10-Q 1 q1051304.txt 10Q FOR THIRD QUARTER 2004 U. S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-QSB (Mark One) |X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004. | | 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. (Exact name of small business issuer as specified in its charter) Massachusetts 04-2601571 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 200 Lake Street, Suite 102, Peabody MA 01960 (Address of principal executive offices) (Zip Code) 978-536-2777 (Issuer's telephone number) -- 1 -- Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the 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_ __ Number of shares outstanding of each class of common equity, as of May 3, 2004: Class A Common Stock 16,575,289 Class B Common Stock 726,991 Transitional Small Business Disclosure Format (Check one): Yes______ No X -- 2 -- PHC, Inc. PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - March 31, 2004 and June 30, 2003. Condensed Consolidated Statements of Operations - Three and nine months ended March 31, 2004 and March 31, 2003. Condensed Consolidated Statements of Cash Flows - Nine months ended March 31, 2004 and March 31, 2003. Notes to Condensed Consolidated Financial Statements. Item 2. Management's Discussion and Analysis or Plan of Operation Item 3. Controls and Procedures PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 6. Exhibits and Reports on form 8-K Signatures -- 3 -- PART I. FINANCIAL INFORMATION Item 1. Financial Statements PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS March 31, June 30, 2004 2003 ___________ __________ ASSETS (Unaudited) Current assets: Cash and cash equivalents $ 963,737 $ 494,991 Accounts receivable, net of allowance for bad debts of $2,333,907 at March 31, 2004 and $2,348,445 at June 30, 2003 4,924,379 4,345,301 Prepaid expenses 273,901 69,541 Third party settlement receivables 10,046 172,043 Other receivables and advances 307,040 255,006 Deferred income tax assets, net 808,607 808,607 ___________ __________ Total current assets 7,287,710 6,145,489 Accounts receivable, noncurrent 505,000 600,000 Other receivables 94,388 111,976 Property and equipment, net 1,296,454 1,295,113 Deferred financing costs, net of amortization of $134,109 at March 31, 2004 and $130,109 at June 30, 2003 -- 4,000 Goodwill 969,099 969,099 Other assets 384,431 286,046 ___________ __________ Total assets $ 10,537,082 $9,411,723 ============ ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,402,578 $860,952 Notes payable--related parties 100,000 100,000 Current maturities of long-term debt 1,885,648 883,659 Revolving credit note 1,675,425 1,103,561 Deferred revenue 65,497 160,720 Current portion of obligations under capital leases 25,923 50,805 Accrued payroll, payroll taxes and benefits 1,117,415 1,016,088 Accrued expenses and other liabilities 1,412,501 958,527 Convertible debentures 250,000 275,000 ___________ __________ Total current liabilities 7,934,987 5,409,312 ___________ __________ Long-term debt 432,301 2,030,285 Obligations under capital leases, net of current portion 23,662 36,869 ___________ __________ Total noncurrent liabilities 455,963 2,067,154 ___________ __________ Total liabilities 8,390,950 7,476,466 ___________ __________ Stockholders' equity: Class A common stock, $.01 par value; 20,000,000 shares authorized, 14,354,059 and 13,437,067 shares issued at March 31, 2004 and June 30, 2003, respectively 143,541 134,371 Class B common stock, $.01 par value; 2,000,000 shares authorized, 726,991 outstanding convertible into 726,991 shares of Class A common stock 7,270 7,270 Additional paid-in capital 20,107,477 19,147,604 Treasury stock, 148,020 shares of Class A common stock at March 31, 2004 (121,091) (72,380) and 97,804 shares at June 30, 2003, at cost Notes receivable, common stock -- (80,000) Accumulated deficit (17,991,065) (17,201,608) ___________ __________ Total stockholders' equity 2,146,132 1,935,257 ___________ __________ Total liabilities and stockholders' equity $ 10,537,082 $ 9,411,723 ============ =========== See Notes to Condensed Consolidated Financial Statements. -- 4 -- PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Nine Months Ended March 31, March 31, __________________________________________ 2004 2003 2004 2003 Revenues: Patient care, net $ 5,583,625 $ 5,341,816 $16,323,589 $15,863,921 Contract support services 733,411 393,328 2,240,550 943,513 Pharmaceutical study 155,152 136,690 500,044 711,957 ___________ __________ ___________ ___________ Total revenues 6,472,188 5,871,834 19,064,183 17,519,391 ___________ __________ ___________ ___________ Operating expenses: Patient care expenses 3,201,426 2,638,772 9,033,540 