UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549


FORM 10-K





[X]
Annual report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 2011


[   ]
Transition report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from       to




Commission file number    1-33323


PHC, INC.(Exact name of registrant as specified in its charter)Massachusetts

04-2601571(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)200 Lake Street, Suite 102, Peabody MA

01960(Address of principal executive offices)

(Zip Code)


978-536-2777(Registrant’s telephone number)





Securities registered under Section 12(b) of the Act:


CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE


Securities registered under Section 12(g) of the Act:


NONE


(Title of Class)


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.


Yes ___
No _X_





Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.


Yes ___
No _X_





Indicate by check mark whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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 whether the registrant has submitted electronically and posted on corporate Web site, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).


Yes ___
No ___





Indicate by check mark if disclosure of delinquent filers in response 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one)





Large Accelerated Filer  ____

Accelerated Filer ____Non-Accelerated Filer ___­­__

Smaller reporting company
_X_





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


Yes ___
No _X_





As of December 31, 2010, the aggregate market value of the shares of common stock of the registrant held by non-affiliates of the registrant was approximately $29.1 million.


As of August 10, 2011, 18,764,118 shares of the registrant’s Class A Common Stock and 773,717 shares of the registrant’s Class B Common Stock were outstanding.


1


Table of Contents
  Index

PagePART IItem 1.
Description of Business
3Item 1A.
Risk Factors
19Item 1B.
Unresolved staff comments
22Item 2.
Description of Property
22Item 3.
Legal Proceedings
24PART IIItem 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
25Item 6.
Selected Financial Data
27Item 7.
Management’s Discussion and Analysis of Financial Condition and Results

of Operations
28Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
38Item 8.
Financial Statements and Supplementary Data
39Index to financial statements
39Item 9.
Changes in and Disagreements with Accountants on Accounting and

Financial Disclosure
71Item9A.
Controls and Procedures
71PART IIIItem 10.
Directors, Executive Officers and Corporate Governance
73Item 11.
Executive Compensation
79Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related

Stockholder Matters
87Item 13.
Certain Relationships and Related Transactions and Director Independence
89Item 14.
Principal Accountant Fees and Services
89PART IVItem 15.
Exhibits and Financial Statement Schedules
91Signatures
94


2





PART I





All references in this Annual Report on Form 10-K to “Pioneer,” “PHC,” “the Company,” “we,” “us,” or “our” mean, unless the context otherwise requires, PHC, Inc. and its consolidated subsidiaries.




Item 1.           DESCRIPTION OF BUSINESS





INTRODUCTION





Our Company is a national healthcare company, which, through wholly owned subsidiaries, provides psychiatric services to individuals who have behavioral health disorders including alcohol and drug dependency and to individuals in the gaming and transportation industries.  Our subsidiaries operate substance abuse treatment facilities in Utah, Virginia and Michigan, four outpatient psychiatric facilities in Michigan, three outpatient psychiatric facilities in Nevada, one outpatient psychiatric facility in Pennsylvania and three psychiatric hospitals, one in Delaware, acquired July 1, 2011, one in Michigan and one in Nevada and a residential treatment facility in Michigan.  We provide management, administrative and help line services through contracts with major railroads and a call center contract with Wayne County, Michigan.  The Company also operates a website, Wellplace.com, which provides education and training for the behavioral health professional and internet support services to all of our subsidiaries.





Our Company provides behavioral health services through inpatient and outpatient facilities.  Our substance abuse facilities provide specialized treatment services to patients who typically have poor recovery prognoses and who are prone to relapse.  These services are offered in small specialty care facilities, which permit us to provide our clients with efficient and customized treatment without the significant costs associated with the management and operation of general acute care hospitals.  We tailor these programs and services to "safety-sensitive" industries and concentrate our marketing efforts on the transportation, heavy equipment, manufacturing, law enforcement, gaming and health services industries.  Our psychiatric facilities provide inpatient psychiatric care, intensive outpatient treatment and partial hospitalization programs to children, adolescents and adults.  Our outpatient mental health clinics provide services to employees of major employers, as well as to managed care companies and Medicare and Medicaid clients.  The psychiatric services are offered in a larger, more traditional setting than PHC's substance abuse facilities, enabling PHC to take advantage of economies of scale to provide cost-effective treatment alternatives.





The Company treats employees who have been referred for treatment as a result of compliance with Subchapter D of the Anti-Drug Abuse Act of 1988 (commonly known as the Drug Free Workplace Act), which requires employers who are Federal contractors or Federal grant recipients to establish drug-free awareness programs which, among other things, inform employees about available drug counseling, rehabilitation and employee assistance programs.  We also provide treatment under the Department of Transportation implemented regulations, which broaden the coverage and scope of alcohol and drug testing for employees in "safety-sensitive" positions in the transportation industry.





The Company was incorporated in 1976 and is a Massachusetts corporation.  Our corporate offices are located at 200 Lake Street, Suite 102, Peabody, MA  01960 and our telephone number is (978) 536-2777.




On July 1, 2011, the Company completed the acquisition of MeadowWood Behavioral Health, a behavioral  health facility located in New Castle, Delaware (“MeadowWood”) from Universal Health Services, Inc. (the “Seller”) pursuant to the terms of an Asset Purchase Agreement, dated as of March 15, 2011, between the Company and the Seller (the “Purchase Agreement”).  In accordance with the Purchase Agreement, PHC MeadowWood, Inc., a Delaware corporation and subsidiary of the Company (“PHC MeadowWood”) acquired substantially all of the operating assets (other than cash) and assumed certain liabilities associated with MeadowWood.  The purchase price was $21,500,000, and is subject to a working capital adjustment.  At closing, PHC MeadowWood hired Seller’s employees currently employed at MeadowWood and assumed certain obligations with respect to those transferred employees.  Also at closing, PHC MeadowWood and the Seller entered into a transition services agreement to facilitate the transition of the business.  (For additional information regarding this transaction, please see our report on Form 8-K, filed with the Securities and Exchange Commission on July 8, 2011).







3




In addition, on May 23, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Acadia Healthcare Company, Inc., a Delaware corporation (“Acadia”), and Acadia Merger Sub, LLC, a Delaware limited liability company and wholly-owned subsidiary of Acadia (“Merger Sub”), pursuant to which, subject to the satisfaction or waiver of the conditions therein, the Company will merge with and into Merger Sub, with Merger Sub continuing as the surviving company (the “Merger”).  Upon the completion of the Merger, Acadia stockholders will own approximately 77.5% of the combined company and PHC’s stockholders will own approximately 22.5% of the combined company. The Merger is intended to qualify for federal income tax purposes as a reorganization under the provisions of Section 368 of the Internal Revenue Code of 1986, as amended. Acadia operates a network of 19 behavioral health facilities with more than 1,700 beds in 13 states. (For additional information regarding this transaction, please see our report on Form 8-K, filed with the Securities and Exchange Commission on May 25, 2011 and our preliminary proxy statement filed with the Securities and Exchange Commission on July 13, 2011).














4





PSYCHIATRIC SERVICES INDUSTRY





Substance Abuse Facilities





Industry Background





The demand for substance abuse treatment services has increased rapidly over the last decade.  The Company believes that the increased demand is related to clinical advances in the treatment of substance abuse, greater societal willingness to acknowledge the underlying problems as treatable illnesses, improved health insurance coverage for addictive disorders and chemical dependencies and governmental regulation which requires certain employers to provide information to employees about drug counseling and employee assistance programs.





To contain costs associated with behavioral health issues in the 1980s, many private payors instituted managed care programs for reimbursement, which included pre-admission certification, case management or utilization review and limits on financial coverage or length of stay. These cost containment measures have encouraged outpatient care for behavioral problems, resulting in a shortening of the length of stay and revenue per day in inpatient chemical abuse facilities.  The Company believes that it has addressed these cost containment measures by specializing in treating relapse-prone patients with poor prognoses who have failed in other treatment settings.  These patients require longer lengths of stay and come from a wide geographic area. The Company continues to develop alternatives to inpatient care including residential programs, partial day and evening programs in addition to onsite and offsite outpatient programs.





The Company believes that because of the apparent unmet need for certain clinical and medical services, and its continued expansion into various modalities of care for the chemically dependent, that its strategy has been successful despite national trends towards shorter inpatient stays and rigorous scrutiny by managed care organizations.





Company Operations





The Company has been able to secure insurance reimbursement for longer-term inpatient treatment as a result of its success with poor prognosis patients.  The Company’s two adult substance abuse facilities work together to refer patients to the center that best meets the patient's clinical and medical needs.  Each facility caters to a slightly different patient population including high-risk, relapse-prone chronic alcoholics, drug addicts and dual diagnosis patients (those suffering from both substance abuse and psychiatric disorders).  The programs are sensitive to the special behavioral health problems of children, women and Native Americans.  The Company concentrates on providing services to insurers, managed care networks and health maintenance organizations for both adults and adolescents.  The Company's clinicians often work directly with managers of employee assistance programs to select the best treatment facility possible for their clients.





Each of the Company's facilities operates a case management program for each patient including a clinical and financial evaluation of a patient's circumstances to determine the most cost-effective modality of care from among detoxification, inpatient, residential, day care, specialized relapse treatment, outpatient treatment, and others.  In addition to any care provided at one of the Company's facilities, the case management program for each patient includes aftercare.  Aftercare may be provided through the outpatient services provided by a facility.  Alternatively, the Company may arrange for outpatient aftercare, as well as family and mental health services, through its numerous affiliations with clinicians located across the country once the patient is discharged.





In general, the Company does not accept patients who do not have either insurance coverage or adequate financial resources to pay for treatment.  Each of the Company's substance abuse facilities does, however, provide treatment free of charge to a small number of patients each year who are unable to pay for treatment but who meet certain clinical criteria and who are believed by the Company to have the requisite degree of motivation for treatment to be successful.  In addition, the Company provides follow-up treatment free of charge to relapse patients who satisfy certain criteria.  The number of patient days attributable to all patients who receive treatment free of charge in any given fiscal year is less than 5% of the total patient days.





5





The Company believes that it has benefited from an increased awareness of the need to make substance abuse treatment services accessible to the nation’s workforce.  For example, The Drug Free Workplace Act of 1988 requires employers who are Federal contractors or Federal grant recipients to establish drug free awareness programs to inform employees about available drug counseling, rehabilitation and employee assistance programs and the consequences of drug abuse violations.  In response to the Drug Free Workplace Act, many companies, including many major national corporations and transportation companies, have adopted policies that provide for treatment options as an alternative to termination of employment.





