-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QmApP9SbYccEVgki/4BFgZD0psyU7EYi7wYSLjViKGxVOKYulX3BMX9Xf1YTsEDC 8ZbHtO3KemjtMGkhyxGUkg== 0000915127-06-000046.txt : 20061114 0000915127-06-000046.hdr.sgml : 20061114 20061114164953 ACCESSION NUMBER: 0000915127-06-000046 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061114 DATE AS OF CHANGE: 20061114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PHC INC /MA/ CENTRAL INDEX KEY: 0000915127 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HOME HEALTH CARE SERVICES [8082] IRS NUMBER: 042601571 STATE OF INCORPORATION: MA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22916 FILM NUMBER: 061216137 BUSINESS ADDRESS: STREET 1: 200 LAKE ST STE 102 CITY: PEABODY STATE: MA ZIP: 01960 BUSINESS PHONE: 9785362777 MAIL ADDRESS: STREET 1: 200 LAKE ST STREET 2: STE 102 CITY: PEABODY STATE: MA ZIP: 01960 10-Q 1 q10_1106.txt QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006. |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ----------- Commission file number 0-22916 PHC, INC. (Exact name of registrant 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 (Registrant's telephone number) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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___ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ____ Accelerated filer___- Non accelerated filer X Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ____ No X APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Number of shares outstanding of each class of common equity, as of October 30, 2006: Class A Common Stock 17,814,365 Class B Common Stock 775,760 1 PHC, Inc. PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements. Condensed Consolidated Balance Sheets - September 30, 2006 (unaudited) and June 30, 2006. Condensed Consolidated Statements of Operations (unaudited) - Three months ended September 30, 2006 and September 30, 2005. Condensed Consolidated Statements of Cash Flows (unaudited) - Three months ended September 30, 2006 and September 30, 2005. Notes to Condensed Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Item 3. Quantitative and Qualitative Disclosure About Market Risk. Item 4. Controls and Procedures PART II. OTHER INFORMATION Item 6. Exhibits Signatures 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS September 30, June 30, ASSETS 2006 2006 (unaudited) _______ _____________ __________ Current assets: Cash and cash equivalents $ 1,774,410 $1,820,105 Accounts receivable, net of allowance for doubtful accounts of $3,155,365 at September 30, 2006 and $3,100,586 at June 30, 2006 7,167,055 6,955,475 Pharmaceutical receivables 1,474,353 1,470,019 Prepaid expenses 948,474 490,655 Other receivables and advances 907,769 751,791 Deferred income tax asset 2,960,768 3,110,000 _____________ __________ Total current assets 15,232,829 14,598,045 Accounts receivable, non-current 35,000 40,000 Other receivable 47,680 53,457 Property and equipment, net 1,943,734 1,799,888 Deferred financing costs, net of amortization of $115,661 at September 30, 2006 and $106,422 June 30, 2006 107,785 117,023 Customer relationships, net of amortization of $290,000 at September 30, 2006 and $260,000 at June 30, 2006 2,110,000 2,140,000 Goodwill 2,664,643 2,664,643 Other assets 555,377 571,931 _____________ __________ Total assets $22,697,048 $ 21,984,987 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,831,519 $ 1,518,615 Current maturities of long-term debt 872,518 909,057 Revolving credit note 1,777,931 1,603,368 Deferred revenue 246,286 385,742 Current portion of obligations under capital leases 146,660 57,881 Accrued payroll, payroll taxes and benefits 1,632,449 1,619,672 Accrued expenses and other liabilities 1,052,408 1,026,419 _____________ __________ Total current liabilities 7,559,771 7,120,754 Long-term debt 890,997 1,021,546 Obligations under capital leases 47,075 61,912 Deferred tax liability 325,000 325,000 _____________ __________ Total liabilities 8,822,843 8,529,212 _____________ __________ Stockholders' equity: Preferred Stock, 1,000,000 shares authorized, none issued or outstanding -- -- Class A common stock, $.01 par value, 30,000,000 shares authorized, 17,953,463 and 17,874,966 shares issued at September 30, 2006 and June 30, 2006, respectively 179,535 178,749 Class B common stock, $.01 par value, 2,000,000 shares authorized, 775,760 issued and outstanding at September 30, 2006 and June 30, 2006, respectively, each convertible into one share of Class A common Stock 7,758 7,758 Additional paid-in capital 23,852,558 23,718,197 Treasury stock, 199,098 shares of Class A common stock at September 30, 2006 and June 30, 2006, at cost (191,700) (191,700) Accumulated deficit (9,973,946) (10,257,229) _____________ __________ Total stockholders' equity 13,874,205 13,455,775 _____________ __________ Total liabilities and stockholders' equity $22,697,048 $21,984,987 ============= =========== See Notes to Condensed Consolidated Financial Statements 3 PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended September 30, 2006 2005 ____________________________ Revenues: Patient care, net $ 7,876,432 $ 6,712,980 Pharmaceutical studies 1,051,383 1,306,009 Contract support services 1,134,391 925,837 ___________ ___________ Total revenues 10,062,206 8,944,826 ___________ ___________ Operating expenses: Patient care expenses 3,955,652 3,261,911 Patient care expenses, pharmaceutical 486,937 563,154 Cost of contract support services 838,555 597,795 Provision for doubtful accounts 452,525 656,887 Administrative expenses 3,095,455 2,629,676 Administrative expenses, pharmaceutical 679,108 633,999 ___________ ___________ Total operating expenses 9,508,232 8,343,422 ___________ ___________ Income from operations 553,974 601,404 ___________ ___________ Other income (expense): Interest income 32,849 22,864 Other (expense)income (943) 10,785 Interest expense (119,830) (155,218) ___________ ___________ Total other expenses, net (87,924) (121,569) ___________ ___________ Income before provision for taxes 466,050 479,835 Provision for income taxes 182,767 95,628 ___________ ___________ Net income $283,283 $384,207 Basic net income per common share $ 0.02 $ 0.02 ___________ ___________ Basic weighted average number of shares outstanding 18,514,142 18,099,342 ___________ ___________ Diluted net income per common share $ 0.01 $ 0.02 ___________ ___________ Diluted diluted weighted average number of shares outstanding 19,296,638 19,270,164 ___________ ___________ See Notes to Condensed Consolidated Financial Statements. 