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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K (Mark One) [X]
    
    Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934for the fiscal year ended December 31, 2003 or[   ]
    
    Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934for the transition period from
 to
 Commission file number 0-20488 PSYCHIATRIC SOLUTIONS, INC.  DELAWARE
    
    23-2491707(State or Other Jurisdiction of Incorporation or
    
    (I.R.S. Employer Identification No.)Organization)
 113 Seaboard Lane, Suite C-100
Franklin, TN 37067
(Address of Principal Executive Offices, Including Zip Code) (615) 312-5700
(Registrants Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Title Of Each Class
    
    Name of Each Exchange On Which RegisteredCommon Stock, $.01 par value
    
    NASDAQ National Market
 Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [   ] No [X] As of March 17, 2004, 11,994,722 shares of the registrants common stock
were outstanding. As of June 30, 2003, the aggregate market value of the
shares of common stock of the registrant held by non-affiliates of the
registrant was approximately $44 million. For purposes of calculating such
aggregate market value, shares owned by directors, executive officers and 5%
beneficial owners of the registrant have been excluded.




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DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants definitive proxy statement for its 2004
annual meeting of stockholders to be held on May 4, 2004 are incorporated by
reference into Part III of this Form 10-K.




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INDEX  
 PAGEPART IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    17Item 3.
    
    Legal Proceedings
    
    
    18Item 4.
    
    Submission of Matters To a Vote of Security Holders
    
    
    18PART IIItem 5.
    
    Market For Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    18Item 6.
    
    Selected Financial Data
    
    
    19Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    38Item 8.
    
    Financial Statements and Supplementary Data
    
    
    38Item 9.
    
    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    38Item 9A.
    
    Controls and Procedures
    
    
    38PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    39Item 11.
    
    Executive Compensation
    
    
    40Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    40Item 13.
    
    Certain Relationships and Related Transactions
    
    
    40Item 14.
    
    Principal Accountant Fees and Services
    
    
    40Item 15.
    
    Exhibits, Financial Statement Schedules, and Reports of Form 8-K
    
    
    41Index to Financial Statements
    
    
    F-1Signatures
    
    
    II-1EX-10.13 INDEMNIFICATION AGREEMENT 03/25/03EX-10.21 LONG TERM EQUITY COMPENSATION PLANEX-12.1 COMPUTATION OF RATIO OF EARNINGSEX-21.1 LIST OF SUBSIDIARIESEX-23.1 CONSENT OF ERNST & YOUNG LLPEX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CAOEX-32.1 SECTION 906 CERTIFICATION OF THE CEO & CAO




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PART I All references in this Annual Report onForm 10-Kto Psychiatric
Solutions, the Company, we, us or our mean, unless the context
otherwise requires, Psychiatric Solutions, Inc. and its consolidated
subsidiaries. 
 Item 1. Business Overview We are a leading provider of inpatient behavioral health care services in
the United States. Through our inpatient division, we operate 26 owned or
leased inpatient behavioral health care facilities with approximately 3,200
beds in 15 states. In addition, through our inpatient management contract
division, we manage 43 inpatient behavioral health care units for third parties
and 11 inpatient behavioral health care facilities for government agencies. We
believe that our singular focus on the provision of inpatient behavioral health
care services allows us to operate more efficiently and provide higher quality
care than our competitors. We primarily operate in underserved markets with
limited competition and favorable demographic trends. We generated revenue of
$293.7 million and $113.9 million for the years ended December 31, 2003 and
2002, respectively. Our inpatient behavioral health care facilities accounted for
approximately 76.1% of our revenue for the year ended December 31, 2003. These
facilities offer a wide range of inpatient behavioral health care services. We
offer these services through a combination of inpatient behavioral facilities
and residential treatment centers. Our inpatient behavioral facilities provide
the most intensive level of care, including 24-hour skilled nursing observation
and care, daily interventions and oversight by a psychiatrist and intensive,
highly coordinated treatment by a physician-led team of mental health
professionals. Our residential treatment centers, or RTCs, offer longer term
treatment programs primarily for children and adolescents with long-standing
acute behavioral health problems. Our RTCs provide physician-led,
multi-disciplinary treatments that address the overall medical, psychiatric,
social and academic needs of the patient. Our inpatient management contract division accounted for approximately
23.9% of our revenue for the year ended December 31, 2003. This portion of our
business involves the development, organization and management of behavioral
health care programs within medical surgical hospitals and the management of
inpatient behavioral health care facilities for government agencies. We provide
our customers with a variety of management options, including (1) clinical and
management infrastructure, (2) personnel recruitment, staff orientation and
supervision, (3) corporate consultation and (4) performance improvement plans.
Our broad range of services can be customized into individual programs that
meet specific facility and community requirements. We are dedicated to
providing quality programs with integrity, innovation and flexibility. The Company was incorporated in the State of Delaware in 1988. Our
principal executive offices are located at 113 Seaboard Lane, Suite C-100,
Franklin, Tennessee 37067. Our telephone number is (615) 312-5700. Significant Recent Transactions On March 1, 2004, we
acquired two inpatient psychiatric facilities from
Brentwood Behavioral Health (Brentwood) for approximately $28 million cash with an earn-out
of up to $5 million contingent upon Brentwoods future financial results. The
facilities, which have an aggregate of 311 licensed beds, are located in
Shreveport, Louisiana and Jackson, Mississippi. On January 6, 2004, we entered into a revolving credit facility with Bank
of America, N.A. of up to $50 million. We will incur a $6.4 million loss from
refinancing long-term debt in the first quarter of 2004, which includes the
payment of a termination fee to CapitalSource Finance LLC, our former senior
lender. On December 24, 2003, we closed on the sale of 6,900,000 shares of our
common stock at $16.00 per share. Of these shares, 900,000 were sold through
the full exercise of the underwriters over-allotment option. We sold 3,271,538
shares for approximately $48.9 million after underwriting discounts and other
issuance costs. Certain 1




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existing stockholders sold 3,628,462 shares in the offering. We did not
receive any proceeds from the sale of common stock by the selling stockholders. On November 1, 2003, we acquired the 109-bed Alliance Health Center
located in Meridian, Mississippi. Alliance Health Center is a licensed acute
care hospital that provides psychiatric care for children, adolescents and
adults. In addition, a 60-bed residential treatment center is under
construction and is scheduled to open during the second quarter of 2004. On June 30, 2003, we consummated the acquisition of Ramsay Youth Services,
Inc. (Ramsay), a public company that traded on the Nasdaq SmallCap Market
under the symbol RYOU, for approximately $81.3 million, consisting of $56.2
million in cash, or $5.00 per share, $22.3 million in net assumed debt that was
repaid in connection with the acquisition and $2.8 million in fees and
expenses. Through the acquisition, we acquired 11 owned or leased inpatient
behavioral health care facilities, which had an aggregate of 1,292 beds, and
assumed 10 contracts to manage inpatient behavioral health care facilities for
government agencies. Also, on June 30, 2003, we issued $150 million in 10 5/8% senior
subordinated notes, which are fully and unconditionally guaranteed on a senior
subordinated basis by substantially all of our existing operating subsidiaries.
Interest on the senior subordinated notes accrues at the rate of 10.625% per
annum and is payable semi-annually in arrears on June 15 and December 15,
commencing on December 15, 2003. The senior subordinated notes will mature on
June 15, 2013. In April 2003, we consummated the acquisition of six inpatient behavioral
health care facilities from The Brown Schools, Inc. (The Brown Schools) for
$63.0 million in cash. The six inpatient facilities, which have an aggregate of
895 licensed beds, are located in Austin, San Antonio and San Marcos, Texas;
Charlottesville, Virginia; Colorado Springs, Colorado; and Tulsa, Oklahoma. On August 5, 2002, PMR Acquisition Corporation, a newly formed,
wholly-owned subsidiary of PMR Corporation (PMR), merged with and into
Psychiatric Solutions, Inc., whose name, subsequent to the merger, was changed
to Psychiatric Solutions Hospitals, Inc. (PSH). The surviving corporation in
the merger was PSH, which became a wholly-owned subsidiary of PMR, a publicly
traded company. In connection with the merger, PMR changed its name to
Psychiatric Solutions, Inc. and, effective August 6, 2002, the shares of
Psychiatric Solutions, Inc., formerly known as PMR Corporation, were approved
for listing on the Nasdaq National Market under the ticker symbol PSYS. Our Industry An estimated 22% of the U.S. adult population and 10% of U.S. children and
adolescents suffer from a diagnosable mental disorder in a given year. Based on
the 2002 U.S. census, these figures translate to approximately 50 million
Americans. In addition, four of the ten leading causes of disability in the
United States are mental disorders. The behavioral health care industry is extremely fragmented with only a
few large national providers. During the 1990s, the behavioral health care
industry experienced a significant contraction following a long period of
growth. Between 1990 and 1999, nearly 300 inpatient behavioral health care
facilities, accounting for over 40% of available beds, were closed. The
reduction was largely driven by third party payors who decreased reimbursement,
implemented more stringent admission criteria and decreased the authorized
length of stay. We believe this reduced capacity has resulted in an underserved
patient population. Reduced capacity, coupled with mental health parity legislation providing
for greater access to mental health services, has resulted in favorable
industry fundamentals. Behavioral health care providers have enjoyed
significant improvement in reimbursement rates, increased admissions and
stabilized lengths of stay. According to the National Association of
Psychiatric Health Systems, payments for the inpatient care of behavioral
health and addictive disorders have increased nationwide. Inpatient admissions
increased from an average of approximately 2,350 in 2001 to an average of
approximately 2,500 in 2002, while the average occupancy rates stabilized at
approximately 74% for both 2001 and 2002 after being approximately 69% in 2000.
Following a rapid decrease 2




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during the early 1990s, inpatient average length of stay stabilized
between 9 and 10 days from 1997 to 2002. In 2002, the inpatient average length
of stay was 10.3 days. The average RTC net revenue per day in 2002 was $288 for
hospital-based units and $273 for freestanding RTC facilities. The average
number of admissions for hospital-based units was 171 for 2002. The average
number of admissions for freestanding RTC facilities was 213 for 2002. The
average occupancy rate for hospital-based units increased from 73.0% in 2001 to
74.9% in 2002, with an average length of stay of 165.5 days in 2002. The
average occupancy rate for freestanding RTC facilities was 82.6% in 2002, with
an average length of stay of 187.3 days in 2002. These favorable trends have
resulted in high demand for inpatient behavioral health care services. Our Strategy We intend to continue to successfully grow our business and increase our
profitability by improving the performance of our existing inpatient facilities
and through strategic acquisitions. The following are the principal elements of
our strategy:  
    
    Same-Facility Growth We increased our revenue by approximately 9% for the year ended
December 31, 2003 as compared to our revenue for the year ended December 31, 2002
through same-facility growth. Same-facility growth refers to the comparison of the
five inpatient facilities owned during 2002 with the comparable period in 2003. We
owned four inpatient facilities throughout 2002 and acquired a fifth inpatient
facility on July 1, 2002. We expect to continue to increase our same-facility growth
by increasing our admissions and maximizing reimbursement. We plan to accomplish these
goals by:  
    
    building relationships that enhance our presence in local and regional markets;
    
    developing formal marketing initiatives and expanding referral networks;
    
    continuing to provide the highest quality service; and
    
    expanding our services and developing new services to take advantage of increased
demand in select markets where we operate.  
    
    Strong and Sustainable Market Position Our inpatient facilities have an established
presence in each of our markets, and we believe that the majority of our owned and
leased inpatient facilities have the leading market share in their respective service
areas. Our relationships and referral networks would be difficult, time-consuming and
expensive for new competitors to replicate. In addition, many of the states in which
we operate require a certificate of need to open an inpatient behavioral health care
facility, which may be difficult to obtain and may further preclude new market
participants.
    
    Growth Through Strategic Acquisitions Our industry is highly fragmented and we plan
to selectively pursue the acquisition of additional inpatient behavioral health care
facilities. There are approximately 500 acute and residential treatment facilities in
the U.S. and the top three providers operate less than 17% of these facilities. We
believe there are a number of acquisition candidates available at attractive
valuations, and we have a number of potential acquisitions that are in various stages
of development and negotiation. We believe our focus on inpatient behavioral health
care provides us with a strategic advantage when assessing a potential acquisition.
    
    Ability to Identify and Integrate Acquisitions We have successfully integrated the
five inpatient facilities we acquired in 2001 and 2002 as well as the inpatient
facilities we acquired in 2003 in connection with our acquisition of Ramsay, an
operator of 11 owned or leased inpatient behavioral health care facilities, and six
inpatient facilities from The Brown Schools. We attribute part of our success in
integrating these inpatient facilities to our rigorous due diligence review prior to
completing the 3




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acquisitions as well as our ability to retain key employees at the
acquired facilities. We employ a disciplined acquisition strategy that is based on
defined criteria including quality of service, return on invested capital and
strategic benefits. We also have a comprehensive post-acquisition strategic plan to
facilitate the integration of acquired inpatient facilities that includes improving
facility operations, recruiting psychiatrists and expanding the breadth of services
offered by the facilities.
    
    Diversified Payor Mix and Revenue Base As we have grown our business, we have
focused on diversifying our sources of revenue. For the year ended December 31, 2003,
we received 32.3% of our revenue from Medicaid, 21.9% from multiple commercial payors,
14.2% from various state and local government payors, 19.4% from various third parties
and 12.2% from Medicare. As we receive Medicaid payments from more than 35 states, we
are not significantly affected by changes in reimbursement policies in any one state.
The majority of our Medicaid payments relate to the care of children and adolescents.
Management believes that children and adolescents are a patient class that is less
susceptible to reductions in reimbursement rates. For the year ended December 31,
2003, no single inpatient facility represented more than 11% of our revenue.
    
    Experienced Management Team Our senior management team has an average of 20 years of
experience in the health care industry. Joey A. Jacobs, our Chairman, President and
Chief Executive Officer, has over 28 years experience in various capacities in the
health care industry. Jack R. Salberg, our Chief Operating Officer, has more than 32
years of operational experience in both profit and non-profit health care sectors. Our
senior management operates as a cohesive, complementary group and has extensive
operating knowledge of our industry and understanding of the regulatory environment in
which we operate. Our senior managers employ conservative fiscal policies and have a
successful track record in both operating our core business and integrating acquired
assets.
    
    Operating Efficiencies Our management team has extensive experience in the operation of
multi-facility health care services companies. We intend to focus on improving our profitability by
optimizing staffing ratios, controlling contract labor costs and reducing supply costs through group
purchasing. We believe that our focus on efficient operations increases our profitability and will
attract qualified behavioral health care professionals and patients.
    
    Consistent Free Cash Flow and Minimal Capital
Requirements We generate consistent free cash flow
due to the profitable operation of our business, our low capital expenditure requirements and through
the active management of our working capital. As the behavioral health care business does not require
the procurement and replacement of expensive medical equipment, our capital expenditure requirements
are less than that of other facility-based health care providers. Historically, our capital
expenditures have amounted to less than 2% of our revenue. Our accounts receivable management is less
complex than acute care providers because there are fewer billing codes for inpatient behavioral
health care facilities.
    
    Singular Focus on Inpatient Behavioral Health CareWe focus exclusively on the provision of
inpatient behavioral health care services. We believe this allows us to operate more efficiently and
provide higher quality care than our competitors. In addition, we believe our focus and reputation
have helped us to develop important relationships and extensive referral networks within our markets
and to attract and retain qualified behavioral health care professionals. Services by Segment We operate two reportable segments: (1) our owned and leased facilities
segment operates inpatient behavioral health care facilities and (2) our
management contract segment manages inpatient behavioral health care units and
facilities for third parties and government agencies. For financial information
regarding our operating 4




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segments, see Note 14 to our Consolidated Financial Statements included
elsewhere in this Annual Report on Form 10-K. Inpatient Behavioral Health Care Facilities Division Our inpatient division operates 26 owned or leased inpatient behavioral
health care facilities. These facilities offer a wide range of inpatient
behavioral health care services for children, adolescents and adults. Our
inpatient facilities work closely with mental health professionals, including
licensed professional counselors, therapists and social workers; psychiatrists;
non-psychiatric physicians; emergency rooms; law enforcement and community
agencies that interact with individuals who may need treatment for mental
illness or substance abuse. Many of our inpatient facilities have mobile assessment teams
who travel to prospective clients in order to assess their condition and
determine if they meet criteria for inpatient care. Those clients not meeting
criteria for inpatient care may qualify for outpatient care or a less intensive level of care also
provided by the facility. During the year ended December
31, 2003, our inpatient behavioral health care facilities division produced
approximately 76% of our revenue. Through the diversity of programming and levels of care available, the
patient can receive a seamless treatment experience from acute care to
residential long-term care to group home living to outpatient treatment. This
seamless care system provides the continuity of care needed to step the patient
down and allow the patient to develop and use successful coping skills and
treatment interventions to sustain long-term treatment success. Treatment
modalities include comprehensive assessment, multidisciplinary treatment
planning including the patient and family, group, individual and family therapy
services, medical and dental services, educational services, recreational
services and discharge planning services. Specialized interventions such as
skills training include basic daily living skills, social skills, work/school
adaptation skills and symptom management skills. Collateral consultations are
provided to significant others such as family members, teachers, employers and
other professionals when needed to help the patient successfully reintegrate
back into his/her world. Services offered at our inpatient facilities include:  
    
    acute psychiatric care;
    
    
    detoxification;
    
    partial hospitalization;
    
    
    developmentally delayed disorders ;
    
    chemical dependency;
    
    
    therapeutic foster care;
    
    intensive outpatient;
    
    
    neurological disorders;
    
    acute eating disorders;
    
    
    rapid adoption services;
    
    reactive attachment disorder;
    
    
    day treatment;
    
    dual diagnosis;
    
    
    independent living skills;
    
    rehabilitation care;
    
    
    attention deficit/hyperactivity disorders; and
    
    day treatment;
    
    
    vocational training. Acute inpatient hospitalization is the most intensive level of care
offered and typically involves 24-hour skilled nursing observation and care,
daily interventions and oversight by a psychiatrist, and intensive, highly
coordinated treatment by a physician-led team of mental health professionals.
Every patient admitted to acute care is assessed by a medical doctor within 24
hours of admission. Patients with non-complex medical conditions are monitored
during their stay by the physician and nursing staff at the inpatient facility. Patients
with more complex medical needs are referred to more appropriate facilities for
diagnosis and stabilization prior to treatment. Patients admitted to our acute
care facilities also receive comprehensive nursing and psychological
assessments within 24 to 72 hours 5




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of admission. Oversight and management of patients
medication is performed by licensed psychiatrists on staff at the facility, and
individual, family, and group therapy is performed by licensed counselors as
appropriate to the patients assessed needs. Education regarding their illness
is also provided by trained medical health professionals. Detoxification for adult patients with a diagnosis of substance abuse is
provided at some inpatient facilities. Substance abuse therapy and education is provided
to these patients during their stay and referrals to appropriate aftercare
services are made for the patient upon discharge, usually to an intensive
outpatient program provided by the inpatient facility. Our RTCs provide longer term treatment programs for children and
adolescents with long-standing behavioral health problems. Twenty four hour
observation and care is provided in our RTCs, along with individualized therapy
that usually consists of one-on-one sessions with a licensed counselor, as well
as process and rehabilitation group therapy. Another key component of the
treatment of children and adolescents in our inpatient facilities is family therapy.
Participation of the childs or adolescents immediate family is strongly
encouraged in order to heighten the chance of success once the resident is
discharged. Medications for residents are managed by licensed, often
board-certified, psychiatrists while they remain at the inpatient facility. Our RTCs also
provide academic programs by certified teachers to children and adolescent
residents. These programs are individualized for each resident based on
analysis by the teacher upon admission. Upon discharge of the resident, an
academic reports are forwarded to the residents school. Specialized programs
for children and adolescents in our RTCs include programs for sexually reactive
children, sex offenders, reactive attachment disorders and clients who are
developmentally delayed with a behavioral component. Our RTCs often
receive out-of-state referrals to their programs due to the lack of specialized
programs for these disorders within the referrals own state. Other major diagnoses treated at our inpatient behavioral health care
facilities include bipolar disorder, major depression, schizophrenia, attention
deficit/hyperactivity disorder, impulse disorder and oppositional and conduct
disorders. Our inpatient facilities programs have been adapted to the requests of
various sources to provide services to patients with multiple issues and
specialized needs. Our success rate with these difficult to treat cases has
expanded our network of referrals. The services provided at each inpatient
facility are continually assessed and monitored through an ongoing quality
improvement program. This purpose of this program is to strive for the highest
quality of care possible to individuals with behavioral health issues, and
includes regular site visits to each inpatient facility in order to assess their
compliance with legal and regulatory standards, as well as adherence to our
compliance program. Standardized performance measures based on a national
outcomes measurement data base comparing our inpatient facilities performance with
national norms are also reported, reviewed and corrective steps are taken when
necessary. Inpatient Management Contract Division Our inpatient management contract division develops, organizes and manages
behavioral health care programs within general third party medical/surgical
hospitals and manages inpatient behavioral health care facilities for
government agencies. We manage 43 inpatient behavioral health units for third
parties in 15 states, including a contract to provide mental health case
management services to approximately 4,400 children and adults with serious
mental illness in the Nashville, Tennessee area, and 11 inpatient behavioral
health care facilities for government agencies. For the year ended December
31, 2003, our inpatient management contract division produced approximately 24%
of our revenue. Our broad range of services can be customized into individual programs
that meet specific inpatient facility and community requirements. Our inpatient
management contract division is dedicated to providing high quality programs
with integrity, innovation and sufficient flexibility to develop customized
individual programs. We provide our customer with a variety of management
options, including clinical and management infrastructure, personnel
recruitment, staff orientation and supervision, corporate consultation and
performance improvement plans. Under the contracts, the
hospital is the actual provider of the mental health services and utilizes its
own facilities, support services, and generally its own nursing staff in
connection with the operation of its programs. 6




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In general the contracts have an initial term of two to
five years and are extended for successive one-year periods unless terminated
by either party. The contracts contain termination provisions that allow either
party to terminate upon certain material events, including the failure to cure
a breach or default under the contract, bankruptcy and the failure to maintain
required licensure. While turnover of contracts is expected, we expect the
number of contracts to remain relatively stable. Substantially all of the
management contracts contain non-compete and confidentiality provisions. In
addition, the management contracts typically prohibit the client hospital from
soliciting our employees during the term of the contract and for a specified
period thereafter. In addition, we manage 11 inpatient behavioral health care facilities for
government agencies located in Florida, Georgia and Puerto Rico. In general,
our contracts to manage these inpatient facilities have an initial term of one
to five years. Most of these contracts may be extended for up to three
successive one-year periods at the discretion of the government agency. Payment
under the contracts is contingent on the annual appropriation of funds by the
respective state legislature. Most contracts allow us to terminate the
agreement without cause upon 90 days notice and the government agency may
terminate without cause upon 30 days notice or upon the occurrence of certain
material events, including our failure to meet certain performance standards
for a specified period of time, bankruptcy or default under the contract. Our management contract revenue is sensitive to regulatory and economic
changes in the States of Tennessee and Florida. Our contract to provide case
management services in and around Nashville, Tennessee comprised 8% of our
consolidated revenue for the year ended December 31, 2003 and our contracts to
manage nine inpatient facilities for the Florida Department of Juvenile Justice
comprised 6% of our consolidated revenue for the year ended December 31, 2003.
The loss of these contracts would have a material adverse effect on our
management contract segment. Seasonality of Services Our inpatient behavioral health care facilities division typically
experiences lower patient volumes and revenue during the end of the second
quarter, the beginning of the third quarter, the end of the fourth quarter and
the beginning of the first quarter. Because a high proportion of patients
served by our inpatient behavioral health care facilities division are children
and adolescents, this seasonality corresponds to periods that school is out of
session. We believe that, for a variety of reasons, children and adolescent
patients are less likely to be admitted during the summer months and the
year-end holidays. Marketing Our local and regional marketing is led by clinical and business
development representatives at each of our inpatient facilities. These
individuals manage relationships among a variety of referral sources in their
respective communities. Our national marketing efforts are focused on
increasing the census at our RTCs from various state referral sources by
developing relationships and identifying contracting opportunities in their
respective territories. Our customer service is managed through our call
center. Both families and agencies seeking placement for children receive
quick, confidential service through the call center which further promotes our
facilities. Competition The inpatient behavioral health care facility industry and the inpatient
behavioral health care unit management industry are highly fragmented. The
industry is subject to continual changes in the method in which services are
provided and the types of companies providing such services. We compete with
several national competitors and many regional and local competitors, some of
which have greater resources than us. In addition, 7




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some of our competitors are owned by governmental agencies and supported
by tax revenue, and others are owned by nonprofit corporations and may be
supported to a large extent by endowments and charitable contributions. Such
support is not available to our facilities. In addition, our owned, leased and managed inpatient behavioral health
care facilities and managed inpatient behavioral health care units compete for
patients with other providers of mental health care services, including other
inpatient behavioral health care facilities, medical/surgical hospitals,
independent psychiatrists and psychologists. We also compete with hospitals,
nursing homes, clinics, physicians offices and contract nursing companies for
the services of registered nurses. We believe we differentiate
ourselves from our competition through our singular focus on the
provision of behavioral health care services, our reputation for the quality of
our services, recruitment of first rate
medical staff and accessibility to our facilities. In addition, we believe that the active development of our referral network
and participation in selected managed care provider panels enable us to successfully compete for patients in
need of our services. Reimbursement Our inpatient owned and leased facilities receive payment for services
from the federal government primarily under the Medicare program, state
governments under their respective Medicaid programs, private insurers,
including managed care plans, and directly from patients. Most of our inpatient
behavioral health facilities are certified as providers of Medicare and
Medicaid services by the appropriate governmental authorities. The requirements
for certification are subject to change, and, in order to remain qualified for
such programs, it may be necessary for us to make changes from time to time in
our inpatient facilities, equipment, personnel and services. If an inpatient
facility loses certification, it will be unable to receive payment for patients
under the Medicare or Medicaid programs. Although we intend to continue
participating in such programs, there can be no assurance that we will continue
to qualify for participation. Medicare Medicare provides hospital and medical insurance benefits to persons age
65 and over, some disabled persons and persons with end-stage renal disease.
Freestanding psychiatric hospitals and certified psychiatric units of acute
care hospitals are currently exempt from the inpatient services prospective
payment system (PPS) applicable to general acute care hospitals and are
reimbursed on a reasonable cost basis, subject to a per discharge ceiling,
calculated based on an annual allowable rate of increase over the facilitys
base year amount under the Medicare law and regulations. Capital-related costs
are exempt from this limitation. Medicare makes interim payments to the
provider based on an estimate of the providers cost, and then makes a final
settlement based on an annual cost report filed by the provider. Consistent with reimbursement trends for other segments of the health care
services industry, the Centers for Medicare and Medicaid Services (CMS)
proposed on November 19, 2003 a new Medicare PPS for inpatient behavioral
health care facilities including both freestanding psychiatric hospitals and
certified psychiatric units in general acute care hospitals. CMS is proposing a
per diem PPS. The proposed base per diem amount will cover nearly all labor and
non-labor costs of furnishing covered inpatient behavioral health care services
 including routine, ancillary and capital costs. The proposed per diem will
not, however, include the costs of bad debts and certain other costs that are
paid separately. CMS is proposing that the base per diem be adjusted for specific facility
characteristics that increase the cost of patient care. CMS is proposing that
payment rates for individual inpatient facilities be adjusted to reflect
geographic differences in wages and that rural providers receive an increased
payment adjustment, as would teaching facilities. CMS is proposing that the
base rate be adjusted by factors that influence the cost of an individual
patients care, such as each patients diagnosis related group (DRG), certain
other medical and psychiatric comorbidities (i.e., other coexisting conditions
that may complicate treatment), and age. Because the cost of inpatient
behavioral care tends to be greatest at admission and a few days thereafter,
CMS is proposing to adjust the per diem rate for each day up to and including
the eighth day to reflect the number of days the patient has been in the
facility. Medicare will pay this per diem amount, as adjusted, regardless of
whether it is more or less than a hospitals actual costs. CMS currently plans
to begin implementing the new PPS for behavioral health care facilities on
April 1, 2004, although CMS may delay implementation beyond such date. CMS has
also proposed a three-year 8




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transition period that will be a blend of decreasing cost-based payments
and increasing PPS payments, with full PPS rates becoming effective in the
fourth year. We are uncertain when a final rule and effective date will be
released. Please see http://www.cms.hhs.gov/providers/ipfppsfor additional
information. With respect to revenue derived from behavioral health care unit
management services, we bill our fees to the provider as a purchased
management, administrative and consultative support service. Substantially all
of the patients admitted to these programs are eligible for Medicare coverage.
As a result, the providers rely upon payment from Medicare for the services.
Many of the patients are also eligible for Medicaid payments. To the extent
that a hospital deems revenue for a program we manage to be inadequate, it may
seek to terminate its contract with us or not renew the contract. Similarly, we
may not necessarily solicit new unit management contracts if prospective
customers do not believe that such programs will generate sufficient revenue. Although Medicare currently uses a cost-based reimbursement formula for
inpatient behavioral health care facility services, Medicare will not pay these
full amounts to a facility. It will deduct from that rate an amount for patient
coinsurance, or the amount that the patient is expected to pay. Many patients
are unable to pay the coinsurance amount. Even if these patients are also
covered by Medicaid, some states Medicaid programs will not pay the Medicare
coinsurance amount. As a result, the Medicare coinsurance amount will go
uncollected by the provider except to the extent that the provider is partially
reimbursed that amount as a Medicare bad debt. To the extent that neither a
Medicare patient nor any secondary payor for that patient pays the Medicare
coinsurance amount after a reasonable collection effort or the patients
indigence is documented, the provider is entitled to be paid 70% of this bad
debt by Medicare. However, there are instances when Medicare denies
reimbursement for all or part of claimed bad debts for coinsurance on Medicare
patients on grounds that the provider did not engage in a reasonable collection
effort or that the provider failed to maintain adequate documentation of its
collection effort or of the patients indigence. Medicaid Medicaid, a joint federal-state program that is administered by the
respective states, provides hospital benefits to qualifying individuals who are
unable to afford care. We cannot predict the extent or scope of changes that
may occur in the ways in which state Medicaid programs contract for and deliver
services to Medicaid recipients. All Medicaid funding is generally conditioned
upon financial appropriations to state Medicaid agencies by the state
legislatures and there are political pressures on such legislatures in terms of
controlling and reducing such appropriations. Some states may adopt substantial health care reform measures that could
modify the manner in which all health services are delivered and reimbursed,
especially with respect to Medicaid recipients and other individuals funded by
public resources. Many states have enacted or are considering enacting measures
designed to reduce their Medicaid expenditures. As we receive Medicaid payments
from more than 35 states, we are not significantly affected by changes in
reimbursement policies in any one state. Most states have applied for and been
granted federal waivers from current Medicaid regulations to allow them to
serve some or all of their Medicaid participants through managed care
providers. The majority of our Medicaid payments relate to the care of children
and adolescents. We believe that children and adolescents are a patient class
that is less susceptible to reductions in reimbursement rates. The reduction in
other public resources could have an impact on the delivery of services to
Medicaid recipients. Any significant changes in Medicaid funding, the structure
of a particular states Medicaid program, the contracting process or
reimbursement levels could have a material adverse impact on our financial
condition and results of operations. Managed Care and Commercial Insurance Carriers In addition to government programs, our inpatient facilities are
reimbursed for certain behavioral health care services by private payors
including health maintenance organizations (HMOs), preferred provider
organizations (PPOs), commercial insurance companies, employers and
individual private payors. To attract additional volume, our inpatient
facilities offer discounts from established charges to certain large group
purchasers 9




