Psychiatirc 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 September 30, 2007


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 Organization)		(I.R.S. Employer Identification No.)

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. þ Yes o No

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 filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

As of November 5, 2007, 54,954,662 shares of the registrant’s common stock were outstanding.

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements.

PSYCHIATRIC SOLUTIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)


	September 30,		December 31,
	2007		2006
ASSETS
Current assets:
Cash and cash equivalents	$	22,398	$	18,572
Accounts receivable, less allowance for doubtful accounts of $34,946 and $18,672, respectively		241,838		179,050
Prepaids and other		68,716		45,364

Total current assets		332,952		242,986
Property and equipment, net of accumulated depreciation		680,541		539,758
Cost in excess of net assets acquired		1,089,053		760,268
Other assets		66,765		37,910

Total assets	$	2,169,311	$	1,580,922


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	29,676	$	25,222
Salaries and benefits payable		79,990		66,236
Other accrued liabilities		71,667		45,855
Current portion of long-term debt		5,903		2,386

Total current liabilities		187,236		139,699
Long-term debt, less current portion		1,176,553		740,921
Deferred tax liability		53,650		44,924
Other liabilities		28,158		27,599

Total liabilities		1,445,597		953,143
Minority interest		4,433		—
Stockholders’ equity:
Common stock, $0.01 par value, 125,000 shares authorized; 54,608 and 53,421 issued and outstanding, respectively		546		534
Additional paid-in capital		562,159		523,193
Retained earnings		156,576		104,052

Total stockholders’ equity		719,281		627,779

Total liabilities and stockholders’ equity	$	2,169,311	$	1,580,922

See accompanying notes.

PSYCHIATRIC SOLUTIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, in thousands except for per share amounts)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Revenue	$	402,021		$	253,696		$	1,078,585		$	742,534

Salaries, wages and employee benefits (including share-based compensation of $4,423, $2,059, $12,006 and $10,449 for the respective three and nine month periods in 2007 and 2006)		223,902			143,920			599,137			420,490
Professional fees		40,565			24,072			106,629			70,827
Supplies		21,820			14,494			59,745			42,766
Rentals and leases		5,747			3,274			15,391			9,906
Other operating expenses		38,517			23,038			105,026			70,428
Provision for doubtful accounts		7,019			4,401			20,958			13,756
Depreciation and amortization		8,525			5,194			22,037			14,745
Interest expense		22,253			10,059			53,669			28,537
Loss on refinancing of long-term debt		—			—			8,179			—

		368,348			228,452			990,771			671,455

Income from continuing operations before income taxes		33,673			25,244			87,814			71,079
Provision for income taxes		12,831			9,593			33,457			27,010

Income from continuing operations		20,842			15,651			54,357			44,069
Loss from discontinued operations, net of income tax benefit of $322, $78, $800 and $608 for the respective three and nine month periods in 2007 and 2006		(517	)		(127	)		(1,300	)		(992	)

Net income	$	20,325		$	15,524		$	53,057		$	43,077


Basic earnings per share:
Income from continuing operations	$	0.38		$	0.29		$	1.00		$	0.83
Loss from discontinued operations, net of taxes		(0.01	)		—			(0.02	)		(0.01	)

Net income	$	0.37		$	0.29		$	0.98		$	0.82


Diluted earnings per share:
Income from continuing operations	$	0.38		$	0.29		$	0.98		$	0.81
Loss from discontinued operations, net of taxes		(0.01	)		—			(0.02	)		(0.01	)

Net income	$	0.37		$	0.29		$	0.96		$	0.80


Shares used in computing per share amounts:
Basic		54,278			53,114			54,064			52,849
Diluted		55,415			54,266			55,343			54,077

See accompanying notes.

PSYCHIATRIC SOLUTIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)


	Nine Months Ended September 30,
	2007			2006
Operating activities:
Net income	$	53,057		$	43,077
Adjustments to reconcile net income to net cash provided by continuing operating activities:
Depreciation and amortization		22,037			14,745
Share-based compensation		12,006			10,449
Loss on refinancing of long-term debt		8,179			—
Amortization of loan costs and bond premium		1,591			1,225
Loss from discontinued operations		1,300			992
Change in income tax assets and liabilities		8,219			24,270
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		(18,557	)		(11,721	)
Prepaids and other current assets		648			(3,685	)
Accounts payable		(6,784	)		(2,038	)
Salaries and benefits payable		(766	)		4,740
Accrued liabilities and other liabilities		297			1,416

Net cash provided by continuing operating activities		81,227			83,470
Net cash used in discontinued operating activities		(493	)		(2,677	)

Net cash provided by operating activities		80,734			80,793

Investing activities:
Cash paid for acquisitions, net of cash acquired		(462,729	)		(167,065	)
Capital purchases of leasehold improvements, equipment and software		(48,361	)		(20,880	)
Other assets		(750	)		35

Net cash used in investing activities		(511,840	)		(187,910	)

Financing activities:
Borrowings on long-term debt		481,875			—
Principal payments on long-term debt		(40,220	)		(274	)
Net (decrease) increase in revolving credit facility borrowings		(11,000	)		52,000
Payment of loan and stock issuance costs		(6,603	)		(101	)
Costs to refinance long-term debt		(7,127	)		—
Excess tax benefits from share-based payment arrangements		4,072			5,771
Proceeds from issuance of common stock upon exercise of stock options		13,935			5,456

Net cash provided by financing activities		434,932			62,852

Net increase (decrease) in cash		3,826			(44,265	)
Cash and cash equivalents at beginning of the period		18,572			54,699

Cash and cash equivalents at end of the period	$	22,398		$	10,434


Effect of Acquisitions:
Assets acquired, net of cash acquired	$	533,084		$	182,056
Liabilities assumed		(52,653	)		(10,745	)
Long-term debt assumed		(8,702	)		(4,246	)
Common stock issued		(9,000	)		—

Cash paid for acquisitions, net of cash acquired	$	462,729		$	167,065

See accompanying notes.

PSYCHIATRIC SOLUTIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SEPTEMBER 30, 2007

1. Recent Developments

On May 31, 2007, we completed the acquisition of Horizon Health Corporation (“Horizon Health”) for $426.7 million in cash and the assumption of a mortgage loan of approximately $7.0 million. We also repurchased in a tender offer substantially all of our 10⁵/₈% Senior Subordinated Notes due 2013 (the “10⁵/₈% Notes”). These transactions were financed with an additional $225 million of term loans pursuant to our senior secured credit facility and the net proceeds of our offering of $250 million of 7³/₄%Senior Subordinated Notes due 2015 (the “7³/₄%Notes”). In connection with these financing transactions, we recorded a loss of $8.2 million, which consists primarily of the amount above par value paid to repurchase our 10⁵/₈% Notes, the write-off of capitalized financing costs associated with our 10⁵/₈% Notes and the amount paid to exit our interest rate swap agreements.