Although the Company does not directly provide federally approved mandated drug testing, the Company treats employees who have been referred to the Company as a result of compliance with the Drug Free Workplace Act, particularly from companies that are part of the gaming industry as well as “safety-sensitive” industries such as railroads, airlines, trucking firms, oil and gas exploration companies, heavy equipment companies, manufacturing companies and health services.





HIGHLAND RIDGE -Highland Ridge is a 41-bed, freestanding alcohol and drug treatment hospital, which the Company has been operating since 1984.  The hospital increased its bed capacity to 41 from 32 in November 2003 and expanded medical staff to include psychiatric care in its treatment plans.  Its focus remains substance abuse and it is the oldest facility dedicated to substance abuse in Utah.  Highland Ridge is accredited by The Joint Commission on Accreditation of Healthcare Organizations (“The Joint Commission”) and is licensed by the Utah Department of Health.





Although Highland Ridge does provide services to individuals from all of the States through contracts with the railroads and other major employers, most patients at this facility are from Utah and surrounding states.  Individuals typically access Highland Ridge’s services through professional referrals, family members, employers, employee assistance programs or contracts between the Company and health maintenance organizations located in Utah.





Highland Ridge was the first private for-profit hospital to address specifically the special needs of chemically dependent women in Salt Lake County.  In addition, Highland Ridge has contracted with Salt Lake County to provide medical detoxification services targeted to women.  The hospital also operates a specialized continuing care support group to address the unique needs of women and minorities.





A pre-admission evaluation, which involves an evaluation of psychological, cognitive and situational factors, is completed for each prospective patient.  In addition, each prospective patient is given a physical examination upon admission.  Diagnostic tools, including those developed by the American Psychological Association, the American Society of Addiction Medicine and the Substance Abuse Subtle Screening Inventory are used to develop an individualized treatment plan for each client.  The treatment regimen involves an interdisciplinary team which integrates the twelve-step principles of self-help organizations, medical detoxification, individual and group counseling, family therapy, psychological assessment, psychiatric support, stress management, dietary planning, vocational counseling and pastoral support.  Highland Ridge also offers extensive aftercare assistance at programs strategically located in areas of client concentration throughout the United States.  Highland Ridge maintains a comprehensive array of professional affiliations to meet the needs of discharged patients and other individuals not admitted to the hospital for treatment.





Highland Ridge periodically conducts or participates in research projects.  Highland Ridge was the site of a research project conducted by the University of Utah Medical School.  The research explored the relationship between individual motivation and treatment outcomes.  The research was regulated and reviewed by the Human Subjects Review Board of the University of Utah and was subject to federal standards that delineated the nature and scope of research involving human subjects.  Highland Ridge benefited from this research by expanding its professional relationships within the medical school community and by applying the findings of the research to improve the quality of services the Company delivers.





During fiscal 2011, Highland Ridge expanded its services to include the operation and management of a 26 bed psychiatric unit at Pioneer Valley Hospital located in West Valley City, Utah.  The contract calls for reimbursement to Highland Ridge of all costs incurred in the management of the unit and a share in the profitability of the unit.  Highland Ridge also provides assessment and referral services to other local hospitals on a fee for service basis.





6





MOUNT REGIS -Mount Regis is a 25-bed, freestanding alcohol and drug treatment center located in Salem, Virginia, near Roanoke. The Company acquired the center in 1987.  It is the oldest of its kind in the Roanoke Valley.  Mount Regis is accredited by The Joint Commission and licensed by the Virginia Department of Behavioral Health and Developmental Services. Mount Regis also operates Right Track, which is a residential program designed to provide individuals with the tools they need to make a smooth transition from inpatient treatment back into their everyday routine. In addition, Mount Regis operates Changes, an outpatient clinic, at its Salem, Virginia location.  The Changes clinic provides structured intensive outpatient treatment for patients who have been discharged from Mount Regis and for patients who do not need the formal structure of a residential treatment program. The program is licensed by the Commonwealth of Virginia and approved for reimbursement by major insurance carriers.





Similar to Highland Ridge, the programs at Mount Regis Center are sensitive to the needs of women and minorities.  The majority of Mount Regis clients are from Virginia and surrounding states.  In addition, because of its relatively close proximity and accessibility to New York, Mount Regis has been able to attract an increasing number of referrals from New York-based labor unions.  Mount Regis has also been able to attract a growing number of clients through the Internet.  Mount Regis has established programs that allow the Company to better treat dual diagnosis patients (those suffering from both substance abuse and psychiatric disorders), cocaine addiction and relapse-prone patients.  The multi-disciplinary case management, aftercare and family programs are key factors to the prevention of relapse.





RENAISSANCE RECOVERY— Renaissance Recovery is a 24-bed alcohol and drug treatment facility located in Detroit, Michigan which opened in April 2011. Renaissance Recovery treats boys and girls between the ages of 12 and 17, in need of behavioral health treatment due to chemical impairment.




The program incorporates a co-occurring based assessment model to identify and treat both substance abuse and mental health disorders, combining substance abuse therapy, educational services, medication therapy, group therapy and peer support and family counseling (parent(s), guardians and extended family and care givers). Techniques to recognize and manage internal emotional “triggers” that lead to substance or psychiatric relapse are taught as a feature of the therapy each child receives, individually and within a group.




Multi-disciplinary teams of licensed, certified and boarded professional staff utilize an eclectic therapy approach which includes cognitive behavioral therapy.







The residential program is case dependent, and length of stay may be from a period of minimally 5-7 days or up to a full program of thirty days or more as warranted. Step down from this program is continued through other Pioneer facilities for in-patient or out-patient treatment as appropriate to the “treatment plan’’ developed upon discharging.







The program accepts most insurance plans and is licensed by the State of Michigan as a Substance Abuse provider and as a Child Caring Institution and accredited by the Council on Accreditation.






General Psychiatric Facilities





Introduction





The Company believes that its proven ability to provide high quality, cost-effective care in the treatment of substance abuse has enabled it to grow in the related behavioral health field of psychiatric treatment.  The Company’s main advantage is its ability to provide an integrated delivery system of inpatient and outpatient care.  As a result of integration, the Company is better able to manage and track patients.





The Company offers inpatient and partial hospitalization and psychiatric services through Harbor Oaks Hospital located in New Baltimore, Michigan and Seven Hills Hospital located in Las Vegas, Nevada and residential treatment to adjudicated juveniles through Detroit Behavioral Institute, Inc., dba Capstone Academy, located in Detroit Michigan.  In addition, the Company currently operates seven outpatient psychiatric facilities.





7





The Company’s philosophy at these facilities is to provide the most appropriate and efficacious care with the least restrictive modality of care possible.  An attending physician, a case manager and a clinical team work together to manage the care plan.  The integrated delivery system allows for better patient tracking and follow-up and fewer repeat procedures and therapeutic or diagnostic errors.  Qualified, dedicated staff members take a full history on each new patient, and through test and evaluation procedures, they provide a thorough diagnostic write-up of the patient’s condition.  In addition, a physician does a complete physical examination for each new patient.  This information allows the caregivers to determine which treatment alternative is best suited for the patient and to design an individualized recovery program for the patient.





Managed health care organizations, state agencies, physicians and patients themselves refer patients to our facilities.  These facilities have a patient population ranging from children as young as five years of age to senior citizens.  Compared to the substance abuse facilities, the psychiatric facilities treat a larger percentage of female patients.





HARBOR OAKS -The Company acquired Harbor Oaks Hospital, a 71-bed psychiatric hospital located in New Baltimore, Michigan, approximately 20 miles northeast of Detroit, in September 1994.  Harbor Oaks Hospital is licensed by the Michigan Department of Community Health, Medicare certified and accredited by The Joint Commission.  Harbor Oaks provides inpatient psychiatric care, partial hospitalization and outpatient treatment to children, adolescents and adults.  Harbor Oaks Hospital has treated clients from Macomb, Oakland and St. Clair counties and has expanded its coverage area to include Wayne, Sanilac and Livingston counties.





Harbor Oaks has become a primary provider for Medicaid patients from Wayne, Macomb and St. Clair counties.  Utilization of a short-term crisis management model in conjunction with strong case management has allowed Harbor Oaks to successfully enter this segment of the market.  Reimbursement for these services is comparable to traditional managed care payors.  Given the current climate of public sector treatment availability, Harbor Oaks anticipates continued growth in this sector of the business.





In September 2009, Harbor Oaks Hospital replaced its residential unit with a much needed specialty unit for the treatment of chemical dependency.  Harbor Oaks also operates an outpatient site near New Baltimore, Michigan.  Its close proximity to the hospital allows for a continuum of care for patients after discharge.





DETROIT BEHAVIORAL INSTITUTE – Detroit Behavioral Institute operates a 66-bed residential treatment facility licensed as Capstone Academy. It is located in midtown Detroit and serves adjudicated adolescents diagnosed as seriously emotionally disturbed. These adolescents are placed in Capstone Academy by court order.




Prior to January of 2009, this program was operated in a setting on the campus of the Detroit Medical Center, and was licensed for fifty residents (30 boys/20 girls). In early 2009, all residents were moved to the current Capstone Academy location. Pursuant to licensing guidelines and the review and approval of sound and therapeutic programming, the State of Michigan Department of Human Services allowed the Company to increase the number of beds by 16. This became effective in June 2009.  In its present configuration, the facility includes twelve designated beds for a special program for girls requiring a more intensive and comprehensive treatment model, while the remaining fifty-four beds, which can be allocated for either boys or girls as referrals dictate, offer a more traditional treatment model.  In all programs, however, intensive treatment models address and treat residents as appropriate to their needs with individual, group and family counseling.




The residents in the programs range from 12 to 17 years of age, with a minimum IQ of 70.  Each program provides individual, group and family therapy sessions for medication orientation, anger management, impulse control, grief and loss, family interactions, coping skills, stress management, substance abuse, discharge and aftercare planning (home visits and community reintegration), recreation therapy and sexual/physical abuse counseling as required.




As a part of the treatment model, each resident learns life skills (didactics) and receives education, in accordance with Michigan’s required educational curriculum, from state certified teachers, who are members of our staff.  Typically, a resident is placed for treatment for an initial period of 30 days to six months, case dependent.







8







Periodic case review and psychiatric evaluations are conducted to evaluate progress or areas requiring improvement in accordance with goals and planning for discharge and eventual transition back to the community. The treatment teams that provide therapy and review each resident for progress include licensed counselors, nursing staff, certified teachers, psychiatrists, youth specialists and other program personnel.




