-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Rxb5mlkofZJKn7//n3sHZLZJWGNhLcvl+KRiIRML3P2kRxRTRxC6PdQRFN2lAO68 EdMQYVbzKdI5Ft/MgoBB/Q== 0000915127-02-000049.txt : 20020919 0000915127-02-000049.hdr.sgml : 20020919 20020919142546 ACCESSION NUMBER: 0000915127-02-000049 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020919 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PHC INC /MA/ CENTRAL INDEX KEY: 0000915127 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HOME HEALTH CARE SERVICES [8082] IRS NUMBER: 042601571 STATE OF INCORPORATION: MA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-22916 FILM NUMBER: 02767665 BUSINESS ADDRESS: STREET 1: 200 LAKE ST STE 102 CITY: PEABODY STATE: MA ZIP: 01960 BUSINESS PHONE: 9785362777 MAIL ADDRESS: STREET 1: 200 LAKE ST STREET 2: STE 102 CITY: PEABODY STATE: MA ZIP: 01960 10-K 1 k10k_0902.txt 10K ANNUAL REPORT U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB [X] Annual report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 2002 [ ] Transition report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to Commission file number: 0-22916 PHC, INC. (Name of small business issuer in its charter) MASSACHUSETTS 04-2601571 (State or other jurisdiction of (I.R.S. Employer Identification No.) Incorporation or organization) 200 LAKE STREET, SUITE 102, PEABODY, MA 01960 (Address of principal executive offices) (Zip Code) Issuer's telephone number: (978) 536-2777 Securities registered under Section 12(b) of the Act: NONE. Securities registered under Section 12(g) of the Act: CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. No Disclosure X The issuer's revenues for the fiscal year ended June 30, 2002 were $22,698,268 . The aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of August 1, 2002, was $7,439,461.90. (See definition of affiliate in Rule 12b-2 of Exchange Act). At August 1, 2002, 12,880,916 shares of the issuer's Class A Common Stock and 726,991 shares of the issuer's Class B Common Stock were outstanding. TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT: Yes__ No X - 1 - PART I ITEM 1. DESCRIPTION OF BUSINESS INTRODUCTION Our company is a national health care company, which provides psychiatric services primarily to individuals who have alcohol and drug dependency, related disorders and to individuals in the gaming and transportation industries. We operate substance abuse treatment facilities in Utah and Virginia, four outpatient psychiatric facilities in Michigan, two outpatient psychiatric facilities in Nevada, one outpatient psychiatric facility in Kansas and an inpatient psychiatric facility in Michigan. We also operate a website, Wellplace.com, which provides education, training and materials to behavioral health professionals in addition to providing Internet support to all of our other subsidiaries. We also provide help line services through contracts with major railroads and the State of Nebraska. Through our newest subsidiary in Michigan the company conducts studies of the effects of psychiatric pharmaceuticals on a controlled population through contracts with major manufacturers of these pharmaceuticals. Until February 2001 we also provided management and administrative services to psychotherapy and psychological practices in New York. Our company provides behavioral health services and products through inpatient and outpatient facilities and online to behavioral health professionals. Our substance abuse facilities provide specialized treatment services to patients who typically have poor recovery prognoses and who are prone to relapse. These services are offered in small specialty care facilities, which permit us to provide our clients with efficient and customized treatment without the significant costs associated with the management and operation of general acute care hospitals. We tailor these programs and services to "safety-sensitive" industries and concentrate our marketing efforts on the transportation, heavy equipment, manufacturing, law enforcement, gaming and health services industries. Our psychiatric facility provides inpatient psychiatric care and intensive outpatient treatment, referred to as partial hospitalization, to children, adolescents and adults. Our outpatient mental health clinics provide services to employees of major employers, as well as to managed care, Medicare and Medicaid clients. The psychiatric services are offered in a larger, more traditional setting than PHC's substance abuse facilities, enabling PHC to take advantage of economies of scale to provide cost-effective treatment alternatives. The company treats employees who have been referred for treatment as a result of compliance with Subchapter D of the Anti-Drug Abuse Act of 1988 (commonly known as the Drug Free Workplace Act), which requires employers who are Federal contractors or Federal grant recipients to establish drug-free awareness programs which, among other things, inform employees about available drug counseling; rehabilitation and employee assistance programs. We also provide treatment under the Department of Transportation implemented regulations, which broaden the coverage and scope of alcohol and drug testing for employees in "safety sensitive" positions in the transportation industry. The company was incorporated in 1976 and is a Massachusetts corporation. Our corporate offices are located at 200 Lake Street, Suite 102, Peabody, MA 01960 and our telephone number is (978) 536-2777. - 2 - PSYCHIATRIC SERVICES INDUSTRY Substance Abuse Facilities Industry Background The demand for substance abuse treatment services increased rapidly in the last decade. The company believes that the increased demand is related to clinical advances in the treatment of substance abuse, greater societal willingness to acknowledge the underlying problems as treatable illnesses, improved health insurance coverage for addictive disorders and chemical dependencies and governmental regulation which requires certain employers to provide information to employees about drug counseling and employee assistance programs. To contain costs associated with behavioral health issues in the 1980s, many private payors instituted managed care programs for reimbursement, which included pre-admission certification, case management or utilization review and limits on financial coverage or length of stay. These cost containment measures have encouraged outpatient care for behavioral problems, resulting in a shortening of the length of stay and revenue per day in inpatient chemical abuse facilities. The company believes that it has addressed these cost containment measures by specializing in treating relapse-prone patients with poor prognoses who have failed in other treatment settings. These patients require longer lengths of stay and come from a wide geographic area. The company continues to develop alternatives to inpatient care including partial day and evening programs in addition to on site and off site outpatient programs. The company believes that because of the apparent unmet need for certain clinical and medical services, its strategy has been successful despite national trends towards outpatient treatment, shorter inpatient stays and rigorous scrutiny by managed care organizations. Company Operations The company has been able to secure insurance reimbursement for longer-term inpatient treatment as a result of its success with poor prognosis patients. The company's two substance abuse facilities work together to refer patients to the center that best meets the patient's clinical and medical needs. Each facility caters to a slightly different patient population including high-risk, relapse-prone chronic alcoholics, drug addicts, Native Americans and dual diagnosis patients (those suffering from both substance abuse and psychiatric disorders). The company concentrates on providing services to insurers, managed care networks and health maintenance organizations for both adults and adolescents. The company's clinicians often work directly with managers of employee assistance programs to select the best treatment facility possible for their clients. Each of the company's facilities operates a case management program for each patient including a clinical and financial evaluation of a patient's circumstances to determine the most cost-effective modality of care from among outpatient treatment, detoxification, inpatient, day care, specialized relapse treatment and others. In addition to any care provided at one of the company's facilities, the case management program for each patient includes aftercare. Aftercare may be provided through the outpatient services provided by a facility. Alternatively, the company may arrange for outpatient aftercare, as well as family and mental health services, through its numerous affiliations with clinicians located across the country once the patient is discharged. - 3 - In general, the company does not accept patients who do not have either insurance coverage or adequate financial resources to pay for treatment. Each of the company's substance abuse facilities does, however, provide treatment free of charge to a small number of patients each year who are unable to pay for treatment, but who meet certain clinical criteria and who are believed by the company to have the requisite degree of motivation for treatment to be successful. In addition, the company provides follow-up treatment free of charge to relapse patients who satisfy certain criteria. The number of patient days attributable to all patients who receive treatment free of charge in any given fiscal year is less than 5%. The company believes that it has benefited from an increased awareness of the need to make substance abuse treatment services accessible to the nation's workforce. For example, Subchapter D of the Anti-Drug Abuse Act of 1988 (commonly known as The Drug Free Workplace Act), requires employers who are Federal contractors or Federal grant recipients to establish drug free awareness programs to inform employees about available drug counseling, rehabilitation and employee assistance programs and the consequences of drug abuse violations. In response to the Drug Free Workplace Act, many companies, including many major national corporations and transportation companies, have adopted policies that provide for treatment options as an alternative to termination of employment. Although the company does not directly provide federally approved mandated drug testing, the company treats employees who have been referred to the company as a result of compliance with the Drug Free Workplace Act, particularly from companies that are part of the gaming industry as well as safety sensitive industries such as railroads, airlines, trucking firms, oil and gas exploration companies, heavy equipment companies, manufacturing companies and health services. HIGHLAND RIDGE - Highland Ridge is a 32-bed, freestanding alcohol and drug treatment hospital, which the company has been operating since 1984. It is the oldest facility dedicated to substance abuse in Utah. Highland Ridge is accredited by the Joint Commission on Accreditation of Healthcare Organizations ("JCAHO") and is licensed by the Utah Department of Health. Highland Ridge is recognized nationally for its excellence in treating substance abuse disorders. Most patients are from Utah and surrounding states. Individuals typically access Highland Ridge's services through professional referrals, family members, employers, employee assistance programs or contracts between the company and health maintenance organizations located in Utah. Highland Ridge was the first private for-profit hospital to address specifically the special needs of chemically dependent women in Salt Lake County. In addition, Highland Ridge has contracted with Salt Lake County to provide medical detoxification services targeted to women. The hospital also operates a specialized continuing care support group to address the unique needs of women and minorities. A pre-admission evaluation, which involves an evaluation of psychological, cognitive and situational factors, is completed for each prospective patient. In addition, each prospective patient is given a physical examination upon admission. Diagnostic tools, including those developed by the American Psychological Association, the American Society of Addiction Medicine and the Substance Abuse Subtle Screening Inventory are used to develop an individualized treatment plan for each client. The treatment regimen involves an interdisciplinary team which integrates the twelve-step principles of self-help organizations, medical detoxification, individual and group counseling, family therapy, psychological assessment, psychiatric support, stress management, dietary planning, vocational counseling and pastoral support. Highland Ridge also offers extensive aftercare assistance at programs strategically located in areas of client concentration throughout the United States. Highland Ridge - 4 - maintains a comprehensive array of professional affiliations to meet the needs of discharged patients and other individuals not admitted to the hospital for treatment. Highland Ridge periodically conducts or participates in research projects. Highland Ridge was the site of a research project conducted by the University of Utah Medical School. The research explored the relationship between individual motivation and treatment outcomes. The research was regulated and reviewed by the Human Subjects Review Board of the University of Utah and was subject to federal standards that delineated the nature and scope of research involving human subjects. Highland Ridge benefited from this research by expanding its professional relationships within the medical school community and by applying the findings of the research to improve the quality of services the company delivers. In the spring of 1994, the company began to operate a crisis hotline service under contract with a major transportation client. The hotline, Pioneer Development Support Services, or PDS2 ("PDS2"), shown as Contract support services on the accompanying income statement, is a national, 24-hour telephone service, which supplements the services provided by the client's Employee Assistance Programs. The services provided include information, crisis intervention, critical incidents coordination, employee counselor support, client monitoring, case management and health promotion. The hotline is staffed by counselors who refer callers to the appropriate professional resources for assistance with personal problems. Four major transportation companies subscribed to these services as of June 30, 2002. This operation is physically located in Highland Ridge Hospital, but a staff dedicated to PDS2 provides the services. PDS2 is currently operated by the parent entity, PHC, Inc. MOUNT REGIS - Mount Regis is a 26-bed, freestanding alcohol and drug treatment center located in Salem, Virginia, near Roanoke. The company acquired the center in 1987. It is the oldest of its kind in the Roanoke Valley. Mount Regis is accredited by the JCAHO, and licensed by the Department of Mental Health, Mental Retardation and Substance Abuse Services of the Commonwealth of Virginia. In addition, Mount Regis operates Changes, an outpatient clinic, at its Salem Virginia location. The Changes clinic provides structured intensive outpatient treatment for patients who have been discharged from Mount Regis and for patients who do not need the formal structure of a residential treatment program. The program is licensed by the Commonwealth of Virginia and approved for reimbursement by major insurance carriers. Mount Regis Center's programs are sensitive to needs of women and minorities. The majority of Mount Regis clients are from Virginia and surrounding states. In addition, because of its relatively close proximity and accessibility to New York, Mount Regis has been able to attract an increasing number of referrals from New York-based labor unions. Mount Regis has established programs that allow the company to better treat dual diagnosis patients (those suffering from both substance abuse and psychiatric disorders), cocaine addiction and relapse-prone patients. The multi-disciplinary case management, aftercare and family programs are key to the prevention of relapse. General Psychiatric Facilities Introduction The company believes that its proven ability to provide high quality, cost-effective care in the treatment of substance abuse has enabled it to grow in the related behavioral health field of psychiatric treatment. The company's main advantage is its ability to provide an integrated delivery system of inpatient and outpatient care. As a result of integration, the company is better able to manage and track patients. - 5 - The company offers inpatient and partial hospitalization psychiatry services through Harbor Oaks Hospital. The company also currently operates seven outpatient psychiatric facilities. The company's philosophy at these facilities is to provide the most appropriate and efficacious care with the least restrictive modality of care. An attending physician and a case manager with continuing oversight of the patient as the patient receives care in different locations or programs handle case management. The integrated delivery system allows for better patient tracking and follow-up, and fewer repeat procedures and therapeutic or diagnostic errors. Qualified, dedicated staff members take a full history on each new patient and through test and evaluation procedures they provide a thorough diagnostic write-up of the patient's condition. In addition a physician does a complete physical examination for each new patient. This information allows the caregivers to determine which treatment alternative is best suited for the patient and to design an individualized recovery program for the patient. Managed health care organizations, state agencies, physicians and patients themselves refer patients to our facilities. These facilities have a patient population ranging from children as young as 5 years of age to senior citizens. The psychiatric facilities treat a larger percentage of female patients than the substance abuse facilities. HARBOR OAKS - The Company acquired Harbor Oaks Hospital, a 64-bed psychiatric hospital located in New Baltimore, Michigan, approximately 20 miles northeast of Detroit, in September 1994. Harbor Oaks Hospital is licensed by the Michigan Department of Commerce and it is accredited by JCAHO. Harbor Oaks provides inpatient psychiatric care, partial hospitalization and outpatient treatment to children, adolescents and adults. Harbor Oaks Hospital has serviced clients from Macomb, Oakland and St. Clair Counties and has now expanded its coverage area to include Wayne, Sanilac and Livingston Counties. The company utilizes the Harbor Oaks facility as a mental health resource to complement its nationally focused substance abuse treatment programs. Harbor Oaks Hospital has a specialty program that treats substance abuse patients who have a coexisting psychiatric disorder. This program provides an integrated holistic approach to the treatment of individuals who have both substance abuse and psychiatric problems. Both adults and adolescents can benefit from this program. On February 10, 1997, Harbor Oaks Hospital opened an 8-bed adjudicated residential unit serving adolescents with a substance abuse problem and a co-existing mental disorder who have been adjudicated to have committed criminal acts and who have been referred or required to undergo psychiatric treatment by a court or family service agency. The patients in the program range from 13 to 18 years of age. The program provides patients with educational and recreational activities and adult life functioning skills as well as treatment. Typically, a patient is admitted to the unit for an initial period of 30 days to six months. A case review is done for any patient still in the program at six months, and each subsequent six-month period thereafter, to determine if additional treatment is required. State authorization allowed the company to increase the number of beds in the adjudicated residential unit to twelve on May 1, 1998 and twenty on June 26, 1998. HARMONY HEALTHCARE - Harmony Healthcare, which consists of two psychiatric clinics in Nevada, provides outpatient psychiatric care to children, adolescents and adults in the local area. Harmony also operates employee assistance programs for railroads, health care companies and several large casino companies including Boyd Gaming Corporation, the MGM Grand and the Venetian with a rapid response program to provide immediate assistance 24 hours a day. Harmony also provides outpatient psychiatric care and inpatient psychiatric case management through a capitated rate behavioral health carve-out with Pacific Care Insurance. In addition, Harmony began clinical trials in the last quarter of the current fiscal year. - 6 - TOTAL CONCEPT EAP - Total Concept, an outpatient clinic located in Shawnee Mission, Kansas, provides psychiatric and substance abuse treatment to children, adolescents and adults and manages employee assistance programs for local businesses, gaming, railroads and managed health care companies. NORTH POINT-PIONEER, INC. - NPP consists of four psychiatric clinics in Michigan. The clinics provide outpatient psychiatric and substance abuse treatment to children, adolescents and adults operating under the name Pioneer Counseling Center. The four clinics are located in close proximity to the Harbor Oaks facility, which provides more efficient integration of inpatient and outpatient services, a larger coverage area and the ability to share personnel which results in cost savings. PIONEER PHARMACEUTICAL RESEARCH, INC. - PPR works with major manufacturers of psychiatric pharmaceuticals to assist in the study of the effects of certain pharmaceuticals in the treatment of specific mental illness. These studies are conducted primarily through our facilities in Michigan, Harbor Oaks Hospital and North Point-Pioneer with the permission and assistance of patients who are in treatment. Internet Operations WELLPLACE - Behavioral Health Online designs, develops and maintains the company's web site, Wellplace.com in addition to providing Internet support services and maintaining the web sites of all of the other subsidiaries of the company. The company's web sites provide behavioral health professionals with the educational tools required to keep them abreast of behavioral health breakthroughs and keeps individuals informed of current issues in behavioral health of interest to them. - 7 - Operating Statistics The following table reflects selected financial and statistical information for all psychiatric services. Year Ended June 30, 2002 2001 _____________________________ Inpatient Net patient service revenues $ 14,130,471 $ 13,507,124 Net revenues per patient day (1) $ 413 $ 418 Average occupancy rate (2) 76.9% 72.0% Total number of licensed beds at end of period 122 122 Source of