Psychiatric Solutions, Inc.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2007 or


o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to

Commission file number 0-20488

Psychiatric Solutions, Inc.

(Exact Name of Registrant as Specified in Its Charter)


DELAWARE		23-2491707
(State or Other Jurisdiction of Incorporation or		(I.R.S. Employer Identification No.)
Organization)

6640 Carothers Parkway, Suite 500
Franklin, TN 37067
(Address of Principal Executive Offices, Including Zip Code)

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

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

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

Large accelerated filerþ Accelerated filer o Non-accelerated filero

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

As of April 30, 2007, 54,291,687 shares of the registrant’s common stock were outstanding.

PSYCHIATRIC SOLUTIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)


	Three Months Ended March 31,
	2007			2006
Operating activities:
Net income	$	18,125		$	12,192
Adjustments to reconcile net income to net cash provided by continuing operating activities:
Depreciation and amortization		6,298			4,744
Share-based compensation		3,673			6,254
Amortization of loan costs		517			405
Loss from discontinued operations		19			206
Change in income tax assets and liabilities		(1,798	)		4,202
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		(9,305	)		(8,297	)
Prepaids and other current assets		(924	)		(1,891	)
Accounts payable		(831	)		(2,617	)
Salaries and benefits payable		(9,432	)		(5,248	)
Accrued liabilities and other liabilities		(1,064	)		(701	)

Net cash provided by continuing operating activities		5,278			9,249
Net cash (used in) provided by discontinued operating activities		(145	)		1,306

Net cash provided by operating activities		5,133			10,555

Investing activities:
Cash paid for acquisitions, net of cash acquired		(25,241	)		(38,300	)
Capital purchases of leasehold improvements, equipment and software		(9,872	)		(5,513	)
Other assets		233			239

Net cash used in investing activities		(34,880	)		(43,574	)

Financing activities:
Principal payments on long-term debt		(315	)		(93	)
Net increase in revolving credit facility		19,000			—
Payment of loan and issuance costs		(85	)		(22	)
Excess tax benefits from share-based payment arrangements		2,569			2,446
Proceeds from issuance of common stock upon exercise of stock options		5,706			1,644

Net cash provided by financing activities		26,875			3,975

Net decrease in cash		(2,872	)		(29,044	)
Cash and cash equivalents at beginning of the period		18,541			54,700

Cash and cash equivalents at end of the period	$	15,669		$	25,656


Effect of Acquisitions:
Assets acquired, net of cash acquired	$	35,928		$	43,372
Cash paid for prior year acquisitions		2,081			—
Liabilities assumed		(2,064	)		(1,109	)
Long-term debt assumed		(1,704	)		(3,963	)
Common stock issued		(9,000	)		—

Cash paid for acquisitions, net of cash acquired	$	25,241		$	38,300

See accompanying notes.

PSYCHIATRIC SOLUTIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

MARCH 31, 2007

1. Recent Developments

During January 2007, we completed the acquisition of an 86-bed inpatient behavioral heath care facility in Columbia, South Carolina.

On December 20, 2006, we signed a definitive merger agreement to acquire Horizon Health Corporation (NASDAQ: HORC) (“Horizon Health”) in a transaction valued at $426 million, consisting of cash of $20 per share totaling $321 million and the assumption of Horizon Health’s outstanding debt. Horizon Health produced revenue of $275 million for its 2006 fiscal year, which ended August 31, 2006, primarily through the operation and management of inpatient behavioral health facilities and units. At February 28, 2007, Horizon Health owned/leased 15 inpatient behavioral health care facilities with approximately 1,571 licensed beds in 11 states. Horizon Health also provided services under 114 behavioral health and physical rehabilitation program management contracts with acute care hospitals at February 28, 2007 and operated an employee assistance program services business. Consummation of the transaction is subject to customary closing conditions, including regulatory approvals and clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“Hart-Scott-Rodino Act”). The transaction has been approved by Horizon Health’s stockholders. On February 12, 2007, we received a request for additional information (commonly referred to as a “Second Request”) from the Federal Trade Commission (the “FTC”) in connection with the pending acquisition of Horizon Health. The Second Request extends the waiting period imposed by the Hart-Scott-Rodino Act and relates to two markets. Psychiatric Solutions, Inc. (“PSI”) and Horizon Health have certified substantial compliance with the Second Request and are working with the FTC to resolve its concerns. Consummation of the transaction is anticipated during the second quarter of 2007.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for audited financial statements. The condensed consolidated balance sheet at December 31, 2006 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. Certain reclassifications have been made to the prior year to conform to current year presentation. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position have been included. The majority of our expenses are “cost of revenue” items. General and administrative expenses, excluding stock compensation expense, were approximately 2.9% of net revenue for the three months ended March 31, 2007. Operating results for the three months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2006.

3. Earnings Per Share

Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings per Share, 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, upon exercise or conversion, could share in our earnings. We have calculated earnings per share in accordance with SFAS No. 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):

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007


	Three Months Ended March 31,
	2007			2006
Numerator:
Income from continuing operations	$	18,144		$	12,398
Loss from discontinued operations, net of taxes		(19	)		(206	)

Net income	$	18,125		$	12,192


Denominator:
Weighted average shares outstanding for basic earnings per share		53,804			52,514
Effects of dilutive stock options and restricted stock outstanding		1,433			1,376

Shares used in computing diluted earnings per common share		55,237			53,890


Basic earnings per share:
Income from continuing operations	$	0.34		$	0.24
Loss from discontinued operations, net of taxes		—			(0.01	)

	$	0.34		$	0.23


Diluted earnings per share:
Income from continuing operations	$	0.33		$	0.23
Loss from discontinued operations, net of taxes		—			—

	$	0.33		$	0.23

4. Share-Based Compensation

We recognized $3.7 million and $6.3 million in share-based compensation expense and approximately $1.4 million and $2.4 million of related income tax benefit for the three months ended March 31, 2007 and 2006, respectively. The fair value of our stock options was estimated using the Black-Scholes option pricing model. Share-based compensation expense for the three months ended March 31, 2006 includes $2.2 million related to options modified in the settlement of an employment contract with one of our former executive officers. The impact of share-based compensation expense, net of tax, on our basic and diluted earnings per share was approximately $0.04 and $0.07 per share for the three months ended March 31, 2007 and 2006, respectively. We classified $2.6 million and $2.4 million in income tax benefits in excess of share-based compensation expense on stock options exercised in 2007 and 2006 as cash flows from financing activities in our Condensed Consolidated Statement of Cash Flows for the three months ended March 31, 2007 and 2006, respectively.

Based on our stock option and restricted stock grants outstanding at March 31, 2007, we estimate remaining unrecognized share-based compensation expense to be approximately $43.3 million with a weighted average remaining life of 3.7 years.

The total intrinsic value, which represents the difference between the underlying stock’s market price and the option’s exercise price, of options exercised during the three months ended March 31, 2007 and 2006 was $7.3 million and $9.2 million, respectively.