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 as of December 31, 2006 has been derived from our audited financial statements as of 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 share-based compensation expense, were less than 3% of net revenue for the three and nine months ended September 30, 2007. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. 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):


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Numerator:
Income from continuing operations	$	20,842		$	15,651		$	54,357		$	44,069
Loss from discontinued operations, net of taxes		(517	)		(127	)		(1,300	)		(992	)

Net income	$	20,325		$	15,524		$	53,057		$	43,077


Denominator:
Weighted average shares outstanding for basic earnings per share		54,278			53,114			54,064			52,849
Effects of dilutive stock options and restricted stock outstanding		1,137			1,152			1,279			1,228

Shares used in computing diluted earnings per common share		55,415			54,266			55,343			54,077


Basic earnings per share:
Income from continuing operations	$	0.38		$	0.29		$	1.00		$	0.83
Loss from discontinued operations, net of taxes		(0.01	)		—			(0.02	)		(0.01	)

	$	0.37		$	0.29		$	0.98		$	0.82


Diluted earnings per share:
Income from continuing operations	$	0.38		$	0.29		$	0.98		$	0.81
Loss from discontinued operations, net of taxes		(0.01	)		—			(0.02	)		(0.01	)

	$	0.37		$	0.29		$	0.96		$	0.80

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

4. Share-Based Compensation

We recognized approximately $4.4 million and $12.0 million in share-based compensation expense and approximately $1.7 million and $4.6 million of related income tax benefit for the three and nine months ended September 30, 2007, respectively. We recognized approximately $2.1 million and $10.4 million in share-based compensation expense and approximately $0.8 million and $4.0 million of related income tax benefit for the three and nine months ended September 30, 2006, respectively. The fair value of our stock options was estimated using the Black-Scholes option pricing model. Share-based compensation expense for the nine months ended September 30, 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 diluted earnings per share was approximately $0.05 and $0.13 per share for the three and nine months ended September 30, 2007, respectively. The impact of share-based compensation expense, net of tax, on our diluted earnings per share was approximately $0.02 and $0.12 per share for the three and nine months ended September 30, 2006, respectively. We classified $4.1 million and $5.8 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 nine months ended September 30, 2007 and 2006, respectively.

Based on our stock option and restricted stock grants outstanding at September 30, 2007, we estimate remaining unrecognized share-based compensation expense to be approximately $44.6 million with a weighted average remaining life of 3.4 years.

The total intrinsic value, which represents the difference between the underlying stock’s market price and an option’s exercise price, of options exercised during the nine months ended September 30, 2007 and 2006 was $15.1 million and $18.8 million, respectively.

We granted 2,521,427 stock options to employees during the nine months ended September 30, 2007. These options vest over four years in annual increments of 25% on each anniversary of the grant date and had a weighted-average grant-date fair value of $14.35.

We granted 253,332 shares of restricted stock to certain executive officers during the nine months ended September 30, 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 $41.02 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. We account for acquisitions using the purchase method of accounting.

On May 31, 2007, we completed the acquisition of Horizon Health for $426.7 million in cash and the assumption of a mortgage loan of approximately $7.0 million. We also repurchased in a tender offer substantially all of our 10⁵/₈% Notes. These transactions were financed with an additional $225 million of term loans pursuant to our senior secured credit facility and the net proceeds of our offering of $250 million of 7³/₄%Notes. The purchase price allocation for Horizon Health is preliminary pending final measurement of certain assets and liabilities related to the acquisition.

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

The following represents the unaudited pro forma results of our consolidated operations as if the Horizon Health acquisition had occurred on January 1, 2006, after giving effect to certain adjustments, including the depreciation and amortization of the assets acquired based on their estimated fair values and changes in interest expense resulting from changes in consolidated debt (in thousands, except per share data):


	Three Months
	Ended		Nine Months
	September 30,		Ended September 30,
	2006		2007		2006
Revenue	$	328,519	$	1,200,501	$	963,040
Net income	$	16,762	$	54,233	$	45,427
Earnings per common share, basic	$	0.32	$	1.00	$	0.86
Earnings per common share, diluted	$	0.31	$	0.98	$	0.84

The pro forma information for the nine months ended September 30, 2007 includes a loss on refinancing of long-term debt of approximately $8.2 million. The pro forma information does not purport to be indicative of what our results of operations would have been if the acquisition had in fact occurred at the beginning of the periods presented, and is not intended to be a projection of our future results of operations. No pro forma information is presented for the three months ended September 30, 2007, as the acquisition

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

of Horizon Health occurred on May 31, 2007.

6. Long-term debt

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


	September 30,		December 31,
	2007		2006
Senior credit facility:
Revolving line of credit facility, expiring on December 21, 2009 and bearing interest of 6.7% at September 30, 2007 and December 31, 2006	$	90,000	$	101,000
Senior secured term loan facility, expiring on July 1, 2012 and bearing interest of 7.2% and 7.1% at September 30, 2007 and December 31, 2006, respectively		574,250		350,000
7 3/4% Senior Subordinated Notes		476,667		220,000
10 5/8% Senior Subordinated Notes		34		38,681
Mortgage loans on facilities, maturing in 2036, 2037 and 2038 bearing fixed interest rates of 5.7% to 7.6%		33,766		27,062
Other		7,739		6,564

		1,182,456		743,307
Less current portion		5,903		2,386

Long-term debt	$	1,176,553	$	740,921

Senior Credit Facility

On May 31, 2007, we amended our Credit Agreement to increase our senior secured term loan facility from $350 million to $575 million to finance the acquisition of Horizon Health and complete the tender offer for our 10⁵/₈% Notes. Quarterly principal payments of $937,500 are due on our senior secured term loan facility 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) and are due December 21, 2009 and July 1, 2012, respectively. The “Base Rate” and “Eurodollar Rate” fluctuate based upon market rates and certain leverage ratios, as defined in the Credit Agreement. At September 30, 2007, we had $90.0 million in borrowings outstanding and $203.0 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 0.30% per annum on the unused portion of our revolving credit facility. Commitment fees were approximately $0.3 million for the nine months ended September 30, 2007.

Our Credit Agreement contains customary covenants that include: (1) limitations on capital expenditures and investments, sales of assets, mergers, changes of ownership, new principal lines of business, indebtedness, liens, transactions with affiliates, dividends and redemptions; (2) total leverage ratio covenant; and (3) cross-default covenants triggered by a default of any other indebtedness of ours or our guarantor subsidiaries of at least $5.0 million. As of September 30, 2007, we were in compliance with all debt covenant requirements. If we violate one or more of these covenants, amounts outstanding under our Credit Agreement 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% Notes. On May 31, 2007, we issued an additional $250 million in 7³/₄% Notes to finance the acquisition of Horizon Health and complete the tender offer for our 10⁵/₈% Notes. The 7³/₄% Notes are fully and unconditionally guaranteed on a senior subordinated basis by substantially all of our existing operating subsidiaries. We received a premium of 2.75% plus accrued interest from January 15, 2007 from the sale of the $250 million 7³/₄% Notes on May 31, 2007. This premium is being amortized over the remaining life of the 7³/₄% Notes using the effective interest method, which results in an effective interest rate of 7.3% on the $250 million issuance. Interest on these notes accrues at the rate of 7³/₄% per annum and is

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

payable semi-annually in arrears on January 15 and July 15. The 7³/₄% Notes will mature on July 15, 2015.

10⁵/₈% Notes

On May 31, 2007, we used a portion of the proceeds from our sale of 7³/₄% Notes and borrowings under our senior secured term loan facility to complete the tender offer for substantially all of our 10⁵/₈% Notes.

Mortgage Loans

With the acquisition of Horizon Health, we assumed a mortgage loan agreement insured by the U.S. Department of Housing and Urban Development (“HUD”) of approximately $7.0 million. We have five mortgage loans insured by HUD that are secured by the real estate of five behavioral healthcare facilities. Interest accrues on the HUD loans at 5.7% to 7.6% and principal and interest are payable in 420 monthly installments through December 2038. The carrying amount of assets held as collateral approximated $36.3 million at September 30, 2007.