The Company is approved by the local school district, in accordance with state law to operate as a school under its auspices, for the education of program residents. Consequently, when residents transition back to the community they do so without losing school credits. Transcripts, testing scores and related items are readily accepted by the new education environment.  We have successfully fulfilled this obligation for five years, with improved success.  This allows our programs to integrate the residents’ education with their individual treatment model and provide the best education possible without transporting the individuals to another site.




SEVEN HILLS HOSPITAL -Seven Hills Hospital, a 58-bed psychiatric hospital located in Las Vegas, Nevada is licensed by the State of Nevada, accredited by The Joint Commission and received Medicare certification in July 2010.  Seven Hills provides services to clients covered under the capitated contracts of the Company’s other subsidiary, Harmony Healthcare.  Seven Hills has provided inpatient psychiatric care to adults since its opening in 2008 and began providing psychiatric care to adolescents in the third quarter of fiscal 2010.  Its treatment programs were expanded in fiscal 2009 to include detoxification and residential treatment of chemical dependency.  PHC, through its subisdiary Seven Hills Hospital, Inc., leases Seven Hills Hospital from Seven Hills Psych Center, LLC, which constructed the hospital to PHC's specifications.  PHC owns a 15.24% interest in Seven Hills Psych Center, LLC.




HARMONY HEALTHCARE -Harmony Healthcare, which consists of three psychiatric clinics in Nevada, provides outpatient psychiatric care to children, adolescents and adults in the local area.  Harmony also operates employee assistance programs for railroads, health care companies and several large gaming companies including Boyd Gaming Corporation, the MGM Grand and the Venetian with a rapid response program to provide immediate assistance 24 hours a day and seven days a week.  Harmony also provides outpatient psychiatric care and inpatient psychiatric case management through capitated rate behavioral health carve-outs with Behavioral Health Options and PacifiCare Insurance.  The agreement with Behavioral Health Options is a significant contract which began in January 2007 and caused a major expansion of Harmony to better serve the contract population.





NORTH POINT-PIONEER, INC. –North Point consists of three outpatient clinical offices strategically and geographically located to serve a large and populous region in Michigan.  The clinics provide outpatient psychiatric and substance abuse treatment to children, adolescents and adults operating under the name Pioneer Counseling Center.  The three clinics are located in close proximity to the Harbor Oaks facility, which allows for more efficient integration of inpatient and outpatient services and provides for a larger coverage area and the ability to share personnel which results in cost savings.  Since 2005, North Point has provided services under a contract with Macomb County Office of Substance Abuse to provide behavioral health outpatient and intensive outpatient services for indigent and Medicaid clients residing in Macomb County.  The contract is renewable annually with an estimated annual value of $55,000.





MEADOWWOOD BEHAVIORAL HEALTH. – MeadowWood, located in New Castle, Delaware, was acquired by PHC on July 1, 2011. The facility is an acute care psychiatric hospital with 58 beds providing services to adults suffering with mental illness and substance abuse. MeadowWood is licensed by the Delaware Department of Health and Social Services, Medicare certified and accredited by The Joint Commission. MeadowWood has both inpatient and partial hospitalization services focused on geriatric, co-occurring and acute mental disorders. MeadowWood anticipates seeking approval for additional beds to expand the facility during the next 12 months.    The acquisition was made in connection with the divestiture requirements imposed on Universal Health Services following its acquisition of PSI.





Call Center Operations





WELLPLACE, INC. - In 1994, the Company began to operate a crisis hotline service under contract with a major transportation client.  The hotline, Wellplace, shown as contract support services on the accompanying Consolidated Statements of Operations, is a national, 24-hour telephone service, which supplements the services provided by the client's Employee Assistance Programs.  The services provided include information, crisis intervention, critical incidents coordination, employee counselor support, client monitoring, case management and health promotion. The





9





hotline is staffed by counselors who refer callers to the appropriate professional resources for assistance with personal problems. Three major transportation companies subscribed to these services as of June 30, 2010.  This operation is physically located in Highland Ridge hospital, but a staff dedicated to Wellplace provides the services from a separate designated area of the Hospital.    Wellplace also contracts with Wayne County Michigan to operate its call center.  This call center is located in mid-town Detroit on the campus of the Detroit Medical Center and provides 24-hour crisis, eligibility and enrollment services for the Detroit-Wayne County Community Mental Health Agency which oversees 56,000 lives or consumers for mental health services in Wayne County Michigan.  Wellplace’s primary focus is now on growing its operations to take advantage of current opportunities and capitalize on the economies of scale in providing similar services to other companies and government units.





Internet Operations





BEHAVIORAL HEALTH ONLINE, INC.– Behavioral Health Online designs, develops and maintains the Company’s web site, Wellplace.com, in addition to providing Internet support services and maintaining the web sites of all of the other subsidiaries of the Company.  The Company’s web sites provide behavioral health professionals with the educational tools required to keep them abreast of behavioral health breakthroughs and keep individuals informed of current issues in behavioral health.





10





Operating Statistics





The following table reflects selected financial and statistical information for all services.





Year Ended June 30,

(unaudited)2011

2010

2009

2008

2007InpatientNet patient service revenues
$
36,693,784
$
29,743,377
$
23,634,602
$
22,327,159
$
21,508,417Net revenues per patient day (1)
$
542
$
477
$
438
$
383
$
395Average occupancy rate (2)

78.7%

75.7%

69.7%

85.0%

83.0%Total number of licensed beds at the end of the period

285

260

260

244

180Source of Revenues:Private (3)

59.0%

56.2%

54.9%

48.2%

50.2%Government (4)

41.0%

43.8%

45.1%

51.8%

49.8%Partial Hospitalization and OutpatientNet Revenues:Individual
$
8,792,896
$
7,325,916
$
5,800,090
$
6,603,002
$
6,518,115Contract
$
12,009,055
$
12,578,102
$
13,165,271
$
11,925,916
$
7,995,997Sources of revenues:Private

98.6%

98.9%

99.1%

99.1%

98.6%Government

1.4%

1.1%

0.9%

0.9%

1.4%Other  Services:Contract Services (Wellplace)(5)
$
4,512,144
$
3,429,831
$
3,811,056
$
4,541,260
$
4,540,634





(1)
Net revenues per patient day equals net patient service revenues divided by total patient days excluding bed days provided by the Seven Hills subsidiary under the Harmony capitated contract.


(2)
Average occupancy rates were obtained by dividing the total number of patient days in each period including capitated contract bed days by the number of beds available in such period.


(3)
Private pay percentage is the percentage of total patient revenue derived from all payors other than Medicare and Medicaid and county programs.


(4)
Government pay percentage is the percentage of total patient revenue derived from the Medicare and Medicaid and county programs.


(5)
Wellplace provides contract support services including clinical support, referrals management and professional services for a number of the Company’s national contracts and operates the Wayne County Michigan call center.





11








Business Strategy





The Company’s objective is to become the leading national provider of behavioral health services.





The Company focuses its marketing efforts on “safety-sensitive” industries such as transportation and medical.  This focus results in customized outcome oriented programs that the Company believes produce overall cost savings to the patients and/or client organizations.  The Company intends to leverage experience gained from providing services to customers in certain industries that it believes will enhance its selling efforts within these certain industries.





Marketing and Customers





The Company markets its substance abuse, inpatient and outpatient psychiatric health services both locally and nationally, primarily to “safety-sensitive” industries, including transportation, manufacturing and healthcare services.  Additionally, the Company markets its services in the gaming industry both in Nevada and nationally and its help line services nationally.





The Company employs three individuals dedicated to marketing the Company’s facilities. Each facility performs marketing activities in its local region.  The Senior Vice President of the Company coordinates the Company’s national marketing efforts.  In addition, employees at certain facilities perform local marketing activities independent of the Senior Vice President.  The Company, with the support of its owned integrated outpatient systems and management services, continues to pursue more at-risk contracts and outpatient, managed health care fee-for-service contracts.  “At-risk” contracts require that the Company provides all the clinically necessary behavioral health services for a group of people for a set fee per person per month.  The Company currently has two at-risk contracts with large insurance carriers, which require the Company to provide behavioral health services to a large number of its insured for a fixed fee.  These at-risk contracts represent less than 15% of the Company’s total gross revenues.  In addition to providing excellent services and treatment outcomes, the Company will continue to negotiate pricing policies to attract patients for long-term intensive treatment which meet length of stay and clinical requirements established by insurers, managed health care organizations and the Company’s internal professional standards.





The Company’s integrated systems of comprehensive outpatient mental health programs complement the Company’s inpatient facilities.  These outpatient programs are strategically located in Nevada, Virginia, Michigan, and Utah.  They make it possible for the Company to offer wholly integrated, comprehensive, mental health services for corporations and managed care organizations on an at-risk or exclusive fee-for-service basis.  Additionally, the Company operates Wellplace located in the Highland Ridge facility in Salt Lake City, Utah and in Detroit, Michigan.  Wellplace provides clinical support, referrals, management and professional services for a number of the Company’s national contracts.  It gives the Company the capacity to provide a complete range of fully integrated mental health services.





The Company provides services to employees of a variety of corporations including: Boyd Gaming Corporation, CSX Corporation, MGM Mirage, Union Pacific Railroad, Union Pacific Railroad Hospital Association and others.





In addition to its direct patient care services, the Company maintains its web site, Wellplace.com, which provides articles and information of interest to the general public as well as the behavioral health professional.  The Company’s internet company also provides the added benefit of web availability of information for various Employee Assistance Program contracts held and serviced by those subsidiaries providing direct treatment services.





12





Competition





The Company’s substance abuse programs compete nationally with other health care providers, including general and chronic care hospitals, both non-profit and for-profit, other substance abuse facilities and short-term detoxification centers.  Some competitors have substantially greater financial resources than the Company.  The Company believes, however, that it can compete successfully with such institutions because of its success in treating poor prognosis patients.  The Company will compete through its focus on such patients, its willingness to negotiate appropriate rates and its capacity to build and service corporate relationships.





The Company’s psychiatric facilities and programs compete primarily within the respective geographic area serviced by them.  The Company competes with private doctors, hospital-based clinics, hospital-based outpatient services and other comparable facilities.  The main reasons that the Company competes well are its integrated delivery and dual diagnosis programming.  Integrated delivery provides for more efficient follow-up procedures and reductions in length of stay.  Dual diagnosis programming provides a niche service for clients with a primary mental health and a secondary substance abuse diagnosis.  The Company developed its dual diagnosis service in response to demand from insurers, employers and treatment facilities.  The Company’s internet subsidiary provides the competitive edge for service information and delivery for our direct patient care programs.