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of health care services. Generally, patients covered by HMOs, PPOs and
other private insurers will be responsible for certain co-payments and
deductibles, which are paid by the patient. The Mental Health Parity Act of 1996 (MHPA) is a federal law that
requires annual or lifetime limits for mental health benefits be no lower than
the dollar limits for medical/surgical benefits offered by a group health plan.
MHPA applies to group health plans or health insurance coverage offered in
connection with a group health plan that offers both mental health and
medical/surgical benefits. However it does not require plans to offer mental
health benefits. MHPA was scheduled to sunset on December 31, 2003, but the
Mental Health Reauthorization Act of 2003 extended the sunset date of MHPA to
December 31, 2004. Bills have also been introduced in Congress that could
potentially apply this concept on a more far-reaching scale. Approximately 34
states have also enacted some form of mental health parity laws. Some of these
laws apply only to select groups such as those with severe mental illness or
specific diagnosis. Annual Cost Reports All facilities participating in the Medicare program and some Medicaid
programs, whether paid on a reasonable cost basis or under a PPS, are required
to meet certain financial reporting requirements. Federal regulations require
submission of annual cost reports identifying medical costs and expenses
associated with the services provided by each facility to Medicare
beneficiaries and Medicaid recipients. Annual cost reports required under the
Medicare and some Medicaid programs are subject to routine governmental audits,
which may result in adjustments to the amounts ultimately determined to be due
to us under these reimbursement programs. These audits often require several
years to reach the final determination of amounts earned under the programs.
Nonetheless, once the Medicare fiscal intermediaries have issued a final Notice
of Program Reimbursement (NPR) after audit, any disallowances of claimed
costs are due and payable within 30 days of receipt of the NPR. Providers have
rights to appeal, and it is common to contest issues raised in audits of prior
years cost reports. Regulation and Other Factors Licensure, Certification and Accreditation Health care facilities are required to comply with extensive regulation at
the federal, state and local levels. Under these laws and regulations, health
care facilities must meet requirements for licensure and qualify to participate
in government programs, including the Medicare and Medicaid programs. These
requirements relate to the adequacy of medical care, equipment, personnel,
operating policies and procedures, fire prevention, maintenance of adequate
records, hospital use, rate-setting, and compliance with building codes and
environmental protection laws. There are also extensive regulations governing a
facilitys participation in government programs. Facilities are subject to
periodic inspection by governmental and other authorities to assure continued
compliance with the various standards necessary for licensing and
accreditation. All of the inpatient facilities owned and operated by us are properly
licensed under applicable state laws. Most of the inpatient facilities owned
and operated by us are certified under Medicare and Medicaid programs and most
are accredited by the Joint Commission on Accreditation or Healthcare
Organizations (JCAHO), the effect of which is to permit the inpatient
facilities to participate in the Medicare and Medicaid programs. Should any of
our inpatient facilities lose its accreditation by JCAHO, or otherwise lose its
certification under the Medicare and/or Medicaid program, that inpatient
facility would be unable to receive reimbursement from the Medicare and
Medicaid programs. If a provider contracting with us were excluded from any
federal health care programs, no services furnished by that provider would be
covered by any federal health care program. If we were excluded from federal
health care programs, our owned and leased inpatient facilities would not be
eligible for reimbursement by any federal health care program. In addition,
providers would as a practical matter cease contracting for our inpatient
behavioral health care unit management services because they could not be
reimbursed for any management fee amounts they paid to us. We believe that the inpatient facilities we own and operate are in
substantial compliance with current applicable federal, state, local and
independent review body regulations and standards. The requirements for 10




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licensure, certification and accreditation are subject to change and, in
order to remain qualified, it may be necessary for us to effect changes in our
inpatient facilities, equipment, personnel and services. Additionally, certain
of the personnel working at inpatient facilities owned and operated by us are
subject to state laws and regulations governing their particular area of
professional practice. We assist our client hospitals in obtaining required
approvals for new programs. Some approval processes may lengthen the time
required for programs to begin operations. Fraud and Abuse Laws Participation in the Medicare and/or Medicaid programs is heavily
regulated by federal law and regulation. If a hospital fails to substantially
comply with the numerous federal laws governing that facilitys activities, the
hospitals participation in the Medicare and/or Medicaid programs may be
terminated and/or civil or criminal penalties may be imposed. For example, a
hospital may lose its ability to participate in the Medicare and/or Medicaid
program if it pays money to induce the referral of patients or purchase of
items or services where such items or services are reimbursable under a federal
or state health care program. The anti-kickback provision of the Social Security Act prohibits the
payment, receipt, offer or solicitation of money with the intent of generating
referrals or orders for services or items covered by a federal or state health
care program (the Anti-kickback Statute). Violations of the Anti-kickback
Statute may be punished by criminal or civil penalties, exclusion from federal
and state health care programs, imprisonment and damages up to three times the
total dollar amount involved. The Anti-kickback Statute has been interpreted
broadly by federal regulators and certain courts to prohibit the intentional
payment of anything of value if even one purpose of the payment is to influence
the referral of Medicare or Medicaid business. Therefore, many commonplace
commercial arrangements between hospitals and physicians could be considered by
the government to violate the Anti-kickback Statute. The Health Insurance Portability and Accountability Act of 1996 (HIPAA)
broadened the scope of the fraud and abuse laws by adding several criminal
statutes that are not related to receipt of payments from a federal health care
program. HIPAA created civil penalties for proscribed conduct, including
upcoding and billing for medically unnecessary goods or services. HIPAA
established new enforcement mechanisms to combat fraud and abuse. These new
mechanisms include a bounty system, where a portion of the payments recovered
is returned to the government agencies, as well as a whistleblower program.
HIPAA also expanded the categories of persons that may be excluded from
participation in federal and state health care programs. The Office of Inspector General (OIG) of the Department of Health and
Human Services (HHS) is responsible for identifying fraud and abuse
activities in government programs. In order to fulfill its duties, the OIG
performs audits, investigations and inspections. In addition, it provides
guidance to health care providers by identifying types of activities that could
violate the Anti-kickback Statute. We have a variety of financial relationships
with physicians who refer patients to our owned and leased facilities, as well
as at behavioral health programs and facilities we manage. We also have
contracts with physicians providing for a variety of financial relationships
including employment contracts, independent contractor agreements, professional
service agreements and medical director agreements. The OIG is authorized to publish regulations outlining activities and
business relationships that would be deemed not to violate the Anti-kickback
Statute. These regulations are known as safe harbor regulations. The safe
harbor regulations do not make conduct illegal, but instead delineate standards
that, if complied with, protect conduct that might otherwise be deemed in
violation of the Anti-kickback Statute. We use our best efforts to structure
each of our arrangements, especially each of our business relationships with
physicians, to fit as closely as possible within an applicable safe harbor.
However, not all of our business arrangements fit wholly within safe harbors,
so we cannot guarantee that these arrangements will not be scrutinized by
government authorities or, if scrutinized, that they will be determined to be
in compliance with the Anti-kickback Statute or other applicable laws. The
failure of a particular activity to comply with the safe harbor regulations
does not mean that the activity violates the Anti-kickback Statute. If we do
violate the Anti-kickback Statute, we would be subject to criminal and civil
penalties and/or possible exclusion from participating in Medicare, Medicaid or
other governmental health care programs. 11




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The OIG also issues advisory opinions to outside parties regarding the
interpretation and applicability of the Anti-kickback Statute and other OIG
health care fraud and abuse sanctions. An OIG advisory opinion only applies to
the people or entities which requested it. However, advisory opinions are
published and made available to the public (see
http://oig.hhs.gov/fraud/advisoryopinions.html), and they provide guidance on
those practices the OIG believes may (or may not) violate federal law. On April
3, 2003, the OIG issued Advisory opinion No. 03-8 regarding an arrangement
whereby a company would develop and manage distinct part inpatient
rehabilitation units located within general acute care hospitals in exchange
for a management fee calculated on a per patient per day basis. The OIG found
that the proposed arrangement could potentially generate prohibited
remuneration under the Anti-kickback Statute and that the OIG could potentially
impose administrative sanctions on the management company. The OIG noted that
any definitive conclusion regarding the existence of an anti-kickback violation
would require a determination of the parties intent, which is beyond the scope
of the advisory opinion process. The OIGs analysis noted that the proposed arrangement did not qualify for
the safe harbor for personal services and management contracts because the
aggregate compensation paid by the hospital to the management company was not
set in advance. The OIG noted that per patient, per click, per order, and
similar payment arrangements with parties in a position, either directly or
indirectly, to refer or recommend an item or service payable by a federal
health care program are disfavored under the Anti-kickback Statute. The
principal concern is that such arrangements promote overutilization and
unnecessarily lengthy stays. Other items of concern to the OIG included that
the unit was under the medical direction of a physician in a position to
generate referrals to the unit, the management company performed community
outreach including marketing, and the fee arrangement could be deemed a success
fee. While the proposed arrangement had certain features that would appear to
reduce the risk, the OIG could not conclude that the residual risk was
sufficiently low to grant protection prospectively. We provide services to medical/surgical facilities through behavioral
health care management contracts and are compensated, in part, on a per
discharge basis. We have not requested an advisory opinion from the OIG with
respect to our inpatient management contracts. We believe that we are in
compliance with the Anti-kickback Statute, despite the fact that our inpatient
management contracts do not qualify for the safe harbor for personal services
and management contracts because the aggregate compensation paid by our client
hospitals is not set in advance. There can be no assurances that our contracts
will not be reviewed and challenged by the OIG or other regulatory authorities
empowered to do so. The Social Security Act also includes a provision commonly known as the
Stark Law. This law prohibits physicians from referring Medicare and Medicaid
patients for the furnishing of any designated health services to health care
entities in which they or any of their immediate family members have ownership
or other financial interest. These types of referrals are commonly known as
self referrals. Sanctions for violating the Stark Law include civil monetary
penalties, assessments equal to twice the dollar value of each service rendered
for an impermissible referral and exclusion from the Medicare and Medicaid
programs. There are ownership and compensation arrangement exceptions for many
customary financial arrangements between physicians and facilities, including
employment contracts, leases and recruitment agreements. The federal government
released regulations interpreting some, but not all, of the provisions included
in the Stark Law in January 2001, and the government has said it intends to
release the second phase of the final Stark Law regulations in the future. We
have structured our financial arrangements with physicians to comply with the
statutory exceptions included in the Stark Law and subsequent regulations.
However, the future Stark Law regulations may interpret provisions of this law
in a manner different from the manner in which we have interpreted them. We
cannot predict the effect such future regulations will have on us. Many states in which we operate also have adopted, or are considering
adopting, laws similar to the Anti-kickback Statute and/or the Stark Law. Some
of these state laws apply even if the government is not the payor. These
statutes typically provide criminal and civil penalties as remedies. While
there is little precedent for the interpretation or enforcement of these state
laws, we have attempted to structure our financial relationships with
physicians and others in light of these laws. However, if a state determines
that we have violated such a law, we would be subject to criminal and civil
penalties. Emergency Medical Treatment and Active Labor Act 12




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The Emergency Medical Treatment and Active Labor Act (EMTALA) is a
federal law that requires any health care facility that participates in the
Medicare program to conduct an appropriate medical screening examination of
every person who presents to the hospitals emergency department for treatment
and, if the patient is suffering from an emergency medical condition, to either
stabilize that condition or make an appropriate transfer of the patient to a
facility that can handle the condition. The obligation to screen and stabilize
emergency medical conditions exists regardless of a patients ability to pay
for treatment. There are severe penalties under EMTALA if a hospital fails to
screen or appropriately stabilize or transfer a patient or if the hospital
delays appropriate treatment in order to first inquire about the patients
ability to pay. Penalties for violations of EMTALA include civil monetary
penalties and exclusion from participation in the Medicare program. In
addition, an injured patient, the patients family or a medical facility that
suffers a financial loss as a direct result of another hospitals violation of
the law can bring a civil suit against the hospital. On September 9, 2003, CMS published a final rule, which became effective
November 10, 2003, clarifying a hospitals duties under EMTALA. In the final
rule, CMS clarified when a patient is considered to be on a hospitals property
for purposes of treating the person pursuant to EMTALA. CMS rules did not
specify on-call physician requirements for an emergency department, but
provided a subjective standard stating that on-call hospital schedules should
meet the hospitals and communitys needs. CMS also did not directly address
whether EMTALA applies to direct admissions, individuals who come to a hospital
pursuant to a physicians orders for a routine procedure, individuals who
present themselves at a hospitals psychiatric department or delivery/labor
department and whether screening requirements apply to patients transferred
from other facilities. Although we believe that our inpatient behavioral
health care facilities comply with EMTALA, we cannot predict if CMS will
implement new requirements in the future and whether we will comply with any
new requirements. The Federal False Claims Act The federal False Claims Act prohibits providers from knowingly submitting
false claims for payment to the federal government. This law has been used not
only by the federal government, but also by individuals who bring an action on
behalf of the government under the laws qui tam or whistleblower
provisions. When a private party brings a qui tam action under the federal
False Claims Act, the defendant will generally not be aware of the lawsuit
until the government makes a determination whether it will intervene and take a
lead in the litigation. Civil liability under the federal False Claims Act can be up to three
times the actual damages sustained by the government plus civil penalties for
each separate false claim. There are many potential bases for liability under
the federal False Claims Act, including claims submitted pursuant to a referral
found to violate the Anti-kickback Statute. Although liability under the
federal False Claims Act arises when an entity knowingly submits a false claim
for reimbursement to the federal government, the federal False Claims Act
defines the term knowingly broadly. Although simple negligence will not give
rise to liability under the federal False Claims Act, submitting a claim with
reckless disregard to its truth or falsity can constitute knowingly
submitting a false claim. From time to time, companies in the health care
industry, including us, may be subject to actions under the federal False
Claims Act. HIPAA Transaction, Privacy and Security Requirements There are currently numerous laws at the state and federal levels
addressing patient privacy concerns. Federal regulations issued pursuant to
HIPAA contain, among other measures, provisions that require many
organizations, including our inpatient facilities, to implement very
significant and potentially expensive new computer systems, employee training
programs and business procedures. The federal regulations are intended to
encourage electronic commerce in the health care industry. On August 17, 2000, HHS finalized regulations requiring our inpatient
facilities to use standard data formats and code sets established by the rule
when electronically transmitting information in connection with several
transactions, including health claims and equivalent encounter information,
health care payment and remittance advice and health claim status. On February
20, 2003, HHS issued final modifications to these regulations. Compliance with
these regulations was required on October 16, 2003. We have implemented or
upgraded computer systems, as appropriate, at our inpatient facilities and at
our corporate headquarters to comply with the new transaction and code set
regulations and have tested these systems with several of our payers. 13




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HIPAA requires HHS to issue regulations establishing standard unique
health identifiers for individuals, employers, health plans and health care
providers to be used in connection with standard electronic transactions. On
May 31, 2002, HHS issued a final rule that calls for using the Employer
Identification Number (the taxpayer identifying number for employers that is
assigned by the Internal Revenue Service) as the standard unique health
identifier for employers. Most health care organizations, including our
inpatient facilities, must comply with this final rule by July 30, 2004. Health
plans, health care clearinghouses and providers would use this identifier,
among other uses, in connection with the standard electronic transactions
standards. On January 23, 2004, HHS published a final rule that adopted the National
Provider Identifier (NPI) as the standard unique health identifier for health
care providers. When the NPI is implemented, health care providers, including
our inpatient facilities, will use only the NPI to identify themselves in
connection with electronic transactions. Legacy numbers, such as Medicaid
numbers, CHAMPUS numbers, and Blue Cross-Blue Shield numbers, will not be
permitted. Health care providers will no longer have to keep track of multiple
numbers to identify themselves in the standard electronic transactions with one
or more health plans. The NPI will be a 10-digit all numeric number that will
be assigned to eligible health care providers, including our inpatient
facilities, by the National Provider System (NPS), an independent government
contractor. Under the final rule, all health care providers may begin applying
for NPIs on May 23, 2005 with the NPS. All health care providers, including
our inpatient facilities, must obtain and start using NPIs in connection with
the standard electronic transactions no later than May 23, 2007. HHS has not yet issued proposed rules that establish the standard for
unique health identifiers for health plans or individuals. Once these
regulations are issued in final form, we expect to have about two years to
become fully compliant. On February 20, 2003, HHS finalized a rule that establishes, in part,
standards to protect the confidentiality, availability and integrity of health
information by health plans, health care clearinghouses and health care
providers that receive, store, maintain or transmit health and related
financial information in electronic form, regardless of format. These security
standards require our inpatient facilities to establish and maintain reasonable
and appropriate administrative, technical and physical safeguards to ensure the
integrity, confidentiality and the availability of electronic health and
related financial information. The security standards were designed to protect
electronic information against reasonably anticipated threats or hazards to the
security or integrity of the information and to protect the information against
unauthorized use or disclosure. Although the security standards do not
reference or advocate a specific technology, and covered health care providers,
plans and clearinghouses have the flexibility to choose their own technical
solutions, we expect that the security standards will require our inpatient
facilities to implement significant new systems, business procedures and
training programs. Our inpatient facilities must comply with these security
regulations by April 21, 2005. On December 28, 2000, HHS published a final rule establishing standards
for the privacy of individually identifiable health information. The final
rule establishing the privacy standards became effective on April 14, 2001,
with compliance required by April 14, 2003. On August 14, 2002, HHS published
final revisions to the privacy rule. The final revisions did not alter the
compliance date of April 14, 2003 for the majority of the requirements in the
privacy regulations. These privacy standards apply to all health plans, all
health care clearinghouses and health care providers that transmit health
information in an electronic form in connection with the standard transactions.
Our inpatient facilities are covered entities under the final rule. The
privacy standards apply to individually identifiable information held or
disclosed by a covered entity in any form, whether communicated electronically,
on paper or orally. These standards impose extensive new administrative
requirements on our inpatient facilities. They require our compliance with
rules governing the use and disclosure of this health information. They create
new rights for patients in their health information, such as the right to amend
their health information, and they require our inpatient facilities to impose
these rules, by contract, on any business associate to whom they disclose such
information in order to perform functions on their behalf. In addition, our
inpatient facilities will continue to remain subject to any state laws that are
more restrictive than the privacy regulations issued under HIPAA. These state
laws vary by state and could impose additional penalties. A violation of these regulations could result in civil money penalties of
$100 per incident, up to a maximum of $25,000 per person per year per standard.
HIPAA also provides for criminal penalties of up to $50,000 14




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and one year in prison for knowingly and improperly obtaining or
disclosing protected health information, up to $100,000 and five years in
prison for obtaining protected health information under false pretenses, and up
to $250,000 and ten years in prison for obtaining or disclosing protected
health information with the intent to sell, transfer or use such information
for commercial advantage, personal gain or malicious harm. Since there is no
history of enforcement efforts by the federal government at this time, it is
not possible to ascertain the likelihood of enforcement efforts in connection
with the HIPAA regulations or the potential for fines and penalties which may
result from the violation of the regulations. Compliance with these regulations has and will continue to require
significant commitment and action by us and our inpatient facilities. We have
appointed members of our management team to direct our compliance with these
standards. Implementation of these regulations has and will continue to require
our inpatient facilities and us to engage in extensive preparation and make
significant expenditures. At this time we have appointed a privacy officer at
each inpatient facility, prepared privacy policies, trained our workforce on
these policies and entered into business associate agreements with the
appropriate vendors. Because some of the regulations are proposed regulations,
we cannot predict the total financial impact of the regulations on our
operations. Certificates of Need (CON) The construction of new health care facilities, the acquisition or
expansion of existing facilities, the transfer or change of ownership and the
addition of new beds, services or equipment may be subject to state laws that
require prior approval by state regulatory agencies. These CON laws generally
require that a state agency determine the public need for construction or
acquisition of facilities or the addition of new services. Failure to obtain
necessary state approval can result in the inability to expand facilities, add
services, complete an acquisition or change ownership. Violations of these
state laws may result in the imposition of civil sanctions or revocation of a
facilitys license. Corporate Practice of Medicine and Fee Splitting Some states have laws that prohibit unlicensed persons or business
entities, including corporations or business organizations that own hospitals,
from employing physicians. Some states also have adopted laws that prohibit
direct and indirect payments or fee-splitting arrangements between physicians
and unlicensed persons or business entities. Possible sanctions for violation
of these restrictions include loss of a physicians license, civil and criminal
penalties and rescission of business arrangements. These laws vary from state
to state, are often vague and have seldom been interpreted by the courts or
regulatory agencies. Although we attempt to structure our arrangements with
health care providers to comply with the relevant state laws and the few
available regulatory interpretations, there can be no assurance that government
officials charged with responsibility for enforcing these laws will not assert
that we, or certain transactions in which we are involved, are in violation of
such laws, or that such laws ultimately will be interpreted by the courts in a
manner consistent with our interpretation. Health Care Industry Investigations Significant media and public attention has focused in recent years on the
hospital industry. Because the law in this area is complex and constantly
evolving, ongoing or future governmental investigations or litigation may
result in interpretations that are inconsistent with industry practices,
including our practices. It is possible that governmental entities could
initiate investigations or litigation in the future at inpatient facilities
owned or managed by us and that such matters could result in significant
penalties as well as adverse publicity. It is also possible that our executives
and other management personnel could be included in governmental investigations
or litigation or named as defendants in private litigation. Insurance As is typical in the health care industry, we are subject to claims and
legal actions by patients in the ordinary course of business. To cover these
claims, we maintain professional malpractice liability insurance and general
liability insurance in amounts we believe to be sufficient for our operations,
although it is possible that some 15




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claims may exceed the scope of the coverage in effect. At various times in
the past, the cost of malpractice insurance and other liability insurance has
risen significantly. Therefore, there can be no assurance that such insurance
will continue to be available at reasonable prices which would allow us to
maintain adequate levels of coverage. Conversion Legislation Many states have adopted legislation regarding the sale or other
disposition of hospitals operated by not-for-profit entities. In other states
that do not have such legislation, the attorneys general have demonstrated an
interest in these transactions under their general obligations to protect
charitable assets. These legislative and administrative efforts primarily focus
on the appropriate valuation of the assets divested and the use of the proceeds
of the sale by the not-for-profit seller. These reviews and, in some instances,
approval processes can add additional time to the closing of a not-for-profit
hospital acquisition. Future actions by state legislators or attorneys general
may seriously delay or even prevent our ability to acquire certain hospitals. Regulatory Compliance Program We are committed to ethical business practices and to operating in
accordance with all applicable laws and regulations. Our Compliance Program was
established to ensure that all employees have a solid framework for business,
legal, ethical, and employment practices. Our Compliance Program establishes
mechanisms to aid in the identification and correction of any actual or
perceived violations of any of our policies or procedures or any other
applicable rules and regulations. We have an appointed Chief Compliance Officer
as well as compliance coordinators at each inpatient facility. The Chief
Compliance Officer heads our Compliance Committee which consists of senior
management personnel and a member of our board of directors. Employee training
is a key component of the Compliance Program. All employees receive training
during orientation and annually thereafter. Insurance Due to our acquisition of Ramsay, we have two distinct insurance programs
that cover our inpatient facilities. For our inpatient facilities that were not
acquired from Ramsay, we have obtained professional and general liability
insurance for claims in excess of $3 million with an insured limit of $10
million. In December 2003, we increased this insured limit to $20 million. For
the inpatient facilities acquired from Ramsay, we have obtained professional
and general liability insurance for claims in excess of $500,000 with an
insured limit of $25 million. These policies include umbrella coverage of $20
million and $25 million, respectively. The self-insured reserves for
professional and general liability risks are calculated based on historical claims,
demographic factors, industry trends, severity factors, and other actuarial
assumptions calculated by an independent third party. The self-insured reserve
is discounted to its
present value using a 5% discount rate. This estimated accrual for professional
and general liabilities could be significantly affected should current and
future occurrences differ from historical claim trends and expectations. We
have established a captive insurance company to manage this additional
self-insured retention for our inpatient facilities not acquired from Ramsay.
We plan to merge these plans in the near future. While claims are monitored closely when estimating professional and general
liability accruals, the complexity of the claims and wide range of potential
outcomes often hampers timely adjustments to the assumptions used in these
estimates. We believe that our insurance coverage conforms to industry
standards. There are no assurances, however, that our insurance will cover all
claims (e.g., claims for punitive damages) or that claims in excess of our
insurance coverage will not arise. A successful lawsuit against us that is not
covered by, or is in excess of, our insurance coverage may have a material
adverse effect on our business, financial condition and results of operations. Employees As of December 31, 2003, we employed approximately 6,780 employees, of
whom approximately 4,810 are full-time employees. Approximately 4,940
employees staff our owned and leased inpatient behavioral health care
facilities, approximately 1,780 employees staff our inpatient management
contracts and approximately 60 are in corporate management including finance,
accounting, development, utilization review, training and education,
information systems, member services, and human resources. None of our
employees is subject to a collective bargaining agreement and we believe that
our employee relations are good. 16




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##### Table of Contents



Available Information We make available free of charge through our website, which you can find
at www.psysolutions.com, our Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K, and amendments to these reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the Securities and Exchange Commission. 
 Item 2. Properties. At December 31, 2003, our inpatient behavioral health care facilities
division operated 24 owned or leased inpatient behavioral health care
facilities with approximately 3,100 licensed beds in 14 states. The following
table sets forth the name, location, number of licensed beds and the
acquisition date for each of our owned and leased inpatient behavioral health
care facilities. DateFacility
    
    Location
    
    Beds
    
    Own/Lease
    
    Acquired(1)Cypress Creek Hospital
    
    Houston, TX
    
    94
    
    Own
    
    9/01West Oaks Hospital
    
    Houston, TX
    
    160
    
    Own
    
    9/01Texas NeuroRehab Center
    
    Austin, TX
    
    127
    
    Own
    
    11/01Holly Hill Hospital
    
    Raleigh, NC
    
    108
    
    Own
    
    12/01Riveredge Hospital
    
    Chicago, IL
    
    210
    
    Own
    
    7/02Whisper Ridge Behavioral Health System
    
    Charlottesville, VA
    
    58
    
    Lease
    
    4/03Cedar Springs Behavioral Health System
    
    Colorado Springs, CO
    
    110
    
    Own
    
    4/03Laurel Ridge Treatment Center
    
    San Antonio, TX
    
    196
    
    Own
    
    4/03San Marcos Treatment Center
    
    San Marcos, TX
    
    265
    
    Own
    
    4/03The Oaks Treatment Center
    
    Austin, TX
    
    118
    
    Own
    
    4/03Shadow Mountain Behavioral Health System
    
    Tulsa, OK
    
    148
    
    Own
    
    4/03Laurel Oaks
Behavioral Health Center
    
    Dothan, AL
    
    103
    
    Own
    
    6/03Hill Crest Behavioral Health
    
    Birmingham, AL
    
    189
    
    Own
    
    6/03Gulf Coast Youth Academy
    
    Fort Walton Beach, FL
    
    168
    
    Own
    
    6/03Manatee Palms Youth Services
    
    Bradenton, FL
    
    60
    
    Own
    
    6/03Havenwyck Facility
    
    Auburn Hills, MI
    
    178
    
    Lease
    
    6/03Heartland Behavioral Health
    
    Nevada, MO
    
    172
    
    Own
    
    6/03Brynn Marr Behavioral Health
    
    Jacksonville, NC
    
    76
    
    Own
    
    6/03Mission Vista Hospital
    
    San Antonio, TX
    
    73
    
    Lease
    
    6/03Benchmark Behavioral Health
    
    Woods Cross, UT
    
    170
    
    Own
    
    6/03Macon Behavioral Treatment System
    
    Macon, GA
    
    101
    
    Own
    
    6/03Manatee Adolescent Treatment Services
    
    Bradenton, FL
    
    85
    
    Own
    
    6/03Alliance Health Center
    
    Meridian, MS
    
    109
    
    Own
    
    11/03Calvary Center
    
    Phoenix, AZ
    
    50
    
    Lease
    
    12/03
   (1)
    
    Acquisition dates of April 2003 indicate facilities acquired in connection with The Brown Schools acquisition.
Acquisition dates of June 2003 indicate facilities acquired in connection with the acquisition of Ramsay. In addition, our principal executive offices are located in approximately
7,745 square feet of leased space in Franklin, Tennessee. We do not anticipate
that we will experience any difficulty in renewing our lease upon its 17




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##### Table of Contents



expiration in December 2006, or obtaining different space on comparable
terms if such lease is not renewed. We believe our executive offices and our
hospital property and equipment are generally well maintained, in good
operating condition and adequate for our present needs. 
 Item 3. Legal Proceedings. We are subject to various claims and legal actions that arise in the
ordinary course of our business. In the opinion of management, Psychiatric
Solutions is not currently a party to any proceeding that would have a material
adverse effect on its financial condition or results of operations. 
 Item 4. Submission of Matters to a Vote of Security Holders. None. 
 PART II 
 Item 5. Market For Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Our common stock has traded on the Nasdaq National Market under the symbol
PSYS since August 6, 2002. Prior to August 6, 2002, our common stock was
traded on the Nasdaq National Market under the symbol PMRP. The table below sets forth, for the calendar quarters indicated, the high
and low sales prices per share as reported on the Nasdaq National Market for
our common stock and, prior to August 6, 2002, for PMR Corporations common
stock. The stock prices have been adjusted to reflect a 1-for-3 reverse stock
split effected on August 5, 2002. High
    
    Low2002First Quarter
    
    $
    7.68
    
    
    $
    4.89Second Quarter
    
    $
    11.43
    
    
    $
    3.72Third Quarter
    
    $
    6.75
    
    
    $
    4.75Fourth Quarter
    
    $
    5.94
    
    
    $
    5.002003First Quarter
    
    $
    8.50
    
    
    $
    4.47Second Quarter
    
    $
    10.17
    
    
    $
    7.95Third Quarter
    
    $
    14.51
    
    
    $
    9.53Fourth Quarter
    
    $
    20.95
    
    
    $
    12.26
 At the close of business on March 17, 2004, there were approximately 105
holders of record of our common stock. On May 6, 2002, PMRs board of directors declared a special cash dividend
of $5.10 per share of common stock payable on May 24, 2002 to the stockholders
of record as of the close of business on May 17, 2002. The total amount of the
dividend was approximately $12.3 million. We currently intend to retain future
earnings for use in the expansion and operation of our business. Our Credit
Agreement with Bank of America, N.A. prohibits us from paying
dividends on our common stock. Also,
the Indenture governing our 10 5/8% senior subordinated notes provides certain
financial conditions that must be met in order for us to pay dividends. Subject
to the terms of applicable contracts, the 18




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##### Table of Contents



payment of any future cash dividends will be determined by our Board of
Directors in light of conditions then existing, including our earnings,
financial condition and capital requirements, restrictions in financing
agreements, business opportunities and conditions, and other factors. On April 1, 2003, we sold 2,272,727 shares of our series A convertible
preferred stock for $12.5 million to Oak Investment Partners X, Limited
Partnership, Oak X Affiliates Fund, Limited Partnership, Salix Ventures II,
L.P., Salix Affiliates II, L.P. and The 1818 Mezzanine Fund II, L.P. These
investors purchased an additional 2,272,727 shares of our series A convertible
preferred stock for $12.5 million on June 19, 2003. Our
shares of series A convertible preferred stock were not registered
under the Securities Act of 1933, as amended. We issued these shares
in reliance upon the exception from registration provided in Section
4(2) of the Securities Act and the rules and regulations promulgated
thereunder. Each of these sales was made solely to accredited
investors without the use of an underwriter. The holders of the series A
convertible preferred stock have the right, at any time, at such holders
option, to convert any or all outstanding shares (and fractional shares) of
series A convertible preferred stock, in whole or in part, into shares of our
common stock. In addition, the series A convertible preferred stock will
automatically be converted into shares of our common stock if at any time after
October 1, 2004, our common stock price on the Nasdaq National Market (computed
on a volume-weighted average basis) exceeds $15.00 per share (as adjusted) for
thirty consecutive trading days. Each share of series A convertible preferred
stock is convertible into one share of our common stock. Holders of our series
A convertible preferred stock are entitled to receive pay-in-kind dividends,
compounded quarterly, equal to 5% per share of the original share price through
March 31, 2005. Thereafter, pay-in-kind dividends will compound quarterly at 7%
per share of the original share price. 
 Item 6. Selected Financial Data. The selected financial data presented below for the years ended December
31, 2003, 2002 and 2001, and at December 31, 2003 and December 31, 2002, are
derived from our audited consolidated financial statements included elsewhere
in this Annual Report on Form 10-K. The selected financial data for the years
ended December 31, 2000 and 1999, and at December 31, 2001, 2000 and 1999, are
derived from our audited consolidated financial statements not included herein.
The selected financial data presented below should be read in conjunction with
Managements Discussion and Analysis of Financial Condition and Results of
Operations and with our consolidated financial statements and notes thereto
included elsewhere in this Annual Report on Form 10-K. 19




