to 2002, is primarily attributable to growth in the contract to provide case management services in and around Nashville, Tennessee where actual services provided are subcontracted. Other operating expenses at our corporate office increased to $2.0 million in 2003 from approximately $1.4 million in 2002. 3 Depreciation and amortization. Depreciation and amortization expense was $5.7 million for the year ended December 31, 2003 compared to $1.8 million for the year ended December 31, 2002, an increase of approximately $4.0 million. This increase in depreciation and amortization expense is the result of the acquisitions of Riveredge Hospital, PMR, The Brown Schools and Ramsay. Interest expense. Interest expense was $14.8 million for the year ended December 31, 2003 compared to $5.6 million for the year ended December 31, 2002, an increase of $9.2 million or 164.3%. The increase in interest expense is primarily attributable to the increase in our long-term debt from approximately $43.8 million at December 31, 2002 to approximately $175.0 million at December 31, 2003 due to our 10 5/8% senior subordinated note offering, the expansion of our senior credit facility and the refinancing of our term loans from CapitalSource Finance LLC ("CapSource") with mortgage loans insured by the U.S. Department of Housing and Urban Development ("HUD"). The proceeds from the 10 5/8% senior subordinated notes and the expanded credit facility were used to finance acquisitions in 2003. Other expenses. Other expenses totaled $5.3 million for the year ended December 31, 2003 compared to approximately $180,000 for the year ended December 31, 2002. Other expenses in 2003 consisted of $4.9 million in loss on the refinancing of our long-term debt, $960,000 in expense recorded to recognize the change in fair value of stock purchase "put" warrants (for additional information on these warrants, see "Liquidity and Capital Resources" below) and the release of $545,000 in reserves related to our stockholder notes. Other expenses in 2002 consisted of approximately $90,000 in loss on the refinancing of our long-term debt and approximately $90,000 to increase the reserve related to our stockholder notes. Loss from discontinued operations, net of taxes. The loss from discontinued operations of approximately $25,000 for the year ended December 31, 2003 is from the operations of 3 contracts to manage inpatient facilities for the Florida Department of Juvenile Justice. These contracts were assumed from Ramsay in 2003 and exited in 2004. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Revenue. Revenue from continuing operations was $113.9 million for the year ended December 31, 2002 compared to $44.0 million for the year ended December 31, 2001, an increase of $69.9 million or 158.9%. Revenue from our owned and leased inpatient facilities segment accounted for $81.9 million of the 2002 results compared to $16.0 million of the 2001 results, an increase of $65.9 million or 411.9%. The increase in revenues from our owned and leased inpatient facilities segment relates primarily to revenues of $11.0 million and $15.0 million during the first eight months of 2002 for Cypress Creek Hospital and West Oaks Hospital, respectively, acquired in September 2001, $14.4 million during the first ten months of 2002 for Texas NeuroRehab Hospital acquired in November 2001, $10.8 million during the first eleven months of 2002 for Holly Hill Hospital acquired in December 2001 and $13.2 million during 2002 for Riveredge Hospital acquired in July 2002. Revenue from our inpatient management contracts segment accounted for $32.0 million of the 2002 results compared to $28.0 million of the 2001 results, an increase of $4.0 million or 14.3%. The increase in revenues from our inpatient management contracts segment relates to the additional inpatient management contracts assumed in the merger with PMR. Salaries, wage, and employee benefits. SWB expense was $62.3 million for the year ended December 31, 2002, or 54.7% of revenue, compared to $26.2 million for the year ended December 31, 2001, or 59.5% of revenue. SWB expense for our owned and leased inpatient facilities segment was $47.0 million in 2002, or 57.4% of revenue from this segment. Same-facility SWB expense for our owned and leased inpatient facilities segment was $10.6 million in 2002, or 60.5% of revenue from this segment, compared to $9.5 million in 2001, or 59.2% of revenue from this segment. SWB expense for our inpatient management contracts segment was $13.2 million in 2002, or 41.2% of revenue from this segment. Same-facility SWB expense for our inpatient management contracts segment was $12.9 million in 2002, or 52.7% of revenue from this segment, compared to $15.5 million in 2001, or 55.3% of 2001 revenue from this segment. SWB expense for our corporate office was $2.1 million for 2002 compared to $1.2 million for 2001 as the result the hiring of additional staff necessary to manage the inpatient facilities acquired during the latter part of 2001 and July 2002. Professional fees. Professional fees were $14.4 million for the year ended December 31, 2002, or 12.6% of revenue, compared to $7.0 million for the year ended December 31, 2001, or 16.0% of revenue. Professional fees for our owned and leased inpatient facilities segment were $10.3 million in 2002, or 12.5% of revenue from this segment. Same-facility professional fees for our owned and leased inpatient facilities segment were $2.2 million in 2002, or 12.6% of revenue from this segment, compared to $2.6 million in 2001, or 16.2% of 2001 revenue from this segment. Professional fees for our inpatient management contracts segment were $3.5 million in 2002, or 11.1% of revenue from this segment. Same-facility professional fees for our inpatient management contracts segment were $3.5 million in 2002, or 14.2% of revenue from this segment, compared to $4.1 million in 2001, or 14.7% of revenue from this segement. Professional fees for our corporate office were approximately $500,000 in 2002 compared to approximately $300,000 in 2001. The increase in professional fees at our corporate office relates to accounting, legal, and other services required as a public company. Supplies. Supplies expense was $5.3 million for the year ended December 31, 2002, or 4.7% of revenue, compared to $1.2 million for the year ended December 31, 2001, or 2.8% of revenue. Supplies expense for our owned and leased inpatient facilities segment comprises almost the entire balance of our consolidated supplies expense. Supplies necessary for our owned and leased inpatient facilities segment include medical, pharmaceutical and office supplies. The increase in supplies expense as a percentage of revenue is due to our acquisition of four inpatient facilities in the last four months of 2001 and Riveredge Hospital in July 2002. Supplies expense for our inpatient management contracts segment and our corporate office consists of office supplies and is negligible to our 4 supplies expense overall. Provision for bad debts. The provision for bad debts was $3.7 million for the year ended December 31, 2002, or 3.2% of revenue, compared to $662,000 for the year ended December 31, 2001, or 1.5% of revenue. The provision for bad debts for our owned and leased inpatient facilities segment comprises the majority of our provision for bad debts as a whole. The increase in provision for bad debts as a percentage of revenue relates to changes in our payer mix and the impact of our acquisitions. Other operating expenses. Other operating expenses were approximately $16.0 million for the year ended December 31, 2002, or 14.1% of revenue, compared to $3.0 million in 2001, or 6.9% of revenue for the year ended December 31, 2001. Other operating expenses for our owned and leased inpatient facilities segment were $6.6 million in 2002, or 8.0% of revenue from this segment. Same-facility other operating expenses from our owned and leased inpatient facilities segment were $1.3 million in 2002, or 7.3% of revenue from this segment, compared to $1.1 million in 2001, or 6.9% of revenue from this segment. This increase in other operating expenses for our owned and leased inpatient facilities segment as a percentage of revenue from this segment on a same-facility basis, as compared to 2001, relates primarily to increased insurance costs in 2002. Other operating expenses for our inpatient management contracts segment were $7.9 million in 2002, or 24.9% of revenue from this segment. Same-facility other operating expenses for our inpatient management contracts segment were $1.3 million in 2002, or 5.3% of revenue from this segment, compared to $1.6 million in 2001, or 5.6% of revenue from this segment. The overall increase in other operating expenses for our inpatient management contracts segment as a percentage of revenue from this segment is attributable to our assumption from PMR of a contract to provide case management services in and around Nashville, Tennessee where actual services provided are subcontracted and all related expenses are recorded in other operating expenses. Other operating expenses for our corporate office increased to $1.3 million in 2002 from approximately $400,000 in 2001 primarily due to increased insurance costs in 2002. Depreciation and amortization. Depreciation and amortization expense was $1.8 million for the year ended December 31, 2002 compared to $945,000 for the year ended December 31, 2001, an increase of approximately $800,000 or 87.3%. This increase in depreciation and amortization expense is the result of full year operations in 2002 for the inpatient facilities acquired in the last four months of 2001 as well as our acquisition of Riveredge Hospital in July 2002. Interest expense. Interest expense was $5.6 million for the year ended December 31, 2002 compared to $2.7 million for the year ended December 31, 2001, an increase of $2.9 million or 107.4%. The increase in interest expense is due to borrowings under our senior credit facility as well as subordinated debt obtained to fund acquisitions in 2001 and 2002. Income from discontinued operations, net of taxes. Income from discontinued operations was approximately $1.6 million for the year ended December 31, 2001, which consists primarily of a gain on the sale of the Employee Assistance Programs division of $1,170,000 (net of taxes of $223,000), the operations of the employee assistance programs division from the measurement date through the disposal date of $246,000 and final adjustments to our loss on disposal of $84,000 for the year ended December 31, 2000. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2003, we had working capital of $67.2 million, including cash and cash equivalents of $45.0 million, compared to working capital of $2.4 million at December 31, 2002. We did not maintain a balance under our revolving line of credit at December 31, 2003 whereas we had a balance of $5.4 million on our revolving line of credit at December 31, 2002. The increase in working capital is primarily due to cash raised in our public equity offering of approximately $48.9 million as well as cash provided by operating activities of $15.5 million during the year ended December 31, 2003. Cash provided by operating activities was $18.3 million for the year ended December 31, 2003 compared to $8.9 million for the year ended December 31, 2002. The increase in cash flows from operating activities was primarily due to the cash generated from our acquisitions of the operations of Ramsay and the six inpatient facilities from The Brown Schools in 2003 and by the full year operations of PMR and Riveredge Hospital, which we acquired in 2002. Cash used in investing activities was $108.1 million for the year ended December 31, 2003 compared to cash provided by investing activities of $4.2 million for the year ended December 31, 2002. Cash used in investing activities for the year ended December 31, 2003 was primarily the result of $100.4 million cash paid for acquisitions, net of cash acquired. Cash used in the acquisition of The Brown Schools was approximately $13.4 million, of which $12.5 million came from our private placement of series A convertible preferred stock. The balance of The Brown Schools purchase of approximately $51.2 million was financed from our former credit facility with CapSource. Cash used in the acquisition of Ramsay, including the subsequent purchase for $3.6 million of real estate at our Macon facility, was $84.4 million, net of cash acquired of approximately $4 million. Cash used in the acquisition of Alliance Health Center was approximately $1.4 million, which paid for certain transaction costs. The $12.5 million purchase price for Alliance Health Center was financed from our former credit facility with CapSource. Cash used for other acquisitions, including Calvary Center, was approximately $1.2 million. In January 2004, we paid the balance of the purchase price for the Calvary Center of approximately $3.3 million after certain state licensure matters were resolved. The remainder of cash used in investing activities for the year ended December 31, 2003 included capital expenditures of approximately $5.8 million and purchases of investments of approximately $1.0 million offset by changes in other long-term assets of approximately $1.8 million. Capital expenditures are generally not for the expansion of capacity within our inpatient facilities and historically approximate 2% of our net revenues. During 2003, our capital expenditures included typical non-expansion capital expenditures, as well as expenditures to upgrade computer 5 systems at some of our newly acquired facilities and certain expansion projects. These expansion projects included the construction of a 60-bed RTC at Alliance Health Center. Cash provided by investing activities for the year ended December 31, 2002 was the result of cash acquired of approximately $6.0 million in our acquisition of PMR offset by cash used in capital purchases of $1.5 million and other assets of $612,000. Cash provided by financing activities was $132.3 million for the year ended December 31, 2003. During 2003, we received cash from borrowings of approximately $62.0 million, net of refinancings and not including proceeds from borrowings that were paid directly to the sellers of our acquisitions. Also during 2003, we received $48.9 million and $24.5 million, net of issuance costs, from the secondary offering of our common stock and from our issuance of series A convertible preferred stock, respectively. These sources of cash from financing activities were offset by cash payments during 2003 of $2.0 million and $1.4 million for capitalized loan costs on new debt and early termination fees on debt that we refinanced, respectively. Finally, we received approximately $300,000 in cash from the exercise of stock options and warrants during 2003. Cash used in financing activities of $12.0 million for the year ended December 31, 2002 consisted primarily of payments on long-term debt, not including proceeds from borrowings that were paid directly to the sellers of our acquisitions. On January 26, 2004, we entered into an interest rate swap agreement to manage our exposure to fluctuations in interest rates. The swap agreement effectively converts $20 million of fixed-rate long-term debt to a LIBOR indexed variable rate instrument plus an agreed upon interest rate spread. On January 6, 2004, we entered into a revolving credit facility with Bank of America, N.A. of up to $50 million. The revolving credit facility has a three-year term and is secured by all real property owned by us or our subsidiaries that has a value in excess of $2.5 million, the stock of all of our operating subsidiaries and substantially all of the personal property owned by us or our subsidiaries. On November 5, 2003, we borrowed approximately $12.1 million under a mortgage loan agreement insured by HUD, secured by real estate located at Riveredge Hospital near Chicago, Illinois. Interest accrues on the HUD loan at 5.65% and principal and interest are payable in 420 monthly installments through December 2038. We used the proceeds from the loan to repay approximately $11.2 million of our term debt under our former amended and restated senior secured credit facility, pay certain financing costs, and fund required escrow amounts for future improvements to the property. On August 28, 2003, we borrowed approximately $6.8 million under a mortgage loan agreement insured by HUD, secured by real estate located at West Oaks Hospital in Houston, Texas. Interest accrues on the HUD loan at 5.85% and principal and interest are payable in 420 monthly installments through September 2038. We used the proceeds from the loan to repay approximately $5.8 million of our term debt under our former amended and restated senior secured credit facility, pay certain financing costs, and fund required escrow amounts for future improvements to the property. On June 30, 2003, we issued $150 million in 10 5/8% senior subordinated notes, which are fully and unconditionally guaranteed on a senior subordinated basis by substantially all of our existing operating subsidiaries. Proceeds from the issuance of the senior subordinated notes and the private placement of $12.5 million in series A convertible preferred stock were used to finance the acquisition of Ramsay and pay down substantially all of our long-term debt. Interest on the senior subordinated notes accrues at the rate of 10.625% per annum and is payable semi-annually in arrears on June 15 and December 15, commencing on December 15, 2003. The senior subordinated notes will mature on June 15, 2013. In connection with the closing of the sale of our 10 5/8% senior subordinated notes, we amended and restated our former senior credit facility with CapSource to increase our senior secured revolving line of credit to $50.0 million from $28.0 million and to refinance $36.0 million in term loans with the proceeds from the sale of our 10 5/8% senior subordinated notes. Our former credit facility was secured by substantially all of our assets and the stock of our existing operating subsidiaries. The term loans accrued interest at the Citibank, N.A. prime rate plus 4.5% subject to a floor of 8.75% and were due in November 2003. We refinanced the remaining $11.2 million in term loans with a mortgage loan insured by HUD on November 5, 2003. The revolving line of credit accrued interest at the Citibank, N.A. prime rate plus 2% subject to a floor of 6.25% and was due in June 2006. We were required to pay interest on a minimum balance of $17.5 million under our revolving line of credit. At December 31, 2003, the interest rate under the revolving line of credit was 6.25%. As of December 31, 2003, we had $50.0 million available under the revolving line of credit. We were required to pay on a monthly basis an unused fee in the amount of 0.5% per annum on the unused portion of the amended and restated credit facility. Such fees were approximately $110,000 for the year ended December 31, 2003. On April 1, 2003, concurrent with the acquisition of The Brown Schools, we received $12.5 million from the private placement of 2,272,727 shares of our series A convertible preferred stock with affiliates of Oak Investment Partners and Salix Ventures and The 1818 Mezzanine Fund II, L.P. (the "1818 Fund"). These investors purchased an additional 2,272,727 shares of our series A convertible preferred stock for $12.5 million on June 19, 2003. The proceeds were used to acquire The Brown Schools and Ramsay. Each share of series A convertible preferred stock is convertible into one share of our common stock. Holders of our series A convertible preferred stock are entitled to receive pay-in-kind dividends, compounded quarterly, equal to 5% per share of the original share price through March 31, 2005. Thereafter, pay-in-kind dividends will compound quarterly at 7% per share of the original share price. The impact of the series A convertible preferred stock on diluted earnings per share is calculated using the if-converted method. 