7,877,313 Cost of contract support services 546,667 354,632 1,667,041 855,862 Provision for doubtful accounts 227,196 196,195 1,113,033 818,652 Website expenses 73,191 54,770 219,537 168,345 Administrative expenses 3,096,804 2,369,205 7,446,760 6,631,883 ___________ __________ ___________ ___________ Total operating expenses 7,145,284 5,613,574 19,479,911 16,352,055 ___________ __________ ___________ ___________ Income (loss) from operations (673,096) 258,260 (415,728) 1,167,336 ___________ __________ ___________ ___________ Other expenses: Interest income 20,888 3,119 26,070 10,943 Other income 26,059 22,830 77,472 75,206 Interest expense and other financing costs (219,116) (127,324) (466,150) (419,455) ___________ __________ ___________ ___________ Total other expenses (172,169) (101,375) (362,608) (333,306) ___________ __________ ___________ ___________ Income (loss) before provision for income taxes (845,265) 156,885 (778,336) 834,030 Provision for income taxes -- 26,074 11,121 36,074 ___________ __________ ___________ ___________ Income (loss) applicable to common shareholders $ (845,265) $ 130,811 $ (789,457) $ 797,956 ============ =========== =========== ========== Income (loss) per share information: Basic income (loss) per common share $ (0.06) $ 0.01 $ (0.06) $ 0.06 ============ =========== =========== ========== Basic weighted average number of shares outstanding 14,402,988 14,099,929 14,149,261 13,963,138 ============ =========== ========== ========== Diluted income (loss) per common $ (0.06) $ 0.01 $ (0.06) $ 0.06 ============ =========== =========== ========== Diluted weighted average number of shares outstanding 14,402,988 14,814,570 14,149,261 14,577,540 ============ =========== =========== ========== See Notes to Condensed Consolidated Financial Statements
-- 5 -- PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Nine Months Ended March 31, 2004 2003 ___________ __________ Cash flows from operating activities: Net income (loss) $(789,457) $797,956 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 211,031 131,714 Non-cash compensation expense 128,586 19,198 Changes in operating assets and liabilities: Accounts receivable (356,527) 454,663 Prepaid expenses (204,360) (145,097) Other assets (160,269) (98,090) Accounts payable 547,146 (271,344) Accrued expenses and other liabilities 482,698 145,651 ___________ __________ Net cash provided by (used in) operating activities (141,152) 1,034,651 ___________ __________ Cash flows from investing activities: Acquisition of property and equipment (150,488) (172,128) ___________ __________ Net cash used in investing activities (150,488) (172,128) ___________ __________ Revolving credit note, net 571,864 (119,044) Repayment of debt, net (659,084) (738,391) Deferred financing costs 4,000 6,000 Issuance of common stock 897,398 73,408 Purchase of treasury stock (48,711) -- Costs related to issuance of capital stock (5,081) (7,212) ___________ __________ Net cash provided by (used in) financing activities 760,386 (785,239) ___________ __________ NET INCREASE IN CASH AND CASH EQUIVILENTS 468,746 77,284 BEGINNING CASH AND CASH EQUIVILENTS 494,991 204,564 ___________ __________ ENDING CASH AND CASH EQUIVILENTS $ 963,737 $ 281,848 =========== ========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 338,233 $ 419,406 Income taxes 18,713 113,163 SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock in cashless exercise of options $ -- $ 302,516 Issuance of common stock in cashless exercise of warrants -- 42,363 See Notes to Condensed Consolidated Financial Statements -- 6 -- PHC, INC. and Subsidiaries Notes to Condensed Consolidated Financial Statements March 31, 2004 Note A - The Company PHC, Inc. (the "Company") is a national health care Company, which operates subsidiaries 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 also treats 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 six outpatient behavioral health locations (two in Las Vegas, Nevada operating as Harmony Healthcare, one in Shawnee Mission, Kansas operating as Total Concept, which was recently closed and three 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. Wellplace, formerly known as Pioneer Development and Support Services ("PDSS"), provides help line services primarily through contracts with major railroads, smoking cessation contracts with the states of Nebraska and Kansas and a call center contract with the State of Michigan. Pioneer Pharmaceutical Research 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, are provided through Behavioral Health Online, Inc., the Company's internet operations, which provides Internet support services for all other subsidiaries of