Revenues: Private (3) 76.82% 82.0% Government (4) 23.18% 18.0% Partial Hospitalization and Outpatient Net Revenues:* Individual $ 4,678,493 $ 5,283,278 Contract $ 2,300,140 $ 2,297,071 Sources of revenues: Private 98.1% 97.9% Government 1.9% 2.1% Other Psychiatric Services: PDS2 (5) $ 842,345 $ 944,567 Practice Management (6) $ 0 $ 345,111 (1) Net revenues per patient day equals net patient service revenues divided by total patient days. (2) Average occupancy rates were obtained by dividing the total number of patient days in each period by the number of beds available in such period. (3) Private pay percentage is the percentage of total patient revenue derived from all payors other than Medicare and Medicaid. (4) Government pay percentage is the percentage of total patient revenue derived from the Medicare and Medicaid programs. (5) PDS2, Pioneer Development and Support Services, provides clinical support, referrals management and professional services for a number of the company's national contracts and a smoking cessation help line for the state of Nebraska. (6) Practice Management revenue was produced through BSC-NY and PHC, Inc. During the fiscal year ended June 30, 2001 the company closed it practice management services as outlined in this report under "Description of Business" and detailed in footnote A to the financial statements included in this report. - 8 - Business Strategy The company's objective is to become the leading national provider of treatment services, specializing in substance abuse and psychiatric care. The company focuses its marketing efforts on "safety-sensitive" industries. This focus results in customized outcome oriented programs that the company believes produce overall cost savings to the patients and/or client organizations. The company intends to leverage experience gained from providing services to customers in certain industries that it believes will enhance its selling efforts within these certain industries. Marketing and Customers The company markets its substance abuse, inpatient and outpatient psychiatric health services both locally and nationally, primarily to safety sensitive industries, including transportation, oil and gas exploration, heavy machinery and equipment, manufacturing and healthcare services. Additionally, the company markets its services in the gaming industry both in Nevada and nationally. The company employs four individuals dedicated to marketing among the company's facilities. Each facility performs marketing activities in its local region. The Senior Vice President of the company coordinates the company's national marketing efforts. In addition, employees at certain facilities perform local marketing activities independent of the Senior Vice President. The company, with the support of its owned integrated outpatient systems and management services, continues to pursue more at-risk contracts and outpatient, managed health care fee-for-service contracts. In addition to providing excellent services and treatment outcomes, the company will continue to negotiate pricing policies to attract patients for long-term intensive treatment which meet length of stay and clinical requirements established by insurers, managed health care organizations and the company's internal professional standards. The company's integrated systems of comprehensive outpatient mental health clinics complement the company's inpatient facilities. These clinics are strategically located in Nevada, Virginia, Kansas City, Michigan, and Utah. They make it possible for the company to offer wholly integrated, comprehensive, mental health services for corporations and managed care organizations on an at-risk or exclusive fee-for-service basis. Additionally, the company operates Pioneer Development and Support Services (PDS2) located in the Highland Ridge facility in Salt Lake City, Utah. PDS2 provides clinical support, referrals, management and professional services for a number of the company's national contracts. It gives the company the capacity to provide a complete range of fully integrated mental health services. The company has been successful in securing a number of national accounts with a variety of corporations including: Boyd Gaming, Conrail, CSX, the IUE, MCC, MGM, Station Casinos, Union Pacific Railroad, Union Pacific Railroad Hospital Association, VBH, and others. In addition to its direct patient care services; the company maintains its web site, Wellplace.com, which provides articles and information of interest to the general public as well as the behavioral health professional. The company's Internet Company also provides the added benefit of web availability of information for various EAP contracts held and serviced by those subsidiaries providing direct treatment services. - 9 - Competition The company's substance abuse programs compete nationally with other health care providers, including general and chronic care hospitals, both non-profit and for-profit, other substance abuse facilities and short-term detoxification centers. Some competitors have substantially greater financial resources than the company. The company believes, however, that it can compete successfully with such institutions because of its success in treating poor-prognosis patients. The company will compete through its focus on such patients, its willingness to negotiate appropriate rates and its capacity to build and service corporate relationships. The company's psychiatric facilities and programs compete primarily within the respective geographic area serviced by them. The company competes with private doctors, hospital-based clinics, hospital-based outpatient services and other comparable facilities. The main reasons that the company competes well are its integrated delivery and dual diagnosis programming. Integrated delivery provides for more efficient follow-up procedures and reductions in length of stay. Dual diagnosis programming provides a niche service for clients with a primary mental health and a secondary substance abuse diagnosis. The company developed its dual diagnosis service in response to demand from insurers, employers and treatment facilities. The company's Internet Company provides the competitive edge for service information and delivery for our direct patient care programs. Revenue Sources and Contracts The company has entered into relationships with numerous employers, labor unions and third-party payors to provide services to their employees and members for the treatment of substance abuse and psychiatric disorders. In addition, the company admits patients who seek treatment directly without the intervention of third parties and whose insurance does not cover these conditions in circumstances where the patient either has adequate financial resources to pay for treatment directly or is eligible to receive free care at one of the company's facilities. The company's psychiatric patients either have insurance or pay at least a portion of treatment costs based on their ability to pay. Free treatment provided each year amounts to less than 5% of the company's total patient days. Each contract is negotiated separately, taking into account the insurance coverage provided to employees and members, and, depending on such coverage, may provide for differing amounts of compensation to the company for different subsets of employees and members. The charges may be capitated, or fixed with a maximum charge per patient day, and, in the case of larger clients, frequently result in a negotiated discount from the company's published charges. The company believes that such discounts are appropriate as they are effective in producing a larger volume of patient admissions. The company treats non-contract patients and bills them on the basis of the company's standard per diem rates and for any additional ancillary services provided to them by the company. Quality Assurance and Utilization Review The company has established comprehensive quality assurance programs at all of its facilities. These programs are designed to ensure that each facility maintains standards that meet or exceed requirements imposed upon the company with the objective of providing high-quality specialized treatment services to its patients. To this end, the Joint Commission on Accreditation of Healthcare Organizations ("JCAHO") survey and accredit the company's inpatient facilities and the company's outpatient facilities comply with the standards of National Commission Quality Assurance ("NCQA") although the facilities are not NCQA certified. The company's professional staff, including physicians, social - 10 - workers, psychologists, nurses, dietitians, therapists and counselors, must meet the minimal requirements of licensure related to their specific discipline, in addition to each facility's own internal quality assurance criteria. The company participates in the federally mandated National Practitioners Data Bank, which monitors professional accreditation nationally. In response to the increasing reliance of insurers and managed care organizations upon utilization review methodologies, the company has adopted a comprehensive documentation policy to satisfy relevant reimbursement criteria. Additionally, the company has developed an internal case management system, which provides assurance that services rendered to individual patients are medically appropriate and reimbursable. Implementation of these internal policies has been integral to the success of the company's strategy of providing services to relapse-prone, higher acuity patients. Government Regulation The company's business and the development and operation of the company's facilities are subject to extensive federal, state and local government regulation. In recent years, an increasing number of legislative proposals have been introduced at both the national and state levels that would affect major reforms of the health care system if adopted. Among the proposals under consideration are reforms to increase the availability of group health insurance, to increase reliance upon managed care, to bolster competition and to require that all businesses offer health insurance coverage to their employees. The company cannot predict whether any such legislative proposals will be adopted and, if adopted, what effect, if any, such proposals would have on the company's business. In addition, both the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, intermediary determinations and governmental funding restrictions, all of which may materially increase or decrease the rate of program payments to health care facilities. Since 1983, Congress has consistently attempted to limit the growth of federal spending under the Medicare and Medicaid programs and will likely continue to do so. Additionally, congressional spending reductions for the Medicaid program involving the issuance of block grants to states is likely to hasten the reliance upon managed care as a potential savings mechanism of the Medicaid program. As a result of this reform activity the company can give no assurance that payments under such programs will in the future remain at a level comparable to the present level or be sufficient to cover the costs allocable to such patients. Health Planning Requirements Some of the states in which the company operates, and many of the states where the company may consider expansion opportunities, have health planning statutes which require that prior to the addition or construction of new beds, the addition of new services, the acquisition of certain medical equipment or certain capital expenditures in excess of defined levels, a state health planning agency must determine that a need exists for such new or additional beds, new services, equipment or capital expenditures. These state determination of need or certificate of need ("DoN") programs are designed to enable states to participate in certain federal and state health related programs and to avoid duplication of health services. DoN's typically are issued for a specified maximum expenditure, must be implemented within a specified time frame and often include elaborate compliance procedures for amendment or modification, if needed. Several states have instituted moratoria on some types of DoN's or otherwise stated intent not to grant approvals for certain health services. Such moratoria may adversely affect the company's ability to expand in such states, but may also provide a barrier to entry to potential competitors. - 11 - Licensure and Certification State regulatory authorities must license all of the company's facilities. The company's Harbor Oaks facility is certified for participation as a provider in the Medicare and Medicaid programs. The company's initial and continued licensure of its facilities, and certification to participate in the Medicare and Medicaid programs, depends upon many factors, including accommodations, equipment, services, patient care, safety, personnel, physical environment, the existence of adequate policies, procedures and controls and the regulatory process regarding the facility's initial licensure. Federal, state and local agencies survey facilities on a regular basis to determine whether such facilities are in compliance with governmental operating and health standards and conditions for participating in government programs. Such surveys include review of patient utilization and inspection of standards of patient care. The company has procedures in place to ensure that its facilities are operated in compliance with all such standards and conditions. To the extent these standards are not met, however, the license of a facility could be restricted, suspended or revoked, or a facility could be decertified from the Medicare or Medicaid programs. Medicare Reimbursement Currently the only facility of the company that receives Medicare reimbursement is Harbor Oaks. For the fiscal year ended June 30, 2002 13.36% of revenues for Harbor Oaks were derived from Medicare programs. The Medicare program generally reimburses psychiatric facilities pursuant to its prospective payment system ("PPS"), in which each facility receives an interim payment of its allowable costs during the year which is later adjusted to reflect actual allowable direct and indirect costs of services based upon the submission of a cost report at the end of each year. However, current Medicare payment policies allow certain psychiatric service providers an exemption from PPS. In order for a facility to be eligible for exemption from PPS, the facility must comply with numerous organizational and operational requirements. PPS-exempt providers are cost reimbursed, receiving the lower of reasonable costs or reasonable charges. The Medicare program fiscal intermediary pays a per diem rate based upon prior year costs, which may be retroactively adjusted upon the submission of annual cost reports. The Harbor Oaks facility is currently PPS-exempt. The amount of its cost-based reimbursement may be limited by the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") and regulations promulgated under the Act. Generally, TEFRA limits the amount of reimbursement a facility may receive to a target amount per discharge, adjusted annually for inflation. The facility's reasonable Medicare operating costs divided by Medicare discharges, plus a per diem allowance for capital costs during its base year of operations determines the target amount. It is not possible to predict the ability of Harbor Oaks to remain PPS-exempt or to anticipate the impact of TEFRA upon the reimbursement received by Harbor Oaks in future periods. In order to receive Medicare reimbursement, each participating facility must meet the applicable conditions of participation set forth by the federal government relating to the type of facility, its equipment, its personnel and its standards of medical care, as well as compliance with all state and local laws and regulations. In addition, Medicare regulations generally require that entry into such facilities be through physician referral. The company must offer services to Medicare recipients on a non-discriminatory basis and may not preferentially accept private pay or commercially insured patients. - 12 - Medicaid Reimbursement Currently the only facility of the company that receives reimbursement under any state Medicaid program is Harbor Oaks. A portion of Medicaid costs is paid by states under the Medicaid program and the federal matching payments are not made unless the state's portion is made. Accordingly, the timely receipt of Medicaid payments by a facility may be affected by the financial condition of the relevant state. Harbor Oaks is a participant in the Medicaid program administered by the State of Michigan. The company receives reimbursement on a per diem basis, inclusive of ancillary costs. The state determines the rate and adjusts it annually based on cost reports filed by the company. Fraud and Abuse Laws Various federal and state laws regulate the business relationships and payment arrangements between providers and suppliers of health care services, including employment or service contracts, and investment relationships. These laws include the fraud and abuse provisions of the Medicare and Medicaid statutes as well as similar state statutes (collectively, the "Fraud and Abuse Laws"), which prohibit the payment, receipt, solicitation or offering of any direct or indirect remuneration intended to induce the referral of patients, the ordering, arranging, or providing of covered services, items or equipment. Violations of these provisions may result in civil and criminal penalties and/or exclusion from participation in the Medicare, Medicaid and other government-sponsored programs. The federal government has issued regulations that set forth certain "safe harbors," representing business relationships and payment arrangements that can safely be undertaken without violation of the federal Fraud and Abuse Laws. Failure to fall within a safe harbor does not constitute a per se violation of the federal fraud and abuse laws. The company believes that its business relationships and payment arrangements either fall within the safe harbors or otherwise comply with the Fraud and Abuse Laws. The company has an active compliance program in place with a corporate compliance officer and compliance liaisons at each facility and a toll free compliance hotline. Compliance in services and trainings are conducted on a regular basis. Employees As of July 31, 2002 the company had 327 employees of which 4 were dedicated to marketing, 77 (13 part time) to finance and administration and 246 (84 part time) to patient care. All of the company's 327 employees are leased through Inovis, which was recently purchased by Team America, a national employee-leasing firm. The company has elected to lease its employees to provide more favorable employee health benefits at lower cost than would be available to the company as a single employer and to eliminate certain administrative tasks which otherwise would be imposed on the management of the company. The agreement provides that Inovis, now Team Inovis, will administer payroll, provide for compliance with workers' compensation laws, including procurement of workers' compensation insurance and administering claims, and procure and provide designated employee benefits. The company retains the right to reject the services of any leased employee and Inovis has the right to increase its fees at any time upon thirty days' written notice or immediately upon any increase in payroll taxes, workers' compensation insurance premiums or the cost of employee benefits provided to the leased employees. - 13 - The company believes that it has been successful in attracting skilled and experienced personnel. Competition for such employees is intense, however, and there can be no assurance that the company will be able to attract and retain necessary qualified employees in the future. None of the company's employees are covered by a collective bargaining agreement. The company believes that its relationships with its employees are good. Insurance Each of the company's facilities maintains separate professional liability insurance policies. Harbor Oaks, Mount Regis Center, Harmony Healthcare, Total Concept and NPP have coverage of $1,000,000 per claim and $3,000,000 in the aggregate. In addition to this coverage Harbor Oaks and Mount Regis Center each maintain an umbrella policy of $1,000,000. Highland Ridge has limits of $1,000,000 per claim and $6,000,000 in the aggregate. In addition, these entities maintain general liability insurance coverage in similar amounts. The parent company maintains $1,000,000 of directors and officers' liability insurance coverage, general liability coverage of $1,000,000 per claim and $2,000,000 in aggregate and an umbrella policy of $1,000,000. The company believes, based on its experience, that its insurance coverage is adequate for its business and that it will continue to be able to obtain adequate coverage. - 14 - ITEM 2. DESCRIPTION OF PROPERTY Executive Offices The company's executive offices are located in Peabody, Massachusetts. The company's lease agreement in Peabody covers approximately 4,800 square feet for a 60-month term, which expires September 17, 2004. The current annual payment under the lease is $85,728 and increases to $88,896 in the final year. The company believes that this facility will be adequate to satisfy its needs for the foreseeable future. Highland Ridge Hospital The Highland Ridge premises consist of approximately 24,000 square feet of space occupying the majority of first floor of a two-story hospital owned by Valley Mental Health. The lease is for a five-year agreement, which provides for monthly rental payments of approximately $16,360, which included housekeeping and maintenance provided by the landlord for the first six months, and includes changes in rental payments each year based on increases or decreases in the CPI. In July 1999 the facility began paying approximately $6,500 each month for housekeeping and maintenance. The lease expires December 31, 2004, and includes an option to renew for an additional five years. The company believes that these premises are adequate for its current and anticipated needs. Mount Regis Center The company owns the Mount Regis facility, which consists of a three-story wooden building located on an approximately two-acre site in a residential neighborhood. The building consists of over 14,000 square feet and is subject to a mortgage in the approximate amount of $406,000. The facility is used for both inpatient and outpatient services. The company believes that these premises are adequate for its current and anticipated needs. Psychiatric Facilities The company owns or leases premises for each of its psychiatric facilities. Harmony, Total Concept, North Point Pioneer and Pioneer Pharmaceutical Research lease their premises. The company believes that each of these premises is leased at fair market value and could