We granted 1,736,812 stock options to employees during the three months ended March 31, 2007. These options vest over four years in annual increments of 25% on each anniversary of the grant date and each had a grant-date fair value of $14.99.

We granted 228,332 shares of restricted stock to certain executive officers during the three months ended March 31, 2007. These shares of restricted stock vest 25% on each anniversary of the grant date and had a weighted average grant-date fair value of $41.54 per share.

5. Mergers and Acquisitions

Acquiring free-standing psychiatric facilities is a key part of our business strategy. Our financial statements for the periods presented are not comparable because of the numerous acquisitions we have consummated.

During January 2007, we completed the acquisition of an 86-bed inpatient behavioral health care facility in Columbia, South Carolina.

On December 20, 2006, we signed a definitive merger agreement to acquire Horizon Health

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

in a transaction valued at $426 million, consisting of cash of $20 per share totaling $321 million and the assumption of Horizon Health’s outstanding debt. Horizon Health produced revenue of $275 million for its 2006 fiscal year, which ended August 31, 2006, primarily through the operation and management of inpatient behavioral health facilities and units. At February 28, 2007, Horizon Health owned/leased 15 inpatient behavioral health care facilities with approximately 1,571 licensed beds in 11 states. Horizon Health also provided services under 114 behavioral health and physical rehabilitation program management contracts with acute care hospitals at February 28, 2007 and operated an employee assistance program services business. Consummation of the transaction is subject to customary closing conditions, including regulatory approvals and clearance under the Hart-Scott-Rodino Act. The transaction has been approved by Horizon Health’s stockholders. On February 12, 2007, we received a Second Request from the FTC in connection with the pending acquisition of Horizon Health. The Second Request extends the waiting period imposed by the Hart-Scott-Rodino Act and relates to two markets. PSI and Horizon Health have certified substantial compliance with the Second Request and are working with the FTC to resolve its concerns. Consummation of the transaction is anticipated during the second quarter of 2007.

6. Long-term debt

Long-term debt consists of the following (in thousands):


	March 31,		December 31,
	2007		2006
Senior credit facility:
Revolving line of credit facility, expiring on December 21, 2009 and bearing interest of 6.6% and 6.7% at March 31, 2007 and December 31, 2006, respectively	$	120,000	$	101,000
Senior Secured Term Loan Facility, expiring on July 1, 2012 and bearing interest of 7.1% at March 31, 2007 and December 31, 2006, respectively		350,000		350,000
7 3/4% Senior Subordinated Notes		220,000		220,000
10 5/8% Senior Subordinated Notes		38,681		38,681
Mortgage loans on facilities, maturing in 2036, 2037 and 2038 bearing fixed interest rates of 5.7% to 7.6%		26,988		27,062
Other		8,009		6,564

		763,678		743,307
Less current portion		2,836		2,386

Long-term debt	$	760,842	$	740,921

Senior Credit Facility

On December 1, 2006, we amended our credit agreement (the “Credit Agreement”) with Bank of America, N.A. (“Bank of America”) to increase our senior secured term loan facility from $ 200 million to $ 350 million and to increase our revolving credit facility to $300 million. On December 1, 2006, we borrowed $150 million under our senior secured term loan facility and $60 million under our revolving credit facility to finance the acquisition of Alternative Behavioral Services, Inc. (“ABS”). Quarterly principal payments of $375,000 are due on our senior secured term loan facility beginning March 31, 2007 and the balance of our senior secured term loan facility is payable in full at July 1, 2012.

Our Credit Agreement is secured by substantially all of the personal property owned by us or our subsidiaries, substantially all real property owned by us or our subsidiaries that has a value in excess of $5.0 million and the stock of our operating subsidiaries. In addition, the Credit Agreement is fully and unconditionally guaranteed by substantially all of our operating subsidiaries. The revolving credit facility and senior secured term loan facility accrue interest at our choice of the “Base Rate” or the “Eurodollar Rate” (as defined in the Credit Agreement). The “Base Rate” and “Eurodollar Rate” fluctuate based upon market rates and certain leverage ratios, as defined in the Credit Agreement. At March 31, 2007, we had $120.0 million in borrowings outstanding and $179.4 million available for future borrowings under the revolving credit facility. Until the maturity date, we may borrow, repay and re-borrow an amount not to exceed $300 million on our revolving credit facility. All repayments made under the senior secured term loan facility are permanent. We pay a quarterly commitment fee of 0.25% per annum on the unused portion of our revolving credit facility. Commitment fees were approximately $0.1 million for the three months ended

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

March 31, 2007.

Our Credit Agreement contains customary covenants that include: (1) a limitation on capital expenditures and investments, sales of assets, mergers, changes of ownership, new principal lines of business, indebtedness, transactions with affiliates, dividends and redemptions; (2) various financial covenants; and (3) cross-default covenants triggered by a default of any other indebtedness of at least $5.0 million. As of March 31, 2007, we were in compliance with all debt covenant requirements. If we violate one or more of these covenants, amounts outstanding under the revolving credit facility, senior secured term loan facility and the majority of our other debt arrangements could become immediately payable and additional borrowings could be restricted.

7³/₄% Notes

On July 6, 2005, we issued $220 million in 7³/₄% Senior Subordinated Notes (the “7³/₄% Notes”), which are fully and unconditionally guaranteed on a senior subordinated basis by substantially all of our existing operating subsidiaries. Interest on these notes accrues at the rate of 7³/₄% per annum and is payable semi-annually in arrears on January 15 and July 15. The 7³/₄% Notes will mature on July 15, 2015.

10⁵/₈% Notes

Interest on the 10⁵/₈% Senior Subordinated Notes (the “10⁵/₈% Notes ”), which are fully and unconditionally guaranteed on a senior subordinated basis by substantially all of our existing operating subsidiaries, is payable semi-annually in arrears on June 15 and December 15. The 10⁵/₈% Notes will mature on June 15, 2013.

Mortgage Loans

In connection with the purchase of real estate at a formerly leased inpatient facility, we assumed a mortgage loan agreement insured by the U.S. Department of Housing and Urban Development (“HUD”) of approximately $4.0 million in 2006. 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, Riveredge Hospital near Chicago, Illinois, and Canyon Ridge Hospital in Chino, California. Interest accrues on the Holly Hill, West Oaks, Riveredge, and Canyon Ridge HUD loans at 6.0%, 5.9%, 5.7%, and 7.6% and principal and interest are payable in 420 monthly installments through December 2037, September 2038, December 2038 and January 2036, respectively. The carrying amount of assets held as collateral approximated $30.1 million at March 31, 2007.

7. Income Taxes

The provision for income taxes for the three months ended March 31, 2007 and 2006 reflects an effective tax rate of approximately 38.3% and 38.0%, respectively. The increase in the effective tax rate is primarily due to an increase in our overall effective state income tax rate.