6 On April 1, 2003, our former senior credit facility with CapSource was expanded to approximately $81.0 million with the increase of our revolving line of credit to $28.0 million from $17.5 million and a new $36.0 million term loan in addition to our then-existing $17.0 million term loan. We borrowed approximately $52.2 million during April 2003, including the $36.0 million term loan and $16.2 million under the revolving line of credit, to partially fund our acquisition of six inpatient facilities from The Brown Schools. The revolving line of credit and new $36.0 million term loan were repaid on June 30, 2003 with proceeds from the issuance of our 10 5/8% senior subordinated notes. On June 28, 2002, we entered into a Securities Purchase Agreement with the 1818 Fund where the 1818 Fund agreed to purchase up to $20 million of senior subordinated notes with detachable nominal warrants. At closing on June 28, 2002, a total of $10 million of the senior subordinated notes were issued. In connection with the issuance of the senior subordinated notes to the 1818 Fund, we issued detachable stock purchase warrants for the purchase of 372,412 shares of our common stock at an exercise price of $.01 per share. Also, we provided the 1818 Fund with the ability to require us to repurchase its warrants or the common stock acquired upon exercise of its warrants at fair market value for cash. On May 16, 2003, the 1818 Fund exercised its stock purchase warrant to purchase 372,412 shares of our common stock. Deducting the exercise price of $0.01 per share based on the closing price of our common stock on May 15, 2003, the 1818 Fund received 372,039 shares of our common stock from the exercise of its warrant. In connection with the exercise of the warrants, the 1818 Fund provided us with a written consent to waive its ability to require that we repurchase the warrants for cash effective April 1, 2003. On June 30, 2003, we repaid principal of $10 million, accrued interest and a prepayment penalty of 3% to the 1818 Fund with proceeds from the issuance of our 10 5/8% senior subordinated notes, and we no longer have the ability to borrow under the Securities Purchase Agreement with the 1818 Fund. The 1818 Fund's right to require us to repurchase the 372,039 shares of our common stock that it received upon the exercise of its stock purchase warrant terminated upon the 1818 Fund's sale of its shares in our secondary equity offering that we closed in December 2003. In connection with our acquisition of Sunrise Behavioral Health, Ltd. in May 2000, we issued subordinated convertible notes in the amount of $3.6 million. The principal amount of these convertible notes and the interest thereon was converted into 537,908 shares of our common stock in April and May 2003 based on a conversion price of $8.53 per share. In addition, we also issued two promissory notes totaling $4.5 million in connection with our acquisitions of three facilities in 2001. At December 31, 2003, one note with a current principal balance of $1.0 million remained outstanding. This note accrues interest at 9% per annum and is due June 30, 2005. Among other customary covenants, the note contains cross-default covenants triggered by a default of any other indebtedness of at least $1.0 million. We were in compliance with these covenants as of December 31, 2003. As part of the determination of our provision for income taxes, we are required to estimate and record reserves for certain tax positions that, though we believe are fully supportable, are subject to audit by taxing authorities. We have accrued for certain tax contingencies for which the ultimate determination by the taxing authorities is uncertain. If the taxing authorities were to propose and sustain assessments on the contingencies, we would incur approximately $4 million in additional tax payments in future years. We believe we have adequately provided for this tax contingency. We believe that our working capital on hand, cash flows from operations and funds available under our revolving line of credit will be sufficient to fund our operating needs, planned capital expenditures and debt service requirements for the next 12 months. In addition, we are actively seeking acquisitions that fit our corporate growth strategy and may acquire additional inpatient psychiatric facilities. Management continually assesses our capital needs and, should the need arise, we will seek additional financing, including debt or equity, to fund potential acquisitions or for other corporate purposes. In negotiating such financing, there can be no assurance that we will be able to raise additional capital on terms satisfactory to us. Failure to obtain additional financing on reasonable terms could have a negative effect on our plans to acquire additional inpatient psychiatric facilities. OBLIGATIONS AND COMMITMENTS

The fair value of our $150 million 10 5/8% senior subordinated notes was approximately $167 million as of December 31, 2003. The carrying value of our other long-term debt, including current maturities, of $25.0 million and $43.8 million at December 31, 2003 and December 31, 2002, respectively, approximated fair value. We had no variable rate debt outstanding at December 31, 2003. IMPACT OF INFLATION AND ECONOMIC TRENDS Although inflation has not had a material impact on our results of operations, the health care industry is very labor intensive and salaries and benefits are subject to inflationary pressures as are rising supply costs which tend to escalate as vendors pass on the rising costs through price increases. Some of our freestanding owned, leased and managed inpatient behavioral health care facilities we operate are experiencing the effects of the tight labor market, including a shortage of nurses, which has caused and may continue to 7 cause an increase in our salaries, wages and benefits expense in excess of the inflation rate. Although we cannot predict our ability to cover future cost increases, management believes that through adherence to cost containment policies, labor management and reasonable price increases, the effects of inflation on future operating margins should be manageable. Our ability to pass on increased costs associated with providing health care to Medicare and Medicaid patients is limited due to various federal, state and local laws which have been enacted that, in certain cases, limit our ability to increase prices. In addition, as a result of increasing regulatory and competitive pressures and a continuing industry wide shift of patients into managed care plans, our ability to maintain margins through price increases to non-Medicare patients is limited. The behavioral health care industry is typically not directly impacted by periods of recession, erosions of consumer confidence or other general economic trends as most health care services are not considered a component of discretionary spending. However, our inpatient facilities may be indirectly negatively impacted to the extent such economic conditions result in decreased reimbursements by federal or state governments or managed care payers. We are not aware of any economic trends that would prevent us from being able to remain in compliance with all of our debt covenants and to meet all required obligations and commitments in the near future. CRITICAL ACCOUNTING POLICIES Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. In preparing our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses included in the financial statements. Estimates are based on historical experience and other information currently available, the results of which form the basis of such estimates. While we believe our estimation processes are reasonable, actual results could differ from our estimates. The following represent the estimates considered most critical to our operating performance and involve the most subjective and complex assumptions and assessments. Allowance for Doubtful Accounts Our ability to collect outstanding patient receivables from third party payors and receivables due under our inpatient management contracts is critical to our operating performance and cash flows. The primary collection risk with regard to patient receivables lies with uninsured patient accounts or patient accounts for which primary insurance has paid, but the portion owed by the patient remains outstanding. We estimate the allowance for doubtful accounts primarily based upon the age of the accounts since patient discharge date. We continually monitor our accounts receivable balances and utilize cash collection data to support our estimates of the provision for doubtful accounts. Significant changes in payor mix or business office operations could have a significant impact on our results of operations and cash flows. The primary collection risk with regard to receivables due under our inpatient management contracts is attributable to contractual disputes. We estimate the allowance for doubtful accounts for these receivables based primarily upon the specific identification of potential collection issues. As with our patient receivables, we continually monitor our accounts receivable balances and utilize cash collection data to support our estimates of the provision for doubtful accounts. Allowances for Contractual Discounts The Medicare and Medicaid regulations are complex and various managed care contracts may include multiple reimbursement mechanisms for different types of services provided in our inpatient facilities and cost settlement provisions requiring complex calculations and assumptions subject to interpretation. We estimate the allowance for contractual discounts on a payor-specific basis given our interpretation of the applicable regulations or contract terms. The services authorized and provided and related reimbursement are often subject to interpretation that could result in payments that differ from our estimates. Additionally, updated regulations and contract renegotiations occur frequently necessitating continual review and assessment of the estimation process by our management. Professional and General Liability We are subject to medical malpractice and other lawsuits due to the nature of the services we provide. Due to our acquisition of Ramsay, we have two distinct insurance programs that cover our inpatient facilities. For our inpatient facilities that were not acquired from Ramsay, we have obtained professional and general liability insurance for claims in excess of $3 million with an insured limit of $10 million. In December 2003, we increased this insured limit to $20 million. For the inpatient facilities acquired from Ramsay, we have obtained professional and general risks liability insurance for claims in excess of $500,000 with an insured limit of $25 million. These policies include umbrella coverage of $20 million and $25 million, respectively. The self-insured reserves for professional and general liability risks are calculated based on historical claims, demographic factors, industry trends, severity factors, and other actuarial assumptions calculated by an independent third party. The self-insured reserve is discounted to its present value using a 5% discount rate. This estimated accrual for professional and general liabilities could be significantly affected should current and future occurrences differ from historical claim trends and expectations. We have established a captive insurance company to manage this additional self-insured retention for our inpatient facilities not acquired from Ramsay. We plan to merge these plans in the new future. While claims are monitored closely when estimating professional and general liability accruals, the complexity of the claims and wide range of potential outcomes often hampers timely adjustments to the assumptions used in these estimates. 8 Income Taxes As part of our process for preparing our consolidated financial statements, our management is required to compute income taxes in each of the jurisdictions in which we operate. This process involves estimating the current tax benefit or expense of future deductible and taxable temporary differences. The future deductible and taxable temporary differences are recorded as deferred tax assets and liabilities which are components of our balance sheet. Management then assesses our ability to realize the deferred tax assets based on reversals of deferred tax liabilities and, if necessary, estimates of future taxable income. If management determines that some or all of a deferred tax asset will more likely than not be realized, then a valuation allowance is recorded against the deferred tax asset. Management must also assess the impact of acquisitions on the realization of deferred tax assets subject to a valuation allowance to determine if all or a portion of the valuation allowance will be offset by reversing taxable differences or future taxable income of the acquired entity. To the extent the valuation allowance can be reversed due to the estimated future taxable income of an acquired entity, then our valuation allowance is reduced accordingly as an adjustment to purchase price. FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K and other materials we have filed or may file with the Securities and Exchange Commission, as well as information included in oral statements or other written statements made, or to be made, by our senior management, contain, or will contain, disclosures that are "forward-looking statements" within the meaning of the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts and can be identified by the use of words such as "may," "will," "expect," "believe," "intend," "plan," "estimate," "project," "continue," "should" and other comparable terms. These forward-looking statements are based on the current plans and expectations of management and are subject to a number of risks and uncertainties, including those set forth below, which could significantly affect our current plans and expectations and future financial condition and results. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Stockholders and investors are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in our filings and reports. While it is not possible to identify all these factors, we continue to face many risks and uncertainties that could cause actual results to differ from those forward-looking statements, including: - potential competition that alters or impedes our acquisition strategy by decreasing our ability to acquire additional inpatient facilities on favorable terms; - our ability to improve the operations of acquired inpatient facilities; - our ability to maintain favorable and continuing relationships with physicians who use our inpatient facilities; - our limited operating history; - our ability to receive timely additional financing on terms acceptable to us to fund our acquisition strategy and capital expenditure needs; - risks inherent to the health care industry, including the impact of unforeseen changes in regulation, reimbursement rates from federal and state health care programs or managed care companies and exposure to claims and legal actions by patients and others; - our ability to retain key employees who are instrumental to our successful operations; - our ability to ensure confidential information is not inappropriately disclosed and that we are in compliance with federal and state health information privacy standards; and - our ability to comply with federal and state governmental regulation covering healthcare-related products and services on-line, including the regulation of medical devices and the practice of medicine and pharmacology. In addition, future trends for pricing, margins, revenues and profitability remain difficult to predict in the industries that we serve. RISK FACTORS IF WE FAIL TO COMPLY WITH EXTENSIVE LAWS AND GOVERNMENT REGULATIONS, WE COULD SUFFER PENALTIES OR BE REQUIRED TO MAKE SIGNIFICANT CHANGES TO OUR OPERATIONS. The health care industry is required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things: 9 - billing for services; - relationships with physicians and other referral sources: - adequacy of medical care; - quality of medical equipment and services; - qualifications of medical and support personnel; - confidentiality, maintenance and security issues associated with health-related information and medical records; - licensure; - hospital rate or budget review; - operating policies and procedures; and - addition of facilities and services. Among these laws are the Anti-kickback Statute and the Stark Law. These laws impact the relationships that we may have with physicians and other referral sources. The OIG has enacted safe harbor regulations that outline practices that are deemed protected from prosecution under the Anti-kickback Statute. Our current financial relationships with physicians and other referral sources may not qualify for safe harbor protection under the Anti-kickback Statute. Failure to meet a safe harbor does not mean that the arrangement automatically violates the Anti-kickback Statute, but may subject the arrangement to greater scrutiny. Further, we cannot guarantee that practices that are outside of a safe harbor will not be found to violate the Anti-kickback Statute. In order to comply with the Stark Law, our financial relationships with physicians and their immediate family members must meet an exception. We attempt to structure our relationships to meet an exception to the Stark Law, but the regulations implementing the exceptions, some of which are still under review, are detailed and complex, and we cannot guarantee that every relationship fully complies with the Stark Law. If we fail to comply with the Anti-kickback Statute, the Stark Law or other applicable laws and regulations, we could be subjected to liabilities, including criminal penalties, civil penalties (including the loss of our licenses to operate one or more inpatient facilities), and exclusion of one or more of our inpatient facilities from participation in the Medicare, Medicaid and other federal and state health care programs. See "Item 1. Business -- Regulation and Other Factors." Because many of these laws and regulations are relatively new, we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In the future, different interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our inpatient facilities, equipment, personnel, services, capital expenditure programs and operating expenses. A determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, could have a material adverse effect on our business, financial condition, results of operations or prospects and our business reputation could suffer significantly. In addition, we are unable to predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation or regulation will take or their impact. WE MAY BE REQUIRED TO SPEND SUBSTANTIAL AMOUNTS TO COMPLY WITH LEGISLATIVE AND REGULATORY INITIATIVES RELATING TO PRIVACY AND SECURITY OF PATIENT HEALTH INFORMATION AND STANDARDS FOR ELECTRONIC TRANSACTIONS. There are currently numerous legislative and regulatory initiatives at the federal and state levels addressing patient privacy and security concerns. In particular, federal regulations issued under HIPAA contain provisions that have required, and in the future may require, our facilities to implement costly new computer systems and to adopt business procedures designed to protect the privacy and security of each of their patients' individually identifiable health and related financial information. Compliance with the privacy regulations was required on April 14, 2003 for most health care organizations, including our inpatient facilities. The privacy regulations have had a financial impact on the health care industry because they impose extensive new administrative requirements, restrictions on the use and disclosure of individually identifiable patient health and related financial information, provide patients with new rights with respect to their health information and require our inpatient facilities to enter into contracts extending many of the privacy regulation requirements to third parties who perform functions on our behalf involving health information. On February 20, 2003, HHS issued final security regulations. Compliance with these security regulations is required by April 21, 2005 for most health care organizations, including our inpatient facilities. These security regulations require our inpatient facilities to implement administrative, physical and technical safeguards to protect the integrity, confidentiality and availability of electronically received, maintained or transmitted patient individually identifiable health and related financial information. We cannot predict the total financial or other impact of these regulations on our business. Compliance with these regulations requires substantial 10 expenditures, which could negatively impact our financial results. In addition, our management has spent, and may spend in the future, substantial time and effort on compliance measures. On August 17, 2000, HHS issued regulations requiring most health care organizations, including our inpatient facilities, to use standard data formats and code sets by October 16, 2003 when electronically transmitting information in connection with several types of transactions, including health claims, health care payment and remittance advice and health claim status transactions. We have implemented or upgraded computer systems, as appropriate, at our inpatient facilities and at our corporate headquarters to comply with the new transaction and code set regulations and have tested these systems with several of our payers. Violations of the privacy, security and transaction regulations could subject our inpatient facilities to civil penalties of up to $25,000 per calendar year for each provision contained in the privacy, security and transaction regulations that is violated and criminal penalties of up to $250,000 per violation for certain other violations. Since there is no history of enforcement efforts by the federal government at this time, it is not possible to ascertain the likelihood of enforcement efforts in connection with these regulations or the potential for fines and penalties which may result from the violation of the regulations. OTHER COMPANIES WITHIN THE HEALTH CARE INDUSTRY CONTINUE TO BE THE SUBJECT OF FEDERAL AND STATE INVESTIGATIONS, WHICH INCREASES THE RISK THAT WE MAY BECOME SUBJECT TO INVESTIGATIONS IN THE FUTURE. Both federal and state government agencies as well as private payors have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of health care organizations. These investigations relate to a wide variety of topics, including: - cost reporting and billing practices; - quality of care; - financial relationships with referral sources; - medical necessity of services provided; and - treatment of indigent patients. The OIG and the U.S. Department of Justice have, from time to time, undertaken national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Moreover, health care providers are subject to civil and criminal false claims laws, including the federal False Claims Act, which allows private parties to bring whistleblower lawsuits against private companies doing business with or receiving reimbursement under government programs. Some states have adopted similar state whistleblower and false claims provisions. Publicity associated with the substantial amounts paid by other health care providers to settle these lawsuits may encourage our current and former employees and other health care providers to bring whistleblower lawsuits. Any investigations of us or our executives or managers could result in significant liabilities or penalties as well as adverse publicity. AS A PROVIDER OF HEALTH CARE SERVICES, WE ARE SUBJECT TO CLAIMS AND LEGAL ACTIONS BY PATIENTS AND OTHERS. Facilities acquired by us may have unknown or contingent liabilities, including liabilities related to patient care and liabilities for failure to comply with health care laws and regulations, which could result in large claims and significant defense costs. Although we generally seek indemnification covering these matters from prior owners of facilities we acquire, material liabilities for past activities of acquired facilities may exist and such prior owners may not be able to satisfy their indemnification obligations. We are also susceptible to being named in claims brought related to patient care and other matters at inpatient facilities owned by third parties and operated by us. To protect ourselves from the cost of these claims, professional malpractice liability insurance and general liability insurance coverage is maintained in amounts and with deductibles common in the industry. Due to our acquisition of Ramsay, we have two distinct insurance programs that cover our inpatient facilities. For our inpatient facilities that were not acquired from Ramsay, we have obtained professional and general liability insurance for claims in excess of $3 million with an insured limit of $10 million. In December 2003, we increased this insured limit to $20 million. For the inpatient facilities acquired from Ramsay, we have obtained professional and general liability insurance for claims in excess of $50,000 with an insured limit of $25 million. These policies include umbrella coverage of $20 million and $25 million, respectively. The self-insured reserves for professional and general liability risks are calculated based on historical claims, demographic factors, industry trends, severity factors, and other actuarial assumptions calculated by an independent third party. The self-insured reserve is discounted to its present value using a 5% discount rate. This estimated accrual for professional and general liabilities could be significantly affected should current and future occurrences differ from historical claim trends and expectations. We have established a captive insurance company to manage this additional self-insured retention for our inpatient facilities not acquired from Ramsay. While claims are monitored closely when estimating professional and general liability accruals, the complexity of the claims and wide range of potential outcomes often hampers timely adjustments to the assumptions used in these estimates. There are no assurances that our insurance will cover all claims (e.g., claims for punitive damages) or that claims in excess of our insurance coverage will not arise. A successful lawsuit against us that is not covered by, or is in excess of, our insurance coverage may have a material adverse effect on our business, financial condition and results of operations. 11 This insurance coverage may not continue to be available at a reasonable cost, especially given the significant increase in insurance premiums generally experienced in the health care industry. IF FEDERAL OR STATE HEALTH CARE PROGRAMS OR MANAGED CARE COMPANIES REDUCE REIMBURSEMENT RATES OR METHODS OF REIMBURSEMENT FOR SERVICES PROVIDED, REVENUES MAY DECLINE. A large portion of our revenue comes from the Medicare and Medicaid programs. In recent years, federal and state governments have made significant changes in these programs. These changes have, in certain instances, decreased the amount of money we receive for our services. Future federal and state legislation may further reduce the payments received for services provided or increase the timing of reimbursement payments to us. In addition, we are particularly sensitive to regulatory and economic changes in the State of Texas. We operated seven inpatient facilities in Texas that generated 33% of our revenue for the year ended December 31, 2003. Insurance and managed care companies and other third parties from whom we receive payment are increasingly attempting to control health care costs by requiring that facilities discount their fees in exchange for exclusive or preferred participation in their benefit plans. This trend may continue and may reduce the payments received by us for our services. IF COMPETITION DECREASES THE ABILITY TO ACQUIRE ADDITIONAL INPATIENT FACILITIES ON FAVORABLE TERMS, WE MAY BE UNABLE TO EXECUTE OUR ACQUISITION STRATEGY. Competition among hospitals and other health care providers in the United States has intensified in recent years due to cost containment pressures, changing technology, changes in government regulation and reimbursement, changes in practice patterns (such as shifting from inpatient to outpatient treatments), the impact of managed care organizations and other factors. An important part of our business strategy is to acquire inpatient facilities in growing markets. Some inpatient facilities and health care providers that compete with us have greater financial resources and a larger, more experienced development staff focused on identifying and completing acquisitions. In addition, some competitors are owned by governmental agencies or not-for-profit corporations supported by endowments and charitable contributions, and can finance capital expenditures on a tax-exempt basis. Any or all of these factors may impede our business strategy. IF WE FAIL TO IMPROVE THE OPERATIONS OF ACQUIRED INPATIENT FACILITIES, WE MAY BE UNABLE TO ACHIEVE OUR GROWTH STRATEGY. We may be unable to maintain or increase the profitability of, or operating cash flows at, any existing hospital or other acquired inpatient facility, effectively integrate the operations of any acquisitions or otherwise achieve the intended benefit of our growth strategy. STATE EFFORTS TO REGULATE THE SALE OF INPATIENT FACILITIES OPERATED BY NOT-FOR-PROFIT ENTITIES COULD PREVENT US FROM ACQUIRING ADDITIONAL INPATIENT FACILITIES AND EXECUTING OUR BUSINESS STRATEGY. Hospital acquisitions generally require a longer period to complete than acquisitions in many other industries and are subject to additional regulatory uncertainty. Many states have adopted legislation regarding the sale or other disposition of facilities operated by not-for-profit entities. In other states that do not have specific legislation, the attorneys general have demonstrated an interest in these transactions under their general obligations to protect charitable assets from waste. These legislative and administrative efforts focus primarily on the appropriate valuation of the assets divested and the use of the proceeds of the sale by the non-profit seller. In addition, the acquisition of facilities in certain states requires advance regulatory approval under "certificate of need" or state licensure regulatory regimes. These state-level procedures could seriously delay or even prevent us from acquiring inpatient facilities, even after significant transaction costs have been incurred. ADDITIONAL FINANCING MAY BE NECESSARY TO FUND OUR ACQUISITION PROGRAM AND CAPITAL EXPENDITURES, AND ADDITIONAL FINANCING MAY NOT BE AVAILABLE WHEN NEEDED. Our acquisition program requires substantial capital resources. Likewise, the operation of existing inpatient facilities requires ongoing capital expenditures for renovation, expansion and the upgrade of equipment and technology. We may not receive additional financing on satisfactory terms. In addition, our level of indebtedness at any time may restrict our ability to borrow additional funds. If we are not able to obtain financing, then we may not be in a position to consummate acquisitions or undertake capital expenditures. RECENTLY ACQUIRED BUSINESSES AND BUSINESSES ACQUIRED IN THE FUTURE WILL EXPOSE US TO INCREASED OPERATING RISKS. We acquired four inpatient facilities in 2001, one inpatient hospital in 2002 and seventeen inpatient facilities in 2003. This expansion exposes us to additional business and operating risk and uncertainties, including: - our ability to effectively manage the expanded activities; - our ability to realize our investment in the increased number of inpatient facilities; 12 - our exposure to unknown liabilities; and - our ability to meet contractual obligations. If we are unable to manage this expansion efficiently or effectively, or are unable to attract and retain additional qualified management personnel to run the expanded operations, it could have a material adverse effect on our business, financial condition and results of operations. WE DEPEND ON OUR RELATIONSHIPS WITH PHYSICIANS WHO USE OUR INPATIENT FACILITIES. Our business depends upon the efforts and success of the physicians who provide health care services at our inpatient facilities and the strength of the relationships with these physicians. Our business could be adversely affected if a significant number of physicians or a group of physicians: - terminate their relationship with, or reduce their use of, our inpatient facilities; - fail to maintain acceptable quality of care or to otherwise adhere to professional standards; - suffer damage to their reputation; or - exit the market entirely. WE DEPEND ON OUR KEY MANAGEMENT PERSONNEL. We are highly dependent on our senior management team, which has many years of experience addressing the broad range of concerns and issues relevant to our business. We have entered into employment agreements with Joey A. Jacobs, Chief Executive Officer, and Jack Salberg, Chief Operating Officer, which include non-competition and non-solicitation provisions. Key man life insurance policies are not maintained on any member of senior management other than Mr. Jacobs. The loss of key management or the inability to attract, retain and motivate sufficient numbers of qualified management personnel could have a material adverse effect on us. WE HAVE A LIMITED OPERATING HISTORY. We began operations in 1997 and acquired our first inpatient facility in 2001. Because of our limited operating history, we have limited insight into trends that may emerge in our industry and that affect our business. As a result, there can be no assurance that we will achieve satisfactory operating results. OUR STOCK PRICE COULD BE VOLATILE. The market price of our common stock could fluctuate significantly in response to various factors, including: - problems in achieving revenue enhancements and operating efficiencies; - actual and estimated earnings and cash flows; - quarter-to-quarter variations in operating results; - changes in market conditions in the mental health or behavioral health care industries; - changes in general economic conditions; - fluctuations in the securities markets in general; - operating results differing from analysts' estimates; and - changes in analysts' earnings estimates. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Our interest expense is sensitive to changes in the general level of interest rates. With respect to our interest-bearing liabilities, all of our long-term debt outstanding at December 31, 2003 is subject to a weighted average fixed interest rate of 9.95%. Since all of our long-term debt outstanding at December 31, 2003 is subject to a fixed interest rate, we did not estimate changes to our interest expense or fair value of long-term debt based on a hypothetical increase in interest rates. As discussed above, we do have a $50 million revolving credit facility that is subject to variable interest rates; however, at December 31, 2003, no balance was outstanding under the revolving line of credit. In the event we increase our amount outstanding under the revolving credit facility and interest rates change 13 significantly, we expect management would take actions intended to further mitigate our exposure to such change. Information on quantitative and qualitative disclosure about market risk is included in Part II, Item 7 of this Annual Report on Form 10-K under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Contractual Obligations." 14 EX-99.3 5 g92119exv99w3.txt EX-99.3 RE-ISSUED FORM 10-K - ITEM 8 . . . EXHIBIT 99.3 PSYCHIATRIC SOLUTIONS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Psychiatric Solutions, Inc. We have audited the accompanying consolidated balance sheets of Psychiatric Solutions, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Psychiatric Solutions, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting in 2001 for goodwill and intangible assets. /s/ Ernst & Young LLP Nashville, Tennessee March 3, 2004, except for Note 4 as to which the date is November 22, 2004 F-2 PSYCHIATRIC SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)