Revenue Sources and Contracts





The Company has entered into relationships with numerous employers, labor unions and third-party payors to provide services to their employees and members for the treatment of substance abuse and psychiatric disorders.  In addition, the Company admits patients who seek treatment directly without the intervention of third parties and whose insurance does not cover these conditions in circumstances where the patient either has adequate financial resources to pay for treatment directly or is eligible to receive free care at one of the Company’s facilities.  The Company’s psychiatric patients either have insurance or pay at least a portion of treatment costs based on their ability to pay.  Most of our patients are covered by insurance.  Free treatment provided each year amounts to less than 5% of the Company’s total patient days.





Each contract is negotiated separately, taking into account the insurance coverage provided to employees and members, and, depending on such coverage, may provide for differing amounts of compensation to the Company for different subsets of employees and members.  The charges may be capitated, or fixed with a maximum charge per patient day, and, in the case of larger clients, frequently result in a negotiated discount from the Company’s published charges.  The Company believes that such discounts are appropriate as they are effective in producing a larger volume of patient admissions.  The Company treats non-contract patients and bills them on the basis of the Company’s standard per diem rates and for any additional ancillary services provided to them by the Company.





With Meditech, the billing software in use by the company, the charges are contractually adjusted at the time of billing using adjustment factors based on agreements or contracts with the insurance carriers and the specific plans held by the individuals as outlined above.  This method may still require additional adjustment based on ancillary services provided and deductibles and copays due from the individuals, which are estimated at the time of admission based on information received from the individual.  Adjustments to these estimates are recognized as adjustments to revenue in the period they are identified, usually when payment is received, and are not material to the financial statements.





The Company’s policy is to collect estimated co-payments and deductibles at the time of admission in the form of an admission deposit.  Payments are made by way of cash, check or credit card.  For inpatient services, if the patient does not have sufficient resources to pay the estimated co-payment in advance, the Company’s policy is to allow payment to be made in three installments, one third due upon admission, one third due upon discharge and the balance due 30 days after discharge.  At times, the patient is not physically or mentally stable enough to comprehend or agree to any financial arrangement.  In this case, the Company will make arrangements with the patient once his or her condition is stabilized.  At times, this situation will require the Company to extend payment arrangements beyond the three payment method previously outlined.  Whenever extended payment arrangements are made, the patient, or the individual who is financially responsible for the patient, is required to sign a promissory note to the Company, which includes interest on the balance due.  For outpatient services, the Company’s policy is to charge a $5.00 billing/statement fee for any accounts still outstanding at month end.





13





The Company’s days sales outstanding (“DSO”) are significantly different for each type of service and each facility based on the payors for each service.  Overall, the DSO for the combined operations of the Company was 71 and 61 days as of June 30, 2011 and 2010, respectively.  This increase in the DSO is due primarily to increased revenue in our start up operations with slower payment and a delay in some contract payments.  Contract services DSO’s fluctuate dramatically by the delay in payment of a few days for any of our large contracts.  There was such a delay in payments for the Michigan call center at the end of fiscal 2011, artificially inflating the DSO’s for the period.





DSO’s for each year for each business segment are as follows:





Fiscal

Treatment

ContractYear End

Services

Services06/30/2011

61

6906/30/2010

61

53





Amounts pending approval from Medicare or Medicaid, as with all other third party payors, are maintained as receivables based on the discharge date of the patient, while appeals are made for payment.  If accounts remain unpaid, when all levels of appeal have been exhausted, accounts are written off.  Where possible, the Company will turn to the patient or the responsible party to seek reimbursement and send the account to collections before writing the account off.





Insurance companies and managed care organizations are entering into sole source contracts with healthcare providers, which could limit our ability to obtain patients.Private insurers, managed care organizations and, to a lesser extent, Medicaid and Medicare, are beginning to carve-out specific services, including mental health and substance abuse services, and establish small, specialized networks of providers for such services at fixed reimbursement rates.  We are not aware of any lost business as a result of sole source contracts to date, as we have not been advised by any payor that we have been eliminated as a provider from their system based on an exclusivity contract with another provider.  Continued growth in the use of carve-out systems could materially adversely affect our business to the extent we are not selected to participate in such smaller specialized networks or if the reimbursement rate is not adequate to cover the cost of providing the service.





Quality Assurance and Utilization Review





The Company has established comprehensive quality assurance programs at all of its facilities.  These programs are designed to ensure that each facility maintains standards that meet or exceed requirements imposed upon the Company with the objective of providing high-quality specialized treatment services to its patients.  To this end, the Joint Commission surveys and accredits the Company’s inpatient facilities, except Detroit Behavioral Institute and Renaissance Recovery which are accredited through the Council on Accreditation (“COA”).  The Company’s outpatient facilities comply with the standards of National Commission on Quality Assurance (“NCQA”) although the facilities are not NCQA certified and are not required to be NCQA certified..  The Company’s outpatient facilities in Michigan are certified by the American Osteopathic Association (“AOA”), which is a nationally accepted accrediting body, recognized by payors as the measure of quality in outpatient treatment and the only accrediting body whose standards are recognized by the Centers for Medicare and Medicaid Services, (“CMS”). The Company’s professional staff, including physicians, social workers, psychologists, nurses, dietitians, therapists and counselors, must meet the minimum requirements of licensure related to their specific discipline, in addition to each facility’s own internal quality assurance criteria as adopted by the facility for operational purposes and approved by the Executive Committee.  The Company participates in the federally mandated National Practitioners Data Bank, which monitors professional accreditation nationally.  In each facility, continuing quality improvement (CQI) activity is reviewed quarterly by the Company’s corporate compliance unit and quality assurance activities are approved by the executive committee.





In response to the increasing reliance of insurers and managed care organizations upon utilization review methodologies, the Company has adopted a comprehensive documentation policy to satisfy relevant reimbursement criteria.  Additionally, the Company has developed an internal case management system, which provides assurance that services rendered to individual patients are medically appropriate and reimbursable.  Implementation of these internal





14





policies has been integral to the success of the Company’s strategy of providing services to relapse-prone, higher acuity patients.





Government Regulation





The Company’s business and the development and operation of the Company’s facilities are subject to extensive federal, state and local government regulation.  In recent years, an increasing number of legislative proposals have been introduced at both the national and state levels that would affect major reforms of the health care system if adopted.  Among the proposals under consideration are reforms to increase the availability of group health insurance, to increase  reliance upon managed care, to bolster competition and to require that all businesses offer health insurance coverage to their employees.  Some states have already instituted laws that mandate employers offer health insurance plans to their employees.  The Company cannot predict whether additional legislative proposals will be adopted and, if adopted, what effect, if any, such proposals would have on the Company’s business.





In addition, both the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings and interpretations of policy, intermediary determinations and governmental funding restrictions, all of which may materially increase or decrease the rate of program payments to health care facilities.  Since 1983, Congress has consistently attempted to limit the growth of federal spending under the Medicare and Medicaid programs and will likely continue to do so.  Additionally, congressional spending reductions for the Medicaid program involving the issuance of block grants to states is likely to hasten the reliance upon managed care as a potential savings mechanism of the Medicaid program.  As a result of this reform activity, the Company can give no assurance that payments under such programs will in the future remain at a level comparable to the present level or be sufficient to cover the costs allocable to such patients.





Control of the healthcare industry exercised by federal, state and local regulatory agencies can increase costs, establish maximum reimbursement levels and limit expansion.  Our Company and the health care industry are subject to rapid regulatory change with respect to licensure and conduct of operations at existing facilities, construction of new facilities, acquisition of existing facilities, the addition of new services, compliance with physical plant safety and land use requirements, implementation of certain capital expenditures, reimbursement for services rendered and periodic government inspections.  Governmental budgetary restrictions have resulted in limited reimbursement rates in the healthcare industry including our Company.  As a result of these restrictions, we cannot be certain that payments under government programs will remain at a level comparable to the present level or be sufficient to cover the costs allocable to such patients.  In addition, many states, including the State of Michigan, where the majority of our Medicaid revenue is generated, are considering reductions in state Medicaid budgets.





Health Planning Requirements





Most of the states in which the Company operates have health planning statutes which require that prior to the addition or construction of new beds, the addition of new services, the acquisition of certain medical equipment or certain capital expenditures in excess of defined levels, a state health planning agency must determine that a need exists for such new or additional beds, new services, equipment or capital expenditures.  These state determinations of need or certificate of need (“DoN”) programs are designed to enable states to participate in certain federal and state health related programs and to avoid duplication of health services.  DoN’s typically are issued for a specified maximum expenditure, must be implemented within a specified time frame and often include elaborate compliance procedures for amendment or modification, if needed.





Licensure and Certification





All of the Company’s facilities must be licensed by state regulatory authorities.  The Company’s Harbor Oaks facility is certified for participation as a provider in the Medicare and Medicaid programs and, as of July 8, 2010, the Company’s Seven Hills Hospital in Las Vegas is also certified for participation in these programs.





15





The Company’s initial and continued licensure of its facilities, and certification to participate in the Medicare and Medicaid programs, depends upon many factors, including accommodations, equipment, services, patient care, safety, personnel, physical environment, the existence of adequate policies, procedures and controls and the regulatory process regarding the facility’s initial licensure.  Federal, state and local agencies survey facilities on a regular basis to determine whether such facilities are in compliance with governmental operating and health standards and conditions for participating in government programs.  Such surveys include review of patient utilization and inspection of standards of patient care.  The Company has procedures in place to ensure that its facilities are operated in compliance with all such standards and conditions.  To the extent these standards are not met, however, the license of a facility could be restricted, suspended or revoked, or a facility could be decertified from the Medicare or Medicaid programs.





Environmental Matters




The Company is subject to various federal, state and local environmental laws that (i) regulate certain activities and operations that may have environmental or health and safety effects, such as the handling, storage, transportation, treatment and disposal of medical waste products generated at its facilities; the identification and warning of the presence of asbestos-containing materials in buildings, as well as the removal of such materials; the presence of other hazardous substances in the indoor environment; and protection of the environment and natural resources in connection with the development or construction of our facilities; (ii) impose liability for costs of cleaning up, and damages to natural resources from, past spills, waste disposals on and off-site, or other releases of hazardous materials or regulated substances, and (iii) regulate workplace safety. Some of the Company’s facilities generate infectious or other hazardous medical waste due to the illness or physical condition of our patients.  The management of infectious medical waste is subject to regulation under various federal, state and local environmental laws, which establish management requirements for such waste.  These requirements include record-keeping, notice and reporting obligations.  Each of the Company’s in-patient facilities has an agreement with a waste management company for the disposal of medical waste.  The use of such companies, however, does not completely protect us from alleged violations of medical waste laws or from related third-party claims for clean-up costs.




