10-Q 1 q2_021407.txt 10Q SECOND QUARTER FISCAL YEAR 2007 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 December 31, 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 January 29, 2007: Class A Common Stock 19,047,327 Class B Common Stock 775,760 1 PHC, Inc. PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements. Condensed Consolidated Balance Sheets - December 31, 2006 (unaudited) and June 30, 2006. Condensed Consolidated Statements of Operations (unaudited) - Three and six months ended December 31, 2006 and December 31, 2005. Condensed Consolidated Statements of Cash Flows (unaudited) - Three months ended December 31, 2006 and December 31, 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 4. Submission of Matters to a Vote of Security Holders Item 6. Exhibits Signatures 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS December 31, June 30, ASSETS 2006 2006 (unaudited) Current assets: Cash and cash equivalents $ 4,150,210 $ 1,820,105 Accounts receivable, net of allowance for doubtful accounts of $3,389,836 at December 31, 2006 and $3,100,586 at June 30, 2006 6,736,235 6,955,475 Pharmaceutical receivables 1,466,484 1,470,019 Prepaid expenses 863,292 490,655 Other receivables and advances 853,165 751,791 Deferred income tax asset 2,918,779 3,110,000 ___________ __________ Total current assets 16,988,165 14,598,045 Accounts receivable, non-current 35,000 40,000 Other receivable 47,680 53,457 Property and equipment, net 2,018,990 1,799,888 Deferred financing costs, net of amortization of $124,899 at December 31, 2006 and $106,422 June 30, 2006 98,546 117,023 Customer relationships, net of amortization of $320,000 at December 31, 2006 and $260,000 at June 30, 2006 2,080,000 2,140,000 Goodwill 3,164,643 2,664,643 Other assets 828,190 571,931 ___________ ___________ Total assets $25,261,214 $21,984,987 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable (includes short term notes payable of $336,683 and $5,000) $ 1,903,578 $ 1,518,615 Current maturities of long-term debt 1,120,998 909,057 Revolving credit note 1,105,949 1,603,368 Deferred revenue 388,967 385,742 Current portion of obligations under capital leases 203,401 57,881 Accrued payroll, payroll taxes and benefits 1,510,571 1,619,672 Accrued expenses and other liabilities 1,248,154 1,026,419 ___________ __________ Total current liabilities 7,481,618 7,120,754 Long-term debt 1,006,783 1,021,546 Obligations under capital leases 74,619 61,912 Deferred tax liability 325,000 325,000 ___________ ___________ Total liabilities 8,888,020 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, 19,175,592 and 17,874,966 shares issued at December 31, 2006 and June 30, 2006, respectively 191,756 178,749 Class B common stock, $.01 par value, 2,000,000 shares authorized, 775,760 issued and outstanding at December 31, 2006 and June 30, 2006, respectively, each convertible into one share of Class A common sTOCK 7,758 7,758 Additional paid-in capital 26,078,238 23,718,197 Treasury stock, 199,098 shares of Class A common stock at December 31, 2006 and June 30, 2006, at cost (191,700) (191,700) Accumulated deficit (9,712,858) (10,257,229) ___________ ___________ Total stockholders' equity 16,373,194 13,455,775 Total liabilities and stockholders' equity $25,261,214 $21,984,987 =========== =========== See Notes to Condensed Consolidated Financial Statements 3 PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Six Months Ended December 31, December 31, _______________________ _____________________ 2006 2005 2006 2005 __________ __________ __________ __________ Revenues: Patient care, net $ 7,946,670 $ 6,465,356 $15,823,102 $13,178,336 Pharmaceutical studies 873,920 1,084,084 1,925,303 2,390,093 Contract support services 1,131,770 1,153,073 2,266,161 2,078,910 ___________ ___________ ___________ __________ Total revenues 9,952,360 8,702,513 20,014,566 17,647,339 Operating expenses: Patient care expenses 4,243,531 3,292,393 8,199,183 6,554,304 Patient care expenses, pharmaceutical 421,549 510,834 908,486 1,073,988 Cost of contract support services 687,174 587,067 1,525,729 1,184,862 Provision for doubtful accounts 347,458 475,768 799,983 1,132,655 Administrative expenses 3,118,099 2,749,100 6,213,554 5,378,776 Administrative expenses, pharmaceutical 529,555 538,291 1,208,663 1,172,290 ___________ ___________ ___________ ___________ Total operating expenses 9,347,366 8,153,453 8,855,598 16,496,875 ___________ ___________ ___________ ___________ Income from operations 604,994 549,060 1,158,968 1,150,464 ___________ ___________ ___________ __________ Other income (expense): Interest income 33,808 15,397 66,657 38,261 Other income (expense) (3,135) 21,263 (4,078) 32,048 Interest expense (212,441) (174,338) (332,271) (329,556) ___________ ___________ __________ __________ Total other expenses, net (181,768) (137,678) (269,692) (259,247) ___________ ___________ __________ _________ Income before provision for taxes 423,226 411,382 889,276 891,217 Provision for income taxes 162,138 64,600 344,905 160,228 ___________ ___________ __________ _________ Net income $ 261,088 $ 346,782 $ 544,371 $ 730,989 =========== =========== =========== =========== Basic net income per common share $ 0.01 $ 0.02 $ 0.03 $ 0.04 =========== =========== =========== =========== Basic weighted average number of shares outstanding 18,758,151 18,159,188 18,636,146 18,125,265 =========== =========== ========== ========== Fully diluted net income per common share $ 0.01 $ 0.02 $ 0.03 $ 0.04 =========== =========== =========== =========== Fully diluted weighted average number of shares outstanding 19,409,232 19,301,486 19,280,727 19,302,592 =========== =========== =========== ==========
See Notes to Condensed Consolidated Financial Statements. 4 PHC, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Six Months Ended December 31, 2006 2005 __________ ________ Cash flows from operating activities: Net income $ 544,371 $730,989 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 34,924 331,319 Non-cash interest expense 113,018 27,864 Deferred income taxes 191,221 (23,670) Non-cash stock-based compensation 91,684 90,872 Change in allowance for doubtful accounts 289,250 1,216,020 Changes in: Accounts receivable (157,072) (1,515,378) Prepaid expenses and other current assets (35,954) (67,975) Other assets (272,301) (28,685) Accounts payable 48,280 668,460 Accrued expenses and other liabilities 115,859 (556,073) __________ ___________ Net cash provided by operating activities 1,263,280 873,743 __________ ___________ Cash flows from investing activities: Acquisition of property and equipment (217,580) (627,776) __________ ___________ Net cash used in investing activities (217,580) (627,776) __________ ___________ Cash flows from financing activities: Revolving debt, net (497,419) 137,406 Principal payments on long-term debt (499,540) (288,880) Proceeds from issuance of common stock, net 2,281,364 53,100 Purchase of treasury stock -- (36,613) __________ ___________ Net cash provided by financing activities 1,284,405 (134,987) __________ ___________ Net increase in cash and cash equivalents 2,330,105 110,980 Beginning cash and cash equivalents 1,820,105 917,630 __________ ___________ Ending cash and cash equivalents $4,150,210 $1,028,610 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 268,612 $ 329,556 Income taxes 118,561 235,171 SUPPLEMENTAL DISCLOSURE OF NONCASH OPERATING INVESTING AND FINANCING ACTIVITIES: Issuance of common stock in cashless exercise of warrants $ 30 $ 24,242 Obligations under capital leases 241,927 -- Pivotal acquisition Note B recorded 500,000 Issuance of common stock in cashless exercise of options -- 18,577 Value of warrants issued in connection with the Pivotal acquisition -- 51,860 Short Term Note payable 500,873 508,039 See Notes to Condensed Consolidated Financial Statements. 5 PHC, INC. and Subsidiaries Notes to Condensed Consolidated Financial Statements December 31, 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 three clinic study sites: two in Arizona, in Peoria and Mesa and one in Midvale, Utah. The Company closed its research site in Royal Oak, Michigan at the end of last quarter. 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 and six months ended December 31, 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 inpatient 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 76 days for the six months ended December 31, 2006 and 65 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 __________ _________ ______________ ________ 12/31/2006 78 140 60 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 may 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 December 31, 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 is 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 December 31, 2006, $20,903, is the Black-Scholes value of the vested