be replaced without significant time or expense if necessary. The company believes that all of these premises are adequate for its current and anticipated needs. The company owns the building in which Harbor Oaks operates, which is a single story brick and wood frame structure comprising approximately 32,000 square feet situated on an approximately three acre site. The company has a $2,500,000 mortgage on this property. The company believes that these premises are adequate for its current and anticipated needs. ITEM 3. LEGAL PROCEEDINGS. As a consequence of Franvale's bankruptcy and subsequent receivership, a number of claims were asserted against the Company. In April 2002 the Bankruptcy Court allowed the Final Report and Account of the Trustee in this matter closing all claims relating to the bankruptcy. This resulted in the elimination of the current liability of discontinued operations and an increase in equity of approximately $800,000. - 15 - On or about May 15, 2000, the company was served with a subpoena by the United States Attorney for the District of Massachusetts. The subpoena requested, inter alia, patient and financial records relating to Franvale Nursing and Rehabilitation Center for the period of 1995 through 1998. The company has reached an agreement in principle with the government to settle all outstanding billing issues. The final agreement is currently being drafted for signatures. The company believes that it has adequately accrued for the settlement of this claim in the accompanying financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the company's security holders during the fourth quarter of the fiscal year ended June 30, 2002. - 16 - PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Since the company's public offering which was declared effective on March 3, 1994, until December 2000 the company's Units, Class A Common Stock and Class A Warrants were traded on the NASDAQ National Market under the symbols "PIHCU," "PIHC" and "PIHCW," respectively. In December 2000 the Company's stock was delisted due to failure to meet listing criteria. Currently the company's Class A common Stock is traded on the NASDAQ Bulletin Board under the symbol "PIHC-BB." There is no public trading market for the company's Class B Common Stock. In March 2001 the company's warrants issued with its initial public offering expired: therefore, there is currently no market for the company's warrants or units. The following table sets forth, for the periods indicated, the high and low sale price of the company's Class A Common Stock, as reported by NASDAQ. HIGH LOW 2001 First Quarter $ 1.50 $ .50 Second Quarter $ .5625 $ .6250 Third Quarter $ .6094 $ .1250 Fourth Quarter $ .59 $ .19 2002 First Quarter $ .48 $ .30 Second Quarter $ .63 $ .34 Third Quarter $ .45 $ .35 Fourth Quarter $ .99 $ .37 2003 First Quarter (through August 1, 2002) $ .81 $ .56 On August 1, 2002, the last reported sale price of the Class A Common Stock was $.65. On August 1, 2002 there were 696 holders of record of the company's Class A Common Stock and 313 holders of record of the company's Class B Common Stock. DIVIDEND POLICY The company has never paid any cash dividends on its Common Stock. During the fiscal year ended June 30, 2002 the company was precluded under capital law from paying cash dividends, however, the company accrued dividends on preferred stock according to the preferred stock agreement and paid all dividends in common stock, as required, upon conversion of the preferred stock. Although there are now no restrictions on the Company's ability to pay dividends, the Company anticipates that, in the future, earnings will be retained for use in the business or for other corporate purposes, and it is not anticipated that cash dividends in respect to Common Stock will be paid in the foreseeable future. Any decision as to the future payment of dividends will depend on the results of operations, the financial position of the Company and such other factors, as the Company's Board of directors, in its discretion, deems relevant. - 17 - ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following is a discussion and analysis of the financial condition and results of operations of the company for the years ended June 30, 2002 and 2001. It should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein. During fiscal year 2001 BSC-NY, Inc. was closed, as part of the divestiture of unprofitable business, as outlined in this report under "Description of Business" and detailed in footnote A to the consolidated financial statements included in this report. Overview The company presently provides behavioral health care services through two substance abuse treatment centers, a psychiatric hospital and seven outpatient psychiatric centers (collectively called "treatment facilities"). The company's revenue for providing behavioral health services through these facilities is derived from contracts with managed care companies, Medicare, Medicaid, state agencies, railroads, gaming industry corporations and individual clients. The profitability of the company is largely dependent on the level of patient census and the payor mix at these treatment facilities. Patient census is measured by the number of days a client remains overnight at an inpatient facility or the number of visits or encounters with clients at out patient clinics. Payor mix is determined by the source of payment to be received for each client being provided billable services. The company's administrative expenses do not vary greatly as a percentage of total revenue but the percentage tends to decrease slightly as revenue increases. Although the company has changed the focus and reduced expenses of its' internet operation, Behavioral Health Online, Inc., to provide technology and internet support for the company's other operations, it also continues to provide behavioral health information and education through its web site at Wellplace.com. The expenses of the Internet operation decreased approximately 78% through the consolidation of operations and elimination of excess leased space. The company's most recent addition, Pioneer Pharmaceutical Research, contracts with major manufacturers of psychiatric pharmaceuticals to assist in the study of the effects of certain pharmaceuticals in the treatment of specific mental illness. The healthcare industry is subject to extensive federal, state and local regulation governing, among other things, licensure and certification, conduct of operations, audit and retroactive adjustment of prior government billings and reimbursement. In addition, there are on going debates and initiatives regarding the restructuring of the health care system in its entirety. The extent of any regulatory changes and their impact on the company's business is unknown. The current administration has put forth proposals to mandate equality in the benefits available to those individuals suffering from mental illness. If passed this legislation will improve access to the companies programs. Managed care has had a profound impact on the company's operations, in the form of shorter lengths of stay, extensive certification of benefits requirements and, in some cases, reduced payment for services. Critical Accounting Policies The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an on-going basis, we evaluate our estimates and assumptions, including but not limited to those related to revenue recognition, accounts receivable reserves and the impairment of long-lived assets, goodwill and other intangible assets. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. - 18 - Revenue recognition and accounts receivable: Patient care revenues and accounts receivable are recorded at established billing rates or at the amount realizable under agreements with third-party payors, including Medicaid and Medicare. Revenues under third-party payor agreements are subject to examination and contractual adjustment, and amounts realizable may change due to periodic changes in the regulatory environment. Provisions for estimated third party payor settlements are provided in the period the related services are rendered. Differences between the amounts provided and subsequent settlements are recorded in operations in the year of settlement. The provision for contractual allowances is deducted directly from revenue and the net revenue amount is recorded as accounts receivable. The allowance for doubtful accounts does not include the contractual allowances. Allowance for doubtful accounts: Reserves for bad debt are maintained at a percentage of outstanding accounts receivable based on the company's historic collection results, the age of the receivable and other relevant information. Property and equipment: Property and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the assets using accelerated and straight-line methods. Organization costs: Organization costs are expensed as incurred as required by the American Institute of Certified Public Accounts Statement of Position 98-5 "Reporting the Costs of Start-up Activities". Goodwill: The excess of the purchase price over the fair market value of net assets of an acquisition is recorded as goodwill. The company's net goodwill relates to the treatment services segment of the company and is evaluated at least annually for impairment. Results of Operations Years Ended June 30, 2002 and 2001 The company experienced a significant increase in profitability from its ongoing operations during the fiscal year ended June 30, 2002. Total revenues excluding BSC-NY, Inc., the practice management operation closed in the previous fiscal year, increased 1.3% to $22,698,268 for the year ended June 30, 2002 from $22,404,725 for the year ended June 30, 2001. The stability of the company's core business revenues and reduced operating expenses, resulted in an increase in income from operations of 82.7% to $1,764,274 for the year ended June 30, 2002 from $937,486 before closing expenses of the practice management operation for the year ended June 30, 2001 and an increase in net income before dividends of $1,148,294 to $1,083,895 for the fiscal year ended June 30, 2002 from a loss of $64,399, excluding BSC-NY, Inc. closing costs of $5,186,306, for the fiscal year ended June 30, 2001. The company has returned to profitability having recorded its sixth consecutive profitable quarter from ongoing operations with the quarter ended June 30, 2002. - 19 - Total net patient care revenue from all facilities, remained relatively stable at $21,109,104 for the year ended June 30, 2002 as compared to $21,087,473 for the year ended June 30, 2001. This stability of core business revenues coupled with reductions in expenses resulted in increased net income. Although patient census increased as shown in "Operating Statistics" on page 7 of this report, a change in payor mix resulted in lower net revenue per patient day. Net inpatient care revenue from psychiatric services increased 4.6% to $14,130,471 for the year ended June 30, 2002 from $13,507,124 for the fiscal year ended June 30, 2001. Net partial hospitalization and outpatient care revenue decreased 7.9% to $6,978,633 for the year ended June 30, 2002 from $7,580,349 for the year ended June 30, 2001. This decrease is due in part to the decrease in the number of employees covered under our contracts in the aftermath of September 11, 2001. Revenues from Pioneer Development and Support Services ("PDS2") decreased 10.8% to $842,345 for the year ended June 30, 2002 from $944,567 for the year ended June 30, 2001. This is due to the completion of a large short-term contract in the fiscal year ended June 30, 2001 and the elimination of the related revenues. All revenues reported in the accompanying statements of operations are shown net of estimated contractual adjustments and charity care provided. When payment is made, if the contractual adjustment is found to have been understated or overstated appropriate adjustments are made in the period the payment is received in accordance with the AICPA Audit and Accounting Guide for Health Care Organizations. Patient care expenses increased by approximately $1,028,772 due to the increase in patient census at our inpatient facilities for the year ended June 30, 2002. Inpatient census increased by approximately 1,900 patient days, 6%, for the year ended June 30, 2002 compared to the year ended June 30, 2001. Direct patient care payroll and payroll related expenses increased approximately 8% to $9,762,087 for the year ended June 30, 2002 from $8,617,575 for the year ended June 30, 2001; pharmacy costs increased approximately 9% to $351,531 for the year ended June 30, 2002 from $322,520 for the year ended June 30, 2001; laboratory fees increased approximately 48% to $213,973 for the year ended June 30, 2002 from $144,485 for the year ended June 30, 2001; and food expense increased approximately 8% to $481,363 for the year ended June 30, 2002 from $445,651 for the year ended June 30, 2001. All of these increases were a result of increased patient census and increased acuity of patients. We also increased our census from outside of the facilities' local areas resulting in an increase in patient transportation expense of approximately 6% to $289,715 for the year ended June 30, 2002 from $274,493 for the year ended June 30, 2001. Other patient related expenses increased approximately 259% due to the increase in patients participating in research studies through our newest subsidiary Pioneer Pharmaceutical Research. The corresponding revenue increase was approximately $388,000 or 109% over last year's revenues. We continue to closely monitor the ordering of hospital supplies, food and pharmaceutical supplies but these expenses all relate directly to the number of days of inpatient services we provide and are expected to increase with higher patient census (see "Operating Statistics" Part I, Item 1). Website expenses decreased 78.7% to $287,556 for the year ended June 30, 2002 from $1,351,150 for the year ended June 30, 2001. This decrease is due to the change in focus of the Internet company to internal support of the other operating locations. Website expenses are expected to continue at this level while the Internet company's focus remains internal. In December 2000 the Company's Board of Directors decided to close its' BSC-NY, Inc. practice management operations due to the deterioration of operating results. Revenues of BSC-NY, Inc. were dependent on the success of the professional corporation for which it provided management services. Although the New York practice management operations reported operating income of approximately $131,000 for the fiscal year ended June 30, 2000, adverse business conditions resulted in a loss of approximately $399,000 for the six months ended - 20 - December 31, 2000 before closing expenses. These adverse operating conditions were caused by the decline in revenues produced by the professional corporation which had closed down its business operations. Closing expenses for the practice management company were $5,186,306 and included $1,545,609 in goodwill impairment, $3,401,650 in receivables due from the Professional Corporation and $239,047 in lease termination and other expenses. Contract expenses related to PDS2 decreased 17.6% to $704,363 for the year ended June 30, 2002 from $855,128 for the year ended June 30, 2001. This decrease is due to the completion of a large short-term contract and the elimination of related expenses. Total administrative expenses for all facilities increased 14.5% to $8,533,571 for the year ended June 30, 2002 from $7,452,714 for the year ended June 30, 2001. This increase in administrative expense is due to the increase in expenses for Pioneer Pharmaceutical Research and the non-cash equity based compensation charge of approximately $264,000. Interest expense decreased 24.2% to $790,955 for the year ended June 30, 2002 from $1,043,030 for the year ended June 30, 2001. This decrease is due to the refinancing of debt resulting in lower interest rates and the decrease in prime rate, which dictates the interest rate on the majority of the company's long-term debt. The Company's income taxes of $15,446 and $44,450 for the years ended June 30, 2002 and June 30, 2001, respectively, are significantly below the Federal statutory rate of 34% primarily related to the availability of net operating loss carry-forward. Total income tax expense for fiscal 2002 and 2001 represents state income taxes for certain subsidiaries with no available net operating loss carry-forwards. Bad debt expense decreased 71.2% to $716,681 for the fiscal year ended June 30, 2002 from $2,490,307 for the fiscal year ended June 30, 2001. This is due primarily to the elimination of bad debt related to the closed practice management company and the overall decrease in the age of outstanding accounts receivable. The environment the company operates in today makes collection of receivables, particularly older receivables, more difficult than in previous years. Accordingly, the company has increased staff, standardized some procedures for collecting receivables and instituted a more aggressive collection policy, which has resulted in an overall decrease in its accounts receivable. Although the company's receivables have decreased, the company continues to reserve for bad debts based on managed care denials and past difficulty in collections. The growth of managed care has negatively impacted reimbursement for behavioral health services with a higher rate of denials requiring higher reserves. Liquidity and Capital Resources The company`s net cash provided by operating activities was $1,576,109 for the year ended June 30, 2002 compared to cash used by operating activities of $461,277 for the year ended June 30, 2001. Cash flow from operations in fiscal 2002 consists of net income of $1,083,895 plus depreciation and amortization of $202,776, decrease in accounts receivable of $440,638 and non-cash equity based charges of $336,745 less cash used for net changes in other operating assets and liabilities of $487,945. Cash flow from operations would have been $156,506 higher in fiscal 2002 without the legal expenses related to the final disposition of the Franvale bankruptcy. - 21 - Cash used in investing activities in fiscal 2002 consisted of $124,362 in capital expenditures compared to $186,842 and $70,226 in capital expenditures and website development costs, respectively in fiscal 2001. Cash used in financing activities in fiscal 2002 primarily consisted of $1,113,344 in debt repayments compared to $63,806 in net borrowings during fiscal 2001. Other fiscal 2002 financing activities are summarized below. During the fiscal years ended June 30, 2000 and 2001 the company issued 8% series C convertible preferred stock in a private placement. As of June 30, 2002 all of this preferred stock has been converted with the issuance of approximately 4,600,000 shares of class A common stock. Approximately 541,000 additional shares were issued in payment of unpaid accrued dividends on the preferred stock. The company incurred costs of $198,149 in fiscal 2002, related to the private placement of the preferred stock conversion shares. A significant factor in the liquidity and cash flow of the company is the timely collection of its accounts receivable. Current accounts receivable from patient care, net of allowance for doubtful accounts decreased approximately 7% to $5,768,419 on June 30, 2002 from $6,220,715 on June 30, 2001. This decrease is a result of better accounts receivable management due to increased staff, standardization of some procedures for collecting receivables and a more aggressive collection policy. The increased staff has allowed the company to concentrate on current accounts receivable and resolve any problem issues before they become uncollectable. The company's collection policy calls for earlier contact with insurance carriers with regard to payment, use of fax and registered mail to follow-up or resubmit claims and earlier employment of collection agencies to assist in the collection process. Our collectors will also seek assistance through every legal means, including the State Insurance Commissioner's office, when appropriate, to collect claims. At the same time, the company continues to closely monitor reserves for bad debt based on potential insurance denials and past difficulty in collections. In May 2001, in order to support the company's continued revenue growth, the company increased its accounts receivable funding revolving credit agreement with Heller Healthcare Finance, Inc. on behalf of three of its subsidiaries. The amended agreement provides for funding of up to $3,000,000 based on outstanding receivables. The outstanding balance on this receivables financing on June 30, 2002 was $1,468,644, reflecting a $642,942 decrease from June 30, 2001. In November 2001 the company refinanced all of the outstanding mortgage debt with Heller Healthcare Finance. This resulted in the consolidation of several outstanding notes, the reduction of interest on the debt from prime plus 5% to prime plus 3.5% and the reduction in the principal payments due each month. Total proceeds from the refinancing transaction during fiscal 2002 amounted to $748,912. Principal payments on long-term debt totaled $1,219,314 in fiscal 2002 compared to $639,157 in fiscal 2001. - 22 - The Company's future minimum payments under contractual obligations related to capital leases, operating leases and term notes as of June 30, 2002 are as follows: Year Ending Term Capital Operating June 30, Notes Leases Leases Total _______________________________________________________________________________ 2003 $ 765,415 $ 13,556 $ 776,551 $1,555,522 2004 823,659 10,536 748,119 1,582,314 2005 1,255,415 8,126 539,195 1,802,736 2006 47,598 5,037 181,607 234,242 2007 32,307 -- 111,239 143,546 Thereafter 269,966 -- -- 269,966 _________ _________ ___________ ___________ Total minimum payments $ 3,194,360 $ 37,255 $2,356,711 $5,588,326 =========== ========= =========== ========== In addition to the above term notes, the company also has $500,000 in outstanding convertible debentures, which include the provision that the holders of the debentures may put all or any portion of the debentures to the company at the original purchase price plus unpaid interest upon 30 days written notice beginning December 3, 2001. The holders of the debentures have exercised the put provision in the agreement as to 50% of the outstanding debentures. The company will begin making monthly payments of $25,000 plus accrued interest in October 2002, which will further reduce indebtedness and interest costs. . The company believes that, with the refinancing debt mentioned above, its revolving credit facility through its primary lender and cash flow from operations, it will have sufficient cash and financing available to fund its growing operations for the foreseeable future. The company is concentrating on its core business and expansion