4 PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Three Months Ended September 30 2006 2005 ____________________________ Cash flows from operating activities: Net income $ 283,283 $ 384,207 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 170,591 135,976 Non-cash interest expense 16,489 13,932 Deferred income tax asset 149,232 -- Non-cash stock-based compensation 70,781 75,497 Change in allowance for doubtful accounts 54,779 753,851 Changes in: Accounts receivable (415,894) 589,090 Prepaid expenses and other current assets (457,819) (465,900) Other assets (1,188) (33,769) Accounts payable 312,904 1,282,177 Accrued expenses and other liabilities (100,690) (641,447) ___________ __________ Net cash provided by operating activities 82,468 915,434 ___________ __________ Cash flows from investing activities: Acquisition of property and equipment (152,959) (369,848) ___________ __________ Net cash used in investing activities (152,959) (369,848) ___________ __________ Cash flows from financing activities: Revolving debt, net 174,563 188,078 Proceeds from borrowings on long-term debt -- 13,932 Principal payments on long-term debt (214,132) (192,420) Proceeds from issuance of common stock, net 64,365 50,424 Purchase of treasury stock -- (18,533) ___________ __________ Net cash provided by financing activities 24,796 41,481 ___________ __________ Net (decrease) increase in cash and cash equivalents (45,695) 587,067 Beginning cash and cash equivalents 1,820,105 917,630 ___________ __________ Ending cash and cash equivalents $1,774,410 $ 1,504,697 ___________ __________ SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 171,548 $ 155,218 Income taxes 116,384 108,300 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of common stock in cashless exercise of warrants $ 30 $ -- Obligations under capital leases 104,497 -- See Notes to Condensed Consolidated Financial Statements. 5 PHC, INC. and Subsidiaries Notes to Condensed Consolidated Financial Statements September 30, 2006 Note A - The Company PHC, Inc. (the "Company") is a national healthcare 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: (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, Detroit Behavioral Institute, a 50-bed residential facility and six outpatient behavioral health locations (one in New Baltimore, Michigan operating in conjunction with Harbor Oaks Hospital, two in Las Vegas, Nevada operating as Harmony Healthcare and three locations operating as Pioneer Counseling Center in the Detroit, Michigan metropolitan area); (2) Pharmaceutical research study services, including four clinic 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; (3) Call center and help line services (contract services), including two call centers, one operating in Midvale, Utah and one in Detroit, Michigan provides help line services through contracts with major railroads and a call center contract with Wayne County Michigan. The call centers both operate under the brand name Wellplace; and (4) 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-Q and Rule 10-01 of Regulation S-X. 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 three months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending June 30, 2007. The accompanying financial statements should be read in conjunction with the June 30, 2006 consolidated financial statements and footnotes thereto included in the Company's 10-K filed on October 13, 2006. Revenue Recognition The Company bills for its behavioral healthcare services at its inpatie nt and outpatient facilities using different software platforms for each type of service; however, in all cases the charges are contractually adjusted at the time of billing using adjustment factors based on agreements or contracts with the insurance carriers and the specific plans held by the individuals. This method may still require additional adjustment based on ancillary services provided and deductibles and copays due from the individuals which are estimated at the time of admission based on information received from the individual. Adjustments to these estimates are recognized as adjustments to revenue during the period identified, usually when payment is received. 6 The Company's policy is to collect estimated co-payments and deductibles at the time of admission. Payments are made by way of cash, check or credit card. If the patient does not have sufficient resources to pay the estimated co-payment in advance, the Company's policy is to allow payment to be made in three installments- one third due upon admission, one third due upon discharge and the balance due 30 days after discharge. At times the patient is not physically or mentally stable enough to comprehend or agree to any financial arrangement. In this case the Company will make arrangements with the patient once his or her condition is stabilized. At times, this situation will require the Company to extend payment arrangements beyond the three payment method previously outlined. Whenever extended payment arrangements are made, the patient, or the individual who is financially responsible for the patient, is required to sign a promissory note to the Company, which includes interest on the balance due. 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. All revenues and receivables from our research division are derived from pharmaceutical companies with no related bad debt allowance. 