See accompanying notes. F-3 PSYCHIATRIC SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)

See accompanying notes. F-4 PSYCHIATRIC SOLUTIONS, INC. CONSOLIDATED STATEMENTS STOCKHOLDERS' EQUITY (IN THOUSANDS)

See accompanying notes. F-5 PSYCHIATRIC SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)

(Continued) F-6 PSYCHIATRIC SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)

See accompanying notes. F-7 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Psychiatric Solutions, Inc. was incorporated in 1988 as a Delaware corporation with its corporate office in Franklin, Tennessee. Psychiatric Solutions, Inc. and its subsidiaries ("we," "us" or "our") are a leading provider of inpatient behavioral health care services in the United States. Through our owned and leased facilities segment, we operate 24 owned or leased inpatient behavioral health care facilities with approximately 3,100 beds in 14 states. In addition, through our management contract segment, we manage 42 inpatient behavioral health care units for third parties and 8 inpatient behavioral health care facilities for government agencies. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The majority of our expenses are "cost of revenue" items. Costs that could be classified as general and administrative expenses at our corporate office were approximately 3% of net revenue for the year ended December 31, 2003. The consolidated financial statements include the accounts of Psychiatric Solutions, Inc. and its subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation. CASH Cash consists of demand deposits held at financial institutions. We place our cash in financial institutions that are federally insured. At December 31, 2003, the majority of our cash is deposited with one financial institution. ACCOUNTS RECEIVABLE Accounts receivable vary according to the type of service being provided. Accounts receivable for our inpatient management contract segment is comprised of contractually determined fees for services rendered. Such amounts are recorded net of estimated bad debts. Concentration of credit risk is reduced by the large number of customers. Accounts receivable for our owned and leased segment is comprised of patient service revenue and is recorded net of contractual adjustments and estimated bad debts. Such amounts are owed by various governmental agencies, insurance companies and private patients. Medicare comprised approximately 13% and 14% of net patient receivables for our owned and leased inpatient facilities at December 31, 2003 and 2002, respectively. Medicaid comprised approximately 40% and 28% of net patient receivables for our owned and leased inpatient facilities at December 31, 2003 and 2002, respectively. Concentration of credit risk from other payers is reduced by the large number of patients and payers. ALLOWANCE FOR DOUBTFUL ACCOUNTS Our ability to collect outstanding patient receivables from third party payors and receivables due under our inpatient management contracts is critical to our operating performance and cash flows. The primary collection risk with regard to patient receivables lies with uninsured patient accounts or patient accounts for which primary insurance has paid, but the portion owed by the patient remains outstanding. We estimate the allowance for doubtful accounts primarily based upon the age of the accounts since patient discharge date. We continually monitor our accounts receivable balances and utilize cash collection data to support our estimates of the provision for doubtful accounts. Significant changes in payor mix or business office operations could have a significant impact on our results of operations and cash flows. The primary collection risk with regard to receivables due under our inpatient management contracts is attributable to contractual disputes. We estimate the allowance for doubtful accounts for these receivables based primarily upon the specific identification of potential collection issues. As with our patient receivables, we continually monitor our accounts receivable balances and utilize cash collection data to support our estimates of the provision for doubtful accounts. F-8 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 ALLOWANCES FOR CONTRACTUAL DISCOUNTS The Medicare and Medicaid regulations are complex and various managed care contracts may include multiple reimbursement mechanisms for different types of services provided in our inpatient facilities and cost settlement provisions requiring complex calculations and assumptions subject to interpretation. We estimate the allowance for contractual discounts on a payor-specific basis given our interpretation of the applicable regulations or contract terms. The services authorized and provided and related reimbursement are often subject to interpretation that could result in payments that differ from our estimates. Additionally, updated regulations and contract renegotiations occur frequently necessitating continual review and assessment of the estimation process by our management. INCOME TAXES We account for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based upon differences between the financial statement carrying amounts and tax bases of assets and liabilities and are measured using the enacted tax laws that will be in effect when the differences are expected to reverse. LONG-LIVED ASSETS Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over the useful lives of the assets, which range from 25 to 35 years for buildings and improvements and 2 to 7 years for equipment. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or estimated useful lives of the assets. Depreciation expense was $4,720,000 and $1,408,000 for the years ended December 31, 2003 and 2002, respectively. Cost in Excess of Net Assets Acquired (Goodwill) During July 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards No. 141, Business Combinations ("SFAS 141") and No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). These statements made significant changes to the accounting for business combinations, goodwill, and intangible assets. SFAS 141 eliminates the pooling of interests method of accounting for business combinations. In addition, it further clarifies the criteria for recognition of intangible assets separately from goodwill. SFAS 141 was effective for transactions completed subsequent to June 30, 2001. The application of SFAS 141 did not have a material effect on our results of operations or financial position. Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed at least annually for impairment. The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, we adopted SFAS 142 effective January 1, 2002. Pursuant to SFAS 142, we completed our annual impairment test of goodwill in 2003 which resulted in no goodwill impairment. A reconciliation of previously reported net income to the pro forma amounts adjusted for the exclusion of goodwill amortization follows (in thousands, except per share amounts):

The following table presents the changes in the carrying amount of goodwill for the years ended December 31, 2003 and 2002 (in thousands): F-9 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 Balance at December 31, 2001 $ 15,208 Acquisition of PMR Corporation 12,914 Acquisition of Riveredge 662 Other 38 ------------- Balance at December 31, 2002 $ 28,822 Acquisition of The Brown Schools 17,377 Acquisition of Ramsay Youth Services 19,161 Acquisition of Alliance Health Center 1,755 Acquisition of Calvary Center 4,114 Valuation of contracts acquired from PMR (3,187) Other 928 ------------- Balance at December 31, 2003 $ 68,970 =============

Contracts Contracts represent the fair value of inpatient management contracts and service contracts purchased and are being amortized using the straight-line method over five years. The amounts reported at December 31, 2003 and 2002 are net of accumulated amortization of $1.9 million and $927,000, respectively. Amortization expense related to contracts was $944,000 and $307,000 for the years ended December 31, 2003 and 2002, respectively. Estimated amortization expense for the years ended December 31, 2004 and 2005 of contracts is $938,000 and $637,000, respectively. Estimated amortization expense for the years ended December 31, 2004 and 2005 does not include amortization on the purchase price allocation to the inpatient management contracts, if any, acquired from Ramsay Youth Services, Inc. ("Ramsay"). The purchase price allocation of Ramsay is incomplete as of December 31, 2003. When events, circumstances and operating results indicate that the carrying values of certain long-lived assets and the related identifiable intangible assets might be impaired, we prepare projections of the undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the projections indicate that the recorded amounts are not expected to be recoverable, such amounts are reduced to estimated fair value. Fair value is estimated based upon projections of discounted cash flows. OTHER ASSETS Other assets consist principally of loan costs that are deferred and amortized over the term of the related debt and deferred tax assets which reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Loan costs reported at December 31, 2003 and 2002 are net of accumulated amortization of $1.6 million and $484,000, respectively. STOCK-BASED COMPENSATION In January 2003, the FASB issued Statement on Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an Amendment of FASB Statement No. 123 ("SFAS 148"). SFAS 148 amends Statement on Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), to provide alternative methods of transition for a voluntary change to the fair-value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 has no material impact on our results of operations or financial position, as we do not plan to adopt the fair-value method of accounting for stock options at the current time. We have included the required disclosures below and in Note 10. We account for our stock option plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations as more fully described in Note 10. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if we had accounted for our employee stock options under the fair value method of that Statement. During 2003, 2002 and 2001, we granted 713,000, 515,000 and 35,000 stock options, respectively. The fair value of these options was estimated using the Black-Scholes option pricing model for 2003 and 2002. For 2001, we used the minimum value option pricing model as our stock was not publicly traded. F-10 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 The following weighted-average assumptions were used in the respective pricing models:
2003 2002 2001 ------ ------- ------- Risk-free interest rate 2.79% 3.11% 3.69% Volatility 51.99% 111.70% N/A Expected life 5.6 4.9 6.0 Dividend yield 0.00% 0.00% 0.00%
The weighted-average fair value of options granted are presented in the following table:
2003 2002 2001 -------- -------- -------- Exercise Price equal to Market Price $ 5.05 $ 4.41 $ 0.60 Exercise Price less than Market Price $ -- $ 3.74 $ -- Exercise Price greater than Market Price $ 5.04 $ 2.56 $ --
Option valuation models require the input of highly subjective assumptions. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the option's vesting period. Our pro forma information follows (in thousands, except per share amounts):
2003 2002 2001 --------- --------- --------- Net income available to common stockholders (1) $ 4,405 $ 5,684 $ 2,578 Pro forma compensation expense from stock options 605 127 8 --------- --------- --------- Pro forma net income $ 3,800 $ 5,557 $ 2,570 ========= ========= ========= Basic earnings per share: As reported $ 0.53 $ 0.93 $ 0.51 Pro forma $ 0.45 $ 0.91 $ 0.51 Diluted earnings per share: As reported $ 0.44 $ 0.86 $ 0.49 Pro forma $ 0.39 $ 0.84 $ 0.48
(1) Net income available to common stockholders reflects stock compensation expense of $118,000 for the year ended December 31, 2002, for stock options granted with exercise prices below market price during 2002. RISK MANAGEMENT Due to our acquisition of Ramsay, we have two distinct insurance programs that cover our facilities. For our facilities that were not acquired from Ramsay, we have obtained professional and general liability insurance for claims in excess of $3 million with an insured limit of $10 million. In December 2003, we increased this insured limit to $20 million. For the facilities acquired from Ramsay, we have obtained professional and general liability insurance for claims in excess of $500,000 with an insured limit of $25 million. These policies include umbrella coverage of $20 million and $25 million, respectively. The self-insured reserves for professional and general liability risks are calculated based on historical claims, demographic factors, industry trends, severity factors, and other actuarial assumptions calculated by an independent third party. The self-insured reserve is discounted to its present value using a 5% discount rate. This estimated accrual for professional and general liabilities could be significantly affected should current and future occurrences differ from historical claim trends and expectations. We have established a captive insurance company to manage this additional self-insured retention for our facilities not acquired from Ramsay. We plan to merge these plans in the near future. While claims are monitored closely when estimating professional and general liability accruals, the complexity of the claims and wide range of potential outcomes often hampers timely adjustments to the assumptions used in these estimates. We believe that our insurance coverage conforms to industry standards. There are no assurances, however, that our insurance will cover all claims (e.g., claims for punitive damages) or that claims in excess of our insurance coverage will not arise. A successful lawsuit against us that is not covered by, or is in excess of, our insurance coverage may have a material adverse effect on our business, financial condition and results of operations. The reserve for professional and general liability was approximately $4.2 million as of December 31, 2003. F-11 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 We carry a portion of our workers' compensation insurance from an unrelated commercial insurance carrier. Our experience with workers' compensation claims has been insignificant. We also have a rent-a-captive arrangement for a portion of our workers' compensation coverage. With the rent-a-captive arrangement we fund the expected losses of claims with an offshore entity wholly-owned by a United States insurance carrier. We also maintain an aggregate stop loss policy for our workers' compensation claims. We believe that adequate provision has been made for workers compensation and professional and general liability risks. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the accompanying Consolidated Balance Sheets for cash, accounts receivable, and accounts payable approximate their fair value given the short-term maturity of these instruments. At December 31, 2003, the carrying value and fair value of our 10 5/8% senior subordinated notes was approximately $150 million and $167 million, respectively. Based upon the borrowing rates currently available to us, the carrying amounts reported in the accompanying Consolidated Balance Sheets for other long-term debt approximate fair value. MERGER WITH PMR CORPORATION On August 5, 2002, pursuant to a definitive Merger Agreement, dated May 6, 2002, and with respective stockholder and regulatory approvals, PMR Acquisition Corporation, a newly formed, wholly-owned subsidiary of PMR Corporation, merged with and into Psychiatric Solutions, Inc., a Delaware corporation whose name, subsequent to the merger, was changed to Psychiatric Solutions Hospitals, Inc. ("PSH"). The surviving corporation in the merger was PSH, which became a wholly-owned subsidiary of PMR Corporation ("PMR"). In connection with the merger, PMR changed its name to Psychiatric Solutions, Inc. ("PSI"). In exchange for their outstanding shares of common stock or preferred stock in PSH, stockholders of PSH received newly-issued shares of PSI common stock. Options to acquire PSH common stock were converted into options to purchase shares of PSI common stock based on the common stock exchange ratio used in the merger. Warrants to purchase shares of PSH common stock were converted into warrants to purchase shares of PSI common stock. After giving effect to the exercise of all outstanding options and warrants of PSH following the merger, the former PSH stockholders and PSI's pre-merger stockholders received approximately 72% and 28% of our common stock, respectively. In addition, effective August 6, 2002, our common stock was approved for listing on the Nasdaq National Market under the ticker symbol "PSYS." The Merger Agreement is on file with the Securities and Exchange Commission ("SEC") as an exhibit to Amendment No. 1 to our Registration Statement on Form S-4 filed on June 12, 2002, as amended July 11, 2002. Since the former PSH stockholders had ownership of more than half of our outstanding common stock pursuant to the merger, PSH has been treated as the acquiring company for accounting purposes. The condensed consolidated financial statements located herein relate to PSH only prior to August 5, 2002, and to the merged company on and subsequent to August 5, 2002. Historical financial information relating to PMR just prior to the merger can be found in PMR's quarterly report on Form 10-Q for the quarter ended July 31, 2002, as filed with the Securities and Exchange Commission on September 16, 2002. RECLASSIFICATIONS Certain reclassifications have been made to the prior year to conform with current year presentation. RECENT PRONOUNCEMENTS In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"), which supersedes Statements on Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of ("SFAS 121"), and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS 144 removes goodwill from its scope and clarifies other implementation issues related to SFAS 121. SFAS 144 also provides a single framework for evaluating long-lived assets to be disposed of by sale. We do not expect SFAS 144 to have a material effect on our results of operations or financial position. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145 prohibits the classification of gains or losses from debt extinguishments as extraordinary items unless the criteria outlined in APB Opinion No. 30, Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, are met. SFAS 145 also eliminates an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback F-12 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 transactions. SFAS 145 is effective for fiscal years beginning after May 15, 2002, with early adoption encouraged. We adopted the provisions of SFAS 145 effective January 1, 2003 and have reclassified amounts previously reported as an extraordinary item to a component of income from continuing operations. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51" ("FIN 46"). FIN 46 requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003 and to existing entities in the first fiscal year or interim period ending after December 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. This statement has not had a material impact on our results of operations or financial position. In May, 2003, the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"). SFAS 150 generally requires liability classification for certain financial instruments that represent obligations to issuer and have characteristics of both liabilities and equity. SFAS 150 has not had a material impact on our results of operations or financial position. In October 2003, the FASB voted to defer for an indefinite period, the application of the SFAS 150 guidance to noncontrolling interests in limited-life subsidiaries. The deferral has not had a material impact on our results of operations or financial position. 2. REVENUE Revenue consists of the following amounts (in thousands):
December 31, --------------------------------- 2003 2002 2001 -------- -------- ------- Patient service revenue $223,340 $ 81,929 $16,026 Management fee revenue 61,606 31,983 27,973 -------- -------- ------- Total revenue $284,946 $113,912 $43,999 ======== ======== =======
NET PATIENT SERVICE REVENUE Patient service revenue is reported on the accrual basis in the period in which services are provided, at established rates, regardless of whether collection in full is expected. Net patient service revenue includes amounts we estimate to be reimbursable by Medicare and Medicaid under provisions of cost or prospective reimbursement formulas in effect. Amounts received are generally less than the established billing rates of the facilities and the differences (contractual allowances) are reported as deductions from patient service revenue at the time the service is rendered. The effect of other arrangements for providing services at less than established rates is also reported as deductions from patient service revenue. During the year ended December 31, 2003, approximately 12.2% and 32.3% of our revenues related to patients participating in the Medicare and Medicaid programs, respectively. We provide care without charge to patients who are financially unable to pay for the health care services they receive. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in revenues. Settlements under cost reimbursement agreements with third party payers are estimated and recorded in the period in which the related services are rendered and are adjusted in future periods as final settlements are determined. Final determination of amounts earned under the Medicare and Medicaid programs often occur in subsequent years because of audits by the programs, rights of appeal and the application of numerous technical provisions. Our revenue is particularly sensitive to regulatory and economic changes in the State of Texas. As of December 31, 2003 and 2002, we operated seven and three inpatient facilities in Texas, respectively. We generated approximately 34% and 50% of our revenue from our Texas operations for the years ended December 31, 2003 and 2002, respectively. MANAGEMENT CONTRACT REVENUE Revenue is recorded as management contract revenue for our inpatient management contract segment. Our inpatient management contract segment receives contractually determined management fees from hospitals and clinics for providing inpatient psychiatric management and development services. F-13 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 Our management contract revenue is sensitive to regulatory and economic changes in the State of Florida because, as of December 31, 2003, we managed 6 inpatient facilities for the Florida Department of Juvenile Justice. We generated approximately 3% of our revenue for the year ended December 31, 2003 from our management contracts for the Florida Department of Juvenile Justice. Our management contract revenue is also sensitive to regulatory and economic changes in the State of Tennessee because of the contract to provide case management services in and around Nashville, Tennessee. This contract generated approximately 8% and 6% of our revenue for the years ended December 31, 2003 and 2002, respectively. There were no other individual or group of affiliated contracts in 2002 that provided a significant concentration of our management contract revenue. 3. EARNINGS PER SHARE Statement of Financial Accounting Standards No. 128, Earnings per Share ("SFAS 128"), requires dual presentation of basic and diluted earnings per share by entities with complex capital structures. Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of the entity. We have calculated earnings per share in accordance with SFAS 128 for all periods presented. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Year ended December 31, ----------------------------- 2003 2002 2001 -------- ------ ------ Numerator: Basic earnings per share: Income from continuing operations $ 5,241 $5,684 $ 990 Accrued dividends on series A convertible preferred stock 811 -- -- -------- ------ ------ Income from continuing operations used in computing basic earnings per share 4,430 5,684 990 (Loss) income from discontinued operations, net of taxes (25) -- 1,588 -------- ------ ------ Net income available to common stockholders $ 4,405 $5,684 $2,578 ======== ====== ====== Diluted earnings per share: Income from continuing operations $ 5,241 $5,684 $ 990 Add: Interest expense on convertible notes -- 324 -- -------- ------ ------ Income from continuing operations used in computing diluted earnings per share 5,241 6,008 990 (Loss) income from discontinued operations, net of taxes (25) -- 1,588 -------- ------ ------ Net income used in computing diluted earnings per share $ 5,216 $6,008 $2,578 ======== ====== ====== Denominator: Weighted average shares outstanding for basic earnings per share 8,370 6,111 5,010 Effects of dilutive stock options and warrants outstanding 431 453 299 Effect of dilutive convertible debt outstanding -- 422 -- Effect of dilutive series A convertible preferred stock outstanding 2,948 -- -- -------- ------ ------ Shares used in computing diluted earnings per common share 11,749 6,986 5,309 ======== ====== ====== Basic earnings per share: Income from continuing operations $ 0.53 $ 0.93 $ 0.20 (Loss) income from discontinued operations, net of taxes -- -- 0.31 -------- ------ ------ $ 0.53 $ 0.93 $ 0.51 ======== ====== ====== Diluted earnings per share: Income from continuing operations $ 0.44 $ 0.86 $ 0.19 (Loss) income from discontinued operations, net of taxes -- -- 0.30 -------- ------ ------ $ 0.44 $ 0.86 $ 0.49 ======== ====== =======
F-14 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 Diluted earnings per share for the years ended December 31, 2003 and 2001 does not include the potential dilutive effect of debt outstanding which was convertible into 106,000 and 483,000 shares of our common stock, respectively, as the effects would be anti-dilutive. Interest expense related to this convertible debt was approximately $124,000 and $324,000 for the years ended December 31, 2003 and 2001, respectively. 4. DISCONTINUED OPERATIONS SFAS No. 144 requires that all components of an entity that have been disposed of (by sale, by abandonment or in a distribution to owners) or are held for sale and whose cash flows can be clearly distinguished from the rest of the entity be presented as discontinued operations. During 2004, we exited three of our contracts to manage state-owned facilities in Florida. Accordingly, the operations of these contracts, net of applicable income taxes, have been presented as discontinued operations and prior period condensed consolidated statements of income have been reclassified. Also included in discontinued operations are the operating results and estimated losses on the unwind of service agreements entered into with physicians, as well as the operating results and gain on disposal for the employee assistance program. As part of our discontinued physician practice management division, we acquired certain net assets of psychiatric clinics, and operated the clinics and managed the physician practices under long-term service agreements with the physicians that practiced exclusively through the clinics. We did not consolidate these clinics or the physician practices we managed, as we did not have operating control. Additionally, discontinued operations include the operating results and estimated losses on the closure of clinics we owned. Such clinics provided group and individual therapy sessions to patients through partial hospitalization and intensive outpatient programs. Our owned clinics were all closed as of December 31, 2000. Our employee assistance programs division contracted with employers to provide confidential assistance and counseling to their employees. The components of income (loss) from discontinued operations, net of taxes, are as follows (in thousands):
Year Ended December 31, ----------------------- 2003 2001 ------- ------- Revenue $ 8,720 $ 2,368 Salaries, wages and employee benefits 6,430 1,199 Professional fees 827 359 Supplies 703 53 Rentals and leases 66 207 Other operating expenses 715 (38) Depreciation and amortization 19 153 Interest expense, net -- 20 Gain on disposal of discontinued lines of business -- (1,396) ------- ------- 8,760 557 (Loss) income from discontinued operations before income taxes (40) 1,811 (Benefit from) provision for income taxes (15) 223 ------- ------- (Loss) income from discontinued operations, net of income taxes $ (25) $ 1,588 ======= =======
5. ACQUISITIONS 2001 ACQUISITIONS During 2001, we acquired four free-standing inpatient psychiatric facilities, three in Texas and one in North Carolina. All of the acquisitions were accounted for by the purchase method. The aggregate purchase price of these transactions was allocated to the assets acquired and liabilities assumed based upon their respective fair values. The consolidated financial statements include the accounts and operations of the acquired entities for periods subsequent to the respective acquisition dates. The goodwill associated with these acquisitions is deductible for federal income tax purposes. The following table summarizes the allocation of the aggregate purchase price of the aforementioned acquisitions (in thousands): F-15 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003
West Oaks Texas Neuro and Cypress Rehab 2001 Creek Holly Hill Center Total - ---- ----------- ---------- ----------- ------- Assets acquired: Accounts receivable $ 7,091 $1,617 $ 3,400 $12,108 Other current assets 244 99 154 497 Fixed assets 6,833 6,264 4,738 17,835 Costs in excess of net assets acquired -- 403 135 538 ------- ------ ------- ------- 14,168 8,383 8,427 30,978 Liabilities assumed 2,105 758 798 3,661 Subordinated notes issued 2,000 -- 2,500 4,500 Long-term debt issued 9,908 7,542 5,062 22,512 ------- ------ ------- ------- Cash paid, net of cash acquired $ 155 $ 83 $ 67 $ 305 ======= ====== ======= =======
2002 ACQUISITIONS During 2002, we acquired one free-standing inpatient psychiatric hospital in Illinois (Riveredge Hospital). Also during 2002, we merged with PMR Corporation, a developer and manager of specialized mental health programs and disease management services designed to treat individuals diagnosed with a serious mental illness. The acquisition of the hospital and merger with PMR Corporation were accounted for by the purchase method. The aggregate purchase price of these transactions was allocated to the assets acquired and liabilities assumed based upon their respective fair values. The consolidated financial statements include the accounts and operations of the acquired entities for periods subsequent to the respective acquisition dates. As these transactions involved the acquisition of stock, the goodwill associated with these acquisitions is not deductible for federal income tax purposes. The purchase of Riveredge Hospital included an escrow arrangement whereby we deposited $4.5 million of the purchase price with an escrow agent. The escrowed funds will be released to the seller upon satisfaction of certain earnings targets and indemnification by the seller of certain claims and cost report settlements. Any claims by us on these escrowed funds would affect the purchase price. Approximately $1.5 million of these funds were released during 2002. The following table summarizes the allocation of the aggregate purchase price of the aforementioned acquisitions (in thousands):
2002 Riveredge PMR Total - ---- --------- -------- -------- Assets acquired: Accounts receivable $ 4,208 $ 121 $ 4,329 Other current assets 833 168 1,001 Fixed assets 15,350 155 15,505 Costs in excess of net assets acquired 662 10,938 11,600 Other assets 100 3,544 3,644 ------- -------- -------- 21,153 14,926 36,079 Liabilities assumed 4,289 5,784 10,073 Subordinated notes issued 10,000 -- 10,000 Long-term debt issued 6,864 -- 6,864 Common stock issued -- 15,385 15,385 ------- -------- -------- Cash acquired, net of cash paid $ -- $ (6,243) $ (6,243) ======= ======== ========
The purchase price allocation for PMR was completed during the quarter ended March 31, 2003, with the valuation of identifiable intangible assets acquired in the merger and related deferred tax liability. 2003 ACQUISITIONS During 2003, we acquired Ramsay, an operator of 11 owned or leased inpatient behavioral health care facilities and 10 contracts to manage inpatient behavioral health care facilities for state government agencies. Also during 2003, we acquired six inpatient behavioral health care facilities from The Brown Schools, Inc. ("The Brown Schools"). In addition, we purchased Alliance Health Center F-16 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 ("Alliance") and the Calvary Center ("Cavalry") during 2003. These acquisitions were accounted for by the purchase method. The aggregate purchase price of these transactions was allocated to the assets acquired and liabilities assumed based upon their respective fair values. The consolidated financial statements include the accounts and operations of the acquired entities for periods subsequent to the respective acquisition dates. Our liabilities assumed included approximately $3.3 million payable to the seller of Calvary upon the completion of certain licensing issues. This amount was paid to the seller in January 2004. As the acquisitions of Ramsay and Alliance involved the acquisition of stock, the goodwill associated with these acquisitions is not deductible for federal income tax purposes. The goodwill associated with the acquisitions of The Brown Schools and Calvary is deductible for federal income tax purposes. The following table summarizes the allocation of the aggregate purchase price of the aforementioned acquisitions (in thousands):
The Brown 2003 Ramsay Schools Alliance Calvary Total - ---- ------- ------- -------- -------- -------- Assets acquired: Accounts receivable $18,396 $11,367 $ 1,901 $ 70 $ 31,734 Other current assets 7,228 1,046 139 20 8,433 Fixed assets 53,607 43,756 14,460 36 111,859 Costs in excess of net assets acquired 11,719 17,377 1,755 4,114 34,965 Other assets 8,357 591 -- 9 8,957 ------- ------- ------- -------- -------- 99,307 74,137 18,255 4,249 195,948 Liabilities assumed 18,536 9,601 4,229 3,591 35,957 Long-term debt issued -- 51,171 12,594 -- 63,765 ------- ------- ------- -------- -------- Cash paid, net of cash acquired $80,771 $13,365 $ 1,432 $ 658 $ 96,226 ======= ======= ======= ======== ========