From time to time, the Company’s operations have resulted in, or may result in, non-compliance with, or liability pursuant to, environmental or health and safety laws or regulations.  We believe that the Company’s operations are generally in compliance with environmental and health and safety regulatory requirements or that any non-compliance will not result in a material liability or cost to achieve compliance.  Historically, the costs of achieving and maintaining compliance with environmental laws and regulations have not been material.  However, no assurance can be made that future costs and expenses required for the Company to comply with any new or changes in existing environmental and health and safety laws and regulations or new or discovered environmental conditions will not have a material adverse effect on our business.




The Company has not been notified of and is otherwise currently not aware of any contamination at its currently or formerly operated facilities for which it could be liable under environmental laws or regulations for the investigation and remediation of such contamination and the Company currently is not undertaking any remediation or investigation activities in connection with any contamination conditions.  There may however be environmental conditions currently unknown to us relating to the Company’s prior, existing or future sites or operations or those of predecessor companies whose liabilities the Company may have assumed or acquired which could have a material adverse effect on its business.




New laws, regulations or policies or changes in existing laws, regulations or policies or their enforcement, future spills or accidents or the discovery of currently unknown conditions or non-compliances may give rise to investigation and remediation liabilities, compliance costs, fines and penalties, or liability and claims for alleged personal injury or property damage due to substances or materials used in the Company’s operations; any of which may have a material adverse effect on our business, financial condition, operating results or cash flow.





Medicare Reimbursement





The Company received Medicare reimbursement in fiscal 2011 from Harbor Oaks Hospital and Seven Hills Hospital.  For the fiscal year ended June 30, 2011, 27.4% of revenues for these facilities were derived from Medicare programs.  Total revenue from Harbor Oaks and Seven Hills accounted for 39.3% of the Company’s total net patient care revenues for fiscal 2011.





16





Medicare reimbursement rates are based 100% on the prospective payment rates.  Although the rates are prospective, the Company will continue to file cost reports annually as required by Medicare to determine ongoing rates.  These cost reports are routinely audited on an annual basis.  Activity and cost report expense differences are reviewed on an interim basis and adjustments are made to the net expected collectable revenue accordingly.  The Company believes that adequate provision has been made in the financial statements for any adjustments that might result from the outcome of Medicare audits.  Approximately 27% of the Company’s total revenue is derived from Medicare and Medicaid payors for the both of years ended June 30, 2011 and 2010.  Differences between the amounts provided and subsequent settlements are recorded in operations in the year of the settlement.  To date, settlement adjustments have not been material.





In order to receive Medicare reimbursement, each participating facility must meet the applicable conditions of participation set forth by the federal government relating to the type of facility, its equipment, its personnel and its standards of medical care, as well as compliance with all state and local laws and regulations.  In addition, Medicare regulations generally require that entry into such facilities be through physician referral.  The Company must offer services to Medicare recipients on a non-discriminatory basis and may not preferentially accept private pay or commercially insured patients.  The Company currently meets all of these conditions and requirements and has systems in place to assure compliance in the future.





Medicaid Reimbursement





Currently, the only facilities of the Company that receive reimbursement under any state Medicaid program are Harbor Oaks, Seven Hills and Detroit Behavioral Institute.  A portion of Medicaid costs is paid by states under the Medicaid program and the federal matching payments are not made unless the state’s portion is made.  Accordingly, the timely receipt of Medicaid payments by a facility may be affected by the financial condition of the relevant state.  For the period ended June 30, 2011, 16% of total net patient revenues of the Company were derived from Medicaid programs.





Harbor Oaks and Detroit Behavioral Institute are both participants in the Medicaid programs administered by the State of Michigan.  Seven Hills participates in the Medicaid program administered by the State of Nevada.  The Company receives reimbursement on a per diem basis, inclusive of ancillary costs.  The state determines the rate and adjusts it annually based on cost reports filed by the Company.





Fraud and Abuse Laws





Various federal and state laws regulate the business relationships and payment arrangements between providers and suppliers of health care services, including employment or service contracts, and investment relationships.  These laws include the fraud and abuse provisions of the Medicare and Medicaid statutes as well as similar state statutes (collectively, the “Fraud and Abuse Laws”), which prohibit the payment, receipt, solicitation or offering of any direct or indirect remuneration intended to induce the referral of patients, and the ordering, arranging, or providing of covered services, items or equipment.  Violations of these provisions may result in civil and criminal penalties and/or exclusion from participation in the Medicare, Medicaid and other government-sponsored programs.  The federal government has issued regulations that set forth certain “safe harbors,” representing business relationships and payment arrangements that can safely be undertaken without violation of the federal Fraud and Abuse Laws.  Failure to fall within a safe harbor does not constitute a per se violation of the federal Fraud and Abuse Laws.  The Company believes that its business relationships and payment arrangements either fall within the safe harbors or otherwise comply with the Fraud and Abuse Laws.





The Company has an active compliance program in place with a corporate compliance officer and compliance liaisons at each facility and a toll free compliance hotline.  Compliance in-services and trainings are conducted on a regular basis.  Information on our compliance program and our hot line number is available to our employees on our intranet and to the public on our website at www.phc-inc.com.





17





Employees





As of August 1, 2011, the Company had 962 employees of which six were dedicated to marketing, 224 (47 part time and 5 seasonal) to finance and administration and 732 (233 part time and 97 contingent) to patient care.  These numbers include employees of PHC MeadowWood, which was acquired July 1, 2011 as follows:  187 employees of which three were dedicated to marketing, 36 (11 part time to finance and administration) and 148 (13 part time and 54 contingent) to patient care.





The Company believes that it has been successful in attracting skilled and experienced personnel.  Competition for such employees is intense; however, and there can be no assurance that the Company will be able to attract and retain necessary qualified employees in the future.  On July 31, 2003, the Company's largest facility, Harbor Oaks Hospital, with approximately 125 union eligible nursing and administrative employees, voted for union (UAW) representation.  The Company and the UAW reached their first collective bargaining agreement in December 2004.  The current agreement was negotiated in 2010 and will expire in December 2014.  As of July 31, 2011, approximately 82% of the total number of employees of that subsidiary were covered by the collective bargaining agreement.  In addition, in January, 2007, the Company’s largest out-patient facility, Harmony Healthcare, with approximately 43 union eligible employees, voted for union (Teamsters) representation.  In April, 2007, the Company and Teamsters reached a collective bargaining Agreement, which was signed by Teamsters on April 26, 2007 and the Company on April 30, 2007 to be effective January 1, 2007 and expiring on January 1, 2010.  This agreement was extended while the new contract was being negotiated.  The Company and Teamsters reached a new agreement which was ratified on July 11, 2010, and expires on January 1, 2013.  As of July 31, 2011, approximately 30% of the total number of employees of that subsidiary were covered by the collective bargaining agreement.





The limited number of healthcare professionals in the areas in which the Company operates may create staffing shortages.The Company’s success depends, in large part, on its ability to attract and retain highly qualified personnel, particularly skilled health care personnel, which are in short supply.  The Company faces competition for such personnel from governmental agencies, health care providers and other companies and is constantly increasing its employee benefit programs, and related costs, to maintain required levels of skilled professionals.  As a result of staffing shortages, the Company uses professional placement services to supply it with a pool of professionals from which to choose.  These individuals generally are higher skilled, seasoned individuals who require higher salaries, richer benefit plans, and in some instances, require relocation.  The Company has also entered into contracts with agencies to provide short-term interim staffing in addition to placement services.  These additional costs impact the Company’s profitability.





Insurance





Each of the Company’s subsidiaries maintains professional liability insurance policies with coverage of $1,000,000 per claim and $3,000,000 in the aggregate.  In addition to this coverage, all of the subsidiaries collectively maintain a $20,000,000 umbrella policy shared by all facilities.  In addition, each of these entities maintains general liability insurance coverage, which includes business owner’s liability insurance coverage, in similar amounts, as well as property insurance coverage.





The Company maintains $1,000,000 of directors’ and officers’ liability insurance coverage. The Company believes, based on its experience, that its insurance coverage is adequate for its business and, although cost has escalated in recent years, that it will continue to be able to obtain adequate coverage.





18





Item 1A. RISK FACTORS





OPERATING RISKS





AGING OF ACCOUNTS RECEIVABLE COULD RESULT IN OUR INABILITY TO COLLECT RECEIVABLES REQUIRING US TO INCREASE OUR DOUBTFUL ACCOUNTS RESERVE WHICH WOULD DECREASE OUR NET INCOME AND WORKING CAPITAL




As our accounts receivable age and become uncollectible our cash flow is negatively impacted.Our accounts receivable from patient accounts (net of allowance for bad debts) were $11,106,008 at June 30, 2011 compared with $8,793,831 at June 30, 2010.  As we expand, we will be required to seek payment from a larger number of payors and the amount of accounts receivable will likely increase.  Because the behavioral health industry is typically a difficult collection environment, we have focused on better accounts receivable management through increased staff, standardization of some procedures for collecting receivables and a more aggressive collection policy in order to keep the change in receivables consistent with the change in revenue.  We have also established a more aggressive reserve policy, allowing greater amounts of reserves as accounts age from the date of billing.  If the amount of receivables, which eventually become uncollectible, exceeds such reserves, we could be materially adversely affected.  The following chart represents our Accounts Receivable and Allowance for Doubtful Accounts at June 30, 2011 and 2010 and Bad Debt Expense for the fiscal years ended June 30, 2011 and 2010:





Accounts
Allowance for
Bad DebtReceivable
doubtful accounts
ExpenseJune 30, 2011
$
16,155,900
$
5,049,892
$
3,406,443June 30, 2010
$
11,796,154
$
3,002,323
$
2,131,392





NEGATIVE CASH FLOW COULD ARISE AS A RESULT OF SLOW GOVERNMENT PAYMENTS WHICH COULD REQUIRE THE COMPANY TO BORROW ADDITIONAL FUNDS AT UNFAVORABLE RATES AND AFFECT OUR NET INCOME, WORKING CAPITAL AND LIQUIDITY





The concentration of accounts receivable due from state and federal payors including Medicare and Medicaid (“government payors”) could create a severe cash flow problem should these agencies fail to make timely payment.We had receivables from government payors of approximately $3,447,238 at June 30, 2011 and $2,333,300  at June 30, 2010, which would create a cash flow problem should these agencies defer or fail to make reimbursement payments as due, which would require us to borrow at unfavorable rates or pay additional interest as overline fees on current debt instruments.  This would result in lower net income for the same services provided and lower earnings per share.