the Company and provides behavioral health education, training and products for the behavioral health professional, through its website wellplace.com. Note B - Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-QSB and Item 310 of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending June 30, 2004. The accompanying financial statements should be read in conjunction with the June 30, 2003 consolidated financial statements and footnotes thereto included in the Company's 10-KSB filed on September 19, 2003. Note C - Stock Based Compensation The Company re-priced 791,500 options in January 2001 of which 103,500 remained outstanding at June 30, 2003 and 50,000 at March 31, 2004 and are subject to variable accounting from the date of the modification through the date of exercise or expiration. Compensation expense relating to vested repriced options was $16,511 for the nine months ended March 31, 2004 compared to compensation expense of $14,175 for the nine months ended March 31, 2003. The Company has adopted the disclosure only provisions of Statement of Financial Accounting Standards ("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: -- 7 -- Three MonthsEnded Nine Months Ended March 31, March 31, 2004 2003 2004 2003 Net income (loss), as reported $(845,265) $130,811 $(789,457) $797,956 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 747 31,368 103,229 19,198 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (36,902) (46,542) (184,422) (102,382) __________ _________ _________ __________ Pro forma net income (loss) $(881,420) $115,637 $(870,650) $714,772 ========== ========= ========== ========== Earnings (loss) per share: Basic - as reported $ (0.06) $ 0.01 $ (0.06) $ 0.06 ========== ======== ========== ======== Basic - pro forma $ (0.06) $ 0.01 $ (0.06) $ 0.05 ========== ======== ========== ======== Diluted - as reported $ (0.06) $ 0.01 $ (0.06) $ 0.05 ========== ======== ========== ======== Diluted - pro forma $ (0.06) $ 0.01 $ (0.06) $ 0.06 ========== ======== ========== ========
Note D - Reclassifications Certain March 31, 2003 amounts have been reclassified to be consistent with the March 31, 2004 presentation. Note E - 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: -- 8 -- TREATMENT ADMINISTRATIVE ONLINE SERVICES SERVICES SERVICES ELIMINATIONS TOTAL For the three months ended March 31, 2004 Revenues - external customer $ 5,583,625 $ 888,563 $ -- $ -- $ 6,472,188 Revenues - intersegment 65,660 733,620 75,000 (874,280) -- Net income (loss) (218,760) (553,314) (73,191) -- (845,265) For the three months ended March 31, 2003 Revenues - external customers $ 5,408,116 $ 463,718 $ -- $ -- $ 5,871,834 Revenues - intersegment 400 665,556 75,000 (740,956) -- Net income (loss) 822,844 (637,263) (54,770) -- 130,811 For the nine months ended March 31, 2004 Revenues - external customers $16,333,689 $ 2,730,494 $ -- $ -- $19,064,183 Revenues - intersegment 176,000 2,201,340 225,000 (2,602,340) -- Net income (loss) 779,782 (1,349,702) (219,537) -- (789,457) Identifiable assets at March 31, 2004 7,951,487 2,562,476 23,119 -- 10,537,082 For the nine months ended March 31, 2003 Revenues - external customers $15,930,221 $ 1,589,170 $ -- $ -- $ 17,519,391 Revenues - intersegment 249,500 1,978,668 225,000 (2,453,168) -- Net income (loss) 2,543,431 (1,577,130) (168,345) -- 797,956 Identifiable assets at March 31, 2003 7,699,250 1,583,264 91,324 -- 9,373,838
Litigation settlement and related legal fees for the three and nine months ended March 31,2004 of $833,000 and $1,031,249, respectively, are included in the net loss from Treatment Services. -- 9 -- Note F - Equity Financing During the quarter ended March 31, 2004, the Company offered for sale an aggregate of up to 800,000 shares of its Class A common Stock and warrants to purchase up to 200,000 shares of its Class A Common Stock, for a total of $880,000, in order to supplement debt for financing the acquisition, discussed at Note H, and to provide short-term working capital. As a result of this offering the Company issued 684,999 shares of Class A Common Stock and warrants to purchase 171,249 shares of Class A Common Stock at a purchase price of $753,499. Note G - Legal Proceedings A medical malpractice claim was filed by a former patient against the Company's subsidiary, North Point-Pioneer, Inc. and a former clinician, alleging sexual abuse by a former clinician that first manifested itself prior to the Company's acquisition of the subsidiary in 1996. At trial in December 2002, a jury returned a verdict in favor of the plaintiff in the amount of approximately $9 million plus interest and taxable costs and attorney's fee for conduct. The clinician declared