Other Information The following represents the unaudited pro forma results of consolidated operations as if the aforementioned acquisitions had occurred at the beginning of the immediate preceding period, after giving effect to certain adjustments, including the depreciation and amortization of the assets acquired based upon their fair values and changes in interest expense resulting from changes in consolidated debt:
2003 2002 2001 -------- -------- -------- Revenues $406,876 $367,507 $134,735 Net income available to common stockholders 4,988 6,912 4,035 Earnings per common share, basic $ 0.60 $ 1.13 $ 0.81
The pro forma information for the year ended December 31, 2003 includes a loss from refinancing long-term debt of approximately $4.6 million. The pro forma information given does not purport to be indicative of what our results of operations would have been if the acquisitions had in fact occurred at the beginning of the periods presented, and is not intended to be a projection of the impact on future results or trends. 6. LONG-TERM DEBT Long-term debt consists of the following (in thousands): F-17 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003
December 31, --------------------- 2003 2002 -------- ------- Senior credit facility: Revolving line of credit, expiring on June 30, 2006 and bearing interest at the prime rate plus 2% (6.25% at December 31, 2003) $ -- $ 5,383 Term loan, due on November 30, 2003 and bearing interest at the prime rate plus 4.75% -- 17,275 10 5/8% senior subordinated notes 150,000 -- Mortgage loans on facilities, maturing in 2037 and 2038 bearing fixed interest rates of 5.65% to 5.95% 23,833 4,928 Senior subordinated notes -- 10,144 Subordinated seller notes with varying maturities 1,170 2,394 Subordinated convertible notes -- 3,600 Other -- 98 -------- ------- 175,003 43,822 Less current portion 1,023 7,070 -------- ------- Long-term debt $173,980 $36,752 ======== =======
SENIOR CREDIT FACILITY In conjunction with the closing of the sale of our 10 5/8% senior subordinated notes on June 30, 2003, our senior credit facility with CapitalSource Finance LLC ("CapSource") was amended and restated to increase our senior secured revolving line of credit to $50.0 million from $28.0 million and to refinance $36.0 million in term loans with proceeds from the sale of our 10 5/8% senior subordinated notes. Our senior credit facility is secured by substantially all of our assets and the stock of our existing operating subsidiaries. The term loans accrued interest at the Citibank, N.A. prime rate plus 4.5% subject to a floor of 8.75% and were due in November 2003. The revolving line of credit accrues interest at the Citibank, N.A. prime rate plus 2% subject to a floor of 6.25% and is due in June 2006. Under our revolving working capital line of credit we are required to pay interest on a minimum balance of $17.5 million. At December 31, 2003, the interest rate under the revolving line of credit was 6.25%. Until the maturity date, we may borrow, repay and re-borrow an amount not to exceed the lesser of $50.0 million or the borrowing base (as defined in the amended and restated credit facility). As of December 31, 2003, we had $50.0 million available under the revolving line of credit under our senior credit facility. Under the revolving line of credit, all of our collections, except for Medicare and Medicaid payments, are deposited into lockbox accounts controlled by CapSource. The funds deposited in the lockboxes are returned to us on a daily basis. Prior to amending and restating the senior credit facility, funds deposited in the lockboxes were applied to outstanding borrowings on a daily basis. As a result, the outstanding borrowings under the revolving line of credit were classified as short-term as of December 31, 2002 and all periods prior to June 30, 2003. We must pay on a monthly basis an unused fee in the amount of 0.5% per annum on the unused portion of our amended and restated credit facility. Such fees were approximately $100,000 for the year ended December 31, 2003. As of December 31, 2003, our senior credit facility consisted of the $50.0 million revolving working capital line of credit. During 2003 we refinanced $17.0 million in term loans with borrowings insured by the U.S. Department of Housing and Urban Development ("HUD"), see Mortgage Loans below. Our amended and restated senior credit facility contains customary covenants which include: (1) a specified monthly patient census for any owned, operated or leased inpatient facilities; (2) a limitation on capital expenditures, sales of assets, mergers, changes of ownership, new principal lines of business, indebtedness, dividends and redemptions; and (3) various financial covenants. In addition, the amended and restated credit facility provides CapSource with a right of first refusal to provide additional debt financing to us. As of December 31, 2003, we were in compliance with all debt covenant requirements. If we violate one or more of these covenants, amounts outstanding under the amended and restated credit facility could become immediately payable and additional borrowings could be restricted. 10 5/8% SENIOR SUBORDINATED NOTES On June 30, 2003, we issued $150 million in 10 5/8% senior subordinated notes, which are fully and unconditionally guaranteed on a senior subordinated basis by substantially all of our existing operating subsidiaries. Proceeds from the issuance of the senior subordinated notes and the issuance of $12.5 million in series A convertible preferred stock were used to finance the acquisition of Ramsay and pay down substantially all of our previously existing long-term debt. Interest on the senior subordinated notes accrues at the rate of 10.625% per annum and is payable semi-annually in arrears on June 15 and December 15, commencing on December 15, 2003. The senior F-18 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 subordinated notes will mature on June 15, 2013. MORTGAGE LOANS During 2002 and 2003 we borrowed approximately $23.8 million under mortgage loan agreements insured by HUD. The mortgage loans insured by HUD are secured by real estate located at Holly Hill Hospital in Raleigh, North Carolina, West Oaks Hospital in Houston, Texas and Riveredge Hospital near Chicago, Illinois. Interest accrues on the Holly Hill, West Oaks and Riveredge HUD loans at 5.95%, 5.85% and 5.65% and principal and interest are payable in 420 monthly installments through December 2037, September 2038 and December 2038, respectively. We used the proceeds from the mortgage loans to repay approximately $4.4 million in 2002 and $17.0 million in 2003 of our term debt under our senior credit facility, pay certain financing costs, and fund required escrow amounts for future improvements to the property. The carrying amount of assets held as collateral approximated $23 million at December 31, 2003. SENIOR SUBORDINATED NOTES On June 28, 2002, we entered into a securities purchase agreement with The 1818 Mezzanine Fund II, L.P. (the "1818 Fund") where the 1818 Fund agreed to purchase up to $20 million of senior subordinated notes with detachable nominal warrants. At the closing on June 28, 2002, a total of $10 million of the senior subordinated notes were issued. On June 30, 2003, we repaid principal of $10 million, accrued interest and a prepayment penalty of 3% to the 1818 Fund with proceeds from our issuance of 10 5/8% senior subordinated notes, and we no longer have the ability to borrow under the securities purchase agreement with the 1818 Fund. In connection with the issuance of the senior subordinated notes to the 1818 Fund, we issued detachable stock purchase warrants for the purchase of 372,412 shares of our common stock at an exercise price of $.01 per share. Also, we provided the 1818 Fund with the ability to require us to repurchase their warrants or common stock acquired upon exercise of the warrants at fair market value for cash. The 1818 Fund exercised its stock purchase warrant and received 372,039 shares of our common stock on May 16, 2003. Because the 1818 Fund had the ability to require us to repurchase the warrants for cash, the warrants constituted a derivative that required changes in value of the warrants to be recorded as an increase or decrease to our earnings. In connection with the exercise of the warrants, the 1818 Fund provided us with a written consent to waive its ability to require that we repurchase the warrants for cash effective April 1, 2003. As such, we are no longer required to record non-cash expense for changes in the fair market value of our common stock. In addition, the 1818 Fund sold its shares of our common stock on December 24, 2003 so it no longer has the right to require us to repurchase the shares of our common stock it received upon the exercise of its warrant. SUBORDINATED SELLER NOTES In connection with an acquisition in 2000, we issued a promissory note payable in the amount of $400,000 bearing interest at 9% for the year ended December 31, 2000. Principal on this note is payable in five equal annual installments beginning April 1, 2001. Accrued interest is due and payable on the first day of each calendar quarter beginning July 1, 2000. The principal amount we owe on this note is $160,000 at December 31, 2003. In connection with two acquisitions in 2001, we issued two promissory notes totaling $4.5 million. A $2.5 million note bore interest at 9% per annum and matured June 30, 2002. A $2.0 million note bears interest at 9% per annum and matures June 30, 2005, with periodic principal and interest payments due beginning September 30, 2002. The principal amount we owe on this note is approximately $1.0 million at December 31, 2003. These subordinated seller notes contain customary covenants which include a cross-default covenant with the occurrence of a default of any indebtedness of at least $1,000,000 held by any creditor. As of December 31, 2003, we were in compliance with these covenants. SUBORDINATED CONVERTIBLE NOTES In connection with an acquisition during May 2000, we issued subordinated convertible notes in the amount of $3.6 million. The principal amount of these convertible notes and the interest thereon was converted into 537,908 shares of our common stock in April and May 2003, based on a conversion price of $8.53 per share. OTHER The aggregate maturities of long-term debt are as follows (in thousands): F-19 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 2004 $ 1,023 2005 603 2006 249 2007 263 2008 279 Thereafter 172,586 -------- Total $175,003 ========

7. SERIES A CONVERTIBLE PREFERRED STOCK In conjunction with our acquisitions of The Brown Schools and Ramsay, we issued 4,545,454 shares of our series A convertible preferred stock for $25.0 million in equal installments in April and June of 2003. Each share of series A convertible preferred stock is convertible into one share of our common stock. Holders of the series A convertible preferred stock are entitled to receive pay-in-kind dividends, compounded quarterly, equal to 5% per share of the original share price through March 31, 2005. Thereafter, pay-in-kind dividends will compound quarterly at 7% per share of the original share price. Accrued pay-in-kind dividends are convertible into approximately 147,000 shares of our common stock at December 31, 2003. Because we may be required to redeem the series A convertible preferred stock upon certain change of control events that may not be within our control, the series A convertible preferred stock has been classified outside of our permanent stockholders' equity. The series A convertible preferred plus accrued pay-in-kind dividends will automatically convert to shares of our common stock when, beginning on October 1, 2004, our common stock trades for more than $15 on a volume-weighted average basis for 30 consecutive trading days. 8. LEASES At December 31, 2003, future minimum lease payments under non-cancelable leases are as follows (in thousands): 2004 $ 5,982 2005 5,786 2006 3,937 2007 3,337 2008 2,674 Thereafter 3,318 -------- Total $ 25,034 ========

We lease the buildings for our Whisper Ridge facility, which expires in August 2005 and has annual lease payments of approximately $500,000, our Havenwyck facility, which expires in April 2010 and has annual lease payments of approximately $1.5 million, and our Mission Vista facility, which expires in April 2010 and has annual lease payments of approximately $600,000. Rent expense totaled $4.1 million and $870,000 for the years ended December 31, 2003 and 2002, respectively. 9. INCOME TAXES Total income tax for the year ended December 31, 2003 was allocated as follows (in thousands): Provision for income taxes attributable to income from continuing operations $ 3,800 Benefit from income taxes attributable to loss from discontinued operations (15) ------- Total provision for income taxes $ 3,785 =======

The provision for (benefit from) income taxes attributable to income from continuing operations consists of the following (in thousands): F-20 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003
2003 2002 ------- ------- Current: Federal $ -- $ -- State 421 323 ------- ------- 421 323 Deferred: Federal 3,372 (1,192) State 7 (138) ------- ------- 3,379 (1,330) ------- ------- Provision for income taxes $ 3,800 $(1,007) ======= =======
The reconciliation of income tax computed by applying the U.S. federal statutory rate to the actual income tax (benefit) expense attributable to income from continuing operations is as follows (in thousands):
2003 2002 ------ ------- Federal tax $3,074 $ 1,590 State income taxes (net of federal) 282 179 Change in valuation allowance -- (2,809) Other 444 33 ------ ------- Provision for (benefit from) income taxes $3,800 $(1,007) ====== =======
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant items comprising temporary differences are as follows (in thousands):
2003 2002 -------- ------- Deferred tax assets: Net operating loss carryforwards $ 17,711 $ 6,296 Allowance for doubtful accounts 1,955 904 Capital loss carryforwards 445 -- Alternative minimum tax credit carryovers 1,150 -- Accrued Liabilities 3,498 1,176 -------- ------- Total gross deferred tax assets 24,759 8,376 Less: Valuation allowance (11,283) (5,860) -------- ------- Total deferred tax assets 13,476 2,516 Deferred tax liabilities: Amortization (6,867) (611) Depreciation (13,201) (2,111) Other (170) (52) -------- ------- Net deferred tax liability $ (6,762) $ (258) ======== =======
Current accounting standards generally accepted in the United States ("GAAP") require that deferred income taxes reflect the tax consequences of differences between the tax bases of assets and liabilities and their carrying values for GAAP. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not. A valuation allowance is established for those benefits that do not meet the more likely than not criteria. We have evaluated the need for a valuation allowance against deferred tax assets and have established a valuation allowance of $11.3 million and $5.9 million at December 31, 2003 and 2002 respectively. The valuation allowance increased by approximately $5.4 million during the year ended December 31, 2003 as a result of the following items (in thousands): F-21 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 Valuation allowance at December 31, 2002 $ (5,860) Valuation allowance recorded against acquired Ramsay net deferred tax asset (7,024) Release of valuation allowance recorded as purchase accounting adjustments 1,601 -------- Valuation allowance at December 31, 2003 $(11,283) ========

As of December 31, 2003, we had federal net operating loss carryforwards of $47.4 million expiring in the years 2012 through 2023. As of December 31, 2003, we also had capital loss carryforwards of approximately $1.1 million expiring in 2004 and an alternative minimum tax credit carryover of approximately $1.2 million available to reduce future federal income taxes. 10. STOCK OPTION PLANS Upon the merger with PMR Corporation on August 5, 2002, we acquired PMR Corporation's 1997 Equity Incentive Plan, which was subsequently renamed the Psychiatric Solutions, Inc. Equity Incentive Plan (the "Equity Incentive Plan"). The Equity Incentive Plan was amended and restated at our 2003 Annual Meeting of Stockholders to increase the number of shares of our common stock subject to grant under the Equity Incentive Plan to 2,233,333 from 1,333,333. Under the Equity Incentive Plan, options may be granted for terms of up to ten years and are generally exercisable in cumulative annual increments of 25% each year, commencing one year after the date of grant. The exercise prices of incentive stock options and nonqualified options shall not be less than 100% and 85%, respectively, of the fair market value of the common shares on the trading day immediately preceding the date of grant. Also upon the merger with PMR Corporation, we acquired PMR Corporation's Outside Directors' Non-qualified Stock Option Plan of 1992, which was subsequently renamed the Psychiatric Solutions, Inc. Outside Directors' Stock Option Plan (the "Directors' Plan"). The Directors' Plan provides for a grant of 4,000 stock options at each annual meeting of stockholders to each outside director at the fair market value of our common shares on the trading day immediately preceding the date of grant. The options vest 25% on the grant date and 25% on the succeeding three anniversaries of the grant date. Options for a maximum of 341,667 shares may be granted under the Directors' Plan. During 2002, we recognized $118,000 compensation expense related to stock options issued to certain officers and employees with exercise prices below fair market value. No options with exercise prices below fair market value were granted during 2003. Stock option activity, including options granted for acquisitions, is as follows (number of options in thousands):