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 and receivables from our contract services division are based on a prorated monthly allocation of the total contract amount and usually paid within 30 days of the end of the month. The Company's days sales outstanding ("DSO") are significantly different for each type of service and each facility based on the payors for each service. Overall, the DSO for the combined operations of the Company were 86 days for the three months ended September 30, 2006 and 92 days the fiscal year ended June 30, 2006. The table below shows the DSO by segment for the same periods. Period Treatment Pharmaceutical Contract End Services Services Services 09/30/2006 84 129 64 06/30/2006 91 93 51 This increase in the Pharmaceutical Services DSO's is related to the high DSO's normally associated with research receivables coupled with the recent start up of a large research contract. Contract Services DSO's fluctuate dramatically by the delay in payment of a few days for any of our large contracts. There was such a delay in payments for the Michigan call center at the end of the quarter ended September 30, 2006, inflating the DSO's for the period. Note C- Stock Based Compensation The Company has three active stock plans: a stock option plan, an employee stock purchase plan and a non-employee directors' stock option plan. The stock option plan provides for the issuance of a maximum of 1,300,000 shares of Class A common stock of the Company pursuant to the grant of incentive stock options to employees or nonqualified stock options to employees, directors, consultants and others whose efforts are important to the success of the Company. Subject to the provisions of this plan, the compensation committee of the Board of Directors has the authority to select the optionees and determine the terms of the options including: (i) the number of shares, (ii) option exercise terms, (iii) the exercise or purchase price (which in the case of an incentive stock option will not be less than the market price of the Class A common stock as of the date of grant), (iv) type and duration of transfer or other restrictions and (v) the time and form of payment for restricted stock upon exercise of options. The employee stock purchase plan provides for the purchase of Class A common stock at 85 percent of the fair market value at specific dates, to encourage stock ownership by all eligible employees. A maximum of 500,000 shares may be issued under this plan. The non-employee directors' stock option plan provides for the grant of nonstatutory stock options automatically at the time of each annual meeting of the Board. Under the plan a maximum of 350,000 shares may be issued. Each 7 outside director is granted an option to purchase 20,000 shares of Class A common stock annually at fair market value on the date of grant, vesting 25% immediately and 25% on each of the first three anniversaries of the grant and expiring ten years from the grant date. The Company issues stock options to its employees and directors and provides employees the right to purchase stock pursuant to stockholder approved stock option and stock purchase plans. Effective July 1, 2005, the Company adopted the provisions of SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS No. 123R), using the Statement's modified prospective application method. Prior to July 1, 2005, the Company followed Accounting Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock compensation. Under the provisions of SFAS No. 123R, the Company recognizes the fair value of stock compensation in net income, over the requisite service period of the individual grantees, which generally equals the vesting period. All of the Company's stock compensation is accounted for as an equity instrument and there have been no liability awards granted. Any income tax benefit related to stock compensation will be shown under the financing section of the Cash Flow Statement. Based on the Company's historical voluntary turnover rates for individuals in the positions who received options in the period, there was no forfeiture rate assessed. It is assumed these options will remain outstanding for the full term of issue. Under the true-up provisions of SFAS 123R, a recovery of prior expense will be recorded if the actual forfeiture is higher than estimated. At June 30, 2005, the Company accelerated the vesting on all previously granted options. Therefore, as of the date of adoption there was no unrecognized expense for options issued prior to June 30, 2005. The expense recorded in the three months ended September 30, 2006, $70,781, is for the vesting of options issued during the September quarter in fiscal 2006. Under the provisions of SFAS 123R, the Company recorded $70,781 and $75,497 of stock-based compensation on its consolidated condensed statement of operations for the three months ended September 30, 2006 and 2005, respectively, which is included in administrative expenses as follows: Three Months Ended Three Months Ended September 30, 2006 September 30, 2005 Employee compensation $70,781 $75,497 _______ _______ Total $70,781 $75,497 ======= ======= The Company had the following activity in its stock option plans for the three months ended September 30, 2006: Number Weighted-Average Intrinsic Value of Exercise Price at Shares Per Share September 30, 2006 __________ ________________ _________________ Balance - June 30, 2006 1,234,250 $1.45 Granted -- $ -- Exercised (75,500) $0.85 Expired (2,000) $3.50 _________ Balance - September 30, 2006 1,156,750 $1.48 $ 771,256 ========= ========= Exercisable 912,688 $1.25 $821,418 ========= ========= The total intrinsic value of options exercised during the three-months ended September 30, 2006 was $103,245. The following summarizes the activity of the Company's stock options that have not vested for the three months ended September 30, 2006. 