We adopted FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109, on January 1, 2007. As a result, we recognized a cumulative effect adjustment of approximately $0.5 million to decrease the January 1, 2007 retained earnings balance. Our policy is to classify interest and penalties as a component of our tax provision. As a result of the implementation of FIN 48, we recorded $1.6 million of total gross unrecognized tax benefits, plus accrued interest of $0.2 million, less $0.3 million benefit on state taxes and interest, resulting in net liabilities of $1.5 million. Of this total, $0.5 million (net of the tax benefit on state taxes and interest) represents the amount of unrecognized tax and interest that, if recognized, would favorably affect the effective income tax rate.

Our tax years 2003 — 2006 remain open to examination by U.S. taxing authorities. In addition, ABS, an entity acquired in 2006, has tax years going back to 2000, which remain open to examination by the taxing authorities in the U.S. and Puerto Rico. We are fully indemnified under the ABS purchase agreement for any liabilities resulting from such examinations.

It is reasonably possible that unrecognized tax benefits may decrease by up to $1.0 million within the next twelve months as a result of a possible settlement of a current IRS examination. In addition, Puerto Rican taxing authorities have asserted certain tax adjustments against acquired ABS entities, for which we are fully indemnified under the purchase agreement for any resulting liabilities. Unrecognized tax benefits associated with the ABS acquisition will be recorded as we finalize the purchase accounting. Any resulting increase in unrecognized tax benefits would be offset by a receivable under the indemnification provisions of the ABS purchase agreement.

There have been no material changes to the liability for unrecognized tax benefits during the first quarter of 2007.

8. Discontinued Operations

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires that all components of an entity that have

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

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. We terminated three of our contracts to manage state-owned inpatient facilities during 2006 and sold a therapeutic boarding school, previously reported within our owned and leased facilities segment. The operations of the three contracts were previously reported within our management contract and other segment. Accordingly, these operations, net of applicable income taxes, have been presented as discontinued operations and prior period consolidated financial statements have been reclassified.

The components of loss from discontinued operations, net of taxes, are as follows (in thousands):


	Three Months Ended March 31,
	2007			2006
Revenue	$	—		$	1,846
Salaries, wages and employee benefits		12			1,403
Professional fees		—			85
Supplies		—			209
Rentals and leases		3			63
Other operating expenses		14			385
Provision for doubtful accounts		2			22
Depreciation and amortization		—			11

		31			2,178

Loss from discontinued operations before income taxes		(31	)		(332	)
Benefit from income taxes		(12	)		(126	)

Loss from discontinued operations, net of taxes	$	(19	)	$	(206	)

9. Disclosures About Reportable Segments

In accordance with the criteria of SFAS 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 and other. 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 March 31, 2007, the owned and leased facilities segment provides mental health and behavioral heath services to patients in its 67 owned and 8 leased inpatient facilities in 29 states, Puerto Rico and the U.S. Virgin Islands. The management contracts and other segment primarily provides inpatient psychiatric management and development services to inpatient behavioral health units in hospitals and clinics. Activities classified as “Corporate” in the following schedule relate primarily to unallocated home office items and discontinued operations.

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, share-based 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 the 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 U. S. generally accepted accounting principles. Because adjusted EBITDA is not a measure of financial performance under U. S. generally accepted accounting principles 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 reportable segment for the periods indicated (dollars in thousands):

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007


Three Months Ended March 31, 2007
	Owned and		Management
	Leased		Contracts
	Facilities		and Other			Corporate			Consolidated
Revenue	$	306,445	$	17,273		$	—		$	323,718
Adjusted EBITDA	$	60,858	$	2,431		$	(9,526	)	$	53,763
Interest expense		9,027		(4	)		5,363			14,386
Depreciation and amortization		5,768		186			344			6,298
Provision for income taxes		—		—			11,262			11,262
Inter-segment expenses		11,365		788			(12,153	)		—
Other expenses:
Share-based compensation		—		—			3,673			3,673

Total other expenses		—		—			3,673			3,673

Income (loss) from continuing operations	$	34,698	$	1,461		$	(18,015	)	$	18,144


Segment assets	$	1,504,957	$	47,577		$	70,963		$	1,623,497


Three Months Ended March 31, 2006
	Owned and		Management
	Leased		Contracts
	Facilities		and Other		Corporate			Consolidated
Revenue	$	229,756	$	12,556	$	—		$	242,312
Adjusted EBITDA	$	44,766	$	2,144	$	(6,707	)	$	40,203
Interest expense		3,985		1		5,222			9,208
Depreciation and amortization		4,266		170		308			4,744
Provision for income taxes		—		—		7,599			7,599
Inter-segment expenses		9,374		535		(9,909	)		—
Other expenses:
Share-based compensation		—		—		6,254			6,254

Total other expenses		—		—		6,254			6,254

Income (loss) from continuing operations	$	27,141	$	1,438	$	(16,181	)	$	12,398


Segment assets	$	1,070,624	$	29,581	$	96,761		$	1,196,966

10. 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 March 31, 2007 and December 31, 2006, and for the three months ended March 31, 2007 and 2006. 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.

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

Condensed Consolidating Balance Sheet
As of March 31, 2007
(Dollars in thousands)


				Combined								Total
				Subsidiary			Combined Non-		Consolidating			Consolidated
	Parent			Guarantors			Guarantors		Adjustments			Amounts
Current Assets:
Cash and cash equivalents	$	—		$	(1,820	)	$	17,489	$	—		$	15,669
Accounts receivable, net		—			190,748			—		—			190,748
Prepaids and other		—			28,766			15,854		—			44,620

Total current assets		—			217,694			33,343		—			251,037
Property and equipment, net of accumulated depreciation		—			534,149			35,853		(7,529	)		562,473
Cost in excess of net assets acquired		—			776,395			—		—			776,395
Investment in subsidiaries		691,710			—			—		(691,710	)		—
Other assets		11,912			18,103			3,577		—			33,592

Total assets	$	703,622		$	1,546,341		$	72,773	$	(699,239	)	$	1,623,497


Current Liabilities:
Accounts payable	$	—		$	25,411		$	—	$	—		$	25,411
Salaries and benefits payable		—			59,219			—		—			59,219
Other accrued liabilities		13,112			29,693			12,599		(12,451	)		42,953
Current portion of long-term debt		2,530			—			306		—			2,836

Total current liabilities		15,642			114,323			12,905		(12,451	)		130,419
Long-term debt, less current portion		734,160			—			26,682		—			760,842
Deferred tax liability		—			37,331			—		—			37,331
Other liabilities		4,281			12,054			12,298		—			28,633

Total liabilities		754,083			163,708			51,885		(12,451	)		957,225
Stockholders’ (deficit) equity:
Total stockholders’ (deficit) equity		(50,461	)		1,382,633			20,888		(686,788	)		666,272

Total liabilities and stockholders’ (deficit) equity	$	703,622		$	1,546,341		$	72,773	$	(699,239	)	$	1,623,497

Condensed Consolidating Balance Sheet
As of December 31, 2006
(Dollars in thousands)


				Combined							Total
				Subsidiary		Combined Non-		Consolidating			Consolidated
	Parent			Guarantors		Guarantors		Adjustments			Amounts
Current Assets:
Cash and cash equivalents	$	—		$	1,118	$	17,423	$	—		$	18,541
Accounts receivable, net		—			180,137		—		—			180,137
Prepaids and other		—			43,372		1,210		—			44,582