NEGATIVE CASH FLOW COULD IMPACT OUR ABILITY TO MEET OBLIGATIONS WHEN DUE WHICH COULD REQUIRE THE COMPANY TO BORROW ADDITIONAL FUNDS AT UNFAVORABLE RATES AND AFFECT OUR NET INCOME





If managed care organizations delay approving treatment, or reduce the patient length of stay number of visits or reimbursement, our Company’s ability to meet operating expenses is affected.  As managed care organizations and insurance companies adopt policies that limit the length of stay for substance abuse treatment, our business is materially adversely affected since our revenues and cash flow go down and our fixed operating expenses continue or increase based on the additional resources required to collect accounts receivable.





Reimbursement for substance abuse and psychiatric treatment from private insurers is largely dependent on our ability to substantiate the medical necessity of treatment.  The process of substantiating a claim often takes up to four months and sometimes longer.  As a result, we experience significant delays in the collection of amounts reimbursable by third-party payors, which requires us to increase staff to pursue payment and adversely affects our working capital condition.  This causes amounts borrowed on our accounts receivable revolver to remain outstanding for longer periods of time resulting in higher interest expense in addition to the reduced income resulting from the shorter lengths of stay, which combined reduce net income and earnings per share.





19





POTENTIAL STAFFING SHORTAGES COULD REQUIRE US TO INCREASE OUR EMPLOYEE COMPENSATION AND REDUCE OUR NET INCOME





The limited number of healthcare professionals in the areas in which we operate may create staffing shortages.Our success depends, in large part, on our ability to attract and retain highly qualified personnel, particularly skilled health care personnel, which are in short supply.  We face competition for such personnel from governmental agencies, health care providers and other companies and are constantly increasing our employee benefit programs, and related costs, to maintain required levels of skilled professionals.  As a result of staffing shortages, we use professional placement services to supply us with a pool of professionals from which to choose.  These individuals generally are higher skilled, seasoned individuals who require higher salaries, richer benefit plans and in some instances, relocation.  We have also entered into contracts with agencies to provide short-term interim staffing in addition to placement services.  These additional costs impact our profitability.





In December 2004, the Company’s largest inpatient facility voted for UAW representation.  Approximately 82% of the staff of the facility are members of the UAW and could vote to strike when the contract comes up for renewal in December 2014.  In April 2007, the Company’s largest outpatient operations voted for Teamsters representation.  Approximately 30% of the eligible staff of the facility are members of Teamsters and could vote to strike when the contract comes up for renewal in January 2013.  A strike vote on the part of either of these operations would negatively impact profitability by requiring the Company to transfer patients to competing facilities or providers or pay high short term staffing rates.  This could also negatively impact the Company’s reputation in the community creating the need for increased marketing.





THE LOSS OF ANY KEY CLIENTS WOULD REDUCE OUR NET REVENUES AND OUR NET INCOME





The Company relies on contracts with more than ten clients to maintain patient census at its inpatient facilities and provide patients for our outpatient operations and our employee assistance programs.  The loss of any of such contracts would impact our ability to meet our fixed costs.  We have entered into relationships with large employers, health care institutions, insurance companies and labor unions to provide treatment for psychiatric disorders, chemical dependency and substance abuse in conjunction with employer-sponsored employee assistance programs.  The employees of such institutions may be referred to us for treatment, the cost of which is reimbursed on a per diem or per capita basis.  Approximately 20% of our total revenue is derived from these clients.  No one of these large employers, health care institutions, insurance companies or labor unions individually accounts for 10% or more of our consolidated revenues, but the loss of any of these clients would require us to expend considerable effort to replace patient referrals and would result in revenue losses and attendant loss in income.





GOVERNMENT REGULATION COULD RESTRICT OUR ABILITY TO EXPAND, REDUCE THE ALLOWABLE REIMBURSEMENT TO THE COMPANY AND REDUCE OUR NET INCOME





Control of the healthcare industry exercised by federal, state and local regulatory agencies can increase costs, establish maximum reimbursement levels and limit expansion.  Our Company and the healthcare industry are subject to rapid regulatory change with respect to licensure and conduct of operations at existing facilities, construction of new facilities, acquisition of existing facilities, the addition of new services, compliance with physical plant safety and land use requirements, implementation of certain capital expenditures, reimbursement for services rendered and periodic government inspections.  Governmental budgetary restrictions have resulted in limited reimbursement rates in the healthcare industry, including our Company.  As a result of these restrictions, we cannot be certain that payments under government programs will remain at a level comparable to the present level or be sufficient to cover the costs allocable to such patients.  In addition, many states, including the State of Michigan, where the majority of our Medicaid Revenue is generated, are experiencing financial difficulties as a result of the recession and are considering reductions in state Medicaid budgets, which may be reflected through more limited access, lower rates, and higher State imposed utilization assessment fees.





20





SOLE SOURCE CONTRACTING BY MANAGED CARE ORGANIZATIONS MAY REDUCE OUR AVAILABLE PATIENTS BY ELIMINATING OUR ABILITY TO SERVICE THEM





Insurance companies and managed care organizations are entering into sole source contracts with healthcare providers, which could limit our ability to obtain patients.Private insurers, managed care organizations and, to a lesser extent, Medicaid and Medicare, are beginning to carve-out specific services, including mental health and substance abuse services, and establish small, specialized networks of providers for such services at fixed reimbursement rates.  Continued growth in the use of carve-out systems could materially adversely affect our business to the extent we are not selected to participate in such smaller specialized networks or if the reimbursement rate is not adequate to cover the cost of providing the service.





ACQUISITION AND EXPANSION COULD RESULT IN NEGATIVE CASH FLOWWHICH COULD REQUIRE THE COMPANY TO BORROW ADDITIONAL FUNDS AT UNFAVORABLE RATES AND AFFECT OUR NET INCOME





If we acquire new businesses or expand our businesses, the operating costs may be far greater than revenues for a significant period of time.The operating losses and negative cash flow associated with start-up operations or acquisitions could have a material adverse effect on our profitability and liquidity unless and until such facilities are fully integrated with our other operations and become self sufficient.  Until such time we may be required to borrow at higher rates and less favorable terms to supplement short term operating cash flow shortages.  Current situations raising these concerns include:


1.
The MeadowWood acquisition and its integration into the Pioneer group.


2.
The Acadia merger including risks related to its integration, expenses associated with seeking shareholder approval and the risk that the transaction may not be approved.


3.
The pending class action suit regarding the Acadia merger which may result in substantial legal fees and could result in a judgement against the Company.





MANAGEMENT RISKS





CONTROL OF THE COMPANY PROVIDES THE PRINCIPAL SHAREHOLDER WITH THE POWER TO APPROVE ALL TRANSACTIONS AND CONTROL THE BOARD OF DIRECTORS WITHOUT INPUT OF OTHER SHAREHOLDERS





Bruce A. Shear is in control of the Company since he is entitled to elect and replace a majority of the Board of Directors.Bruce Shear and his affiliates own and control 93.2% of the Class B Common Stock, which elects four of the six members of the Board of Directors.  Bruce Shear can establish, maintain and control business policy and decisions by virtue of his control of the election of the majority of the members of the board of directors.





INABILITY TO RETAIN KEY PERSONNELCOULD AFFECT OUR CLIENT RELATIONS AND THUS REDUCE OUR REVENUE AND NET INCOME





Retention of key personnel with knowledge of key contracts and clients is essential to the success of the Company.  PHC is highly dependent on the principal members of its management and professional staff, who are: Bruce A. Shear, PHC’s President and Chief Executive Officer, Robert H. Boswell, PHC’s Senior Vice President and other members of PHC’s management.





We do not anticipate any key member of management will leave the Company but do have a key man life insurance policy on Mr. Shear.





21





MARKET RISKS





THE COMPANY EXPECTS ITS STOCK PRICE TO BE VOLATILE




The market price of the Company’s common stock has been volatile in the past.  The shares have sold at prices varying between a low of $0.91 and a high of $3.85 from July 2009 through June 2011.  Trading prices may continue to fluctuate in response to a number of events and factors, including the following:






quarterly variations in operating results;






new products, services and strategic developments by us or our competitors;






developments in our relationships with our key clients;






regulatory developments; and






changes in our revenues, expense levels or profitability.








PREFERRED STOCK ISSUANCES COULD RESULT IN DIVIDEND, VOTING AND LIQUIDATION PREFERENCES SUPERIOR TO THE COMMON STOCK





Our right to issue convertible preferred stock may adversely affect the rights of the common stock.  Our Board of Directors has the right to establish the preferences for and issue up to 1,000,000 shares of preferred stock without further stockholder action. The terms of any series of preferred stock, which may include priority claims to assets and dividends and special voting rights, could adversely affect the market price of and the ability to sell common stock.





Item 1B. UNRESOLVED STAFF COMMENTS





None.





Item 2.           DESCRIPTION OF PROPERTY





Executive Offices





The Company’s executive offices are located in Peabody, Massachusetts.  The Company’s lease agreement in Peabody covers approximately 4,800 square feet for a 60-month term, which expires September 16, 2014. The current annual payment under the lease is $95,000.  The Company believes that this facility will be adequate to satisfy its needs for the foreseeable future.  The Company’s behavioral health administrative services segment uses this property.





Highland Ridge Hospital





The Highland Ridge premises consist of approximately 24,000 square feet of space occupying the majority of the first floor of a two-story hospital owned by Valley Mental Health and located in Midvale, Utah.  The lease is for a five-year term expiring June 30, 2012, which provides for monthly rental payments of approximately $38,500. Changes in rental payments each year are based on increases or decreases in the Consumer Price Index.  The Company believes that these premises are adequate for its current and anticipated needs and does not anticipate any difficulty in renewing or securing alternate space on expiration of the lease.  The Company’s behavioral health treatment services segment and contract services segment use this property.





Mount Regis Center





The Company owns the Mount Regis facility, which consists of a three-story building located on an approximately two-acre site in Salem, Virginia.  The building consists of over 14,000 square feet and is subject to a mortgage in the approximate amount of $107,000 as of June 30, 2011.  The facility is used for both inpatient and outpatient services.





22





The Company believes that these premises are adequate for its current and anticipated needs.  The Company’s behavioral health treatment services segment uses this property.





Psychiatric Facilities





The Company owns or leases premises for each of its psychiatric facilities.  Harmony Healthcare and North Point-Pioneer lease their premises.  The Company believes that each of these premises is leased at fair market value and could be replaced without significant time or expense if necessary.  The Company believes that all of these premises are adequate for its current and anticipated needs.  The Company’s behavioral health treatment services segment and contract services segment uses this property.