8 Number Weighted- of Average Shares Fair Value _______ __________ Nonvested at July 1, 2006 302,812 $1.16 Granted 0 -- Expired 0 -- Vested 58,750 $1.21 _______ Nonvested at September 30, 2006 244,062 $1.15 ======= The compensation cost related to the fair value of these shares of $281,241 will be recognized when these options vest over the next three years. The Company utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation granted after the adoption of SFAS 123R. There were no options issued in the quarter ended September 30, 2006. The weighted-average fair values of the options granted under the stock option plans for the three months ended September 30, 2005 was $1.21, using the following: Three Months Ended Three Months Ended September 30, 2006 September 30, 2005 __________________ __________________ Average risk-free interest -- 4.50% rate Expected dividend yield -- None Expected life -- 4 years Expected volatility -- 45.0% The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of our common stock over the period commensurate with the expected life of the options. The risk-free interest rate is the U.S. Treasury rate on the date of grant. The expected life was calculated using the Company's historical experience for the expected term of the option. Note D- Reclassifications Certain September 30, 2005 amounts have been reclassified to be consistent with the September 30, 2006 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: Treatment Pharmaceutical Contract Administrative Services Study Services Services Services Eliminations Total ___________ ______________ ________ ______________ ___________ __________ For the three months ended: September 30, 2006 Revenues - external customers $7,876,432 $1,051,383 $1,134,391 $ -- $ -- $10,062,206 Revenues - intersegment 4,500 -- 21,640 924,000 950,140) -- Segment Net income (loss) 1,073,638 (126,767) 255,565 (919,153) -- 283,283 Capital Expenditures 105,468 21,268 1,565 21,268 -- 152,959 Depreciation & Amortization 88,764 37,367 13,444 11,309 -- 150,884 9 Interest Expense 87,397 16,605 1,278 14,550 -- 119,830 Income tax expense 138,498 -- 40,343 3,926 -- 182,767 Identifiable assets 11,163,908 5,594,180 1,006,661 4,932,299 -- 22,697,048 Goodwill 969,099 3,805,544 -- -- -- 4,774,643
Note E - Business Segment Information (continued) Treatment Pharmaceutical Contract Administrative Services Study Services Services Services Eliminations Total ___________ ______________ ________ ______________ ____________ _________ September 30, 2005 Revenues - external $6,712,980 $1,306,009 $ 925,837 $ -- $ -- $ 8,944,826 customers Revenues - intersegment 2,750 -- -- 816,000 (818,750) -- Segment Net income (loss) 684,935 92,828 336,500 (730,056) -- 384,207 Capital Expenditures 333,348 15,495 6,170 14,835 -- 369,848 Depreciation & Amortization 86,503 39,863 2,304 7,306 -- 135,976 Interest Expense 119,479 16,028 -- 19,711 -- 155,218 Income tax expense 81,071 -- 14,557 -- -- 95,628
Note F - Debt covenants For the quarter ended September 30, 2006, the Company was not in compliance with its long term debt covenants related Earnings Before Interest Taxes Depreciation and Amortization. These covenants are based on the Company's projections using an equally distributed average of the Company's annual projections, which we failed to meet for the quarter. The first quarter tends to be less profitable than the third and fourth quarters each year because of lower adolescent census during the summer months. CapitalSource, the Company's lender, has provided the Company with a waiver of this covenant for the period. Note G - Recent Accounting Pronouncements In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin 108, "Considering the Effects on Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements," ("SAB 108"). SAB 108 requires registrants to quantify errors using both the income statement method (i.e. iron curtain method) and the rollover method and requires adjustment if either method indicates a material error. If a correction in the current year relating to prior year errors is material to the current year, then the prior year financial information needs to be corrected. A correction to the prior year results that are not material to those years, would not require a "restatement process" where prior financials would be amended. SAB 108 is effective for fiscal years ending after November 15, 2006. We do not anticipate that SAB 108 will have a material effect on our financial position, results of operations or cash flows. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 will be effective for fiscal years beginning after November 15, 2007, the beginning of the Company's 2008 fiscal year. The Company is assessing the impact the adoption of SFAS No. 157 will have on the Company's financial position and results of operations. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. In addition to historical information, this report contains statements relating to future events or our future results. These statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended (the "Exchange Act") and are subject to the Safe Harbor provisions created by the statute. Generally words such as "may", "will", "should", "could", "anticipate", "expect", "intend", "estimate", "plan", "continue", and "believe" or the negative of or other variation on these and other similar expressions identify forward-looking statements. These forward-looking statements are made only as of the date of this report. We do not undertake to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements are based on current expectations and involve risks and uncertainties and our future results could differ significantly from those expressed or implied by our forward-looking statements. Overview The Company presently provides behavioral health care services through two substance abuse treatment centers, a psychiatric hospital, a residential treatment facility and six 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. The Company's internet operation, Behavioral Health Online, Inc., continues to provide behavioral health information through its web site at Wellplace.com but its primary function is Internet technology support for the subsidiaries and their contracts. As such, the expenses related to Behavioral Health Online, Inc. are included as corporate expenses. 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 illnesses through its clinics in Utah, Michigan and Arizona. The healthcare industry is subject to extensive federal, state and local regulation governing, among other things, licensure and certification, conduct of operations, audit and retroactive adjustment of prior government billings and reimbursement. In addition, there are on-going debates and initiatives regarding the restructuring of the health care system in its entirety. The extent of any regulatory changes and their impact on the Company's business is unknown. The current administration has put forth proposals to mandate equality in the benefits available to those individuals suffering from mental illness. If passed, this legislation 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. 