Total current assets		—			224,627		18,633		—			243,260
Property and equipment, net of accumulated depreciation		—			515,311		36,085		(7,590	)		543,806
Cost in excess of net assets acquired		—			761,026		—		—			761,026
Investment in subsidiaries		681,856			—		—		(681,856	)		—
Other assets		12,349			17,050		3,705		—			33,104

Total assets	$	694,205		$	1,518,014	$	58,423	$	(689,446	)	$	1,581,196


Current Liabilities:
Accounts payable	$	—		$	25,294	$	—	$	—		$	25,294
Salaries and benefits payable		—			66,438		—		—			66,438
Other accrued liabilities		13,247			32,461		1,737		(1,590	)		45,855
Current portion of long-term debt		2,084			—		302		—			2,386

Total current liabilities		15,331			124,193		2,039		(1,590	)		139,973
Long-term debt, less current portion		714,061			—		26,860		—			740,921
Deferred tax liability		—			44,924		—		—			44,924
Other liabilities		6,539			12,140		8,920		—			27,599

Total liabilities		735,931			181,257		37,819		(1,590	)		953,417
Stockholders’ (deficit) equity:
Total stockholders’ (deficit) equity		(41,726	)		1,336,757		20,604		(687,856	)		627,779

Total liabilities and stockholders’ (deficit) equity	$	694,205		$	1,518,014	$	58,423	$	(689,446	)	$	1,581,196

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2007
(Unaudited, dollars in thousands)


				Combined									Total
				Subsidiary			Combined Non-			Consolidating			Consolidated
	Parent			Guarantors			Guarantors			Adjustments			Amounts
Revenue	$	—		$	323,718		$	4,534		$	(4,534	)	$	323,718
Salaries, wages and employee benefits		—			180,999			—			—			180,999
Professional fees		—			31,037			(2	)		—			31,035
Supplies		—			18,477			—			—			18,477
Rentals and leases		—			4,637			—			—			4,637
Other operating expenses		—			31,380			3,749			(3,355	)		31,774
Provision for doubtful accounts		—			6,706			—			—			6,706
Depreciation and amortization		—			6,084			275			(61	)		6,298
Interest expense		14,158			—			228			—			14,386

		14,158			279,320			4,250			(3,416	)		294,312
(Loss) income from continuing operations before income taxes		(14,158	)		44,398			284			(1,118	)		29,406
(Benefit from) provision for income taxes		(5,423	)		16,685			—			—			11,262

(Loss) income from continuing operations		(8,735	)		27,713			284			(1,118	)		18,144
Loss from discontinued operations, net of taxes		—			(19	)		—			—			(19	)

Net (loss) income	$	(8,735	)	$	27,694		$	284		$	(1,118	)	$	18,125

Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2006
(Unaudited, dollars in thousands)


				Combined									Total
				Subsidiary			Combined Non-			Consolidating			Consolidated
	Parent			Guarantors			Guarantors			Adjustments			Amounts
Revenue	$	—		$	242,312		$	2,821		$	(2,821	)	$	242,312
Salaries, wages and employee benefits		—			139,798			—			—			139,798
Professional fees		—			22,667			48			—			22,715
Supplies		—			14,015			—			—			14,015
Rentals and leases		—			3,347			—			—			3,347
Other operating expenses		—			23,170			2,343			(1,791	)		23,722
Provision for doubtful accounts		—			4,766			—			—			4,766
Depreciation and amortization		—			4,542			263			(61	)		4,744
Interest expense		8,893			—			315			—			9,208

		8,893			212,305			2,969			(1,852	)		222,315
(Loss) income from continuing operations before income taxes		(8,893	)		30,007			(148	)		(969	)		19,997
(Benefit from) provision for income taxes		(3,379	)		10,861			117			—			7,599

(Loss) income from continuing operations		(5,514	)		19,146			(265	)		(969	)		12,398
Loss from discontinued operations, net of taxes		—			(206	)		—			—			(206	)

Net (loss) income	$	(5,514	)	$	18,940		$	(265	)	$	(969	)	$	12,192

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2007
(Dollars in thousands)


				Combined									Total
				Subsidiary			Combined Non-			Consolidating			Consolidated
	Parent			Guarantors			Guarantors			Adjustments			Amounts
Operating activities:
Net (loss) income	$	(8,735	)	$	27,694		$	284		$	(1,118	)	$	18,125
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depreciation and amortization		—			6,084			275			(61	)		6,298
Share-based compensation		—			3,673			—			—			3,673
Amortization of loan costs		506			—			11			—			517
Loss from discontinued operations		19			—			—			—			19
Change in income tax assets and liabilities		—			(1,798	)		—			—			(1,798	)
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		—			(9,305	)		—			—			(9,305	)
Prepaids and other current assets		—			(15,568	)		14,644			—			(924	)
Accounts payable		—			(831	)		—			—			(831	)
Salaries and benefits payable		—			(9,432	)		—			—			(9,432	)
Accrued liabilities and other liabilities		10,424			(25,627	)		14,139			—			(1,064	)

Net cash provided by (used in) continuing operating activities		2,214			(25,110	)		29,353			(1,179	)		5,278
Net cash used in discontinued operating activities		—			(145	)		—			—			(145	)

Net cash provided by (used in) operating activities		2,214			(25,255	)		29,353			(1,179	)		5,133
Investing activities:
Cash paid for acquisitions, net of cash acquired		(25,241	)		—			—			—			(25,241	)
Capital purchases of leasehold improvements, equipment and software		—			(9,872	)					—			(9,872	)
Other assets		—			361			(128	)		—			233

Net cash used in investing activities		(25,241	)		(9,511	)		(128	)		—			(34,880	)
Financing activities:
Principal payments on long-term debt		(241	)		—			(74	)		—			(315	)
Net transfers to and from members		(3,922	)		31,828			(29,085	)		1,179			—
Net increase in revolving credit facility		19,000			—			—			—			19,000
Payment of loan and issuance costs		(85	)		—			—			—			(85	)
Excess tax benefits from share-based payment arrangements		2,569			—			—			—			2,569
Proceeds from issuance of common stock upon exercise of stock options		5,706			—			—			—			5,706

Net cash provided by (used in) financing activities		23,027			31,828			(29,159	)		1,179			26,875

Net (decrease) increase in cash		—			(2,938	)		66			—			(2,872	)
Cash and cash equivalents at beginning of period		—			1,118			17,423			—			18,541

Cash and cash equivalents at end of period	$	—		$	(1,820	)	$	17,489		$	—		$	15,669

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007

Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2006
(Dollars in thousands)


