10QSB 1 q10q3q51305.txt 10Q THIRD QUARTER 2005 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, 2005. |_| 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) 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 2, 2005: Class A Common Stock 17,040,181 Class B Common Stock 776,991 Transitional Small Business Disclosure Format (Check one): Yes______ No X 1 PHC, Inc. PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - March 31, 2005 and June 30, 2004. Condensed Consolidated Statements of Operations - Three and nine months ended March 31, 2005 and March 31, 2004. Condensed Consolidated Statements of Cash Flows - Nine months ended March 31, 2005 and March 31, 2004. 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 4. Submission of Matters to a Vote of Security Holders. Item 6. Exhibits and Reports on form 8-K Signatures 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS March 31, June 30, ASSETS 2005 2004 __________ ________ (unaudited) Current assets: Cash and cash equivalents $ 552,874 $ 594,823 Accounts receivable, net of allowance for doubtful accounts of $1,902,740 at March 31 and $2,025,888 at June 30 6,790,975 5,165,150 Prepaid expenses 302,463 168,542 Other receivables and advances 1,579,345 860,195 Deferred income tax asset 937,407 842,806 __________ __________ Total current assets 10,163,064 7,631,516 Accounts receivable, non-current 72,500 96,052 Other receivables 86,497 94,469 Property and equipment, net 1,488,525 1,353,975 Deferred financing costs, net of amortization of $34,097 at March 31, 2005 164,348 -- Customer relationships, net of amortization of $110,000 at March 31, 2005 and $20,000 at June 30, 2004, respectively 2,290,000 2,380,000 Goodwill 2,648,209 1,416,119 Other assets 379,354 339,438 ___________ ___________ Total assets $17,292,497 $13,311,569 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 787,334 $ 1,713,395 Current portion of obligations under capital leases 22,741 18,169 Accounts payable 1,721,286 1,668,509 Revolving credit note 2,521,089 1,714,380 Deferred revenue 139,876 38,151 Accrued payroll, payroll taxes and benefits 1,351,219 1,305,490 Accrued expenses and other liabilities 728,730 682,567 Convertible debentures 100,000 250,000 __________ __________ Total current liabilities 7,372,275 7,390,661 Long-term debt, net of current maturities 2,059,963 529,378 Obligations under capital leases, net of current maturities 14,945 24,493 __________ __________ Total liabilities 9,447,183 7,944,532 __________ __________ Stockholders' equity: Class A common stock, $.01 par value, 30,000,000 shares authorized, 17,211,919 and 16,744,848 shares issued at March 31, 2005 and June 30, 2004, respectively 172,119 167,448 Class B common stock, $.01 par value, 2,000,000 shares authorized, 776,991 issued and outstanding (each convertible into one share of Class A common Stock) 7,770 7,770 Additional paid-in capital 23,214,235 22,791,637 Treasury stock, 181,738 shares and 168,136 shares of Class A common stock at March 31, 2005 and June 30, 2004, respectively, at cost (155,087) (141,207) Accumulated deficit (15,393,723) (17,458,611) __________ __________ Total stockholders' equity 7,845,314 5,367,037 __________ __________ Total liabilities and stockholders' equity $17,292,497 $13,311,569 =========== =========== See Notes to Condensed Consolidated Financial Statements 3 PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Nine Months Ended March 31, March 31, 2005 2004 2005 2004 _________________________ _________________________ Revenues: Patient care, net $6,734,949 $5,583,625 $18,895,774 $16,323,589 Pharmaceutical studies 1,103,205 155,152 3,384,347 500,044 Contract support services 925,528 733,411 2,510,277 2,240,550 __________ __________ ___________ ___________ Total revenues 8,763,682 6,472,188 24,790,398 19,064,183 __________ __________ ___________ ___________ Operating expenses: Patient care expenses 3,978,278 3,201,426 10,788,687 9,033,540 Cost of contract support services 520,475 546,667 1,595,478 1,667,041 Provision for doubtful accounts 217,756 227,196 800,503 1,113,033 Website expenses 53,835 73,191 149,339 219,537 Administrative expenses 3,010,466 3,096,804 8,908,789 7,446,760 __________ __________ ___________ ___________ Total operating expenses 7,780,810 7,145,284 22,242,796 19,479,911 __________ __________ ___________ ___________ Income (loss) from operations 982,872 (673,096) 2,547,602 (415,728) __________ __________ ___________ ___________ Other income (expense): Interest income 15,004 20,888 49,535 26,070 Other income 31,568 26,059 58,060 77,472 Interest expense and other financing costs (148,988) (219,116) (491,840) (466,150) __________ __________ ___________ ___________ Total other expenses, net (102,416) (172,169) (384,245) (362,608) __________ __________ ___________ ___________ Income (loss) before provision for taxes 880,456 (845,265) 2,163,357 (778,336) Provision for income taxes -- -- 98,469 11,121 __________ __________ ___________ ___________ Net income (loss) applicable to common shareholders $ 880,456 $ (845,265) $ 2,064,888 $ (789,457) ========== =========== =========== ============ Basic net income (loss) per common share $ 0.05 $ (.06) $ 0.12 $ (0.06) ========== =========== =========== ============ Basic weighted average number of shares outstanding 17,648,412 14,402,988 17,474,155 14,149,261 ========== =========== =========== ============ Diluted net income (loss) per common share $ 0.05 $ (.06) $ 0.11 $ (0.06) ========== =========== =========== ============ Diluted weighted average number of shares outstanding 18,690,012 14,402,988 18,234,480 14,149,261 ========== =========== =========== ============ See Notes to Condensed Consolidated Financial Statements.
4 PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Nine Months Ended March 31, 2005 2004 ___________________________ Cash flows from operating activities: Net income (loss) $ 2,064,888 $(789,457) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 324,397 211,031 Non-cash stock-based compensation 78,656 128,586 Changes in: Accounts receivable (2,313,451) (356,527) Prepaid expenses and other current assets (133,921) (204,360) Other assets (144,057) (160,269) Accounts payable 52,777 547,146 Accrued expenses and other liabilities 199,942 482,698 ____________ __________ Net cash provided by (used in) operating activities 129,231 (141,152) ____________ __________ Cash flows from investing activities: Acquisition of property and equipment (359,407) (150,488) Costs related to business acquisition (62,258) -- ____________ __________ Net cash used in investing activities (421,665) (150,488) ____________ __________ Cash flows from financing activities: Revolving debt, net 806,709 571,864 Long-term debt, net (538,850) (659,084) Deferred financing costs (164,348) 4,000 Exercise of options 15,500 897,398 Purchase of treasury stock (13,880) (48,711) Cost related to issuance of common stock (30,000) (5,081) Exercise of warrants 175,354 -- ____________ __________ Net cash provided by financing activities 250,485 760,386 ____________ __________ Net (decrease) increase in cash and cash equivalents (41,949) 468,746 Cash and cash equivalents balance, beginning of period 594,823 494,991 ____________ __________ Cash and cash equivalents balance, end of period $ 552,874 $ 963,737 ============ ========= SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $485,659 $ 338,233 Income taxes 118,550 18,713 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Pivotal Acquisition Note A earn out consideration recorded $1,169,832 $ -- Exercise of warrants through reduction of convertible debt 14,250 -- See Notes to Condensed Consolidated Financial Statements. 5 PHC, INC. and Subsidiaries Notes to Condensed Consolidated Financial Statements March 31, 2005 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 conducts pharmaceutical research studies, operates help lines for employee assistance programs, call centers for state and local programs and provides management, administrative and online behavioral health services. The Company primarily operates under four business segments: 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 seven psychiatric treatment locations which include Harbor Oaks Hospital, a 64-bed psychiatric hospital located in New Baltimore, Michigan, Detroit Behavioral Institute, a 30-bed psychiatric hospital dedicated to adjudicated juveniles located in Detroit, Michigan and five outpatient behavioral health locations (two in Las Vegas, Nevada operating as Harmony Healthcare and three locations operating as Pioneer Counseling Center in the Detroit, Michigan metropolitan area); Pharmaceutical study services, including four clinical study sites: two in Arizona, in Peoria and Mesa, one Michigan location in Royal Oak, Michigan and one in Midvale, Utah. These research sites conduct studies of the effects of specified pharmaceuticals on a controlled population through contracts with major manufacturers of the pharmaceuticals. All of the Company's research sites operate as Pivotal Research Centers; Call center and help line services, including two call centers: one operating in Midvale, Utah and one in Detroit, Michigan. The Company provides help line services through contracts with major railroads, a smoking cessation contract with the state of Kansas and a call center contract with the State of Michigan. The call centers