7. Income Taxes

The provision for income taxes for the nine months ended September 30, 2007 and 2006 reflects an effective tax rate of approximately 38.1% 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 that decreased our January 1, 2007 retained earnings balance. Our policy is to classify interest and penalties related to income taxes 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 2004 through 2006 remain open to examination by U.S. taxing authorities. During the quarter ended September 30, 2007, the statute of limitations closed on our 2003 federal income tax return. During the quarter ended June 30, 2007, we entered into a closing agreement with the Internal Revenue Service (“IRS”) with respect to an examination of our 2004 tax year, and we believe that it is highly unlikely the IRS will conduct further examinations of our 2004 federal income tax returns.

In addition, ABS, an entity acquired in 2006, has tax years which remain open to examination in the United States going back to the year 2000. We are entitled to full indemnification under the ABS purchase agreement for any liabilities resulting from such examinations. During the quarter ended June 30, 2007, ABS entered into a closing agreement with Puerto Rican taxing authorities. FHC Health Systems, Inc., as the seller in the ABS transaction paid all taxes and interest due under the closing agreement in accordance with the indemnification provisions of the ABS purchase agreement. The Puerto Rico settlement effectively closed to examination all tax years prior to 2006 with respect to certain entities acquired in the acquisition of ABS. Horizon Health, which we acquired on May 31, 2007, has tax years that remain open to examination going back to the year 2004.

Unrecognized tax benefits may increase over the next twelve months associated with ABS and Horizon Health as we finalize the purchase accounting for those acquisitions. Any resulting increase in unrecognized tax benefits associated with the ABS acquisition would be offset by a receivable under the indemnification provisions of the ABS purchase agreement. Any change in unrecognized tax benefits associated with the Horizon Health acquisition would change goodwill. At this time, we are not able to estimate a range of possible changes in unrecognized tax benefits associated with these transactions. We do not anticipate any other material increase or decrease in unrecognized tax benefits within the next twelve months.

During the quarter ended June 30, 2007, unrecognized tax benefits resulting from tax positions taken during prior periods decreased by approximately $1.0 million as a result of our closing agreement with the IRS with respect to our 2004 tax year and resulting adjustments to subsequent years. The settlement agreement had no impact on our provision for income taxes. During the three and nine months ended September 30, 2007, there have been no material increases in unrecognized tax benefits resulting from tax positions taken during current or prior periods, and there has been no material change in accrued interest and penalties or in the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.

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 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

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

distinguished from the rest of the entity be presented as discontinued operations. During the second quarter of 2007, we elected to dispose of one facility. During 2006, we terminated three of our contracts to manage state-owned inpatient facilities and sold a therapeutic boarding school. Accordingly, these operations, net of applicable income taxes, have been presented as discontinued operations and prior period consolidated financial statements have been reclassified. In addition, the net assets of the discontinued operations have been adjusted to estimated fair value in the period they were first reported as discontinued operations.

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


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Revenue	$	177		$	1,098		$	2,310		$	5,082

Operating expenses		1,016			1,303			3,643			5,922
Loss on disposal		—			—			767			760

		1,016			1,303			4,410			6,682

Loss from discontinued operations before income taxes		(839	)		(205	)		(2,100	)		(1,600	)
Benefit from income taxes		(322	)		(78	)		(800	)		(608	)

Loss from discontinued operations, net of taxes	$	(517	)	$	(127	)	$	(1,300	)	$	(992	)

9. Disclosures About Reportable Segments

In accordance with the criteria of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, owned and leased facilities is our only reportable segment. Each of our inpatient facilities qualifies as an operating segment under SFAS No. 131; however, none is individually material. We have aggregated our inpatient facilities into one reportable segment based on the characteristics of the services provided. As of September 30, 2007, our owned and leased facilities provided mental health and behavioral health services to patients in 81 owned and 9 leased inpatient facilities in 31 states, Puerto Rico and the U.S. Virgin Islands. The column entitled “Other” in the schedules below includes management contracts to provide inpatient psychiatric management and development services to inpatient behavioral health units in hospitals and clinics, employee assistance programs and a managed care plan in Puerto Rico. The operations included in the “Other” column do not qualify as reportable segments under SFAS No. 131. 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 for the periods indicated (dollars in thousands):

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

Three Months Ended September 30, 2007


	Owned and
	Leased
	Facilities		Other			Corporate			Consolidated
Revenue	$	359,295	$	42,726		$	—		$	402,021

Adjusted EBITDA	$	71,142	$	7,299		$	(9,567	)	$	68,874
Interest expense		7,630		(7	)		14,630			22,253
Depreciation and amortization		7,265		895			365			8,525
Provision for income taxes		—		—			12,831			12,831
Inter-segment expenses		14,768		2,530			(17,298	)		—
Other expenses:
Share-based compensation		—		—			4,423			4,423

Total other expenses		—		—			4,423			4,423

Income (loss) from continuing operations	$	41,479	$	3,881		$	(24,518	)	$	20,842


Total assets	$	1,967,533	$	109,703		$	92,075		$	2,169,311

Nine Months Ended September 30, 2007


	Owned and
	Leased
	Facilities		Other			Corporate			Consolidated
Revenue	$	991,299	$	87,286		$	—		$	1,078,585

Adjusted EBITDA	$	196,672	$	15,418		$	(28,385	)	$	183,705
Interest expense		23,220		(17	)		30,466			53,669
Depreciation and amortization		19,599		1,365			1,073			22,037
Provision for income taxes		2		—			33,455			33,457
Inter-segment expenses		39,289		4,537			(43,826	)		—
Other expenses:
Loss on refinancing long-term debt		—		—			8,179			8,179
Share-based compensation		—		—			12,006			12,006

Total other expenses		—		—			20,185			20,185

Income (loss) from continuing operations	$	114,562	$	9,533		$	(69,738	)	$	54,357


Total assets	$	1,967,533	$	109,703		$	92,075		$	2,169,311

Three Months Ended September 30, 2006


	Owned and
	Leased
	Facilities		Other		Corporate			Consolidated
Revenue	$	240,749	$	12,947	$	—		$	253,696

Adjusted EBITDA	$	48,139	$	2,278	$	(7,861	)	$	42,556
Interest expense		1,363		1		8,695			10,059
Depreciation and amortization		4,708		174		312			5,194
Provision for income taxes		—		—		9,593			9,593
Inter-segment expenses		9,434		506		(9,940	)		—
Other expenses:
Share-based compensation		—		—		2,059			2,059

Total other expenses		—		—		2,059			2,059

Income (loss) from continuing operations	$	32,634	$	1,597	$	(18,580	)	$	15,651


Total assets	$	1,214,680	$	29,481	$	73,570		$	1,317,731

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

Nine Months Ended September 30, 2006


	Owned and
	Leased
	Facilities		Other		Corporate			Consolidated
Revenue	$	704,282	$	38,252	$	—		$	742,534

Adjusted EBITDA	$	139,391	$	6,647	$	(21,228	)	$	124,810
Interest expense		10,315		2		18,220			28,537
Depreciation and amortization		13,327		514		904			14,745
Provision for income taxes		—		—		27,010			27,010
Inter-segment expenses		28,071		1,575		(29,646	)		—
Other expenses:
Share-based compensation		—		—		10,449			10,449

Total other expenses		—		—		10,449			10,449

Income (loss) from continuing operations	$	87,678	$	4,556	$	(48,165	)	$	44,069


Total assets	$	1,214,680	$	29,481	$	73,570		$	1,317,731

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 September 30, 2007 and December 31, 2006, and for the three and nine months ended September 30, 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 full and unconditional and joint and several.