				Combined									Total
				Subsidiary			Combined Non-			Consolidating			Consolidated
	Parent			Guarantors			Guarantors			Adjustments			Amounts
Operating activities:
Net (loss) income	$	(5,514)		$	18,940		$	(265	)	$	(969	)	$	12,192
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			4,542			263			(61	)		4,744
Share-based compensation		—			6,254			—			—			6,254
Amortization of loan costs		—			394			11			—			405
Loss from discontinued operations		—			206			—			—			206
Change in income tax assets and liabilities		—			4,202			—			—			4,202
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		—			(8,297	)		—			—			(8,297	)
Prepaids and other current assets		—			6,050			(7,941	)		—			(1,891	)
Accounts payable		—			(2,617	)		—			—			(2,617	)
Salaries and benefits payable		—			(5,248	)		—			—			(5,248	)
Accrued liabilities and other liabilities		(108	)		(8,419	)		7,826			—			(701	)

Net cash (used in) provided by continuing operating activities		(5,622	)		16,007			(106	)		(1,030	)		9,249
Net cash provided by discontinued operating activities		—			1,306			—			—			1,306

Net cash (used in) provided by operating activities		(5,622	)		17,313			(106	)		(1,030	)		10,555
Investing activities:
Cash paid for acquisitions, net of cash acquired		(38,300	)		—			—			—			(38,300	)
Capital purchases of leasehold improvements, equipment and software		—			(5,513	)					—			(5,513	)
Other assets		—			(150	)		389			—			239

Net cash (used in) provided by investing activities		(38,300	)		(5,663	)		389			—			(43,574	)
Financing activities:
Principal payments on long-term debt		(29	)		—			(64	)		—			(93	)
Net transfers to and from members		39,883			(40,900	)		(13	)		1,030			—
Payment of loan and issuance costs		(22	)		—			—			—			(22	)
Excess tax benefits from share-based payment arrangements		2,446			—			—			—			2,446
Proceeds from issuance of common stock upon exercise of stock options		1,644			—			—			—			1,644

Net cash provided by (used in) financing activities		43,922			(40,900	)		(77	)		1,030			3,975

Net (decrease) increase in cash		—			(29,250	)		206			—			(29,044	)
Cash and cash equivalents at beginning of period		—			44,115			10,585			—			54,700

Cash and cash equivalents at end of period	$	—		$	14,865		$	10,791		$	—		$	25,656

11. Recently Issued Accounting Pronouncement

In September 2007, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. We expect to adopt SFAS No. 157 effective January 1, 2008. We have not fully evaluated the impact the adoption of SFAS No. 157 will have, if any, on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115. SFAS No. 159 permits the choice to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 apply only to companies that elect the fair value option; however, the amendment to SFAS No. 115 applies to all companies with available-for-sale and trading securities. Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective as of the beginning of a company’s first fiscal year beginning after November 15, 2007. We have not fully evaluated the impact the adoption of SFAS No. 157 will have, if any, on our consolidated financial statements.

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

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.

This Quarterly Report on Form 10-Q and other materials we have filed or may file with the Securities and Exchange Commission (the “SEC”), 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:

•		our ability to complete the acquisition of Horizon Health Corporation (NASDAQ: HORC) (“Horizon Health”) and successfully integrate Horizon Health operations;

•		potential competition that alters or impedes our acquisition strategy by decreasing our ability to acquire additional inpatient facilities on favorable terms;

•		our ability to successfully integrate and improve the operations of acquired inpatient facilities;

•		our ability to maintain favorable and continuing relationships with physicians who use our inpatient facilities;

•		our substantial indebtedness and our ability to receive timely additional financing on terms acceptable to us to fund our acquisition strategy and capital expenditure needs, including financing for the acquisition of Horizon Health;

•		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;

•		efforts by federal and state health care programs and managed care companies to reduce reimbursement rates for our services;

•		our ability to comply with applicable licensure and accreditation requirements;

•		our ability to comply with extensive laws and government regulations related to billing, physician relationships, adequacy of medical care and licensure;

•		our ability to retain key employees who are instrumental to our successful operations;

•		our ability to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act;

•		our ability to ensure confidential information is not inappropriately disclosed and that we are in compliance with federal and state health information privacy standards;

•		our ability to comply with federal and state governmental regulation covering health care-related products and services on-line, including the regulation of medical devices and the practice of medicine and pharmacology;

•		our ability to obtain adequate levels of general and professional liability insurance; and

•		those risks and uncertainties described from time to time in our filings with the SEC.

In addition, future trends for pricing, margins, revenues and profitability remain difficult to predict in the industries that we serve.

We caution you that the factors listed above, as well as the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2006 may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time to time. We cannot predict such new risk factors, nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied by any forward-looking statements.

Overview

Our business strategy is to acquire inpatient behavioral health care facilities and improve the operating results of our inpatient facilities and managed inpatient behavioral health care operations.

During January 2007, we completed the acquisition of an 86-bed inpatient behavioral health care facility in Columbia, South Carolina. On December 20, 2006, we signed a definitive merger agreement to acquire Horizon Health in a transaction valued at $426 million, consisting of cash of $20 per share totaling $321 million and the assumption of Horizon Health’s outstanding debt. Horizon Health produced revenue of $275 million for its 2006 fiscal year, which ended August 31, 2006, primarily through the operation and management of inpatient behavioral health facilities and units. At February 28, 2007, Horizon Health owned/leased 15 inpatient behavioral health care facilities with approximately 1,571 licensed beds in 11 states. Horizon Health also provided services under 114 behavioral health and physical rehabilitation program management contracts with acute care hospitals at November 30, 2006 and operated an employee assistance program services business. Consummation of the transaction is subject to customary closing conditions, including regulatory approvals and clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“Hart-Scott-Rodino Act”). The transaction has been approved by Horizon Health’s stockholders. On February 12, 2007, we received a request for additional information (commonly referred to as a “Second Request”) from the Federal Trade Commission (the “FTC”) in connection with the pending acquisition of Horizon Health. The Second Request extends the waiting period imposed by the Hart-Scott-Rodino Act and relates to two markets. Psychiatric Solutions, Inc. (“PSI”) and Horizon Health have certified substantial compliance with the Second Request and are working with the FTC to resolve its concerns. Consummation of the transaction is anticipated during the second quarter of 2007.

We strive to improve the operating results of our 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 attempt to improve operating results by optimizing staffing ratios, controlling contract labor costs and reducing supply costs through group purchasing. During the quarter ended March 31, 2007, our same-facility revenue from owned and leased inpatient facilities increased by 5.7% compared to the same period in 2006. Same-facility revenue growth was driven by increases in patient days and revenue per patient day. Patient days increased 1.0% during the quarter ended March 31, 2007 compared to the same period in 2006. Revenue per patient day increased 4.7% for the quarter ended March 31, 2007 compared to the same period in 2006. Same-facility growth refers to the comparison of each inpatient facility owned and leased during 2006 with the results for the comparable period in 2007.

Sources of Revenue

Patient Service Revenue

Patient service revenue is generated by our inpatient facilities as a result of services provided to patients on an inpatient and outpatient basis within the inpatient behavioral health care facility setting. Patient service revenue is recorded at our established billing rates less contractual adjustments. Generally, collection in full is not expected at our established billing rates. Contractual adjustments are recorded to state our patient service revenue at the amount we expect to collect for the services provided based on amounts reimbursable by Medicare or Medicaid under provisions of cost or prospective reimbursement formulas or amounts due from other third-party payors at contractually determined rates. Patient service revenue comprised approximately 94.7% and 94.8% of our total revenue for the three months ended March 31, 2007 and 2006, respectively.