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##### Table of Contents



Psychiatric Solutions, Inc.Selected Financial DataAs of and for the Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in thousands, except per share amounts)Income Statement Data:Revenue
    
    $
    293,665
    
    
    $
    113,912
    
    
    $
    43,999
    
    
    $
    23,502
    
    
    $
    4,500Costs and expenses:Salaries, wages and employee benefits
    
    
    153,498
    
    
    
    62,326
    
    
    
    26,183
    
    
    
    15,257
    
    
    
    4,350Other operating expenses
    
    
    99,045
    
    
    
    35,716
    
    
    
    11,322
    
    
    
    5,826
    
    
    
    1,609Provision for bad debts
    
    
    6,315
    
    
    
    3,681
    
    
    
    662
    
    
    
    467
    
    
    
    529Depreciation and amortization (1)
    
    
    5,754
    
    
    
    1,770
    
    
    
    945
    
    
    
    757
    
    
    
    234Interest expense
    
    
    14,781
    
    
    
    5,564
    
    
    
    2,660
    
    
    
    1,723
    
    
    
    371Other expenses (2)
    
    
    5,271
    
    
    
    178
    
    
    
    1,237
    
    
    
    
    
    
    
    Total costs and expenses
    
    
    284,664
    
    
    
    109,235
    
    
    
    43,009
    
    
    
    24,030
    
    
    
    7,093Income (loss) from continuing operations
before income taxes
    
    
    9,001
    
    
    
    4,677
    
    
    
    990
    
    
    
    (528
    )
    
    
    (2,593
    )Provision for (benefit from) income taxes
    
    
    3,785
    
    
    
    (1,007
    )
    
    
    
    
    
    
    
    
    
    
    Income (loss) from continuing operations
    
    $
    5,216
    
    
    $
    5,684
    
    
    $
    990
    
    
    $
    (528
    )
    
    $
    (2,593
    )Net income (loss) available to common
stockholders
    
    $
    4,405
    
    
    $
    5,684
    
    
    $
    2,578
    
    
    $
    (1,916
    )
    
    $
    (6,877
    )Basic earnings (loss) per share from
continuing operations
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.20
    
    
    $
    (0.11
    )
    
    $
    (0.64
    )Basic earnings (loss) per share
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.51
    
    
    $
    (0.40
    )
    
    $
    (1.69
    )Shares used in computing basic earnings (loss)
per share
    
    
    8,370
    
    
    
    6,111
    
    
    
    5,010
    
    
    
    4,817
    
    
    
    4,062Diluted earnings (loss) per share from
continuing operations
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.49
    
    
    $
    (0.11
    )
    
    $
    (0.64
    )Diluted earnings (loss) per share
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.19
    
    
    $
    (0.40
    )
    
    $
    (1.69
    )Shares used in computing diluted earnings
(loss) per share from continuing operations
    
    
    11,749
    
    
    
    6,986
    
    
    
    5,309
    
    
    
    4,817
    
    
    
    4,062
 20




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##### Table of Contents



Psychiatric Solutions, Inc.Selected Financial Data (continued)As of and for the Years Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(Dollars in thousands, except per share amounts)Balance Sheet Data:Cash
    
    $
    44,832
    
    
    $
    2,392
    
    
    $
    1,262
    
    
    $
    336
    
    
    $
    1,164Working capital (deficit)
    
    
    66,946
    
    
    
    2,369
    
    
    
    (3,624
    )
    
    
    (4,571
    )
    
    
    920Property and equipment, net
    
    
    149,757
    
    
    
    33,547
    
    
    
    17,980
    
    
    
    308
    
    
    
    300Total assets
    
    
    348,635
    
    
    
    90,138
    
    
    
    54,294
    
    
    
    26,356
    
    
    
    13,154Total debt
    
    
    175,003
    
    
    
    43,822
    
    
    
    36,338
    
    
    
    16,641
    
    
    
    6,428Series A convertible preferred stock
    
    
    25,316
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity
    
    
    91,328
    
    
    
    30,549
    
    
    
    9,238
    
    
    
    6,235
    
    
    
    5,817Operating Data:Number of facilities
    
    
    24
    
    
    
    5
    
    
    
    4
    
    
    
    
    
    
    
    Number of licensed beds
    
    
    3,128
    
    
    
    699
    
    
    
    489
    
    
    
    
    
    
    
    Admissions
    
    
    35,824
    
    
    
    14,737
    
    
    
    3,027
    
    
    
    
    
    
    
    Patient days
    
    
    678,506
    
    
    
    145,575
    
    
    
    30,511
    
    
    
    
    
    
    
    Average length of stay
    
    
    19
    
    
    
    10
    
    
    
    10
    
    
    
    
    
    
    
    
    (2)     Refer to the notes to the
consolidated financial statements regarding our
adoption of Statement of Financial Accounting Standards No. 145, Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections (SFAS 145). As a result of our adoption of SFAS 145, we
have reclassified certain losses on refinancing of long-term debt previously
reported as an extraordinary item to a component of income from continuing
operations. 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis should be read in conjunction with
the selected financial data and the accompanying consolidated financial
statements and related notes thereto included in this Annual Report on Form
10-K. Overview Psychiatric
Solutions completed a number of significant transactions in 2003. Through
acquisitions, we increased our inpatient facility operations nearly fivefold to
24 inpatient facilities and 3,128 licensed beds at December 31, 2003 from five
inpatient facilities and 699 licensed beds at December 31, 2002. We also
raised capital through offerings of our common stock, series A convertible
preferred stock and debt securities, as well as borrowings from our credit
facility. As a result, we ended 2003 with nearly $45 million in cash, $67
million in working capital and $150 million in fixed assets, all
significant increases from our 2002 levels. We believe these
developments position us as a
leading provider of inpatient behavioral health care services in the United
States. We also believe that our singular focus on the provision of behavioral health care services allows us to operate more efficiently and
provide higher quality care than our competitors. Our business is characterized
by diversified sources of revenue, stable cash flows and low capital
expenditure requirements. 21




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##### Table of Contents



Our business strategy is to acquire inpatient behavioral health care
facilities and improve operating results within new and existing inpatient
facilities and our other inpatient behavioral health care operations.
We completed our first significant acquisition in 2000 when we
acquired Sunrise Behavioral Health, Ltd. and its inpatient behavioral
health care management contracts. We continued implementing our
acquisition strategy in 2001 with the acquisition of four
inpatient behavioral health care facilities. In 2002, we acquired one
inpatient behavioral health care facility and merged with PMR, a public company
and operator of inpatient behavioral health care management contracts. 2003
marked our largest acquisitions to date with the purchase of six inpatient
behavioral health care facilities from The Brown Schools and the acquisition of
Ramsay, an operator of 11 owned or leased inpatient behavioral health care
facilities and ten contracts to manage inpatient behavioral health care
facilities for certain state governmental agencies. We strive to improve the operating results of new and existing inpatient
behavioral health care operations by providing the highest quality service,
expanding referral networks and marketing initiatives and meeting increased
demand for our services by expanding our services and developing new services.
We also improve operating results by optimizing staffing ratios, controlling
contract labor costs and reducing supply costs through group purchasing. During
2003, we increased our revenue from owned and leased inpatient facilities by
approximately 9% as compared to our 2002 revenue from owned and leased
inpatient facilities through same-facility growth. Same-facility growth also
produced gains in owned and leased inpatient facility admissions and patient
days of approximately 4% and 7%, respectively, in 2003 as compared to 2002.
Same-facility growth refers to the comparison of the five inpatient facilities
owned during 2002 with the comparable period in 2003. We owned four inpatient
facilities throughout 2002 and acquired a fifth inpatient facility on July 1,
2002. Recent Acquisitions On March 1, 2004, we acquired two inpatient psychiatric facilities from
Brentwood Behavioral Health for $28 million cash with an earn-out of up to $5
million contingent upon future financial results. The facilities, which have an
aggregate of 311 licensed beds, are located in Shreveport, Louisiana and
Jackson, Mississippi. On November 1, 2003, we acquired the 109-bed Alliance Health Center
located in Meridian, Mississippi. Alliance Health Center is a licensed acute
care hospital that provides psychiatric care for children, adolescents and
adults. In addition, a 60-bed residential treatment center is under
construction and is scheduled to open during the second quarter of 2004. On June 30, 2003, we consummated the acquisition of Ramsay, a public
company that traded on the Nasdaq SmallCap Market under the symbol RYOU, for
approximately $81.3 million, consisting of $56.2 million in cash, or $5.00 per
share, $22.3 million in net assumed debt that was repaid in connection with the
acquisition and $2.8 million in fees and expenses. We financed the acquisition
of Ramsay with proceeds from the issuance of $150 million in 10 5/8% senior
subordinated notes and an issuance of $12.5 million of our series A convertible
preferred stock. The 11 owned or leased inpatient behavioral health care
facilities we acquired from Ramsay, which have an aggregate of 1,292 beds, are
located primarily in the Southeastern region of the United States with
locations also in Michigan, Missouri and Utah. In the acquisition, we also
assumed 10 contracts to manage inpatient behavioral health care facilities for
government agencies in Florida, Georgia and Puerto Rico. In April 2003, we consummated the acquisition of six inpatient behavioral
health care facilities from The Brown Schools for $63.0 million in cash. The
six inpatient facilities, which have an aggregate of 895 licensed beds, are
located in Austin, San Antonio and San Marcos, Texas; Charlottesville,
Virginia; Colorado Springs, Colorado; and Tulsa, Oklahoma. The Brown Schools
offer a full continuum of care for troubled adolescents and adults. We financed
the acquisition of The Brown Schools with proceeds from the private placement
of $12.5 million of our series A convertible preferred stock and an increase in
funding under our credit facility. Acquiring inpatient behavioral health care facilities is a key part of our
business strategy. Because we have grown through acquisitions accounted for as
purchases, it is difficult to make meaningful comparisons between our financial
statements for the fiscal periods presented. Sources of Revenue 22




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##### Table of Contents



Patient Service Revenue Patient service revenue is generated by our inpatient facilities as a
result of services provided to patients within the inpatient behavioral health
care facility setting. Patient service revenue is reported on an accrual basis
in the period in which services are rendered, at established rates, regardless
of whether collection in full is expected. Patient service revenue includes
amounts estimated by management to be reimbursable by Medicare and Medicaid
under provisions of cost or prospective reimbursement formulas in effect.
Amounts received are generally less than the established billing rates of the
inpatient facilities and the differences are reported as deductions from
patient service revenue at the time the service is rendered. For the year ended
December 31, 2003, patient service revenue comprised approximately 76.1% of our
total revenue. Management Contract Revenue Management contract revenue is earned by our inpatient management contract
division. The inpatient management contract division receives contractually
determined management fees from hospitals and clinics for providing psychiatric
unit management and development services as well as management fees for
managing inpatient behavioral health care facilities for government agencies.
For the year ended December 31, 2003, management contract revenue comprised
approximately 23.9% of our total revenue. Results of Operations The following table illustrates our consolidated results of operations for
the years ended December 31, 2003, 2002 and 2001 (dollars in thousands). Results of Operations, Consolidated Psychiatric SolutionsFor the Year Ended December 31,2003
    
    
    
    
    
    2002
    
    
    
    
    
    2001Amount
    
    %
    
    Amount
    
    %
    
    Amount
    
    %Revenue
    
    $
    293,665
    
    
    
    100.0
    %
    
    $
    113,912
    
    
    
    100.0
    %
    
    $
    43,999
    
    
    
    100.0
    %Salaries, wages, and employee benefits
    
    
    153,498
    
    
    
    52.3
    %
    
    
    62,326
    
    
    
    54.7
    %
    
    
    26,183
    
    
    
    59.5
    %Professional fees
    
    
    33,293
    
    
    
    11.3
    %
    
    
    14,373
    
    
    
    12.6
    %
    
    
    7,039
    
    
    
    16.0
    %Supplies
    
    
    17,074
    
    
    
    5.8
    %
    
    
    5,325
    
    
    
    4.7
    %
    
    
    1,241
    
    
    
    2.8
    %Provision for bad debts
    
    
    6,315
    
    
    
    2.2
    %
    
    
    3,681
    
    
    
    3.2
    %
    
    
    662
    
    
    
    1.5
    %Other operating expenses
    
    
    48,678
    
    
    
    16.6
    %
    
    
    16,018
    
    
    
    14.1
    %
    
    
    3,042
    
    
    
    6.9
    %Depreciation and amortization
    
    
    5,754
    
    
    
    2.0
    %
    
    
    1,770
    
    
    
    1.6
    %
    
    
    945
    
    
    
    2.1
    %Interest expense, net
    
    
    14,781
    
    
    
    5.0
    %
    
    
    5,564
    
    
    
    4.9
    %
    
    
    2,660
    
    
    
    6.0
    %Other expenses:Loss on refinancing long-term debt
    
    
    4,856
    
    
    
    1.7
    %
    
    
    86
    
    
    
    0.1
    %
    
    
    1,237
    
    
    
    2.8
    %Change in valuation of put warrants
    
    
    960
    
    
    
    0.3
    %
    
    
    
    
    
    
    0.0
    %
    
    
    
    
    
    
    0.0
    %Change in reserve on stockholder notes
    
    
    (545
    )
    
    
    -0.2
    %
    
    
    92
    
    
    
    0.1
    %
    
    
    
    
    
    
    0.0
    %Income before income taxes
    
    
    9,001
    
    
    
    3.1
    %
    
    
    4,677
    
    
    
    4.1
    %
    
    
    990
    
    
    
    2.3
    %Provision for income taxes
    
    
    3,785
    
    
    
    1.3
    %
    
    
    (1,007
    )
    
    
    -0.9
    %
    
    
    
    
    
    
    0.0
    %Net income
    
    $
    5,216
    
    
    
    1.8
    %
    
    $
    5,684
    
    
    
    5.0
    %
    
    $
    990
    
    
    
    2.3
    %
 Year Ended December 31, 2003 Compared To Year Ended December 31, 2002 Revenue. Revenue from operations was $293.7 million for the year ended
December 31, 2003 compared to $113.9 million for the year ended December 31,
2002, an increase of $179.8 million or 157.9%. Revenue from owned and leased
inpatient facilities accounted for $223.3 million of the 2003 results compared
to $81.9 million of the 2002 results, an increase of $141.4 million or 172.5%.
The increase in revenues from owned and leased inpatient facilities relates
primarily to revenues of $14.9 million during the first six months of 2003 for
Riveredge Hospital acquired in July 2002, $57.3 million during 2003 for The
Brown Schools acquired in April 2003 and $59.6 million for the owned and leased
inpatient facilities acquired from Ramsay on June 30, 2003. The remainder of
the increase 23




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in revenues from owned and leased inpatient facilities is primarily
attributable to growth in admissions and patient days of 4.1% and 7.0%,
respectively, on a same-facility basis. Revenue from inpatient management
contracts accounted for $70.3 million of the 2003 results compared to $32.0
million of the 2002 results, an increase of $38.3 million or 119.7%. The
increase in revenues from inpatient management contracts relates to revenues of
$13.6 million from inpatient management contracts acquired from PMR in August
2002 and $22.6 million for Ramsays inpatient management contracts acquired in
June 2003. The remainder of the increase in revenues from inpatient management
contracts relates to growth of approximately $3.4 million in our contract to
provide case management services in and around Nashville, Tennessee. This
growth was offset by a reduction in the number of inpatient unit management
contracts from 48 at December 31, 2002 to 42 at December 31, 2003, impacting
revenues by approximately $1.2 million. Salaries, wage, and employee benefits. Salaries, wages and employee
benefits expense was $153.5 million in 2003, or 52.3% of revenue for the year
ended December 31, 2003, compared to $62.3 million in 2002, or 54.7% of revenue
for the year ended December 31, 2002. Salaries, wages and employee benefits
expense from owned and leased inpatient facilities was $122.5 million in 2003,
or 54.9% of 2003 revenue from owned and leased inpatient facilities, compared
to $47.0 million in 2002, or 57.4% of 2002 revenue from owned and leased
inpatient facilities. Same-facility salaries, wages and employee benefits
expense from owned and leased inpatient facilities was $48.2 million in 2003,
or 53.9% of 2003 same-facility revenue from owned and leased inpatient
facilities. This decrease in salaries, wages and employee benefits expense as a
percentage of revenue from owned and leased inpatient facilities relates to
efforts within our owned and leased inpatient facilities to maintain staffing
levels on higher volumes. Salaries, wages and employee benefits expense from
inpatient management contracts was $27.5 million in 2003, or 39.1% of 2003
revenue from inpatient management contracts, compared to $13.2 million in 2002,
or 41.2% of 2002 revenue from inpatient management contracts. Same-facility
salaries, wages and employee benefits expense from inpatient management
contracts was $12.0 million in 2003, or 35.2% of 2003 same-facility revenue
from inpatient management contracts. This decrease in same-facility salaries,
wages and employee benefits expense as a percentage of same-facility revenue
from inpatient management contracts relates to our acquisition from PMR of a
contract to provide case management services in and around Nashville,
Tennessee. We incur very little salaries, wages and employee benefits to
provide these services because almost all costs to provide these services are
recorded in other operating expenses because the actual services provided are
subcontracted. Salaries, wages and employee benefits expense for our corporate
office was $2.8 million for 2003 compared to $2.1 million for 2002 as the
result of the addition of staff necessary to manage the inpatient facilities
and inpatient management contracts acquired during 2002 and 2003. Professional fees. Professional fees were $33.3 million in 2003, or 11.3%
of revenue for the year ended December 31, 2003, compared to $14.4 million in
2002, or 12.6% of revenue for the year ended December 31, 2002.Professional
fees from owned and leased inpatient facilities were $26.3 million in 2003, or
11.8% of 2003 revenue from owned and leased inpatient facilities, compared to
$10.3 million in 2002, or 12.6% of 2002 revenue from owned and leased inpatient
facilities. Same-facility professional fees from owned and leased inpatient
facilities were $10.8 million in 2003, or 12.1% of 2003 same-facility revenue
from owned and leased inpatient facilities. This decrease in professional fees
from same-facility owned and leased inpatient facilities as a percentage of
revenue from same-facility owned and leased inpatient facilities was the result
of efforts within our owned and leased inpatient facilities to reduce our
reliance on contract labor. Professional fees from inpatient management
contracts were $5.2 million in 2003, or 7.3% of 2003 revenue from inpatient
management contracts, compared to $3.5 million in 2002, or 11.1% of 2002
revenue from inpatient management contracts. Same-facility professional fees
from inpatient management contracts were $3.6 million in 2003, or 10.6% of 2003
same-facility revenue from inpatient management contracts. Professional fees
for our corporate office were approximately $1.5 million in 2003 compared to
approximately $500,000 in 2002. The increase in professional fees in our
corporate office relates to accounting, legal and other services required to
meet the needs of a public company and achieving our acquisition strategy. Supplies.Supplies expense was $17.1 million in 2003, or 5.8% of revenue
for the year ended December 31, 2003, compared to $5.3 million in 2002, or 4.7%
of revenue for the year ended December 31, 2002. Supplies expense from owned
and leased inpatient facilities was $15.3 million in 2003, or 6.8% of 2003
revenue from owned and leased inpatient facilities, compared to $5.3 million in
2002, or 6.5% of 2002 revenue from owned and leased inpatient facilities.
Same-facility supplies expense from owned and leased inpatient facilities was
$5.9 million in 2003, or 6.6% of 2003 same-facility revenue from owned and
leased inpatient facilities. Supplies expense from inpatient management
contracts was $1.7 million in 2003, or 2.5% of 2003 revenue from inpatient
management 24




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contracts, compared to $40,000 in 2002, or less than 1% of 2002 revenue
from inpatient management contracts. Supplies expense at owned and leased
inpatient facilities has historically comprised the majority of our supplies
expense as a whole; however, our inpatient management contracts segment began
to utilize supplies to a larger extent due to the assumption of ten inpatient
management contracts from Ramsay. Supplies expense for our corporate office
consists of office supplies and are negligible to supplies expense overall. Provision for bad debts. The provision for bad debts was $6.3 million in
2003, or 2.2% of revenue for the year ended December 31, 2003, compared to $3.7
million in 2002, or 3.2% of revenue for the year ended December 31, 2002. The
provision for bad debts at owned and leased inpatient facilities was $6.7
million in 2003, or 3.0% of 2003 revenue from owned and leased inpatient
facilities, compared to approximately $3.5 million in 2002, or 4.3% of 2002
revenue from owned and leased inpatient facilities. This reduction in provision
for bad debts from owned and leased inpatient facilities as a percentage of
owned and leased inpatient facility revenue was driven by the acquisition of
inpatient facilities from The Brown Schools and Ramsay, which have
fewer self-pay accounts. Historically, the provision for bad debts from inpatient
management contracts has amounted to less than 1% of revenue from inpatient
management contracts. Other operating expenses. Other operating expenses were approximately
$48.7 million in 2003, or 16.6% of revenue for the year ended December 31,
2003, compared to $16.0 million in 2002, or 14.1% of revenue for the year ended
December 31, 2002. Other operating expenses for owned and leased inpatient
facilities were $21.7 million in 2003, or 9.7% of 2003 revenue from owned and
leased inpatient facilities, compared to $6.6 million in 2002, or 8.1% of 2002
revenue from owned and leased inpatient facilities. Same-facility other
operating expenses from owned and leased inpatient facilities were $7.9 million
in 2003, or 8.8% of 2003 same-facility revenue from owned and leased inpatient
facilities. This increase in other operating expenses for same-facility owned
and leased inpatient facilities as a percentage of same-facility revenue from
owned and leased inpatient facilities revenue relates primarily to increased
insurance costs in 2003. Other operating expenses for inpatient management
contracts were $24.9 million in 2003, or 35.5% of 2003 revenue from inpatient
management contracts, compared to $7.9 million in 2002, or 24.8% of 2002
inpatient management contract revenue. Same-facility other operating expenses
from inpatient management contracts was $11.1 million in 2003, or 32.5% of 2003
same-facility revenue from inpatient management contracts. This increase in
other operating expenses for same-facility inpatient management contracts as a
percentage of same-facility revenue from inpatient management contracts is
attributable to growth in the contract to provide case management services in
and around Nashville, Tennessee where actual services provided are
subcontracted. Other operating expenses at our corporate office increased to
$1.4 million in 2003 from approximately $1.3 million in 2002. Depreciation and amortization. Depreciation and amortization expense was
$5.8 million for the year ended December 31, 2003 compared to $1.8 million for
the year ended December 31, 2002, an increase of approximately $4.0 million or
222.2%. This increase in depreciation and amortization expense is the result of
the acquisitions of Riveredge Hospital in July 2002, PMR in August 2002, The
Brown Schools in April 2003 and Ramsay in June 2003. Interest expense. Interest expense was $14.8 million for the year ended
December 31, 2003 compared to $5.6 million for the year ended December 31,
2002, an increase of $9.2 million or 164.3%. The increase in interest expense
is primarily attributable to the increase in our long-term debt from
approximately $43.8 million at December 31, 2002 to approximately $175.0
million at December 31, 2003 due to our 10 5/8% senior subordinated note
offering, the expansion of our senior credit facility and the refinancing of
our term loans from CapitalSource Finance LLC (CapSource) with mortgage loans
insured by the U.S. Department of Housing and Urban Development (HUD). The
proceeds from the 10 5/8% senior subordinated notes and the expanded credit
facility were used to finance acquisitions in 2003. Other expenses.Other expenses totaled $5.3 million for the year ended
December 31, 2003 compared to approximately $180,000 for the year ended
December 31, 2002. Other expenses in 2003 consisted of $4.9 million in loss on
the refinancing of our long-term debt, $960,000 in expense recorded to
recognize the change in fair value of stock purchase put warrants (for
additional information on these warrants, see Liquidity and Capital Resources
below) and the release of $545,000 in reserves related to our stockholder
notes. Other expenses in 2002 consisted of approximately $90,000 in loss on the
refinancing of our long-term debt and approximately $90,000 to increase the
reserve related to our stockholder notes. 25




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Year Ended December 31, 2002 Compared To Year Ended December 31, 2001 Revenue. Revenue from continuing operations was $113.9 million for the
year ended December 31, 2002 compared to $44.0 million for the year ended
December 31, 2001, an increase of $69.9 million or 158.9%. Revenue from owned
and leased inpatient facilities accounted for $81.9 million of the 2002 results
compared to $16.0 million of the 2001 results, an increase of $65.9 million or
411.9%. The increase in revenues from owned and leased inpatient facilities
relates primarily to revenues of $11.0 million and $15.0 million during the
first eight months of 2002 for Cypress Creek Hospital and West Oaks Hospital,
respectively, acquired in September 2001, $14.4 million during the first ten
months of 2002 for Texas NeuroRehab Hospital acquired in November 2001, $10.8
million during the first eleven months of 2002 for Holly Hill Hospital acquired
in December 2001 and $13.2 million during 2003 for Riveredge Hospital acquired
in July 2002. Revenue from inpatient management contracts accounted for $32.0
million of the 2002 results compared to $28.0 million of the 2001 results, an
increase of $4.0 million or 14.3%. The increase in revenues from our inpatient
management contracts relates to the additional inpatient management contracts
assumed in the merger with PMR. Salaries, wage, and employee benefits. Salaries, wages and employee
benefits expense was $62.3 million in 2002, or 54.7% of revenue for the year
ended December 31, 2002, compared to $26.2 million in 2001, or 59.6% of revenue
for the year ended December 31, 2001. Salaries, wages and employee benefits
expense from owned and leased inpatient facilities was $47.0 million in 2002,
or 57.4% of 2002 revenue from owned and leased inpatient facilities, compared
to $9.5 million in 2001, or 59.2% of 2001 revenue from owned and leased
inpatient facilities. Same-facility salaries, wages and employee benefits
expense from owned and leased inpatient facilities was $10.6 million in 2002,
or 60.5% of same-facility revenue from owned and leased inpatient facilities.
Salaries, wages and employee benefits expense from inpatient management
contracts was $13.2 million in 2002, or 41.3% of 2002 revenue from inpatient
management contracts, compared to $15.5 million in 2001, or 55.3% of 2001
revenue from inpatient management contracts. Same-facility salaries, wages and
employee benefits expense from inpatient management contracts was $12.9 million
in 2002, or 52.7% of same-facility 2002 revenue from inpatient management
contracts. Salaries, wages and employee benefits expense for our corporate
office was $2.1 million for 2002 compared to $1.2 million for 2001 as the
result of the addition of staff necessary to manage the inpatient facilities
acquired during the latter part of 2001 and July 2002. Professional fees. Professional fees were $14.4 million in 2002, or 12.6%
of revenue for the year ended December 31, 2002, compared to $7.0 million in
2001, or 16.0% of revenue for the year ended December 31, 2001.Professional
fees from owned and leased inpatient facilities were $10.3 million in 2002, or
12.5% of 2002 revenue from owned and leased inpatient facilities, compared to
$2.6 million in 2001, or 16.1% of 2001 revenue from owned and leased inpatient
facilities. Same-facility professional fees from owned and leased inpatient
facilities were $2.2 million in 2002, or 12.6% of same-facility revenue from
owned and leased inpatient facilities. Professional fees from inpatient
management contracts were $3.5 million in 2002, or 11.1% of 2002 revenue from
inpatient management contracts, compared to $4.1 million in 2001, or 14.7% of
2001 revenue from inpatient management contracts. Same-facility professional
fees from inpatient management contracts were $3.5 million in 2002, or 14.2% of
same-facility 2002 revenue from inpatient management contracts. Professional
fees for our corporate office were approximately $500,000 in 2002 compared to
approximately $300,000 in 2001. The increase in professional fees at our
corporate office relates to accounting, legal, and other services required as a
public company. Supplies.Supplies expense was $5.3 million in 2002, or 4.7% of revenue
for the year ended December 31, 2002, compared to $1.2 million in 2001, or 2.8%
of revenue for the year ended December 31, 2001. Supplies expense at owned and
leased inpatient facilities comprise almost the entire amount of our
consolidated supplies expense. Supplies necessary at our owned and leased
inpatient facilities include medical, pharmaceutical and office supplies. The
increase in supplies expense as a percentage of revenue is due to our
acquisition of four inpatient facilities in the last four months of 2001 and
Riveredge Hospital in July 2002. Supplies expense for inpatient management
contracts and our corporate office consists of office supplies and is
negligible to our supplies expense overall. Provision for bad debts. The provision for bad debts was $3.7 million in
2002, or 3.2% of revenue for the year ended December 31, 2002, compared to
$662,000 in 2001, or 1.5% of revenue for the year ended December 31, 2001. The
provision for bad debts at owned and leased inpatient facilities was $3.5
million in 2002, or 4.3% of 2002 revenue from owned and leased inpatient
facilities, compared to approximately $400,000 in 2001, or 2.4% of 2001 26




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revenue from owned and leased inpatient facilities. This increase in
provision for bad debts at owned and leased inpatient facilities as a
percentage of owned and leased inpatient facility revenue relates to changes in
our payer mix and the impact of our acquisitions. Other operating expenses. Other operating expenses were approximately
$16.0 million in 2002, or 14.1% of revenue for the year ended December 31,
2002, compared to $3.0 million in 2001, or 6.9% of revenue for the year ended
December 31, 2001. Other operating expenses for owned and leased inpatient
facilities were $6.6 million in 2002, or 8.0% of 2002 revenue from owned and
leased inpatient facilities, compared to $1.1 million in 2001, or 6.9% of 2001
revenue from owned and leased inpatient facilities. Same-facility other
operating expenses from owned and leased inpatient facilities were $1.3 million
in 2002, or 7.3% of same-facility revenue from owned and leased inpatient
facilities. This increase in same-facility other operating expenses for owned
and leased inpatient facilities as a percentage of same-facility revenue from
owned and leased inpatient facilities relates primarily to increased insurance
costs in 2002. Other operating expenses for inpatient management contracts were
$7.9 million in 2002, or 24.9% of 2002 revenue from inpatient management
contacts, compared to $1.6 million in 2001, or 5.6% of 2001 revenue from
inpatient management contracts. Same-facility other operating expenses from
inpatient management contracts were $1.3 million in 2002, or 5.3% of
same-facility 2002 revenue from inpatient management contracts. This overall
increase in other operating expenses for inpatient management contracts as a
percentage of revenue from inpatient management contracts is attributable to
our assumption from PMR of a contract to provide case management services in
and around Nashville, Tennessee where actual services provided are
subcontracted and all related expenses are recorded in other operating
expenses. Other operating expenses at our corporate office increased to $1.3
million in 2002 from approximately $400,000 in 2001 primarily due to increased
insurance costs in 2002. Depreciation and amortization. Depreciation and amortization expense was
$1.8 million for the year ended December 31, 2002 compared to $945,000 for the
year ended December 31, 2001, an increase of approximately $800,000 or 87.3%.
This increase in depreciation and amortization expense is the result of full
year operations in 2002 for the inpatient facilities acquired in the last four
months of 2001 as well as our acquisition of Riveredge Hospital in July 2002. Interest expense. Interest expense was $5.6 million for the year ended
December 31, 2002 compared to $2.7 million for the year ended December 31,
2001, an increase of $2.9 million or 107.4%. The increase in interest expense
is due to borrowings under our senior credit facility as well as subordinated
debt obtained to fund acquisitions in 2001 and 2002. Liquidity and Capital Resources As of December 31, 2003, we had working capital of $66.9 million,
including cash and cash equivalents of $44.8 million, compared to working
capital of $2.4 million at December 31, 2002. We did not maintain a balance
under our revolving line of credit at December 31, 2003 whereas we had a
balance of $5.4 million on our revolving line of credit at December 31, 2002.
The increase in working capital is primarily due to cash raised in our public
equity offering of approximately $48.9 million as well as cash provided by
operating activities of $15.5 million during the year ended December 31, 2003. Cash provided by operating activities was $15.5 million for the year ended
December 31, 2003 compared to $8.9 million for the year ended December 31,
2002. The increase in cash flows from operating activities was primarily due to
the cash generated from our acquisitions of the operations of Ramsay and the
six inpatient facilities from The Brown Schools in 2003 and by the full year
operations of PMR and Riveredge Hospital, which we acquired in 2002. Cash used in investing activities was $105.3 million for the year ended
December 31, 2003 compared to cash provided by investing activities of $4.2
million for the year ended December 31, 2002. Cash used in investing activities
for the year ended December 31, 2003 was primarily the result of $100.4 million
cash paid for acquisitions, net of cash acquired. Cash used in the acquisition
of The Brown Schools was approximately $13.4 million, of which $12.5 million
came from our private placement of series A convertible preferred stock. The 27