number of options issued during the period. The expense recorded in the six months ended December 31, 2006 also includes $70,781 for the vesting of options previously issued based on the terms of the agreements. Under the provisions of SFAS 123R, the Company recorded $20,903 and $5,500 of stock-based compensation on its consolidated condensed statement of operations for the three months ended December 31, 2006 and 2005, respectively, and $91,684 and $75,338 for the six months ended December 31, 2006 and 2005, respectively. The Company had the following activity in its stock option plans for the six months ended December 31, 2006: Number Weighted-Average Intrinsic Value Of Exercise Price At Shares Per Share December 31, 2006 _______________________________________________ Balance - June 30, 2006 1,234,250 $1.45 Granted 56,250 $2.07 Exercised (104,500) $0.75 Expired (12,000) $2.30 __________ Balance - December 31, 2006 1,174,000 $1.53 $1,935,045 __________ _____ __________ Exercisable 899,000 $1.29 $1,700,689 __________ _____ __________ The total intrinsic value of options exercised during the six-months ended December 31, 2006 was $169,545. The following summarizes the activity of the Company's stock options that have not vested for the six months ended December 31, 2006. Number Weighted- Of Average Shares Fair Value ______ ___________ Nonvested at July 1, 2006 300,938 $1.17 Granted 56,250 1.10 Expired/Forfeited (2,500) 1.24 Vested (79,688) 1.15 ________ ______ Nonvested at December 31, 2006 275,000 $1.16 ________ ______ 8 The compensation cost related to the fair value of these shares of $276,320 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. The weighted-average fair values of the options granted under the stock option plans for the three months ended December 31, 2006 was $1.10 and the weighted-average fair value of the options granted for the six months ended December 31, 2006 and 2005 was $1.10 and $1.12, using the following assumptions: Three Months Three Months Six Months Six Months Ended Ended Ended Ended December December December December 31, 2006 31, 2005 31, 2006 31, 2005 ____________ ____________ __________ _________ Average risk-free interest RATE 4.60% 4.50% 4.60% 4.50% Expected dividend yield None None None None Expected life 5 years 4 years 5 years 4 years Expected volatility 48.0% 45.0% 48.0% 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 December 31, 2005 amounts have been reclassified to be consistent with the December 31, 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: December 31, 2006 Revenues - external customers $7,946,670 $ 873,920 $1,131,770 $ -- $ -- $9,952,360 Revenues - intersegment -- -- 19,470 924,000 (943,470) -- Net income (loss) 968,831 (168,603) 375,829 (914,969) -- 261,088 Capital Expenditures 49,393 4,040 -- 11,188 -- 64,621 Depreciation & Amortization 88,563 40,010 13,278 12,574 -- 154,425 Interest Expense 105,566 91,419 1,115 14,341 -- 212,441 Income tax expense 94,859 -- 68,462 (1,183) -- 162,138 9 Note E - Business Segment Information (continued December 31, 2005 Treatment Pharmaceutical Contract Administrative Services Study Services Services Services Eliminations Total ___________________________________________________________________________________ Revenues - external customers $ 6,465,356 $1,084,084 $1,153,073 $ -- $ -- $ 8,702,513 Revenues - intersegment 23,900 -- 21,265 816,000 (861,165) -- Net income (loss) 544,426 (2,356) 557,577 (752,865) -- 346,782 Capital Expenditures 124,355 10,797 78,974 43,803 -- 257,929 Depreciation & Amortization 123,698 40,947 16,943 12,842 -- 194,430 Interest Expense 136,371 33,475 2,429 2,063 -- 174,338 Income tax expense 51,160 3,840 6,000 3,600 -- 64,600 For the six months ended: December 31, 2006 Revenues - external customers $15,823,102 $1,925,303 $2,266,161 $ -- $ -- $20,014,566 Revenues - intersegment 4,500 -- 41,110 1,848,000 (1,893,610) -- Net income (loss) 2,042,469 (295,370) 631,394 (1,834,122) -- 544,371 Capital Expenditures 154,861 25,308 1,565 35,846 -- 217,580 Depreciation & Amortization 177,327 77,377 37,858 23,883 -- 316,445 Interest Expense 192,963 108,024 2,393 28,891 -- 332,271 Income tax expense 233,357 -- 2,743 -- -- 344,905 Identifiable assets 10,538,634 6,078,733 1,019,944 7,623,903 -- 25,261,214 Goodwill and customer relationships 969,099 4,275,544 -- -- -- 5,244,643 December 31, 2005 Revenues - external customers $13,178,336 $2,390,093 $2,078,910 $ -- $ -- $17,647,339 Revenues - intersegment 35,650 -- 44,280 1,632,000 (1,711,930) -- Net income (loss) 1,252,376 90,472 871,062 (1,482,921) -- 730,989 Capital Expenditures 457,703 26,291 85,144 58,638 -- 627,776 Depreciation & Amortization 191,791 80,810 19,247 20,148 -- 311,996 Interest Expense 255,850 49,503 2,429 21,774 -- 329,556 Income tax expense 132,231 3,840 20,557 3,600 -- 160,228 At June 30, 2006: Identifiable assets 10,399,918 5,584,753 844,784 5,155,532 -- 21,984,987 Goodwill and customer relationships 969,099 1,695,544 -- -- -- 2,664,643