both operate as Wellplace; and Behavioral health administrative services, including delivery of management and administrative and online services. The parent company provides management and administrative services for all of its subsidiaries and online services for its behavioral health treatment subsidiaries and its call center subsidiaries. It also provides behavioral health information 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 generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the nine months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending June 30, 2005. The accompanying financial statements should be read in conjunction with the June 30, 2004 consolidated financial statements and footnotes thereto included in the Company's 10-KSB filed on September 24, 2004. Note C- Stock Based Compensation The Company re-priced options to purchase 791,500 shares of Class A common stock in January 2001 of which 50,000 remained outstanding at June 30, 2004 and were subject to variable accounting from the date of the modification. During the quarter ended March 31, 2005, all remaining repriced options were exercised. Compensation expense relating to the vested repriced options was $16,435 for the fiscal year 6 Note C- Stock Based Compensation (continued) ended June 30, 2004 and $69,175 for the three-month and nine month period ended March 31, 2005, as compared to $9,415 and $16,511 for the three months and nine months ended March 31, 2004, respectively. The Company has adopted the disclosure only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", but applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", 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, net income (loss) and Net income (loss) per share would have been changed to the pro forma amounts indicated below: Three Months Ended Nine Months Ended March 31, March 31, 2005 2004 2005 2004 __________________________________________________ Net income (loss), as reported $880,456 $(845,265) $2,064,888 $(789,457) Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 70,575 747 78,656 103,229 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (93,775) (36,902) ( 184,506) (184,422) _________ ___________ ___________ _________ Pro forma net income (loss) $ 857,256 $(881,420) $1,959,038 $(870,650) ========= =========== =========== =========== Earnings (loss) per share: Basic - as reported $ 0.05 $ (0.06) $ 0.12 $ (0.06) ========= =========== =========== =========== Basic - pro forma $ 0.05 $ (0.06) $ 0.11 $ (0.06) ========= =========== =========== =========== Diluted - as reported $ 0.05 $ (0.06) $ 0.11 $ (0.06) ========= =========== =========== =========== Diluted - pro forma $ 0.05 $ (0.06) $ 0.11 $ (0.06) ========= =========== =========== ===========
Note D - 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. Residual income and expenses from closed facilities are included in the administrative services segment. The following summarizes the Company's segment data: Treatment Pharmaceutical Contract Administrative Services Study Services Services Services Eliminations Total _________________________________________________________________________ For the three months ended March 31, 2005 Revenue-external customers $ 6,734,949 $1,103,205 $ 925,528 $ -- $ -- $8,763,682 Revenues - intersegment 5,940 -- 15,437 690,000 (711,377) -- Net income (loss) 1,186,896 59,042 399,053 (764,535) -- 880,456 7 Note D - Business Segment Information (continued) Treatment Pharmaceutical Contract Administrative Services Study Services Services Services Eliminations Total _________________________________________________________________________ For the three months ended March 31, 2004 Revenue-external customers $ 5,583,625 $ 155,152 $ 733,411 $ -- $ -- $ 6,472,188 Revenues - intersegment 65,660 -- -- 808,620 (874,280) -- Net income (loss) (218,760) (44,751) 186,744 (768,498) -- (845,265) For the nine months ended March 31, 2005 Revenue-external customers $18,895,774 $3,384,347 $2,510,277 $ -- $ -- $24,790,398 Revenues - intersegment 5,940 -- 40,132 2,034,000 (2,080,072) -- Net income (loss) 3,182,988 211,794 896,799 (2,226,693) -- 2,064,888 Total assets 9,267,352 5,717,032 563,097 1,745,016 -- 17,292,497 For the nine months ended March 31, 2004 Revenues - external customers $16,333,689 $ 489,944 $2,240,550 $ -- $ -- $19,064,183 Revenues - intersegment 176,000 -- -- 2,426,340 (2,602,340) -- Net income (loss) 779,782 (37,778) 630,509 (2,161,970) -- (789,457) Total assets as of June 30, 2004 7,799,709 3,620,676 283,666 1,607,518 -- 13,311,569