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 11 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". 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. All revenues reported by the Company are shown net of estimated contractual adjustment 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." Net Contractual adjustments recorded in the quarter ended September 30, 2006 for revenue booked in prior years resulted in an increase in net revenue of approximately $21,400. Net contractual adjustments recorded in fiscal 2006 for revenue booked in prior years resulted in an increase in net revenue for the year of approximately $343,700. During the fiscal year ended June 30, 2006, a Medicare cost report settlement of $158,100 was received. No cost report settlements were received or recorded during the three months ended September 30, 2006. Our accounts receivable systems are capable of providing an aging based on responsible party or payor. This information is critical in estimating our required allowance for bad debts. Below is revenue by payor and the accounts receivable aging information as of September 30, 2006, 2005 and June 30, 2006, for our treatment services segment. Net Revenue by Payor (in thousands) For the Three Months Ended For the Three Months Ended For the Twelve Months Ended September 30, 2006 September 30, 2005 June 30, 2006 Amount Percentage Amount Percentage Amount Percentage ___________________________ ___________________________ ___________________________ Private Pay $ 340 4% $ 311 5% $ 1,207 5% Commercial 4,881 62% 4,470 67% 17,572 63% Medicare * 359 5% 292 4% 946 3% Medicaid 2,296 29% 1,640 24% 8,137 29% ________ ___ ________ ___ _______ ___ Net Revenue $ 7,876 $ 6,713 $27,862 ________ _______ _______
* includes Medicare settlement revenue as noted above 12 Accounts Receivable Aging (Net of allowance for bad debts- in thousands) Quarter Ended September 30, 2006 Over Over Over Over Over Over Over Payor Current 30 60 90 120 150 270 360 Total _____ _______ _____ ____ ____ ____ ____ ____ ____ _____ Private Pay $ 420 $ 333 $280 $158 $136 $ 736 $ 42 $ 18 $2,123 Commercial 1,617 603 259 195 166 514 110 111 3,575 Medicare 202 23 6 2 11 73 -- -- 317 Medicaid 784 101 41 34 40 187 -- -- 1,187 _______ _____ ____ ____ ____ ______ ____ ____ ______ Total $3,023 $1,060 $586 $389 $353 $1,510 $152 $129 $7,202 Fiscal Year Ended June 30, 2006 Over Over Over Over Over Over Over Payor Current 30 60 90 120 150 270 360 Total Private Pay $ 113 $ 119 $106 $113 $ 84 $ 593 $ 33 $ 23 $1,184 Commercial 1,499 595 364 284 229 836 126 92 4,025 Medicare 133 38 6 17 18 73 -- -- 285 Medicaid 971 152 69 32 34 243 -- -- 1,501 _______ ______ ____ ____ ____ ______ ____ ____ _______ Total $2,716 $ 904 $545 $446 $365 $1,745 $159 $115 $6,995
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. All revenues and receivables from our research division are derived from pharmaceutical companies with no related bad debt allowance. 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 and receivables from our contract services division are based on a prorated monthly allocation of the total contract amount and usually paid within 30 days of the end of the month. 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 80-100% 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 20% or greater of the total outstanding receivables balance. Income Taxes: 13 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. During the fourth quarter of fiscal year ended June 30, 2006, the Company recognized 100% of its deferred tax benefit based on past profitability and future projections. The total tax benefit recorded was $1,638,713. 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 are reviewed by the Company, at least annually, and represent fair values. 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 The following table illustrates our consolidated results of operations for the quarters ended September 30, 2006 and 2005 (in thousands): 2006 2005 (in thousands) Statements of Operations Data: Amount % Amount % Revenue $10,062 100.0% $8,945 100.0% _______ ______ _______ ______ Cost and Expenses: Patient care expenses 4,442 44.2% 3,825 42.8% Contract expenses 839 8.3% 598 6.7% Administrative expenses 3,774 37.5% 3,264 36.5% Provision for bad debts 453 4.5% 657 7.3% Interest expense 120 1.2% 155 1.7% Other (income) expenses, net (32) -0.3% (34) -0.4% _______ ______ ______ _______ Total expenses 9,596 95.4% 8,465 94.6% Income before income taxes 466 4.6% 480 5.4% Provision for income taxes 183 1.8% 96 1.1% _______ ______ ______ _______ Net income $ 283 2.8% $ 384 4.3% _______ ______ ______ _______ Results of Operations Total net revenue from operations increased 12.5% to $10,062,206 for the three months ended SepFtember 30,2006 from $8,944,826 for the three months ended September 30, 2005. Net patient care revenue increased 17.3% to $7,876,432 for the three months ended September 30, 2006 from $6,712,980 for the three months ended September 30, 2005. This increase in revenue is due primarily to the addition of the 20 adjudicated juvenile beds at Detroit Behavioral Institute which helped to create 14 a 31.0% increase in patient days for the three months ended September 30, 2006 over the same period last year. Excluding Detroit Behavioral Institute, combined census in our other inpatient facilities increased 15% largely due to renewed marketing efforts. 