of its pharmaceutical research operations through additional contracts, which will increase revenues considerably and provide for additional cash from operations. The liquidation of the assets and liabilities of Franvale resulted in a non-cash increase in equity of $804,046 in the quarter ended June 30, 2002. In April 2002 the bankruptcy was finalized and all obligations were recorded. (see Note A to the accompanying consolidated financial statements for additional information.) This increase in equity, coupled with the increase in equity from fiscal 2002 net income, contributed to a positive stockholders' equity of $615,985 for the company as of June 30, 2002 compared to a total stockholders' deficit of $1,281,120 as of June 30, 2001. The company has operated ongoing operations profitably for six consecutive quarters. The current positive business environment towards behavioral health treatment and the new business opportunities give us confidence to foresee continued improved results. New accounting standards In June 2001, the Financial Accounting Standards Board finalized FASB Statements No. 141, Business Combinations ("SFAS 141") and No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interest method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after July 1, 2001 and for purchase business combinations completed on or after July 1, 2001. It also may require, upon adoption of SFAS 142 that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. - 23 - SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purpose of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidelines in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized The Company elected early adoption of SFAS 142 in the quarter ended September 30, 2001. The Company's net goodwill of $969,099 relating to the treatment services segment of the Company was evaluated as of July 1, 2001. The adoption of SFAS 142 resulted in a decrease in amortization expense of $65,700 for the year ended June 30, 2002. The impact of the adoption of SFAS 142 is summarized as follows: For the Year Ended June 30, 2002 2001 ___________ ____________ Reported net income (loss) applicable to common shareholders $ 985,484 $ (5,634,323) Add back: Goodwill amortization -- 65,700 ___________ ____________ Adjusted net income (loss) 985,484 (5,568,623) Basic earnings per share: Reported net income(loss)applicable to common shareholders $ 0.10 $ (0.66) Goodwill amortization -- .01 ___________ ____________ Adjusted net income (loss) $ 0.10 $ (0.65) Diluted earnings per share: Reported net income (loss)applicable to common shareholders $ 0.09 $ (0.66) Goodwill amortization -- .01 ___________ ____________ Adjusted net income (loss) $ 0.09 $ (0.65) In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" and APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business". SFAS No.144 becomes effective for the fiscal years beginning after December 15, 2001. The Company will adopt SFAS No. 144 in the first quarter of fiscal 2003. The Company does not expect the adoption of SFAS No. 144 to impact its financial position and results of operations. - 24 - In July 2002, the FASB issued SFAS No. 146, "Accounting for Cost Associated with Exit or Disposal Activities". SFAS No. 146 requires companies to recognize cost associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 will be applied prospectively to any exit or disposal activities initiated after December 31, 2002. The company expects there will be no effect on its financial results relating to the adoption of SFAS No. 146. - 25 - ITEM 7. FINANCIAL STATEMENTS. PAGE Index F-1 Report of independent certified public accountants F-2 Consolidated balance sheets F-3 Consolidated statements of operations F-4 Consolidated statements of changes in stockholders'equity (deficit) F-5 Consolidated statements of cash flows F-6, F-7 Notes to consolidated financial statements F-8, F-26 F-1 - 26 - REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders PHC, Inc. Peabody, Massachusetts We have audited the accompanying consolidated balance sheets of PHC, Inc. and subsidiaries as of June 30, 2002 and 2001 and the related consolidated statements of operations, changes in stockholders' equity (deficit), and cash flows for the years then ended. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PHC, Inc. and subsidiaries at June 30, 2002 and 2001 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. BDO Seidman, LLP Boston, Massachusetts August 16, 2002 F-2 - 27 - PHC, INC. AND SUBSIDIARIES Consolidated Balance Sheets June 30, 2002 2001 ___________ __________ ASSETS (Note C) Current assets: Cash and cash equivalents $ 204,564 $ 43,732 Accounts receivable, net of allowance for doubtful accounts of $2,715,760 and $2,632,525 at June 30, 2002 and 2001, respectively (Note A) 5,078,419 5,620,715 Prepaid expenses 66,652 63,940 Other receivables and advance 137,032 112,579 Deferred income tax asset (Note F) 766,793 613,980 ___________ ___________ Total current assets 6,253,460 6,454,946 Accounts receivable, non-current 690,000 600,000 Other receivables (Note A) 92,068 104,863 Property and equipment, net (Notes A, B and D) 1,259,648 1,338,066 Deferred financing costs, net of amortization of $122,109 and $114,109 at June 30, 2002 and 2001, respectively 12,000 20,000 Goodwill, net of accumulated amortization of $270,105 at June 30, 2002 and 2001 (Note A) 969,099 969,099 Other assets (Note A) 197,340 236,478 ___________ ___________ Total assets $9,473,615 $9,723,452 =========== ========== LIABILITIES Current liabilities: Accounts payable $1,283,389 $1,866,631 Notes payable - related parties (Note E) 200,000 200,000 Current maturities of long-term debt (Note C) 765,415 2,038,077 Revolving credit note (Note C) 1,468,644 2,111,586 Deferred revenue 129,258 -- Current portion of obligations under capital leases (Note D) 11,020 16,725 Accrued payroll, payroll taxes and benefits 452,177 460,723 Accrued expenses and other liabilities 1,597,642 1,208,469 Convertible debentures (Notes C) 500,000 500,000 Net liabilities of discontinued operations (Note I) -- 960,552 ___________ ___________ Total current liabilities 6,407,545 9,362,763 Long-term debt, less current maturities (Note C) 2,428,945 1,609,649 Obligations under capital leases (Note D) 21,140 32,160 ___________ ___________ Total liabilities 8,857,630 11,004,572 ___________ ___________ Commitments and contingent liabilities (Notes D, G, H, I, and J ) STOCKHOLDERS' EQUITY (DEFICIT) (Notes A, C, H, J and K) Convertible Preferred stock, $.01 par value; 1,000,000 shares authorized: series C, none and 150,700 shares issued and outstanding at June 30, 2002 and 2001, respectively, stated value $10 per share, liquidation preference of $1,507,000 at June 30, 2001 -- 1,507 - 28 - Class A common stock, $.01 par value; 20,000,000 shares authorized, 12,919,042 and 8,709,834 shares issued June 30, 2002 and 2001, respectively 129,190 87,098 Class B common stock, $.01 par value; 2,000,000 shares authorized, 726,991 issued and outstanding June 30, 2002 and 2001, convertible into one share of Class A common stock. 7,270 7,270 Additional paid-in capital 18,769,863 18,696,779 Treasury stock, 38,126 and 22,926 common shares at cost at June 30, 2002 and 2001, respectively (30,988) (24,894) Notes receivable - common stock (80,000) (80,000) Accumulated deficit (18,179,350) (19,968,880) ___________ ___________ Total stockholders' equity (deficit) 615,985 (1,281,120) ___________ ___________ Total liabilities and stockholders' equity (deficit) $ 9,473,615 $ 9,723,452 =========== =========== See accompanying notes to consolidated financial statements F-3 - 29 - PHC, INC. AND SUBSIDIARIES Consolidated Statements of Operations For the Year Ended June 30, 2002 2001 ___________ _____________ Revenues: Patient care, net (Note A) $21,109,104 $ 21,087,473 Management fees -- 345,111 Pharmaceutical study 742,380 354,618 Website services 4,439 18,067 Contract support services 842,345 944,567 ___________ _____________ Total revenues 22,698,268 22,749,836 ___________ _____________ Operating expenses: Patient care expenses 10,691,823 9,663,051 Cost of contract support services 704,363 855,128 Provision for doubtful accounts 716,681 2,490,307 Website expenses 287,556 1,351,150 Practice management closing expenses (Note A) -- 5,186,306 Administrative expenses 8,533,571 7,452,714 ___________ _____________ Total operating expenses 20,933,994 26,998,656 ___________ _____________ Income (loss) from operations 1,764,274 (4,248,820) ___________ _____________ Other income (expense): Interest income 10,852 23,519 Interest expense (790,955) (1,043,030) Other income, net 115,170 62,076 ___________ _____________ Total other expense, net (664,933) (957,435) ___________ _____________ Income (loss) before income taxes 1,099,341 (5,206,255) Income taxes (Notes A and F) 15,446 44,450 ___________ _____________ Net income (loss) 1,083,895 (5,250,705) Dividends (Note J) (98,411) (383,618) ___________ _____________ Income (loss) applicable to common shareholders $ 985,484 $ (5,634,323) ========== ============= Basic income (loss) per common share (Note A) $ .10 $ (.66) ___________ _____________ Basic weighted average number of shares outstanding 10,232,286 8,518,408 ========== ============= Fully diluted income (loss) per common share (Note A) $ .09 $ (.66) ___________ _____________ Fully diluted weighted average number of shares outstanding 11,012,861 8,518,408 ========== ============= See accompanying notes to consolidated financial statements F-4 - 30 - PHC, INC. AND SUBSIDIARIES Consolidated Statements of Changes In Stockholders' Equity (Deficit) (See Notes A, C, H, J and K) Class A Class B Common Stock Common Stock Preferred Stock Shares Amount Shares Amount Shares Amount _________ __________ ________ ________ __________ _________ Balance - June 30, 2000 7,019,608 $ 70,196 726,991 $7,270 136,000 $1,360 Costs related to private placements Issuance of shares for earn-out obligations 414,815 4,148 Issuance of notes receivable for employee stock purchase Conversion of preferred stock 1,130,646 11,308 (19,300) (193) Common stock issued for accrued dividends 29,514 295 Issuance of preferred stock at a discount 34,000 340 Beneficial conversion feature of preferred stock Dividends on preferred stock Shares issued for employee bonuses 92,663 925 Issuance of warrants for services Issuance of employee stock purchase plan shares 22,588 226 - 31 - Class A Class B Common Stock Common Stock Preferred Stock Shares Amount Shares Amount Shares Amount _________ __________ ________ ________ __________ _________ Purchase of treasury stock in exchange for note Repurchase of shares on open market Net loss - year ended June 30, 2001 _________ __________ ________ ________ __________ _________ Balance - June 30, 2001 8,709,834 87,098 726,991 7,270 150,700 1,507 Costs related to private placements Dividends on preferred stock Issuance of shares for options exercised 1,250 13 Repurchase of shares on open market Issuance of warrants for services Shares issued for employee bonuses 71,750 717 Conversion of preferred stock 3,483,583 34,836 (150,700) (1,507) Common stock issued for accrued dividends 511,800 5,118 Issuance of shares for warrants exercised 31,624 316 Issuance of employee stock purchase plan shares 25,871 259 Issuance of shares for services provided 83,330 833 Reclassification of net liabilities of discontinued operations - 32 - Class A Class B Common Stock Common Stock Preferred Stock Shares Amount Shares Amount Shares Amount _________ __________ ________ ________ __________ _________ Net income-year ended June 30, 2002 ____________ __________ ________ ________ __________ _________ Balance - June 30, 2002 12,919,042 $ 129,190 726,991 $ 7,270 $ 0 $ 0 =========== ========= ======= ======= ======== ========= See accompanying notes to consolidated financial statements.
- 33 - PHC, INC. AND SUBSIDIARIES (con't) Consolidated Statements of Changes In Stockholders' Equity (Deficit) (See Notes A, C, H, J and K) Notes Additional Receivable Paid-in Stock Treasury Stock Accumulated Capital Purchase Shares Amount Deficit Total ____________ __________ _________ __________ ____________ ___________ Balance - June 30, 2000 $ 17,895,162 $ -- 2,776 $ (12,122) $(14,334,557) $3,627,309 Costs related to private placements (45,102) (45,102) Issance of shares for earn-out obligations 293,352 297,500 Issuance of notes receivable for employee stock purchase (90,000) (90,000) Conversion of preferred stock (11,115) 0 Common stock issued for accrued dividends 3,211 3,506 Issuance of preferred stock at a discount 339,660 (90,000) 250,000 Beneficial conversion feature of preferred stock 166,500 (166,500) 0 Dividends on preferred stock (127,118) (127,118) Shares issued for employee bonuses 29,741 30,666 - 34 - Notes Additional Receivable Paid-in Stock Treasury Stock Accumulated Capital Purchase Shares Amount Deficit Total ____________ __________ _________ __________ ____________ ___________ Issuance of warrants for services 14,640 14,640 Issuance of employee stock purchase plan shares 10,730 10,956 Purchase of treasury stock in exchange for note 10,000 11,750 (10,000) 0 Repurchase of shares on open market 8,400 ( 2,772) ( 2,772) Net loss - year ended June 30, 2001 (5,250,705) (5,250,705) ____________ __________ _________ __________ ____________ ___________ Balance - June 30, 2001 18,696,779 (80,000) 22,926 (24,894) (19,968,880) (1,281,120) Costs related to private placements (198,149) (198,149) Dividends on preferred stock (98,411) (98,411) Issuance of shares for options exercised 612 625 Repurchase of shares on open market 15,200 (6,094) (6,094) Issuance of warrants for services 5,461 5,461 Shares issued for employee bonuses 29,780 30,497 Conversion of preferred stock (31,690) 1,639 Common stock issued for accrued dividends 213,644 218,762 Issuance of shares for warrants exercised 9,684 10,000 - 35 - Notes Additional Receivable Paid-in Stock Treasury Stock Accumulated Capital Purchase Shares Amount Deficit Total ____________ __________ _________ __________ ____________ ___________ Issuance of employee stock purchase plan shares 9,575 9,834 Issuance of shares for services provided 34,167 35,000 Reclassification of net liabilities of discontinued operations 804,046 804,046 Net income-year ended June 30,2002 1,083,895 1,083,895 ____________ __________ _________ __________ ____________ ___________ Balance - June 30, 2002 $ 18,769,863 $ (80,000) 38,126 $ (30,988) $(18,179,350) $ 615,985 ============ ========= ========== =========== ============= =========== See accompanying notes to consolidated financial statements F-5
- 36 - PHC, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Year Ended June 30, 2002 2001 ____________________________ Cash flows from operating activities: Net income (loss) $ 1,083,895 $(5,250,705) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 202,776 262,227 Goodwill impairment -- 1,545,609 Write down of accounts receivable from professional corporation -- 3,401,650 Compensatory stock options and stock and warrants issued for obligations 72,745 5,306 Equity based compensation charge 264,000 40,000 Changes in operating assets and liabilities: Accounts receivable 440,638 649,407 Prepaid expenses and other current assets (2,712) 56,541 Other assets (113,675) (22,873) Accounts payable (462,580) 152,775 Accrued expenses and other liabilities 247,528 (377,532) Net liabilities of discontinued operations (156,506) (923,682) ___________ __________ Net cash provided by (used in) operating activities 1,576,109 (461,277) ___________ __________ Cash flows from investing activities: Acquisition of property and equipment (124,362) (186,842) Website development costs -- (70,226) Disposition of property, equipment and intangibles -- 3,689 ___________ __________ Net cash used in investing activities (124,362) (253,379) ___________ __________ Cash flows from financing activities: Borrowing (repayment) revolving debt, net (642,942) 556,437 Proceeds from borrowings 748,912 146,526 Principal payments on long-term debt (1,219,314) (639,157) Deferred financing costs 8,000 26,554 Preferred stock dividends -- (6,767) Issuance of preferred stock at a discount -- 250,000 Cost related to preferred stock issuance (198,149) (45,102) Purchase of treasury stock (6,094) (2,772) Issuance of common stock 18,672 10,956 Notes receivable for stock purchase -- (90,000) ___________ __________ Net cash provided by (used in) financing activities (1,290,915) 206,675 ___________ __________ Net increase in cash and cash equivalents 160,832 (507,981) Cash and cash equivalents, beginning of year 43,732 551,713 activities Cash and cash equivalents, end of year $ 204,564 $ 43,732 ========= ======== Supplemental cash flow information: Cash paid during the period for: Interest $ 782,416 $1,040,276 Income taxes $ 25,164 $ 94,780 See accompanying notes to consolidated financial statements F-6 - 37 - PHC, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (continued) For the Year Ended June 30, 2002 2001 ____________________________ Supplemental disclosures of non-cash investing and financing activities: Conversion of preferred stock at stated value $ 1,507,000 $ 193,000 Issuance of stock in lieu of cash for dividends due 218,762 3,506 Accrued dividends on series C preferred stock 98,411 120,351 Increase in equity as a result of the reclassification of net liabilities of discontinued operations 804,046 -- Issuance of warrants in connection with preferred stock conversion 53,848 -- Issuance of stock for the earn-out liability -- 297,500 Beneficial conversion feature of preferred stock -- 166,500 Preferred stock discount -- 90,000 Purchase of treasury stock in exchange for note -- 10,000 See accompanying notes to consolidated financial statements F-7 - 38 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Operations and business segments: PHC, Inc. and its wholly owned subsidiaries (the "company") is a national health care company specializing in behavioral health services including the treatment of substance abuse, which includes alcohol and drug dependency and related disorders and the provision of psychiatric services. The company also provides management, administrative and online behavioral health services. The company primarily operates under three business segments: 1. Behavioral health treatment services, including two substance abuse treatment facilities: Highland Ridge Hospital, located in Salt Lake City, Utah, which has recently begun a treatment program for psychiatric patients; and Mount Regis Center, located in Salem Virginia, and eight psychiatric treatment locations which include Harbor Oaks Hospital, a 64-bed psychiatric hospital located in New Baltimore, Michigan and seven outpatient behavioral health locations (two in Las Vegas, Nevada operating as Harmony Healthcare, one in Shawnee Mission, Kansas operating as Total Concept and four locations operating as Pioneer Counseling Center in the Detroit, Michigan metropolitan area); 2. Behavioral health administrative services, including delivery of management, administrative and help line services. PHC, Inc. provides management and administrative services for its behavioral health treatment subsidiaries. BSC-NY, Inc., a subsidiary of PHC, Inc., which closed in fiscal 2001, provided management services on behalf of physician owned behavioral health practices in the greater New York City metropolitan area (see below). Pioneer Development and Support Services ("PDS2") provides help line services primarily through contracts with major railroads and the State of Nebraska. Pioneer Pharmaceutical Research, Inc. conducts studies of the effects of psychiatric pharmaceuticals on a controlled population through contracts with major manufacturers of these pharmaceuticals; and 3. Behavioral health online services, provides internet support services for all of the other subsidiaries and their contracts and provides behavioral health education, training and products for the behavioral health professional, through its website Wellplace.com. In December 2000 the Company's Board of Directors decided to close its' BSC-NY, Inc. practice management operations due to the deterioration of operating results. The table below summarizes the practice management closing expenses for the year ended June 30, 2001. Goodwill impairment $1,545,609 Write down of the receivable due from the professional corporation 3,401,650 Lease termination and other expenses 239,047 ___________ Total $5,186,306 On October 5, 1998 Quality Care Centers of Massachusetts, Inc., which operated the company's long-term care facility, Franvale Nursing and Rehabilitation Center, filed for protection under the Chapter 7 Bankruptcy Code. In April 2002, the bankruptcy court accepted the report of the trustee and the bankruptcy was closed. This event resulted in the reclassification of the net liabilities of discontinued operations of $804,046 to stockholders' equity in the fourth quarter of fiscal 2002. F-8 - 39 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE A - OPERATIONS AND BUSINESS SEGMENTS (CONTINUED): Revenues and accounts receivable: Patient care revenues and accounts receivable are recorded at established billing rates or at the amount realizable under agreements with third-party payors, including Medicaid and Medicare. Revenues under third-party payor agreements are subject to examination and contractual adjustment, and amounts realizable may change due to periodic changes in the regulatory environment. Provisions for estimated third party payor settlements are provided in the period the related services are rendered. Differences between the amounts provided and subsequent settlements are recorded in operations in the year of settlement. The provision for contractual allowances is deducted directly from revenue and the net revenue amount is recorded as accounts receivable. The allowance for doubtful accounts does not include the contractual allowances. Medicaid reimbursements are currently based on established rates depending on the level of care provided and are adjusted prospectively. Medicare reimbursements are currently based on provisional rates that are adjusted retroactively based on annual cost reports filed by the company with Medicare. The company's cost reports to Medicare are routinely audited on an annual basis. The company periodically reviews its provisional billing rates and provides for estimated Medicare adjustments. The company believes that adequate provision has been made in the financial statements for any adjustments that might result from the outcome of Medicare audits. Approximately 15% and 11% of the company's total revenue is derived from Medicare and Medicaid payors for the years ended June 30, 2002 and 2001, respectively. Long-term assets include accounts receivable non-current, other receivables, non-current, related party and other receivables. Accounts receivable, non-current consists of amounts due from former patients for service. This amount represents estimated amounts collectable