Harbor Oaks Hospital





The Company owns the building in which Harbor Oaks operates, which is a single story brick and wood frame structure comprising approximately 32,000 square feet situated on an approximately three acre site.  The Company has a $297,500 mortgage on this property as of June 30, 2011.  The Company believes that these premises are adequate for its current and anticipated needs.  The Company’s behavioral health treatment services segment uses this property.





Seven Hills Hospital





The Seven Hills premises is a two story steel and concrete block structure comprising approximately 26,500 square feet of space situated on an approximately one and a half acre site owned by Seven Hills Psych Center LLC and located in Las Vegas, Nevada.  The lease is for a ten-year term expiring April 30, 2018, which provides for monthly rental payments of approximately $87,600. Changes in rental payments each year are based on increases in the Consumer Price Index.  The Company believes that these premises are adequate for its current and anticipated needs and does not anticipate any difficulty in renewing or securing alternate space on expiration of the lease.  The Company’s behavioral health treatment services segment uses this property.  PHC owns a 15.24% interest in Seven Hills Psych Center, LLC.





Detroit Behavioral Institute





The Detroit Behavioral Institute – Capstone Academy premises is a two story steel and concrete block structure comprising approximately 35,000 square feet of space located in Detroit, Michigan.  The lease is for five years with an option to renew for an additional five years through May 31, 2018, which provides for monthly rental payments of approximately $60,500 with a scheduled 5% increase in rent each year.  The Company believes that these premises are adequate for its current and anticipated needs and does not anticipate any difficulty in renewing or securing alternate space on expiration of the lease.  The Company’s behavioral health treatment services segment uses this property.





Renaissance Recovery





Renaissance Recovery—The Renaissance Recovery program is located in a two-story block and brick structure comprising approximately 10,000 square feet of space located in Detroit, Michigan.  The commercial lease for this program is for a ten year term through the end of calendar year 2020. The Company has annual lease payments of $125,000, and annual increases of 1.5% for the first two years and 2.5% increases each year thereafter.  The Company believes that these premises are adequate for its current and anticipated needs and does not anticipate any difficulty in renewing or securing alternate space on expiration of the lease.  The Company's behavioral health treatment services segment uses this property.





MeadowWood Behavioral Health





MeadowWood Behavioral Health—On July 1, 2011 the Company acquired the MeadowWood Behavioral Health facility, a single story steel and concrete block structure comprising approximately 47,000 square feet of space,  located on a 10-acre site in New Castle, Delaware.  The Company’s behavioral health treatment services segment will utilize this property.





23




Item 3.                      LEGAL PROCEEDINGS.





The Company is subject to various claims and legal action that arise in the ordinary course of business.  In the opinion of management, the Company is not currently a party to any proceeding that would have a material adverse effect on its financial condition or results of operations.





On June 2, 2011, a putative stockholder class action lawsuit was filed in Massachusetts state court, MAZ Partners LP v. Bruce A. Shear, et al., C.A. No. 11-1041, against the Company, the members of the Company’s board of directors, and Acadia Healthcare Company, Inc. The MAZ Partners complaint asserts that the members of the Company’s board of directors breached their fiduciary duties by causing the Company to enter into the merger agreement and further asserts that Acadia aided and abetted those alleged breaches of fiduciary duty. Specifically, the MAZ Partners complaint alleged that the process by which the merger agreement was entered into was unfair and that the agreement itself is unfair in that, according to the plaintiff, the compensation to be paid to the Company’s Class A shareholders is inadequate, particularly in light of the proposed cash payment to be paid to Class B shareholders and the anticipated pre-closing payment of a dividend to Arcadia shareholders and the anticipated level of debt to be held  by the merged entity. The complaint sought, among other relief, an order enjoining the consummation of the merger and rescinding the merger agreement.





On June 13, 2011, a second lawsuit was filed in federal district court in Massachusetts, Blakeslee v. PHC, Inc., et al., No. 11-cv-11049, making essentially the same allegations against the same defendants. On June 21, 2011, the Company removed the MAZ Partners case to federal court (11-cv-11099). On July 7, 2011, the parties to the MAZ Partners case moved to consolidate that action with the Blakeslee case and asked the court to approve a schedule for discovery and a potential hearing on plaintiff's motion for a preliminary injunction.





On August 11, 2011, the plaintiffs in the MAZ Partners case filed an amended class action complaint. Like the original complaint, the amended complaint asserts claims of breach of fiduciary duty against the Company, members of the Company’s board of directors, and claims of aiding and abetting those alleged breaches of fiduciary duty against Acadia. The amended complaint alleges that both the merger process and the provisions of the merger are unfair, that the directors and executive officers of the Company have conflicts of interests with regard to the merger, that the dividend to be paid to Acadia shareholders is inappropriate, that a special committee or independent director should have been appointed to represent the interest of the Class A shareholders, that the merger consideration is grossly inadequate and the exchange ratio is unfair, and that the preliminary proxy filed by the Company contains material misstatements and omissions. The amended complaint also seeks, among other things, an order enjoining the consummation of the merger and rescinding the merger agreement.





PHC and Acadia believe that these lawsuits are without merit and intend to defend against them vigorously.  PHC and Acaida have recently filed motions to dismiss in each case.  Regardless of the disposition of the motions to dismiss, PHC and Acadia do not anticipate the outcome to have a material impact on the progress of the merger.





24





PART II





Item 5.     MARKET FOR REGISTRANT’S COMMON EQUITY RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES





Our Class A Common Stock has been listed on the American Stock Exchange, now NYSE Amex, since February 2007 under the symbol “PHC”.  Prior to that date it was quoted on the Over-the-Counter Bulletin Board under the symbol “PIHC-BB.”  The following table sets forth the high and low sales price of the Company's Class A Common Stock, as reported.


HIGH
LOW2010First Quarter (July 1, 2009 – September 30, 2009)
$
1.70
$
1.22Second Quarter (October 1, 2009 – December 31, 2009)
$
1.34
$
0.99Third Quarter (January 1, 2010 – March 31, 2010)
$
1.55
$
1.06Fourth Quarter (April 1, 2010 – June 30, 2010)
$
1.35
$
0.982011First Quarter (July 1, 2010 – September 30, 2010)
$
1.34
$
1.00Second Quarter (October 1, 2010 – December 31, 2010)
$
1.80
$
1.25Third Quarter (January 1, 2011 – March 31, 2011)
$
2.86
$
1.61Fourth Quarter (April 1, 2011 – June 30, 2011)
$
3.85
$
2.08





On June 30, 2011, there were 649 holders of record of the Company's Class A Common Stock and 296 holders of record of the Company's Class B Common Stock.  During fiscal 2011, the Company repurchased 173,495 shares of its equity securities that were registered under Section 12 of the Securities Act.




Of the 173,495 shares of the Company’s Class A common stock that were repurchased all but 50 shares were repurchased pursuant to a repurchase plan which was approved by the Company’s  Board of Directors in June, 2010.  The repurchase plan was publicly announced on June 14, 2010 and is effective for the fiscal year ending June 30, 2011.  The plan allows for the purchase of up to 1,000,000 shares of the Company’s Class A common stock on the open market during the 2011 fiscal year based on market conditions, opportunity and excess cash availability.




No equity securities were repurchased during the fourth quarter.





There were no sales of unregistered securities during the period.





DIVIDEND POLICY





Although the Company has no current restrictions on the issuance of dividends, the Company has never paid any cash dividends on its common stock.  The Company anticipates that, in the future, earnings will be retained for use in the business or for other corporate purposes, and it is not anticipated that cash dividends in respect to common stock will be paid in the foreseeable future.  Any decision as to the future payment of dividends will depend on the results of operations, the financial position of the Company and such other factors, as the Company’s board of directors, in its discretion, deems relevant.





SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS





Information required with respect to “Securities Authorized for Issuance Under Equity Compensation Plans” is included in Part III, Item 12 in this Annual Report on Form 10-K.





MARKET RISKS





The market price of the Company’s Common Stock has been volatile in the past.  The shares have sold at prices varying between a low of $0.91 and a high of $3.85 from July 2009 through June 2011.  Trading prices may continue to fluctuate in response to general market conditions and changes in the Company’s results of operations from quarter to quarter.  The Company did not issue any unregistered shares during the fiscal year ended June 30, 2011.





25





Our right to issue convertible preferred stock may adversely affect the rights of the common stock.  Our Board of Directors has the right to establish the preferences for and issue up to 1,000,000 shares of preferred stock without further stockholder action. The terms of any series of preferred stock, which may include priority claims to assets and dividends and special voting rights, could adversely affect the market price of and the ability to sell common stock.  During the twelve month period ended June 30, 2011, the Company did not issue any preferred stock.





STOCK PERFORMANCE GRAPH





The following table depicts the cumulative total return on the Company's common stock compared to the cumulative total return for the Nasdaq Composite-US Index and the Nasdaq Health Services Index (which includes both U.S. and foreign companies). The table assumes the investment of $100 on June 30, 2006 in stock and index-including reinvestment of dividends, for each of the fiscal years ending June 30.











26


Item 6.  SELECTED FINANCIAL DATA





The following table sets forth selected consolidated financial data of our Company.  The selected consolidated financial data as of June 30, 2011 and 2010 and for each of the two years in the period ended June 30, 2011 should be read with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and have been derived from our consolidated financial statements which are included elsewhere in this annual report on Form 10-K and were audited by BDO USA, LLP, an independent registered public accounting firm, as of and for the two years ended June 30, 2011.  The selected consolidated financial data as of and for the years ended June 30, 2009, 2008 and 2007 have been derived from our consolidated financial statements not included herein. The consolidated financial statements for the year ended June 30, 2007 were audited by Eisner, LLP, also an independent registered public accounting firm, and the consolidated financial statements for the years ended June 30, 2009 and 2008 were audited by BDO USA, LLP.  All information has been adjusted to reflect the elimination of Pivotal Research Centers in February 2009 in order to present comparative information.





The historical results are not necessarily indicative of the results to be expected for any future period.





PHC, Inc.