Note F - Debt covenants For the period and quarter ended December 31, 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 10 projections, which we failed to meet for the quarter ended December 31, 2006. The first and second quarters of each year tend to be less profitable than the third and fourth quarters each year because of lower adolescent census during the summer months and lower Chemical Dependency census during November and December. CapitalSource, the Company's lender, has provided the Company with a waiver of this covenant for the period and has agreed to modify these covenants, restructure the debt and lower interest rates. The Company expects to execute a new agreement by the end of the current quarter. Note G - Private Placement On December 19, 2006, the Company entered into an agreement pursuant to which the Company sold $2,000,000 in unregistered Class A Common Stock to a single investor to provide the equity component for the build-out of the Company's Las Vegas hospital project, Seven Hills. The agreement allowed the investor, Camden Partners Limited Partnership, to purchase $2,000,000 in PHC, Inc. Class A Common Stock at $2.08 per share, which is the average selling price per share over the 20 trading days prior to the sale, minus 4%. In addition to providing a certificate evidencing the 961,539 unregistered shares within three business days from the close of the transaction, the Company is also obligated to file a Registration Statement with the Securities and Exchange Commission within 90 days of the close of the transaction to register the shares issued, to put forth it's best efforts to cause the Registration Statement to brought effective within 120 days of the close of the transaction and to maintain the Registration Statement's current status for a period of two years from the date of the close of the transaction. If the Company fails to meet such 120 day deadline, it would be required to pay to the investor, in cash or shares (at the Company's option), 1% of the aggregate purchase price for each monthly period or pro rata portion thereof in which the Company is not in compliance with its registration obligations. The total amount of consideration that the Company could be required to transfer under this registration payment arrangement would be $480,000. If the Company was to exercise its option to settle the above liability using its Common Stock, the Company potentially could have to issue 230,769 shares based upon the per share purchase price of $2.08. At December 31, 2006, the Company has not recorded a liability in its accompanying financial statements based on its assessment of the likelihood of default under any of these provisions. (For additional information see the Company's current report filed with the Securities and Exchange Commission on Form 8-K dated December 20, 2006). Note H - Recent Accounting Pronouncements In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes", an interpretation of FASB Statement No. 109, (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of FIN 48 to have a material impact on our financial reporting, and we are currently evaluating the impact, if any, the adoption of FIN 48 will have on our disclosure requirements, 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. Note I - Subsequent Events 11 Subsequent to December 31, 2006, through it's subsidiary Harmony Healthcare, the Company finalized an agreement with Behavioral Healthcare Options (BHO), a subsidiary of Sierra Health Services, Inc., to operate four clinics in the BHO network in Las Vegas and northwest Arizona. Harmony Healthcare will provide a full array of services including inpatient hospitalization, utilization and case management, outpatient services including individual and group therapy, medication management, psychological testing, as well as crisis and triage