under supplemental payment agreements, arranged by the company and its' collection agencies, entered into because of the patients' inability to pay under normal payment terms. All of these receivables have been extended beyond their original due date. Accounts of former patients that do not comply with these supplemental payment agreements are written off when deemed unrecoverable. Charity care amounted to approximately $415,700 and $491,000 for the years ended June 30, 2002 and June 30, 2001, respectively. Patient care revenue is stated net of charity care in the accompanying consolidated statements of operations. Estimates and assumptions: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Cash equivalents: Cash equivalents include short-term highly liquid investments with maturities of less than three months, when purchased. F-9 - 40 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE A - OPERATIONS AND BUSINESS SEGMENTS (CONTINUED): Property and equipment: Property and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the assets using accelerated and straight-line methods. The estimated useful lives are as follows: Estimated Assets Useful Life _______________________ ___________________ Buildings 39 years Furniture and equipment 3 through 10 years Motor vehicles 5 years Leasehold improvements Term of lease Other assets: Other assets consists of deposits, deferred expenses and web development costs. Organization Costs: Organization costs are expensed as incurred as required by the American Institute of Certified Public Accountants Statement of Position 98-5 "Reporting the Costs of Start-up Activities". Goodwill: The excess of the purchase price over the fair market value of net assets acquired was amortized on a straight-line basis over twenty years through June 30, 2001. During fiscal year 2001, the company recorded goodwill impairment of $1,545,609 in connection with the closing of its practice management operations in accordance with Statement of Financial Accounting Standard (SFAS) No. 121, which required that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The company adopted SFAS 142 in the first quarter of fiscal 2002. SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purpose of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. The Company's net goodwill of $969,099 relating to the treatment services segment of the Company was evaluated under SFAS 142 as of July 1, 2001. The Company ceased amortization of goodwill resulting in a decrease in expenses of $65,700 for the year ended June 30, 2002. The company will continue to test goodwill for impairment at least annually in accordance with the guidelines of SFAS 142. F-10 - 41 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE A - OPERATIONS AND BUSINESS SEGMENTS (CONTINUED): The impact of the adoption of SFAS 142 is summarized as follows: For the Year Ended June 30, 2002 2001 __________ _____________ Reported net income (loss) applicable to common shareholders $ 985,484 $ (5,634,323) Add back: Goodwill amortization -- 65,700 __________ _____________ Adjusted net income (loss) 985,484 (5,568,623) Basic earnings per share: Reported net income (loss) applicable to common shareholders $ 0.10 $ (0.66) Goodwill amortization -- .01 __________ _____________ Adjusted net income (loss) $ 0.10 $ (0.65) Diluted earnings per share: Reported net income (loss) applicable to common shareholders $ 0.09 $ (0.66) Goodwill amortization -- .01 __________ _____________ Adjusted net income (loss) $ 0.09 $ (0.65) Fair value of financial instruments: The carrying amounts of cash, trade receivables, other current assets, accounts payable, notes payable and accrued expenses approximate fair value based on their short-term maturity and prevailing interest rates. Basic and diluted income (loss) per share: The income (loss) per share is computed by dividing the income (loss) applicable to common shareholders, net of dividends charged directly to retained earnings, by the weighted average number of shares of common stock outstanding for each fiscal year. All dilutive common stock equivalents have been included in the calculation of diluted earnings per share for the fiscal year ended June 30, 2002: however, because their effect would be anti-dilutive, no common stock equivalents were included in the calculations of diluted loss per share for the fiscal year ended June 30, 2001. The weighted average number of common shares outstanding used in the computation of earnings per share is summarized as follows: F-11 - 42 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE A - OPERATIONS AND BUSINESS SEGMENTS (CONTINUED): Years Ended June 30, 2002 2001 __________ _____________ Denominator for basic earnings per share- weighted average shares 10,232,286 8,518,408 Effect of dilutive securities: Employee stock options 439,431 -- Warrants 91,144 -- Convertible debentures 250,000 -- __________ _____________ Denominator for diluted earnings per share- adjusted weighted average shares and assumed conversions 11,012,861 8,518,408 ========== =========== The following table summarizes securities, which were outstanding as of June 30, 2002 and 2001 but not included in the calculation of diluted net earnings per share because such shares are antidilutive: Years Ended June 30, 2002 2001 __________ _____________ Employee stock options 191,500 1,141,000 Warrants 1,013,800 1,623,362 Stock-based compensation: The company accounts for its employee stock-based compensation under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation", SFAS No.123 establishes a fair-value-based method of accounting for stock-based compensation plans. The company adopted the disclosure only alternative, which requires disclosure of the pro forma effects on loss and loss per share as if SFAS No. 123 had been adopted, as well as certain other information. All of the company's employees are employed under leasing arrangements. The company believes that its leased employees meet the common law definition of employee and therefore qualify as employees for purposes of applying SFAS No.123. The company's employee leasing arrangement meets the employee definition requirements under FASB Interpretation No.44 "Accounting for Certain Transactions involving Stock Compensation". Income taxes: The company follows the liability method of accounting for income taxes, as set forth in SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 prescribes an asset and liability approach, which requires the recognition of, deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of the assets and liabilities. The company's policy is to record a valuation allowance against deferred tax assets unless it is more likely than not that such assets will be realized in future periods. The company considers estimated future taxable income or loss and other available evidence when assessing the need for its deferred tax valuation allowance. F-12 - 43 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE A - OPERATIONS AND BUSINESS SEGMENTS (CONTINUED): New accounting standards: In June 2001, the Financial Accounting Standards Board finalized FASB Statements No. 141, Business Combinations ("SFAS 141") and No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interest method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after July 1, 2001 and for purchase business combinations completed on or after July 1, 2001. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of," and APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business." SFAS No. 144 becomes effective for the fiscal years beginning after December 15, 2001. The Company will adopt SFAS No. 144 in the first quarter of fiscal 2003. The Company does not expect the adoption of SFAS No. 144 to impact its financial position and results of operations. In July 2002, the FASB issued SFAS No. 146, "Accounting for Cost Associated with Exit or Disposal Activities". SFAS No. 146 requires companies to recognize cost associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 will be applied prospectively to any exit or disposal activities initiated after December 31, 2002. The company expects there will be no effect on its financial results relating to the adoption of SFAS No. 146. NOTE B - PROPERTY AND EQUIPMENT Property and equipment is comprised of the following: June 30, 2002 2001 __________ _____________ Land $ 69,259 $ 69,259 Buildings 1,136,963 1,136,963 Furniture and equipment 1,123,258 1,023,636 Motor vehicles 92,871 92,871 Leasehold improvements 443,733 418,992 __________ _____________ 2,866,084 2,741,720 Less accumulated depreciation and amortization 1,606,436 1,403,654 __________ _____________ Property and equipment, net $1,259,648 $1,338,066 ========== ========== F-13 - 44 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE C - NOTES PAYABLE AND LONG-TERM DEBT Long-term debt is summarized as follows: June 30, 2002 2001 ____________ ___________ 9% mortgage note due in monthly installments of $4,850, including interest through July 1, 2012, when the remaining principal balance is payable, collateralized by a first mortgage on the PHC of Virginia, Inc, Mount Regis Center facility. $406,068 $ 426,702 Note Payable issued in conjunction with the final earn-out on the BSC-NY, Inc. acquisition due in monthly installments of $11,567 including interest at 11% through July 2005 (see Note K). 361,564 454,939 Note Payable issued in conjunction with the final earn-out on the BSC-NY, Inc. acquisition due in monthly installments of $3,653 including interest at 11% through July 2005 (see Note K). 114,178 143,665 Note Payable due in monthly installments of $429 including interest at 8.69% through May 2004. 9,119 13,347 Note Payable due in monthly installments of $5,088 including interest at 9% through October 2002. 20,352 81,408 Note Payable due in monthly installments of $665 including interest at 10.8% through November 2005. 22,538 27,774 Term mortgage note payable with principal installments of $45,000 beginning December 2001 through November 2002 and increasing annually by $5,000 through November 2004 at which time the remaining balance of approximately $830,500 becomes due. The note bears interest at prime plus 3.5% (8.25% at June 30, 2002) is collateralized by all assets of PHC of Michigan, Inc., guaranteed by PHC, Inc. and may be renewed at the end of three years. 2,260,541 -- Term mortgage notes refinanced in November 2001. -- 2,499,891 ____________ ___________ Total 3,194,360 3,647,726 Less current maturities 765,415 2,038,077 ____________ ___________ Long-term portion $ 2,428,945 $1,609,649 =========== ========== Maturities of long-term debt are as follows as of June 30, 2002: Year Ending June 30, Amount _____________ _________ 2003 $ 765,415 2004 823,659 2005 1,255,415 2006 47,598 2007 32,307 Thereafter 269,966 ___________ $3,194,360 F-14 - 45 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE C - NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED) The company has a revolving credit note under which a maximum of $3,000,000 may be outstanding at any time. At June 30, 2002 and 2001 the outstanding balance was $1,468,644 and $2,111,586, respectively. Advances are made based on a percentage of accounts receivable and principal is payable upon receipt of proceeds of the accounts receivable. Interest is payable monthly at prime plus 2.25% (7% at June 30, 2002). The agreement is automatically renewable for one-year periods unless terminated by either party. Upon expiration, all remaining principal and interest is due. The notes are collateralized by substantially all of the assets of the company's subsidiaries and guaranteed by PHC. On December 7, 1998 the company issued the principal sum of $500,000 of convertible debentures with interest at 12% per annum that are due on December 2, 2004. Interest is payable quarterly. The debentures and any unpaid interest are convertible into shares of common stock at the rate of $1,000 for 500 shares of common stock, which equates to $2.00 per share of common stock. The traded market price of the company's common stock at the date of issuance of the convertible debentures was $1.188 per share and accordingly there was no beneficial conversion feature. The holders of the debentures have the right to put all or any portion of the debentures to the company at the original purchase price plus unpaid interest upon 30 days written notice beginning December 3, 2001. Accordingly, the $500,000 is classified as a current liability on the accompanying Balance Sheet. The company has the right to call the debentures upon the same terms as above. If called, the holders of the debentures then have 20 days from the date of written notice to exercise their conversion privilege as to any debentures not then already converted. In July 2002 the holders of the debentures have exercised the put provision in the agreement as to 50% of the outstanding debentures. The company will begin making monthly payments of $25,000 each plus accrued interest in October 2002. NOTE D - CAPITAL LEASE OBLIGATION At June 30, 2001, the company was obligated under various capital leases for equipment providing for monthly payments of approximately $1,100 and $1,400 for fiscal 2002 and 2001, respectively and terms expiring from July 2002 through June 2006. The carrying value of assets under capital leases included in property and equipment is as follows: June 30, 2002 2001 __________ __________ Equipment and improvements $ 50,271 $ 73,888 Less accumulated amortization (33,108) (39,940) __________ __________ $ 17,163 $ 33,948 ========== ========== F-15 - 46 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE D - CAPITAL LEASE OBLIGATION (CONTINUED) Future minimum lease payments under the terms of the capital lease agreements are as follows at June 30, 2002: Year Ending June 30, ____________ 2003 $ 13,556 2004 10,536 2005 8,126 2006 5,037 _________ Total future minimum lease payments 37,255 Less amount representing interest 5,095 _________ Present value of future minimum lease payments 32,160 Less current portion 11,020 _________ Long-term obligations under capital leases $ 21,140 ========= NOTE E - NOTES PAYABLE - RELATED PARTIES Related party debt is summarized as follows: June 30, 2002 2001 __________ __________ Notes payable, Tot Care, Inc., company owned by the President and principal stockholder, interest at 12% and payable on demand $100,000 $100,000 Note payable, President and principal stockholder, interest at 12% payable on demand 100,000 100,000 __________ __________ Total $200,000 $200,000 ========== ========== F-16 - 47 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE F - INCOME TAXES The company has the following deferred tax assets included in the accompanying balance sheets: Year Ended June 30, 2002 2001 __________ __________ Temporary differences attributable to: Allowance for doubtful accounts $1,086,000 $1,053,000 Depreciation 72,000 89,000 Reserves not currently deductible and other 173,000 208,000 Operating loss carryforward 3,383,000 3,578,000 __________ __________ Total deferred tax asset 4,714,000 4,928,000 Less: Valuation allowance (3,947,207) (4,314,020) __________ __________ Subtotal 766,793 613,980 Current portion (766,793) (613,980) __________ __________ Long-term portion $ -- $ -- =========== ========== The company had no deferred tax liabilities at June 30, 2002 and 2001. The company anticipates that it will have sufficient taxable income in future fiscal years to realize its net deferred tax asset. During the past four years, the company has closed three facilities that contributed most significantly to its past losses, the Franvale Nursing and Rehabilitation Center, the Good Hope Center and the Pioneer Counseling of Virginia clinics. The company has also closed its practice management business and has implemented procedures to improve the operating efficiency of its remaining centers. Income tax expense is as follows: Year Ended June 30, 2002 2001 __________ __________ Current state income taxes $ 15,446 $ 44,450 =========== ========== The above current state income taxes are significantly below the Federal statutory rate of 34% primarily related to the availability of net operating loss carry-forward. Total income tax expense for fiscal 2002 and 2001 represents state income taxes for certain subsidiaries with no available net operating loss carry-forwards. In fiscal 2002 the company's deferred tax benefit of $152,813 was offset by current tax accrual changes of similar amounts. F-17 - 48 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE F - INCOME TAXES (CONTINUED) At June 30, 2002 the company had a federal net operating loss carryforward amounting to approximately $10,000,000. The Company's Federal net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service and are subject to certain limitations in the event of cumulative changes in the ownership interest of significant stockholders over a three-year period in excess of 50%. The Federal carryforward expires beginning in 2011 through 2020. The company has provided a significant valuation allowance against its deferred tax asset at June 30, 2002 and 2001 due to the uncertainty of its full recoverability given the company's history of operating losses. No additional valuation allowance was provided on the company's net deferred tax asset of $766,793 and $613,980 at June 30, 2002 and 2001, respectively, based on managements estimated projection of future taxable income. NOTE G - COMMITMENTS AND CONTINGENT LIABILITIES Operating leases: The company leases office and treatment facilities, furniture and equipment under operating leases expiring on various dates through May 2005. Rent expense for the years ended June 30, 2002 and 2001 was approximately $799,000 and $812,000 respectively. Rent expense includes certain short-term rentals. Minimum future rental payments under non-cancelable operating leases, having remaining terms in excess of one year as of June 30, 2001 are as follows: Year Ending June 30, Amount ____________ __________ 2003 $ 776,551 2004 748,119 2005 539,195 2006 181,607 2007 111,239 _________ $2,356.711 ========== Litigation: Various legal proceedings, claims and investigations of a nature considered normal to its business operations are pending against the company. The most significant of these matters is described below. On or about May 15, 2000, the company was served with a subpoena by the United States Attorney for the District of Massachusetts. The subpoena requested, inter alia, patient and financial records relating to Franvale Nursing and Rehabilitation Center for the period of 1995 through 1998. The company has reached an agreement in principle with the government to settle all outstanding billing issues. The final agreement is currently being drafted for signatures. The company believes that it has adequately accrued for the settlement of this claim in the accompanying financial statements. F-18 - 49 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE H - STOCK PLANS [1] Stock plans: The company has three stock plans: a stock option plan, an employee stock purchase plan and a nonemployee directors' stock option plan. The stock option plan provides for the issuance of a maximum of 1,750,000 shares of Class A common stock of the company pursuant to the grant of incentive stock options to employees or nonqualified stock options to employees, directors, consultants and others whose efforts are important to the success of the company. Subject to the provisions of this plan, the compensation committee of the Board of Directors has the authority to select the optionees and determine the terms of the options including: (i) the number of shares, (ii) option exercise terms, (iii) the exercise or purchase price (which in the case of an incentive stock option will not be less than the market price of the Class A common stock as of the date of grant), (iv) type and duration of transfer or other restrictions and (v) the time and form of payment for restricted stock upon exercise of options. The employee stock purchase plan provides for the purchase of Class A common stock at 85 percent of the fair market value at specific dates, to encourage stock ownership by all eligible employees. A maximum of 250,000 shares may be issued under this plan. The non-employee directors' stock option plan provides for the grant of nonstatutory stock options automatically at the time of each annual meeting of the Board. Through June 30, 2002, options for 65,500 shares were granted under this plan. A maximum of 250,000 shares may be issued under this plan. Each outside director is granted an option to purchase 10,000 shares of Class A common stock at fair market value on the date of grant, vesting 25% immediately and 25% on each of the first three anniversaries of the grant. Under the above plans, at June 30, 2002, 884,565 shares were available for future grant or purchase. The company had the following activity in its stock option plans for fiscal 2002 and 2001: Number Weighted-Average Of Exercise Price Shares Per Share __________ ________________ Balance - June 30, 2000 782,500 $1.46 Granted 420,500 $0.28 Cancelled (62,000) $0.25 Repriced Options Original (791,500) $1.38 Repriced 791,500 $0.25 __________ __________ Balance - June 30, 2001 1,141,000 $0.33 Granted 245,000 $0.51 Expired (111,000) $0.27 __________ __________ Balance - June 30, 2002 1,275,000 $0.37 ========== =========== F-19 - 50 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE H - STOCK PLANS (CONTINUED) [2] Stock-based compensation: The following tables summarize information about stock options outstanding and exercisable at June 30, 2002: Options Outstanding ___________________________________________________________________________ Weighted-Average Number Outstanding Remaining Contractual Exercise Price At June 30, 2002 Life (years) ___________________________________________________________________________ $ .19 5,000 3.5 .22 8,000 3.5 .25 665,000 2.35 .30 332,500 3.75 .35 40,000 8.25 .45 33,000 4.5 .55 148,000 5 .75 14,000 5 .81 6,000 7.5 1.03 6,000 6.5 2.06 6,000 5.5 3.50 6,000 4.5 6.63 5,500 3.5 _______ __________ ________ $ .37 1,275,000 3.4 ======= ========== ======== Options Exercisable ___________________________________________________________________________ Weighted-Average Number Exercisable Remaining Contractual Exercise Price At June 30, 2002 Life (years) ___________________________________________________________________________ $ .19 2,500 3.5 .22 4,000 3.5 .25 566,500 1.85 .30 166,250 3.75 .35 10,000 8.25 .45 8,250 4.5 .55 37,000 5 .75 3,500 5 .81 4,500 7.5 1.03 6,000 6.5 2.06 6,000 5.5 3.50 6,000 4.5 6.63 5,500 3.5 _______ __________ ________ $ .37 826,000 2.7 ======= ========== ======== F-20 - 51 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE H - STOCK PLANS (CONTINUED) [2] Stock-based compensation: (continued) The Company re-priced 791,500 options in January 2001. As a result of this modification, 572,750 of the options remaining at June 30, 2002 are subject to variable accounting