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balance of The Brown Schools purchase of approximately $51.2 million was
financed from our former credit facility with CapSource. Cash used in the
acquisition of Ramsay, including the subsequent purchase for $3.6 million of
real estate at our Macon facility, was $84.4 million, net of cash acquired of
approximately $4 million. Cash used in the acquisition of Alliance Health
Center was approximately $1.4 million, which paid for certain transaction
costs. The $12.5 million purchase price for Alliance Health Center was financed
from our former credit facility with CapSource. Cash used for other
acquisitions, including Calvary Center, was approximately $1.2 million. In
January 2004, we paid the balance of the purchase price for the Calvary Center
of approximately $3.3 million after certain state licensure matters were
resolved. The remainder of cash used in investing activities for the year ended
December 31, 2003 included capital expenditures of approximately $5.8 million
and purchases of investments of approximately $1.0 million offset by changes in
other long-term assets of approximately $1.8 million. Capital expenditures are
generally not for the expansion of capacity within our inpatient facilities and
historically approximate 2% of our net revenues. During 2003, our capital
expenditures included typical non-expansion capital expenditures, as well as
expenditures to upgrade computer systems at some of our newly acquired
facilities and certain expansion projects. These expansion projects included
the construction of a 60-bed RTC at Alliance Health Center. Cash provided by investing activities for
the year ended December 31, 2002 was the result of cash acquired of
approximately $6.0 million in our acquisition of PMR offset by cash used in
capital purchases of $1.5 million and other assets of $612,000. Cash provided by financing activities was $132.3 million for the year
ended December 31, 2003. During 2003, we received cash from borrowings of
approximately $62.0 million, net of refinancings and not including proceeds
from borrowings that were paid directly to the sellers of our acquisitions.
Also during 2003, we received $48.9 million and $24.5 million, net of issuance
costs, from the secondary offering of our common stock and from our issuance of
series A convertible preferred stock, respectively. These sources of cash from
financing activities were offset by cash payments during 2003 of $2.0 million
and $1.4 million for capitalized loan costs on new debt and early termination
fees on debt that we refinanced, respectively. Finally, we received
approximately $300,000 in cash from the exercise of stock options and warrants
during 2003. Cash used in financing activities of $12.0 million for the year
ended December 31, 2002 consisted primarily of payments on long-term debt, not
including proceeds from borrowings that were paid directly to the sellers of
our acquisitions. On
January 26, 2004, we entered into an interest rate swap
agreement to manage our exposure to fluctuations in interest rates.
The swap agreement effectively converts $20 million of fixed-rate
long-term debt to a LIBOR indexed variable rate instrument plus an
agreed upon interest rate spread. On January 6, 2004, we entered into a revolving credit facility with Bank
of America, N.A. of up to $50 million. The revolving credit facility has a
three-year term and is secured by all real property owned by us or our
subsidiaries that has a value in excess of $2.5 million, the stock of all of
our operating subsidiaries and substantially all of the personal
property owned by us
or our subsidiaries. On November 5, 2003, we borrowed approximately $12.1 million under a
mortgage loan agreement insured by HUD, secured by real estate located at
Riveredge Hospital near Chicago, Illinois. Interest accrues on the HUD loan at
5.65% and principal and interest are payable in 420 monthly installments
through December 2038. We used the proceeds from the loan to repay
approximately $11.2 million of our term debt under our former amended and
restated senior secured credit facility, pay certain financing costs, and fund
required escrow amounts for future improvements to the property. On August 28, 2003, we borrowed approximately $6.8 million under a
mortgage loan agreement insured by HUD, secured by real estate located at West
Oaks Hospital in Houston, Texas. Interest accrues on the HUD loan at 5.85% and
principal and interest are payable in 420 monthly installments through
September 2038. We used the proceeds from the loan to repay approximately $5.8
million of our term debt under our former amended and restated senior secured
credit facility, pay certain financing costs, and fund required escrow amounts
for future improvements to the property. On June 30, 2003, we issued $150 million in 10 5/8% senior subordinated
notes, which are fully and unconditionally guaranteed on a senior subordinated
basis by substantially all of our existing operating subsidiaries. Proceeds
from the issuance of the senior subordinated notes and the private placement of
$12.5 million in series A convertible preferred stock were used to finance the
acquisition of Ramsay and pay down substantially all of our long-term debt.
Interest on the senior subordinated notes accrues at the rate of 10.625% per
annum and is payable semi-annually in arrears on June 15 and December 15,
commencing on December 15, 2003. The senior subordinated notes will mature on
June 15, 2013. 28




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In connection with the closing of the sale of our 10 5/8% senior
subordinated notes, we amended and restated our former senior credit facility
with CapSource to increase our senior secured revolving line of credit to $50.0
million from $28.0 million and to refinance $36.0 million in term loans with the
proceeds from the sale of our 10 5/8% senior subordinated notes. Our former
credit facility was secured by substantially all of our assets and the stock of
our existing operating subsidiaries. The term loans accrued interest at the
Citibank, N.A. prime rate plus 4.5% subject to a floor of 8.75% and were due in
November 2003. We refinanced the remaining $11.2 million in term loans with a
mortgage loan insured by HUD on November 5, 2003. The revolving line of credit
accrued interest at the Citibank, N.A. prime rate plus 2% subject to a floor of
6.25% and was due in June 2006. We were required
to pay interest on a minimum balance of $17.5 million under our revolving line
of credit. At December 31, 2003, the interest rate under
the revolving line of credit was 6.25%. As of December 31, 2003, we had $50.0
million available under the revolving line of credit. We were required to pay
on a monthly basis an unused fee in the amount of 0.5% per annum on the unused
portion of the amended and restated credit facility. Such fees were
approximately $110,000 for the year ended December 31, 2003. On April 1, 2003, concurrent with the acquisition of The Brown Schools, we
received $12.5 million from the private placement of 2,272,727 shares of our
series A convertible preferred stock with affiliates of Oak Investment Partners
and Salix Ventures and The 1818 Mezzanine Fund II, L.P. (the 1818 Fund).
These investors purchased an additional 2,272,727 shares of our series A
convertible preferred stock for $12.5 million on June 19, 2003. The proceeds
were used to acquire The Brown Schools and Ramsay. Each share of series A
convertible preferred stock is convertible into one share of our common stock.
Holders of our series A convertible preferred stock are entitled to receive
pay-in-kind dividends, compounded quarterly, equal to 5% per share of the
original share price through March 31, 2005. Thereafter, pay-in-kind dividends
will compound quarterly at 7% per share of the original share price. The impact
of the series A convertible preferred stock on diluted earnings per share is
calculated using the if-converted method. On April 1, 2003, our former senior credit facility with CapSource was
expanded to approximately $81.0 million with the increase of our revolving line
of credit to $28.0 million from $17.5 million and a new $36.0 million term loan
in addition to our then-existing $17.0 million term loan. We borrowed
approximately $52.2 million during April 2003, including the $36.0 million term
loan and $16.2 million under the revolving line of credit, to partially fund
our acquisition of six inpatient facilities from The Brown Schools. The
revolving line of credit and new $36.0 million term loan were repaid on June
30, 2003 with proceeds from the issuance of our 10 5/8% senior subordinated
notes. On June 28, 2002, we entered into a Securities Purchase Agreement with the
1818 Fund where the 1818 Fund agreed to purchase up to $20 million of senior
subordinated notes with detachable nominal warrants. At closing on June 28,
2002, a total of $10 million of the senior subordinated notes were issued. In
connection with the issuance of the senior subordinated notes to the 1818 Fund,
we issued detachable stock purchase warrants for the purchase of 372,412 shares
of our common stock at an exercise price of $.01 per share. Also, we provided
the 1818 Fund with the ability to require us to repurchase its warrants or the
common stock acquired upon exercise of its warrants at fair market value for
cash. On May 16, 2003, the 1818 Fund exercised its stock purchase warrant to
purchase 372,412 shares of our common stock. Deducting the exercise price of
$0.01 per share based on the closing price of our common stock on May 15, 2003,
the 1818 Fund received 372,039 shares of our common stock from the exercise of
its warrant. In connection with the exercise of the warrants, the 1818 Fund
provided us with a written consent to waive its ability to require that we
repurchase the warrants for cash effective April 1, 2003. On June 30, 2003, we
repaid principal of $10 million, accrued interest and a prepayment penalty of
3% to the 1818 Fund with proceeds from the issuance of our 10 5/8% senior
subordinated notes, and we no longer have the ability to borrow under the
Securities Purchase Agreement with the 1818 Fund. The 1818 Funds right to
require us to repurchase the 372,039 shares of our common stock that it
received upon the exercise of its stock purchase warrant terminated upon the
1818 Funds sale of its shares in our secondary equity offering that we closed
in December 2003. In connection with our acquisition of Sunrise Behavioral Health, Ltd. in
May 2000, we issued subordinated convertible notes in the amount of $3.6
million. The principal amount of these convertible notes and the interest
thereon was converted into 537,908 shares of our common stock in April and May
2003 based on a conversion price of $8.53 per share. In addition, we also
issued two promissory notes totaling $4.5 million in connection with our
acquisitions of three facilities in 2001. At December 31, 2003, one note with a
current principal balance of $1.0 million remained outstanding. This note
accrues interest at 9% per annum and is due June 30, 2005. Among other 29




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customary covenants, the note contains cross-default covenants triggered
by a default of any other indebtedness of at least $1.0 million. We were in
compliance with these covenants as of December 31, 2003. As
part of the determination of our provision for income taxes, we are
required to estimate and record reserves for certain tax positions
that, though we believe are fully supportable, are subject to audit
by taxing authorities. We have accrued for certain tax contingencies
for which the ultimate determination by the taxing authorities is
uncertain. If the taxing authorities were to propose and sustain
assessments on the contingencies, we would incur approximately $4
million in additional tax payments in future years. We believe we
have adequately provided for this tax contingency. We believe that our working capital on hand, cash flows from operations
and funds available under our revolving line of credit will be sufficient to
fund our operating needs, planned capital expenditures and debt service
requirements for the next 12 months. In addition, we are actively seeking acquisitions that fit our corporate
growth strategy and may acquire additional inpatient psychiatric facilities.
Management continually assesses our capital needs and, should the need arise,
we will seek additional financing, including debt or equity, to fund potential
acquisitions or for other corporate purposes. In negotiating such financing,
there can be no assurance that we will be able to raise additional capital on
terms satisfactory to us. Failure to obtain additional financing on reasonable
terms could have a negative effect on our plans to acquire additional inpatient
psychiatric facilities. Obligations and Commitments Payments Due by Period (in thousands)Less than
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 yearsLong term debt obligations
    
    $
    175,003
    
    
    $
    1,023
    
    
    $
    852
    
    
    $
    542
    
    
    $
    172,586Lease obligations
    
    
    25,094
    
    
    
    6,013
    
    
    
    9,752
    
    
    
    6,011
    
    
    
    3,318$
    200,097
    
    
    $
    7,036
    
    
    $
    10,604
    
    
    $
    6,553
    
    
    $
    175,904
 The
fair value of our $150 million 10 5/8% senior subordinated notes
was approximately $167 million as of December 31, 2003. The
carrying value of our other long-term debt, including current
maturities, of $25.0 million and $43.8 million at December 31, 2003 and
December 31, 2002, respectively, approximated fair value. We had no variable
rate debt outstanding at December 31, 2003. Impact of Inflation and Economic Trends Although inflation has not had a material impact on our results of
operations, the health care industry is very labor intensive and salaries and
benefits are subject to inflationary pressures as are rising supply costs which
tend to escalate as vendors pass on the rising costs through price increases.
Some of our freestanding owned, leased and managed inpatient behavioral health
care facilities we operate are experiencing the effects of the tight labor
market, including a shortage of nurses, which has caused and may continue to
cause an increase in our salaries, wages and benefits expense in excess of the
inflation rate. Although we cannot predict our ability to cover future cost
increases, management believes that through adherence to cost containment
policies, labor management and reasonable price increases, the effects of
inflation on future operating margins should be manageable. Our ability to pass
on increased costs associated with providing health care to Medicare and
Medicaid patients is limited due to various federal, state and local laws which
have been enacted that, in certain cases, limit our ability to increase prices.
In addition, as a result of increasing regulatory and competitive pressures and
a continuing industry wide shift of patients into managed care plans, our
ability to maintain margins through price increases to non-Medicare patients is
limited. The behavioral health care industry is typically not directly impacted by
periods of recession, erosions of consumer confidence or other general economic
trends as most health care services are not considered a component of
discretionary spending. However, our inpatient facilities may be indirectly
negatively impacted to the extent such economic conditions result in decreased
reimbursements by federal or state governments or managed care payers. We are
not aware of any economic trends that would prevent us from being able to
remain in compliance with all of our debt covenants and to meet all required
obligations and commitments in the near future. 30




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Critical Accounting Policies Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States. In
preparing our financial statements, we are required to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
and expenses included in the financial statements. Estimates are based on
historical experience and other information currently available, the results of
which form the basis of such estimates. While we believe our estimation
processes are reasonable, actual results could differ from our estimates. The
following represent the estimates considered most critical to our operating
performance and involve the most subjective and complex assumptions and
assessments. Allowance for Doubtful Accounts Our ability to collect outstanding patient receivables from third party
payors and receivables due under our inpatient management contracts is critical
to our operating performance and cash flows. The primary collection risk with regard to patient receivables lies with
uninsured patient accounts or patient accounts for which primary insurance has
paid, but the portion owed by the patient remains outstanding. We estimate the
allowance for doubtful accounts primarily based upon the age of the accounts
since patient discharge date. We continually monitor our accounts receivable
balances and utilize cash collection data to support our estimates of the
provision for doubtful accounts. Significant changes in payor mix or business
office operations could have a significant impact on our results of operations
and cash flows. The primary collection risk with regard to receivables due under our
inpatient management contracts is attributable to contractual disputes. We
estimate the allowance for doubtful accounts for these receivables based
primarily upon the specific identification of potential collection issues. As
with our patient receivables, we continually monitor our accounts receivable
balances and utilize cash collection data to support our estimates of the
provision for doubtful accounts. Allowances for Contractual Discounts The Medicare and Medicaid regulations are complex and various managed care
contracts may include multiple reimbursement mechanisms for different types of
services provided in our inpatient facilities and cost settlement provisions
requiring complex calculations and assumptions subject to interpretation. We
estimate the allowance for contractual discounts on a payor-specific basis
given our interpretation of the applicable regulations or contract terms. The
services authorized and provided and related reimbursement are often subject to
interpretation that could result in payments that differ from our estimates.
Additionally, updated regulations and contract renegotiations occur frequently
necessitating continual review and assessment of the estimation process by our
management. Professional and General Liability We are subject to medical malpractice and other lawsuits due to the nature
of the services we provide. Due to our acquisition of Ramsay, we have two
distinct insurance programs that cover our inpatient facilities. For our
inpatient facilities that were not acquired from Ramsay, we have obtained
professional and general liability insurance for claims in excess of $3 million
with an insured limit of $10 million. In December 2003, we increased this
insured limit to $20 million. For the inpatient facilities acquired from
Ramsay, we have obtained professional and general risks liability insurance for
claims in excess of $500,000 with an insured limit of $25 million. These
policies include umbrella coverage of $20 million and $25 million,
respectively. The self-insured reserves for professional and general liability
risks are calculated based on historical claims, demographic factors, industry trends,
severity factors, and other actuarial assumptions calculated by an independent
third party. The self-insured reserve is discounted to its present value using a 5% discount rate. This
estimated accrual for professional and general liabilities could be
significantly affected should current and future occurrences differ from
historical claim trends and expectations. We have established a captive
insurance company to manage this additional self-insured retention for our
inpatient facilities not acquired from Ramsay. We plan to merge these
plans in the new future. While claims are monitored
closely when estimating professional and general liability accruals, the
complexity of the claims and wide range of potential outcomes often hampers
timely adjustments to the assumptions used in these estimates. 31




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Income Taxes As part of our process for preparing our consolidated financial
statements, our management is required to compute income taxes in each of the
jurisdictions in which we operate. This process involves estimating the
current tax benefit or expense of future deductible and taxable temporary
differences. The future deductible and taxable temporary differences are
recorded as deferred tax assets and liabilities which are components of our
balance sheet. Management then assesses our ability to realize the deferred
tax assets based on reversals of deferred tax liabilities and, if necessary,
estimates of future taxable income. If management determines that some or all
of a deferred tax asset will more likely than not be realized, then a valuation
allowance is recorded against the deferred tax asset. Management must also
assess the impact of acquisitions on the realization of deferred tax assets
subject to a valuation allowance to determine if all or a portion of the
valuation allowance will be offset by reversing taxable differences or future
taxable income of the acquired entity. To the extent the valuation allowance
can be reversed due to the estimated future taxable income of an acquired
entity, then our valuation allowance is reduced accordingly as an adjustment to
purchase price. Forward-Looking Statements This Annual Report on Form 10-K and other materials we have filed or may
file with the Securities and Exchange Commission, as well as information
included in oral statements or other written statements made, or to be made, by
our senior management, contain, or will contain, disclosures that are
forward-looking statements within the meaning of the safe harbor provisions
of The Private Securities Litigation Reform Act of 1995. Forward-looking
statements include all statements that do not relate solely to historical or
current facts and can be identified by the use of words such as may, will,
expect, believe, intend, plan, estimate, project, continue,
should and other comparable terms. These forward-looking statements are based
on the current plans and expectations of management and are subject to a number
of risks and uncertainties, including those set forth below, which could
significantly affect our current plans and expectations and future financial
condition and results. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Stockholders and investors are cautioned not to unduly
rely on such forward-looking statements when evaluating the information
presented in our filings and reports. While it is not possible to identify all these factors, we continue to
face many risks and uncertainties that could cause actual results to differ
from those forward-looking statements, including:  
    
    potential competition that alters or impedes our acquisition
strategy by decreasing our ability to acquire additional inpatient
facilities on favorable terms;
    
    our ability to improve the operations of acquired inpatient
facilities;
    
    our ability to maintain favorable and continuing
relationships with physicians who use our inpatient facilities;
    
    our limited operating history;
    
    our ability to receive timely additional financing on terms
acceptable to us to fund our acquisition strategy and capital
expenditure needs;
    
    risks inherent to the health care industry, including the
impact of unforeseen changes in regulation, reimbursement rates from
federal and state health care programs or managed care companies and
exposure to claims and legal actions by patients and others;
    
    our ability to retain key employees who are instrumental to
our successful operations;
    
    our ability to ensure confidential information is not
inappropriately disclosed and that we are in compliance with federal
and state health information privacy standards; and 32




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
    
    our ability to comply with federal and state governmental
regulation covering healthcare-related products and services
on-line, including the regulation of medical devices and the
practice of medicine and pharmacology. In addition, future trends for pricing, margins, revenues and
profitability remain difficult to predict in the industries that we serve. Risk Factors If we fail to comply with extensive laws and government regulations, we
could suffer penalties or be required to make significant changes to our
operations. The health care industry is required to comply with extensive and complex
laws and regulations at the federal, state and local government levels relating
to, among other things:  
    
    billing for services;
    
    relationships with physicians and other referral sources:
    
    adequacy of medical care;
    
    quality of medical equipment and services;
    
    qualifications of medical and support personnel;
    
    confidentiality, maintenance and security issues associated
with health-related information and medical records;
    
    licensure;
    
    hospital rate or budget review;
    
    operating policies and procedures; and
    
    addition of facilities and services. Among these laws are the Anti-kickback Statute and the Stark Law. These
laws impact the relationships that we may have with physicians and other
referral sources. The OIG has enacted safe harbor regulations that outline
practices that are deemed protected from prosecution under the Anti-kickback
Statute. Our current financial relationships with physicians and other
referral sources may not qualify for safe harbor protection under the
Anti-kickback Statute. Failure to meet a safe harbor does not mean that the
arrangement automatically violates the Anti-kickback Statute, but may subject
the arrangement to greater scrutiny. Further, we cannot guarantee that
practices that are outside of a safe harbor will not be found to violate the
Anti-kickback Statute. In order to comply with the Stark Law, our financial relationships with
physicians and their immediate family members must meet an exception. We
attempt to structure our relationships to meet an exception to the Stark Law,
but the regulations implementing the exceptions, some of which are still under
review, are detailed and complex, and we cannot guarantee that every
relationship fully complies with the Stark Law. If we fail to comply with the Anti-kickback Statute, the Stark Law or
other applicable laws and regulations, we could be subjected to liabilities,
including criminal penalties, civil penalties (including the loss of our
licenses to operate one or more inpatient facilities), and exclusion of one or
more of our inpatient facilities from participation in the Medicare, Medicaid
and other federal and state health care programs. See Item 1. Business 
Regulation and Other Factors. 33




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Because many of these laws and regulations are relatively new, we do not
always have the benefit of significant regulatory or judicial interpretation of
these laws and regulations. In the future, different interpretations or
enforcement of these laws and regulations could subject our current or past
practices to allegations of impropriety or illegality or could require us to
make changes in our inpatient facilities, equipment, personnel, services,
capital expenditure programs and operating expenses. A determination that we
have violated these laws, or the public announcement that we are being
investigated for possible violations of these laws, could have a material
adverse effect on our business, financial condition, results of operations or
prospects and our business reputation could suffer significantly. In addition,
we are unable to predict whether other legislation or regulations at the
federal or state level will be adopted, what form such legislation or
regulation will take or their impact. We may be required to spend substantial amounts to comply with legislative and
regulatory initiatives relating to privacy and security of patient health
information and standards for electronic transactions. There are currently numerous legislative and regulatory initiatives at the
federal and state levels addressing patient privacy and security concerns. In
particular, federal regulations issued under HIPAA contain provisions that have
required, and in the future may require, our facilities to implement costly new
computer systems and to adopt business procedures designed to protect the
privacy and security of each of their patients individually identifiable
health and related financial information. Compliance with the privacy
regulations was required on April 14, 2003 for most health care organizations,
including our inpatient facilities. The privacy regulations have had a
financial impact on the health care industry because they impose extensive new
administrative requirements, restrictions on the use and disclosure of
individually identifiable patient health and related financial information,
provide patients with new rights with respect to their health information and
require our inpatient facilities to enter into contracts extending many of the
privacy regulation requirements to third parties who perform functions on our
behalf involving health information. On February 20, 2003, HHS issued final security regulations. Compliance
with these security regulations is required by April 21, 2005 for most health
care organizations, including our inpatient facilities. These security
regulations require our inpatient facilities to implement administrative,
physical and technical safeguards to protect the integrity, confidentiality and
availability of electronically received, maintained or transmitted patient
individually identifiable health and related financial information. We cannot
predict the total financial or other impact of these regulations on our
business. Compliance with these regulations requires substantial expenditures,
which could negatively impact our financial results. In addition, our
management has spent, and may spend in the future, substantial time and effort
on compliance measures. On August 17, 2000, HHS issued regulations requiring most health care
organizations, including our inpatient facilities, to use standard data formats
and code sets by October 16, 2003 when electronically transmitting information
in connection with several types of transactions, including health claims,
health care payment and remittance advice and health claim status transactions.
We have implemented or upgraded computer systems, as appropriate, at our
inpatient facilities and at our corporate headquarters to comply with the new
transaction and code set regulations and have tested these systems with several
of our payers. Violations of the privacy, security and transaction regulations could
subject our inpatient facilities to civil penalties of up to $25,000 per
calendar year for each provision contained in the privacy, security and
transaction regulations that is violated and criminal penalties of up to
$250,000 per violation for certain other violations. Since there is no history
of enforcement efforts by the federal government at this time, it is not
possible to ascertain the likelihood of enforcement efforts in connection with
these regulations or the potential for fines and penalties which may result
from the violation of the regulations. Other companies within the health care industry continue to be the subject of
federal and state investigations, which increases the risk that we may become
subject to investigations in the future. Both federal and state government agencies as well as private payors have
heightened and coordinated civil and criminal enforcement efforts as part of
numerous ongoing investigations of health care organizations. These
investigations relate to a wide variety of topics, including:  
    
    cost reporting and billing practices; 34




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
    
    quality of care;
    
    financial relationships with referral sources;
    
    medical necessity of services provided; and
    
    treatment of indigent patients. The OIG and the U.S. Department of Justice have, from time to time,
undertaken national enforcement initiatives that focus on specific billing
practices or other suspected areas of abuse. Moreover, health care providers
are subject to civil and criminal false claims laws, including the federal
False Claims Act, which allows private parties to bring whistleblower lawsuits
against private companies doing business with or receiving reimbursement under
government programs. Some states have adopted similar state whistleblower and
false claims provisions. Publicity associated with the substantial amounts paid
by other health care providers to settle these lawsuits may encourage our
current and former employees and other health care providers to bring
whistleblower lawsuits. Any investigations of us or our executives or managers
could result in significant liabilities or penalties as well as adverse
publicity. As a provider of health care services, we are subject to claims and legal
actions by patients and others. Facilities acquired by us may have unknown or contingent liabilities,
including liabilities related to patient care and liabilities for failure to
comply with health care laws and regulations, which could result in large
claims and significant defense costs. Although we generally seek
indemnification covering these matters from prior owners of facilities we
acquire, material liabilities for past activities of acquired facilities may
exist and such prior owners may not be able to satisfy their indemnification
obligations. We are also susceptible to being named in claims brought related
to patient care and other matters at inpatient facilities owned by third
parties and operated by us. To protect ourselves from the cost of these claims, professional
malpractice liability insurance and general liability insurance coverage is
maintained in amounts and with deductibles common in the industry. Due to our
acquisition of Ramsay, we have two distinct insurance programs that cover our
inpatient facilities. For our inpatient facilities that were not acquired from
Ramsay, we have obtained professional and general liability insurance for
claims in excess of $3 million with an insured limit of $10 million. In
December 2003, we increased this insured limit to $20 million. For the
inpatient facilities acquired from Ramsay, we have obtained professional and
general liability insurance for claims in excess of $50,000 with an insured
limit of $25 million. These policies include umbrella coverage of $20 million
and $25 million, respectively. The self-insured reserves for professional and
general liability risks are calculated based on historical claims, demographic factors,
industry trends, severity factors, and other actuarial assumptions calculated
by an independent third party. The self-insured reserve is discounted to its present value using a
5% discount rate. This estimated accrual for professional and general
liabilities could be significantly affected should current and future
occurrences differ from historical claim trends and expectations. We have
established a captive insurance company to manage this additional self-insured
retention for our inpatient facilities not acquired from Ramsay. While claims
are monitored closely when estimating professional and general liability
accruals, the complexity of the claims and wide range of potential outcomes
often hampers timely adjustments to the assumptions used in these estimates.
There are no assurances that our insurance will cover all claims (e.g., claims
for punitive damages) or that claims in excess of our insurance coverage will
not arise. A successful lawsuit against us that is not covered by, or is in
excess of, our insurance coverage may have a material adverse effect on our
business, financial condition and results of operations. This insurance
coverage may not continue to be available at a reasonable cost, especially
given the significant increase in insurance premiums generally experienced in
the health care industry. If federal or state health care programs or managed care companies reduce
reimbursement rates or methods of reimbursement for services provided, revenues
may decline. A large portion of our revenue comes from the Medicare and Medicaid
programs. In recent years, federal and state governments have made significant
changes in these programs. These changes have, in certain instances, decreased
the amount of money we receive for our services. Future federal and state
legislation may further reduce 35




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the payments received for services provided or increase the timing of
reimbursement payments to us. In addition, we are particularly sensitive to
regulatory and economic changes in the State of Texas. We operated seven
inpatient facilities in Texas that generated 33% of our revenue for the year
ended December 31, 2003. Insurance and managed care companies and other third parties from whom we
receive payment are increasingly attempting to control health care costs by
requiring that facilities discount their fees in exchange for exclusive or
preferred participation in their benefit plans. This trend may continue and may
reduce the payments received by us for our services. If competition decreases the ability to acquire additional inpatient facilities
on favorable terms, we may be unable to execute our acquisition strategy. Competition among hospitals and other health care providers in the United
States has intensified in recent years due to cost containment pressures,
changing technology, changes in government regulation and reimbursement,
changes in practice patterns (such as shifting from inpatient to outpatient
treatments), the impact of managed care organizations and other factors. An
important part of our business strategy is to acquire inpatient facilities in
growing markets. Some inpatient facilities and health care providers that
compete with us have greater financial resources and a larger, more experienced
development staff focused on identifying and completing acquisitions. In
addition, some competitors are owned by governmental agencies or not-for-profit
corporations supported by endowments and charitable contributions, and can
finance capital expenditures on a tax-exempt basis. Any or all of these factors
may impede our business strategy. If we fail to improve the operations of acquired inpatient facilities, we may
be unable to achieve our growth strategy. We may be unable to maintain or increase the profitability of, or
operating cash flows at, any existing hospital or other acquired inpatient
facility, effectively integrate the operations of any acquisitions or otherwise
achieve the intended benefit of our growth strategy. State efforts to regulate the sale of inpatient facilities operated by
not-for-profit entities could prevent us from acquiring additional inpatient
facilities and executing our business strategy. Hospital acquisitions generally require a longer period to complete than
acquisitions in many other industries and are subject to additional regulatory
uncertainty. Many states have adopted legislation regarding the sale or other
disposition of facilities operated by not-for-profit entities. In other states
that do not have specific legislation, the attorneys general have demonstrated
an interest in these transactions under their general obligations to protect
charitable assets from waste. These legislative and administrative efforts
focus primarily on the appropriate valuation of the assets divested and the use
of the proceeds of the sale by the non-profit seller. In addition, the
acquisition of facilities in certain states requires advance regulatory
approval under certificate of need or state licensure regulatory regimes.
These state-level procedures could seriously delay or even prevent us from
acquiring inpatient facilities, even after significant transaction costs have
been incurred. Additional financing may be necessary to fund our acquisition program and
capital expenditures, and additional financing may not be available when
needed. Our acquisition program requires substantial capital resources. Likewise,
the operation of existing inpatient facilities requires ongoing capital
expenditures for renovation, expansion and the upgrade of equipment and
technology. We may not receive additional financing on satisfactory terms. In
addition, our level of indebtedness at any time may restrict our ability to
borrow additional funds. If we are not able to obtain financing, then we may
not be in a position to consummate acquisitions or undertake capital
expenditures. Recently acquired businesses and businesses acquired in the future will expose
us to increased operating risks. 36