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 decreased 19.5% to $1,051,383 for the three months ended September 30, 2006 from $1,306,009 for the three months ended September 30, 2005. This decrease is due to the cyclical nature of the pharmaceutical research business where the size and number of clinical trial starts and stops changes daily. As a result, revenues from pharmaceutical studies vary greatly from period to period based on the number of active studies and available qualified participants for each active study. Contract support services revenue provided by Wellplace increased 22.5% to $1,134,391 for the three months ended September 30, 2006 from $925,837 for the three months ended September 30, 2005. This increase in revenue is due to the start of the smoking cessation contract with a government contractor in October 2005, which increased monthly revenue by approximately $70,000 per month since the executiuon of the contract. Patient care expenses in our treatment centers increased 21.3% to $3,955,652 for the three months ended September 30, 2006 from $3,261,911 for the three months ended September 30, 2005. 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, hospital supplies, food and pharmacy expense. Lower census in some facilities tends to result in a higher acuity requiring a higher staffing ratio and higher ancillary costs. Patient care expenses related to our pharmaceutical or research division decreased 13.5% to $486,937 for the three months ended September 30, 2006 from $563,154 for the three months ended September 30, 2005. This is due to the decrease in the number of study patients receiving stipends for participation in studies. Contract support services expenses increased 40.3% to $838,555 for the three months ended September 30, 2006 from $597,795 for the three months ended September 30, 2005. This increase was due to expenses incurred in the commencement of the new smoking cessation contract previously mentioned. This resulted in increased payroll and related expenses and additional depreciation cost related to new equipment purchases. Administrative expenses increased 17.7% to $3,095,455 for the quarter ended September 30, 2006 from $2,629,676 for the quarter ended September 30, 2005. These changes are a result of the increased administrative payroll and employee benefits related to the establishment and opening of the additional beds at Detroit Behavioral Institute. Administrative payroll increased 18.5% and employee benefits increased 23.8%. Marketing expenses increased approximately 156% as we increased national marketing efforts for our facilities. Rent expense increased approximately 29% due to the increase in space at Detroit Behavioral Institute for the girls unit. Insurance expense increased 16.7% for the quarter ended September 30, 2006. Utilities increased approximately 14.4% for the quarter ended September 30, 2006. Administrative expenses related to the research division increased 7.11% to $679,108 for the three months ended September 30, 2006 from $633,999 for the three months ended September 30, 2005. This increase is primarily due to a 21.0% increase in payroll expense, a 17.6% increase in advertising, a 23.2% increase in telephone expense and a 9.9% increase in office expense as the study business is rebuilding. Provision for doubtful accounts decreased 31.1% to $452,525 for the three months ended September 30, 2006 from $656,887 for the three months ended September 30, 2005. The Company's policy is to maintain reserves based on the age of its receivables. This decrease in the provision for doubtful accounts is largely attributable to the additional provision amount last year because of the software failure at Harbor Oaks. With the software issues largely resolved the provision for doubtful accounts is leveling off at a more reasonable amount at 6% of net patient care revenue as opposed to the 10% that was recorded last year. 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. 15 Interest income increased 43.7% to $32,849 for the three months ended September 30, 2006 from $22,864 for the three months ended September 30, 2005. This increase is a result of increased cash in our investment accounts resulting in higher interest payments. Other income / expense decreased 108.7% to $(943) for the three months ended September 30, 2006 from $10,785 for the three months ended September 30, 2005. This change is due processing of the amount lost from the theft at our smallest inpatient facility. The amount the loss was offset by an insurance settlement of $10,000. Interest expense decreased 22.8% to $119,830 for the three months ended September 30, 2006 from $155,218 for the three months ended September 30, 2005. This decrease is due to the reduction of our long term debt over the last year. The Company's provision for income taxes of $182,767 for the three month period ended September 30, 2006 is based on an estimated combined tax rate of approximately 39% for both Federal and State taxes based on Company earnings projections. If this estimate is found to be high or low, adjustments will be made in the period of the determination. This will most likely be at year end when tax estimates can be more accurately made. Liquidity and Capital Resources The Company's net cash provided by operating activities was $82,468 for the three months ended September 30, 2006 compared to $915,434 for the three months ended September 30, 2005. During fiscal 2005, the amount provided was due to an increase in Accounts Payable of $1,282,177 partially offset by a decrease in Accrued expenses of $641,447 and an increase in allowance for doubtful account of $753,851 partially offset by an increse in accounts receivable of $589,090. Cash flow provided by operations in the three months ended September 30, 2006 consists of net income of $283,283 plus depreciation and amortization of $170,591, non-cash interest expense $16,489, non-cash equity based charges of $70,781, a decrease in deferred tax asset of $149,232 and an increase in net accounts payable of $312,904 less cash used for net changes in accounts receivable and other operating assets of $362,303, decreases in accrued expenses of $314,430 and an increase in prepaid expenses of $457,819. Cash used in investing activities in the three months ended September 30, 2006 consisted of $152,959 in capital expenditures compared to $369,848 in capital expenditures during the same period last year. The Company has a lease line that is currently being used to purchase the hardware