bankruptcy and was not a party to the proceeding. After numerous successful motions by the Company to reduce the amount of the verdict, a judgment in the amount of $3,079,741 was entered on October 24, 2003. The Company's subsidiary, North Point-Pioneer, Inc., is covered by malpractice insurance in the amount of $1 million provided by Frontier Insurance Company, which is insolvent and is being administered by the State of New York. Representatives of Frontier's receiver acknowledged to the Company, Frontier's obligations under the policy and the Company has recovered a small portion of the legal fees expended to date on this matter. Subsequent to quarter end, the Company successfully resolved this medical malpractice lawsuit. As a result of the settlement, the Company made payment of approximately $463,000, which compares to the previous judgment of approximately $3 million. The Company has not released other parties, including an insurance company. Payments made by insurance and other related parties, if collected, could significantly reduce the Company's financial burden below the $463,000 payment. The financial impact of this $463,000 settlement and related legal fees of approximately $370,000 are reflected in the operating results of the quarter ended March 31, 2004. The Company will continue to seek reimbursement from all sources for amounts expended on this case. Note H - Subsequent Events In addition to the litigation settlement referenced above, in April 2004 the Company finalized the agreement to purchase Pivotal Research Centers, LLC ("Pivotal") for approximately $1.5 million in cash and $500,000 in Pioneer class A common stock with additional amounts due based on future earnings. Pivotal, which is based in Phoenix, AZ, performs all phases of clinical research for Phase I-IV drugs under development through two dedicated research sites. Subsequent to quarter end, the Company offered for sale an aggregate of up to 1,918,196 shares of its Class A Common Stock and warrants to purchase up to 479,549 shares of Class A Common Stock for a total of $2,110,016. This -- 10 -- transaction was effected to provide cash for the use in the acquisition of Pivotal Research Centers, LLC and for working capital. Initial financing discussions resulted in $114,500 of financing costs expensed in this quarter that would have been deferred and amortized over the term of the debt if the loan transaction had been completed. This amount is included in interest expense and other financing costs in the accompanying condensed consolidated statements of operations. For further information regarding the acquisition see the Company's report on form 8-K filed on May 13, 2004. Item 2. Management's Discussion and Analysis or Plan of Operation PHC, INC. and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Overview The Company presently provides behavioral health care services through two substance abuse treatment centers, a psychiatric hospital and five 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 Company's research subsidiary, 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 illnesses. With the acquisition of Pivotal Research Centers, LLC subsequent to quarter end, Pivotal will provide all oversight and all research activities will be included as Pivotal activity. 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 ongoing 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 Company's 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. -- 11 -- Critical Accounting Policies The preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America, 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 and goodwill. 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. 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. Amounts due as a result of cost report settlements are recorded and listed separately on the consolidated balance sheets as "Other receivables, third party". 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. The Company currently has one "at-risk" contract. The contract calls for the Company to provide for all of their inpatient and outpatient behavioral health needs of the insurance carrier's enrollees in Nevada for a fixed monthly fee per member per month. Revenues are recorded monthly based on this formula and the expenses related to providing the services under this contract are recorded as incurred. The Company provides most of the outpatient care directly and, through utilization review, monitors closely, and pre-approves all inpatient and outpatient services not provided directly. The contract is considered "at-risk" because the payments to third-party providers for services rendered could equal or