from the date of the modification. The compensation expense related to 502,250 of the vested re-priced options amounted to approximately $264,000 and $40,000, for the year ended June 30, 2002 and 2001, respectively. Approximately $250,000 of the expense related to the current fiscal year was recorded in the fourth quarter of fiscal 2002 due to the increase in share price during that quarter. The company has adopted the disclosure only provisions of SFAS No. 123, but applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its plans. If the company had elected to recognize compensation cost for the plans based on the fair value at the grant date for awards granted, consistent with the method prescribed by SFAS No. 123, the net income (loss) per share would have been changed to the pro forma amounts indicated below: Year Ended June 30, 2002 2001 _________________________ Net income (loss) applicable to common Shareholders As reported $ 985,484 $ (5,634,323) Pro forma $ 947,118 (5,721,161) Basic net income (loss) Per share As reported $ .10 $ (.66) Pro forma $ .09 $ (.67) Diluted net income (loss) Per share As reported $ .09 $ (.66) Pro forma $ .09 $ (.67) The fair value of the company's stock options used to compute pro forma net income (loss) and net income (loss) per share disclosures is the estimated present value at grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for 2002 and 2001: dividend yield of 0%; expected volatility of 30%; a risk-free interest rate of 6.0% and 6.5% respectively; and an expected holding period of five years. The per share weighed average grant date fair value of options granted during the years ended June 30, 2002 and 2001 was $.16 and $.10, respectively. F-21 - 52 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE I - DISCONTINUED OPERATIONS On May 26, 1998, PHC, Inc.'s wholly owned subsidiary, Quality Care, which operated Franvale filed for reorganization under Chapter 11. On May 29, 1998, the Bankruptcy Court terminated the Chapter 11 proceeding determining that there was no likelihood of reorganization since the prospective acquirer of the facility was now imposing certain terms unacceptable to all interested parties and that the transfer of patients and liquidation of assets could be as readily effectuated in a state court receivership under the aegis of the Massachusetts Health Care Statutes and accordingly dismissed the Chapter 11 case. On June 1, 1998, a receiver was appointed to transfer the patients and close the facility expeditiously. The company has recorded the losses of Franvale through May 31, 1998. The company's Bankruptcy Attorney was notified that effective September 30, 1998 the patient care receivership for Quality Care had been terminated. On October 5, 1998, in response to the termination of the State Receivership, the company filed for protection under Chapter 7. In April 2002 the bankruptcy court accepted the trustees' final bankruptcy report, closing the bankruptcy. This final disposition resulted in a non-cash increase in stockholders' equity of $804,046. Net liabilities of discontinued operations consists of the following: June 30, 2002 2001 ____________ ____________ Debt forgiveness and reserve for contingencies $ 2,641,537 $ 2,641,537 Less legal and other expenses incurred to date (1,837,491) (1,680,986) Reclassified to stockholders' equity (804,046) -- ____________ ____________ Net liabilities of discontinued operations $ -- $ 960,551 ============ ============ NOTE J - CERTAIN CAPITAL TRANSACTIONS In addition to the outstanding options under the company's stock plans (Note H), the company has the following options and warrants outstanding at June 30, 2002: Date of Number of Exercise Expiration Issuance Description Shares Price Date _________ _________________________________________ ______________ _______________ ___________ 03/03/1997 Consultant warrant for investor relations $16,306 value passed as an adjustment 20,000 shares $ .50 per share March 2002 09/17/1998 Consultant warrant for investor relations $12,776 value passed as an adjustment 40,000 shares $ .50 per share March 2002 09/19/1997 Private Placement warrants with common stock issuance Equity transaction 86,207 shares $2.90 per share Sept 2002 F-22 - 53 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE J - CERTAIN CAPITAL TRANSACTIONS (CONTINUED) Date of Number of Exercise Expiration Issuance Description Shares Price Date _________ _________________________________________ ______________ _______________ ___________ 03/10/1998 Warrants issued as a penalty for late registration of private placement shares. Equity transaction 3,000 shares $2.90 per share March 2003 03/10/1998 Warrants issued as additional interest on debt $48,809 value charged to interest expense over term of loan 71,186 shares $1.76 per share March 2003 07/10/1998 Warrants issued with extension of debt $28,740 value charged to interest expense over term of loan 69,347 shares $1.37 per share July 2003 07/10/1998 Warrants issued with extension of debt as price guarantee $14,779 value charged to interest expense over term of loan 25,827 shares $1.16 per share July 2003 12/31/1998 Warrants issued with convertible debenture $9,240 value charged to professional fees over term of debentures 30,298 shares $ .83 per share Dec 2004 12/31/1998 Warrants issued for convertible debentures finder's fee $25,873 value charged to professional fees over term of debentures 72,724 shares $1.51 per share Dec 2003 12/31/1998 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 13,288 shares $1.51 per share Dec 2003 12/31/1998 Warrants issued for convertible debentures finders fee $3,246 value charged to professional fees over term of debentures 19,311 shares $1.17 per share Dec 2003 12/01/1998 Warrants issued for convertible debentures finders fee $1,302 value charged to professional fees over term of debentures 12,119 shares $ .83 per share Dec 2003 01/01/1999 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 12,119 shares $ .83 per share Jan 2004 02/01/1999 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 12,119 shares $ .83 per share Feb 2004 03/01/1999 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 12,078 shares $ .83 per share Mar 2004 04/01/1999 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 12,078 shares $ .83 per share Apr 2004 05/01/1999 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 12,078 shares $ .83 per share May 2004 06/01/1999 Warrants issued for convertible debentures finders fee $3,696 value charged to professional fees over term of debentures 12,037 shares $ .83 per share June 2004 01/05/1999 Warrants issued for investment banker services $18,100 value charged to professional fees over service period 48,071 shares $1.13 per share Jan 2004 04/05/1999 Warrants issued for investment banker services $18,100 value charged to professional fees over service period 47,680 shares $1.14 per share Apr 2004 02/23/1999 Consultant warrant for investor relations $1,307 value charged to professional fees 3,724 shares $ .97 per share Feb 2004 04/21/1999 Consultant warrant for web site development services $1,547 value charged to professional fees 6,039 shares $ .83 per share Apr 2004 05/18/1999 Consultant warrant for web site advisory services $1,848 value charged to professional fees 6,020 shares $ .83 per share Apr 2004 04/21/1999 Warrant issued for management consultant services $1,547 value charged to professional fees 5,373 shares $ .93 per share Apr 2004 05/18/1999 Warrant issued for management consultant services $370 value charged to professional fees 1,204 shares $ .83 per share May 2004 07/01/1999 Warrants issued for convertible debentures finders fee $5,745 value charged to professional fees over term of debentures 12,037 shares $ .83 per share July 2004 08/01/1999 Warrants issued for convertible debentures finders fee $4,187 value charged to professional fees over term of debentures 12,037 shares $ .83 per share Aug 2004 07/05/1999 Warrants for investment banker services $12,944 value charged to professional fees over service period 47,369 shares $1.15 per share July 2004 10/05/1999 Warrants for investment banker services $6,042 value charged to professional fees over service period 47,369 shares $1.15 per share Oct 2004 F-23 - 54 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE J - CERTAIN CAPITAL TRANSACTIONS (CONTINUED) Date of Number of Exercise Expiration Issuance Description Shares Price Date _________ _________________________________________ ______________ _______________ ___________ 03/31/2000 Warrants issued for services $10,000 value charged to website development 11,334 shares $1.32 per share Mar 2005 05/26/2000 Warrants issued as additional interest on debt $33,264 value charged to interest expense 60,000 shares $1.50 per share May 2005 06/28/2000 Warrants issued with preferred stock placement Equity transaction 125,000 shares $3.00 per share June 2005 06/28/2000 Warrants issued with preferred stock placement Equity transaction 115,710 shares $1.41 per share June 2005 12/20/2000 Warrants issued for investment banker services $1,938 value charged to professional fees 52,530 shares $ .20 per share Dec 2005 03/20/2001 Warrants issued for investment banker services $969 value charged to professional fees 25,195 shares $ .21 per share Mar 2006 04/15/2001 Warrants issued for investor relations consulting services $1,136 value charged to professional fees 10,061 shares $ .25 per share Apr 2006 05/15/2001 Warrants issued for investor relations consulting services $2,577 value charged to professional fees 10,000 shares $ .25 per share May 2006 06/15/2001 Warrants issued for investor relations consulting services $2,577 value charged to professional fees 10,000 shares $ .25 per share June 2006 06/20/2001 Warrants issued for investment banker services $5,383 value charged to professional fees 25,000 shares $ .21 per share June 2006 07/20/2001 Warrants issued for investor relations consulting services $1,786 value charged to professional fees 12,000 shares $ .35 per share July 2006 02/08/2002 Warrants issued for investor relations consulting services $391 value charged to professional fees 3,000 shares $ .42 per share Feb 2007 03/01/2002 Warrants issued for investor relations consulting services $1,476 charged to professional fees 25,000 shares $.37 per share Mar 2007 03/01/2002 Warrants issued for investor relations consulting services $398 charged to professional fees 20,000 shares $ .37 per share Mar 2007 03/01/2002 Warrants issued for investor relations consulting services $310 charged to professional fees 3,000 shares $ .38 per share Mar 2007 04/01/2002 Warrants issued for investor relations consulting services $310 value charged to professional fees 3,000 shares $ .38 per share Apr 2007 05/01/2002 Warrants issued for investor relations consulting services $790 charged to professional fees 3,000 shares $ .59 per share May 2007 05/07/2002 Warrants issued as a finders fee in connection with preferred stock conversion. Equity transaction. 151,783 shares $ .62 per share May 2005 05/07/2002 Warrants issued as a finders fee in connection with preferred stock conversion. Equity transaction. 50,594 shares $ .62 per share May 2005
Warrants issued for services or in connection with debt are valued at fair value at grant date using the Black-Scholes pricing model and charged to operations consistent with the underlying reason the warrants were issued. Charges to operations in connection with these warrants amounted to $5,461 and $14,640 in fiscal 2002 and 2001, respectively. On June 28, 2000 the company issued 136,000 shares of series C 8% convertible preferred stock, with a stated and liquidation value of $10.00 per share, at a discount for $1,000,000, which resulted in a dividend charge to retained earnings of $360,000 for the year ended June 30, 2000. In conjunction with this transaction the company also issued a warrant to purchase 125,000 shares of class A common stock, which resulted in a charge to retained earnings of $14,963 in the year ended June 30, 2000. The investor was required to purchase an additional 34,000 shares of series C preferred stock as provided in the agreement for $250,000. This additional purchase of 34,000 shares was completed in August 2000 resulting in an additional dividend charge to retained earnings in fiscal year 2001 of $90,000. F-24 - 55 - PHC, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements June 30, 2002 and 2001 NOTE J - CERTAIN CAPITAL TRANSACTIONS (CONTINUED) The series C preferred stock was convertible into shares of class A common stock. In February 2001 the Series C preferred stock agreement was amended to allow for conversion at 90% of the market value of class A common Stock. This beneficial conversion feature resulted in a dividend charge to retained earnings of $166,500 for the year ended June 30, 2001. As part of the amendment, the holders of the series C preferred stock also agreed to limit its conversions of preferred stock so that such conversions will not in the aggregate convert into greater than 20% of the outstanding common stock of the corporation, 821,705 additional shares of class A common stock, from the date of the agreement through July 31, 2001. Through June 30, 2001, 1,160,160 shares of class A common stock had been issued upon conversion of 19,300 shares of series C convertible preferred stock, including accrued dividends outstanding on those preferred shares. During the fiscal year ended June 30, 2002 the remaining series C preferred stock were converted resulting in the issuance of 3,483,583 shares of class A common stock. In addition 511,800 shares of class A common stock were issued in payment of accrued dividends in fiscal 2002. Accrued dividends included in accrued expenses and other liabilities in the accompanying consolidated balance sheet were $120,350 at June 30, 2001. No dividends were accrued and unpaid at June 30, 2002. Under existing dilution agreements with other stockholders the issuance of common stock under agreements other than the employee stock purchase and option plans will increase the number of shares issuable and decrease the exercise price of certain of the above warrant agreements based on the difference between the then current market price and the price at which the new common stock is being issued. The dilutive effect of transactions through June 30, 2002 are reflected in the table above. The value of the additional shares issuable as a result of these dilution provisions was not material. NOTE K - ACQUISITIONS On November 1, 1996, BSC-NY, Inc. ("BSC"), merged with Behavioral Stress Centers, Inc., a provider of management and administrative services to psychotherapy and psychological practices in the greater New York City Metropolitan Area. In connection with the merger, the company advanced 150,000 shares of PHC, Inc. Class A common stock and funds to the professional corporation, which were in turn issued to the former owners of Behavioral Stress Centers, Inc. to acquire the assets of the medical practices previously serviced by BSC. In December 2000 the company's Board of Directors decided to close BSC due to the deterioration of its operating results. Although the company had no ownership interest in the professional corporation, BSC was dependent on the success of its operations through its management services agreement. During fiscal 2001, the professional corporation closed its business operations and the net amount due from the professional corporation of $3,401,650 was deemed unrecoverable and charged to practice management closing expenses (see note A). F-25 - 56 - NOTE L - BUSINESS SEGMENT INFORMATION The company's behavioral health treatment services have similar economic characteristics, services, patients and clients. Accordingly, all behavioral health treatment services are reported on an aggregate basis under one segment. The company's segments are more fully described in Note A above. Residual income and expenses from closed facilities are included in the administrative services segment. The following summarizes the company's segment data: BEHAVIORAL HEALTH TREATMENT ADMINISTRATIVE ONLINE SERVICES SERVICES SERVICES ELIMINATIONS TOTAL For the Year ended _____________ _________________ _________ _______________ ________ June 30, 2002 Revenues - external customers $21,114,504 $1,579,325 $ 4,439 $ 0 $ 22,698,268 Revenues - intersegment 162,468 1,896,000 300,000 (2,358,468) 0 Segment net income (loss) 3,421,774 (2,060,457) (277,422) 0 1,083,895 Total assets 7,834,299 1,541,976 97,340 0 9,473,615 Capital expenditures 89,957 34,405 0 0 124,362 Depreciation & amortization 140,130 50,628 20,078 0 202,776 June 30, 2001 Revenues - external customers $21,087,473 $ 1,644,296 $ 18,067 0 $ 22,749,836 Revenues - intersegment 0 1,932,792 35,245 $(1,968,037) 0 Segment net income (loss) 2,936,935 (7,384,801) (802,839) 0 $ (5,250,705) Total assets 8,503,698 1,094,172 125,582 0 $ 9,723,452 Capital expenditures 126,566 43,063 87,439 0 $ 257,068 Depreciation & amortization $ 187,876 $ 53,179 $ 21,172 0 $ 262,227
F-26 - 57 - PART III ITEM 9. Directors, Executive Officers, Promoters and Control Persons DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and officers of the company as of June 30, 2002 are as follows: Name Age Position ______________________________________________________________________________ Bruce A. Shear 47 Director, President and Chief Executive Officer Robert H. Boswell 54 Senior Vice President Michael R. Cornelison 52 Executive Vice President Paula C. Wurts 53 Controller, Treasurer and Assistant Clerk Gerald M. Perlow, M.D. (1)(2) 64 Director and Clerk Donald E. Robar (1)(2) 65 Director Howard W. Phillips 72 Director William F. Grieco (1) 48 Director David E. Dangerfield 61 Director (1) Member of Audit Committee. (2) Member of Compensation Committee. All of the directors hold office until the annual meeting of stockholders next following their election, or until their successors are elected and qualified. The Compensation Committee reviews and sets executive compensation. Officers are elected annually by the Board of Directors and serve at the discretion of the Board. There are no family relationships among any of the directors or officers of the company. Information with respect to the business experience and affiliations of the directors and officers of the company is set forth below. BRUCE A. SHEAR has been President, Chief Executive Officer and a Director of the company since 1980 and Treasurer of the company from September 1993 until February 1996. From 1976 to 1980 he served as Vice President, Financial Affairs, of the company. Mr. Shear has served on the Board of Governors of the Federation of American Health Systems for over ten years. Mr. Shear received an M.B.A. from Suffolk University in 1980 and a B.S. in Accounting and Finance from Marquette University in 1976. ROBERT H. BOSWELL has served as the Senior Vice President of the company since February 1999 and as executive vice president of the company from 1992 to 1999. From 1989 until the spring of 1994 Mr. Boswell served as the Administrator of the company's Highland Ridge Hospital facility where he is based. Mr. Boswell is principally involved with the company's substance abuse facilities. From 1981 until 1989, he served as the Associate Administrator at the Prevention Education Outpatient Treatment Program--the Cottage Program, International. Mr. Boswell graduated from Fresno State University in 1975 and from 1976 until 1978 attended Rice University's doctoral program in philosophy. Mr. Boswell is a Board Member of the National Foundation for Responsible Gaming and the Chair for the National Center for Responsible Gaming. - 58 - MICHAEL R. CORNELISON has served as Executive Vice President and Chief Operating Officer of the company since June 1999. Mr. Cornelison also served as the Director of Michigan Operations from December of 1997 through April 1998 and Vice President of Operations from April 1998 through June of 1999. Prior to joining the company Mr. Cornelison spent eleven years as a psychiatric hospital administrator for both Universal Health Services and Charter Medical Systems. Mr. Cornelison attended Washington State University and received a degree in Business Management from LaSalle University in 1975. Mr. Cornelison has served two terms as member of the Board of Governors of the Federation of American Health Systems. PAULA C. WURTS has served as the Controller of the company since 1989, as Assistant Clerk since January 1996, as Assistant Treasurer from 1993 until April 2000 when she became Treasurer. Ms. Wurts served as the company's Accounting Manager from 1985 until 1989. Ms. Wurts received an Associate's degree in Accounting from the University of South Carolina in 1980, a B.S. in Accounting from Northeastern University in 1989 and passed the examination for Certified Public Accountants. She received a Master's Degree in Accounting from Western New England College in 1996. GERALD M. PERLOW, M.D. has served as a Director of the company since May 1993 and as Clerk since February 1996. Dr. Perlow is a retired cardiologist who practiced medicine in Lynn, Massachusetts, and has been Associate Clinical Professor of Cardiology at the Tufts University School of Medicine since 1972. Dr. Perlow is a Diplomat of the National Board of Medical Examiners and the American Board of Internal Medicine (with a subspecialty in cardiovascular disease) and a Fellow of the American Heart Association, the American College of Cardiology and the American College of Physicians. From 1987 to 1990, Dr. Perlow served as the Director, Division of Cardiology, at AtlantiCare Medical Center in Lynn, Massachusetts. Dr. Perlow served as a consultant to Wellplace.com, formerly Behavioralhealthonline.com, in fiscal year 2000 and has been a contributing journalist to Wellplace.com since 1999. Dr. Perlow received a B.A. from Harvard College in 1959 and an M.D. from Tufts University School of Medicine in 1963. DONALD E. ROBAR has served as a Director of the company since 1985 and as the Treasurer from February 1996 until April 2000. He served as the Clerk of the company from 1992 to 1996. Dr. Robar has been a professor of Psychology since 1961, most recently at Colby-Sawyer College in New London, New Hampshire. Dr. Robar received an Ed.D. from the University of Massachusetts in 1978, an M.A. from Boston College in 1968 and a B.A. from the University of Massachusetts in 1960. HOWARD W. PHILLIPS has served as a Director of the company since August 27, 1996 and has been employed by the company as a public relations specialist since August 1, 1995. From 1982 until October 31, 1995, Mr. Phillips was the Director of Corporate Finance for D.H. Blair Investment Corp. From 1969 until 1981, Mr. Phillips was associated with Oppenheimer & Co. where he was a partner and Director of Corporate Finance. From 1995 until 1999 Mr. Phillips served as a member of the Board of Directors of Food Court Entertainment Network, Inc., an operator of