Weighted Average Number of Options Option Exercise Price Exercise Price ----------------- --------------------- ---------------- Balance at December 31, 2000 237 $0.87 to $3.04 $ 2.00 Granted 35 $3.04 $ 3.04 Canceled (54) $0.87 to $3.04 $ 2.61 Exercised (4) $0.87 to $3.04 $ 1.04 ----- --------------- ------ Balance at December 31, 2001 214 $0.87 to $3.04 $ 2.08 Granted 515 $0.87 to $5.50 $ 5.07 Stock options acquired 408 $4.50 to $30.00 $17.10 Canceled (26) $0.87 to $29.25 $ 4.28 Exercised (38) $0.87 to $3.04 $ 1.14 ----- --------------- ------ Balance at December 31, 2002 1,073 $0.87 to $30.00 $ 9.21 Granted 713 $5.05 to $13.75 $10.77 Canceled (83) $0.87 to $30.00 $11.38 Exercised (64) $0.87 to $9.56 $ 4.92 ----- --------------- ------ Balance at December 31, 2003 1,639 $0.87 to $30.00 $ 9.94
The following table summarizes information concerning outstanding and exercisable options at December 31, 2003 (number of options in thousands). F-22 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003
Options Outstanding Options Exercisable ------------------------------------ -------------------------------------- Number Weighted Avg. Weighted Number Outstanding at Remaining Average Exercisable at December 31 Contruactual Exercise December 31, Exercise Prices 2003 Life Price 2003 - --------------- ----------- ------------- -------- ------------- $0.87 to $3.03 83 5.19 $ 0.87 82 $3.04 to $4.50 95 6.68 $ 3.26 78 $4.51 to $5.50 509 8.70 $ 5.48 123 $5.51 to $11.63 364 8.12 $ 9.31 66 $11.64 to $21.38 521 6.73 $18.71 197 $21.39 to $30.00 67 1.53 $26.97 67 ----- ------ --- $0.87 to $30.00 1,639 $11.59 613 ===== ====== ===
11. EMPLOYEE BENEFIT PLAN We adopted the Psychiatric Solutions, Inc. Retirement Savings Plan (the "Plan"). The Plan is a tax-qualified profit sharing plan with a cash or deferred arrangement whereby employees who have completed two months of service and are age 21 or older are eligible to participate. The Plan allows eligible employees to make contributions of 1% to 15% of their annual compensation. The Plan includes a discretionary company matching contribution not to exceed 15% of eligible employee compensation. Employer contributions vest 20% after two years of service and continue vesting at 20% per year until fully vested. 12. CONTINGENCIES AND HEALTH CARE REGULATION CONTINGENCIES We are subject to various claims and legal actions which arise in the ordinary course of business. We have professional liability insurance to protect against such claims or legal actions. We believe the ultimate resolution of such matters will be adequately covered by insurance and will not have a material adverse effect on our financial position or results of operations. EMPLOYMENT AGREEMENTS Effective August 6, 2002, we entered into an Amended and Restated Employment Agreement with Joey A. Jacobs, our Chairman, Chief Executive Officer and President. Mr. Jacobs' Amended and Restated Employment Agreement was amended on November 26, 2003. Mr. Jacobs' agreement provides for an annual base salary and an annual cash incentive compensation award tied to objective criteria as established by the board of directors. The employment agreement has an initial term of one year and is subject to automatic annual renewals absent prior notice from either party. Mr. Jacobs' employment agreement provides for various payments to Mr. Jacobs upon cessation of employment, depending on the circumstances. If we terminate Mr. Jacobs's employment "without cause" or if he resigns pursuant to a constructive discharge, then (i) all options scheduled to vest during the succeeding 24 month period will immediately vest and will remain exercisable for 12 months from the date of termination, (ii) certain restricted stock will immediately vest, (iii) Mr. Jacobs will receive a cash payment equal to 200% of his base salary and bonus earned during the twelve months prior to termination, and (iv) all benefits and perquisites will continue for 18 months. In the event of a change in control, his employment agreement requires that we pay him 200% of his base salary and bonus earned in the twelve months prior to termination, paid out over a period of 24 months, and to continue all benefits and perquisites for 18 months. Effective October 1, 2002, we entered into an employment agreement with Jack Salberg, our Chief Operating Officer. Mr. Salberg's agreement provides for an annual base salary and an annual cash incentive compensation award tied to objective criteria established by the board of directors. The employment agreement had an initial term of 15 months, subject to automatic annual renewals absent prior notice from either party. Mr. Salberg's employment agreement provides for various payments to Mr. Salberg upon cessation of employment, depending upon the circumstances. If we terminate Mr. Salberg's employment without cause or if he resigns pursuant to a constructive discharge, then (i) all options scheduled to vest during the succeeding 18 months will immediately vest, (ii) any restricted stock will immediately vest, (iii) Mr. Salberg will receive a cash payment equal to 150% of his base salary and bonus earned in 12 months prior to termination, and (iv) all benefits and perquisites will continue for 18 months. If Mr. Salberg is terminated after a change in control, his employment F-23 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 agreement requires we pay him a cash amount equal to 150% of his base salary and bonus earned during the 12 months prior to termination, paid out over a period of 18 months, and to continue all benefits and perquisites for 18 months. CURRENT OPERATIONS Final determination of amounts earned under prospective payment and cost-reimbursement activities is subject to review by appropriate governmental authorities or their agents. We believe adequate provision has been made for any adjustments that may result from such reviews. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. We believe that we are in compliance with all applicable laws and regulations and are not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from the Medicare and Medicaid programs. We have acquired and may continue to acquire professional corporations with prior operating histories. Acquired corporations may have unknown or contingent liabilities for failure to comply with health care laws and regulations, such as billing and reimbursement, fraud and abuse and similar anti-referral laws. Although we attempt to assure ourselves that no such liabilities exist and obtains indemnification from prospective sellers covering such matters, there can be no assurance that any such matter will be covered by indemnification or, if covered, that the liability sustained will not exceed contractual limits or the financial capacity of the indemnifying party. 13. RELATED PARTY TRANSACTIONS During 2001 and 2000, we leased office space from a company whose chief executive officer is Dr. Richard Treadway, the former chairman of our board of directors. The term of the lease was from May 16, 1999 to July 2002 and was terminated on December 7, 2001. Rent expense for this space totaled $142,154 for the year ended December 31, 2001. We believe the terms of this lease were at fair market value. Currently we lease 7,745 square feet of office space for our executive offices from a company in which Dr. Treadway is a minority investor. The lease was entered into in October 2001 and has a term of approximately six years. The annual rent under this lease is approximately $145,000. We believe the terms of this lease are at fair market value. Joey Jacobs, our Chief Executive Officer, serves as a member of the board of directors of Stones River Hospital, a hospital in which we manage a psychiatric unit pursuant to a management agreement. The term of the third amendment to the management agreement is two years, and automatically renews for one year terms unless terminated by either party. Total revenue from this management agreement was $783,000 for the year ended December 31, 2003. We believe the terms of the management agreement are consistent with management agreements negotiated at arms-length. Jack Salberg, our Chief Operating Officer, served as a minority owner and member of the board of directors of the entity which owned Riveredge Hospital prior to our acquisition of it in July 2002. Mr. Salberg disclosed his interest to the board of directors and was not directly involved in the negotiations to acquire the hospital. We believe that the purchase price it paid for the Riveredge acquisition constituted our best estimate of fair value. All terms were negotiated on an arms-length basis. Edward Wissing, one of our outside directors, occasionally provides advisory and consulting services during 2002 to Brentwood Capital Advisors, our financial advisor. Mr. Wissing also was a party to a consulting arrangement with Brentwood Capital pursuant to which he provided certain consulting services. According to the terms of this consulting arrangement, Mr. Wissing received a fixed consulting fee of $5,000 per month beginning in August 2002 and ending in May 2003. In January 2000, PMR loaned Mark. P. Clien, PMR's chief executive officer at the time and currently one of our directors, $467,500 pursuant to promissory notes for the purchase of stock in connection with the exercise of stock options (the "Stock Notes"). The Stock Notes, due December 31, 2004, bear interest at the rate of 6.21% per annum and are with recourse in addition to being secured by stock under pledge agreements. PMR also received promissory notes from Mr. Clein for up to $257,208 for tax liabilities related to the purchase of such stock (the "Tax Notes"). The Tax Notes, due December 31, 2004, bear interest at the rate of 6.21% and are secured by stock pledges, but are otherwise without recourse. In May 2002, the Stock Notes and Tax Notes were amended to include a provision that allowed the principal and interest on the notes to be paid, at any time prior to December 31, 2003, through the delivery to us of our common stock valued at the higher of (i) $7.92 or (ii) the average closing sales prices of our common stock for the five trading days prior to the delivery of such stock. The amendments also eliminated the provision in each Note that required any dividends received with F-24 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 respect to shares being purchased with the proceeds of such Note to be immediately applied toward the payment of amounts outstanding under such note. At December 31, 2003, Mr. Clein owed us $59,554 and $281,498 under the Stock Notes and Tax Notes, respectively. Joseph P. Donlan, a director of the Company, is the co-manager of The 1818 Mezzanine Fund II, L.P. (the "1818 Fund"), which is managed by Brown Brothers Harriman & Co. ("Brown Brothers"). Mr. Donlan is a managing director of Brown Brothers. On June 28, 2002, we entered into a securities purchase agreement with the 1818 Fund to issue up to $20 million of senior subordinated notes with detachable warrants. At the closing on June 28, 2002, a total of $10 million of the senior subordinated notes were issued. The notes have a term of seven years and bear interest at 12% annually, payable quarterly. We issued detachable stock purchase warrants to the 1818 Fund for the purchase of 372,412 shares of our common stock at an exercise price of $.01 per share. On May 16, 2003, we issued 372,039 shares of our common stock to the 1818 Fund upon exercise of the 1818 Fund's stock purchase warrant. On June 30, 2003, we repaid principal of $10 million, accrued interest and a prepayment penalty of 3% to the 1818 Fund with proceeds from our issuance of 10 5/8% senior subordinated notes, and we no longer have the ability to borrow under the Securities Purchase Agreement with the 1818 Fund. On February 4, 2003, our stockholders approved the private placement of $25 million of series A convertible preferred stock with affiliates of Oak Investment Partners and Salix Ventures and the 1818 Fund. The 1818 Fund invested an aggregate of $999,999 and received an aggregate of 181,818 shares of series A convertible preferred stock. Oak Investment Partners invested an aggregate of $20,000,001 and received an aggregate of 3,636,364 shares of series A convertible preferred stock. Salix Ventures invested an aggregate of $3,999,996 and received an aggregate of 727,272 shares of series A convertible preferred stock. One half of the series A convertible preferred stock was issued on April 1, 2003. The other half was issued on June 19, 2003. The proceeds of the sale of the series A convertible preferred stock were used to acquire Ramsay, six facilities from The Brown Schools, and to pay down a portion of our long-term debt. 14. DISCLOSURES ABOUT REPORTABLE SEGMENTS In accordance with the criteria of Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information, ("SFAS 131") we operate two reportable segments: (1) owned and leased facilities and (2) management contracts. Each of our inpatient facilities and inpatient management contracts qualifies as an operating segment under SFAS 131; however, none is individually material. We have aggregated our operations into two reportable segments based on the characteristics of the services provided. As of December 31, 2003, the owned and leased facilities segment provides mental health and behavioral heath services to patients in its 20 owned and four leased inpatient facilities in 14 states. The management contracts segment provides inpatient psychiatric management and development services to 42 inpatient behavioral health units in hospitals and clinics in 15 states and provides mental health and behavioral health services to 8 inpatient facilities for state government agencies. Activities classified as "Corporate and Other" in the following schedule relate primarily to unallocated home office items. Adjusted EBITDA is a non-GAAP financial measure and is defined as net income (loss) before discontinued operations, interest expense (net of interest income), income taxes, depreciation, amortization, stock compensation and other items included in the caption labeled "Other expenses." These other expenses may occur in future periods, but the amounts recognized can vary significantly from period to period and do not directly relate to ongoing operations of our health care facilities. Our management relies on adjusted EBITDA as the primary measure to review and assess the operating performance of our inpatient facilities and their management teams. We believe it is useful to investors to provide disclosures of our operating results on the same basis as that used by management. Management and investors also review adjusted EBITDA to evaluate our overall performance and to compare our current operating results with corresponding periods and with other companies in the health care industry. You should not consider adjusted EBITDA in isolation or as a substitute for net income, operating cash flows or other cash flow statement data determined in accordance with accounting principles generally accepted in the United States. Because adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States and is susceptible to varying calculations, it may not be comparable to similarly titled measures of other companies. The following is a financial summary by business segment for the periods indicated (dollars in thousands): F-25 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 Year ended December 31, 2003
Owned and Leased Management Corporate Facilities Contracts and Other Consolidated ---------- --------- -------- ------------ Revenue $223,340 $ 61,606 $ -- $ 284,946 Adjusted EBITDA $ 30,801 $ 11,365 $ (7,339) $ 34,827 Interest expense, net 6,996 92 7,693 14,781 Provision for income taxes 2,165 73 1,562 3,800 Depreciation and amortization 4,410 1,135 189 5,734 Inter-segment expenses 5,639 1,432 (7,071) -- Other expenses: Loss on refinancing long-term debt -- -- 4,856 4,856 Change in valuation of put warrants -- -- 960 960 Change in reserve of stockholder notes -- (545) -- (545) -------- -------- -------- --------- Total other expenses -- (545) 5,816 5,271 -------- -------- -------- --------- Income (loss) from continuing operations $ 11,591 $ 9,178 $(15,528) $ 5,241 ======== ======== ======== ========= Segment assets $246,526 $ 35,599 $ 65,533 $ 347,658 ======== ======== ======== ========= Capital expenditures $ 5,516 $ -- $ 239 $ 5,755 ======== ======== ======== ========= Cost in excess of net assets acquired $ 45,093 $ 23,877 $ -- $ 68,970 ======== ======== ======== =========
Year ended December 31, 2002
Owned and Leased Management Corporate Facilities Contracts and Other Consolidated ---------- --------- --------- ------------ Revenue $81,929 $31,983 $ -- $ 113,912 Adjusted EBITDA $ 9,343 $ 7,082 $(4,118) $ 12,307 Provision for (benefit from) income taxes -- 324 (1,331) (1,007) Depreciation and amortization 1,286 379 105 1,770 Interest expense 3,375 325 1,864 5,564 Inter-segment expenses 3,149 902 (4,051) -- Other expenses: Stock compensation expense -- -- 118 118 Loss on refinancing long-term debt -- -- 86 86 Change in reserve of stockholder notes -- 92 -- 92 ------- ------- ------- --------- Total other expenses -- 92 204 296 ------- ------- ------- --------- Income (loss) from continuing operations $ 1,533 $ 5,060 $ (909) $ 5,684 ======= ======= ======= ========= Segment assets $51,004 $33,012 $ 6,122 $ 90,138 ======= ======= ======= ========= Capital expenditures $16,092 $ 171 $ 622 $ 16,885 ======= ======= ======= ========= Cost in excess of net assets acquired $ 1,238 $27,580 $ 4 $ 28,822 ======= ======= ======= =========
F-26 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 Year ended December 31, 2001
Owned and Leased Management Corporate Facilities Contracts and Other Consolidated ---------- --------- --------- ------------ Revenue $16,020 $27,979 $ -- $43,999 Adjusted EBITDA $ 1,374 $ 6,469 $(2,011) $ 5,832 Depreciation and amortization 170 715 60 945 Interest expense 533 324 1,803 2,660 Inter-segment expenses 448 1,773 (2,221) -- Other expenses: Loss on refinancing long-term debt -- -- 1,237 1,237 ------- ------- ------- ------- Total other expenses -- -- 1,237 1,237 ------- ------- ------- ------- Income (loss) from continuing operations $ 223 $ 3,657 $(2,890) $ 990 ======= ======= ======= ======= Segment assets $31,471 $20,394 $ 2,429 $54,294 ======= ======= ======= ======= Capital expenditures $18,373 $ -- $ 116 $18,489 ======= ======= ======= ======= Cost in excess of net assets acquired $ 538 $14,666 $ 4 $15,208 ======= ======= ======= =======