exceed the total amount of the revenue recorded. Pharmaceutical study revenue is recognized only after a pharmaceutical study contract has been awarded and the patient has been selected and accepted based on study criteria and billable units of service are provided. Where a contract requires completion of the study by the patient, no revenue is recognized until the patient completes the study program. Contract support service revenue is a result of fixed contracts to provide telephone support. Revenue for these services is recognized ratably over the service period, as there is no contingency for a change in the contracted amount based on services provided. -- 12 -- Allowance for doubtful accounts: The provision for bad debts is calculated based on a percentage of each aged accounts receivable category beginning at 0-5% on current accounts and increasing incrementally for each additional 30 days the account remains outstanding until the account is over 360 days outstanding, at which time the provision is 60-100% of the outstanding balance. These percentages vary by facility based on each facility's experience in collecting older receivables. The Company compares this required reserve amount to the current "Allowance for doubtful accounts" to determine the required bad debt expense for the period. This method of determining the required "Allowance for doubtful accounts" has historically resulted in an allowance for doubtful accounts of 30% or greater of the total outstanding receivables balance. 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. 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. 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 Total net revenue from operations increased 10.22% to $6,472,188 for the three months ended March 31, 2004 from $5,871,834 for the three months ended March 31, 2003 and increased 8.82% to $19,064,183 for the nine months ended March 31, 2004 from $17,519,391 for the nine months ended March 31, 2003. Net patient care revenue increased 4.53% to $5,583,625 for the three months ended March 31, 2004 from $5,341,816 for the three months ended March 31, 2003 and 2.90% to $16,323,589 for the nine months ended March 31, 2004 from $15,863,921 for the nine months ended March 31, 2003. This increase in revenue is due primarily to a 6.57% increase in patient days for the three months ended March 31, 2004 and 3.94% increase in patient days for the nine months ended March 31, 2004 over the same periods last year. The increase in patient days can be partially attributed to an increase in available beds at our Utah facility in -- 13 -- November 2003. Renewed marketing efforts have helped to maintain increased census in the current quarter, but the economy continues to play a major role in the number of people seeking treatment. Two key indicators of profitability of inpatient facilities are patient days, or census, and payor mix. Patient days is the product of the number of patients times length of stay. Increases in the number of patient days result in higher census, which coupled with a more favorable payor mix (more patients with higher paying insurance contracts or paying privately) will usually result in higher profitability. Therefore, patient census and payor mix are monitored very closely. Contract support services revenue provided by Wellplace increased 86.46% to $733,411 for the three months ended March 31, 2004 from $393,328 for the three months ended March 31, 2003 and increased 137.47% to $2,240,550 for the nine months ended March 31, 2004 from $943,513 for the same period last year. This increase in revenue is due to the March 2003 start of the Michigan call center contract, which produces a set revenue of $156,000 per month and the smoking cessation contract for the State of Kansas, which started in July 2003, and currently provides $6,600 in gross revenue monthly. Revenue from pharmaceutical studies increased 13.51% to $155,152 for the three months ended March 31, 2004 from $136,690 for the three months ended March 31, 2003 and decreased 29.76% to $500,044 for the nine months ended March 31, 2004 from $711,957 for the same period last year. These changes in revenue are due to changes in the number of active studies and the number of patients enrolled in the studies. The current Pioneer research business is expected to increase substantially as a result of the synergies with our recent acquisition of Pivotal Research Centers, LLC ("Pivotal"). Pivotal brings a top-tier client base, state-of the art competencies and more than a decade of experience to the Pioneer family. (For more information regarding the Pivotal acquisition see the Company's report for form 8-K filed