Condensed Consolidating Balance Sheet
As of September 30, 2007
(Dollars in thousands)


				Combined							Total
				Subsidiary		Combined Non-		Consolidating			Consolidated
	Parent			Guarantors		Guarantors		Adjustments			Amounts
Current Assets:
Cash and cash equivalents	$	—		$	1,985	$	20,413	$	—		$	22,398
Accounts receivable, net		—			233,876		7,962		—			241,838
Prepaids and other		—			59,249		11,961		(2,494	)		68,716

Total current assets		—			295,110		40,336		(2,494	)		332,952
Property and equipment, net of accumulated depreciation		—			630,006		57,942		(7,407	)		680,541
Cost in excess of net assets acquired		—			1,089,053		—		—			1,089,053
Investment in subsidiaries		1,079,524			—				(1,079,524	)		—
Other assets		16,101			46,400		4,264		—			66,765

Total assets	$	1,095,625		$	2,060,569	$	102,542	$	(1,089,425	)	$	2,169,311


Current Liabilities:
Accounts payable	$	—		$	28,227	$	1,449	$	—		$	29,676
Salaries and benefits payable		—			78,810		1,180		—			79,990
Other accrued liabilities		20,794			47,522		5,845		(2,494	)		71,667
Current portion of long-term debt		5,512			—		391		—			5,903

Total current liabilities		26,306			154,559		8,865		(2,494	)		187,236
Long-term debt, less current portion		1,143,178			—		33,375		—			1,176,553
Deferred tax liability		—			53,650		—		—			53,650
Other liabilities		5,630			10,141		12,376		11			28,158

Total liabilities		1,175,114			218,350		54,616		(2,483	)		1,445,597
Minority Interest		—			—		—		4,433			4,433
Total stockholders’ (deficit) equity		(79,489	)		1,842,219		47,926		(1,091,375	)		719,281

Total liabilities and stockholders’ (deficit) equity	$	1,095,625		$	2,060,569	$	102,542	$	(1,089,425	)	$	2,169,311

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

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	$	—		$	1,149	$	17,423	$	—		$	18,572
Accounts receivable, net		—			179,050		—		—			179,050
Prepaids and other		—			44,154		1,210		—			45,364

Total current assets		—			224,353		18,633		—			242,986
Property and equipment, net of accumulated depreciation		—			511,263		36,085		(7,590	)		539,758
Cost in excess of net assets acquired		—			760,268		—		—			760,268
Investment in subsidiaries		681,856			—		—		(681,856	)		—
Other assets		12,349			21,856		3,705		—			37,910

Total assets	$	694,205		$	1,517,740	$	58,423	$	(689,446	)	$	1,580,922


Current Liabilities:
Accounts payable	$	—		$	25,222	$	—	$	—		$	25,222
Salaries and benefits payable		—			66,236		—		—			66,236
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			123,919		2,039		(1,590	)		139,699
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			180,983		37,819		(1,590	)		953,143
Total stockholders’ (deficit) equity		(41,726	)		1,336,757		20,604		(687,856	)		627,779

Total liabilities and stockholders’ (deficit) equity	$	694,205		$	1,517,740	$	58,423	$	(689,446	)	$	1,580,922

Condensed Consolidating Statement of Income
For the Three Months Ended September 30, 2007
(Dollars in thousands)


				Combined									Total
				Subsidiary			Combined Non-			Consolidating			Consolidated
	Parent			Guarantors			Guarantors			Adjustments			Amounts
Revenue	$	—		$	402,021		$	12,588		$	(12,588	)	$	402,021
Salaries, wages and employee benefits		—			217,303			6,599			—			223,902
Professional fees		—			38,830			1,735			—			40,565
Supplies		—			21,295			525			—			21,820
Rentals and leases		—			5,535			212			—			5,747
Other operating expenses		—			36,788			(1,677	)		3,406			38,517
Provision for doubtful accounts		—			6,769			250			—			7,019
Depreciation and amortization		—			7,956			630			(61	)		8,525
Interest expense		21,910			—			343			—			22,253

		21,910			334,476			8,617			3,345			368,348
(Loss) income from continuing operations before income taxes		(21,910	)		67,545			3,971			(15,933	)		33,673
(Benefit from) provision for income taxes		(8,348	)		21,179			—			—			12,831

(Loss) income from continuing operations		(13,562	)		46,366			3,971			(15,933	)		20,842
Loss from discontinued operations, net of taxes		—			(517	)		—			—			(517	)

Net (loss) income	$	(13,562	)	$	45,849		$	3,971		$	(15,933	)	$	20,325

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

Condensed Consolidating Statement of Income
For the Three Months Ended September 30, 2006
(Dollars in thousands)


				Combined								Total
				Subsidiary			Combined Non-		Consolidating			Consolidated
	Parent			Guarantors			Guarantors		Adjustments			Amounts
Revenue	$	—		$	253,696		$	2,863	$	(2,863	)	$	253,696
Salaries, wages and employee benefits		—			143,920			—		—			143,920
Professional fees		—			24,058			14		—			24,072
Supplies		—			14,493			1		—			14,494
Rentals and leases		—			3,274			—		—			3,274
Other operating expenses		—			22,829			1,976		(1,767	)		23,038
Provision for doubtful accounts		—			4,401			—		—			4,401
Depreciation and amortization		—			4,980			275		(61	)		5,194
Interest expense		9,773			—			286		—			10,059

		9,773			217,955			2,552		(1,828	)		228,452

(Loss) income from continuing operations before income taxes		(9,773	)		35,741			311		(1,035	)		25,244
(Benefit from) provision for income taxes		(3,714	)		13,307			—		—			9,593

(Loss) income from continuing operations		(6,059	)		22,434			311		(1,035	)		15,651
Loss from discontinued operations, net of taxes		—			(127	)		—		—			(127	)

Net (loss) income	$	(6,059	)	$	22,307		$	311	$	(1,035	)	$	15,524

Condensed Consolidating Statement of Income
For the Nine Months Ended September 30, 2007
(Dollars in thousands)


				Combined								Total
				Subsidiary			Combined Non-		Consolidating			Consolidated
	Parent			Guarantors			Guarantors		Adjustments			Amounts
Revenue	$	—		$	1,078,585		$	25,587	$	(25,587	)	$	1,078,585
Salaries, wages and employee benefits		—			590,466			8,671		—			599,137
Professional fees		—			104,348			2,281		—			106,629
Supplies		—			59,012			733		—			59,745
Rentals and leases		—			15,147			244		—			15,391
Other operating expenses		—			102,360			5,910		(3,244	)		105,026
Provision for doubtful accounts		—			20,423			535		—			20,958
Depreciation and amortization		—			20,933			1,286		(182	)		22,037
Interest expense		52,827			—			842		—			53,669
Loss on refinancing long-term debt		8,179			—			—		—			8,179

		61,006			912,689			20,502		(3,426	)		990,771
(Loss) income from continuing operations before income taxes		(61,006	)		165,896			5,085		(22,161	)		87,814
(Benefit from) provision for income taxes		(23,243	)		56,700			—		—			33,457

(Loss) income from continuing operations		(37,763	)		109,196			5,085		(22,161	)		54,357
Loss from discontinued operations, net of taxes		—			(1,300	)		—		—			(1,300	)

Net (loss) income	$	(37,763	)	$	107,896		$	5,085	$	(22,161	)	$	53,057

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

Condensed Consolidating Statement of Income
For the Nine Months Ended September 30, 2006
(Dollars in thousands)