Management Contract and Other Revenue

Our management contracts and other segment primarily provides inpatient psychiatric management and development services to hospitals and clinics based on negotiated contracts. Services provided are recorded as management contract revenue in the period the services are provided at contractually determined rates, provided that collectibility of such amounts is reasonably assured. Management contract and other revenue comprised approximately 5.3% and 5.2% of our total revenue for the three months ended March 31, 2007 and 2006, respectively.

Results of Operations

The following table illustrates our consolidated results of operations for the three months ended March 31, 2007 and 2006 (dollars in thousands):


	For the Three Months Ended March 31,
	2007				2006
	Amount		%		Amount		%

Revenue	$	323,718	100.0	%	$	242,312	100.0	%
Salaries, wages, and employee benefits (including share-based compensation of $3,673 and $6,254 for 2007 and 2006, respectively)		180,999	55.9	%		139,798	57.7	%
Professional fees		31,035	9.6	%		22,715	9.4	%
Supplies		18,477	5.7	%		14,015	5.8	%
Provision for doubtful accounts		6,706	2.1	%		4,766	1.9	%
Other operating expenses		36,411	11.3	%		27,069	11.2	%
Depreciation and amortization		6,298	1.9	%		4,744	1.9	%
Interest expense, net		14,386	4.4	%		9,208	3.8	%

Income from continuing operations before income taxes		29,406	9.1	%		19,997	8.3	%
Provision for income taxes		11,262	3.5	%		7,599	3.2	%

Income from continuing operations	$	18,144	5.6	%	$	12,398	5.1	%

Three Months Ended March 31, 2007 Compared To Three Months Ended March 31, 2006

The following table compares key operating statistics for owned and leased inpatient facilities for the quarters ended March 31, 2007 and 2006 (revenue in thousands). Same-facility statistics for the quarter ended March 31, 2007 are shown on a comparable basis with statistics for the quarter ended March 31, 2006.


	Three Months Ended March 31,				%
	2007		2006		Change
Total facility results:
Revenue	$	306,445	$	229,756		33.4	%
Number of facilities at period end		75		58		29.3	%
Admissions		32,571		26,937		20.9	%
Patient days		556,911		446,054		24.9	%
Average length of stay		17.1		16.6		3.0	%
Revenue per patient day	$	550	$	515		6.8	%

Same-facility results:
Revenue	$	241,306	$	228,376		5.7	%
Number of facilities at period end		58		58		0.0	%
Admissions		27,370		26,887		1.8	%
Patient days		447,082		442,595		1.0	%
Average length of stay		16.3		16.5		-1.2	%
Revenue per patient day	$	540	$	516		4.7	%

Revenue. Revenue from continuing operations was $323.7 million for the quarter ended March 31, 2007 compared to $242.3 million for the quarter ended March 31, 2006, an increase of $81.4 million, or 33.6%. Revenue from owned and leased inpatient facilities accounted for $306.4 million in 2007 compared to $229.8 million in 2006, an increase of $76.7 million, or 33.4%. The increase in revenue from owned and leased inpatient facilities relates primarily to acquisitions of behavioral health care facilities. Acquisitions during 2006 and 2007 accounted for $65.1 million of the increase in revenue. The remainder of the increase in revenue from owned and leased inpatient facilities is attributable to same-facility growth in patient days and revenue per patient day of 1.0% and 4.7%, respectively. Revenue from management contracts and other was $17.3 million in 2007 compared to $12.6 million in 2006. The increase in revenue from management contracts and other is largely due to the acquisition of ABS.

Salaries, wages and employee benefits. Salaries, wages and employee benefits (“SWB”) expense was $181.0 million for the quarter ended March 31, 2007 compared to $139.8 million for the quarter ended March 31, 2006. SWB expense includes $3.7 million and $6.3 million of share-based compensation expense for the quarters ended March 31, 2007 and 2006, respectively. Share-based compensation expense for the quarter ended March 31, 2006 includes $2.2 million related to options modified in the settlement of an employment contract with a former executive officer of the company. Excluding share-based compensation expense, SWB expense was $177.3 million, or 54.8% of total revenue, in the quarter ended March 31, 2007 compared to $133.5 million, or 55.1% of total revenue, for the quarter ended March 31, 2006. SWB expense for owned and leased inpatient facilities was $165.4 million, or 54.0% of revenue, in 2007. Same-facility SWB expense for owned and leased inpatient facilities was $129.5 million, or 53.7% of revenue, in 2007 compared to $124.3 million, or 54.1% of total revenue, in 2006. SWB expense for management contracts and other was $5.6 million in 2007 compared to $5.0 million in 2006. SWB expense for our corporate office was $10.0 million, including $3.7 million in share-based compensation, for 2007 compared to $10.5 million, including $6.3 million in share-based compensation, for 2006. Excluding share-based compensation, SWB expense for our corporate office increased approximately $2.1 million primarily the result of hiring additional staff necessary to manage the inpatient facilities acquired during 2006 and 2007.

Professional fees. Professional fees were $31.0 million for the quarter ended March 31, 2007, or 9.6% of total revenue, compared to $22.7 million for the quarter ended March 31, 2006, or 9.4% of total revenue. Professional fees for owned and leased inpatient facilities were $28.7 million in 2007, or 9.4% of revenue. Same-facility professional fees for owned and leased inpatient facilities were $22.4 million in 2007, or 9.3% of revenue, compared to $20.9 million in 2006, or 9.1% of revenue. Professional fees for management contracts and other as well as our corporate office were $2.3 million in 2007 compared to $1.8 million in 2006.

Supplies. Supplies expense was $18.5 million for the quarter ended March 31, 2007, or 5.7% of total revenue, compared to $14.0 million for the quarter ended March 31, 2006, or 5.8% of total revenue. Supplies expense for owned and leased inpatient facilities was $18.1 million in 2007, or 5.9% of revenue. Same-facility supplies expense for owned and leased inpatient facilities was $14.3 million in 2007, or 5.9% of revenue, compared to $13.7 million in 2006, or 6.0% of revenue. Supplies expense for management contracts and other as well as our corporate office consist primarily of office supplies and is negligible to supplies expense overall.

Provision for doubtful accounts. The provision for doubtful accounts was $6.7 million for the quarter ended March 31, 2007, or 2.1% of total revenue, compared to $4.8 million for the quarter ended March 31, 2006, or 1.9% of total revenue. The provision for doubtful accounts at our owned and leased inpatient facilities comprises substantially all of our provision for doubtful accounts.