care for all Sierra members accessing BHO services. Harmony will operate four clinics, two in greater Las Vegas and two in northwest Arizona, formerly operated by BHO. Also, subsequent to December 31, 2006, the Company, through it's Seven Hills Hospital, Inc. subsidiary, entered into an agreement to purchase a 15.24% membership interest, for $400,000, in the Seven Hills Psych Center, LLC. Seven Hills Psych Center, LLC is the corporation that owns the property and will own the building that will house our Seven Hills Hospital operations in Las Vegas. The Company anticipates the opening of this hospital by the end of the calendar year. 12 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 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 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 13 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. Subsequent to quarter end, the Company entered into an additional "at-risk" contract with Behavioral Healthcare Options (BHO), a subsidiary of Sierra Health Services, Inc., to operate four clinics in the BHO network in Las Vegas and northwest Arizona formerly operated by BHO. Harmony Healthcare will provide a full array of services including inpatient hospitalization, utilization and case management, outpatient services including individual and group therapy, medication management, psychological testing, as well as crisis and triage care for all Sierra members accessing BHO services. This contract mirrors the above referenced contract with a greater number of members resulting in an expected higher utilization of services. 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 six months ended December 31, 2006 for revenue booked in prior years resulted in an increase in net revenue of approximately $12,122. 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. During the quarter ended December 31, 2006 a cost report settlement of $53,446 from Medicare and $98,400 from Blue Cross were received and recorded during the three months ended December 31, 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 December 31, 2006, 2005 and June 30, 2006, for our treatment services segment. Net Revenue by Payor (in thousands)_ For the Three Months For the Six Months For the Twelve Ended December 31, Ended December 31, Months Ended 2006 2005 2006 2005 June 30, 2006 ________________________________________________________________________________ $ % $ % $ % $ % Amount Percentage Private Pay $ 343 4 $ 287 4 $ 682 4 $ 598 5 $ 1,207 5 Commercial 4,933 62 4,128 64 9,815 62 8,599 65 17,572 63 Medicare * 322 4 264 4 681 4 556 4 946 3 Medicaid 2,349 30 1,786 28 4,645 30 3,425 26 8,137 29 _______ ______ _______ ______ ________ Net Revenue $ 7,947 $6,465 $15,823 $13,178 $ 27,862 ======= ======= ======= ======= ======== * includes Medicare settlement revenue as noted above
14 Accounts Receivable Aging (Net of allowance for bad debts- in thousands) As of December 31, 2006 Over Over Over Over Over Over Over Payor Current 30 60 90 120 180 270 360 Total ______ _____ _____ ___ ___ ______ ____ ____ ______ Private Pay 247 242 205 135 92 693 66 25 $1,705 Commercial 1,302 627 281 246 189 565 95 159 3,464 Medicare 122 15 34 25 5 54 -- -- 255 Medicaid 902 126 90 22 41 166 -- -- 1,347 ______ _____ _____ ___ ___ ______ ____ ____ ______ Total 2,573 1,010 610 428 327 1,478 161 184 $6,771 Fiscal Year Ended June 30, 2006 Over Over Over Over Over Over Over Payor Current 30 60 90 120 180 270 360 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: 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 15 will be realized in future periods. During the fourth quarter of fiscal year ended June 30, 2006, the Company recognized 100% of its federal 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. During the quarter ended December 31, 2006 the Company recorded an additional $500,000 in goodwill as a result of the Pivotal acquisition earn-out. Results of Operations The following table illustrates our consolidated results of operations for the three and six months ended December 31, 2006 and 2005 (in thousands): For the Three Months Ended For the Six Months ended December 31, December 31, 2006 2005 2006 2005 ______________________________________________________________________________ (in thousands) Statements of Operations Data: Amount % Amount % Amount % Amount % Revenue $9,952 100.0 $8,703 100.0 $20,015 100.0 $17,647 100.0 ______ ______ ______ ______ _______ ______ _______ _____ Cost and Expenses: Patient care expenses 4,665 46.87 3,803 43.70 9,108 45.51 7,628 43.23 Contract expenses 687 6.90 587 6.75 1,526 7.62 1,185 6.71 Administrative expenses 3,649 36.66 3,288 37.77 7,422 37.08 6,550 37.12 Provision for bad debts 347 3.49 476 5.47 800 4.00 1,133 6.42 Interest expense 212 2.14 174 2.00 332 1.66 330 1.87 Other (income)expenses, net (31) -0.31 (37) -0.42 (63) -0.31 (70) -0.40 ______ ______ ______ ______ _______ ______ _______ _____ Total expenses 9,529 95.75 8,291 95.27 19,125 95.56 16,756 94.95 ______ ______ ______ ______ _______ ______ _______ _____ Income before income taxes 423 4.25 412 4.73 889 4.44 891 5.05 Provision for income taxes 162 1.63 65 0.74 345 1.72 160 0.91 ______ ______ ______ ______ _______ ______ _______ _____ Net income 261 2.62 47 3.98 $ 544 2.72 $ 731 4.14 ______ ______ ______ ______ _______ ______ _______ _____
Results of Operations Total net revenue from operations increased 14.4% to $9,952,360 for the three months ended December 31, 2006 from $8,702,513 for the three months ended December 31, 2005 and 13.4% to 20,014,566 for the six months ended December 31, 2006 from $17,647,339 for the six months ended December 31, 2005. Net patient care revenue increased 22.9% to $7,946,670 for the three months ended December 31, 2006 from $6,465,356 for the three months ended December 31, 2005 and 20.1% to $15,823,102 for the six months ended December 31, 2006 from 16 $13,178,336 for the six months ended December 31, 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 a 12.2% and 16.8% increase in patient days for the three months and six months ended December 31, 2006, respectively, over the same periods last year. Excluding Detroit Behavioral Institute, combined census in our other inpatient facilities increased 1.1% and 2.1% for the same periods. 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 19.4% to $873,920 for the three months ended December 31, 2006 form $1,084,084 for the three months ended December 31, 2005 and 19.5% to $1,925,303 for the six months ended December 31, 2006 from $2,390,093 for the six months ended December 31, 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 type of study, the number of active studies and available qualified participants for each active study. Contract support services revenue provided by Wellplace decreased 1.9% to $1,131,770 for the quarter ended December 31, 2006 from $1,153,073 for the three months ended December 31, 2005 and increased 9.0% to $2,266,161 for the six months ended December 31, 2006 from $2,078,910 for the six months ended December 31, 2005. This increase in revenues is due to the start of the smoking cessation contract with a government contractor in October 2005. Patient care expenses in our treatment centers increased 28.9% to $4,243,531 for the three months ended December 31, 2006 from $3,292,393 for the three months ended December 31, 2005 and 25.1% to $8,199,183 for the six months ended December 31, 2006 from 6,554,304 for the six months ended December 31, 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, nursing and medical agency fees, hospital supplies, food lab 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 17.5% to $421,549 for the three months ended December 31, 2006 from $510,834 for the three months ended December 31, 2005 and 15.4% to 908,486 for the six months ended December 31, 2005 from 1,073,988 for the six months ended December 31, 2005. This is due to the decrease in the number of study patients receiving stipends for participation in studies and a decrease in the professional fees related to study services. Contract support services expenses increased 17.1% to $687,174 for the three months ended December 31, 2006 from $587,067 for the three months ended December 31, 2005 and 28.8% to $1,525,729 for the six months ended December 31, 2006 from $1,184,862 for the six months ended December 31, 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 and amortization of software designed specifically for our smoking cessation program. Administrative expenses increased 13.4% to $3,118,099 for the three months ended December 31, 2006 from $2,749,100 for the three months ended December 31, 2005 and 15.5% to $6,213,554 for the six months ended December 31, 2006 from $5,378,776 for the six months ended December 31, 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 11.7% and employee benefits increased 