				Combined								Total
				Subsidiary			Combined Non-		Consolidating			Consolidated
	Parent			Guarantors			Guarantors		Adjustments			Amounts
Revenue	$	—		$	742,534		$	8,547	$	(8,547	)	$	742,534
Salaries, wages and employee benefits		—			420,490			—		—			420,490
Professional fees		—			70,739			88		—			70,827
Supplies		—			42,765			1		—			42,766
Rentals and leases		—			9,906			—		—			9,906
Other operating expenses		—			69,626			6,141		(5,339	)		70,428
Provision for doubtful accounts		—			13,756			—		—			13,756
Depreciation and amortization		—			14,114			813		(182	)		14,745
Interest expense		27,610			—			927		—			28,537

		27,610			641,396			7,970		(5,521	)		671,455

(Loss) income from continuing operations before income taxes		(27,610	)		101,138			577		(3,026	)		71,079
(Benefit from) provision for income taxes		(10,492	)		37,385			117		—			27,010

(Loss) income from continuing operations		(17,118	)		63,753			460		(3,026	)		44,069
Loss from discontinued operations, net of taxes		—			(992	)		—		—			(992	)

Net (loss) income	$	(17,118	)	$	62,761		$	460	$	(3,026	)	$	43,077

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended September 30, 2007
(Dollars in thousands)


				Combined
				Subsidiary			Combined			Consolidating			Total Consolidated
	Parent			Guarantors			Non-Guarantors			Adjustments			Amounts
Operating activities:
Net (loss) income	$	(37,763	)	$	107,896		$	5,085		$	(22,161	)	$	53,057
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			20,933			1,286			(182	)		22,037
Share-based compensation		—			12,006			—			—			12,006
Loss on refinancing of long-term debt		8,179			—			—			—			8,179
Amortization of loan costs and bond premium		1,557			—			34			—			1,591
Loss from discontinued operations		—			1,300			—			—			1,300
Change in income tax assets and liabilities		—			8,219			—			—			8,219
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		—			(18,616	)		59			—			(18,557	)
Prepaids and other current assets		—			8,182			(10,028	)		2,494			648
Accounts payable		—			(6,683	)		(101	)		—			(6,784	)
Salaries and benefits payable		—			(552	)		(214	)		—			(766	)
Accrued liabilities and other liabilities		7,860			(11,589	)		6,520			(2,494	)		297

Net cash (used in) provided by continuing operating activities		(20,167	)		121,096			2,641			(22,343	)		81,227
Net cash used in discontinued operating activities		—			(493	)		—			—			(493	)

Net cash (used in) provided by operating activities		(20,167	)		120,603			2,641			(22,343	)		80,734
Investing activities:
Cash paid for acquisitions, net of cash acquired		(462,729	)		—			—			—			(462,729	)
Capital purchases of leasehold improvements, equipment and software		—			(48,030	)		(331	)		—			(48,361	)
Other assets		—			(1,016	)		266			—			(750	)

Net cash used in investing activities		(462,729	)		(49,046	)		(65	)		—			(511,840	)
Financing activities:
Borrowings on long-term debt		481,875			—			—			—			481,875
Principal payments on long-term debt		(39,971	)		—			(249	)		—			(40,220	)
Net transfers to and from members		47,715			(70,721	)		663			22,343			—
Net decrease in revolving credit facility		(11,000	)		—			—			—			(11,000	)
Payment of loan and issuance costs		(6,603	)		—			—			—			(6,603	)
Costs to refinance long-term debt		(7,127	)		—			—			—			(7,127	)
Excess tax benefits from share-based payment arrangements		4,072			—			—			—			4,072
Proceeds from issuance of common stock upon exercise of stock options		13,935			—			—			—			13,935

Net cash provided by (used in) financing activities		482,896			(70,721	)		414			22,343			434,932

Net increase in cash		—			836			2,990			—			3,826
Cash and cash equivalents at beginning of period		—			1,149			17,423			—			18,572

Cash and cash equivalents at end of period	$	—		$	1,985		$	20,413		$	—		$	22,398

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2007

Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended September 30, 2006
(Dollars in thousands)


				Combined
				Subsidiary			Combined			Consolidating			Total Consolidated
	Parent			Guarantors			Non-Guarantors			Adjustments			Amounts
Operating activities:
Net (loss) income	$	(17,118	)	$	62,761		$	460		$	(3,026	)	$	43,077
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization		—			14,114			813			(182	)		14,745
Share-based compensation		—			10,449			—			—			10,449
Amortization of loan costs		1,192			(1	)		34			—			1,225
Loss from discontinued operations, net of taxes		—			992			—			—			992
Change in income tax assets and liabilities		—			24,270			—			—			24,270
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		—			(11,721	)		—			—			(11,721	)
Prepaids and other current assets		—			2,171			(5,856	)		—			(3,685	)
Accounts payable		—			(2,038	)		—			—			(2,038	)
Salaries and benefits payable		—			4,740			—			—			4,740
Accrued liabilities and other liabilities		(3,447	)		(3,172	)		8,035			—			1,416

Net cash (used in) provided by continuing operating activities		(19,373	)		102,565			3,486			(3,208	)		83,470
Net cash used in discontinued operating activities		—			(2,677	)		—			—			(2,677	)

Net cash (used in) provided by operating activities		(19,373	)		99,888			3,486			(3,208	)		80,793
Investing activities:
Cash paid for acquisitions, net of cash acquired		(167,065	)		—			—			—			(167,065	)
Capital purchases of leasehold improvements, equipment and software		—			(20,880	)		—			—			(20,880	)
Other assets		—			(176	)		211			—			35

Net cash (used in) provided by investing activities		(167,065	)		(21,056	)		211			—			(187,910	)
Financing activities:
Principal payments on long-term debt		(68	)		—			(206	)		—			(274	)
Net increase in revolving credit facility		52,000			—			—			—			52,000
Net transfers to and from members		123,380			(126,336	)		(252	)		3,208			—
Payment of loan and issuance costs		(101	)		—			—			—			(101	)
Excess tax benefits from share-based payment arrangements		5,771			—			—			—			5,771
Proceeds from issuance of common stock upon exercise of stock options		5,456			—			—			—			5,456

Net cash provided by (used in) financing activities		186,438			(126,336	)		(458	)		3,208			62,852

Net (decrease) increase in cash		—			(47,504	)		3,239			—			(44,265	)
Cash and cash equivalents at beginning of period		—			44,114			10,585			—			54,699

Cash and cash equivalents at end of period	$	—		$	(3,390	)	$	13,824		$	—		$	10,434

11. Recently Issued Accounting Pronouncements

In September 2006, 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. 159 will have, if any, on our consolidated financial statements.

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

Forward-Looking Statements.

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.” 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 of operations.

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 successfully integrate the operations of Horizon Health Corporation (“Horizon Health”);

•		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;

•		risks inherent to the health care industry, including the impact of unforeseen changes in regulation 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;

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

•		future trends for pricing, margins, revenue and profitability that 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 and other SEC filings, 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.

due 2013 (the “10⁵/₈% Notes”). These transactions were financed with an additional $225 million of term loans pursuant to our senior secured credit facility and the net proceeds of our offering of $250 million of 7³/₄%Senior Subordinated Notes due 2015 (the “7³/₄%Notes”). During January 2007, we completed the acquisition of an 86-bed inpatient behavioral health care facility in Columbia, South Carolina.