Other operating expenses. Other operating expenses consist primarily of rent, utilities, insurance, travel, and repairs and maintenance expenses. Other operating expenses were approximately $36.4 million for the quarter ended March 31, 2007, or 11.3% of total revenue, compared to $27.1 million for the quarter ended March 31, 2006, or 11.2% of total revenue. Other operating expenses for owned and leased inpatient facilities were $26.6 million in 2007, or 8.7% of revenue. Same-facility other operating expenses for owned and leased inpatient facilities were $20.6 million in 2007, or 8.6% of revenue, compared to $21.3 million in 2006, or 9.3% of revenue. The decrease in same-facility other operating expenses for owned and leased inpatient facilities as a percentage of revenue is primarily the result of reductions in risk management costs as a percent of revenue. Other operating expenses for management contracts were $8.1 million in 2007 compared to $4.3 million in 2006. The increase in other operating expenses for management contracts and other is primarily due to new operations from the acquisition of ABS. Other operating expenses at our corporate office were $1.8 million in 2007 compared to $1.4 million in 2006.

Depreciation and amortization. Depreciation and amortization expense was $6.3 million for the quarter ended March 31, 2007 compared to $4.7 million for the quarter ended March 31, 2006. This increase in depreciation and amortization expense is primarily the result of the acquisitions of inpatient facilities during 2006 and 2007.

Interest expense, net. Interest expense, net of interest income, was $14.4 million for the quarter ended March 31, 2007 compared to $9.2 million for the quarter ended March 31, 2006, an increase of $5.2 million. This increase in interest expense is the result of an increase of $277.4 million in our long-term debt during the past twelve months used primarily to finance acquisitions during that period. At March 31, 2007, we had $763.7 million in long-term debt compared to $486.3 million at March 31, 2006. We borrowed $210.0 million in December 2006 to finance the cash purchase price of ABS. Additionally, we borrowed $20.0 million in January 2007 to finance the cash purchase price of an 86-bed inpatient behavioral health care facility in Columbia, South Carolina.

Loss from discontinued operations, net of taxes. The loss from discontinued operations (net of income tax effect) of $19,000 and $206,000 for the quarters ended March 31, 2007 and 2006, respectively. We did not have any operations which were discontinued during the quarter ended March 31, 2007.

Liquidity and Capital Resources

Working capital at March 31, 2007 was $120.6 million, including cash and cash equivalents of $15.7 million, compared to working capital of $103.3 million, including cash and cash equivalents of $18.5 million, at December 31, 2006. The increase in working capital is primarily the result of an increase of $10.6 million in accounts receivable and a decrease of $7.2 million in salaries and benefits payable at March 31, 2007 as compared to December 31, 2006. The increase in accounts receivable is primarily the result of increases in same-facility revenues, while our consolidated day’s sales outstanding remained constant at 53 for March 31, 2007 and December 31, 2006. The decrease in salaries and benefits payable is primarily the result of payments of incentive compensation for the year ended December 31, 2006 that were accrued at the end of 2006 and paid during the quarter ended March 31, 2007.

Cash provided by continuing operating activities was $5.3 million for the three months ended March 31, 2007 compared to $9.2 million for the three months ended March 31, 2006. This $3.9 million decrease in cash flows from continuing operating activities as compared to 2006 was primarily the result of income tax payments of $10.2 million in 2007 as we substantially utilized our net operating loss carryforwards and began making payments in 2007. This impact was partially offset by cash inflows resulting from an improvement in operating results.

Cash used in investing activities was $34.9 million for the three months ended March 31, 2007 compared to $43.6 million for the three months ended March 31, 2006. Cash used in investing activities for the three months ended March 31, 2007 was primarily the result of $25.2 million paid for acquisitions and $9.9 million for purchases of fixed assets. Cash used for routine and expansion capital expenditures was approximately $5.7 million and $4.1 million, respectively, for the three months ended March 31, 2007. We define expansion capital expenditures as those which increase our capacity or otherwise enhance revenue. Routine or maintenance capital expenditures were 1.8% of our net revenue for the three months ended March 31, 2007. Cash used in investing activities for the three months ended March 31, 2006 was primarily the result of cash paid for acquisitions of approximately $38.3 million and capital expenditures of approximately $5.5 million.

Cash provided by financing activities was $26.9 million for the three months ended March 31, 2007 compared to $4.0 million for the three months ended March 31, 2006. Cash provided by financing activities for the three months ended March 31, 2007 was primarily the result of $19.0 million in net borrowings under our revolving credit facility, which were used to finance the acquisition of a behavioral healthcare facility in Columbia, South Carolina. Additionally, we received $5.7 million in proceeds from the exercise of stock options and $2.6 million in income tax benefits in excess of share-based compensation expense on stock options exercised in 2007 during the three months ended March 31, 2007. Cash provided by financing activities for the three months ended March 31, 2006 was primarily the result of $2.4 million in income tax benefits in excess of share-based compensation expense on stock options exercised in 2006 and $1.6 million in proceeds from the exercise of stock options.

We have a universal shelf registration statement on Form S-3 under which we may sell an indeterminate amount of our common stock, common stock warrants, preferred stock and debt securities. We may from time to time offer these securities in one or more

series, in amounts, at prices and on terms satisfactory to us.

We have entered into interest rate swap agreements to manage our exposure to fluctuations in interest rates. These interest rate swap agreements effectively convert approximately $38.7 million of fixed-rate long-term debt to LIBOR indexed variable rate instruments plus agreed upon interest rate spreads ranging from 5.51% to 5.86%.

We anticipate financing the acquisition of Horizon Health through additional borrowings under our existing $300 million revolving credit facility, with new debt and with cash on hand. We have entered into a commitment letter with Citigroup and Merrill Lynch to provide the financing for an addition to our existing term loan facility, subject to the terms and conditions of such letter.

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.

Contractual Obligations


	Payments Due by Period (in thousands)
			Less than						After
	Total		1 year		1-3 years		3-5 years		5 years
Long-term debt (1):
Senior Credit Facility:
Revolving line of credit facility, expiring on December 21, 2009 and bearing interest of 6.6% and 6.7% at March 31, 2007 and December 31, 2006, respectively	$	120,000	$	—	$	120,000	$	—	$	—
Senior Secured Term Loan Facility, expiring on July 1, 2012 and bearing interest of 7.1% at March 31, 2007 and December 31, 2006, respectively		350,000		1,875		3,000		3,000		342,125
7 3/4% Senior Subordinated Notes due July 15, 2015		220,000		—		—		—		220,000
10 5/8% Senior Subordinated Notes due June 15, 2013		38,681		—		—		—		38,681
Mortgage loans on facilities, maturing in 2036, 2037 and 2038 bearing fixed interest rates of 5.7% to 7.6%		26,988		306		670		756		25,256

		755,669		2,181		123,670		3,756		626,062

Lease and other obligations		56,679		10,755		17,013		7,598		21,313

Total contractual obligations	$	812,348	$	12,936	$	140,683	$	11,354	$	647,375


(1)		Excludes capital lease and other obligations of $8.0 million, which are included in lease and other obligations.