and software for the Meditech system. These assets are being put into place but will not be depreciated until fully operational which is expected to be April 2007. Cash provided by financing activities of $24,796 in the three months ended September 30, 2006 was the result of the issuance of common stock for the exercise of options, an increase in the borrowing on the revolving credit facility offset by the repayment of long term debt for a total net reduction in debt of $39,569. A significant factor in the liquidity and cash flow of the Company is the timely collection of its accounts receivable. As of September 30, 2006, accounts receivable from patient care, net of allowance for doubtful accounts, increased 2% to $7,202,055 from $6,995,475 on June 30, 2005. This minimal increase is a result of increased revenue. The Company monitors increases in accounts receivable closely and, based on the aging of the receivables outstanding, is confident that the increase is not indicative of a payor problem. Over the years, we have increased staff, standardization of 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. Our collectors will also seek assistance through every legal means, including the State Insurance Commissioner's office, when appropriate, to collect claims. The Company has begun the process of changing its software related to the recording, billing and collecting of Accounts Receivable. This system will assist staff in the timely billing and collection of receivables. At the same time, the Company continues to closely monitor reserves for bad debt based on potential insurance denials and past difficulty in collections. Contractual Obligations 16 The Company's future minimum payments under contractual obligations related to capital leases, operating leases and term notes as of September 30, 2006 are as follows (in thousands): YEAR ENDING OPERATING September 30, TERM NOTES CAPITAL LEASES * LEASES TOTAL Principal Interest Principal Interest 2007 $ 872 $ 31 $ 181 $ 73 $1,507 $2,684 2008 392 24 195 41 1,524 2,156 2009 135 19 168 28 1,493 1,843 2010 223 15 111 12 1,019 1,380 2011 47 11 97 23 369 547 2012 52 5 -- -- 73 130 Thereafter 44 2 -- -- -- 46 ______ _____ _____ _____ ______ ______ Total $1,765 $ 108 $ 752 $ 177 $5,985 $8,786 * This amount includes scheduled payments on the Master lease for the hardware and software which has not yet been recorded as debt. In addition to the above, the Company is also subject to three contingent notes with a total face value of $2,500,000 as part of the Pivotal acquisition. Of these notes, two totaling $1,500,000, one for $1,000,000 and one for $500,000, bear interest at 6% per annum. These notes are subject to additional adjustment based on the earnings of the acquired operations. Since adjustment can be positive or negative based on earnings, with no ceiling or floor, the liability for only one of these notes was recorded as of June 30, 2006. This treatment is in accordance with SFAS No. 141, "Business Combinations", which states that contingent consideration should be recognized only when determinable beyond a reasonable doubt. Payments on the $1,000,000 note began on January 1, 2005. The above table includes the outstanding balance on this note of $669,908 which represents the earn out for the Pivotal acquisition through December 31, 2005 net of payments made through September 30, 2006. No payment is due on the $500,000 note as earn-out requirements have not been attained. The final note for $1,000,000 does not bear interest, is also subject to adjustment based on earnings but has a minimum value of $200,000 to be paid in PHC, Inc. Class A common stock on March 31, 2009. This minimum liability has been recorded with imputed interest of 6% and $172,205 is included in the schedule above. 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, with a balance of $564,272 at September 30, 2006, 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. The term loan note carries interest at prime plus 3.5%, but not less than 9%, with twelve monthly principal payments of $25,000, twelve 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 and is included in the above table. 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 balance on the revolving credit agreement as of September 30, 2006 was $1,777,931. For additional information regarding this transaction, see the Company's current report on form 8-K filed with the Securities and Exchange Commission on October 22, 2004. The balance outstanding as of September 30, 2006 is not included in the above table. During the fiscal year ended June 30, 2006, the Company amended the above agreement on two separate occasions, first to modify the required covenants to more closely reflect the fluctuations in the Company's normal business flow and second to extend the period of the agreement for an additional year through October 19, 2008. 17 For the quarter ended September 30, 2006, the Company was not in compliance with its long term debt covenants related Earnings Before Interest Taxes Depreciation and Amortization. These covenants are based on the Company's projections using an equally distributed average of the Company's annual projections, which we failed to meet for the quarter. The first quarter tends to be less profitable than the third and fourth quarters each year because of lower adolescent census during the summer months. CapitalSource, the Company's lender, has provided the Company with a waiver of this covenant for the period. The Company has operated ongoing operations profitably for twenty-three 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 project whether the current positive business environment towards behavioral health treatment and the new business opportunities will continue, it gives us confidence to foresee continued improved results. Off Balance Sheet Arrangements The Company has no off-balance-sheet arrangements, except the contingent notes disclosed in contractual obligations, that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to the Company. Item 3. Quantitative and Qualitative Disclosure About Market Risk The market price of our common stock could be