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 three months and nine months ended September 30, 2007, our same-facility revenue from owned and leased inpatient facilities increased by 8.3% and 7.0%, respectively, compared to the same period in 2006. Same-facility revenue growth was driven by increases in same-facility patient days and same-facility revenue per patient day. Same-facility patient days increased 1.5% and 1.6% during the three months and nine months ended September 30, 2007, respectively, compared to the same periods in 2006. Same-facility revenue per patient day increased 6.9% and 5.4%, respectively, for the three months and nine months ended September 30, 2007 compared to the same period in 2006. Same-facility growth refers to the comparison of each inpatient facility owned and leased by us 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 91.9% and 94.8% of our total revenue for the nine months ended September 30, 2007 and 2006, respectively. The decrease in the composition of patient service revenue relative to total revenue is primarily attributable to the other revenue generated from the contract management business, employee assistance programs and managed care plan in Puerto Rico acquired in the acquisitions of Alternative Behavioral Services, Inc. (“ABS”) and Horizon Health.

Other Revenue

Other revenue is primarily generated by our contract management business. Our contract management business provides inpatient psychiatric management and development services to hospitals and clinics based on negotiated contracts. Revenue generated by our contract management services is recorded as management contract revenue in the period the services are provided at contractually determined rates, provided that collectability of such amounts is reasonably assured. Other revenue is also generated by our employee assistance programs and our managed care plan in Puerto Rico. Other revenue comprised approximately 8.1% and 5.2% of our total revenue for the nine months ended September 30, 2007 and 2006, respectively.

Results of Operations

The following table illustrates our consolidated results of operations for the three and nine months ended September 30, 2007 and 2006 (dollars in thousands):


	For the Three Months Ended September 30,										For the Nine Months Ended September 30,
	2007					2006					2007					2006
	Amount		%			Amount		%			Amount		%			Amount		%
Revenue	$	402,021		100.0	%	$	253,696		100.0	%	$	1,078,585		100.0	%	$	742,534		100.0	%
Salaries, wages and employee benefits (including share-based compensation of $4,423, $2,059, $12,006 and $10,449 for the respective three and nine month periods in 2007 and 2006)		223,902		55.7	%		143,920		56.7	%		599,137		55.6	%		420,490		56.6	%
Professional fees		40,565		10.1	%		24,072		9.5	%		106,629		9.9	%		70,827		9.5	%
Supplies		21,820		5.4	%		14,494		5.7	%		59,745		5.5	%		42,766		5.8	%
Provision for doubtful accounts		7,019		1.8	%		4,401		1.7	%		20,958		1.9	%		13,756		1.9	%
Other operating expenses		44,264		11.0	%		26,312		10.4	%		120,417		11.2	%		80,334		10.8	%
Depreciation and amortization		8,525		2.1	%		5,194		2.0	%		22,037		2.0	%		14,745		2.0	%
Interest expense, net		22,253		5.5	%		10,059		4.0	%		53,669		5.0	%		28,537		3.8	%
Loss on refinancing long-term debt		—		0.0	%		—		0.0	%		8,179		0.8	%		—		0.0	%

Income from continuing operations before income taxes		33,673		8.4	%		25,244		10.0	%		87,814		8.1	%		71,079		9.6	%
Provision for income taxes		12,831		3.2	%		9,593		3.8	%		33,457		3.1	%		27,010		3.7	%

Income from continuing operations	$	20,842		5.2	%	$	15,651		6.2	%	$	54,357		5.0	%	$	44,069		5.9	%

Three Months Ended September 30, 2007 Compared To Three Months Ended September 30, 2006

The following table compares key operating statistics for our owned and leased inpatient facilities for the quarters ended September 30, 2007 and 2006 (revenue in thousands). Same-facility statistics for the quarter ended September 30, 2007 are shown on a comparable basis with statistics for the quarter ended September 30, 2006.


	Three Months Ended September 30,				%
	2007		2006		Change
Total facility results:
Revenue	$	359,295	$	240,749		49.2	%
Number of facilities at period end		90		63		42.9	%
Admissions		36,749		26,250		40.0	%
Patient days		642,650		459,518		39.9	%
Average length of stay		17.5		17.5		0.0	%
Revenue per patient day	$	559	$	524		6.7	%

Same-facility results:
Revenue	$	254,680	$	235,171		8.3	%
Number of facilities at period end		61		61		0.0	%
Admissions		25,888		25,738		0.6	%
Patient days		454,129		447,533		1.5	%
Average length of stay		17.5		17.4		0.6	%
Revenue per patient day	$	561	$	525		6.9	%

Revenue. Revenue from continuing operations was $402.0 million for the quarter ended September 30, 2007 compared to $253.7 million for the quarter ended September 30, 2006, an increase of $148.3 million, or 58.5%. Revenue from owned and leased inpatient facilities accounted for $359.3 million in 2007 compared to $240.7 million in 2006, an increase of $118.5 million, or 49.2%. The increase in revenue from owned and leased inpatient facilities relates primarily to our acquisitions of behavioral health care facilities during 2006 and 2007, which accounted for $99.7 million of the increase in revenue. The remainder of the increase in revenue from owned and leased inpatient facilities was primarily attributable to same-facility growth in patient days and revenue per patient day of 1.5% and 6.9%, respectively. The increase in revenue from other operations was primarily due to new operations acquired in the ABS and Horizon Health acquisitions.

Salaries, wages and employee benefits. Salaries, wages and employee benefits (“SWB”) expense was $223.9 million for the quarter ended September 30, 2007 compared to $143.9 million for the quarter ended September 30, 2006. SWB expense includes $4.4 million and $2.1 million of share-based compensation expense for the quarters ended September 30, 2007 and 2006, respectively. Excluding share-based compensation expense, SWB expense was $219.5 million, or 54.6% of total revenue, in the quarter ended September 30, 2007 compared to $141.9 million, or 55.9% of total revenue, for the quarter ended September 30, 2006. SWB expense for owned and leased inpatient facilities was $195.9 million, or 54.5% of revenue, in 2007. Same-facility SWB expense for owned and leased inpatient facilities was $136.7 million, or 53.7% of revenue, in 2007 compared to $129.3 million, or 54.6% of revenue, in 2006. The increase in SWB expense for other operations was primarily a result of new operations acquired in the ABS and Horizon Health acquisitions. SWB expense for our corporate office was $10.7 million, including $4.4 million in share-based compensation, for 2007 compared to $7.6 million, including $2.1 million in share-based compensation, for 2006. Excluding share-based compensation, SWB expense for our corporate office increased approximately $0.8 million primarily because of the hiring of additional staff to manage the inpatient facilities acquired during 2006 and 2007.

Professional fees. Professional fees were $40.6 million for the quarter ended September 30, 2007, or 10.1% of total revenue, compared to $24.1 million for the quarter ended September 30, 2006, or 9.5% of total revenue. Professional fees for owned and leased inpatient facilities were $33.7 million in 2007, or 9.4% of revenue. Same-facility professional fees for owned and leased inpatient facilities were $22.3 million in 2007, or 8.7% of revenue, compared to $21.8 million in 2006, or 9.2% of revenue. The increase in professional fees for other operations was primarily a result of new operations acquired in the ABS and Horizon Health acquisitions.

Supplies. Supplies expense was $21.8 million for the quarter ended September 30, 2007, or 5.4% of total revenue, compared to $14.5 million for the quarter ended September 30, 2006, or 5.7% of total revenue. Supplies expense for owned and leased inpatient facilities was $21.4 million in 2007, or 5.9% of revenue. Same-facility supplies expense for owned and leased inpatient facilities was $14.6 million in 2007, or 5.7% of revenue, compared to $13.9 million in 2006, or 5.9% of revenue.