The fair values of our $220.0 million 7³/₄% Notes and $38.7 million 10⁵/₈% Notes were approximately $222.5 million and approximately $42.1 million, respectively, as of March 31, 2007. The fair values of our $220.0 million 7³/₄% Notes and $38.7 million 10⁵/₈% Notes were approximately $218.6 million and approximately $42.4 million, respectively, as of December 31, 2006. The carrying value of our other long-term debt, including current maturities, of $505.0 million and $484.6 million at March 31, 2007 and December 31, 2006, respectively, approximated fair value. We had $350.0 million and $120.0 million of variable rate debt outstanding under our term loan facility and revolving credit facility, respectively, as of March 31, 2007. In addition, interest rate swap agreements effectively convert $38.7 million of fixed rate debt into variable rate debt at March 31, 2007. At our March 31, 2007 borrowing level, a hypothetical 10% increase in interest rates would decrease our annual net income and cash flows by approximately $2.3 million.

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. 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 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 the 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 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 by comparing our established billing rates with the amount we determine to be reimbursable given our interpretation of the applicable regulations or contract terms. Most payments are determined based on negotiated per-diem rates. While the services authorized and provided and related reimbursement are often subject to interpretation that could result in payments that differ from our estimates, these differences are deemed immaterial. Additionally, updated regulations and contract renegotiations occur frequently necessitating continual review and assessment of the estimation process by our management. We periodically compare the contractual rates on our patient accounting systems with the Medicare and Medicaid reimbursement rates or the third-party payor contract for accuracy. We also monitor the adequacy of our contractual adjustments using financial measures such as comparing cash receipts to net patient revenue adjusted for bad debt expense.

Professional and General Liability

We are subject to medical malpractice and other lawsuits due to the nature of the services we provide. At March 31, 2007, all of our operations have professional and general liability insurance in umbrella form for claims in excess of $3.0 million with an insured limit of $50.0 million. 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 actuary. This self-insurance 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 utilized our captive insurance company to manage the self-insured retention. While claims are monitored closely when estimating professional and general liability accruals, the complexity of the claims and wide range of potential outcomes often hamper timely adjustments to the assumptions used in these estimates.

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. A valuation allowance for deferred tax assets is established when we believe that it is more likely than not that the deferred tax asset will not be realized. Management must also assess the impact of our 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.

We adopted FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109, on January 1, 2007. Applying the provisions of FIN 48 requires significant judgments regarding the recognition and measurement of each tax position. Changes in these judgments may materially affect the estimate of our effective tax rate and our operating results.

Share-Based Compensation

We adopted SFAS No. 123R under the modified-prospective transition method on January 1, 2006, which requires us to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of such awards. We utilize the Black-Scholes option pricing model to estimate the grant-date fair value of our stock options. The Black-Scholes model includes certain variables and assumptions that require judgment, such as the expected volatility or our stock price and the expected term of our stock options. Additionally, SFAS No. 123R requires us to use judgment in the estimation of forfeitures over the vesting period of share-based awards.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Information required by this item is provided in Part I, Item 2 of this Quarterly Report on Form 10-Q under the captions “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.”

Item 4. Controls and Procedures.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us (including our consolidated subsidiaries) in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported on a timely basis.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the quarter ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

We are subject to various claims and legal actions that arise in the ordinary course of our business. In the opinion of management, Psychiatric Solutions is not currently a party to any proceeding that would have a material adverse effect on its financial condition or results of operations.

Item 1A. Risk Factors.

There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.

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

On January 2, 2007, as part of the consideration for the purchase of Three Rivers Behavioral Health Center, we issued to four individuals 242,780 shares of our common stock that were not registered under the Securities Act of 1933, as amended (the “Securities Act”). The transaction was conducted in reliance upon the exemptions from registration provided in Section 4(2) of the Securities Act and Regulation D and the other rules and regulations promulgated thereunder. The issuance was made without the use of an underwriter, and the certificates and other documentation evidencing the securities issued in connection with this transaction bears a restrictive legend permitting transfer of the securities only upon registration under the Securities Act or pursuant to an exemption from registration.

Item 6. Exhibits.


Exhibit
Number		Description
3.1		Amended and Restated Certificate of Incorporation of PMR Corporation, filed with the Delaware Secretary of State on March 9, 1998 (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 1998).

3.2		Certificate of Amendment to Amended and Restated Certificate of Incorporation of PMR Corporation, filed with the Delaware Secretary of State on August 5, 2002 (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2002).

3.3		Certificate of Amendment to Amended and Restated Certificate of Incorporation of Psychiatric Solutions, Inc., filed with the Delaware Secretary of State on March 21, 2003 (incorporated by reference to Appendix A of the Company’s Definitive Proxy Statement, filed on January 22, 2003).

3.4		Certificate of Amendment to Amended and Restated Certificate of Incorporation of Psychiatric Solutions, Inc., filed with the Delaware Secretary of State on December 15, 2005 (incorporated by reference to Exhibit 3.4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005).

3.5		Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 1997).

4.1		Reference is made to Exhibits 3.1 through 3.5.

4.2		Common Stock Specimen Certificate (incorporated by reference to Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).

4.3		Indenture, dated as of June 30, 2003, among Psychiatric Solutions, Inc., the Guarantors named therein and Wachovia Bank, National Association, as Trustee (incorporated by reference to Exhibit 4.10 to the Company’s Registration Statement on Form S-4, filed on July 30, 2003 (Registration No. 333-107453) (the “2003 S-4”)).


Exhibit
Number		Description
4.4		Form of Notes (included in Exhibit 4.3).

4.5		Indenture, dated as of July 6, 2006, by and among Psychiatric Solutions, Inc., the Guarantors named therein and Wachovia Bank, National Association, as Trustee (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed July 8, 2006).

4.6		Form of Notes (included in Exhibit 4.5).

10.1		Psychiatric Solutions, Inc. 2007 Cash Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company’s Current Report or Form 8-K, filed on February 22, 2007).

10.2		Psychiatric Solutions, Inc. 2007 Long-Term Equity Compensation Plan (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed on February 22, 2007).

10.3*		Form of Nonstatutory Stock Option Agreement.

31.1*		Certification of the Chief Executive Officer of Psychiatric Solutions, Inc. Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification of the Chief Accounting Officer of Psychiatric Solutions, Inc. Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*		Certifications of the Chief Executive Officer and Chief Accounting Officer of Psychiatric Solutions, Inc. Pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Filed herewith


	Psychiatric Solutions, Inc.
	By:	/s/ Jack E. Polson
		Jack E. Polson
		Executive Vice President, Chief Accounting Officer

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	PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006 (Unaudited)		1
Condensed Consolidated Statements of Income for the three month periods ended March 31, 2007 and 2006 (Unaudited)		2
Condensed Consolidated Statements of Cash Flows for the three month periods ended March 31, 2007 and 2006 (Unaudited)		3
Notes to Condensed Consolidated Financial Statements (Unaudited)		4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3. Quantitative and Qualitative Disclosures About Market Risk		19
Item 4. Controls and Procedures		20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		20
Item 1A. Risk Factors		20
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		20
Item 6. Exhibits		20
Ex-10.3 Nonstatutory Stock Option
Ex-31.1 Section 302 Certification
Ex-31.2 Section 302 Certification
Ex-32.1 Section 906 Certification