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We acquired four inpatient facilities in 2001, one inpatient hospital in
2002 and seventeen inpatient facilities in 2003. This expansion exposes us to additional business and operating risk and uncertainties, including:  
    
    our ability to effectively manage the expanded activities;
    
    our ability to realize our investment in the increased number of inpatient facilities;
    
    our exposure to unknown liabilities; and
    
    our ability to meet contractual obligations. If we are unable to manage this expansion efficiently or effectively, or
are unable to attract and retain additional qualified management personnel to
run the expanded operations, it could have a material adverse effect on our
business, financial condition and results of operations. We depend on our relationships with physicians who use our inpatient
facilities. Our business depends upon the efforts and success of the physicians who
provide health care services at our inpatient facilities and the strength of
the relationships with these physicians. Our business could be adversely affected if a significant number of physicians or a group of physicians:  
    
    terminate their relationship with, or reduce their use of, our inpatient facilities;
    
    fail to maintain acceptable quality of care or to otherwise adhere to professional standards;
    
    suffer damage to their reputation; or
    
    exit the market entirely. We depend on our key management personnel. We are highly dependent on our senior management team, which has many
years of experience addressing the broad range of concerns and issues relevant
to our business. We have entered into employment agreements with Joey A.
Jacobs, Chief Executive Officer, and Jack Salberg, Chief Operating Officer,
which include non-competition and non-solicitation provisions. Key man life
insurance policies are not maintained on any member of senior management other
than Mr. Jacobs. The loss of key management or the inability to attract, retain
and motivate sufficient numbers of qualified management personnel could have a
material adverse effect on us. We have a limited operating history. We began operations in 1997 and acquired our first inpatient facility in
2001. Because of our limited operating history, we have limited insight into
trends that may emerge in our industry and that affect our business. As a
result, there can be no assurance that we will achieve satisfactory operating
results. Our stock price could be volatile. The market price of our common stock could fluctuate significantly in
response to various factors, including:  
    
    problems in achieving revenue enhancements and operating efficiencies; 37




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
    
    actual and estimated earnings and cash flows;
    
    quarter-to-quarter variations in operating results;
    
    changes in market conditions in the mental health or behavioral health care industries;
    
    changes in general economic conditions;
    
    fluctuations in the securities markets in general;
    
    operating results differing from analysts estimates; and
    
    changes in analysts earnings estimates. 
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 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 at December 31, 2003 is subject to a weighted
average fixed interest rate of 9.95%. Since all of our long-term debt
outstanding at December 31, 2003 is subject to a fixed interest rate, we did
not estimate changes to our interest expense or fair value of long-term debt
based on a hypothetical increase in interest rates. As discussed above, we do
have a $50 million revolving credit facility that is subject to variable
interest rates; however, at December 31, 2003, no balance was outstanding under
the revolving line of credit. In the event we increase our amount outstanding
under the revolving credit facility and interest rates change significantly, we
expect management would take actions intended to further mitigate our exposure
to such change. Information on quantitative and qualitative disclosure about
market risk is included in Part II, Item 7 of this Annual Report on Form 10-K
under the caption Managements Discussion and Analysis of Financial Condition
and Results of Operations  Liquidity and Capital Resources and Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Liquidity and Capital Resources  Contractual Obligations. 
 Item 8. Financial Statements and Supplementary Data. Information with respect to this Item is contained in our consolidated
financial statements indicated in the Index on Page F-1 of this Annual Report
on Form 10-K. 
 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None. 
 Item 9A. Controls and Procedures. Evaluation of Disclosure Controls and Procedures Our chief executive officer and principal accounting officer have reviewed
and evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities
Exchange Act of 1934 (the Exchange Act)) as of the end of the period covered
by this annual report. Based on that evaluation, the chief executive officer
and principal accounting officer have concluded that our disclosure controls
and procedures effectively and timely provide them with material information
relating to Psychiatric Solutions and its consolidated subsidiaries required to
be disclosed in the reports we file or submit under the Exchange Act. Changes in Internal Controls Over Financial Reporting 38




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During the period covered by this report, there have been no changes in
our internal control over financial reporting that have materially affected or
are reasonable likely to materially affect our internal control over financial
reporting. 
 PART III 
 Item 10. Directors And Executive Officers of the Registrant. Directors The information relating to our directors set forth in the Companys Proxy
Statement relating to the 2004 Annual Meeting of Stockholders under the caption
Election of Directors and Corporate
Governance  Audit Committee is incorporated herein by reference. Executive Officers of the Registrant The executive officers of the Company are: Name
    
    Age
    
    Officer Since
    
    PositionsJoey A. Jacobs
    
    
    50
    
    
    April 1997
    
    President and Chief Executive OfficerSteven T. Davidson
    
    
    46
    
    
    August 1997
    
    Chief Development Officer and SecretaryJack R. Salberg
    
    
    55
    
    
    May 2000
    
    Chief Operating OfficerJack E. Polson
    
    
    37
    
    
    August 2002
    
    Chief Accounting OfficerBrent Turner
    
    
    38
    
    
    February 2003
    
    Vice President, Treasurer and Investor Relations
 Joey A. Jacobs, President and Chief Executive Officer. Mr. Jacobs serves
as President and Chief Executive Officer and was one of our co-founders in
April 1997. Prior to our founding, Mr. Jacobs served for 21 years in various
capacities with Hospital Corporation of America (HCA, also formerly known as
Columbia and Columbia/HCA), most recently as President of the Tennessee
Division. Mr. Jacobs background at HCA also includes serving as president of
HCAs Central Group, vice president of the Western Group, assistant vice
president of the Central Group and assistant vice president of the Salt Lake
City Division. Steven T. Davidson, Chief Development Officer. Mr. Davidson has served as
Chief Development Officer since August 1997 and has over 21 years of health
care experience. Prior to joining us, Mr. Davidson served as the Director of
Development at HCA from 1991 until 1997. Mr. Davidson also served as a Senior
Audit Supervisor and Hospital Controller during his term at HCA, which began in
1983, where he supervised audits of hospitals and other corporate functions.
Prior to joining HCA, Mr. Davidson was employed by Ernst & Young LLP as a
Senior Auditor. Mr. Davidson is a Certified Public Accountant and a member of
the American Institute of Certified Public Accountants. Jack Salberg, Chief Operating Officer. Mr. Salberg has served as Chief
Operating Officer since May 2000 and has more than 32 years of operational
experience in both for-profit and non-profit health care sectors. Prior to
joining us, Mr. Salberg served as president and chief executive officer of
Sunrise Behavioral Health, Ltd. from 1996 to 2000. In addition, Mr. Salberg
served for ten years in various capacities with American Healthcorp, most
recently as senior vice president with specific responsibilities for
multi-facility contract management. Mr. Salberg also spent three years as head
of Health Group, Inc.s psychiatric division. In addition, Mr. Salberg was
employed for four years with Humana Corporation as a hospital executive
director and seven years with Arden Hill Hospital, an independent hospital, as
its associate executive director. 39




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##### Table of Contents



Jack E. Polson, Chief Accounting Officer. Mr. Polson has served as Chief
Accounting Officer since August 2002. Prior to being appointed Chief Accounting
Officer, Mr. Polson had served as Controller since June 1997. From June 1995
until joining us, Mr. Polson served as controller for Columbia Healthcare
Network, a risk-bearing physician health organization. From May 1992 until June
1995, Mr. Polson served as an internal audit supervisor for HCA. Brent Turner, Vice President, Treasurer and Investor Relations. Mr.
Turner has served as the Vice President, Treasurer and Investor Relations since
February 2003. From April 2002 until joining us, Mr. Turner served as
Executive Vice President and Chief Financial Officer of Educational Services of
America, a privately-held owner and operator of schools for children with
learning disabilities. From November 2001 until March 2002, Mr. Turner served
as Senior Vice President of Business Development for The Brown Schools, a
provider of educational and therapeutic services for at-risk youth. From 1996
until January 2001, Mr. Turner was employed by Corrections Corporation of
America, a private prison operator, serving as Treasurer from 1998 to 2001. Code of Ethics The Company has adopted a Code of Ethics that applies to all of the
Companys directors, officers and employees. The Code of Ethics is available on
our website at www.psysolutions.com. We will disclose any amendment to, other
than technical, administrative or non-substantive amendments, or waiver of its
code of ethics granted to a director or executive officer by filing a Form 8-K
disclosing the amendment or waiver within five business days. Section 16(a) Compliance The information relating to Section 16(a) beneficial ownership reporting
compliance set forth in our Proxy Statement relating to the 2004 Annual Meeting
of Stockholders under the caption Security Ownership of Certain Beneficial
Owners and Management is incorporated herein by reference. 
 Item 11. Executive Compensation. The information set forth in our Proxy Statement relating to the 2004
Annual Meeting of Stockholders under the caption Executive Compensation is
incorporated herein by reference. The Comparative Performance Graph and the
Compensation Committee Report on Executive Compensation also included in the
Proxy Statement are expressly not incorporated herein by reference. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management. The information set forth in our Proxy Statement relating to the 2004
Annual Meeting of Stockholders under the caption Security Ownership of Certain
Beneficial Owners and Management and Equity Compensation Plan Information is
incorporated herein by reference. 
 Item 13. Certain Relationships and Related Transactions. The information set forth in our Proxy Statement relating to the 2004
Annual Meeting of Stockholders under the caption Certain Relationships and
Related Transactions is incorporated herein by reference. 
 Item 14. Principal Accountant Fees and Services. The information set forth in our Proxy Statement relating to the 2004
Annual Meeting of Stockholders under the caption Independent Auditors  Audit
and Non-Audit Fees is incorporated herein by reference. 40




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##### Table of Contents



Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) The following documents are filed as part of this Annual Report onForm 10-K:  1.
    
    Consolidated Financial Statements: The consolidated financial
statements of Psychiatric Solutions are included as follows: PageReport of Independent Auditors
    
    
    F-2Consolidated Balance Sheets
    
    
    F-3Consolidated Statements of Operations
    
    
    F-4Consolidated Statements of Stockholders Equity
    
    
    F-5Consolidated Statements of Cash Flows
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-8
  2.
    
    Financial Statement Schedules.  All schedules are omitted because they are not applicable or are
not required, or because the required information is included in
the consolidated financial statements or notes in this report.  3.
    
    The exhibits which are filed with this report or which are
incorporated herein by reference are set forth in the Exhibit Index on
pages 41 through
45. (b) Reports onForm 8-K. On October 31, 2003, Psychiatric Solutions furnished a Report on Form 8-K,
which reported the issuance of a press release announcing the operating results
of Psychiatric Solutions for the quarter ended September 30, 2003. On November 6, 2003, Psychiatric Solutions filed a Report on Form 8-K,
which reported the issuance of press releases announcing the registration of
6,000,000 shares of its common stock and the acquisition of the Alliance Health
Center on November 3, 2003. On December 19, 2003, Psychiatric Solutions filed a Report on Form 8-K,
which reported the issuance of a press release announcing the public offering
of 6,000,000 shares of its common stock at $16 per share. On December 29, 2003, Psychiatric Solutions filed a Report on Form 8-K,
which reported the issuance of a press release announcing it closed on the sale
of 6,900,000 shares of its common stock. (c) Exhibit. ExhibitNumber
    
    Description2.1
    
    Agreement and Plan of Merger by and among PMR Corporation, PMR
Acquisition Corporation and Psychiatric Solutions, Inc., dated
May 6, 2002, as amended by Amendment No. 1, dated as of June 10,
2002, and Amendment No. 2, dated as of July 9, 2002 (included as
Annex A to Amendment No. 1 to the Companys Registration
Statement on Form S-4, filed on July 11, 2002 (Reg. No.
333-90372) (the 2002 S-4 Amendment)).
 41




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##### Table of Contents



ExhibitNumber
    
    Description2.2
    
    Asset Purchase Agreement, dated February 13, 2003, by and
between The Brown Schools, Inc. and Psychiatric Solutions, Inc.,
as amended by Amendment No. 1 to Asset Purchase Agreement, dated
March 31, 2003, by and between The Brown Schools, Inc. and
Psychiatric Solutions, Inc. (incorporated by reference to
Exhibit 2.1 of the Companys Current Report on Form 8-K, filed
on April 9, 2003).2.3
    
    Agreement and Plan of Merger, dated April 8, 2003, by and among
Psychiatric Solutions, Inc., PSI Acquisition Sub, Inc. and
Ramsay Youth Services, Inc. (incorporated by reference to
Exhibit 2.1 of the Companys Current Report on Form 8-K, filed
on April 10, 2003).2.4
    
    Asset Purchase Agreement, dated February 23, 2004, by and among
Psychiatric Solutions, Inc., Brentwood Health Management,
L.L.C., Brentwood, A Behavioral Health Company, L.L.C. and River
Rouge, Inc. (incorporated by reference to Exhibit 2.1 of the
Companys Current Report on Form 8-K, filed on March 3, 2004).2.5
    
    Asset Purchase Agreement, dated February 23, 2004, by and among
Psychiatric Solutions, Inc., Brentwood Health Management of MS,
LLC, and Turner-Windham of Mississippi, LLC (incorporated by
reference to Exhibit 2.2 of the Companys Current Report on Form
8-K, filed on March 3, 2004).3.1
    
    Amended and Restated Certificate of Incorporation of PMR
Corporation, filed with the Delaware Secretary of State on March
9, 1998 (incorporated by reference to Exhibit 3.1 to the
Companys Annual Report on Form 10-K for the fiscal year ended
April 30, 1998) (the 1998 10-K)).3.2
    
    Certificate of Amendment to Amended and Restated Certificate of
Incorporation of PMR Corporation, filed with the Delaware
Secretary of State on August 5, 2002 (incorporated by reference
to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q
for the quarter ended July 31, 2002).3.3
    
    Certificate of Amendment to Amended and Restated Certificate of
Incorporation of Psychiatric Solutions, Inc., filed with the
Delaware Secretary of State on March 21, 2003 (incorporated by
reference to Appendix A of the Companys Definitive Proxy
Statement, filed on January 22, 2003).3.4
    
    Amended and Restated Bylaws (incorporated by reference to
Exhibit 3.2 to the Companys Annual Report on Form 10-K for the
fiscal year ended April 30, 1997) (the 1997 10-K)).4.1
    
    Reference is made to Exhibits 3.1 through 3.4.4.2
    
    Common Stock Specimen Certificate (incorporated by reference to
Exhibit 4.2 to the Companys Annual Report on Form 10-K for the
fiscal year ended December 31, 2002) (the 2002 10-K)).4.3
    
    Contingent Value Rights Agreement, dated August 2, 2002
(incorporated by reference to Exhibit 4.1 to the Companys
Current Report on Form 8-K, filed on August 5, 2002).4.4
    
    Stock Purchase Agreement, dated as of January 6, 2003, by and
among Psychiatric Solutions, Inc. and the Purchasers named
therein (incorporated by reference to Appendix B of the
Companys Definitive Proxy Statement, filed January 22, 2003).4.5
    
    Registration Rights Agreement, dated as of January 6, 2003, by
and among Psychiatric Solutions, Inc. and the Purchasers named
therein (incorporated by reference to Appendix C of the
Companys Definitive Proxy Statement, filed January 22, 2003).4.6
    
    Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock, filed with the Delaware Secretary
of State on March 24, 2003 (incorporated by reference to
Appendix D of the Companys Definitive Proxy Statement, filed
January 22, 2003).4.7
    
    Indenture, dated as of June 30, 2003, among Psychiatric
Solutions, Inc., the Guarantors named therein and Wachovia Bank,
National Association, as Trustee (incorporated by reference to
the Companys Registration Statement on Form S-4, filed on July
30, 2003 (Registration No. 333-107453) (the 2003 S-4)).4.8
    
    Form of Notes (included in Exhibit 4.7).
 42




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##### Table of Contents



ExhibitNumber
    
    Description4.9
    
    Purchase Agreement, dated as of June 19, 2003, among Psychiatric
Solutions, Inc., the Guarantors named therein, Lehman Brothers
Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and
Jefferies & Company, Inc. (incorporated by reference to Exhibit
4.12 to the 2003 S-4).4.10
    
    Exchange and Registration Rights Agreement, dated as of June 30,
2003, among Psychiatric Solutions, Inc., the Guarantors named
therein, Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner &
Smith Incorporated and Jefferies & Company, Inc. (incorporated
by reference to Exhibit 4.13 to the 2003 S-4).10.1
    
    Amended and Restated Promissory Note between Mark P. Clein and
PMR Corporation in the amount of $59,554, dated as of May 1,
2002 (incorporated by reference to Exhibit 10.1 to the Companys
Registration Statement on Form S-4, filed on June 12, 2002 (Reg.
No. 333-90372) (the 2002 S-4)).10.2
    
    Amended and Restated Promissory Note between Mark P. Clein and
PMR Corporation in the amount of $278,504.82, dated as of May 1,
2002 (incorporated by reference to Exhibit 10.2 to the 2002
S-4).10.3
    
    Consulting Agreement between Mark P. Clein and PMR Corporation,
dated as of May 10, 2002 (incorporated by reference to Exhibit
10.6 to the 2002 S-4).10.4
    
    Employment Agreement between Jack R. Salberg and Psychiatric
Solutions, Inc., dated as of October 1, 2002 (incorporated by
reference to Exhibit 10.14 to the 2002 10-K).10.5
    
    Second Amended and Restated Employment Agreement between Joey A.
Jacobs and Psychiatric Solutions, Inc., dated as of August 6,
2002 (incorporated by reference to Exhibit 10.16 to the 2002
10-K).10.6
    
    Amendment to Second Amended and Restated Employment Agreement
between Joey A. Jacobs and Psychiatric Solutions, Inc., dated as
of November 26, 2003 (incorporated by reference to Exhibit 10.14
to Amendment No. 2 to the 2003 S-4).10.7
    
    Indemnification Agreement between Mark P. Clein and Psychiatric
Solutions, Inc., dated as of August 20, 2002 (incorporated by
reference to Exhibit 10.17 to the 2002 10-K).10.8
    
    Indemnification Agreement between Joseph P. Donlan and
Psychiatric Solutions, Inc., dated as of August 20, 2002
(incorporated by reference to Exhibit 10.18 to the 2002 10-K).10.9
    
    Indemnification Agreement between Richard D. Gore and
Psychiatric Solutions, Inc., dated as of May 6, 2003
(incorporated by reference to Exhibit 10.15 to Amendment No. 1
to the 2003 S-4 Amendment).10.10
    
    Indemnification Agreement between Christopher Grant, Jr. and
Psychiatric Solutions, Inc., dated as of August 20, 2002
(incorporated by reference to Exhibit 10.19 to the 2002 10-K).10.11
    
    Indemnification Agreement between Joey A. Jacobs and Psychiatric
Solutions, Inc., dated as of August 20, 2002 (incorporated by
reference to Exhibit 10.21 to the 2002 10-K).10.12
    
    Indemnification Agreement between Edward K. Wissing and
Psychiatric Solutions, Inc., dated as of August 20, 2002
(incorporated by reference to Exhibit 10.23 to the 2002 10-K).10.13*
    
    Indemnification Agreement between
Ann H. Lamont and Psychiatric Solutions, Inc., dated as of March 25,
2003.10.14
    
    Consent under Indemnification Agreement between the Company and
members of its Board of Directors, dated as of December, 2002
(incorporated by reference to Exhibit 10.24 to the 2002 10-K).10.15
    
    Indemnification Agreement, dated as of June 28, 2002, by and
among the stockholders of Aeries Healthcare Corporation, a
Delaware corporation, and Psychiatric Solutions, Inc., a
Delaware corporation and/or its designated affiliate
(incorporated by reference to Exhibit 10.15 to the 2002 S-4
Amendment).10.16
    
    Securities Purchase Agreement between Psychiatric Solutions,
Inc. and The 1818 Mezzanine Fund II, L.P., dated as of June 28,
2002 (incorporated by reference to Exhibit 10.18 to the 2002 S-4
Amendment).
 43




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ExhibitNumber
    
    Description10.17
    
    Second Amended and Restated Revolving Credit and Term Loan
Agreement, dated as of June 30, 2003, among Psychiatric
Solutions, Inc., the Guarantors named therein, CapitalSource
Finance LLC, as administrative agent and collateral agent for
Lenders, and the Lenders thereunder (incorporated by reference
to Exhibit 10.27 to the 2003 S-4).10.18
    
    Second Amended and Restated Term Note A, dated June 30, 2003, in
the original principal amount of $8,224,361.69 payable to
CapitalSource Finance LLC issued by Psychiatric Solutions, Inc.
and certain of its related entities (incorporated by reference
to Exhibit 10.25 of the 2003 S-4 Amendment).10.19
    
    Second Amended and Restated Term Note B, dated June 30, 2003, in
the original principal amount of $8,595,840.63 payable to
CapitalSource Finance LLC issued by Psychiatric Solutions, Inc.
and certain of its related entities (incorporated by reference
to Exhibit 10.26 to the 2003 S-4 Amendment).10.20
    
    Second Amended and Restated Term Note C, dated June 30, 2003, in
the original principal amount of $179,797.68 payable to
CapitalSource Finance LLC issued by Psychiatric Solutions, Inc.
and certain of its related entities (incorporated by reference
to Exhibit 10.27 to the 2003 S-4 Amendment).10.21*
    
    Amended and Restated Psychiatric Solutions, Inc. 2003 Long-Term
Equity Compensation Plan.10.22
    
    Amended and Restated Psychiatric Solutions, Inc. Equity
Incentive Plan (incorporated by reference to Appendix B to the
Companys Definitive Proxy Statement, filed on April 14, 2003).10.23
    
    Form of Incentive Stock Option Agreement under the 1997 Plan
(incorporated by reference to Exhibit 10.2 to the 1997 10-K).10.24
    
    Form of Nonstatutory Stock Option Agreement under the 1997 Plan
(incorporated by reference to Exhibit 10 to the 1997 10-K).10.25
    
    Amended and Restated Psychiatric Solutions, Inc. Outside
Directors Non-Qualified Stock Option Plan (incorporated by
reference to Appendix C to the Companys Definitive Proxy
Statement, filed on April 14, 2003).10.26
    
    Form of Outside Directors Non-Qualified Stock Option Agreement
(incorporated by reference to Exhibit 10.5 to the 1997 10-K).10.27
    
    Management and Affiliation Agreement, dated April 13, 1995,
between Mental Health Cooperative, Inc. and Tennessee Mental
Health Cooperative, Inc. with Addendum (incorporated by
reference to Exhibit 10.14 to the 1997 10-K) (Tennessee Mental
Health Cooperative, Inc. subsequently changed its name to
Collaborative Care Corporation).10.28
    
    Second Addendum to Management and Affiliation Agreement, dated
November 1, 1996, between Mental Health Cooperative, Inc. and
Collaborative Care Corporation (incorporated by reference to
Exhibit 10.15 to the Companys Registration Statement on Form
S-2 (Reg. No. 333-36313)).10.29
    
    Provider Services Agreement, dated April 13, 1995, between
Tennessee Mental Health Cooperative, Inc. and Mental Health
Cooperative, Inc. (incorporated by reference to Exhibit 10.15 to
the 1997 10-K) (Tennessee Mental Health Cooperative, Inc.
subsequently changed its name to Collaborative Care
Corporation).10.30
    
    Provider Agreement, dated December 4, 1995, between Tennessee
Behavioral Health, Inc. and Tennessee Mental Health
Corporations, Inc. (incorporated by reference to Exhibit 10.19
to the 1998 10-K).10.31
    
    Addendum No. 1 to Provider Agreement, dated December 4, 1995,
between Tennessee Behavioral Health, Inc. and Tennessee Mental
Health Cooperative, Inc. (incorporated by reference to Exhibit
10.20 to the 1998 10-K).10.32
    
    Addendum No. 2 to Provider Agreement, dated February 4, 1996,
between Tennessee Behavioral Health, Inc. and Tennessee Mental
Health Cooperative, Inc. (incorporated by reference to Exhibit
10.21 to the 1998 10-K).
 44




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##### Table of Contents



ExhibitNumber
    
    Description10.33
    
    Provider Participation Agreement, dated December 1, 1995, among
Green Spring Health Services, Inc., AdvoCare, Inc. and Tennessee
Mental Health Cooperative, Inc. (incorporated by reference to
Exhibit 10.22 to the 1998 10-K).10.34
    
    Amendment to Provider Participation
Agreement, dated February 13, 1996, among Green Spring Health Services, Inc., AdvoCare of
Tennessee, Inc. and Tennessee Mental Health Cooperative, Inc.
(incorporated by reference to Exhibit 10.23 to the 1998 10-K).12.1*
    
    Computation of Ratio of Earnings to Fixed Charges.21.1*
    
    List of Subsidiaries.23.1*
    
    Consent of Ernst & Young LLP, Independent Auditors.31.1*
    
    Certification of the Chief Executive Officer of Psychiatric
Solutions, Inc. Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of the Chief Accounting Officer of Psychiatric
Solutions, Inc. Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certifications of the Chief Executive Officer and Chief
Accounting Officer of Psychiatric Solutions, Inc. Pursuant to
Rule 13a-14(b) of the Securities Exchange Act of 1934, as
amended, and 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
   *
    
    Filed herewith
    
    Management contract or compensatory plan or arrangement 45




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PSYCHIATRIC SOLUTIONS, INC. 
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGEReport of Independent Auditors
    
    
    F-2Consolidated Financial Statements:Consolidated Balance Sheets, December 31, 2003 and 2002
    
    
    F-3Consolidated
Statements of Income for the years ended
December 31, 2003, 2002 and 2001
    
    
    F-4Consolidated Statements of Stockholders Equity for the years
ended December 31, 2003, 2002 and 2001
    
    
    F-5Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-8
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS To
the Board of Directors and Stockholders of Psychiatric Solutions, Inc. We have audited the accompanying consolidated balance sheets of Psychiatric
Solutions, Inc. as of December 31, 2003 and 2002 and the related consolidated
statements of income, stockholders equity and cash flows for each of the three
years in the period ended December 31, 2003. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Psychiatric
Solutions, Inc. at December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States. As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting in 2001 for goodwill and intangible assets. ERNST & YOUNG LLP Nashville, Tennessee
March 3, 2004 F-2




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC. 
 CONSOLIDATED BALANCE SHEETS
(in thousands)
 December 31,2003
    
    2002ASSETSCurrent assets:Cash
    
    $
    44,832
    
    
    $
    2,392Accounts receivable, less allowance for doubtful
accounts of
$7,491 and $5,284, respectively
    
    
    60,055
    
    
    
    19,473Prepaids and other
    
    
    8,529
    
    
    
    2,219Total current assets
    
    
    113,416
    
    
    
    24,084Property and equipment:Land
    
    
    23,089
    
    
    
    6,808Buildings
    
    
    123,041
    
    
    
    25,475Equipment
    
    
    10,173
    
    
    
    3,253Less accumulated depreciation
    
    
    (6,546
    )
    
    
    (1,989
    )149,757
    
    
    
    33,547Cost in excess of net assets acquired
    
    
    68,970
    
    
    
    28,822Contracts, net
    
    
    2,850
    
    
    
    607Other assets
    
    
    13,642
    
    
    
    3,078Total assets
    
    $
    348,635
    
    
    $
    90,138LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    11,637
    
    
    $
    3,338Salaries and benefits payable
    
    
    13,642
    
    
    
    4,825Other accrued liabilities
    
    
    20,168
    
    
    
    6,482Revolving line of credit
    
    
    
    
    
    
    5,383Current portion of long-term debt
    
    
    1,023
    
    
    
    1,687Total current liabilities
    
    
    46,470
    
    
    
    21,715Long-term debt, less current portion
    
    
    173,980
    
    
    
    36,752Deferred tax
liability
    
    
    6,762
    
    
    
    258Other liabilities
    
    
    4,779
    
    
    
    864Total liabilities
    
    
    231,991
    
    
    
    59,589Series A convertible preferred stock, $0.01 par value,
6,000 shares
authorized; 4,545 and 0 shares issued and outstanding,
respectively
    
    
    25,316
    
    
    
    Stockholders equity:Common stock, $0.01 par value, 48,000 shares authorized;
11,937 and 7,739 issued and outstanding,
respectively
    
    
    119
    
    
    
    77Additional paid-in capital
    
    
    91,423
    
    
    
    35,008Notes receivable from stockholders
    
    
    (338
    )
    
    
    (259
    )Accumulated unrealized losses
    
    
    (4
    )
    
    
    Accumulated earnings (deficit)
    
    
    128
    
    
    
    (4,277
    )Total stockholders equity
    
    
    91,328
    
    
    
    30,549Total liabilities and stockholders
equity
    
    $
    348,635
    
    
    $
    90,138
 See accompanying notes. F-3




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PSYCHIATRIC SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except for per share amounts) Year Ended December 31,2003
    
    2002
    
    2001Revenue
    
    $
    293,665
    
    
    $
    113,912
    
    
    $
    43,999Salaries, wages and employee benefits
    
    
    153,498
    
    
    
    62,326
    
    
    
    26,183Professional fees
    
    
    33,293
    
    
    
    14,373
    
    
    
    7,039Supplies
    
    
    17,074
    
    
    
    5,325
    
    
    
    1,241Rentals and leases
    
    
    4,109
    
    
    
    870
    
    
    
    328Other operating expenses
    
    
    44,569
    
    
    
    15,148
    
    
    
    2,714Provision for bad debts
    
    
    6,315
    
    
    
    3,681
    
    
    
    662Depreciation and amortization
    
    
    5,754
    
    
    
    1,770
    
    
    
    945Interest expense
    
    
    14,781
    
    
    
    5,564
    
    
    
    2,660Loss on refinancing long-term debt
    
    
    4,856
    
    
    
    86
    
    
    
    1,237Change in valuation of put warrants
    
    
    960
    
    
    
    
    
    
    
    Change in reserve of stockholder notes
    
    
    (545
    )
    
    
    92
    
    
    
    284,664
    
    
    
    109,235
    
    
    
    43,009Income from continuing operations
before income taxes
    
    
    9,001
    
    
    
    4,677
    
    
    
    990Provision for (benefit from) income taxes
    
    
    3,785
    
    
    
    (1,007
    )
    
    
    Income from continuing operations
    
    
    5,216
    
    
    
    5,684
    
    
    
    990Discontinued operations:Income from operations of
discontinued lines of business
    
    
    
    
    
    
    
    
    
    
    89Gain on disposal of discontinued lines of
business, net of income taxes of $223
    
    
    
    
    
    
    
    
    
    
    1,499Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    1,588Net income
    
    
    5,216
    
    
    
    5,684
    
    
    
    2,578Accrued preferred stock dividends
    
    
    811
    
    
    
    
    
    
    
    Net income available to common stockholders
    
    $
    4,405
    
    
    $
    5,684
    
    
    $
    2,578Basic earnings per share:Income from continuing operations
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.20Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.31Net income
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.51Diluted earnings per share:Income from continuing operations
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.19Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.30Net income
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.49Shares used in computing per share amounts:Basic
    
    
    8,370
    
    
    
    6,111
    
    
    
    5,010Diluted
    
    
    11,749
    
    
    
    6,986
    
    
    
    5,309
 See accompanying notes. F-4




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(in thousands) Common Stock
    
    Additional
    
    Notes
    
    Accumulated
    
    AccumulatedPaid-In
    
    Receivable from
    
    Unrealized
    
    EarningsShares
    
    Amount
    
    Capital
    
    Stockholders
    
    Losses
    
    (Deficit)
    
    TotalBalance at December 31, 2000
    
    
    5,085
    
    
    $
    51
    
    
    $
    18,723
    
    
    $
    
    
    
    $
    
    
    
    $
    (12,539
    )
    
    $
    6,235Common stock issued
    
    
    4
    
    
    
    
    
    
    
    720
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    720Reacquired common stock
    
    
    (99
    )
    
    
    (1
    )
    
    
    (294
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (295
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,578
    
    
    
    2,578Balance at December 31, 2001
    
    
    4,990
    
    
    
    50
    
    
    
    19,149
    
    
    
    
    
    
    
    
    
    
    
    (9,961
    )
    
    
    9,238Common stock and options
issued with PMR merger
    
    
    2,421
    
    
    
    24
    
    
    
    15,361
    
    
    
    (259
    )
    
    
    
    
    
    
    
    
    
    
    15,126Value of warrants issued
    
    
    
    
    
    
    
    
    
    
    330
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    330Exercise of stock options and
warrants
    
    
    328
    
    
    
    3
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53Issuance of stock options
    
    
    
    
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,684
    
    
    
    5,684Balance at December 31, 2002
    
    
    7,739
    
    
    
    77
    
    
    
    35,008
    
    
    
    (259
    )
    
    
    
    
    
    
    (4,277
    )
    
    
    30,549Issuance of common stock
    
    
    3,272
    
    
    
    33
    
    
    
    48,864
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,897Conversion of convertible debt
    
    
    538
    
    
    
    5
    
    
    
    4,580
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,585Payment of notes receivable
from stockholders with stock
    
    
    (48
    )
    
    
    
    
    
    
    (483
    )
    