with the Securities and Exchange Commission on May 13, 2004.) Patient care expenses increased 21.32% to $3,201,426 for the three months ended March 31, 2004 from $2,638,772 for the three months ended March 31, 2003 and 14.68% to $9,033,540 for the nine months ended March 31, 2004 from $7,877,313 for the nine months ended March 31, 2003. This increase in expenses is due primarily to the increase in-patient days noted above with the majority of the increases in expenses directly related to patient census such as payroll, food, laundry, hospital supplies and pharmacy. Contract support services expenses increased 54.15% to $546,667 for the three months ended March 31, 2004 from $354,632 for the three months ended March 31, 2003 and 94.78% to $1,667,041 for the nine months ended March 31, 2004 from $855,862 for the same period last year. These increases are a direct result of the increased expenses incurred with the inclusion of the full year of the Michigan call center contract and the smoking cessation contract for the State of Kansas with related start-up costs. Provision for doubtful accounts increased 15.80% to $227,196 for the three months ended March 31, 2004 from $196,195 for the three months ended March 31, 2003 and 35.96% to $1,113,033 for the nine months ended March 31, 2004 from -- 14 -- $818,652 for the same period last year. This is a result of an increase in the age of the Company's receivables and the Company's policy to maintain a higher reserve against older receivables. 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. Although the Company has maintained its aggressive collection policy, the Company's gross accounts receivable from patient care have increased approximately seven percent over the past three months. The growth of managed care has negatively impacted reimbursement for behavioral health services with slower payment and a higher rate of denials requiring higher reserves and more stringent collection practices. Website expenses increased 33.63% to $73,191 for the three months ended March 31, 2004 from $54,770 for the three months ended March 31, 2003 and 30.41% to $219,537 for the nine months ended March 31, 2004 from $168,345 for the nine months ended March 31, 2003. This is a result of increased depreciation expense based on a revision of the estimated remaining useful life of the assets. Without this change, website expenses would have remained relatively stable. Website expenses are expected to continue at this level for the remainder of the fiscal year, as the Internet Company's focus will remain internal and the accelerated depreciation will continue through fiscal year end. Administrative expenses increased 30.71% to $3,096,804 for the quarter ended March 31, 2004 from $2,369,205 for the quarter ended March 31, 2003 and 12.29% to $7,446,760 for the nine months ended March 31, 2004 from $6,631,883 for the same period last year. This increase is due to the increase in legal fees and settlement costs of approximately $833,000 recorded in the quarter ended March 31, 2004, which resulted in a total of $1,031,000 incurred during the nine months ended March 31, 2004 (see Part II, Item 1 Legal proceedings for details regarding the legal settlement). General insurance expense also increased approximately 69% for the quarter ended March 31, 2004 and 55% for the nine month period ended March 31, 2004 as compared with the same periods last year. Utilities increased approximately 5% for the quarter ended March 31, 2004 and 13% for the nine months ended March 31, 2004 as compared to the same periods last year. Rent expense increased approximately 8% for the quarter ended March 31, 2004 and 7% for the nine months ended March 31, 2004 as compared to the same periods last year. Other income increased 14.14% to $26,059 for the three months ended March 31, 2004 from $22,830 for the three months ended March 31, 2003 and 3.01% to $77,472 for the nine months ended March 31, 2004 from $75,206 for nine months ended March 31, 2003. This increase is primarily due to an increased request for medical records at our treatment facilities. Interest income increased 569.70% to $20,888 for the three months ended March 31, 2004 from $3,119 for the three months ended March 31, 2003 and 138.23% to $26,070 for the nine months ended March 31, 2004 from $10,943 for the same period last year. This is a result of a change in the Company's policy which now charges finance charges when extending credit to patients. Although patients requiring credit to pay for services have always signed an agreement to pay finance charges, the Company recently implemented the policy to charge for credit. -- 15 -- Interest expense and other