Note E - Legal Proceedings In April 2004, the Company successfully resolved a medical malpractice lawsuit brought against the Company. As a result of the settlement, the Company made a payment of approximately $463,000, which compares to the previous judgment of approximately $3.0 million. The Company did not release the other parties, including an insurance company. Payments made by insurance and other related parties, if collected, could 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 during the year ended June 30, 2004. The Company will continue to seek reimbursement from all sources for amounts expended on this case. Included in other income for the three months ended March 31, 2005 is a payment of $25,000, received by the Company, related to a release of one insurance company. In fiscal 2004, the State of Nebraska asked the Company to provide the history of payments received from the State of Nebraska and the payments made to a consultant in Nebraska for his work on the smoking cessation contract. In the fourth quarter of fiscal 2004, the Company became aware that the State and the Federal governments are investigating the consultant. The Company is cooperating fully with the investigating agencies on this matter and to date has expended approximately $146,000 in legal fees related to their cooperation. 8 Note F - Debt Refinancing In October 2004, the Company entered into a revolving credit, term loan and security agreement with CapitalSource Finance, LLC to replace the Company's primary lender and provide additional liquidity. Each of the Company's material subsidiaries, other than Pivotal Research Centers, Inc. is a co-borrower under the agreement. The agreement includes a term loan in the amount of $1,400,000 and an accounts receivable funding revolving credit agreement with a maximum loan amount of $3,500,000, including $900,000 available as an overline for growth. During the three months ended March 31, 2005, the lender requested that the Company sign two replacement notes for the original $3,500,000 note to make it possible for them to assign a portion of the debt to an affiliate company. The outstanding balance on the term loan and the revolving credit loan on March 31, 2005 was $1,220,000 and $2,521,089, respectively. Under the revolving credit agreement, the Company must meet certain financial and administrative covenants, as defined therein. As of March 31, 2005, the Company was not in compliance with one of the financial covenants. The Company's failure to meet these covenants was a result of a Michigan Quality Assurance Assessment fee that the Company was not previously subject to and was not included in the Company's budget. The Company is appealing the size and substance of the fee based on the size of the facility. In previous years the fee was only assessed on larger facilities. The Company received notification from the lender on May 10, 2005 waiving the covenant non-compliance at March 31, 2005. Note G - Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123 (revised 2004), "Share-Based Payment", which is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No. 123 (R) supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees", and amends SFAS No. 95, "Statement of Cash Flows". Generally, the approach in SFAS No. 123 (R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123 (R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro-forma disclosure is no longer an alternative. The Company is required to adopt SFAS No. 123 (R) on July 1, 2005. The effect of this change on the results of operations of the Companuy is unknown at this time. 9 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 This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company including statements preceded by, followed by or that include words or phrases such as "believes," "expects," "anticipates," "plans," "trend," "objective," "continue," "remain," "pattern' or similar expressions or future or conditional verbs such as "will," "would," "should," "could," "might," "can," "may" or similar expressions, which are intended to identify "forward looking statement" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. Overview The Company presently provides behavioral health care services through two substance abuse treatment centers, two psychiatric hospitals 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 outpatient 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. it continues 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 over 30% for the nine months ended March 31, 2005 compared to the same period last year, as the savings resulting from the change in focus are being realized. The Company's research division, Pivotal Research Centers, Inc., contracts with major manufacturers of pharmaceuticals to assist in the study of the effects of certain pharmaceuticals in the treatment of specific illness through its clinics in Arizona, Michigan and Utah. 