Provision for doubtful accounts. The provision for doubtful accounts was $7.0 million for the quarter ended September 30, 2007, or 1.8% of total revenue, compared to $4.4 million for the quarter ended September 30, 2006, or 1.7% of total revenue.

Other operating expenses. Other operating expenses consist primarily of rent, utilities, insurance, travel, and repairs and maintenance expenses. Other operating expenses were approximately $44.3 million for the quarter ended September 30, 2007, or 11.0% of total revenue, compared to $26.3 million for the quarter ended September 30, 2006, or 10.4% of total revenue. Other operating expenses for owned and leased inpatient facilities were $30.4 million in 2007, or 8.5% of revenue. Same-facility other operating expenses for owned and leased inpatient facilities were $20.0 million in 2007, or 7.8% of revenue, compared to $20.1 million in 2006, or 8.5% of revenue. The decrease in same-facility other operating expenses for owned and leased inpatient facilities was primarily the result of reductions in risk management costs as a percent of revenue. The increase in other operating expenses for other operations resulted primarily from new operations acquired in the ABS and Horizon Health acquisitions.

Depreciation and amortization. Depreciation and amortization expense was $8.5 million for the quarter ended September 30, 2007 compared to $5.2 million for the quarter ended September 30, 2006. This increase in depreciation and amortization expense was primarily the result of our acquisitions of inpatient facilities during 2006 and 2007.

Interest expense, net. Interest expense, net of interest income, was $22.3 million for the quarter ended September 30, 2007 compared to $10.1 million for the quarter ended September 30, 2006, an increase of $12.2 million. At September 30, 2007, we had $1,182.5 million in long-term debt compared to $538.4 million at September 30, 2006. The increase in interest expense was primarily the result of the increase in our long-term debt to finance acquisitions during the past twelve months. We borrowed $210.0 million in December 2006 to finance the acquisition of ABS and we incurred net borrowings of $443.2 million in May 2007 to finance the acquisition of Horizon Health.

Loss from discontinued operations, net of taxes. The loss from discontinued operations (net of income tax effect) was $0.5 million and $0.1 million for the quarters ended September 30, 2007 and 2006, respectively. During the quarter ended June 30, 2007, we elected to dispose of one inpatient facility and accordingly we reclassified its operations as discontinued operations.

Nine Months Ended September 30, 2007 Compared To Nine Months Ended September 30, 2006

The following table compares key operating statistics for our owned and leased inpatient facilities for the nine months ended September 30, 2007 and 2006 (revenue in thousands). Same-facility statistics for the nine months ended September 30, 2007 are shown on a comparable basis with statistics for the nine months ended September 30, 2006.


	Nine Months Ended September 30,				%
	2007		2006		Change
Total facility results:
Revenue	$	991,299	$	704,282		40.8	%
Number of facilities at period end		90		63		42.9	%
Admissions		103,608		79,458		30.4	%
Patient days		1,788,185		1,356,138		31.9	%
Average length of stay		17.3		17.1		1.2	%
Revenue per patient day	$	554	$	519		6.7	%

Same-facility results:
Revenue	$	736,222	$	688,222		7.0	%
Number of facilities at period end		61		61		0.0	%
Admissions		79,846		77,887		2.5	%
Patient days		1,341,105		1,320,133		1.6	%
Average length of stay		16.8		16.9		-0.6	%
Revenue per patient day	$	549	$	521		5.4	%

Revenue. Revenue from continuing operations was $1,078.6 million for the nine months ended September 30, 2007 compared to $742.5 million for the nine months ended September 30, 2006, an increase of $336.1 million, or 45.3%. Revenue from owned and leased inpatient facilities accounted for $991.3 million in 2007 compared to $704.3 million in 2006, an increase of $287.0 million, or 40.8%. The increase in revenue from owned and leased inpatient facilities relates primarily to our acquisitions of behavioral health care facilities during 2006 and 2007, which accounted for $247.8 million of the increase in revenue. The remainder of the increase in revenue from owned and leased inpatient facilities was primarily attributable to same-facility growth in patient days and revenue per patient day of 1.6% and 5.4%, respectively. The increase in revenue from other operations was primarily due to new operations acquired in the ABS and Horizon Health acquisitions.

Salaries, wages and employee benefits. SWB expense was $599.1 million for the nine months ended September 30, 2007 compared to $420.5 million for the nine months ended September 30, 2006. SWB expense includes $12.0 million and $10.4 million of share-based compensation

expense for the nine months ended September 30, 2007 and 2006, respectively. Share-based compensation expense for the nine months ended September 30, 2006 includes $2.2 million related to options modified in the settlement of an employment contract with one of our former executive officers. Excluding share-based compensation expense, SWB expense was $587.1 million, or 54.4% of total revenue, in the nine months ended September 30, 2007 compared to $410.0 million, or 55.2% of total revenue, for the nine months ended September 30, 2006. SWB expense for owned and leased inpatient facilities was $536.4 million, or 54.1% of revenue, in 2007. Same-facility SWB expense for owned and leased inpatient facilities was $393.8 million, or 53.5% of revenue, in 2007 compared to $375.3 million, or 54.1% of revenue, in 2006. The increase in SWB expense for other operations was primarily a result of new operations acquired in the ABS and Horizon Health acquisitions. SWB expense for our corporate office was $30.8 million, including $12.0 million in share-based compensation, for 2007 compared to $24.3 million, including $10.4 million in share-based compensation, for 2006. Excluding share-based compensation, SWB expense for our corporate office increased approximately $4.9 million primarily because of the hiring of additional staff to manage the inpatient facilities acquired during 2006 and 2007.

Professional fees. Professional fees were $106.6 million for the nine months ended September 30, 2007, or 9.9% of total revenue, compared to $70.8 million for the nine months ended September 30, 2006, or 9.5% of total revenue. Professional fees for owned and leased inpatient facilities were $93.6 million in 2007, or 9.4% of revenue. Same-facility professional fees for owned and leased inpatient facilities were $66.7 million in 2007, or 9.1% of revenue, compared to $64.0 million in 2006, or 9.2% of revenue. The increase in professional fees for other operations was primarily a result of new operations acquired in the ABS and Horizon Health acquisitions.

Supplies. Supplies expense was $59.7 million for the nine months ended September 30, 2007, or 5.5% of total revenue, compared to $42.8 million for the nine months ended September 30, 2006, or 5.8% of total revenue. Supplies expense for owned and leased inpatient facilities was $58.6 million in 2007, or 5.9% of revenue. Same-facility supplies expense for owned and leased inpatient facilities was $42.7 million in 2007, or 5.8% of revenue, compared to $41.1 million in 2006, or 5.9% of revenue.

Provision for doubtful accounts. The provision for doubtful accounts was $21.0 million for the nine months ended September 30, 2007, or 1.9% of total revenue, compared to $13.8 million for the quarter ended September 30, 2006, or 1.9% of total revenue.

Other operating expenses. Other operating expenses consist primarily of rent, utilities, insurance, travel, and repairs and maintenance expenses. Other operating expenses were approximately $120.4 million for the nine months ended September 30, 2007, or 11.2% of total revenue, compared to $80.3 million for the nine months ended September 30, 2006, or 10.8% of total revenue. Other operating expenses for owned and leased inpatient facilities were $85.3 million in 2007, or 8.6% of revenue. Same-facility other operating expenses for owned and leased inpatient facilities were $60.3 million in 2007, or 8.2% of revenue, compared to $61.5 million in 2006, or 8.9% of revenue. The decrease in same-facility other operating expenses for owned and leased inpatient facilities was primarily the result of reductions in risk management costs as a percent of revenue. The increase in other operating expenses for other operations was primarily due to new operations acquired in the ABS and Horizon Health acquisitions.