    
    466
    
    
    
    
    
    
    
    
    
    
    
    (17
    )Change in reserve on
stockholder notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (545
    )
    
    
    
    
    
    
    
    
    
    
    (545
    )Exercise of stock options and
warrants
    
    
    436
    
    
    
    4
    
    
    
    3,454
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,458Unrealized loss on investments
available for sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (4
    )Net income available to common
stockholders
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,405
    
    
    
    4,405Balance at December 31, 2003
    
    
    11,937
    
    
    $
    119
    
    
    $
    91,423
    
    
    $
    (338
    )
    
    $
    (4
    )
    
    $
    128
    
    
    $
    91,328
 See accompanying notes. F-5




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Year Ended December 31,2003
    
    2002
    
    2001Operating ActivitiesNet income
    
    $
    5,216
    
    
    $
    5,684
    
    
    $
    2,578Adjustments to reconcile net income to
net cash provided by continuing
operating activities:Depreciation and amortization
    
    
    5,754
    
    
    
    1,770
    
    
    
    945Provision for doubtful accounts
    
    
    6,315
    
    
    
    3,681
    
    
    
    662Accretion of detachable warrants
    
    
    162
    
    
    
    677
    
    
    
    704Non-cash stock compensation expense
    
    
    
    
    
    
    118
    
    
    
    Amortization of loan costs
    
    
    1,478
    
    
    
    419
    
    
    
    172Release of deferred tax asset valuation allowance
    
    
    
    
    
    
    (1,332
    )
    
    
    Loss on refinancing long-term debt
    
    
    4,856
    
    
    
    
    
    
    
    1,237Change in valuation of put warrants
    
    
    960
    
    
    
    
    
    
    
    (Release of) additional reserve on stockholder notes
    
    
    (545
    )
    
    
    92
    
    
    
    Income from discontinued operations
    
    
    
    
    
    
    
    
    
    
    (1,588
    )Long-term interest accrued
    
    
    124
    
    
    
    324
    
    
    
    324Changes in operating assets and liabilities,
net of effect of acquisitions:Accounts receivable
    
    
    (13,561
    )
    
    
    (1,348
    )
    
    
    392Prepaids and other current assets
    
    
    1,061
    
    
    
    (399
    )
    
    
    (118
    )Accounts payable
    
    
    (1,999
    )
    
    
    (2,523
    )
    
    
    (247
    )Salaries and benefits payable
    
    
    1,485
    
    
    
    1,504
    
    
    
    783Accrued liabilities and other liabilities
    
    
    4,176
    
    
    
    255
    
    
    
    947Net cash provided by continuing operating activities
    
    
    15,482
    
    
    
    8,922
    
    
    
    6,791Investing activities:Cash (paid for) acquired in acquisitions, net of cash
acquired or paid
    
    
    (100,424
    )
    
    
    6,243
    
    
    
    (305
    )Capital purchases of leasehold improvements,
equipment and software
    
    
    (5,777
    )
    
    
    (1,470
    )
    
    
    (116
    )Purchase of long-term securities
    
    
    (971
    )
    
    
    
    
    
    
    Change in net assets of discontinued operations
    
    
    
    
    
    
    
    
    
    
    2,388Other assets
    
    
    1,838
    
    
    
    (612
    )
    
    
    Net cash (used in) provided by investing activities
    
    
    (105,334
    )
    
    
    4,161
    
    
    
    1,967
 (Continued) F-6




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Year Ended December 31,2003
    
    2002
    
    2001Financing activities:Net principal (payments) borrowings on long-term debt
    
    $
    61,980
    
    
    $
    (11,772
    )
    
    $
    (6,956
    )Payment of loan costs
    
    
    (1,998
    )
    
    
    (234
    )
    
    
    (880
    )Refinancing of long-term debt
    
    
    (1,410
    )
    
    
    
    
    
    
    Proceeds from issuance of series A convertible
preferred stock, net of issuance costs
    
    
    24,505
    
    
    
    
    
    
    
    Proceeds from secondary offering of common stock,
net of issuance costs
    
    
    48,897
    
    
    
    
    
    
    
    Proceeds from exercises of common stock options
    
    
    318
    
    
    
    53
    
    
    
    4Net cash provided by (used in) financing activities
    
    
    132,292
    
    
    
    (11,953
    )
    
    
    (7,832
    )Net increase in cash
    
    
    42,440
    
    
    
    1,130
    
    
    
    926Cash at beginning of the year
    
    
    2,392
    
    
    
    1,262
    
    
    
    336Cash at end of the year
    
    $
    44,832
    
    
    $
    2,392
    
    
    $
    1,262Supplemental Cash Flow Information:Interest paid
    
    $
    13,017
    
    
    $
    3,905
    
    
    $
    1,717Effect of Acquisitions:Assets acquired, net of cash acquired
    
    $
    201,525
    
    
    $
    34,868
    
    
    $
    30,978Liabilities assumed
    
    
    (37,336
    )
    
    
    (8,862
    )
    
    
    (3,661
    )Notes payable issued
    
    
    
    
    
    
    
    
    
    
    (4,500
    )Common stock and stock options issued
    
    
    
    
    
    
    (15,385
    )
    
    
    Long-term debt issued
    
    
    (63,765
    )
    
    
    (16,864
    )
    
    
    (22,512
    )Cash paid for (acquired in) acquisitions, net of
cash acquired or paid
    
    $
    100,424
    
    
    $
    (6,243
    )
    
    $
    305Significant Non-cash Transactions:Refinancing of long-term debt
    
    $
    3,446
    
    
    $
    
    
    
    $
    818Financing of loan costs
    
    $
    9,172
    
    
    $
    2,004
    
    
    $
    Issuance of common stock upon conversion
of convertible debt
    
    $
    4,588
    
    
    $
    
    
    
    $
    Issuance of common stock upon exercise of warrants
    
    $
    2,979
    
    
    
    
    
    
    
    Deferred tax asset recorded to recognize income tax effect
of stock option exercises
    
    $
    186
    
    
    $
    
    
    
    $
    Receipt of common stock in satisfaction of stockholder
notes receivable, net of notes receivable cancelled
    
    $
    11
    
    
    $
    
    
    
    $
    Issuance of detachable stock warrants as
consideration for Bridge Loan
    
    $
    
    
    
    $
    330
    
    
    $
    718Issuance of detachable stock warrants as
consideration for subordinated debt financing
    
    $
    
    
    
    $
    2,018
    
    
    $
    
 See accompanying notes. F-7




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 1. Summary of Significant Accounting Policies Description of Business Psychiatric Solutions, Inc. was incorporated in 1988 as a Delaware corporation
with its corporate office in Franklin, Tennessee. Psychiatric Solutions, Inc.
and its subsidiaries (we, us or our) are a leading provider of inpatient
behavioral health care services in the United States. Through our owned and
leased facilities segment, we operate 24 owned or leased inpatient behavioral
health care facilities with approximately 3,100 beds in 14 states. In addition,
through our management contract segment, we manage 42 inpatient behavioral
health care units for third parties and 11 inpatient behavioral health care
facilities for government agencies. Basis of Presentation The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates. The majority of our expenses are cost of revenue items.
Costs that could be classified as general and administrative expenses at our
corporate office were approximately 2% of net revenue for the year ended
December 31, 2003. The consolidated financial statements include the accounts of Psychiatric
Solutions, Inc. and its subsidiaries. All significant intercompany
balances and transactions are eliminated in consolidation. Cash Cash consists of demand deposits held at financial institutions. We place our
cash in financial institutions that are federally insured. At December 31,
2003, the majority of our cash is deposited with one financial institution. Accounts Receivable Accounts receivable vary according to the type of service being provided.
Accounts receivable for our inpatient management contract segment is comprised
of contractually determined fees for services rendered. Such amounts are
recorded net of estimated bad debts. Concentration of credit risk is reduced by
the large number of customers. Accounts receivable for our owned and leased segment is comprised of patient
service revenue and is recorded net of contractual adjustments and estimated
bad debts. Such amounts are owed by various governmental agencies, insurance
companies and private patients. Medicare comprised approximately 13% and 14% of
net patient receivables for our owned and leased inpatient facilities at
December 31, 2003 and 2002, respectively. Medicaid comprised approximately 40%
and 28% of net patient receivables for our owned and leased inpatient
facilities at December 31, 2003 and 2002, respectively. Concentration of credit
risk from other payers is reduced by the large number of patients and payers. Allowance
for Doubtful Accounts Our ability to collect outstanding patient receivables from third party
payors and receivables due under our inpatient management contracts is critical
to our operating performance and cash flows. The primary collection risk with regard to patient receivables lies with
uninsured patient accounts or patient accounts for which primary insurance has
paid, but the portion owed by the patient remains outstanding. We estimate the
allowance for doubtful accounts primarily based upon the age of the accounts
since patient discharge date. We continually monitor our accounts receivable
balances and utilize cash collection data to support our estimates of the
provision for doubtful accounts. Significant changes in payor mix or business
office operations could have a significant impact on our results of operations
and cash flows. The primary collection risk with regard to receivables due under our
inpatient management contracts is attributable to contractual disputes. We
estimate the allowance for doubtful accounts for these receivables based
primarily upon the specific identification of potential collection issues. As
with our patient receivables, we continually monitor our accounts receivable
balances and utilize cash collection data to support our estimates of the
provision for doubtful accounts. Allowances
for Contractual Discounts The Medicare and Medicaid regulations are complex and various managed care
contracts may include multiple reimbursement mechanisms for different types of
services provided in our inpatient facilities and cost settlement provisions
requiring complex calculations and assumptions subject to interpretation. We
estimate the allowance for contractual discounts on a payor-specific basis
given our interpretation of the applicable regulations or contract terms. The
services authorized and provided and related reimbursement are often subject to
interpretation that could result in payments that differ from our estimates.
Additionally, updated regulations and contract renegotiations occur frequently
necessitating continual review and assessment of the estimation process by our
management. Income Taxes We account for income taxes under the liability method. Under this method,
deferred tax assets and liabilities are determined based upon differences
between the financial statement carrying amounts and tax bases of assets and
liabilities and are measured using the enacted tax laws that will be in effect
when the differences are expected to reverse. Long-Lived Assets Property
and Equipment
 Property and equipment are stated at cost and depreciated using the
straight-line method over the useful lives of the assets, which range from 25
to 35 years for buildings and improvements and 2 to 7 years for equipment.
Leasehold F-8




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 improvements are amortized on a straight-line basis over the shorter of the
lease term or estimated useful lives of the assets. Depreciation expense was
$4,740,000 and $1,408,000 for the years ended December 31, 2003 and 2002,
respectively. Cost in Excess of Net Assets Acquired (Goodwill) During July 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141, Business Combinations
(SFAS 141) and No. 142, Goodwill and Other Intangible Assets (SFAS 142).
These statements made significant changes to the accounting for business
combinations, goodwill, and intangible assets. SFAS 141 eliminates the pooling of interests method of accounting for business
combinations. In addition, it further clarifies the criteria for recognition of
intangible assets separately from goodwill. SFAS 141 was effective for
transactions completed subsequent to June 30, 2001. The application of SFAS
141 did not have a material effect on our results of operations or financial
position. Under SFAS 142, goodwill and intangible assets with indefinite lives are no
longer amortized but are reviewed at least annually for impairment. The
amortization provisions of SFAS 142 apply to goodwill and intangible assets
acquired after June 30, 2001. With respect to goodwill and intangible assets
acquired prior to July 1, 2001, we adopted SFAS 142 effective January 1, 2002.
Pursuant to SFAS 142, we completed our annual impairment test of goodwill in
2003 which resulted in no goodwill impairment A reconciliation of previously reported net income to the pro forma amounts
adjusted for the exclusion of goodwill amortization follows (in thousands,
except per share amounts): Year ended December 31,2003
    
    2002
    
    2001Reported net income
    
    $
    5,216
    
    
    $
    5,684
    
    
    $
    2,578Add: goodwill amortization
    
    
    
    
    
    
    
    
    
    
    359Proforma adjusted net income
    
    $
    5,216
    
    
    $
    5,684
    
    
    $
    2,937Proforma adjusted earnings per common share, basic
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.59Proforma adjusted earnings per common share, diluted
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.55
 The following table presents the changes in the carrying amount of goodwill for
the years ended December 31, 2003 and 2002 (in thousands): Balance at December 31, 2001
    
    $
    15,208Acquisition of PMR Corporation
    
    
    12,914Acquisition of Riveredge
    
    
    662Other
    
    
    38Balance at December 31, 2002
    
    $
    28,822Acquisition of The Brown Schools
    
    
    17,377Acquisition of Ramsay Youth Services
    
    
    19,161Acquisition of Alliance Health Center
    
    
    1,755Acquisition of Calvary Center
    
    
    4,114Valuation of contracts acquired from PMR
    
    
    (3,187
    )Other
    
    
    928Balance at December 31, 2003
    
    $
    68,970
 F-9




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 Contracts Contracts represent the fair value of inpatient management contracts and
service contracts purchased and are being amortized using the straight-line
method over five years. The amounts reported at December 31, 2003 and 2002 are
net of accumulated amortization of $1.9 million and $927,000, respectively.
Amortization expense related to contracts was $944,000 and $307,000 for the
years ended December 31, 2003 and 2002, respectively. Estimated amortization
expense for the years ended December 31, 2004 and 2005 of contracts is $938,000
and $637,000, respectively. Estimated amortization expense for the years ended
December 31, 2004 and 2005 does not include amortization on the purchase price
allocation to the inpatient management contracts, if any, acquired
from Ramsay Youth Services, Inc. (Ramsay).
The purchase price allocation of Ramsay is incomplete as of December 31, 2003. When events, circumstances and operating results indicate that the carrying
values of certain long-lived assets and the related identifiable intangible
assets might be impaired, we prepare projections of the undiscounted future
cash flows expected to result from the use of the assets and their eventual
disposition. If the projections indicate that the recorded amounts are not
expected to be recoverable, such amounts are reduced to estimated fair value.
Fair value is estimated based upon projections of discounted cash flows. Other Assets Other assets consist principally of loan costs that are deferred and amortized
over the term of the related debt and deferred tax assets which reflect the net
tax effects of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the amounts used for
income tax purposes. Loan costs reported at December 31, 2003 and 2002 are net
of accumulated amortization of $1.6 million and $484,000, respectively. Stock-Based Compensation In January 2003, the FASB issued Statement on Financial Accounting Standards
No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an
Amendment of FASB Statement No. 123 (SFAS 148). SFAS 148 amends Statement on
Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123), to provide alternative methods of transition for a
voluntary change to the fair-value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure
requirements of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
SFAS 148 has no material impact on our results of operations or financial
position, as we do not plan to adopt the fair-value method of accounting for
stock options at the current time. We have included the required disclosures
below and in Note 10. We account for our stock option plans in accordance with the provisions of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations as more fully described in
Note 10. As such, compensation expense would be recorded on the date of grant
only if the current market price of the underlying stock exceeded the exercise
price. Pro forma information regarding net income and earnings per share is required
by SFAS 123, and has been determined as if we had accounted for our employee
stock options under the fair value method of that Statement. During 2003, 2002
and 2001, we granted 713,000, 515,000 and 35,000 stock options, respectively.
The fair value of these options was estimated using the Black-Scholes option
pricing model for 2003 and 2002. For 2001, we used the minimum value option
pricing model as our stock was not publicly traded. The following weighted-average assumptions were used in the respective pricing
models: 2003
    
    2002
    
    2001Risk-free interest rate
    
    
    2.79
    %
    
    
    3.11
    %
    
    
    3.69
    %Volatility
    
    
    51.99
    %
    
    
    111.70
    %
    
    
    N/AExpected life
    
    
    5.6
    
    
    
    4.9
    
    
    
    6.0Dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
 F-10




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 The weighted-average fair value of options granted are presented in the
following table: 2003
    
    2002
    
    2001Exercise Price equal to Market Price
    
    $
    5.05
    
    
    $
    4.41
    
    
    $
    0.60Exercise Price less than Market Price
    
    $
    
    
    
    $
    3.74
    
    
    $
    Exercise Price greater than Market Price
    
    $
    5.04
    
    
    $
    2.56
    
    
    $
    
 Option valuation models require the input of highly subjective assumptions.
Because our employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in our opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of our employee stock options. For purposes of pro forma disclosure, the estimated fair value of the options
is amortized to expense over the options vesting period. Our pro forma
information follows (in thousands, except per share amounts): 2003
    
    2002
    
    2001Net income
available to common stockholders(1)
    
    $
    4,405
    
    
    $
    5,684
    
    
    $
    2,578Pro forma compensation expense from stock
options
    
    
    605
    
    
    
    127
    
    
    
    8Pro forma net income
    
    $
    3,800
    
    
    $
    5,557
    
    
    $
    2,570Basic earnings per share:As reported
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.51Pro forma
    
    $
    0.45
    
    
    $
    0.91
    
    
    $
    0.51Diluted earnings per share:As reported
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.49Pro forma
    
    $
    0.39
    
    
    $
    0.84
    
    
    $
    0.48
   (1)
    
    Net income available to common stockholders reflects stock compensation
expense of $118,000 for the year ended December 31, 2002, for stock options
granted with exercise prices below market price during 2002. Risk Management Due to our acquisition of Ramsay, we have two distinct insurance programs that
cover our facilities. For our facilities that were not acquired from Ramsay, we
have obtained professional and general liability insurance for claims in excess
of $3 million with an insured limit of $10 million. In December 2003, we
increased this insured limit to $20 million. For the facilities acquired from
Ramsay, we have obtained professional and general liability insurance for
claims in excess of $500,000 with an insured limit of $25 million. These
policies include umbrella coverage of $20 million and $25 million,
respectively. The self-insured reserves for professional and general liability
risks are calculated based on historical claims, demographic factors, industry
trends, severity factors, and other actuarial assumptions calculated by an
independent third party. The self-insured reserve is discounted to its present value using a 5% discount
rate. This estimated accrual for professional and general liabilities could be
significantly affected should current and future occurrences differ from
historical claim trends and expectations. We have established a captive
insurance company to manage this additional self-insured retention for our
facilities not acquired from Ramsay. We plan to merge these plans in
the near future. While claims are monitored closely when
estimating professional and general liability accruals, the complexity of the
claims and wide range of potential outcomes often hampers timely adjustments to
the assumptions used in these estimates. We believe that our insurance coverage
conforms to industry standards. There are no assurances, however, that our
insurance will cover all claims (e.g., claims for punitive damages) or that
claims in excess of our insurance coverage will not arise. A
successful lawsuit against us that is not covered by, or is in excess of, our
insurance coverage may have a material adverse effect on our business,
financial condition and results of operations. The reserve for
professional and general liability was approximately
$4.2 million as of December 31, 2003. We carry a portion of our workers compensation insurance from an unrelated commercial
insurance carrier. Our experience with workers compensation claims has been
insignificant. We also have a rent-a-captive arrangement for a
portion of our workers compensation coverage. With the
rent-a-captive arrangement we fund the expected losses of claims with
an offshore entity wholly-owned by a United States insurance carrier.
We also maintain an aggregate stop loss policy for our workers
compensation claims. We believe that adequate provision has been made for workers
compensation and professional and general liability risks. F-11




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 Fair Value of Financial Instruments The carrying amounts reported in the accompanying Consolidated Balance Sheets
for cash, accounts receivable, and accounts payable approximate their fair
value given the short-term maturity of these instruments. At December 31, 2003,
the carrying value and fair value of our 10 5/8% senior subordinated notes was
approximately $150 million and $167 million, respectively. Based upon the
borrowing rates currently available to us, the carrying amounts reported in the
accompanying Consolidated Balance Sheets for other long-term debt approximate
fair value. Merger with PMR Corporation On August 5, 2002, pursuant to a definitive Merger Agreement, dated May 6,
2002, and with respective stockholder and regulatory approvals, PMR Acquisition
Corporation, a newly formed, wholly-owned subsidiary of PMR Corporation, merged
with and into Psychiatric Solutions, Inc., a Delaware corporation whose name,
subsequent to the merger, was changed to Psychiatric Solutions Hospitals, Inc.
(PSH). The surviving corporation in the merger was PSH, which became a
wholly-owned subsidiary of PMR Corporation (PMR). In connection with the
merger, PMR changed its name to Psychiatric Solutions, Inc. (PSI). In
exchange for their outstanding shares of common stock or preferred stock in
PSH, stockholders of PSH received newly-issued shares of PSI common stock.
Options to acquire PSH common stock were converted into options to purchase
shares of PSI common stock based on the common stock exchange ratio used in the
merger. Warrants to purchase shares of PSH common stock were converted into
warrants to purchase shares of PSI common stock. After giving effect to the
exercise of all outstanding options and warrants of PSH following the merger,
the former PSH stockholders and PSIs pre-merger stockholders received
approximately 72% and 28% of our common stock, respectively. In addition,
effective August 6, 2002, our common stock was approved for listing on the
Nasdaq National Market under the ticker symbol PSYS. The Merger Agreement is
on file with the Securities and Exchange Commission (SEC) as an exhibit to
Amendment No. 1 to our Registration Statement on Form S-4 filed on June 12,
2002, as amended July 11, 2002. Since the former PSH stockholders had ownership of more than half of our
outstanding common stock pursuant to the merger, PSH has been treated as the
acquiring company for accounting purposes. The condensed consolidated financial
statements located herein relate to PSH only prior to August 5, 2002, and to
the merged company on and subsequent to August 5, 2002. Historical financial
information relating to PMR just prior to the merger can be found in PMRs
quarterly report on Form 10-Q for the quarter ended July 31, 2002, as filed
with the Securities and Exchange Commission on September 16, 2002. Reclassifications Certain reclassifications have been made to the prior year to conform with
current year presentation. Recent Pronouncements In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS
144), which supersedes Statements on Financial Accounting Standards No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of (SFAS 121), and the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Effects of Disposal of a Segment of a Business
and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.
SFAS 144 removes goodwill from its scope and clarifies other implementation
issues related to SFAS 121. SFAS 144 also provides a single framework for
evaluating long-lived assets to be disposed of by sale. We do not expect SFAS
144 to have a material effect on our results of operations or financial
position. In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS 145). SFAS 145 prohibits the classification of gains or
losses from debt extinguishments as extraordinary items unless the criteria
outlined in APB Opinion No. 30, Reporting the Results of Operations 
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, are
met. SFAS 145 also eliminates an inconsistency between the required accounting
for sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS 145 is effective for fiscal years beginning after May 15,
2002, with early adoption encouraged. We adopted the provisions of SFAS 145
effective January 1, 2003 and have reclassified amounts previously reported as
an extraordinary item to a component of income from continuing operations. F-12




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51 (FIN 46). FIN 46 requires the consolidation of entities in which an
enterprise absorbs a majority of the entitys expected losses, receives a
majority of the entitys expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity. FIN 46 also
requires disclosures about variable interest entities that a company is not
required to consolidate, but in which it has a significant variable interest.
The consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003 and to existing entities in the first
fiscal year or interim period ending after December 15, 2003. Certain of the
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established.
This statement has not had a material impact on our results of operations or
financial position. In May, 2003, the FASB issued Statement of Financial Accounting Standards No.
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (SFAS 150). SFAS 150 generally requires liability
classification for certain financial instruments that represent obligations to
issuer and have characteristics of both liabilities and equity. SFAS 150 has
not had a material impact on our results of operations or financial position.
In October 2003, the FASB voted to defer for an indefinite period, the
application of the SFAS 150 guidance to noncontrolling interests in
limited-life subsidiaries. The deferral has not had a material impact on our
results of operations or financial position. 2. Revenue Revenue consists of the following amounts (in thousands): December 31,2003
    
    2002
    
    2001Patient service revenue
    
    $
    223,340
    
    
    $
    81,929
    
    
    $
    16,026Management fee revenue
    
    
    70,325
    
    
    
    31,983
    
    
    
    27,973Total revenue
    
    $
    293,665
    
    
    $
    113,912
    
    
    $
    43,999
 Net Patient Service Revenue Patient service revenue is reported on the accrual basis in the period in which
services are provided, at established rates, regardless of whether collection
in full is expected. Net patient service revenue includes amounts we estimate
to be reimbursable by Medicare and Medicaid under provisions of cost or
prospective reimbursement formulas in effect. Amounts received are generally
less than the established billing rates of the facilities and the differences
(contractual allowances) are reported as deductions from patient service
revenue at the time the service is rendered. The effect of other arrangements
for providing services at less than established rates is also reported as
deductions from patient service revenue. During the year ended December 31,
2003, approximately 12.2% and 32.3% of our revenues related to patients
participating in the Medicare and Medicaid programs, respectively. We provide care without charge to patients who are financially unable to pay
for the health care services they receive. Because we do not pursue collection
of amounts determined to qualify as charity care, they are not reported in
revenues. Settlements under cost reimbursement agreements with third party
payers are estimated and recorded in the period in which the related services
are rendered and are adjusted in future periods as final settlements are
determined. Final determination of amounts earned under the Medicare and
Medicaid programs often occur in subsequent years because of audits by the
programs, rights of appeal and the application of numerous technical
provisions. Our revenue is particularly sensitive to regulatory and economic changes in the
State of Texas. As of December 31, 2003 and 2002, we operated seven and three
inpatient facilities in Texas, respectively. We generated approximately 33%
and 50% of our revenue from our Texas operations for the years ended December
31, 2003 and 2002, respectively. F-13




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 Management Contract Revenue Revenue is recorded as management contract revenue for our inpatient management
contract segment. Our inpatient management contract segment receives
contractually determined management fees from hospitals and clinics for
providing inpatient psychiatric management and development services. Our management contract revenue is sensitive to regulatory and economic changes
in the State of Florida because, as of December 31, 2003, we managed 9
inpatient facilities for the Florida Department of Juvenile Justice. We
generated approximately 6% of our revenue for the year ended December 31, 2003
from our management contracts for the Florida Department of Juvenile Justice.
Our management contract revenue is also sensitive to regulatory and economic
changes in the State of Tennessee because of the contract to provide case
management services in and around Nashville, Tennessee. This contract
generated approximately 8% and 6% of our revenue for the years ended December
31, 2003 and 2002, respectively. There were no other individual or group of
affiliated contracts in 2002 that provided a significant concentration of our
management contract revenue. 3. Earnings Per Share Statement of Financial Accounting Standards No. 128, Earnings per Share (SFAS
128), requires dual presentation of basic and diluted earnings per share by
entities with complex capital structures. Basic earnings per share includes no
dilution and is computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding for
the period. Diluted earnings per share reflects the potential dilution of
securities that could share in the earnings of the entity. We have calculated
earnings per share in accordance with SFAS 128 for all periods presented. The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except per share amounts): Year ended December 31,2003
    
    2002
    
    2001Numerator:Net income available to common stockholders
    
    $
    4,405
    
    
    $
    5,684
    
    
    $
    2,578Add: Interest expense on convertible notes
    
    
    
    
    
    
    324
    
    
    
    Add: Accrued dividends on series A convertible preferred stock
    
    
    811
    
    
    
    
    
    
    
    Earnings used in computing diluted earnings per common share
    
    $
    5,216
    
    
    $
    6,008
    
    
    $
    2,578Denominator:Weighted average shares outstanding for basic earnings per share
    
    
    8,370
    
    
    
    6,111
    
    
    
    5,010Effects of dilutive stock options and warrants outstanding
    
    
    431
    
    
    
    453
    
    
    
    299Effect of dilutive convertible debt outstanding
    
    
    
    
    
    
    422
    
    
    
    Effect of dilutive series A convertible preferred stock outstanding
    
    
    2,948
    
    
    
    
    
    
    
    Shares used in computing diluted earnings per common share
    
    
    11,749
    
    
    
    6,986
    
    
    
    5,309Earnings per common share, basic
    
    $
    0.53
    
    
    $
    0.93
    
    
    $
    0.51Earnings per common share, diluted
    
    $
    0.44
    
    
    $
    0.86
    
    
    $
    0.49
 Diluted earnings per share for the years ended December 31, 2003 and 2001 does
not include the potential dilutive effect of debt outstanding which was
convertible into 106,000 and 483,000 shares of our common stock, respectively,
as the effects would be anti-dilutive. Interest expense related to this
convertible debt was approximately $124,000 and $324,000 for the years ended
December 31, 2003 and 2001, respectively. F-14




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 4. Discontinued Operations Included in discontinued operations are the operating results and estimated
losses on the unwind of service agreements entered into with physicians, as
well as the operating results and gain on disposal for the employee assistance
program. As part of our discontinued physician practice management division, we
acquired certain net assets of psychiatric clinics, and operated the clinics
and managed the physician practices under long-term service agreements with the
physicians that practiced exclusively through the clinics. We did not
consolidate these clinics or the physician practices we managed, as we did not
have operating control. Additionally, discontinued operations include the
operating results and estimated losses on the closure of clinics we owned. Such
clinics provided group and individual therapy sessions to patients through
partial hospitalization and intensive outpatient programs. Our owned clinics
were all closed as of December 31, 2000. Our employee assistance programs
division contracted with employers to provide confidential assistance and
counseling to their employees. Our implementation of plans during 2000 to exit these lines of business
resulted in an estimated loss on disposal of discontinued operations of
$1,738,000 during the year ended December 31, 2000. For the year ended December
31, 2001, our income (loss) on disposal consists primarily of a gain on the
sale of the Employee Assistance Programs division of $1,170,000 (net of taxes
of $223,000), the operations of the employee assistance programs division from
the measurement date through the disposal date of $246,000 and final
adjustments to our loss on disposal of $84,000 for the year ended December 31,
2000. Management contract revenue earned from service agreements and net patient
service revenue earned from our owned clinics totaled $9,876,000 for the year
ended December 31, 2001. Management contract revenue earned under the service
agreements includes reimbursement of clinic expenses incurred on behalf of the
clinic facilities. These reimbursed clinic expenses do not include the salaries
and benefits of physicians and therapists who provide medical service. 5. Acquisitions 2001 ACQUISITIONS During 2001, we acquired four free-standing inpatient psychiatric facilities,
three in Texas and one in North Carolina. All of the acquisitions were
accounted for by the purchase method. The aggregate purchase price of these
transactions was allocated to the assets acquired and liabilities assumed based
upon their respective fair values. The consolidated financial statements
include the accounts and operations of the acquired entities for periods
subsequent to the respective acquisition dates. The goodwill associated with
these acquisitions is deductible for federal income tax purposes. The following table summarizes the allocation of the aggregate purchase price
of the aforementioned acquisitions (in thousands): West Oaks
    
    
    
    
    
    Texas Neuroand Cypress
    
    
    
    
    
    Rehab2001
    
    Creek
    
    Holly Hill
    
    Center
    
    TotalAssets acquired:Assets receivable
    
    $
    7,091
    
    
    $
    1,617
    
    
    $
    3,400
    
    
    $
    12,108Other current assets
    
    
    244
    
    
    
    99
    
    
    
    154
    
    
    
    497Fixed assets
    
    
    6,833
    
    
    
    6,264
    
    
    
    4,738
    
    
    
    17,835Costs in excess of net assets acquired
    
    
    
    
    
    
    403
    
    
    
    135
    
    
    
    53814,168
    
    
    
    8,383
    
    
    
    8,427
    
    
    
    30,978Liabilities assumed
    
    
    2,105
    
    
    
    758
    
    
    
    798
    
    
    
    3,661Subordinated convertible notes issued
    
    
    2,000
    
    
    
    
    
    
    
    2,500
    
    
    
    4,500Long-term debt issued
    
    
    9,908
    
    
    
    7,542
    
    
    
    5,062
    
    
    