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. The extent of any future 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 (The Parity Act). If passed as proposed, this legislation may 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. As part of the Government Medicare Program, reimbursement rates for behavioral health care have increased. This increase may have a positive impact on performance at the Company's one Medicare facility, Harbor Oaks Hospital. The Company is exploring the possibility of becoming a Medicare provider at its other in- patient facilities. 10 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, income tax valuation allowances, and the impairment of 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. 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 is 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 the 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 fee contracts to provide telephone support. Revenue for these services is recognized ratably over the service period. All revenues reported by the Company are shown net of estimated allowances 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." Allowance for doubtful accounts: The provision for bad debt 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 70-100% of the outstanding balance. These percentages vary by facility based on each facility's experience in and expectations for 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. 11 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 bases 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. Valuation of goodwill and other intangible assets: Goodwill and other intangible assets are initially created as a result of business combinations or acquisitions. The values the Company records for goodwill and other intangible assets represent fair values calculated by independent third-party appraisers. Such valuations require the Company to provide significant estimates and assumptions which are derived from information obtained from the management of the acquired businesses and the Company's business plans for the acquired businesses. Critical estimates and assumptions used in the initial valuation of goodwill and other intangible assets include, but are not limited to: (i) future expected cash flows from services to be provided, customer contracts and relationships, and (ii) the acquired market position. These estimates and assumptions may be incomplete or inaccurate because unanticipated events and circumstances may occur. If estimates and assumptions used to initially value goodwill and intangible assets prove to be inaccurate, ongoing reviews of the carrying values of such goodwill and intangible assets may indicate impairment which will require the Company to record an impairment charge in the period in which the Company identifies the impairment. Results of Operations Total net revenue increased 35.41% to $8,763,682 for the three months ended March 31, 2005 from $6,472,188 for the three months ended March 31, 2004 and increased 30.04% to $24,790,398 for the nine months ended March 31, 2005 from $19,064,183 for the nine months ended March 31, 2004. Net patient care revenue increased 20.62% to $6,734,949 for the three months ended March 31, 2005 from $5,583,625 for the three months ended March 31, 2004 and 15.76% to $18,895,774 for the nine months ended March 31, 2005 from $16,323,589 for the nine months ended March 31, 2004. This increase in revenue is due primarily to the addition of the 30 adjudicated juvenile beds at Detroit Behavioral Institute which helped to create a 22.42% increase in patient days for the three months ended March 31, 2005 and 13.26% increase in patient days for the nine months ended March 31, 2005 over the same periods last year. 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. Revenue from pharmaceutical studies increased 611.05% to $1,103,205 for the three months ended March 31, 2005 from $155,152 for the three months ended March 31, 2004 and increased 576.81% to $3,384,347 for the nine months ended March 31, 2005 from $500,044 for the same period last year. This increase is due to the acquisition of Pivotal Research Centers, LLC on April 30, 2004. Contract support services revenue provided by Wellplace increased 26.19% to $925,528 for the three months ended March 31, 2005 from $733,411 for the three months ended March 31, 2004 and increased 12.04% to $2,510,277 for the nine months ended March 31, 2005 from $2,240,550 for the same period last year. This increase in revenue is due to the October 2004 increase in the Michigan call center contract, which increased the monthly revenue on this contract from $157,000 to $240,000 per month. 