financing costs increased 72.09% to $219,116 for the three months ended March 31, 2004 from $127,324 for the three months ended March 31, 2003 and 11.13% to $466,150 for the nine months ended March 31, 2004 from $419,455 for the same period last year. This increase is due to the immediate write off of $114,500 of costs related to the Company's initial efforts to finance the Pivotal acquisition primarily through debt. This amount would have been amortized over the term of the loan had the loan been consummated. It was determined that equity financing would be in the best interest of the Company and its shareholders when favorable loan terms could not be secured. Without this one time expense, interest expense for the quarter would have decreased 17.83% to $104,616 for the three months ended March 31, 2004 from $127,324 for the three months ended March 31, 2003 and 16.17% to $351,650 for the nine months ended March 31, 2004 from $419,455 for the same period last year. This decrease is due to the general decline in interest rates, the refinancing of debt in November 2001 at a more favorable rate, and repayment of long-term debt. The Company's provision for income taxes of $11,121 for the nine months ended March 31, 2004 is significantly below the Federal statutory rate of 34% primarily due to the availability of net operating loss carry-forwards. Total income tax expense for the nine months ended March 31, 2004 represents state income taxes for certain subsidiaries with no available net operating loss carry-forwards. The Company has provided a significant valuation allowance against its deferred tax asset due to potential changes in IRS rules that may limit the accessibility of the loss carry-forwards. Liquidity and Capital Resources The Company`s net cash used in operating activities was $141,152 for the nine months ended March 31, 2004 compared to $1,034,651 of cash provided by operations for the nine months ended March 31, 2003. Cash flow used in operations in the nine months ended March 31, 2004 consists of net loss of $789,457 less depreciation and amortization of $211,031, non-cash equity based charges of $128,586 and an increase in accounts payable and other liabilities of $1,029,844 less cash used for net changes in accounts receivable and other operating assets of $721,156. Cash used in investing activities in the nine months ended March 31, 2004 consisted of $150,488 in capital expenditures compared to $172,128 in capital expenditures during the same period last year. These funds were primarily used to repair and upgrade the company's owned real estate. Cash provided by financing activities of $760,386 in the nine months ended March 31, 2004 was the result of the issuance of common stock in a private placement outlined below offset by required reductions in long term debt and the purchase of treasury shares. During the quarter ended March 31, 2004, the Company offered for sale an aggregate of up to 800,000 shares of its Class A common Stock and warrants to purchase up to 200,000 shares of its Class A Common Stock, for a total of $880,000, in order to supplement debt for financing the acquisition, discussed at Note H, and to provide short-term working capital. As a result of this offering the Company issued 684,999 shares of Class A Common Stock and warrants -- 16 -- to purchase 171,249 shares of Class A Common Stock at a purchase price of $753,499. Subsequent to quarter end, the Company offered for sale an aggregate of up to 1,918,196 shares of its Class A Common Stock and warrants to purchase up to 479,549 shares of Class A Common Stock for a total of $2,110,016. This transaction was effected to provide cash for the use in the acquisition of Pivotal Research Centers, LLC and for working capital when it was determined that financing terms would not be favorable or in the best interest of the company and its shareholders. A significant factor in the liquidity and cash flow of the Company is the timely collection of its accounts receivable. Accounts receivable from patient care, net of allowance for doubtful accounts, increased approximately 10% to $5,429,379 on March 31, 2004 from $4,945,301 on June 30, 2003. This increase has resulted in increased efforts and staff and a renewed focus on our accounts receivable management practices. We have maintained a high number of support staff for collections, including outsourcing. We have standardized additional procedures for collecting receivables and reviewed and amended contracts, where necessary to improve collections. The increased staff has allowed the Company to concentrate on current accounts receivable to resolve any problem issues early, which results in a smaller number of uncollectable accounts. 