    22,512Cash paid, net of cash acquired
    
    $
    155
    
    
    $
    83
    
    
    $
    67
    
    
    $
    305
 F-15




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 2002 ACQUISITIONS During 2002, we acquired one free-standing inpatient psychiatric hospital in
Illinois (Riveredge Hospital). Also during 2002, we merged with PMR
Corporation, a developer and manager of specialized mental health programs and
disease management services designed to treat individuals diagnosed with a
serious mental illness. The acquisition of the hospital and merger with PMR
Corporation were accounted for by the purchase method. The aggregate purchase
price of these transactions was allocated to the assets acquired and
liabilities assumed based upon their respective fair values. The consolidated
financial statements include the accounts and operations of the acquired
entities for periods subsequent to the respective acquisition dates. As these
transactions involved the acquisition of stock, the goodwill associated with
these acquisitions is not deductible for federal income tax purposes. The
purchase of Riveredge Hospital included an escrow arrangement whereby we deposited $4.5
million of the purchase price with an escrow agent. The escrowed funds will be
released to the seller upon satisfaction of certain earnings targets and
indemnification by the seller of certain claims and cost report settlements.
Any claims by us on these escrowed funds would affect the purchase price.
Approximately $1.5 million of these funds were released during 2002. The following table summarizes the allocation of the aggregate purchase price
of the aforementioned acquisitions (in thousands): 2002
    
    Riveredge
    
    PMR
    
    TotalAssets acquired:Accounts receivable
    
    $
    4,208
    
    
    $
    121
    
    
    $
    4,329Other current assets
    
    
    833
    
    
    
    168
    
    
    
    1,001Fixed assets
    
    
    15,350
    
    
    
    155
    
    
    
    15,505Costs in excess of net assets acquired
    
    
    662
    
    
    
    10,938
    
    
    
    11,600Other assets
    
    
    100
    
    
    
    3,544
    
    
    
    3,64421,153
    
    
    
    14,926
    
    
    
    36,079Liabilities assumed
    
    
    4,289
    
    
    
    5,784
    
    
    
    10,073Subordinated notes issued
    
    
    10,000
    
    
    
    
    
    
    
    10,000Long-term debt issued
    
    
    6,864
    
    
    
    
    
    
    
    6,864Common stock issued
    
    
    
    
    
    
    15,385
    
    
    
    15,385Cash acquired, net of cash paid
    
    $
    
    
    
    $
    (6,243
    )
    
    $
    (6,243
    )
 The purchase price allocation for PMR was completed during the quarter ended
March 31, 2003, with the valuation of identifiable intangible assets acquired
in the merger and related deferred tax liability. 2003 ACQUISITIONS During 2003, we acquired
Ramsay, an operator of
11 owned or leased inpatient behavioral health care facilities and 10 contracts
to manage inpatient behavioral health care facilities for state government
agencies. Also during 2003, we acquired six inpatient behavioral health care
facilities from The Brown Schools, Inc. (The Brown Schools). In addition, we
purchased Alliance Health Center (Alliance) and the Calvary Center
(Cavalry) during 2003. These acquisitions were accounted for by the purchase
method. The aggregate purchase price of these transactions was allocated to the
assets acquired and liabilities assumed based upon their respective fair
values. The consolidated financial statements include the accounts and
operations of the acquired entities for periods subsequent to the respective
acquisition dates. Our liabilities assumed included approximately $3.3 million
payable to the seller of Calvary upon the completion of certain licensing
issues. This amount was paid to the seller in January 2004. As the
acquisitions of Ramsay and Alliance involved the acquisition of stock, the
goodwill associated with these acquisitions is not deductible for federal
income tax purposes. The goodwill associated with the acquisitions of The Brown
Schools and Calvary is deductible for federal income tax purposes. F-16




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 The following table summarizes the allocation of the aggregate purchase price
of the aforementioned acquisitions (in thousands): The Brown2003
    
    Ramsay
    
    Schools
    
    Alliance
    
    Calvary
    
    TotalAssets acquired:Accounts receivable
    
    $
    19,982
    
    
    $
    11,367
    
    
    $
    1,901
    
    
    $
    70
    
    
    $
    33,320Other current assets
    
    
    6,164
    
    
    
    1,046
    
    
    
    139
    
    
    
    20
    
    
    
    7,369Fixed assets
    
    
    56,822
    
    
    
    43,756
    
    
    
    14,460
    
    
    
    36
    
    
    
    115,074Costs in excess of net assets acquired
    
    
    19,161
    
    
    
    17,377
    
    
    
    1,755
    
    
    
    4,114
    
    
    
    42,407Other assets
    
    
    1,496
    
    
    
    591
    
    
    
    
    
    
    
    9
    
    
    
    2,096103,625
    
    
    
    74,137
    
    
    
    18,255
    
    
    
    4,249
    
    
    
    200,266Liabilities assumed
    
    
    19,224
    
    
    
    9,601
    
    
    
    4,229
    
    
    
    3,591
    
    
    
    36,645Long-term debt issued
    
    
    
    
    
    
    51,171
    
    
    
    12,594
    
    
    
    
    
    
    
    63,765Cash paid, net of cash acquired
    
    $
    84,401
    
    
    $
    13,365
    
    
    $
    1,432
    
    
    $
    658
    
    
    $
    99,856
 Other Information The following represents the unaudited pro forma results of consolidated
operations as if the aforementioned acquisitions had occurred at the beginning
of the immediate preceding period, after giving effect to certain adjustments,
including the depreciation and amortization of the assets acquired based upon
their fair values and changes in interest expense resulting from changes in
consolidated debt: 2003
    
    2002
    
    2001Revenues
    
    $
    406,876
    
    
    $
    367,507
    
    
    $
    134,735Net income available to common stockholders
    
    
    4,988
    
    
    
    6,912
    
    
    
    4,035Earnings per common share, basic
    
    $
    0.60
    
    
    $
    1.13
    
    
    $
    0.81
 The pro forma information for the year ended December 31, 2003 includes a loss
from refinancing long-term debt of approximately $4.6 million. The pro forma
information given does not purport to be indicative of what our results of
operations would have been if the acquisitions had in fact occurred at the
beginning of the periods presented, and is not intended to be a projection of
the impact on future results or trends. F-17




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 6. Long-term debt Long-term debt consists of the following (in thousands): December 31,2003
    
    2002Senior credit facility:Revolving line of credit, expiring on June 30, 2006
and bearing interest at the prime rate plus 2% (6.25%
at December 31, 2003)
    
    $
    
    
    
    $
    5,383Term loan, due on November 30, 2003 and bearing interest
at the prime rate plus 4.75%
    
    
    
    
    
    
    17,27510 5/8% senior subordinated notes
    
    
    150,000
    
    
    
    Mortgage loans on facilities, maturing in 2037 and 2038
bearing fixed interest rates of 5.65% to 5.95%
    
    
    23,833
    
    
    
    4,928Senior subordinated notes
    
    
    
    
    
    
    10,144Subordinated seller notes with varying maturities
    
    
    1,170
    
    
    
    2,394Subordinated convertible notes
    
    
    
    
    
    
    3,600Other
    
    
    
    
    
    
    98175,003
    
    
    
    43,822Less current portion
    
    
    1,023
    
    
    
    7,070Long-term debt
    
    $
    173,980
    
    
    $
    36,752
 Senior Credit Facility In conjunction with the closing of the sale of our 10 5/8% senior subordinated
notes on June 30, 2003, our senior credit facility with CapitalSource Finance
LLC (CapSource) was amended and restated to increase our senior secured
revolving line of credit to $50.0 million from $28.0 million and to refinance
$36.0 million in term loans with proceeds from the sale of our 10 5/8% senior
subordinated notes. Our senior credit facility is secured by substantially all
of our assets and the stock of our existing operating subsidiaries. The term
loans accrued interest at the Citibank, N.A. prime rate plus 4.5% subject to a
floor of 8.75% and were due in November 2003. The revolving line of credit
accrues interest at the Citibank, N.A. prime rate plus 2% subject to a floor of
6.25% and is due in June 2006. Under our
revolving working capital line of credit we are required to pay interest on a
minimum balance of $17.5 million. At December 31, 2003, the interest rate under
the revolving line of credit was 6.25%. Until the maturity date, we may borrow,
repay and re-borrow an amount not to exceed the lesser of $50.0 million or the
borrowing base (as defined in the amended and restated credit facility). As of
December 31, 2003, we had $50.0 million available under the revolving line of
credit under our senior credit facility. Under the revolving line of credit,
all of our collections, except for Medicare and Medicaid payments, are
deposited into lockbox accounts controlled by CapSource. The funds deposited in
the lockboxes are returned to us on a daily basis. Prior to amending and
restating the senior credit facility, funds deposited in the lockboxes were
applied to outstanding borrowings on a daily basis. As a result, the
outstanding borrowings under the revolving line of credit were classified as
short-term as of December 31, 2002 and all periods prior to June 30, 2003. We
must pay on a monthly basis an unused fee in the amount of 0.5% per annum on
the unused portion of our amended and restated credit facility. Such fees were
approximately $100,000 for the year ended December 31, 2003. As of December 31, 2003, our senior credit
facility consisted of the $50.0 million revolving working capital line of
credit. During 2003 we refinanced $17.0 million in term loans with borrowings
insured by the U.S. Department of Housing and Urban Development (HUD), see
Mortgage Loans below. Our amended and restated senior credit facility contains customary covenants
which include: (1) a specified monthly patient census for any owned, operated
or leased inpatient facilities; (2) a limitation on capital expenditures, sales
of assets, mergers, changes of ownership, new principal lines of business,
indebtedness, dividends and redemptions; and (3) various financial covenants.
In addition, the amended and restated credit facility provides CapSource with a
right of first refusal to provide additional debt financing to us. As of
December 31, 2003, we were in compliance with all debt covenant requirements.
If we violate one or
more of these covenants, amounts outstanding under the amended and restated
credit facility could become immediately payable and additional borrowings
could be restricted. F-18




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 10 5/8% Senior Subordinated Notes On June 30, 2003, we issued $150 million in 10 5/8% senior subordinated notes,
which are fully and unconditionally guaranteed on a senior subordinated basis
by substantially all of our existing operating subsidiaries. Proceeds from the
issuance of the senior subordinated notes and the issuance of $12.5 million in
series A convertible preferred stock were used to finance the acquisition of
Ramsay and pay down substantially all of our previously existing long-term
debt. Interest on the senior subordinated notes accrues at the rate of 10.625%
per annum and is payable semi-annually in arrears on June 15 and December 15,
commencing on December 15, 2003. The senior subordinated notes will mature on
June 15, 2013. Mortgage Loans During 2002 and 2003 we borrowed approximately $23.8 million under mortgage
loan agreements insured by HUD. The mortgage loans insured by HUD are secured
by real estate located at Holly Hill Hospital in Raleigh, North Carolina, West
Oaks Hospital in Houston, Texas and Riveredge Hospital near Chicago, Illinois.
Interest accrues on the Holly Hill, West Oaks and Riveredge HUD loans at 5.95%,
5.85% and 5.65% and principal and interest are payable in 420 monthly
installments through December 2037, September 2038 and December 2038,
respectively. We used the proceeds from the mortgage loans to repay
approximately $4.4 million in 2002 and $17.0 million in 2003 of our term debt
under our senior credit facility, pay certain financing costs, and fund
required escrow amounts for future improvements to the property. The carrying
amount of assets held as collateral approximated $23 million at December 31,
2003. Senior Subordinated Notes On June 28, 2002, we entered into a securities purchase agreement with The 1818
Mezzanine Fund II, L.P. (the 1818 Fund) where the 1818 Fund agreed to
purchase up to $20 million of senior subordinated notes with detachable nominal
warrants. At the closing on June 28, 2002, a total of $10 million of the senior
subordinated notes were issued. On June 30, 2003, we repaid principal of $10
million, accrued interest and a prepayment penalty of 3% to the 1818 Fund with
proceeds from our issuance of 10 5/8% senior subordinated notes, and we no
longer have the ability to borrow under the securities purchase agreement with
the 1818 Fund. In connection with the issuance of the senior subordinated notes to the 1818
Fund, we issued detachable stock purchase warrants for the purchase of 372,412
shares of our common stock at an exercise price of $.01 per share. Also, we
provided the 1818 Fund with the ability to require us to repurchase their
warrants or common stock acquired upon exercise of the warrants at fair market
value for cash. The 1818 Fund exercised its stock purchase warrant and received
372,039 shares of our common stock on May 16, 2003. Because the 1818 Fund had
the ability to require us to repurchase the warrants for cash, the warrants
constituted a derivative that required changes in value of the warrants to be
recorded as an increase or decrease to our earnings. In connection with the
exercise of the warrants, the 1818 Fund provided us with a written consent to
waive its ability to require that we repurchase the warrants for cash effective
April 1, 2003. As such, we are no longer required to record non-cash expense
for changes in the fair market value of our common stock. In addition, the 1818
Fund sold its shares of our common stock on December 24, 2003 so it no longer
has the right to require us to repurchase the shares of our common stock it
received upon the exercise of its warrant. Subordinated Seller Notes In connection with an acquisition in 2000, we issued a promissory note payable
in the amount of $400,000 bearing interest at 9% for the year ended December
31, 2000. Principal on this note is payable in five equal annual installments
beginning April 1, 2001. Accrued interest is due and payable on the first day
of each
calendar quarter beginning July 1, 2000. The principal amount we owe on this
note is $160,000 at December 31, 2003. In connection with two acquisitions in 2001, we issued two promissory notes
totaling $4.5 million. A $2.5 million note bore interest at 9% per annum and
matured June 30, 2002. A $2.0 million note bears interest at 9% per annum and
matures June 30, 2005, with periodic principal and interest payments due
beginning September 30, 2002. The principal amount we owe on
this note is approximately $1.0 million at December 31, 2003. F-19




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 These subordinated seller notes contain customary covenants which include a
cross-default covenant with the occurrence of a default of any indebtedness of
at least $1,000,000 held by any creditor. As of December 31, 2003, we were in
compliance with these covenants. Subordinated Convertible Notes In connection with an acquisition during May 2000, we issued subordinated
convertible notes in the amount of $3.6 million. The principal amount of these
convertible notes and the interest thereon was converted into 537,908 shares of
our common stock in April and May 2003, based on a conversion price of $8.53
per share. Other The aggregate maturities of long-term debt are as follows (in thousands): 2004
    
    $
    1,0232005
    
    
    6032006
    
    
    2492007
    
    
    2632008
    
    
    279Thereafter
    
    
    172,586Total
    
    $
    175,003
 7. Series A Convertible Preferred Stock In conjunction with our acquisitions of The Brown Schools and Ramsay, we issued
4,545,454 shares of our series A convertible preferred stock for $25.0 million
in equal installments in April and June of 2003. Each share of series A
convertible preferred stock is convertible into one share of our common stock.
Holders of the series A convertible preferred stock are entitled to receive
pay-in-kind dividends, compounded quarterly, equal to 5% per share of the
original share price through March 31, 2005. Thereafter, pay-in-kind dividends
will compound quarterly at 7% per share of the original share price. Accrued
pay-in-kind dividends are convertible into approximately 147,000 shares of our
common stock at December 31, 2003. Because we may be required to redeem the
series A convertible preferred stock upon certain change of control events that
may not be within our control, the series A convertible preferred stock has
been classified outside of our permanent stockholders equity.
The series A convertible preferred plus accrued pay-in-kind
dividends will automatically convert to shares of our common stock
when, beginning on October 1, 2004, our common stock trades for
more than $15 on a volume-weighted average basis for
30 consecutive trading days. 8. Leases At December 31, 2003, future minimum lease payments under non-cancelable leases
are as follows (in thousands): 2004
    
    $
    6,0132005
    
    
    5,8072006
    
    
    3,9452007
    
    
    3,3372008
    
    
    2,674Thereafter
    
    
    3,318Total
    
    $
    25,094
 We
lease the buildings for our Whisper Ridge facility, which expires in
August 2005 and has annual lease payments of approximately
$500,000, our Havenwyck facility, which expires in April 2010
and has annual lease payments of approximately $1.5 million, and
our Mission Vista facility, which expires in April 2010 and has
annual lease payments of approximately $600,000. Rent expense totaled $4.1 million and $870,000 for the years ended December 31,
2003 and 2002, respectively. F-20




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##### Table of Contents



9. Income Taxes The provision for (benefit from) income taxes consists of the following (in
thousands): PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 2003
    
    2002Current:Federal
    
    $
    
    
    
    $
    State
    
    
    406
    
    
    
    323406
    
    
    
    323Deferred:Federal
    
    
    3,372
    
    
    
    (1,192
    )State
    
    
    7
    
    
    
    (138
    )3,379
    
    
    
    (1,330
    )Provision
for (benefit from) income taxes
    
    $
    3,785
    
    
    $
    (1,007
    )
 The reconciliation of income tax computed by applying the U.S. federal
statutory rate to the actual income tax (benefit) expense attributable to
continuing operations is as follows (in thousands): 2003
    
    2002Federal tax
    
    $
    3,060
    
    
    $
    1,590State income taxes (net of federal)
    
    
    273
    
    
    
    179Change in valuation allowance
    
    
    
    
    
    
    (2,809
    )Other
    
    
    452
    
    
    
    33Total tax expense (benefit)
    
    $
    3,785
    
    
    $
    (1,007
    )
 Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The tax effects of
significant items comprising temporary differences are as follows (in
thousands): 2003
    
    2002Deferred tax assets:Net operating loss carryforwards
    
    $
    17,711
    
    
    $
    6,296Allowance for doubtful accounts
    
    
    1,955
    
    
    
    904Capital loss carryforwards
    
    
    445
    
    
    
    Alternative minimum tax credit carryovers
    
    
    1,150
    
    
    
    Accrued Liabilities
    
    
    3,498
    
    
    
    1,176Total gross deferred tax assets
    
    
    24,759
    
    
    
    8,376Less: Valuation allowance
    
    
    (11,283
    )
    
    
    (5,860
    )Total deferred tax assets
    
    
    13,476
    
    
    
    2,516Deferred tax liabilities:Amortization
    
    
    (6,867
    )
    
    
    (611
    )Depreciation
    
    
    (13,201
    )
    
    
    (2,111
    )Other
    
    
    (170
    )
    
    
    (52
    )Net deferred tax liability
    
    $
    (6,762
    )
    
    $
    (258
    )
 Current accounting standards generally accepted in the United States (GAAP)
require that deferred income taxes reflect the tax consequences of differences
between the tax bases of assets and liabilities and their carrying values for
GAAP. Future tax benefits are recognized to the extent that realization of such
benefits is more likely than not. A valuation allowance is established for
those benefits that do not meet the more likely than not criteria. We have
evaluated the need for a valuation allowance against deferred tax assets and
have established a valuation allowance of $11.3 million and $5.9 million at
December 31, 2003 and 2002 respectively. The valuation allowance increased by
approximately $5.4 million during the year ended December 31, 2003 as a result
of the following items (in F-21




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 thousands): Valuation allowance at December 31, 2002
    
    $
    (5,860
    )Valuation allowance recorded against acquired Ramsay net deferred tax asset
    
    
    (7,024
    )Release of valuation allowance recorded as purchase accounting adjustments
    
    
    1,601Valuation allowance at December 31, 2003
    
    $
    (11,283
    )
 As of December 31, 2003, we had federal net operating loss carryforwards of
$47.4 million expiring in the years 2012 through 2023. As of December 31, 2003,
we also had capital loss carryforwards of approximately $1.1 million expiring
in 2004 and an alternative minimum tax credit carryover of approximately $1.2
million available to reduce future federal income taxes. 10. Stock Option Plans Upon the merger with PMR Corporation on August 5, 2002, we acquired PMR
Corporations 1997 Equity Incentive Plan, which was subsequently renamed the
Psychiatric Solutions, Inc. Equity Incentive Plan (the Equity Incentive
Plan). The Equity Incentive Plan was amended and restated at our 2003 Annual
Meeting of Stockholders to increase the number of shares of our common stock
subject to grant under the Equity Incentive Plan to 2,233,333 from 1,333,333.
Under the Equity Incentive Plan, options may be granted for terms of up to ten
years and are generally exercisable in cumulative annual increments of 25% each
year, commencing one year after the date of grant. The exercise prices of
incentive stock options and nonqualified options shall not be less than 100%
and 85%, respectively, of the fair market value of the common shares on the
trading day immediately preceding the date of grant. Also upon the merger with PMR Corporation, we acquired PMR Corporations
Outside Directors Non-qualified Stock Option Plan of 1992, which was
subsequently renamed the Psychiatric Solutions, Inc. Outside Directors Stock
Option Plan (the Directors Plan). The Directors Plan provides for a grant
of 4,000 stock options at each annual meeting of stockholders to each outside
director at the fair market value of our common shares on the trading day
immediately preceding the date of grant. The options vest 25% on the grant date
and 25% on the succeeding three anniversaries of the grant date. Options for a
maximum of 341,667 shares may be granted under the Directors Plan. During 2002, we recognized $118,000 compensation expense related to stock
options issued to certain officers and employees with exercise prices below
fair market value. No options with exercise prices below fair market value were
granted during 2003. Stock option activity, including options granted for acquisitions, is as
follows (number of options in thousands): F-22




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 WeightedNumber
    
    
    
    
    
    Averageof
    
    Option
    
    ExerciseOptions
    
    Exercise Price
    
    PriceBalance at December 31, 2000
    
    
    237
    
    
    $
    0.87 to $3.04
    
    
    $
    2.00Granted
    
    
    35
    
    
    $
    3.04
    
    
    $
    3.04Canceled
    
    
    (54
    )
    
    $
    0.87 to $3.04
    
    
    $
    2.61Exercised
    
    
    (4
    )
    
    $
    0.87 to $3.04
    
    
    $
    1.04Balance at December 31, 2001
    
    
    214
    
    
    $
    0.87 to $3.04
    
    
    $
    2.08Granted
    
    
    515
    
    
    $
    0.87 to $5.50
    
    
    $
    5.07Stock options acquired
    
    
    408
    
    
    $
    4.50 to $30.00
    
    
    $
    17.10Canceled
    
    
    (26
    )
    
    $
    0.87 to $29.25
    
    
    $
    4.28Exercised
    
    
    (38
    )
    
    $
    0.87 to $3.04
    
    
    $
    1.14Balance at December 31, 2002
    
    
    1,073
    
    
    $
    0.87 to $30.00
    
    
    $
    9.21Granted
    
    
    713
    
    
    $
    5.05 to $13.75
    
    
    $
    10.77Canceled
    
    
    (83
    )
    
    $
    0.87 to $30.00
    
    
    $
    11.38Exercised
    
    
    (64
    )
    
    $
    0.87 to $9.56
    
    
    $
    4.92Balance at December 31, 2003
    
    
    1,639
    
    
    $
    0.87 to $30.00
    
    
    $
    9.94
 The following table summarizes information concerning outstanding and
exercisable options at December 31, 2003 (number of options in thousands). Options Outstanding
    
    Options ExercisableNumber
    
    Weighted Avg.
    
    Weighted
    
    NumberOutstanding at
    
    Remaining
    
    Average
    
    Exercisable atDecember 31,
    
    Contractual
    
    Exercise
    
    December 31,Exercise Prices
    
    2003
    
    Life
    
    Price
    
    2003$0.87 to $3.03
    
    
    83
    
    
    
    5.19
    
    
    $
    0.87
    
    
    
    82$3.04 to $4.50
    
    
    95
    
    
    
    6.68
    
    
    $
    3.26
    
    
    
    78$4.51 to $5.50
    
    
    509
    
    
    
    8.70
    
    
    $
    5.48
    
    
    
    123$5.51 to $11.63
    
    
    364
    
    
    
    8.12
    
    
    $
    9.31
    
    
    
    66$11.64 to $21.38
    
    
    521
    
    
    
    6.73
    
    
    $
    18.71
    
    
    
    197$21.39 to $30.00
    
    
    67
    
    
    
    1.53
    
    
    $
    26.97
    
    
    
    67$0.87 to $30.00
    
    
    1,639
    
    
    
    
    
    
    $
    11.59
    
    
    
    613
 11. Employee Benefit Plan We adopted the Psychiatric Solutions, Inc. Retirement Savings Plan (the
Plan). The Plan is a tax-qualified profit sharing plan with a cash or
deferred arrangement whereby employees who have completed two months of service
and are age 21 or older are eligible to participate. The Plan allows eligible
employees to make contributions of 1% to 15% of their annual compensation. The
Plan includes a discretionary company matching contribution not to exceed 15%
of eligible employee compensation. Employer contributions vest 20% after two
years of service and continue vesting at 20% per year until fully vested. 12. Contingencies and Health Care Regulation Contingencies We are subject to various claims and legal actions which arise in the ordinary
course of business. We have professional liability insurance to protect against
such claims or legal actions. We believe the ultimate resolution of F-23




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 such
matters will be adequately covered by insurance and will not have a material
adverse effect on our financial position or results of operations. Employment Agreements Effective August 6, 2002, we entered into an Amended and Restated Employment
Agreement with Joey A. Jacobs, our Chairman, Chief Executive Officer and
President. Mr. Jacobs Amended and Restated Employment Agreement was amended on
November 26, 2003. Mr. Jacobs agreement provides for an annual base salary and
an annual cash incentive compensation award tied to objective criteria as
established by the board of directors. The employment agreement has an initial
term of one year and is subject to automatic annual renewals absent prior
notice from either party. Mr. Jacobs employment agreement provides for various payments to Mr. Jacobs
upon cessation of employment, depending on the circumstances. If we terminate
Mr. Jacobss employment without cause or if he resigns pursuant to a
constructive discharge, then (i) all options scheduled to vest during the
succeeding 24 month period will immediately vest and will remain exercisable
for 12 months from the date of termination, (ii) certain restricted stock will
immediately vest, (iii) Mr. Jacobs will receive a cash payment equal to 200% of
his base salary and bonus earned during the twelve months prior to termination,
and (iv) all benefits and perquisites will continue for 18
months. In the event of a change in control, his employment agreement requires
that we pay him 200% of his base salary and bonus earned in the twelve months
prior to termination, paid out over a period of 24 months, and to continue all benefits and perquisites for 18
months. Effective October 1, 2002, we entered into an employment agreement with Jack
Salberg, our Chief Operating Officer. Mr. Salbergs agreement provides for an
annual base salary and an annual cash incentive compensation award tied to
objective criteria established by the board of directors. The employment
agreement had an initial term of 15 months, subject to automatic annual
renewals absent prior notice from either party. Mr. Salbergs employment agreement provides for various payments to Mr. Salberg
upon cessation of employment, depending upon the circumstances. If we
terminate Mr. Salbergs employment without cause or if he resigns pursuant to a
constructive discharge, then (i) all options scheduled to vest during the
succeeding 18 months will immediately vest, (ii) any restricted stock will
immediately vest, (iii) Mr. Salberg will receive a cash payment equal to 150%
of his base salary and bonus earned in 12 months prior to termination, and (iv)
all benefits and perquisites will continue for 18 months. If Mr. Salberg is
terminated after a change in control, his employment agreement requires we pay
him a cash amount equal to 150% of his base salary and bonus earned during the
12 months prior to termination, paid out over a period of
18 months, and to continue all benefits and perquisites for
18 months. Current Operations Final determination of amounts earned under prospective payment and
cost-reimbursement activities is subject to review by appropriate governmental
authorities or their agents. We believe adequate provision has been made for
any adjustments that may result from such reviews. Laws and regulations governing the Medicare and Medicaid programs are complex
and subject to interpretation. We believe that we are in compliance with all
applicable laws and regulations and are not aware of any pending or threatened
investigations involving allegations of potential wrongdoing. While no such
regulatory inquiries have been made, compliance with such laws and regulations
can be subject to future government review and interpretation as well as
significant regulatory action including fines, penalties, and exclusion from
the Medicare and Medicaid programs. We have acquired and may continue to acquire professional corporations with
prior operating histories. Acquired corporations may have unknown or contingent
liabilities for failure to comply with health care laws and regulations, such
as billing and reimbursement, fraud and abuse and similar anti-referral laws.
Although we attempt to assure ourselves that no such liabilities exist and
obtains indemnification from prospective sellers covering such matters, there
can be no assurance that any such matter will be covered by indemnification or,
if covered, that the liability sustained will not exceed contractual limits or
the financial capacity of the indemnifying party. F-24




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 13. Related Party Transactions During 2001 and 2000, we leased office space from a company whose chief
executive officer is Dr. Richard Treadway, the former chairman of our board of
directors. The term of the lease was from May 16, 1999 to July 2002 and was
terminated on December 7, 2001. Rent expense for this space totaled $142,154
for the year ended December 31, 2001. We believe the terms of this lease were
at fair market value. Currently we lease 7,745 square feet of office space for our executive offices
from a company in which Dr. Treadway is a minority investor. The lease was
entered into in October 2001 and has a term of approximately six years. The
annual rent under this lease is approximately $145,000. We believe the terms of
this lease are at fair market value. Joey Jacobs, our Chief Executive Officer, serves as a member of the board of
directors of Stones River Hospital, a hospital in which we manage a psychiatric
unit pursuant to a management agreement. The term of the third amendment to the
management agreement is two years, and automatically renews for one year terms
unless terminated by either party. Total revenue from this management agreement
was $783,000 for the year ended December 31, 2003. We believe the terms of the
management agreement are consistent with management agreements negotiated at arms-length. Jack Salberg, our Chief Operating Officer, served as a minority owner and
member of the board of directors of the entity which owned Riveredge Hospital
prior to our acquisition of it in July 2002. Mr. Salberg disclosed his
interest to the board of directors and was not directly involved in the
negotiations to acquire the hospital. We believe that the purchase price it
paid for the Riveredge acquisition constituted our best estimate of fair value.
All terms were negotiated on an arms-length basis. Edward Wissing, one of our outside directors, occasionally provides advisory
and consulting services during 2002 to Brentwood Capital Advisors, our
financial advisor. Mr. Wissing also was a party to a consulting arrangement
with Brentwood Capital pursuant to which he provided certain consulting
services. According to the terms of this consulting arrangement, Mr. Wissing
received a fixed consulting fee of $5,000 per month beginning in August 2002
and ending in May 2003. In
January 2000, PMR loaned Mark. P. Clien, PMRs chief
executive officer at the time and currently one of our directors,
$467,500 pursuant to promissory notes for the purchase of stock in
connection with the exercise of stock options (the Stock
Notes). The Stock Notes, due December 31, 2004, bear
interest at the rate of 6.21% per annum and are with recourse in
addition to being secured by stock under pledge agreements. PMR also
received promissory notes from Mr. Clein for up to $257,208 for
tax liabilities related to the purchase of such stock (the Tax
Notes). The Tax Notes, due December 31, 2004, bear
interest at the rate of 6.21% and are secured by stock pledges, but
are otherwise without recourse. In May 2002, the Stock Notes and
Tax Notes were amended to include a provision that allowed the
principal and interest on the notes to be paid, at any time prior to
December 31, 2003, through the delivery to us of our common
stock valued at the higher of (i) $7.92 or (ii) the average
closing sales prices of our common stock for the five trading days
prior to the delivery of such stock. The amendments also eliminated
the provision in each Note that required any dividends received with
respect to shares being purchased with the proceeds of such Note to
be immediately applied toward the payment of amounts outstanding
under such note. At December 31, 2003, Mr. Clein owed us $59,554 and
$281,498 under the Stock Notes and Tax Notes, respectively. Joseph
P. Donlan, a director of the Company, is the co-manager of The
1818 Mezzanine Fund II, L.P. (the 1818 Fund),
which is managed by Brown Brothers Harriman & Co. (Brown
Brothers). Mr. Donlan is a managing director of Brown
Brothers. On June 28, 2002, we entered into a securities
purchase agreement with the 1818 Fund to issue up to
$20 million of senior subordinated notes with detachable
warrants. At the closing on June 28, 2002, a total of
$10 million of the senior subordinated notes were issued. The
notes have a term of seven years and bear interest at 12% annually,
payable quarterly. We issued detachable stock purchase warrants to
the 1818 Fund for the purchase of 372,412 shares of our
common stock at an exercise price of $.01 per share. On May 16,
2003, we issued 372,039 shares of our common stock to the
1818 Fund upon exercise of the 1818 Funds stock
purchase warrant. On June 30, 2003, we repaid principal of
$10 million, accrued interest and a prepayment penalty of 3% to
the 1818 Fund with proceeds from our issuance of 10 5/8% senior
subordinated notes, and we no longer have the ability to borrow under
the Securities Purchase Agreement with the 1818 Fund. On
February 4, 2003, our stockholders approved the private
placement of $25 million of series A convertible preferred
stock with affiliates of Oak Investment Partners and Salix Ventures
and the 1818 Fund. The 1818 Fund invested an aggregate of
$999,999 and received an aggregate of 181,818 shares of
series A convertible preferred stock. Oak Investment Partners
invested an aggregate of $20,000,001 and received an aggregate of
3,636,364 shares of series A convertible preferred stock.
Salix Ventures invested an aggregate of $3,999,996 and received an
aggregate of 727,272 shares of series A convertible
preferred stock. One half of the series A convertible preferred stock was
issued on April 1, 2003. The other half was issued on
June 19, 2003. The proceeds of the sale of the series A
convertible preferred stock were used to acquire Ramsay, six
facilities from The Brown Schools, and to pay down a portion of our
long-term debt. 14. Disclosures About Reportable Segments In accordance with the criteria of Statement of Financial Accounting Standards
No. 131, Disclosures About Segments of an Enterprise and Related Information,
(SFAS 131) we operate two reportable segments: (1) owned and leased
facilities and (2) management contracts. Each of our inpatient facilities and
inpatient management contracts qualifies as an operating segment under SFAS
131; however, none is individually material. We have aggregated our operations
into two reportable segments based on the characteristics of the services
provided. As of December 31, 2003, the owned and leased facilities segment
provides mental health and behavioral heath services to patients in its 20
owned and four leased inpatient facilities in 14 states. The management contracts
segment provides inpatient psychiatric management and development services to
42 inpatient behavioral health units in hospitals and clinics in 15 states and
provides mental health and behavioral health services to 11 inpatient
facilities for state government agencies. Activities classified as Corporate
and Other in the following schedule relate primarily to unallocated home
office items. Adjusted EBITDA is a non-GAAP financial measure and is defined as net income
(loss) before discontinued operations, interest expense (net of interest
income), income taxes, depreciation, amortization, stock compensation and other
items included in the caption labeled Other expenses. These other expenses
may occur in future periods, but the amounts recognized can vary significantly
from period to period and do not directly relate to ongoing operations of our
health care facilities. Our management relies on adjusted EBITDA as the primary
measure to review and assess the operating performance of our inpatient
facilities and their management teams. We believe it is useful to investors to
provide disclosures of our operating results on the same basis as that used by
management. Management and investors also review adjusted EBITDA to evaluate
our overall performance and to compare our current operating results with
corresponding periods and with other companies in the health care industry. You F-25