15. OTHER INFORMATION A summary of activity in allowance for doubtful accounts follows (in thousands):
Balances Additions Additions Accounts written Balances at beginning charged to costs charged to off, net of at end of period and expenses other accounts(1) recoveries of period ------------ --------------- ----------------- ---------------- --------- Allowance for doubtful accounts: Year ended December 31, 2001 $2,443 662 921 86 $3,940 Year ended December 31, 2002 3,940 3,681 461 2,798 5,284 Year ended December 31, 2003 5,284 6,315 4,338 8,446 7,491
(1) Allowances as a result of acquisition. 16. QUARTERLY INFORMATION (UNAUDITED) Summarized results for each quarter in the years ended December 31, 2003 and 2002 are as follows (in thousands, except per share data):
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------- ----------- ----------- ----------- 2003 Revenue $37,104 $ 57,438 $93,923 $96,481 Income (loss) from continuing operations $ 789 $ (594) $ 2,307 $ 2,739 Net income available to common stockholders $ 789 $ (771) $ 2,103 $ 2,284 Earnings per share: Basic $ 0.10 $ (0.09) $ 0.24 $ 0.26 Diluted $ 0.10 $ (0.09) $ 0.18 $ 0.19 2002 Revenue $23,188 $ 22,622 $32,280 $35,822 Net income available to common stockholders $ 755 $ 857 $ 1,606 $ 2,466 Earnings per share: Basic $ 0.15 $ 0.17 $ 0.24 $ 0.32 Diluted $ 0.14 $ 0.16 $ 0.22 $ 0.30
F-27 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 In the second quarter of 2003, we incurred a loss on refinancing long-term debt of approximately $4.6 million in conjunction with early repayments of portions of our long-term debt with proceeds from our issuance of $150 million in 10 5/8% senior subordinated notes. 17. FINANCIAL INFORMATION FOR THE COMPANY AND ITS SUBSIDIARIES We conduct substantially all of our business through our subsidiaries. Presented below is consolidated financial information for us and our subsidiaries as of December 31, 2003 and 2002, and for the years then ended. The information segregates the parent company (Psychiatric Solutions, Inc.), the combined wholly-owned subsidiary guarantors, the combined non-guarantors, and eliminations. All of the subsidiary guarantees are both full and unconditional and joint and several. No combining financial information has been presented for periods prior to December 31, 2002 as there were no non-guarantor subsidiaries prior to November 2002. PSYCHIATRIC SOLUTIONS, INC. CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2003 (DOLLARS IN THOUSANDS)
COMBINED TOTAL SUBSIDIARY COMBINED NON- CONSOLIDATING CONSOLIDATED PARENT GUARANTORS GUARANTORS ADJUSTMENTS AMOUNTS -------- ---------- ----------- ------------- -------- Current Assets: Cash $ -- $ 43,456 $ 1,498 $ -- $ 44,954 Accounts receivable, net -- 56,617 -- -- 56,617 Prepaids and other -- 11,056 19 -- 11,075 -------- -------- ------- --------- -------- Total current assets -- 111,129 1,517 -- 112,646 Property and equipment, net of accumulated depreciation -- 126,879 31,029 (8,319) 149,589 Cost in excess of net assets acquired -- 68,970 -- -- 68,970 Contracts, net -- 2,850 -- -- 2,850 Investment in subsidiaries 199,154 -- -- (199,154) -- Other assets 7,731 1,919 3,953 -- 13,603 -------- -------- ------- --------- -------- Total assets $206,885 $311,747 $36,499 $(207,473) $347,658 ======== ======== ======= ========== ======== Current Liabilities: Accounts payable $ -- $ 11,417 $ -- $ -- $ 11,417 Salaries and benefits payable -- 13,074 -- -- 13,074 Other accrued liabilities 871 18,987 1,090 (969) 19,979 Current portion of long-term debt -- 801 222 -- 1,023 -------- -------- ------- --------- -------- Total current liabilities 871 44,279 1,312 (969) 45,493 Long-term debt, less current portion 150,369 -- 23,611 -- 173,980 Deferred tax liability -- 6,762 -- -- 6,762 Other liabilities 3,218 592 -- 969 4,779 -------- -------- ------- --------- -------- Total liabilities 154,458 51,633 24,923 -- 231,014 Series A convertible preferred stock 25,316 -- -- -- 25,316 Stockholders' equity: Total stockholders' equity 27,111 260,114 11,576 (207,473) 91,328 -------- -------- ------- --------- -------- Total liabilities and stockholders' equity $206,885 $311,747 $36,499 $(207,473) $347,658 ======== ======== ======= ========= ========
F-28 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 PSYCHIATRIC SOLUTIONS, INC. CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2002 (DOLLARS IN THOUSANDS)
COMBINED TOTAL SUBSIDIARY COMBINED NON- CONSOLIDATING CONSOLIDATED PARENT GUARANTORS GUARANTORS ADJUSTMENTS AMOUNTS -------- ---------- ----------- ------------- -------- Current Assets: Cash $ -- $ 1,175 $1,217 $ -- $ 2,392 Accounts receivable, net -- 19,473 -- -- 19,473 Prepaids and other -- 2,204 15 -- 2,219 ------- ------- ------ -------- ------- Total current assets -- 22,852 1,232 -- 24,084 Property and equipment, net of accumulated depreciation -- 27,719 5,828 -- 33,547 Cost in excess of net assets acquired -- 28,822 -- -- 28,822 Contracts, net -- 607 -- -- 607 Investment in subsidiaries 76,693 -- -- (76,693) -- Other assets -- 2,295 783 -- 3,078 ------- ------- ------ -------- ------- Total assets $76,693 $82,295 $7,843 $(76,693) $90,138 ======= ======= ====== ======== ======= Current Liabilities: Accounts payable $ -- $ 3,338 $ -- $ -- $ 3,338 Salaries and benefits payable -- 4,825 -- -- 4,825 Other accrued liabilities 929 5,460 93 -- 6,482 Revolving line of credit 5,383 -- -- -- 5,383 Current portion of long-term debt 1,644 -- 43 -- 1,687 ------- ------- ------ -------- ------- Total current liabilities 7,956 13,623 136 -- 21,715 Long-term debt, less current portion 28,267 3,600 4,885 -- 36,752 Deferred tax liability -- 258 -- -- 258 Other liabilities -- 864 -- -- 864 ------- ------- ------ -------- ------- Total liabilities 36,223 18,345 5,021 -- 59,589 Stockholders' equity: Total stockholders' equity 40,470 63,950 2,822 (76,693) 30,549 ------- ------- ------ -------- ------- Total liabilities and stockholders' equity $76,693 $82,295 $7,843 $(76,693) $90,138 ======= ======= ====== ======== =======
F-29 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 PSYCHIATRIC SOLUTIONS, INC. CONDENSED CONSOLIDATING STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2003 (DOLLARS IN THOUSANDS)
COMBINED TOTAL SUBSIDIARY COMBINED NON- CONSOLIDATING CONSOLIDATED PARENT GUARANTORS GUARANTORS ADJUSTMENTS AMOUNTS -------- ---------- ----------- ------------- -------- Revenue $ -- $ 284,946 $ 1,802 $ (1,802) $ 284,946 Salaries, wages and employee benefits -- 147,069 -- -- 147,069 Professional fees -- 32,372 94 -- 32,466 Supplies -- 16,371 -- -- 16,371 Rentals and leases -- 4,043 -- -- 4,043 Other operating expenses 545 45,109 903 (2,702) 43,855 Provision for bad debts -- 6,315 -- -- 6,315 Depreciation and amortization -- 5,287 447 -- 5,734 Interest expense 14,089 124 568 -- 14,781 Loss on refinancing of long-term debt 4,856 -- -- -- 4,856 Change in valuation of put warrants 960 -- -- -- 960 Change in reserve of stockholder notes (545) -- -- -- (545) --------- --------- ------- --------- --------- 19,905 256,690 2,012 (2,702) 275,905 (Loss) income from continuing operations before income taxes (19,905) 28,256 (210) 900 9,041 (Benefit from) provision for income taxes (7,357) 11,156 1 -- 3,800 --------- --------- ------- --------- --------- (Loss) income from continuing operations (12,548) 17,100 (211) 900 5,241 Loss from discontinued opeations -- (25) -- -- (25) --------- --------- ------- --------- --------- Net (loss) income (12,548) 17,075 (211) 900 5,216 Accrued preferred stock dividends 811 -- -- -- 811 --------- --------- ------- --------- --------- Net (loss) income available to common shareholders $ (13,359) $ 17,075 $ (211) $ 900 $ 4,405 ========= ========= ======= ========= =========
PSYCHIATRIC SOLUTIONS, INC. CONDENSED CONSOLIDATING STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2002 (DOLLARS IN THOUSANDS)
COMBINED TOTAL SUBSIDIARY COMBINED NON- CONSOLIDATING CONSOLIDATED PARENT GUARANTORS GUARANTORS ADJUSTMENTS AMOUNTS -------- ---------- ----------- ------------- -------- Revenue $ -- $ 113,794 $ 118 $ -- $ 113,912 Salaries, wages and employee benefits -- 62,326 -- -- 62,326 Professional fees -- 14,327 46 -- 14,373 Supplies -- 5,325 -- -- 5,325 Rentals and leases -- 870 -- -- 870 Other operating expenses 769 14,489 68 -- 15,326 Provision for bad debts -- 3,681 -- -- 3,681 Equity in earnings of subsidiaries (11,669) -- -- 11,669 -- Depreciation and amortization -- 1,750 20 -- 1,770 Interest expense 5,216 324 24 -- 5,564 --------- --------- -------- --------- --------- (5,684) 103,092 158 11,669 109,235 Income (loss) from continuing operations before income taxes 5,684 10,702 (40) (11,669) 4,677 Benefit from income taxes -- (1,007) -- -- (1,007) --------- --------- -------- --------- --------- Net (loss) income $ 5,684 $ 11,709 $ (40) $ (11,669) $ 5,684 ========= ========= ======== ========= =========
F-30 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 PSYCHIATRIC SOLUTIONS, INC. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2003 (DOLLARS IN THOUSANDS)
COMBINED TOTAL SUBSIDIARY COMBINED NON- CONSOLIDATING CONSOLIDATED PARENT GUARANTORS GUARANTORS ADJUSTMENTS AMOUNTS -------- ---------- ----------- ------------- -------- OPERATING ACTIVITIES Net (loss) income $ (12,548) $ 17,075 $ (211) $ 900 $ 5,216 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization -- 5,287 447 -- 5,734 Provision for doubtful accounts -- 6,315 -- -- 6,315 Accretion of detachable warrants 162 -- -- -- 162 Amortization of loan costs 1,454 -- 24 -- 1,478 Loss on refinancing long-term debt 4,856 -- -- -- 4,856 Change in valuation of put warrants 960 -- -- -- 960 Change in reserve on stockholder notes (545) -- -- -- (545) Loss from discontinued operations -- 25 -- -- 25 Long-term interest accrued -- 124 -- -- 124 Changes in operating assets and liabilities, net of effect of acquisitions: Accounts receivable -- (11,709) -- -- (11,709) Prepaids and other current assets (7,731) 9,948 (4) -- 2,213 Accounts payable -- (1,979) -- (1,979) Accrued liabilities and other liabilities (58) 4,539 997 -- 5,478 --------- -------- -------- -------- --------- Net cash (used in) provided by continuing operating activities (13,450) 29,625 1,253 900 18,328 INVESTING ACTIVITIES: Cash paid for acquisitions, net of cash acquired (100,424) -- -- -- (100,424) Capital purchases of property and equipment -- (5,755) (25,487) 25,487 (5,755) Purchase of long-term securities -- (971) (971) Other assets -- (904) (4) -- (908) --------- -------- -------- -------- --------- Net used in investing activities (100,424) (6,659) (26,462) 25,487 (108,058) FINANCING ACTIVITIES: Net principal borrowings on long-term debt 61,980 -- 18,962 (18,962) 61,980 Net transfers to and from members (18,418) 19,315 6,528 (7,425) -- Payment of loan and issuance costs (1,998) -- -- -- (1,998) Refinancing of long-term debt (1,410) -- -- -- (1,410) Proceeds from issuance of series A convertible preferred stock, net of issuance costs 24,505 -- -- -- 24,505 Proceeds from secondary offering of common stock, net of issuance costs 48,897 -- -- -- 48,897 Proceeds from issuance of common stock 318 -- -- -- 318 --------- -------- -------- -------- --------- Net cash provided by (used in) financing activities 113,874 19,315 25,490 (26,387) 132,292 Net increase in cash -- 42,281 281 -- 42,562 Cash at beginning of year -- 1,175 1,217 -- 2,392 --------- -------- -------- -------- --------- Cash at end of year $ -- $ 43,456 $ 1,498 $ -- $ 44,954 ========= ======== ======== ======== =========
F-31 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 PSYCHIATRIC SOLUTIONS, INC. CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2002 (DOLLARS IN THOUSANDS)
COMBINED TOTAL SUBSIDIARY COMBINED NON- CONSOLIDATING CONSOLIDATED PARENT GUARANTORS GUARANTORS ADJUSTMENTS AMOUNTS -------- ---------- ----------- ------------- -------- OPERATING ACTIVITIES Net income (loss) $ 5,684 11,709 $ (40) $(11,669) $ 5,684 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization -- 1,750 20 -- 1,770 Provision for doubtful accounts -- 3,681 -- -- 3,681 Accretion of detachable warrants -- 677 -- -- 677 Non-cash stock compensation expense -- 118 -- -- 118 Amortization of loan costs -- 419 -- -- 419 Release of deferred tax asset valuation allowance -- (1,332) -- -- (1,332) Additional reserve on stockholder notes -- 92 -- -- 92 Long-term interest accrued -- 324 -- -- 324 (Loss) equity in earnings of subsidiaries (11,669) -- -- 11,669 -- Changes in operating assets and liabilities, net of effect of acquisitions: Accounts receivable -- (1,348) -- -- (1,348) Prepaids and other current assets -- (353) (46) -- (399) Accounts payable -- (2,523) -- (2,523) Accrued liabilities and other liabilities 929 764 66 -- 1,759 -------- -------- ------- -------- -------- Net cash (used in) provided by continuing operating activities (5,056) 13,978 -- -- 8,922 INVESTING ACTIVITIES: Cash acquired for acquisitions, net of cash paid -- 6,243 -- -- 6,243 Capital purchases of property and equipment -- (1,470) -- -- (1,470) Other assets -- (612) -- -- (612) -------- -------- ------- -------- -------- Net used in investing activities -- 4,161 -- -- 4,161 FINANCING ACTIVITIES: Net principal borrowings (payments) on long-term debt 7,484 (19,256) -- -- (11,772) Payment of loan costs -- (234) -- -- (234) Proceeds from issuance of common stock -- 53 -- -- 53 Change in intercompany (2,428) 2,428 -- -- -- -------- -------- ------- -------- -------- Net cash provided by (used in) financing activities 5,056 (17,009) -- -- (11,953) Net increase in cash -- 1,130 -- -- 1,130 Cash at beginning of year -- 45 1,217 -- 1,262 -------- -------- ------- -------- -------- Cash at end of year $ -- $ 1,175 $ 1,217 $ -- $ 2,392 ======== ======== ======= ======== ========
18. SUBSEQUENT EVENTS (UNAUDITED) On January 6, 2004, we entered into a revolving credit facility with Bank of America, N.A. of up to $50 million. The revolving credit facility has a three-year term and is secured by all real property owned by us or our subsidiaries that has a value in excess of $2.5 million, the stock of all of our operating subsidiaries and substantially all of the personal property owned by us or our subsidiaries. Our credit agreement with Bank of America, N.A. prohibits us from paying dividends on our common stock. We will incur a $6.4 million loss from refinancing long-term debt in the first quarter of 2004, which includes the payment of a termination fee to CapitalSource Finance, LLC, our former senior lender. On January 26, 2004, we entered into an interest rate swap agreement to manage our exposure to fluctuations in interest rates. The swap agreement effectively converts $20 million of fixed-rate long-term debt to a LIBOR indexed variable rate instrument plus an agreed upon interest rate spread. On March 1, 2004, we acquired two inpatient psychiatric facilities from Brentwood Behavioral Health ("Brentwood") for approximately $28 million cash with an earn-out of up to $5 million contingent upon Brentwood's future financial results. The facilities, which have an aggregate of 311 licensed beds, are located in Shreveport, Louisiana and Jackson, Mississippi. On April 23, 2004, we entered into an interest rate swap agreement to manage our exposure to fluctuations in interest rates. The swap agreement effectively converts $30.0 million of fixed-rate long-term debt to a LIBOR indexed variable rate instrument plus an agreed upon interest rate spread of 5.51%. F-32 PSYCHIATRIC SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 On May 1, 2004, we completed the acquisition of all of the membership interests of Palmetto Behavioral Health System, LLC, an operator of two inpatient behavioral health care facilities, for approximately $6.4 million. The two inpatient facilities, located in Charleston and Florence, South Carolina, have 161 beds. On June 1, 2004, we completed the acquisition of four inpatient behavioral health care facilities from Heartland Healthcare for $49.9 million. The four facilities, located in Summit, New Jersey, Ft. Lauderdale, Florida, Arlington, Texas and Eden Prairie, Minnesota, have a total of 360 beds. On June 11, 2004, we completed the acquisition of Piedmont Behavioral Health Center LLC ("Piedmont"), a 78 bed inpatient behavioral health care facility located in Leesburg, Virginia, for $10.7 million. On June 30, 2004, we completed the acquisition of substantially all the assets of Alliance Behavioral Health Group ("Alliance Behavioral"), a system of inpatient behavioral health care facilities with 144 beds located in Santa Teresa, New Mexico, for $12.5 million. During the quarter ended June 30, 2004, certain holders of our series A convertible preferred stock converted 2,272,727 shares of series A convertible preferred stock and related accrued dividends into 2,389,428 shares of our common stock. During the quarter ended September 30, 2004, certain holders of our series A convertible preferred stock converted 454,545 shares of series A convertible preferred stock and related accrued dividends into 481,600 shares of our common stock. During the quarter ended December 31, 2004, certain holders of our series A convertible preferred stock converted 1,818,182 shares of our series A convertible preferred stock and related accrued dividends into 1,942,442 shares of our common stock. Following these conversions, we have no shares of our series A convertible preferred stock outstanding. On November 1, 2004, we purchased the real estate housing the operations of Summit Hospital in Summit, New Jersey for approximately $15.9 million. Summit Hospital was one of four inpatient psychiatric facilities acquired from Heartland on June 1, 2004. Subsequent to the acquisition of this facility on June 1, 2004, we leased the real estate from a third party. F-33 ~~-----END PRIVACY-ENHANCED MESSAGE-----~~

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	PSYCHIATRIC SOLUTIONS, INC.
	By:	/s/ Jack E. Polson
		Jack E. Polson
		Chief Accounting Officer