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. The Company has operated ongoing operations profitably for thirteen consecutive quarters with the exception of the litigation settlement and related legal costs. The current positive business environment towards behavioral health treatment and the new business opportunities give us confidence to foresee continued improved results. The Company's future minimum payments under contractual obligations related to capital leases, operating leases and term notes for each fiscal year ending as of June 30 are listed below. There have been no material changes in these obligations as of March 31, 2004. -- 18 -- Year Ending Term Capital Operating June 30, Notes Leases Leases Total __________ __________ __________ __________ __________ 2004 $ 883,659 $ 55,954 $ 845,972 $1,785,585 2005 1,680,415 18,832 745,767 2,445,014 2006 47,598 12,825 499,244 559,667 2007 32,306 7,788 437,680 477,774 2008 35,337 649 326,396 362,382 Thereafter 234,629 -- 142,913 377,542 __________ __________ __________ __________ Total minimum payments $2,913,944 $ 96,048 $ 2,997,972 $6,007,964 =========== ======== =========== ========== -- 17 -- As a part of the acquisition costs of Pivotal on April 30, 2004 the Company signed three promissory notes with a maximum value of $2.5 million. The true value of these notes will be based on the future earnings of Pivotal and the increase in net income of the current Pioneer research operations as a result of synergies created by the Pivotal operations. No payments are due on these notes prior to January, 2005. Item 3. Controls and Procedures Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified within the SEC's Rules and Forms, and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was necessarily required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures to meet the criteria referred to above. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective. Change in Internal Controls There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluations. -- 19 -- PART II. OTHER INFORMATION Item 1. Legal Proceedings. A medical malpractice claim was filed by a former patient against the Company's subsidiary, North Point-Pioneer, Inc. and a former clinician, alleging sexual abuse by a former clinician that first manifested itself prior to the Company's acquisition of the subsidiary in 1996. At trial in December 2002, a jury returned a verdict in favor of the plaintiff in the amount of approximately $9 million plus interest and taxable costs and attorney's fee for conduct. The clinician declared bankruptcy and was not a party to the proceeding. After numerous successful motions by the Company to reduce the amount of the verdict, a judgment in the amount of $3,079,741 was entered on October 24, 2003. The Company's subsidiary, North Point-Pioneer, Inc., is covered by malpractice insurance in the amount of $1 million provided by Frontier Insurance Company, which is insolvent and is being administered by the State of New York. Representatives of Frontier's receiver acknowledged to the Company, Frontier's obligations under the policy and the Company has recovered a small portion of the legal fees expended to date on this matter. Subsequent to quarter end the Company successfully resolved this medical malpractice lawsuit. As a result of the settlement, the Company made payment of approximately $463,000, which compares to the previous judgment of approximately $3 million. The Company has not released other parties, including an insurance company. Payments made by insurance and other related parties, if collected, could significantly reduce the Company's financial burden below the $463,000 payment. The financial impact of this settlement and related legal fees is reflected in the operating results of the quarter ended March 31, 2004. The Company will continue to seek reimbursement from all sources for amounts expended on this case. -- 20 -- Item 6. Exhibits and reports on Form 8-K. Exhibit List Exhibit Description No. 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Reports on Form 8-K The Company filed one report on form 8-K during the quarter ended March 31, 2004. This report provided the same earnings information to the public as shown in the Company's quarterly press release as required by Item 12 of the instructions for form 8-K. -- 21 -- Signatures In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHC, Inc. Registrant Date: May 13, 2004 /s/ Bruce A. Shear _________________ Bruce A. Shear President Chief Executive Officer Date: May 13, 2004 /s/ Paula C. Wurts _________________ Paula C. Wurts Controller Treasurer -- 22 --