volatile and fluctuate significantly in response to various factors, including: o Differences in actual and estimated earnings and cash flows; o Operating results differing from analysts' estimates; o Changes in analysts' earnings estimates; o Quarter-to-quarter variations in operating results; o Changes in market conditions in the behavioral health care industry; o Changes in market conditions in the research industry; o Changes in general economic conditions; and o Fluctuations in securities markets in general. Financial Risk o Our interest expense is sensitive to changes in the general level of interest rates. With respect to our interest-bearing liabilities, all of our long-term debt outstanding is subject to rates at prime plus 2.25% and prime plus 3.5%, which makes interest expense increase with changes in the prime rate. On this debt, each 25 basis point increase in the prime rate will affect an annual increase in interest expense of approximately $5,850. o Failure to meet targeted revenue projections could cause us to be out of compliance with covenants in our debt agreements requiring a waiver from our lender. A waiver of the covenants may require our lender to perform additional audit procedures to assure the stability of their security which could require additional fees. Operating Risk o Aging of accounts receivables could result in our inability to collect receivables. As our accounts receivable age and become uncollectible our cash flow is negatively impacted. Our accounts receivable from patient accounts (net of allowance for bad debts) were $7,202,055 at September 30, 2006, $6,995,475 at June 30, 2006 and $6,330,381 at June 30, 2005. As we expand, we will be required to seek payment from a larger number of payors and the amount of accounts receivable will likely increase. We have focused on better accounts receivable management through increased staff, standardization of some procedures for collecting receivables and a more aggressive collection policy in 18 order to keep the change in receivables consistent with the change in revenue. We have also established a more conservative reserve policy, allowing greater amounts of reserves as accounts age from the date of billing. If the amount of receivables, which eventually become uncollectible, exceeds such reserves, we could be materially adversely affected. The following chart represents our Accounts Receivable and Allowance for Doubtful Accounts at September 30, 2006 and June 30, 2006, respectively, and Bad Debt Expense for the quarter ended September 30, 2006 and the year ended June 30, 2006: Accounts Allowance for Bad Debt Receivable Doubtful Accounts Expense ___________ _________________ _________ September 30, 2006 $10,357,420 $ 3,155,365 $ 452,525 June 30, 2006 10,096,061 3,100,586 1,912,516 o The Company relies on contracts with more than ten clients to maintain patient census at its inpatient facilities and the loss of any of such contracts would impact our ability to meet our fixed costs. We have entered into relationships with large employers, health care institutions and labor unions to provide treatment for psychiatric disorders, chemical dependency and substance abuse in conjunction with employer-sponsored employee assistance programs. The employees of such institutions may be referred to us for treatment, the cost of which is reimbursed on a per diem or per capita basis. Approximately 30% of our total revenue is derived from these clients. No one of these large employers, health care institutions or labor unions individually accounts for 10% or more of our consolidated revenues, but the loss of any of these clients would require us to expend considerable effort to replace patient referrals and would result in revenue losses and attendant loss in income. Item 4. 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 evaluation. 19 PART II OTHER INFORMATION Item 6. Exhibits Exhibit List Exhibit No. Description 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. 20 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PHC, Inc. Registrant Date: November 14, 2006 /s/ Bruce A. Shear Bruce A. Shear President Chief Executive Officer Date: November 14, 2006 /s/ Paula C. Wurts Paula C. Wurts Treasurer Chief Financial Officer 21 EX-31 2 exh31_1.txt CERTIFICATE OF CHIEF EXCUTIVE OFFICER EXHIBIT 31.1 PHC, INC. CERTIFICATION OF CHIEF EXECUTIVE OFFICER Section 302 Certification I, Bruce A. Shear, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PHC, Inc., a Massachusetts corporation (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c. disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a. all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information: and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2006 by: /s/ BRUCE A. SHEAR Bruce A. Shear Chief Executive Officer 22 EX-31 3 exh31_2.txt CERTIFICATE OF CHIEF FINANCIAL OFFICER EXHIBIT 31.2 PHC, INC. CERTIFICATION OF CHIEF FINANCIAL OFFICER Section 302 Certification I, Paula C. Wurts, certify that: 1. I have reviewed this quarterly report on Form 10-Q of PHC, Inc., a Massachusetts corporation (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c. disclosed in this report any change in the registrant's internal controls over financial reporting that occurred during the most recent fiscal quarter that has materially affected or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors: a. all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: November 14, 2006 by: /s/ PAULA C. WURTS Paula C. Wurts Chief Financial Officer 23 EX-32 4 exh32_1.txt CERTIFICATE OF CEO AND CFO Exhibit 32.1 WRITTEN STATEMENT OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER The undersigned hereby certify that, to the best of the knowledge of the undersigned, the Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed by PHC, Inc. with the Securities and Exchange Commission fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. Date: November 14, 2006 By: /s/ Bruce A. Shear Bruce A. Shear, President and Chief Executive Officer Date: November 14, 2006 By: /s/ Paula C. Wurts Paula C. Wurts, Chief Financial Officer 24 -----END PRIVACY-ENHANCED MESSAGE-----