12 Patient care expenses increased 24.27% to $3,978,278 for the three months ended March 31, 2005 from $3,201,426 for the three months ended March 31, 2004 and 19.43% to $10,788,687 for the nine months ended March 31, 2005 from $9,033,540 for the nine months ended March 31, 2004. This increase in expenses is due primarily to the increase in 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 and the increase in patient expenses related to increased pharmaceutical study activity. Pharmaceutical studies account for approximately 34% and 41% of the increase in-patient care expenses for the quarter and nine months, respectively. Contract support services expenses decreased 4.79% to $520,475 for the three months ended March 31, 2005 from $546,667 for the three months ended March 31, 2004 and 4.29% to $1,595,478 for the nine months ended March 31, 2005 from $1,667,041 for the same period last year. This decrease is a result of more efficient use of staff and the elimination of the smoking cessation contract that was labor intensive and carried high outside service costs such as printing. Provision for doubtful accounts decreased 4.16% to $217,756 for the three months ended March 31, 2005 from $227,196 for the three months ended March 31, 2004 and 28.08% to $800,503 for the nine months ended March 31, 2005 from $1,113,033 for the same period last year. This is a result of a decrease in the age of the Company's receivables and the Company's policy to maintain reserves based on the age of the 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 17% over the past three months and 20% over the past nine months. This increase is primarily a result of increased revenues but is also affected by the growth of managed care with slower payments and a higher rate of denials. Website expenses decreased 26.45% to $53,835 for the three months ended March 31, 2005 from $73,191 for the three months ended March 31, 2004 and 31.98% to $149,339 for the nine months ended March 31, 2005 from $219,537 for the nine months ended March 31, 2004. This is a result of the costs of Internet set up being fully expensed. Administrative expenses decreased 2.79% to $3,010,466 for the three months ended March 31, 2005 from $3,096,804 for the three months ended March 31, 2004 and increased 19.63% to $8,908,789 for the nine months ended March 31, 2005 from $7,446,760 for the same period last year. These changes are a result of the higher legal fees and the settlement costs recorded in the third quarter of last year, which were partially offset by the increased administrative expenses related to Pivotal operations and Detroit Behavioral Institute, Inc., the new facility in Michigan. In addition to the expenses related to Pivotal, the individual expenses affected included: general insurance expense which increased approximately 28% for the quarter ended March 31, 2005 and 42% for the nine month period ended March 31, 2005 as compared with the same periods last year. Utilities increased approximately 25% for the quarter ended March 31, 2005 and 2% for the nine months ended March 31, 2005 as compared to the same periods last year. Rent expense increased approximately 13% for the quarter ended March 31, 2005 and 10% for the nine months ended March 31, 2005 as compared to the same periods last year. Fees and licenses increased approximately 237% for the quarter ended March 31, 2005 and 159% for the nine months ended March 31, 2005 as compared to the same periods last year as a result of the newly instituted Michigan quality assurance assessment fee. The charge to compensation expense of approximately $69,000 for previously repriced options, affected an increase in officers compensation expense of approximately 25% for the quarter ended March 31, 2005 and 8% for the nine months ended March 31, 2005 as compared to the same periods last year. 13 Interest income decreased 28.17% to $15,004 for the three months ended March 31, 2005 from $20,888 for the three months ended March 31, 2004 and increased 90.01% to $49,535 for the nine months ended March 31, 2005 from $26,070 for the same period last year. The increase for the nine months ended March 31, 2005 from the nine months ended March 31, 2004 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 to discourage long term credit for services. The decrease for the three months ended March 31, 2005 from the three months ended March 31, 2004 is a result of the Company's policy to extend credit on a more limited basis which reduced the interest income for patients and limited excess