Depreciation and amortization. Depreciation and amortization expense was $22.0 million for the nine months ended September 30, 2007 compared to $14.7 million for the nine months ended September 30, 2006. This increase in depreciation and amortization expense was primarily the result of our acquisitions of inpatient facilities during 2006 and 2007.

Interest expense, net. Interest expense, net of interest income, was $53.7 million for the nine months ended September 30, 2007 compared to $28.5 million for the nine months ended September 30, 2006, an increase of $25.1 million. At September 30, 2007, we had $1,182.5 million in long-term debt compared to $538.4 million at September 30, 2006. The increase in interest expense was primarily the result of the increase in our long-term debt to finance acquisitions during the past twelve months. We borrowed $210.0 million in December 2006 to finance the acquisition of ABS and we incurred net borrowings of $443.2 million in May 2007 to finance the acquisition of Horizon Health.

Loss on refinancing of long-term debt. The cash purchase price for the Horizon Health acquisition and the cash paid for the 10⁵/₈% Notes were provided by an additional $225 million of term loans pursuant to our senior secured credit facility and the net proceeds of our offering of $250 million of 7³/₄%Notes. We incurred a loss of $8.2 million to finance these transactions that consists primarily of the amount above par value paid to repurchase our 10⁵/₈% Notes, the write-off of capitalized financing costs associated with our 10⁵/₈% Notes and the amount paid to exit our interest rate swap agreements.

Loss from discontinued operations, net of taxes. The loss from discontinued operations (net of income tax effect) was $1.3 million and $1.0 million for the nine months ended September 30, 2007 and 2006, respectively. During the quarter ended June 30, 2007, we elected to dispose of one inpatient facility and accordingly we reclassified its operations to discontinued operations.

Liquidity and Capital Resources

Working capital at September 30, 2007 was $145.7 million, including cash and cash equivalents of $22.4 million, compared to working capital of $103.3 million, including cash and cash equivalents of $18.6 million, at December 31, 2006. We acquired $27.8 million of working capital from acquisitions during the nine months ended September 30, 2007. Additionally, accounts receivable,

excluding the effect of acquisitions, increased $18.6 million primarily as a result of a 7.0% increase in our same-facility revenue for the nine months ended September 30, 2007 as compared to the same period last year.

Cash provided by continuing operating activities was $81.2 million for the nine months ended September 30, 2007 compared to $83.5 million for the nine months ended September 30, 2006. This $2.3 million decrease in cash flows from continuing operating activities was primarily the result of income tax payments in 2007 of $21.5 million partially offset by an increase in operating results. We substantially utilized our net operating loss carryforwards in 2006 and began making income tax payments in 2007.

Cash used in investing activities was $511.8 million for the nine months ended September 30, 2007 compared to $187.9 million for the nine months ended September 30, 2006. Cash used in investing activities for the nine months ended September 30, 2007 primarily consisted of $462.7 million paid for acquisitions and $48.4 million for purchases of fixed assets. Cash used for routine and expansion capital expenditures was approximately $21.8 million and $26.6 million, respectively, for the nine months ended September 30, 2007. We define expansion capital expenditures as those that increase our capacity or otherwise enhance revenue. Routine or maintenance capital expenditures were 2.0% of our revenue for the nine months ended September 30, 2007. Cash used in investing activities for the nine months ended September 30, 2006 primarily consisted of cash paid for acquisitions of approximately $167.1 million and capital expenditures of approximately $20.9 million.

Cash provided by financing activities was $434.9 million for the nine months ended September 30, 2007 compared to $62.9 million for the nine months ended September 30, 2006. Cash provided by financing activities for the nine months ended September 30, 2007 consisted primarily of an additional $225.0 million of senior secured term loans, the issuance of an additional $250.0 million of our 7³/₄% Notes as well as an additional $11.0 million in net payments under our revolving credit facility, which were used to finance acquisitions and to repurchase approximately $38.6 million of our 10⁵/₈% Notes. Additionally, during the nine months ended September 30, 2007, we received $13.9 million in proceeds from the exercise of stock options and $4.1 million in income tax benefits in excess of share-based compensation expense on stock options exercised in 2007. Cash provided by financing activities for the nine months ended September 30, 2006 primarily consisted of $52.0 million in net borrowings under our revolving credit facility, $5.8 million in income tax benefits in excess of share-based compensation expense on stock options exercised and $5.5 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.

During the second quarter of 2007, we terminated our interest rate swap agreements that previously were used to manage our exposure to fluctuations in interest rates related to our 10⁵/₈% Notes.

We are actively seeking acquisitions that fit our corporate growth strategy and may acquire additional inpatient behavioral health care 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 behavioral health care 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 6.7% at September 30, 2007 and December 31, 2006		90,000	$	—	$	90,000	$	—	$	—
Senior secured term loan facility, expiring on July 1, 2012 and bearing interest of 7.2% and 7.1% at September 30, 2007 and December 31, 2006, respectively		574,250		4,688		7,500		7,500		554,562
7 3/4% Senior Subordinated Notes due July 15, 2015		476,667		—		—		—		476,667
10 5/8% Senior Subordinated Notes due June 15, 2013		34		—		—		—		34
Mortgage loans on facilities, maturing in 2036, 2037 and 2038 bearing fixed interest rates of 5.7% to 7.6%		33,766		391		859		973		31,543

		1,174,717		5,079		98,359		8,473		1,062,806

Lease and other obligations		88,835		16,767		26,587		15,436		30,045

Total contractual obligations	$	1,263,552	$	21,846	$	124,946	$	23,909	$	1,092,851


(1)		Excludes capital lease and other obligations of $7.7 million, which are included in lease and other obligations.

The fair value of our $470.0 million 7³/₄% Notes was approximately $475.9 million as of September 30, 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 $705.8 million and $484.6 million at September 30, 2007 and December 31, 2006, respectively, approximated fair value. We had $574.3 million and $90.0 million of variable rate debt outstanding under our senior secured term loan facility and revolving credit facility, respectively, as of September 30, 2007. At our September 30, 2007 borrowing level, a hypothetical 10% increase in interest rates would decrease our annual net income and cash flows by approximately $2.9 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, revenue, 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 September 30, 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 an 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 of 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 caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — 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 September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

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).


Exhibit
Number		Description
	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).

	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



Date: November 6, 2007	/s/ Joey A. Jacobs
	Joey A. Jacobs
	Chairman, Chief Executive Officer and President



Date: November 6, 2007	/s/ Jack E. Polson
	Jack E. Polson
	Executive Vice President, Chief Accounting Officer



	/s/ Joey A. Jacobs
	Joey A. Jacobs
	Chairman, Chief Executive Officer and President


	/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 September 30, 2007 and December 31, 2006 (Unaudited)		1
Condensed Consolidated Statements of Income for the three and nine month periods ended September 30, 2007 and 2006 (Unaudited)		2
Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 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		16
Item 3. Quantitative and Qualitative Disclosures About Market Risk		23
Item 4. Controls and Procedures		23
PART II. OTHER INFORMATION
Item 6. Exhibits		23
Ex-31.1 Section 302 Certification of the CEO
Ex-31.2 Section 302 Certification of the CFO
Ex-32.1 Section 906 Certification of the CEO & CFO