shopping mall television networks, and Telechips Corp., a manufacturer of visual phones. WILLIAM F. GRIECO has served as a Director of the company since February 18, 1997. Since November 2001 Mr. Grieco has been Senior Vice President and General Counsel of IDX Systems Corporation, a healthcare information technology company. From August 1999 to October 2001 Mr. Grieco was a Managing Director of Arcadia Strategies, LLC, a legal and business consulting organization. From November 1995 to July 1999 he served as Senior Vice President and General Counsel for Fresenius Medical Care North America. From 1989 until November of 1995, Mr. Grieco was a partner at Choate, Hall & Stewart, a general service law firm. Mr. Grieco received a BS from Boston College in 1975, an MS in Health Policy and Management from Harvard University in 1978 and a JD from Boston College Law School in 1981. - 59 - DAVID E. DANGERFIELD has served as a Director of the company since December 2001. Since 1977, he has served as the Executive Director for Valley Mental Health in Salt Lake City, Utah. Since 1974, Mr. Dangerfield has been a partner for Professional Training Associates (PTA). In 1989, he became a consultant across the nation for managed mental health care and the enhancement of mental health delivery services. David Dangerfield serves as a Board member of the Mental Health Risk Retention Group and Mental Health Corporation of America, which are privately held corporations, and the Utah Hospital Association, which is a state organization. Mr. Dangerfield graduated from the University of Utah in 1972 with a Doctorate of Social Work after receiving his Masters of Social Work from the University in 1967. Compliance With Section 16(A) Of The Exchange Act Based on a review of Forms 3 and 4 furnished to the company, all directors, officers and beneficial owners of more than ten percent of any class of equity securities of the company registered pursuant to Section 12 of the Securities Exchange Act filed on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal year. ITEM 10. Executive compensation. Employment agreements The company has not entered into any employment agreements with its executive officers. The company owns and is the beneficiary on a $1,000,000 key man life insurance policy on the life of Bruce A. Shear. Executive Compensation Four executive officers of the company received compensation in the 2002 fiscal year, which exceeded $100,000. The following table sets forth the compensation paid or accrued by the company for services rendered to these executives in fiscal year 2002, 2001, and 2000: Summary Compensation Table Long Term Compensation Annual Compensation Awards (a) (b) (c) (d) (e) (g) (i) Securities Name and Other Annual Underlying All Other Principal Year Salary Bonus Compensation Options/SARs Compensation Position ($) ($) ($) (#) ($) ______________________ ____ ____________ _______ _______________ ____________ ______________ Bruce A. Shear 2002 $310,000(1) $37,500 $71,390 (2) 20,000 $ 3,400 President and Chief 2001 $310,000(1) -- $19,571 (3) 67,000 $ 6,285 Executive Officer 2000 $300,195(1). -- $10,159 (4) 50,000 $22,517 Robert H. Boswell 2002 $137,000 $ 7,000 $67,301 (5) 25,000 $ 3,725 Senior Vice President 2001 $126,000 $16,309 $15,521 (6) 41,000 $ 3,864 2000 $116,000 $32,200 $12,846 (7) 26,666 $14,261 Michael R. Cornelison 2002 $114,333 -- $60,356 (8) 10,000 $ 1,700 Executive Vice President 2001 $ 96,000 $15,910 $14,160 (9) 41,000 $ 3,864 2000 $ 88,750 $13,000 $11,537(10) 5,000 $ 2,252 Paula C. Wurts 2002 $111,800 $ 2,000 $36,825(11) 25,000 $ 3,725 Controller, Treasurer 2001 $100,800 $ 6,414 $13,867(12) 41,000 $ 3,864 And Assistant Clerk 2000 $90,800 $13,500 $ 9,642(13) 33,334 $17,263
(1) Although the Board of Director authorized base salary effective July 1, 1995 is $310,000 base salary was drawn as listed above. (2) This amount represents $3,983 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Mr. Shear, $4,768 in premiums paid by the company with respect to life insurance for the benefit of Mr. Shear, $336 in club membership dues paid by the company for the benefit of Mr. Shear, $2,678 personal use of a company car held by Mr. Shear and $59,625 based on the intrinsic value of the repricing of options held by Mr. Shear. (3) This amount represents $3,799 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Mr. Shear, $4,768 in premiums paid by the company with respect to life insurance for the benefit of Mr. Shear, $208 in club membership dues paid by the company for the benefit of Mr. Shear, $2,921 personal use of a company car held by Mr. Shear and $7,875 based on the intrinsic value of the repricing of options held by Mr. Shear. (4) This amount represents $3,383 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Mr. Shear, $4,837 in premiums paid by the company with respect to life insurance for the benefit of Mr. Shear and $1,938 personal use of a company car held by Mr. Shear. - 60 - (5) This amount represents a $6,000 automobile allowance, $2,323 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Mr. Boswell, $640 in membership dues paid by the company for the benefit of Mr. Boswell, $363 in benefit derived from the purchase of shares through the employee stock purchase plan, and $57,975 based on the intrinsic value of the repricing of options held by Mr. Boswell. (6) This amount represents a $6,000 automobile allowance, $1,195 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Mr. Boswell, $22 in Class A Common Stock issued to employees, $219 in benefit derived from the purchase of shares through the employee stock purchase plan, and $8,085 based on the intrinsic value of the repricing of options held by Mr. Boswell. (7) This amount represents a $6,000 automobile allowance, $952 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Mr. Boswell, $3,000 in relocation expenses paid to Mr. Boswell and $2,894 in benefit derived from the purchase of shares through the employee stock purchase plan. (8) This amount represents a $7,800 automobile allowance, $243 in medical expenses reimbursed by the company and $52,313 based on the intrinsic value of the repricing of options held by Mr. Cornelison. (9) This amount represents a $7,050 automobile allowance, $22 in Class A Common Stock issued to employees and $7,088 based on the intrinsic value of the repricing of options held by Mr. Cornelison. (10) This amount represents a $4,700 automobile allowance, $6,050 as a result of the exercise of options and $787 in benefit derived from the purchase of shares through the employee stock purchase plan. (11) This amount represents a $4,800 automobile allowance, $4,319 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Ms. Wurts, $181 in benefit derived from the purchase of shares through the employee stock purchase plan and $27,525 based on the intrinsic value of the repricing of options held by Ms. Wurts. (12) This amount represents a $4,800 automobile allowance, $4,319 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Ms. Wurts, $22 in Class A Common Stock issued to employees, $146 in benefit derived from the purchase of shares through the employee stock purchase plan and $4,580 based on the intrinsic value of the repricing of options held by Ms. Wurts. (13) This amount represents a $4,800 automobile allowance, $3,878 contributed by the company to the company's Executive Employee Benefit Plan on behalf of Ms. Wurts and $964 in benefit derived from the purchase of shares through the employee stock purchase plan. COMPENSATION OF DIRECTORS Directors who are employees of the company receive no compensation for services as members of the Board. Directors who are not employees of the company receive $5,000 stipend per year and $1,250 for each Board meeting they attend. In addition, directors of the company are entitled to receive certain stock option grants under the company's Non-Employee Director Stock Option Plan (the "Director Plan"). - 61 - COMPENSATION COMMITTEE The Compensation Committee consists of Mr. Donald Robar and Dr. Gerald Perlow. The compensation Committee met once during fiscal 2002. Mr. Shear does not participate in discussions concerning, or vote to approve, his salary. AUDIT COMMITTEE The Audit Committee consists of Mr. Donald Robar, Dr. Gerald Perlow and Mr. William Grieco. The Audit Committee met two times during fiscal 2002. All committee members attended both meetings. OPTION PLANS Stock Plan The Board of Directors adopted the company's Stock Plan on August 26, 1993 and the stockholders of the company approved the plan on November 30, 1993 and amended the plan on December 26, 1997, December 23, 1998 and December 19, 2001. The Stock Plan provides for the issuance of a maximum of 1,750,000 shares of the Class A Common Stock of the company pursuant to the grant of incentive stock options to employees and the grant of nonqualified stock options or restricted stock to employees, directors, consultants and others whose efforts are important to the success of the company. The Board of Directors administers the Stock Plan. Subject to the provisions of the Stock Plan, the Board of Directors has the authority to select the optionees or restricted stock recipients and determine the terms of the options or restricted stock granted, including: (i) the number of shares, (ii) option exercise terms, (iii) the exercise or purchase price (which in the case of an incentive stock option cannot be less than the market price of the Class A Common Stock as of the date of grant), (iv) type and duration of transfer or other restrictions and (v) the time and form of payment for restricted stock and upon exercise of options. Generally, an option is not transferable by the option holder except by will or by the laws of descent and distribution. Also, generally, no option may be exercised more than 60 days following termination of employment. However, in the event that termination is due to death or disability, the option is exercisable for a period of one year following such termination. During the fiscal year ended June 30, 2002, the company issued additional options to purchase 245,000 shares of Class A Common Stock under the 1993 Stock Plan at a price per share ranging from $.35 to $.75. Generally, options are exercisable upon grant for 25% of the shares covered with an additional 25% becoming exercisable on each of the first three anniversaries of the date of grant. A total of 1,250 options were exercised at $.25 each during the fiscal year ended June 30, 2002. No options were exercised during the fiscal year ended June 30, 2001. - 62 - Employee Stock Purchase Plan On October 18, 1995, the Board of Directors voted to provide employees who work in excess of 20 hours per week and more than five months per year rights to elect to participate in an Employee Stock Purchase Plan (the "Plan") which became effective February 1, 1996. The price per share shall be the lesser of 85% of the average of the bid and ask price on the first day of the plan period or the last day of the plan period. The plan was amended on December 19, 2001 to allow for a total of 250,000 shares of class A common stock to be issued under the plan. As of June 30, 2002 a total of 112,185 shares of class A common stock have been issued under the plan since the first offering which began on February 1, 1997 through the latest completed offering which ended in January 2001. Eight employees are participating in the current offering period under the plan, which began on February 1, 2002 and will end on January 31, 2003. Non-Employee Director Stock Plan The Board of Directors adopted the company's Non-Employee Director Stock Plan (the "Director Plan") on October 18, 1995. The Stockholders of the company approved the plan on December 15, 1995 and amended the plan on December 26, 1997 and December 19, 2001. Non-qualified options to purchase a total of 250,000 shares of Class A Common Stock are available for issuance under the Director Plan. The Board of Directors or a committee of the Board administers the Director Plan. Under the Director Plan, each director of the company who was a director at the time of adoption of the Director Plan and who was not a current or former employee of the company received an option to purchase that number of shares of Class A Common Stock as equals 500 multiplied by the years of service of such director as of the date of the grant. At the first meeting of the Board of Directors subsequent to each annual meeting of stockholders, each non-employee director is granted under the Director Plan an option to purchase 2,000 shares of the Class A Common Stock of the company. The plan was amended December 19, 2001 to increase the number of options issued each year from 2,000 per director to 10,000 per director. The option exercise price is the fair market value of the shares of the company's Class A Common Stock on the date of grant. The options are non-transferable and become exercisable as follows: 25% immediately and 25% on each of the first, second and third anniversaries of the grant date. If an optionee ceases to be a member of the Board of Directors other than for death or permanent disability, the unexercised portion of the options, to the extent unvested, immediately terminate, and the unexercised portion of the options which have vested lapse 180 days after the date the optionee ceases to serve on the Board. In the event of death or permanent disability, all unexercised options vest and the optionee or his or her legal representative has the right to exercise the option for a period of 180 days or until the expiration of the option, if sooner. On February 18, 1997, the company issued options to purchase 6,000 shares of Class A Common Stock under the Director Plan at an exercise price of $3.50 per share. On January 22, 1998, the company issued options to purchase 6,000 shares of Class A Common Stock under the Director Plan at an exercise price of $2.06. On February 23, 1999, the company issued options to purchase 6,000 shares of Class A Common Stock under the Director Plan at an exercise price of $1.03. On December 28, 1999, the company issued options to purchase 6, 000 shares of class A common stock under the Director Plan at an exercise price of $.81. On January 11, 2001 the company issued options to purchase 6,000 shares of class A common stock under the Director Plan at an exercise price of $.22. On December 19, 2001 the company issued options to purchase 30,000 shares of class A common stock under the Director Plan at an exercise price of $.35. As of June 30, 2002, none of the options issued had been exercised. - 63 - The following table provides information about options granted to the named executive officers during fiscal 2002 under the company's Stock Plan, Employee Stock Purchase Plan and Non-Employee Director Stock Plan. Individual Grants (a) (b) (c) (d) (e) % of Total Number of Options/SARs Securities Granted to Underlying Employees Exercise or Options/SARs in Fiscal Base Price Expiration Name Granted (#) Year ($/Share) Date _______________________________________________________________________________ Bruce A. Shear 20,000 8.2% $ .55 04/18/2007 Robert H. Boswell 7,500 3.1% $ .45 12/19/2006 10,000 4.1% $ .55 04/18/2007 7,500 3.1% $ .55 04/18/2007 Michael R. Corneliso 10,000 4.1% $ .55 04/18/2007 Paula C. Wurts 7,500 3.1% $ .45 12/19/2006 10,000 4.1% $ .55 04/18/2007 7,500 3.1% $ .55 04/18/2007 All Directors and Officers as a group (9 Persons) 203,000 82.8% $.35-$.55 12/19/2006-04/18/2007 The following table provides information about options exercised by the named executive officers during fiscal 2002 and the number and value of options held at the end of fiscal 2002. (a) (b) (c) (d) (e) Number of Securities Value of Underlying Unexercised Unexercised In-the-Money Options/SARs Options/SARs Shares Value at FY-End (#) FY-End (#)at Exercise Realized Exercisable/ Exercisable/ (#) ($) Unexercisable Unexercisable ________________ ___________ _________ _____________ ________________ Bruce A. Shear -- -- 237,000/163,500 $118,630/$ 85,115 Robert H. Boswell -- -- 196,666/146,583 $ 97,650/$ 76,567 Michael R. Cornelison -- -- 161,000/130,500 $ 82,140/$ 68,820 Paula C. Wurts -- -- 137,084/83,667 $ 65,475/$ 42,593 All Directors and Officers as a group (9 persons) -- -- 1,079,750/718,250 $502,650/$353,343 In February 1997, all 95,375 shares underlying the then outstanding employee stock options were repriced to the current market price, using the existing exercise durations. In September 1998, all 21,875 options due to expire, were extended for an additional five years. Also in September 1998, all 183,875 shares underlying the then outstanding employee stock options were repriced to the current market price, using the existing exercise durations. In January 2001, all 791,500 shares underlying the then outstanding employee stock options were repriced to $0.25, which was greater than the then current market price, using the existing exercise durations. The computed effect of the option repricing of $251,159 and $55,831 was charged to salaries in the quarter ended June 30, 2002 and 2001. - 64 - ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the ownership of shares of the company's Class A Common Stock and Class B Common Stock (the only classes of common stock of the company currently outstanding) as of August 1, 2002 by each person known by the company to beneficially own more than 5% of any class of the company's voting securities, each director of the company, each of the named executive officers as defined in 17 CFR 228.402(a)(2) and all directors and officers of the company as a group. Unless otherwise indicated below, to the knowledge of the company, all persons listed below have sole voting and investment power with respect to their shares of Common Stock, except to the extent authority is shared by spouses under applicable law. In preparing the following table, the company has relied on the information furnished by the persons listed below: Name and Address Amount and Nature Percent of Title of Class of Beneficial Owner of Beneficial Owner Class (14) ____________________ ___________________ ___________________ __________ Class A Common Stock Gerald M. Perlow 69,875(1) * c/o PHC, Inc. 200 Lake Street Peabody, MA 01960 Donald E. Robar 78,925(2) * c/o PHC, Inc. 200 Lake Street Peabody, MA 01960 Bruce A. Shear 423,495(3) 3.3% c/o PHC, Inc. 200 Lake Street Peabody, MA 01960 Robert H. Boswell 179,150(4) 1.4% c/o PHC, Inc. 200 Lake Street Peabody, MA 01960 Howard W. Phillips 88,875(5) * P. O. Box 2047 East Hampton, NY 11937 William F. Grieco 63,875(6) * 115 Marlborough Street Boston, MA 02116 Paula C. Wurts 107,977(7) * c/o PHC, Inc. 200 Lake Street Peabody, MA 01960 Michael R. Cornelison 143,409(8) 1.1% c/o PHC, Inc. 200 Lake Street Peabody, Ma 01960 David E. Dangerfield 2,500(9) * 5965 South 900 East Salt Lake City, UT 84121 All Directors and 1,158,081(10) 8.5% Officers as a Group (9 persons) - 65 - Name and Address Amount and Nature Percent of Title of Class of Beneficial Owner of Beneficial Owner Class (14) ____________________ ___________________ ___________________ __________ Class B Common Stock The Shaar Fund Ltd. 1,234,327(12) 9.5% c/o Citco Funds Services, Curacao Kaya Flamboyan 9 Curacao, Netherland Antilles Bruce A. Shear 671,259(13) 92.3% c/o PHC, Inc. 200 Lake Street Peabody, MA 01960 All Directors and 671,259 92.3% Officers as a Group (9 persons) * Less than 1% 1. Includes 48,125 shares issuable pursuant to currently exercisable stock options or stock options which will become exercisable within sixty days, having an exercise price range of $.22 to $6.63 per share. 2. Includes 51,625 shares issuable pursuant to currently exercisable stock options or stock options which will become exercisable within sixty days, having an exercise price range of $.22 to $6.63 per share. 3. Includes 163,500 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $.25 to $.55 per share. 4. Includes an aggregate of 146,583 shares of Class A Common Stock issuable pursuant to currently exercisable stock options at an exercise price range of $.25 to $.55 per share. 5. Includes 49,625 shares issuable pursuant to currently exercisable stock options having an exercise price range of $.22 to $.45 per share. 6. Includes 42,125 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $.22 to $3.50 per share. 7. Includes 83,667 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $.25 to $.55 per share. 8. Includes 130,500 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $.25 to $.55 per share. 9. Includes 2,500 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price of $ .55 per share. 10. Includes an aggregate of 718,250 shares issuable pursuant to currently exercisable stock options. Of those options, 5,500 have an exercise price of $6.63 per share, 6,000 have an exercise price of $3.50 per share, 6,000 have an exercise price of $2.06 per share, 6,000 have an exercise price of $1.03 per share, 4,500 have an exercise price of $.81 per share, 37,000 have an exercise price of $.55 per share, 3,750 have an exercise price of $.45 per share, 10,000 have an exercise price of $.35 per share, 133,250 have an exercise price of $.30 per share, 502,250 have an exercise price of $.25 per share and 4,000 have an exercise price of $.22 per share. 11. Each share of class B common stock is convertible into one share of class A common stock automatically upon any sale or transfer or at any time at the option of the holder. 12. Includes 125,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock warrants, having an exercise price of $3.00. 13. Includes 56,369 shares of class B common stock pledged to Steven J. Shear of 2 Addison Avenue, Lynn, Massachusetts 01902, Bruce A. Shear's brother, to secure the purchase price obligation of Bruce A. Shear in connection with his purchase of his brother's stock in the company in December 1988. In the absence of any default under this obligation, Bruce A. Shear retains full voting power with respect to these shares. - 66 - 14. Represents percentage of equity of class, based on numbers of shares listed under the column headed "Amount and Nature of Beneficial Ownership". Each share of Class A Common Stock is entitled to one vote per share and each share of Class B Common Stock is entitled to five votes per share on all matters on which stockholders may vote (except that the holders of the Class A Common Stock are entitled to elect two members of the company's Board of Directors and holders of the Class B Common Stock are entitled to elect all the remaining members of the company's Board of Directors). By virtue of the fact that Mr. Shear owns 92% of the class B shares and the class B shareholders have the right to elect all of the directors except the two directors elected by the class A shareholders, Mr. Shear has the right to elect the majority of the members of the Board of directors and may be deemed to be in control of the company. Based on the number of shares listed under the column headed "Amount and Nature of Beneficial Ownership," the following persons or groups held the following percentages of voting rights for all shares of common stock combined as of August 1, 2002: Bruce A. Shear 22.66% All Directors and Officers as a Group (9 persons) 26.19% ITEM 12. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS. Related Party Indebtedness For approximately the last thirteen years, Bruce A. Shear, a director and the President and Chief Executive Officer of the company, and persons affiliated and associated with him have made a series of unsecured loans to the company and its subsidiaries to enable them to meet ongoing financial commitments. The borrowings generally were entered into when the company did not have financing available from outside sources and, in the opinion of the company, were entered into at market rates given the financial condition of the company and the risks of repayment at the time the loans were made. As of June 30, 2002, the company owed an aggregate of $200,000 to related parties. During the period ended June 30, 2002, the company paid Mr. Shear and affiliates approximately $381,600 in principal and accrued interest under various unsecured notes to meet short term working capital requirements. As of June 30, 2002, the company owed Bruce A. Shear $100,000 on a promissory note, which is dated August 13, 1998, bears interest at the rate of 12% per year and is payable on demand and Tot Care, Inc., an affiliate of Bruce A. Shear, $100,000 on promissory notes dated May 28, 1998 and June 9, 1998 which bear interest at the rate of 12% per year and are payable on demand. - 67 - ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. Exhibit No. Description 3.1 Restated Articles of Organization of the Registrant, as amended. (Filed as exhibit 3.1 to the company's Registration Statement on March 2, 1994). 3.1.1Articles of Amendment filed with the Commonwealth of Massachusetts. (Filed with the 10-QSB dated May 1997). 3.1.2Restated Articles of Organization of the Registrant, as amended. (Filed as exhibit 3.1.2 to the company's report on Form 10-QSB dated May 14, 2001. Commission file number 0-22916). 3.2 By-laws of the Registrant, as amended. (Filed as exhibit 3.2 to the company's Post-Effective Amendment No. 2 on Form S-3 to Registration Statement on Form SB-2 under the Securities Act of 1933 dated November 13, 1995. Commission file number 333-71418). 3.3 Certificate of Designation of Series C Convertible Preferred Stock of PHC, Inc. adopted by the Board of Directors on June 15, 2000 and June 26, 2000. (Filed as exhibit 4.39 to the company's report on Form 10-QSB dated May 14, 2001. Commission file number 0-22916). 4.1 Form of Warrant Agreement. (Filed as exhibit 4.1 to the company's Registration Statement on March 2, 1994). 4.2 Form of Unit Purchase Option. (Filed as exhibit 4.4 to the company's Registration Statement on March 2, 1994). 4.3 Consultant Warrant Agreement by and between PHC, Inc., and C.C.R.I. Corporation dated March 3, 1997 to purchase 160,000 shares Class A Common Stock. (Filed as exhibit 4.18 to the company's Registration Statement on Form SB-2 dated April 15, 1997. Commission file number 333-25231). 4.4 Warrant Agreement by and between PHC, Inc. and ProFutures Special Equities Fund, L.P. for up to 86,207 shares of Class A Common Stock dated 09/19/97. (Filed as exhibit 4.25 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on October 14, 1997. Commission file number 0-22916). 4.5 Warrant Agreement by and between PHC, Inc. and ProFutures Special Equities Fund, LP for 3,000 shares of Class A Common Stock. (Filed as exhibit 4.27 to the company's Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 29, 1998. Commission file number 0-22916). 4.6 Warrant to purchase up to 52,500 shares of Class A Common Stock by and between PHC, Inc., and HealthCare Financial Partners, Inc. dated March 10, 1998. (Filed as exhibit 4.30 to the company's Registration Statement on Form SB-2 dated July 24, 1998. Commission file number 333-59927). 4.7 Warrant to purchase up to 52,500 shares of Class A Common Stock by and between PHC, Inc., and HealthCare Financial Partners, Inc. dated July 10, 1998. (Filed as exhibit 4.31 to the company's Registration Statement on Form SB-2 dated July 24, 1998. Commission file number 333-59927). 4.8 Warrant Agreement by and between HealthCare Financial Partners, Inc. and its subsidiaries (collectively "HCFP") and PHC, Inc. dated July 10, 1998 - Warrant No. 3 for 20,000 shares of Class A Common Stock. (Filed as exhibit 4.14 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on October 14, 1997. Commission file number 0-22916). 4.9 Warrant Guaranty Agreement for Common Stock Purchase Warrants issuable by PHC, Inc. dated August 14, 1998 for Warrants No 2 and No. 3. (Filed as exhibit 4.19 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on October 14, 1997. Commission file number 0-22916). 4.10 12% Convertible Debenture by and between PHC, Inc., and Dean & Co., dated December 3, 1998 in the amount of $500,000. (Filed as exhibit 4.20 to the company's report on Form 10-QSB dated February 12, 1999. Commission file number 0-22916). 4.11 Securities Purchase Agreement for 12% Convertible Debenture by and between PHC, Inc. and Dean & Co., a Wisconsin nominee partnership for Common Stock. (Filed as exhibit 4.21 to the company's report on Form 10-QSB dated February 12, 1999. Commission file number 0-22916). - 68 - Exhibit No. Description 4.12 Warrant Agreement to purchase up to 25,000 shares of Class A Common Stock by and between PHC, Inc., and Dean & Co., dated December 3, 1998. (Filed as exhibit 4.22 to the company's report on Form 10-QSB dated February 12, 1999. Commission file number 0-22916). 4.13 Warrant Agreement by and between PHC, Inc., and National Securities Corporation dated January 5, 1999 to purchase 37,500 shares of Class A Common Stock. (Filed as exhibit 4.23 to the company's report on Form 10-QSB dated February 12, 1999. Commission file number 0-22916). 4.14 Warrant Agreements by and between PHC, Inc., and George H. Gordon for 10,000 shares, 15,000 shares, 5,000 shares, 5,000 shares, 50,000 shares and 10,000 shares of Class A Common Stock dated December 31, 1998; 5,000 shares of Class A Common Stock dated December 1, 1998; 10,000 shares of Class A Common Stock dated January 1, 1999; and 10,000 shares of Class A Common Stock dated February 1, 1999. (Filed as exhibit 4.24 to the company's report on Form 10-QSB dated February 12, 1999. Commission file number 0-22916). 4.15 Warrant Agreement by and between PHC, Inc., and Barrow Street Research for 3,000 shares of Class A Common Stock dated February 23, 1999. (Filed as exhibit 4.24 to the company's Registration Statement on Form S-3 dated April 13, 1999. Commission file number 333-76137). 4.16 Warrant Agreement by and between PHC, Inc., and George H. Gordon for 10,000 shares of Class A Common Stock dated March 1, 1999. (Filed as exhibit 4.25 to the company's Registration Statement on Form S-3 dated April 13, 1999. Commission file number 333-76137). 4.17 Warrant Agreement by and between PHC, Inc., and George H. Gordon for 10,000 shares of Class A Common Stock dated April 1, 1999. (Filed as exhibit 4.26 to the company's Registration Statement on Form S-3 dated June 1, 1999. Commission file number 333-76137). 4.18 Warrant Agreement by and between PHC, Inc., and George H. Gordon for 10,000 shares of Class A Common Stock dated May 1, 1999. (Filed as exhibit 4.27 to the company's Registration Statement on Form S-3 dated May 14, 1999. Commission file number 0-22916). 4.19 Warrant Agreements by and between PHC, Inc., and George H. Gordon for 10,000 shares of Class A Common Stock dated April 1, 1999. (Filed as exhibit 4.28 to the company's report on Form 10-KSB dated October 13, 1999. Commission file number 0-22916). 4.20 Warrant Agreements by and between PHC, Inc., and George H. Gordon for 10,000 shares of Class A Common Stock dated July 1, 1999. (Filed as exhibit 4.29 to the company's report on Form 10-KSB dated October 13, 1999. Commission file number 0-22916). 4.21 Warrant Agreements by and between PHC, Inc., and George H. Gordon for 10,000 shares of Class A Common Stock dated August 1, 1999. (Filed as exhibit 4.30 to the company's report on Form 10-KSB dated October 13, 1999. Commission file number 0-22916). 4.22 Warrant to purchase up to 37,500 shares of Class A Common Stock by and between PHC, Inc., and National Securities Corporation dated April 5, 1999. (Filed as exhibit 4.31 to the company's report on Form 10-KSB dated October 13, 1999. Commission file number 0-22916). 4.23 Warrant to purchase up to 37,500 shares of Class A Common Stock by and between PHC, Inc., and National Securities Corporation dated July 5, 1999. (Filed as exhibit 4.32 to the company's report on Form 10-KSB dated October 13, 1999. Commission file number 0-22916). 4.24 Warrant to purchase 40,000 shares of Class A Common Stock by and between PHC, Inc. and CCRI, Inc. and Warrant to purchase 40,000 shares of Class A Common Stock by and between PHC, Inc. and M&K Partners both dated 3/3/97; replaces warrant for 160,000 shares dated 3/3/97 by and between PHC, Inc. and CCRI, Inc. (Filed as exhibit 4.34 to the company's report on Form 10-QSB filed with the Securities and Exchange Commission on May 11, 2000. Commission file 0-22916). - 69 - Exhibit No. Description 4.25 Common Stock Purchase Warrant by and between PHC, Inc. and The Shaar Fund Ltd. dated June 28, 2000. (Filed as exhibit 4.36 to the company's Registration Statement on Form S-3 dated July 14, 2000. Commission file number 333-41494). 4.26 Common Stock Purchase Warrant by and between PHC, Inc. and Heller Healthcare Finance, Inc. for 60,000 shares of Class A Common Stock. (Filed as exhibit 4.37 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on September 29, 2000. Commission file number 0-22916). 4.27 Equity Purchase Warrant to purchase 1% equity in Behavioral Health Online by and between PHC, Inc., and Heller Healthcare Finance dated March 16, 1998. (Filed as exhibit 4.38 to the company's quarterly report on Form 10-QSB, filed with the Securities and Exchange Commission on November 14, 2000. Commission file number 0-22916). 4.28 Warrant Agreement issued to Union Atlantic Capital, LC. to purchase 25,000 Class A Common shares dated March 20, 2001. (Filed as exhibit 4.40 to the company's report on Form 10-QSB dated May 14, 2001. Commission file number 0-22916). 4.29 Warrant Agreement issued to Marshall Sternan to purchase 10,000 Class A Common shares dated April 15, 2001. (Filed as exhibit 4.41 to the company's report on Form 10-QSB dated May 14, 2001. Commission file number 0-22916). 4.30 Equity Purchase Warrant to purchase 1% equity in Behavioral Health Online by and between PHC, Inc., and Heller Healthcare Finance dated December 18, 2000. (Filed as exhibit 4.36 to the company's report on Form 10-KSB dated September 25, 2001. Commission file number 0-22916). 5.1 Opinion of Arent Fox Kintner Plotkin & Kahn, PPLC dated May 1, 2000.. (Filed as an exhibit to the company's Registration Statement on Form S-3 dated June 6, 2000. Commission file number 333-76137).). 5.2 Opinion of Arent Fox Kintner Plotkin & Kahn, PPLC. (Filed as exhibit 5.2 to the company's report on Form SB-2 dated June 19, 2002. Commission file number 333-76137). 10.1 Deed of Trust Note of Mount Regis Center Limited Partnership in favor of Douglas M. Roberts, dated July 28, 1987, in the amount of $560,000, guaranteed by PHC, Inc., with Deed of Trust executed by Mount Regis Center, Limited Partnership of even date. (Filed as exhibit 10.33 to Form SB-2 dated March 2, 1994). Assignment and Assumption of Limited Partnership Interest, by and between PHC of Virginia Inc. and each assignor dated as of June 30, 1994. (Filed as exhibit 10.57 to Form 10-KSB on September 28, 1994) 10.2 Copy of Note of Bruce A. Shear in favor of Steven J. Shear, dated December 1988, in the amount of $195,695; Pledge Agreement by and between Bruce A. Shear and Steven J. Shear, dated December 15, 1988; Stock Purchase Agreement by and between Steven J. Shear and Bruce A. Shear, dated December 1, 1988. (Filed as exhibit 10.52 to the company's Registration Statement on Form SB-2 dated March 2, 1994. Commission file number 333-71418). 10.3 Unconditional Guaranty of Payment and performance by and between PHC, Inc. in favor of HCFP. (Filed as exhibit 10.112 to the company's quarterly report on Form 10-QSB, filed with the Securities and Exchange Commission on February 25, 1997. Commission file number 0-22916). 10.4 Agreement between Family Independence Agency and Harbor Oaks Hospital effective January 1, 1997. (Filed as exhibit 10.122 to the company's report on Form 10-KSB, with the Securities and Exchange Commission on October 14, 1997. Commission file number 0-22916) 10.5 Master Contract by and between Family Independence Agency and Harbor Oaks Hospital effective January 1, 1997. (Filed as exhibit 10.123 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on October 14, 1997. Commission file number 0-22916). - 70 - Exhibit No. Description 10.6 Financial Advisory Agreement, Indemnification Agreement and Warrant by and between Brean Murray & Company and PHC, Inc. dated 06/01/97. (Filed as exhibit 10.125 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on October 14, 1997. Commission file number 0-22916). 10.7 Loan and Security Agreement by and among HCFP Funding, Inc., and PHC of Michigan, Inc., PHC of Utah,Inc., PHC of Virginia, Inc., PHC of Rhode Island, Inc., and Pioneer Counseling of Virginia, Inc. dated as of February 18, 1998. (Filed as exhibit 10.139 to the company's Registration Statement on Form SB-2 dated July 24, 1998. Commission file number 333-59927). 10.8 Credit Line Deed of Trust by and between PHC of Virginia, Inc., and HCFP Funding II, Inc. dated July 1998. (Filed as exhibit 10.140 to the company's Registration Statement on Form SB-2 dated July 24, 1998. Commission file number 333-59927). 10.9 Promissory Note for $50,000 dated May 18, 1998 by and between PHC, Inc. and Tot Care, Inc. (Filed as exhibit 10.142 to the company's Registration Statement on Form SB-2 dated July 24, 1998. Commission file number 333-59927). 10.10 Promissory Note for $50,000 dated June 9, 1998 by and between PHC, Inc. and Tot Care, Inc. (Filed as exhibit 10.143 to the company's Registration Statement on Form SB-2 dated July 24, 1998. Commission file number 333-59927). 10.11 Amendment No. 1 to Loan and Security Agreement in the amount of $4,000,000 by and among HCFP Funding, Inc., and PHC of Michigan, Inc., PHC of Utah, Inc., PHC of Virginia, Inc., PHC of Rhode Island, Inc., and Pioneer Counseling of Virginia, Inc. dated as of February 18, 1998. (Filed as exhibit 10.57 to the company's report on Form 10-KSB dated October 13, 1998. Commission file number 0-22916). 10.12 Promissory Note by and between PHC, Inc. and Bruce A. Shear dated August 13, 1998, in the amount of $100,000. (Filed as exhibit 10.58 to the company's report on Form 10-QSB dated November 3, 1998. Commission file number 0-23524). 10.13 Financial Advisory and Consultant Agreement by and between National Securities Corporation and PHC, Inc. dated 01/05/99 (Filed as exhibit 10.61 to the company's report on Form 10-QSB dated February 12, 1999. Commission file number 0-22916). 10.14 Promissory Note by and between PHC, Inc. and Mellon US Leasing Corporation dated November 1999, in the amount of $160,000. (Filed as exhibit 10.68 to the company's report on Form 10-QSB dated November 15, 1999. 10.15 Amendment number 1 to Loan and Security Agreement dated February 17, 2000 by and between PHC of Michigan, Inc., PHC, of Utah, Inc., PHC of Virginia, Inc., PHC of Rhode Island, Inc. and Pioneer Counseling of Virginia, Inc. and Heller Healthcare Finance, Inc., f/k/a HCFP Funding in the amount of $2,500,000. (Filed as exhibit 10.70 to the company's report on Form 10-QSB filed with the Securities and Exchange Commission on May 11, 2000. Commission file 0-22916). 10.16 Registration Rights Agreement by and between PHC, Inc. and The Shaar Fund Ltd. dated June 28, 2000. (Filed as exhibit 10.72 to the company's Registration Statement on Form S-3 dated July 14, 2000. Commission file number 333-41494). 10.17 Release Notice by and between PHC, Inc. and The Shaar Fund Ltd. dated June 28, 2000. (Filed as exhibit 10.73 to the company's Registration Statement on Form S-3 dated July 14, 2000. Commission file number 333-41494). 10.18 Escrow Instruction by and between PHC, Inc.; The Shaar Fund Ltd. and Cadwalader, Wickersham & Taft (an Escrow Agent) dated June 28, 2000. (Filed as exhibit 10.74 to the company's Registration Statement on Form S-3 dated July 14, 2000. Commission file number 333-41494). - 71 - Exhibit No. Description 10.19 Securities Purchase Agreement by and between PHC, Inc. and The Shaar Fund Ltd. dated June 28, 2000 to purchase 125,000 shares of Class A Common Stock. (Filed as exhibit 10.75 to the company's Registration Statement on Form S-3 dated July 14, 2000. Commission file number 333-41494). 10.20 Promissory Note for $532,000 dated May 30, 2000 by and between PHC, Inc. and Irwin J. Mansdorf, Ph.D. (Filed as exhibit 10.76 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on September 29, 2000. Commission file number 0-22916). 10.21 Promissory Note for $168,000 dated May 30, 2000 by and between PHC, Inc. and Yakov Burstein, Ph.D. (Filed as exhibit 10.77 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on September 29, 2000. Commission file number 0-22916). 10.22 Settlement Agreement and Mutual Releases by and between PHC, Inc. and Yakov Burstein, Ph.D. and Irwin J. Mansdorf, Ph.D. dated May 30, 2000. (Filed as exhibit 10.78 to the company's report on Form 10-KSB, filed with the Securities and Exchange Commission on September 29, 2000. Commission file number 0-22916). 10.23 Amendment number 2 to Loan and Security Agreement originally dated February 18, 1998 by and among PHC, of Utah, Inc., PHC of Virginia, Inc. and PHC of Michigan, Inc. and Heller Healthcare Finance, Inc. in the amount of $3,000,000 amended as of May 24, 2001. (Filed as exhibit 10.46 to the company's report on Form 10-KSB dated September 25, 2001. Commission file number 0-22916). 10.24 The Company's 1993 Stock Purchase and Option Plan, as amended. (Filed as exhibit 10.47 to the company's report on Form S-8 dated January 29, 2002. Commission file number 333-81528). 10.25 The Company's 1995 Employee Stock Purchase Plan, as amended. (Filed as exhibit 10.48 to the company's report on Form S-8 dated January 29, 2002. Commission file number 333-81528). 10.27 The Company's 1995 Non-Employee Director Stock Option Plan, as amended. (Filed as exhibit 10.49 to the company's report on Form S-8 dated January 29, 2002. Commission file number 333-81528). 10.28 Amendment Number 3 dated December 6, 2001 to Loan and Security Agreement dated February 18, 1998 by and between PHC of Michigan, Inc., PHC of Utah, Inc., and PHC of Virginia, Inc. and Heller Healthcare Finance, Inc. providing collateral for the Loan and Security Agreement in the amount of $3,000,000. (Filed as exhibit 10.50 to the company's quarterly report on Form 10-QSB, filed with the Securities and Exchange Commission on February 12, 2002. Commission file number 0-22916). 10.29 Consolidating Amended and Restated Secured Term Note in the amount of $2,575,542 dated December 6, 2001 by and between PHC of Michigan, Inc. and. Heller Healthcare Finance, Inc. (Filed as exhibit 10.51 to the company's Registration Statement on Form 10-QSB, filed with the Securities and Exchange Commission on February 12, 2002. Commission file number 0-22916). 10.30 Amended and Restated Revolving Credit Note in the amount of $3,000,000 dated December 6, 2001 by and between PHC of Michigan, Inc., PHC of Utah, Inc. and PHC of Virginia, Inc. and. Heller Healthcare Finance, Inc. (Filed as exhibit 10.52 to the company's Registration Statement on Form 10-QSB, filed with the Securities and Exchange Commission on February 12, 2002. Commission file number 0-22916). 10.31 Amended and Restated Consolidated Mortgage Note in the amount of $5,688,598 dated December 6, 2001 by and between PHC of Michigan, Inc and Heller Healthcare Finance, Inc. (Filed as exhibit 10.53 to the company's Registration Statement on Form 10-QSB, filed with the Securities and Exchange Commission on February 12, 2002. Commission file number 0-22916). - 72 - Exhibit No. Description 10.32 Third Amended and Restated Cross-Collateralization and Cross-Default Agreement dated December 6, 2001 by and between PHC, Inc., PHC of Michigan, Inc., PHC of Utah, Inc. and PHC of Virginia, Inc. and. Heller Healthcare Finance, Inc. (Filed as exhibit 10.54 to the company's quarterly report on Form 10-QSB, filed with the Securities and Exchange Commission on February 12, 2002. Commission file number 0-22916). 10.33 Overline Credit Advance in the amount of $100,000 dated January 11, 2002 by and between PHC of Michigan, Inc., PHC of Utah, Inc., PHC of Virginia, Inc. and Heller Healthcare Finance, Inc. (Filed as exhibit 10.56 to the company's quarterly report on Form 10-QSB, filed with the Securities and Exchange Commission on February 12, 2002. Commission file number 0-22916). 21.1 List of Subsidiaries. (Filed as exhibit 21.1 to the company's report on Form SB-2 dated June 19, 2002. Commission file number 333-76137). *99.1 Written Statement of Chief Executive Officer and Chief Financial Officer certifying the 10-KSB Annual Report. * Filed herewith (b) REPORTS ON FORM 8-K. The company filed no reports on Form 8-K during the quarter ended June 30, 2002. - 73 - SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PHC, INC. Date: September 19, 2002 By: /S/ BRUCE A. SHEAR Bruce A. Shear, President and Chief Executive Officer In accordance with the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below. SIGNATURE TITLE(S) DATE /s/ BRUCE A. SHEAR President, Chief September , 2002 Bruce A. Shear Executive Officer and Director (principal executive officer) /s/ PAULA C. WURTS Controller and Treasurer September 19, 2002 Paula C. Wurts (principal financial and accounting officer) /s/ GERALD M. PERLOW Director September 19, 2002 Gerald M. Perlow /s/ DONALD E. ROBAR Director September 19, 2002 Donald E. Robar ________________ Director September , 2002 Howard Phillips /s/ WILLIAM F. GRIECO Director September 19, 2002 William F. Grieco _____________________ Director September , 2002 David E. Dangerfield - 74 - Exhibit 99.1 WRITTEN STATEMENT OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER The undersigned hereby certify that, to the best of the knowledge of the undersigned, the Annual Report on Form 10-KSB for the fiscal year ended June 30, 2002 filed by PHC, Inc. with the Securities and Exchange Commission fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. Date: September 19, 2002 By: /s/ Bruce A. Shear Bruce A. Shear, President and Chief Executive Officer Date: September 19, 2002 By: /s/ Paula C. Wurts Paula C. Wurts, Controller and Chief Financial Officer - 77 - -----END PRIVACY-ENHANCED MESSAGE-----