funds in interest bearing accounts. Other income increased 21.14% to $31,568 for the three months ended March 31, 2005 from $26,059 for the three months ended March 31, 2004 and decreased 25.06% to $58,060 for the nine months ended March 31, 2005 from $77,472 for nine months ended March 31, 2004. These changes are due to the elimination of rental income from the sublease of the New York property, formerly occupied by BSC, which was partially offset by the payment of $25,000 in a legal settlement (see Note E - Legal Proceedings, on page 8 of this report for details). Interest expense and other financing costs decreased 32.00% to $148,988 for the three months ended March 31, 2005 from $219,116 for the three months ended March 31, 2004 and increased 5.51% to $491,840 for the nine months ended March 31, 2005 from $466,150 for the same period last year. The decrease for the three months is due to lower overall interest rates and decreases in long term debt. The increase for the nine months is due in part to the interest on Note A of the Pivotal acquisition and financing costs related to the recent refinancing of the Company's long-term debt and receivables financing and the increased borrowing to provide funds for the start up of Detroit Behavioral Institute. The Company's provision for income taxes of $98,469 for the nine months ended March 31, 2005 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, 2005 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 provided by operating activities was $129,231 for the nine months ended March 31, 2005 compared to $141,152 of cash used in operations for the nine months ended March 31, 2004. Cash flow provided by operations in the nine months ended March 31, 2005 consists of net income of $2,064,888 plus depreciation and amortization of $324,397, non-cash equity based charges of $78,656 and an increase in accounts payable and other liabilities of $252,719 less cash used for net changes in accounts receivable and other operating assets of $2,591,429. Cash used in investing activities in the nine months ended March 31, 2005 consisted of $359,407 in capital expenditures compared to $150,488 in capital expenditures during the same period last year and costs related to a business acquisition of $62,258. The capital expenditures primarily related to the set up of the Detroit Behavioral Institute operations and the upgrade of the corporate exchange server in addition to routine equipment replacement. Cash provided by financing activities of $250,485 in the nine months ended March 31, 2005 was the result of the issuance of common stock for the exercise of options and warrants offset by costs related to the issuance of common stock, required reductions in long term debt and the purchase of treasury shares. A significant factor in the liquidity and cash flow of the Company is the timely collection of its accounts receivable. Total outstanding accounts receivable from patient care, net of allowance for doubtful accounts, increased 30.5% to $6,863,475 at March 31, 2005 from $5,261,202 at June 30, 2004. This increase is due in part to the new receivables being generated by Detroit Behavioral Institute, the new 30 bed adjudicated boys unit in Detroit, and higher revenues during the quarter. The Company monitors increases in accounts receivable closely and, based on the aging of the receivables outstanding, is confident 14 that the increase is not indicative of a payor or collection problem. Over the years the Company has increased staff, standardized some procedures for determining insurance eligibility and collecting receivables and established a more aggressive collection policy. The increased staff has allowed the Company to concentrate on current accounts receivable and resolve any issues before they become uncollectible. 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. The Company's 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 seventeen consecutive quarters with the exception of the litigation settlement and related legal costs incurred in the third quarter of fiscal year 2004. While it is difficult to predict based upon prior experience, if the current positive business environment towards behavioral health treatment and new business opportunities continues, the Company believes that it will see continued improved results. The Company's future minimum payments under contractual obligations related to capital leases, operating leases and term notes as of March 31, 2005 are listed below. Year Ending Term Capital Operating March 31, Notes Leases Leases Total ______________ _________ ________ __________ __________ 2005 $887,336* $22,741 $1,365,933 $2,276,010 2006 876,228 10,229 