21.5%, for the three months ended December 31, 2006, partially due to the increase in expense attributable to stock based compensation and the increase in staffing in preparation for the new contract implemented at Harmony on January 1, 2007. Office expense increased 37% during the quarter related to housing the Meditech hardware in a hosted environment. Rent expense increased approximately 111% due to the increase in space at Detroit Behavioral Institute for the girls unit and insurance expense increased 121% for the six months ended December 31, 2006. Administrative expenses related to the research division decreased 1.6% to $529,555 for the three months ended December 31, 2006 from $538,291 for the three months ended December 31, 2006 and increased 3.1% to $1,208,663 for the six months ended December 31, 2006 from $1,172,290 for the six months ended December 31, 2005. These minimal changes in Administrative expenses are due to tight expense controls maintained while the study census is low with the majority of the increase in Advertising and Marketing expenses. 17 Provision for doubtful accounts decreased 27.0% to $347,458 for the three months ended December 31, 2006 from 475,768 for the three months ended December 31, 2005 and 29.4% to 799,983 for the six months ended December 31, 2006 from $1,132,655 for the six months ended December 31, 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 of approximately 5% to 6% of net patient care revenue as opposed to the 10% or higher 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. Interest income increased 119.6% to $33,808 for the three months ended December 31, 2006 form $15,397 for the three months ended December 31, 2005 and 74.22% to $66,657 for the six months ended December 31, 2006 from $38,261 for the six months ended December 31, 2005. This increase is a result of increased cash in our investment accounts resulting in higher interest earnings. Other income / expense decreased 114.7% to $(3,135) for the three months ended December 31, 2006 from $21,263 for the three months ended December 31, 2005 and 112.7% to ($4,078) for the six months ended December 31, 2006 from $32,048 for the six months ended December 31, 2005. This change is due to processing of the amount lost from the theft at our smallest inpatient facility. The amount of the loss was partially offset by an insurance settlement of $10,000. Interest expense increased 21.9% to $212,441 for the three months ended December 31, 2006 from $174,338 for the three months ended December 31, 2005 and increased 0.8% to $332,271 for the six months ended December 31, 2006 from $329,556 for the six months ended December 31, 2005. This increase is due to the recording of $80,000 of interest on an earn-out note issued at the time of the Pivotal acquisition. As required by GAAP, this Note B and none of the interest due on the Note B was booked since the entire principle balance of the Note was contingent on future earnings. The Company's provision for income taxes of $162,138 for the three month period ended December 31, 2006 and $344,905 for the six months ended December 31, 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 $1,263,280 for the six months ended December 31, 2006 compared to $873,743 for the six months ended December 31, 2005. Cash flow provided by operations in the six months ended December 31, 2006 consists of net income of $544,371 plus depreciation and amortization of $334,924, non-cash interest expense $113,018, non-cash equity based charges of $91,684, a decrease in deferred taxes of $191,221 and an increase in net accounts payable of $384,963, an increase in accrued expenses of $115,859 and a decrease in net accounts receivable of $157,072, less cash used in other operating assets of $272,301 and an increase in prepaid expenses of $372,637. Cash used in investing activities in the six months ended December 31, 2006 consisted of $217,580 in capital expenditures compared to $627,776 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. Leased equipment is listed as supplemental information on the cash flow statement. Cash provided by financing activities of $1,284,405 in the six months ended December 31, 2006 was the result of $2,281,364 in net proceeds from the issuance of common stock in a private placement and for the exercise of warrants and options, offset by a reduction in the revolving credit debt of $497,419 and repayments on