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 should not consider adjusted EBITDA in isolation or as a substitute for net
income, operating cash flows or other cash flow statement data determined in
accordance with accounting principles generally accepted in the United States.
Because adjusted EBITDA is not a measure of financial performance under
accounting principles generally accepted in the United States and is
susceptible to varying calculations, it may not be comparable to similarly
titled measures of other companies. The following is a financial summary by
business segment for the periods indicated (dollars in thousands): Year ended December 31, 2003 Owned andLeased
    
    Management
    
    CorporateFacilities
    
    Contracts
    
    and Other
    
    ConsolidatedRevenue
    
    $
    223,340
    
    
    $
    70,325
    
    
    $
    
    
    
    $
    293,665Adjusted EBITDA
    
    $
    30,801
    
    
    $
    11,345
    
    
    $
    (7,339
    )
    
    $
    34,807Interest expense, net
    
    
    6,996
    
    
    
    92
    
    
    
    7,693
    
    
    
    14,781Provision for income taxes
    
    
    2,165
    
    
    
    73
    
    
    
    1,547
    
    
    
    3,785Depreciation and amortization
    
    
    4,410
    
    
    
    1,155
    
    
    
    189
    
    
    
    5,754Inter-segment expenses
    
    
    5,639
    
    
    
    1,623
    
    
    
    (7,262
    )
    
    
    Other expenses:Loss on refinancing long-term debt
    
    
    
    
    
    
    
    
    
    
    4,856
    
    
    
    4,856Change in valuation of put warrants
    
    
    
    
    
    
    
    
    
    
    960
    
    
    
    960Change in reserve of stockholder notes
    
    
    
    
    
    
    (545
    )
    
    
    
    
    
    
    (545
    )Total other expenses
    
    
    
    
    
    
    (545
    )
    
    
    5,816
    
    
    
    5,271Net income
    
    $
    11,591
    
    
    $
    8,947
    
    
    $
    (15,322
    )
    
    $
    5,216Segment assets
    
    $
    246,526
    
    
    $
    40,221
    
    
    $
    61,888
    
    
    $
    348,635Capital expenditures
    
    $
    5,516
    
    
    $
    
    
    
    $
    261
    
    
    $
    5,777Cost in excess of net assets acquired
    
    $
    45,093
    
    
    $
    23,877
    
    
    $
    
    
    
    $
    68,970
 Year ended December 31, 2002 Owned andLeased
    
    Management
    
    CorporateFacilities
    
    Contracts
    
    and Other
    
    ConsolidatedRevenue
    
    $
    81,929
    
    
    $
    31,983
    
    
    $
    
    
    
    $
    113,912Adjusted EBITDA
    
    $
    9,343
    
    
    $
    7,082
    
    
    $
    (4,118
    )
    
    $
    12,307Provision for (benefit from) income taxes
    
    
    
    
    
    
    324
    
    
    
    (1,331
    )
    
    
    (1,007
    )Depreciation and amortization
    
    
    1,286
    
    
    
    379
    
    
    
    105
    
    
    
    1,770Interest expense
    
    
    3,375
    
    
    
    325
    
    
    
    1,864
    
    
    
    5,564Inter-segment expenses
    
    
    3,149
    
    
    
    902
    
    
    
    (4,051
    )
    
    
    Other expenses:Stock compensation expense
    
    
    
    
    
    
    
    
    
    
    118
    
    
    
    118Loss on refinancing long-term debt
    
    
    
    
    
    
    
    
    
    
    86
    
    
    
    86Change in reserve of stockholder notes
    
    
    
    
    
    
    92
    
    
    
    
    
    
    
    92Total other expenses
    
    
    
    
    
    
    92
    
    
    
    204
    
    
    
    296Net income (loss)
    
    $
    1,533
    
    
    $
    5,060
    
    
    $
    (909
    )
    
    $
    5,684Segment assets
    
    $
    51,004
    
    
    $
    33,012
    
    
    $
    6,122
    
    
    $
    90,138Capital expenditures
    
    $
    16,092
    
    
    $
    171
    
    
    $
    622
    
    
    $
    16,885Cost in excess of net assets acquired
    
    $
    1,238
    
    
    $
    27,580
    
    
    $
    4
    
    
    $
    28,822
 F-26




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 Year ended December 31, 2001 Owned andLeased
    
    Management
    
    CorporateFacilities
    
    Contracts
    
    and Other
    
    ConsolidatedRevenue
    
    $
    16,020
    
    
    $
    27,979
    
    
    $
    
    
    
    $
    43,999Adjusted EBITDA
    
    $
    1,374
    
    
    $
    6,469
    
    
    $
    (2,011
    )
    
    $
    5,832Depreciation and amortization
    
    
    170
    
    
    
    715
    
    
    
    60
    
    
    
    945Interest expense
    
    
    533
    
    
    
    324
    
    
    
    1,803
    
    
    
    2,660Inter-segment expenses
    
    
    448
    
    
    
    1,773
    
    
    
    (2,221
    )
    
    
    Other expenses:Loss on refinancing long-term debt
    
    
    
    
    
    
    
    
    
    
    1,237
    
    
    
    1,237Total other expenses
    
    
    
    
    
    
    
    
    
    
    1,237
    
    
    
    1,237Income (loss) from continuing operations
    
    $
    223
    
    
    $
    3,657
    
    
    $
    (2,890
    )
    
    $
    990Segment assets
    
    $
    31,471
    
    
    $
    20,394
    
    
    $
    2,429
    
    
    $
    54,294Capital expenditures
    
    $
    18,373
    
    
    $
    
    
    
    $
    116
    
    
    $
    18,489Cost in excess of net assets acquired
    
    $
    538
    
    
    $
    14,666
    
    
    $
    4
    
    
    $
    15,208
 15. Other Information A summary of activity in allowance for doubtful accounts follows (in
thousands): Balances
    
    Additions
    
    Additions
    
    Accounts written
    
    Balancesat beginning
    
    charged to costs
    
    charged to
    
    off, net of
    
    at endof period
    
    and expenses
    
    other accounts (1)
    
    recoveries
    
    of periodAllowance for doubtful accounts:Year ended December 31, 2001
    
    $
    2,443
    
    
    
    662
    
    
    
    921
    
    
    
    86
    
    
    $
    3,940Year ended December 31, 2002
    
    
    3,940
    
    
    
    3,681
    
    
    
    461
    
    
    
    2,798
    
    
    
    5,284Year ended December 31, 2003
    
    
    5,284
    
    
    
    6,315
    
    
    
    4,338
    
    
    
    8,446
    
    
    
    7,491
  (1)
    
    Allowances as a result of acquisition. 16. Quarterly Information (Unaudited) Summarized results for each quarter in the years ended December 31, 2003 and
2002 are as follows (in thousands, except per share data): 1st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter2003Revenue
    
    $
    37,104
    
    
    $
    57,438
    
    
    $
    98,470
    
    
    $
    100,653Net income available to common stockholders
    
    $
    789
    
    
    $
    (771
    )
    
    $
    2,103
    
    
    $
    2,284Earnings per share:Basic
    
    $
    0.10
    
    
    $
    (0.09
    )
    
    $
    0.24
    
    
    $
    0.26Diluted
    
    $
    0.10
    
    
    $
    (0.09
    )
    
    $
    0.18
    
    
    $
    0.192002Revenue
    
    $
    23,188
    
    
    $
    22,622
    
    
    $
    32,280
    
    
    $
    35,822Net income available to common stockholders
    
    $
    755
    
    
    $
    857
    
    
    $
    1,606
    
    
    $
    2,466Earnings per share:Basic
    
    $
    0.15
    
    
    $
    0.17
    
    
    $
    0.24
    
    
    $
    0.32Diluted
    
    $
    0.14
    
    
    $
    0.16
    
    
    $
    0.22
    
    
    $
    0.30
 In the second quarter of 2003, we incurred a loss on refinancing long-term debt
of approximately $4.6 million in conjunction with early repayments of portions
of our long-term debt with proceeds from our issuance of $150 F-27




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 million in 10
5/8% senior subordinated notes. 17. Financial Information for the Company and Its Subsidiaries We conduct substantially all of our business through our subsidiaries.
Presented below is consolidated financial information for us and our
subsidiaries as of December 31, 2003 and 2002, and for the years then ended.
The information segregates the parent company (Psychiatric Solutions, Inc.),
the combined wholly-owned subsidiary guarantors, the combined non-guarantors,
and eliminations. All of the subsidiary guarantees are both full and
unconditional and joint and several. No combining financial information has
been presented for periods prior to December 31, 2002 as there were no
non-guarantor subsidiaries prior to November 2002. Psychiatric Solutions, Inc.
Condensed Consolidating Balance Sheet
December 31, 2003
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsCurrent Assets:Cash
    
    $
    
    
    
    $
    43,334
    
    
    $
    1,498
    
    
    $
    
    
    
    $
    44,832Accounts receivable, net
    
    
    
    
    
    
    60,055
    
    
    
    
    
    
    
    
    
    
    
    60,055Prepaids and other
    
    
    
    
    
    
    8,510
    
    
    
    19
    
    
    
    
    
    
    
    8,529Total current assets
    
    
    
    
    
    
    111,899
    
    
    
    1,517
    
    
    
    
    
    
    
    113,416Property and equipment, net of accumulated depreciation
    
    
    
    
    
    
    127,047
    
    
    
    31,029
    
    
    
    (8,319
    )
    
    
    149,757Cost in excess of net assets acquired
    
    
    
    
    
    
    68,970
    
    
    
    
    
    
    
    
    
    
    
    68,970Contracts, net
    
    
    
    
    
    
    2,850
    
    
    
    
    
    
    
    
    
    
    
    2,850Investment in subsidiaries
    
    
    199,154
    
    
    
    
    
    
    
    
    
    
    
    (199,154
    )
    
    
    Other assets
    
    
    7,731
    
    
    
    1,958
    
    
    
    3,953
    
    
    
    
    
    
    
    13,642Total assets
    
    $
    206,885
    
    
    $
    312,724
    
    
    $
    36,499
    
    
    $
    (207,473
    )
    
    $
    348,635Current Liabilities:Accounts payable
    
    $
    
    
    
    $
    11,637
    
    
    $
    
    
    
    $
    
    
    
    $
    11,637Salaries and benefits payable
    
    
    
    
    
    
    13,642
    
    
    
    
    
    
    
    
    
    
    
    13,642Other accrued liabilities
    
    
    871
    
    
    
    19,176
    
    
    
    1,090
    
    
    
    (969
    )
    
    
    20,168Current portion of long-term debt
    
    
    
    
    
    
    801
    
    
    
    222
    
    
    
    
    
    
    
    1,023Total current liabilities
    
    
    871
    
    
    
    45,256
    
    
    
    1,312
    
    
    
    (969
    )
    
    
    46,470Long-term debt, less current portion
    
    
    150,369
    
    
    
    
    
    
    
    23,611
    
    
    
    
    
    
    
    173,980Deferred tax liability
    
    
    
    
    
    
    6,762
    
    
    
    
    
    
    
    
    
    
    
    6,762Other liabilities
    
    
    3,218
    
    
    
    592
    
    
    
    
    
    
    
    969
    
    
    
    4,779Total liabilities
    
    
    154,458
    
    
    
    52,610
    
    
    
    24,923
    
    
    
    
    
    
    
    231,991Series A convertible preferred stock
    
    
    25,316
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,316Stockholders equity:Total stockholders equity
    
    
    27,111
    
    
    
    260,114
    
    
    
    11,576
    
    
    
    (207,473
    )
    
    
    91,328Total liabilities and stockholders equity
    
    $
    206,885
    
    
    $
    312,724
    
    
    $
    36,499
    
    
    $
    (207,473
    )
    
    $
    348,635
 Psychiatric Solutions, Inc.
Condensed Consolidating Balance Sheet
December 31, 2002
(Dollars in thousands) Combined
    
    Combined
    
    
    
    TotalSubsidiary
    
    Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsCurrent Assets:Cash
    
    
    
    
    
    $
    1,175
    
    
    $
    1,217
    
    
    
    
    
    
    $
    2,392Accounts receivable, net
    
    
    
    
    
    
    19,473
    
    
    
    
    
    
    
    
    
    
    
    19,473Prepaids and other
    
    
    
    
    
    
    2,204
    
    
    
    15
    
    
    
    
    
    
    
    2,219Total current assets
    
    
    
    
    
    
    22,852
    
    
    
    1,232
    
    
    
    
    
    
    
    24,084Property and equipment:Land
    
    
    
    
    
    
    5,253
    
    
    
    1,555
    
    
    
    
    
    
    
    6,808Buildings
    
    
    
    
    
    
    20,908
    
    
    
    4,567
    
    
    
    
    
    
    
    25,475Equipment
    
    
    
    
    
    
    3,253
    
    
    
    
    
    
    
    
    
    
    
    3,253Less accumulated depreciation
    
    
    
    
    
    
    (1,695
    )
    
    
    (294
    )
    
    
    
    
    
    
    (1,989
    )
    
    
    
    27,719
    
    
    
    5,828
    
    
    
    
    
    
    
    33,547Cost in excess of net assets acquired
    
    
    
    
    
    
    28,822
    
    
    
    
    
    
    
    
    
    
    
    28,822Contracts, net
    
    
    
    
    
    
    607
    
    
    
    
    
    
    
    
    
    
    
    607Investments in subsidiaries
    
    
    76,693
    
    
    
    
    
    
    
    
    
    
    
    (76,693
    )
    
    
    Other assets
    
    
    
    
    
    
    2,295
    
    
    
    783
    
    
    
    
    
    
    
    3,078Total assets
    
    $
    76,693
    
    
    $
    82,295
    
    
    $
    7,843
    
    
    $
    (76,693
    )
    
    $
    90,138Current Liabilities:Accounts payable
    
    
    
    
    
    
    3,338
    
    
    $
    
    
    
    
    
    
    
    $
    3,338Salaries and benefits payable
    
    
    
    
    
    
    4,825
    
    
    
    
    
    
    
    
    
    
    
    4,825Other accrued liabilities
    
    
    929
    
    
    
    5,460
    
    
    
    93
    
    
    
    
    
    
    
    6,482Revolving line of credit
    
    
    5,383
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,383Current portion of long-term debt
    
    
    1,644
    
    
    
    
    
    
    
    43
    
    
    
    
    
    
    
    1,687Total current liabilities
    
    
    7,956
    
    
    
    13,623
    
    
    
    136
    
    
    
    
    
    
    
    21,715Long-term debt, less current portion
    
    
    28,267
    
    
    
    3,600
    
    
    
    4,885
    
    
    
    
    
    
    
    36,752Deferred tax liability
    
    
    
    
    
    
    258
    
    
    
    
    
    
    
    
    
    
    
    258Other liabilities
    
    
    
    
    
    
    864
    
    
    
    
    
    
    
    
    
    
    
    864Total liabilities
    
    
    36,223
    
    
    
    18,345
    
    
    
    5,021
    
    
    
    
    
    
    
    59,589Stockholders equity:Total stockholders equity
    
    
    40,470
    
    
    
    63,950
    
    
    
    2,822
    
    
    
    (76,693
    )
    
    
    30,549Total liabilities and stockholders equity
    
    $
    76,693
    
    
    $
    82,295
    
    
    $
    7,843
    
    
    $
    (76,693
    )
    
    $
    90,138 F-28




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Income
For the Year Ended December 31, 2003
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsRevenue
    
    $
    
    
    
    $
    293,665
    
    
    $
    1,802
    
    
    $
    (1,802
    )
    
    $
    293,665Salaries, wages and employee benefits
    
    
    
    
    
    
    153,498
    
    
    
    
    
    
    
    
    
    
    
    153,498Professional fees
    
    
    
    
    
    
    33,199
    
    
    
    94
    
    
    
    
    
    
    
    33,293Supplies
    
    
    
    
    
    
    17,074
    
    
    
    
    
    
    
    
    
    
    
    17,074Rentals and leases
    
    
    
    
    
    
    4,109
    
    
    
    
    
    
    
    
    
    
    
    4,109Other operating expenses
    
    
    545
    
    
    
    45,823
    
    
    
    903
    
    
    
    (2,702
    )
    
    
    44,569Provision for bad debts
    
    
    
    
    
    
    6,315
    
    
    
    
    
    
    
    
    
    
    
    6,315Equity in earnings of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    
    
    
    
    5,307
    
    
    
    447
    
    
    
    
    
    
    
    5,754Interest expense
    
    
    14,089
    
    
    
    124
    
    
    
    568
    
    
    
    
    
    
    
    14,781Loss on refinancing of long-term debt
    
    
    4,856
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,856Change in valuation of put warrants
    
    
    960
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    960Change in reserve of stockholder notes
    
    
    (545
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (545
    )19,905
    
    
    
    265,449
    
    
    
    2,012
    
    
    
    (2,702
    )
    
    
    284,664(Loss) income before income taxes
    
    
    (19,905
    )
    
    
    28,216
    
    
    
    (210
    )
    
    
    900
    
    
    
    9,001(Benefit from) provision for income taxes
    
    
    (7,357
    )
    
    
    11,141
    
    
    
    1
    
    
    
    
    
    
    
    3,785Net (loss) income
    
    
    (12,548
    )
    
    
    17,075
    
    
    
    (211
    )
    
    
    900
    
    
    
    5,216Accrued preferred stock dividends
    
    
    811
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    811Net (loss)
income available to common shareholders
    
    $
    (13,359
    )
    
    $
    17,075
    
    
    $
    (211
    )
    
    $
    900
    
    
    $
    4,405
 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Income
For the Year Ended December 31, 2002
(Dollars in thousands) Combined
    
    Combined
    
    
    
    TotalSubsidiary
    
    Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsRevenue
    
    $
    
    
    
    $
    113,794
    
    
    $
    118
    
    
    $
    
    
    
    $
    113,912Salaries, wages and employee benefits
    
    
    
    
    
    
    62,326
    
    
    
    
    
    
    
    
    
    
    
    62,326Professional fees
    
    
    
    
    
    
    14,327
    
    
    
    46
    
    
    
    
    
    
    
    14,373Supplies
    
    
    
    
    
    
    5,325
    
    
    
    
    
    
    
    
    
    
    
    5,325Rentals and leases
    
    
    
    
    
    
    870
    
    
    
    
    
    
    
    
    
    
    
    870Other operating expenses
    
    
    769
    
    
    
    14,489
    
    
    
    68
    
    
    
    
    
    
    
    15,326Provision for bad debts
    
    
    
    
    
    
    3,681
    
    
    
    
    
    
    
    
    
    
    
    3,681Equity (loss) in earnings of subsidiaries
    
    
    (11,669
    )
    
    
    
    
    
    
    
    
    
    
    11,669
    
    
    
    Depreciation and amortization
    
    
    
    
    
    
    1,750
    
    
    
    20
    
    
    
    
    
    
    
    1,770Interest expense
    
    
    5,216
    
    
    
    324
    
    
    
    24
    
    
    
    
    
    
    
    5,564(5,684
    )
    
    
    103,092
    
    
    
    158
    
    
    
    11,669
    
    
    
    109,235Income (loss) from continuing operations before
    income taxes
    
    
    5,684
    
    
    
    10,702
    
    
    
    (40
    )
    
    
    (11,669
    )
    
    
    4,677Provision for (benefit from) income taxes
    
    
    
    
    
    
    (1,007
    )
    
    
    
    
    
    
    
    
    
    
    (1,007
    )Net income (loss)
    
    $
    5,684
    
    
    $
    11,709
    
    
    $
    (40
    )
    
    $
    (11,669
    )
    
    $
    5,684 F-29




---



##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Cash Flows
For the Year Ended December 31, 2003
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsOperating ActivitiesNet (loss) income
    
    $
    (12,548
    )
    
    $
    17,075
    
    
    $
    (211
    )
    
    $
    900
    
    
    $
    5,216Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:Depreciation and amortization
    
    
    
    
    
    
    5,307
    
    
    
    447
    
    
    
    
    
    
    
    5,754Provision for doubtful accounts
    
    
    
    
    
    
    6,315
    
    
    
    
    
    
    
    
    
    
    
    6,315Accretion of detachable warrants
    
    
    162
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    162Non-cash stock compensation expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of loan costs
    
    
    1,454
    
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    1,478Loss on refinancing long-term debt
    
    
    4,856
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,856Change in valuation of put warrants
    
    
    960
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    960Change in reserve on stockholder notes
    
    
    (545
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (545
    )Long-term interest accrued
    
    
    
    
    
    
    124
    
    
    
    
    
    
    
    
    
    
    
    124Changes in operating assets and liabilities, net of
effect of acquisitions:Accounts receivable
    
    
    
    
    
    
    (13,561
    )
    
    
    
    
    
    
    
    
    
    
    (13,561
    )Prepaids and other current assets
    
    
    (7,731
    )
    
    
    8,796
    
    
    
    (4
    )
    
    
    
    
    
    
    1,061Accounts payable
    
    
    
    
    
    
    (1,999
    )
    
    
    
    
    
    
    
    
    
    
    (1,999
    )Accrued liabilities and other liabilities
    
    
    (58
    )
    
    
    4,722
    
    
    
    997
    
    
    
    
    
    
    
    5,661Net cash (used in) provided by continuing operating activities
    
    
    (13,450
    )
    
    
    26,779
    
    
    
    1,253
    
    
    
    900
    
    
    
    15,482Investing Activities:Cash paid for acquisitions, net of cash acquired
    
    
    (100,424
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (100,424
    )Capital purchases of property and equipment
    
    
    
    
    
    
    (5,777
    )
    
    
    (25,487
    )
    
    
    25,487
    
    
    
    (5,777
    )Purchase of long-term securities
    
    
    
    
    
    
    
    
    
    
    (971
    )
    
    
    
    
    
    
    (971
    )Other assets
    
    
    
    
    
    
    1,842
    
    
    
    (4
    )
    
    
    
    
    
    
    1,838Net used in investing activities
    
    
    (100,424
    )
    
    
    (3,935
    )
    
    
    (26,462
    )
    
    
    25,487
    
    
    
    (105,334
    )Financing Activities:Net principal borrowings on long-term debt
    
    
    61,980
    
    
    
    
    
    
    
    18,962
    
    
    
    (18,962
    )
    
    
    61,980Net transfers to and from members
    
    
    (18,418
    )
    
    
    19,315
    
    
    
    6,528
    
    
    
    (7,425
    )
    
    
    Payment of loan and issuance costs
    
    
    (1,998
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,998
    )Refinancing of long-term debt
    
    
    (1,410
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,410
    )Proceeds from issuance of series A convertible preferred stock,
net of issuance costs
    
    
    24,505
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,505Proceeds from secondary offering of common stock,
net of issuance costs
    
    
    48,897
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,897Proceeds from issuance of common stock
    
    
    318
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    318Net cash provided by (used in) financing activities
    
    
    113,874
    
    
    
    19,315
    
    
    
    25,490
    
    
    
    (26,387
    )
    
    
    132,292Net increase in cash
    
    
    
    
    
    
    42,159
    
    
    
    281
    
    
    
    
    
    
    
    42,440Cash at beginning of year
    
    
    
    
    
    
    1,175
    
    
    
    1,217
    
    
    
    
    
    
    
    2,392Cash at end of year
    
    $
    
    
    
    $
    43,334
    
    
    $
    1,498
    
    
    $
    
    
    
    $
    44,832
 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Cash Flows
For the Year Ended December 31, 2002
(Dollars in thousands) Combined
    
    Combined
    
    
    
    TotalSubsidiary
    
    Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsOperating ActivitiesNet income (loss)
    
    $
    5,684
    
    
    $
    11,709
    
    
    $
    (40
    )
    
    $
    (11,669
    )
    
    $
    5,684Adjustments to reconcile net income (loss) to net
    cash provided by (used in) operating activities:Depreciation and amortization
    
    
    
    
    
    
    1,750
    
    
    
    20
    
    
    
    
    
    
    
    1,770Provision for doubtful accounts
    
    
    
    
    
    
    3,681
    
    
    
    
    
    
    
    
    
    
    
    3,681Accretion of detachable warrants
    
    
    
    
    
    
    677
    
    
    
    
    
    
    
    
    
    
    
    677Non-cash stock compensation expense
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    
    
    
    
    118Amortization of loan costs
    
    
    
    
    
    
    419
    
    
    
    
    
    
    
    
    
    
    
    419Release of deferred tax asset valuation allowance
    
    
    
    
    
    
    (1,332
    )
    
    
    
    
    
    
    
    
    
    
    (1,332
    )Additional reserve on stockholder notes
    
    
    
    
    
    
    92
    
    
    
    
    
    
    
    
    
    
    
    92Long-term interest accrued
    
    
    
    
    
    
    324
    
    
    
    
    
    
    
    
    
    
    
    324(Loss) equity in earnings of subsidiaries
    
    
    (11,669
    )
    
    
    
    
    
    
    
    
    
    
    11,669
    
    
    
    Changes in operating assets and liabilities, net
    of effect of acquisitions:Accounts receivable
    
    
    
    
    
    
    (1,348
    )
    
    
    
    
    
    
    
    
    
    
    (1,348
    )Prepaids and other current assets
    
    
    
    
    
    
    (353
    )
    
    
    (46
    )
    
    
    
    
    
    
    (399
    )Accounts payable
    
    
    
    
    
    
    (2,523
    )
    
    
    
    
    
    
    
    
    
    
    (2,523
    )Salaries and benefits payable
    
    
    
    
    
    
    1,504
    
    
    
    
    
    
    
    
    
    
    
    1,504Accrued liabilities and other liabilities
    
    
    929
    
    
    
    (740
    )
    
    
    66
    
    
    
    
    
    
    
    255Net cash provided by (used in) continuing
    operating activities
    
    
    (5,056
    )
    
    
    13,978
    
    
    
    
    
    
    
    
    
    
    
    8,922Investing activities:Cash acquired (paid) for acquisitions, net of
    cash paid or acquired
    
    
    
    
    
    
    6,243
    
    
    
    
    
    
    
    
    
    
    
    6,243Capital purchases of leasehold improvements,
    equipment and software
    
    
    
    
    
    
    (1,470
    )
    
    
    
    
    
    
    
    
    
    
    (1,470
    )Change in net assets of discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other assets
    
    
    
    
    
    
    (612
    )
    
    
    
    
    
    
    
    
    
    
    (612
    )Net cash provided by (used in) investing
    activities
    
    
    
    
    
    
    4,161
    
    
    
    
    
    
    
    
    
    
    
    4,161Financing activities:Net principal (payments) borrowings on long-term
    debt
    
    
    7,484
    
    
    
    (19,256
    )
    
    
    
    
    
    
    
    
    
    
    (11,772
    )Payment of loan costs
    
    
    
    
    
    
    (234
    )
    
    
    
    
    
    
    
    
    
    
    (234
    )Proceeds from issuance of common stock
    
    
    
    
    
    
    53
    
    
    
    
    
    
    
    
    
    
    
    53Change in intercompany
    
    
    (2,428
    )
    
    
    2,428
    
    
    
    
    
    
    
    
    
    
    
    Net cash (used in) provided by financing
    activities
    
    
    5,056
    
    
    
    (17,009
    )
    
    
    
    
    
    
    
    
    
    
    (11,953
    )Net increase in cash
    
    
    
    
    
    
    1,130
    
    
    
    
    
    
    
    
    
    
    
    1,130Cash at beginning of year
    
    
    
    
    
    
    45
    
    
    
    1,217
    
    
    
    
    
    
    
    1,262Cash at end of year
    
    
    
    
    
    
    1,175
    
    
    
    1,217
    
    
    
    
    
    
    
    2,392 18. Subsequent Events (Unaudited) On March 1, 2004, we
acquired two inpatient psychiatric facilities from Brentwood
Behavioral Health (Brentwood) for approximately $28 million cash
with an earn-out of up to $5 million contingent upon
Brentwoods
future financial results. The facilities, which have an aggregate of
311 licensed beds, are located in Shreveport, Louisiana and
Jackson, Mississippi. On January 26, 2004, we
entered into an interest rate swap agreement to manage our exposure
to fluctuations in interest rates. The swap agreement effectively
converts $20 million of fixed-rate long-term debt to a LIBOR
indexed variable rate instrument plus an agreed upon interest rate
spread. On January 6, 2004, we
entered into a revolving credit facility with Bank of America, N.A.
of up to $50 million. The revolving credit facility has a
three-year term and is secured by all real property owned by us or
our subsidiaries that has a value in excess of $2.5 million, the
stock of all of our operating subsidiaries and substantially all of
the personal property owned by us or our subsidiaries.  Our credit
agreement with Bank of America, N.A. prohibits us from paying
dividends on our common stock. We will incur
a $6.4 million loss from refinancing long-term debt in the first
quarter of 2004, which includes the payment of a termination fee to
CapitalSource Finance, LLC, our former senior lender. F-30




---



##### Table of Contents



Pursuant to the requirements of Section 13 or 15(d) 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. Psychiatric Solutions, Inc.By:
    
    /s/ Joey A. JacobsJoey A. JacobsChief Executive Officer
 Dated: March 25, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/
Joey A. Jacobs
    
    Chairman of the Board, President
    
    March 25, 2004

and Chief Executive OfficerJoey A. Jacobs
    
    (Principal Executive Officer)/s/ Jack E. Polson
    
    Chief Accounting Officer
    
    March 25, 2004Jack E. Polson
    
    (Principal Accounting Officer)/s/ Mark P. Clein
    
    Director
    
    March 25, 2004Mark P. Clein/s/
Richard D. Gore
    
    Director
    
    March 25, 2004Richard D. Gore/s/
Christopher Grant, Jr.
    
    Director
    
    March 25, 2004Christopher Grant, Jr./s/
Ann H. Lamont
    
    Director
    
    March 25, 2004Ann H. Lamont/s/
Edward K. Wissing
    
    Director
    
    March 25, 2004Edward K. Wissing