1,087,062 1,973,519 2007 674,766 4,574 869,466 1,548,806 2008 278,385 141 813,632 1,092,158 2009 202,939 -- 409,027 611,966 Thereafter 166,964 -- -- 166,964 ______________ _________ ________ __________ __________ Total minimum payments $3,086,618 $37,685 $4,545,120 $7,669,423 =========== ======== =========== ========== * Includes $100,000 in convertible debentures In October 2004, the Company entered into a revolving credit, term loan and security agreement with CapitalSource Finance, LLC to replace the Company's primary lender and provide additional liquidity. Each of the Company's material subsidiaries, other than Pivotal Research Centers, Inc, is a co-borrower under the agreement. The agreement includes a term loan in the amount of $1,400,000 and an accounts receivable funding revolving credit agreement with a maximum loan amount of $3,500,000, including $900,000 available as an overline for growth. During the quarter ended March 31, 2005, the lender requested that the Company sign two replacement notes for the original $3,500,000 note to make it possible for them to assign a portion of the debt to an affiliate company. The replacement notes are included as exhibits to this Report on Form 10Q-SB. The term loan note carries interest at prime plus 3.5%, but not less than 9%, with twelve monthly principal payments of $25,000, 12 monthly principal payments of $37,500, and eleven monthly principal payments of $50,000 beginning November 1, 2004 with balance due at maturity, on October 1, 2007. The balance due on the term loan as of March 31, 2005 was $1,220,000 and is included in the table above based on its payment terms. The revolving credit note carries interest at prime plus 2.25%, but not less than 6.75% paid through lock box payments of third party accounts receivable. The revolving credit term is three years, renewable for two additional one-year terms. The outstanding balance on the revolving credit note as of March 31, 2005 was $2,521,089. Under the revolving credit agreement, the Company must meet certain financial and administrative covenants, as defined therein. As of March 31, 2005, the Company was not in compliance with one of the financial covenants. The Company's failure to meet these covenants was a result of a Michigan Quality Assurance Assessment fee that the Company was not previously subject to and was not included in the Company's budget. The Company is appealing the size and substance of the fee based on the size of the facility. In previous years the fee was only assessed on larger facilities. The Company received notification from the lender on May 10, 2005 waiving the covenant non-compliance at March 31, 2005. 15 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. 16 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders The Company's annual meeting of stockholders was held on December 21, 2004. Because sufficient proxies were not received to hold the vote on the new non-employee director stock option plan to replace the plan expiring in October 2005, the meeting was adjourned and re-convened on January 20, 2005 at which time the 2005 Non-Employee Director Stock Option Plan (the "Plan") was approved with a total of 11,878,609 votes counted, 11,036,072 for and 842,537 opposed. Under the Plan 350,000 shares of Class A Common Stock are available for issuance to non-employee directors only, subject to the terms and conditions of the Plan. Item 6. Exhibits and reports on Form 8-K. Exhibit List Exhibit No. Description 10.47 One of two (2) Revolving Credit Notes in the amount of $1,500,000 issued to replace the $3,500,000 note signed in favor of CapitalSource Finance, LLC dated October 19, 2004 by PHC of Michigan, Inc., PHC of Nevada, Inc., PHC of Utah, Inc., PHC of Virginia, Inc., North Point - Pioneer, Inc., Wellplace, Inc., Detroit Behavioral Institute, Inc. 10.48 One of two (2) Revolving Credit Notes in the amount of $2,000,000 issued to replace the $3,500,000 note signed in favor of CapitalSource Finance, LLC dated October 19, 2004 by PHC of Michigan, Inc., PHC of Nevada, Inc., PHC of Utah, Inc., PHC of Virginia, Inc., North Point - Pioneer, Inc., Wellplace, Inc., Detroit Behavioral Institute, Inc. 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, 2005. This report provided the same earnings information to the public as shown in the Company's quarterly press release as required by Item 2.02 of the instructions for form 8-K. 17 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, 2005 /s/ Bruce A. Shear _____________________________ Bruce A. Shear President Chief Executive Officer Date: May 13, 2005 /s/ Paula C. Wurts _______________________________ Paula C. Wurts Controller Treasurer 18