long term debt of $499,540. A significant factor in the liquidity and cash flow of the Company is the timely collection of its accounts receivable. As of December 31, 2006, accounts receivable from patient care, net of allowance for doubtful accounts, decreased 3.2% to $6,771,235 from $6,995,475 on June 30, 2006. This decrease is a result of increased collection efforts. The Company monitors accounts receivable closely. Over the years, we have increased staff, standardization of some 18 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 The Company's future minimum payments under contractual obligations related to capital leases, operating leases and term notes as of December 31, 2006 are as follows (in thousands): YEAR ENDING CAPITAL OPERATING December 31. TERM NOTES LEASES * LEASES TOTAL _____________ ___________________ _____________________ ________ ______ Principal Interest Principal Interest 2007 $1,121 $27 $203 $ 49 $1,523 $2,923 2008 599 23 184 33 1,531 2,370 2009 228 18 147 19 1,477 1,889 2010 48 14 113 10 871 1,056 2011 48 10 51 2 356 467 2012 53 5 -- -- -- 58 Thereafter 30 1 -- -- -- 31 ______ ___ ____ ____ ______ ______ Total $2,127 $98 $698 $113 $5,758 $8,794 * 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. The liability for the second Note was recorded as of December 31, 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 $588,145 which represents the earn out for the Pivotal acquisition through December 31, 2005 net of payments made through December 31, 2006. On December 31, 2006 the earn-out requirements on the $500,000 Note were attained, therefore the $500,000 balance plus accrued interest of $80,000 was recorded and is included in Term notes in the above table. Note repayment began on the $500,000 Note on January 1, 2007. 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 $174,802 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 $440,704 at December 31, 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. 19 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 December 31, 2006 was $1,105,949. 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 December 31, 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. For the quarter ended December 31, 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 and second quarters tend to be less profitable than the third and fourth quarters each year because of lower adolescent census during the summer months and lower chemical dependency census during November and December. CapitalSource, the Company's lender, has provided the Company with a waiver of the covenants for the period. The Company has operated ongoing operations profitably for twenty-four 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 $2,340. 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. 20 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 $6,771,235 at December 31, 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 order to keep the change in receivables consistent with the change in revenue. We have also established a 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 December 31, 2006 and June 30, 2006, respectively, and Bad Debt Expense for the six months ended December 31, 2006 and the year ended June 30, 2006: Allowance for Accounts Doubtful Receivable Accounts Bad Debt Expense ___________ _______________ ________________ December 31, 2006 $10,161,071 $3,389,836 $ 799,983 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. 21 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 20, 2006. In addition to the election of directors (with regards to which (i) proxies were solicited pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as amended, (ii) there was no solicitation in opposition to the management's nominees as listed on the proxy statement, and (iii) all of such nominees were elected), the shareholders voted to ratify the selection of Eisner, LLP, Registered Public Accounting firm, to audit the Company's books and records for the fiscal year ending June 30, 2007. No other matters were brought before the shareholders. 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. 22 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: February 14, 2007 /s/ Bruce A. Shear _______________________________ Bruce A. Shear President Chief Executive Officer Date: February 14, 2007 /s/ Paula C. Wurts _______________________________ Paula C. Wurts Treasurer Chief Financial Officer -- 23 --