Selected Financial Data


As of and for the Years Ended June 30,


2011


2010


2009


2008


2007


(in thousands, except share and per share data)


Statements of Operations Data:Revenues
$
62,008
$
53,077
$
46,411
$
45,397
$
40,563Cost and Expenses:Patient care expenses

30,235

26,307

23,835

22,133

19,738Contract expenses

3,618

2,965

3,016

3,390

3,103Provision for doubtful accounts

3,406

2,131

1,638

1,311

1,933Administrative expenses

22,206

19,111

18,721

15,465

12,722Legal Settlement

446

--

--

--

--Interest expense

311

327

452

397

476Other incomeincluding interest income, net

(202)

(280)

(275)

(249)

(468)Total expenses

60,020

50,551

47,387

42,447

37,504Income (loss) before income taxes

1,988

2,526

(976)

2,950

3,059Provision for (benefit from) incometaxes

1,408

1,106

65

1,366

1,144Net income (loss) applicable tocommon shareholders
$
580
$
1,420
$
(2,454)
$
325
$
1,682Basic income (loss) per commonshare
$
0.03
$
0.07
$
(0.12)
$
0.02
$
0.09Basic weighted average number ofshares outstanding

19,504,943

19,813,783

20,090,521

20,166,659

19,287,665Diluted income (loss) per commonshare
$
0.03
$
0.07
$
(0.12)
$
0.02
$
0.09Diluted weighted average number ofshares outstanding

19,787,461

19,914,954

20,090,521

20,464,255

19,704,697





Balance Sheet Data:Cash and cash equivalents
$
3,668
$
4,540
$
3,199
$
3,142
$
3,308Working capital

9,896

8,197

6,082

10,095

11,606Long-term debt and obligations under capital leases, including current portions

424

1,221

1,377

1,444

1,047Total stockholders’ equity

17,915

17,256

16,044

18,659

18,250Total assets

28,282

25,207

22,692

26,507

26,856


27





Item 7.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS





CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.





In addition to historical information, this report contains statements relating to future events or our future results. These statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended (the "Exchange Act") and are subject to the Safe Harbor provisions created by the statute. Generally words such as "may", "will", "should", "could", "anticipate", "expect", "intend", "estimate", "plan", "continue", and "believe" or the negative of or other variation on these and other similar expressions identify forward-looking statements. These forward-looking statements are made only as of the date of this report. We do not undertake to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.  Forward-looking statements are based on current expectations and involve risks and uncertainties and our future results could differ significantly from those expressed or implied by our forward-looking statements.





The following is a discussion and analysis of the financial condition and results of operations of the Company for the years ended June 30, 2011 and 2010.  It should be read in conjunction with the operating statistics (Part I, Item 1) and selected financial data (Part II, Item 6) and the accompanying consolidated financial statements and related notes thereto included in this Annual Report on Form 10-K.





Overview





The Company presently provides behavioral health care services through three substance abuse treatment centers, two psychiatric hospitals, a residential treatment facility and eight outpatient psychiatric centers  (collectively called "treatment facilities").  The Company’s revenue for providing behavioral health services through these facilities is derived from contracts with managed care companies, Medicare, Medicaid, state agencies, railroads, gaming industry corporations and individual clients.  The profitability of the Company is largely dependent on the level of patient census and the payer mix at these treatment facilities.  Patient census is measured by the number of days a client remains overnight at an inpatient facility or the number of visits or encounters with clients at outpatient clinics.  Payor mix is determined by the source of payment to be received for each client being provided billable services.  The Company’s administrative expenses do not vary greatly as a percentage of total revenue but the percentage tends to decrease slightly as revenue increases.  Also included in administrative expenses is the Company’s internet operations, Behavioral Health Online, Inc., which continues to provide internet technology support for the subsidiaries and their contracts.  During the third quarter of fiscal 2009, the Company returned to profitability, which has continued through fiscal 2011, with the exception of the fourth quarter in which transaction costs detailed below resulted in a loss.





The healthcare industry is subject to extensive federal, state and local regulation governing, among other things, licensure and certification, conduct of operations, audit and retroactive adjustment of prior government billings and reimbursement.   In addition, there are on-going debates and initiatives regarding the restructuring of the health care system in its entirety.  The extent of any regulatory changes and their impact on the Company’s business is unknown.  The previous administration put forth proposals to mandate equality in the benefits available to those individuals suffering from mental illness (the “Parity Act”).  The Parity Act is now law and its full implementation started January 1, 2011.  This legislation has improved access to the Company’s programs but its total effect on behavioral health providers cannot be fully assessed at this stage.  Managed care has had a profound impact on the Company's operations, in the form of shorter lengths of stay, extensive certification of benefits requirements and, in some cases, reduced payment for services.  The current economic conditions continue to challenge the Company’s profitability through increased uninsured patients in our fee for service business and increased utilization in our capitated business.





Critical Accounting Policies





The preparation of our financial statements in accordance with US GAAP, requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related





28





disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including but not limited to those related to revenue recognition, accounts receivable reserves, income tax valuation allowances, and the impairment of goodwill and other intangible assets. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.





Revenue recognition and accounts receivable:





Patient care revenues and accounts receivable are recorded at established billing rates or at the amount realizable under agreements with third-party payors, including Medicaid and Medicare.  Revenues under third-party payor agreements are subject to examination and contractual adjustment, and amounts realizable may change due to periodic changes in the regulatory environment.  Provisions for estimated third party payor settlements are provided in the period the related services are rendered.  Differences between the amounts provided and subsequent settlements are recorded in operations in the period of settlement.  Amounts due as a result of cost report settlements are recorded and listed separately on the consolidated balance sheets as “Other receivables”.  The provision for contractual allowances is deducted directly from revenue and the net revenue amount is recorded as accounts receivable.  The allowance for doubtful accounts does not include the contractual allowances.





The Company currently has two “at-risk” contracts.  The contracts call for the Company to provide for all of the inpatient and outpatient behavioral health needs of the insurance carrier’s enrollees in a specified area for a fixed monthly fee per member per month.  Revenues are recorded monthly based on this formula and the expenses related to providing the services under these contracts are recorded as incurred.  The Company provides as much of the care directly and, through utilization review, monitors closely, all inpatient and outpatient services not provided directly.  The contracts are considered “at-risk” because the cost of providing the services, including payments to third-party providers for services rendered, could equal or exceed the total amount of the revenue recorded.





All revenues reported by the Company are shown net of estimated contractual adjustment and charity care provided.  When payment is made, if the contractual adjustment is found to have been understated or overstated, appropriate adjustments are made in the period the payment is received in accordance with the American Institute of Certified Public Accountants (AICPA) “Audit and Accounting Guide for Health Care Organizations.”  Net contractual adjustments recorded in fiscal 2011 for revenue booked in prior years resulted in a decrease in net revenue of approximately $233,800.  Net contractual adjustments recorded in fiscal 2010 for revenue booked in prior years resulted in a decrease in net revenue of approximately $75,200.  These adjustments primarily relate to Commercial payors as Medicare and Medicaid are adjusted through cost reporting and not included here.





For the fiscal year ended June 30, 2010, all cost reports through fiscal 2009 were finalized and a net payment of $92,267 was recorded in final settlement for all years through fiscal 2009. During fiscal 2011, $65,143 was received as tentative settlement for the fiscal 2010 Medicare cost report.





Below is revenue by payor and the accounts receivable aging information as of June 30, 2011 and June 30, 2010 for our treatment services segment.


Net Patient Care Revenue by Payor (in thousands)For the Twelve Months EndedJune 30, 2011

June 30, 2010Amount

Percent

Amount

PercentPrivate Pay
$
4,881
8%
$
3,495
7%Commercial

37,288
65%

32,915
66%Medicare*

6,188
11%

3,237
7%Medicaid

9,139
16%

10,000
20%Net Revenue
$
57,496

$
49,647





*includes Medicare cost report settlement revenue as noted above





29





Accounts Receivable Aging (Net of allowance for bad debts- in thousands)





As of June 30, 2011





Over

Over

Over

Over

Over

Over

OverPayor

Current

30

60

90

120

150

270

360

TotalPrivate Pay
$
136
$
248
$
248
$
190
$
153
$
361
$
2
$
22
$
1,360Commercial

3,540

1,043

440

312

159

261

--

9

5,764Medicare

582

116

64

153

115

83

--

--

1,113Medicaid

1,747

204

112

153

55

58

1

4

2,334Total
$
6,005
$
1,611
$
864
$
808
$
482
$
763
$
3
$
35
$
10,571





As of June 30, 2010


Over

Over

Over

Over

Over

Over

OverPayor

Current

30

60

90

120

150

270

360

TotalPrivate Pay
$
--
$
62
$
45
$
50
$
60
$
137
$
13
$
151
$
518Commercial

3,074

795

529

364

285

374

27

52

5,500Medicare

349

82

19

4

7

23

--

--

484Medicaid

1,537

145

46

57

35

20

5

4

1,849Total
$
4,960
$
1,084
$
639
$
475
$
387
$
554
$
45
$
207
$
8,351





Contract support service revenue is a result of fixed fee contracts to provide telephone support.  Revenue for these services is recognized ratably over the service period.  Revenues and receivables from our contract services division are based on a prorated monthly allocation of the total contract amount and usually paid within 30 days of the end of the month.





Allowance for doubtful accounts:





The provision for bad debts is calculated based on a percentage of each aged accounts receivable category beginning at 0-5% on current accounts and increasing incrementally for each additional 30 days the account remains outstanding until the account is over 300 days outstanding, at which time the provision is 100% of the outstanding balance.  These percentages vary by facility based on each facility’s experience in and expectations for collecting older receivables, which is reviewed at least quarterly and adjusted if required.  The Company compares this required reserve amount to the current “Allowance for doubtful accounts” to determine the required bad debt expense for the period.  This method of determining the required “Allowance for doubtful accounts” has historically resulted in an allowance for doubtful accounts of 25% or greater of the total outstanding receivables balance.





Income Taxes:





The Company follows the liability method of accounting for income taxes, as set forth in Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”) 740.  ASC 740 prescribes an asset and liability approach, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of the assets and liabilities.  The Company’s policy is to record a valuation allowance against deferred tax assets unless it is more likely than not, that such assets will be realized in future periods.  In June 2010, the Company recorded a valuation allowance of $150,103 against its deferred tax asset.  This amount relates to Arizona State tax credits accumulated by the research operations which were sold in fiscal 2009.  Since the Company no longer does business in Arizona, it is not likely that these tax credits will be used.  During fiscal year 2010, the Company recorded a tax expense of $1,106,100.  The Company recorded estimated tax expense of $1,407,936 for the year ended June 30, 2011.





In accordance with ASC 740, we may establish reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement of uncertain tax positions.  We have not established any such reserves at June 30, 2011 or 2010.  Tax authorities periodically challenge certain transactions and deductions  reported on our income tax returns.  We do not expect the outcome of these examinations, either individually or in the aggregate, to have a material adverse effect on our financial position, results of operations, or cash flows.





30





Valuation of Goodwill and Other Intangible Assets




Goodwill and other intangible assets are initially created as a result of business combinations or acquisitions.  The Company makes significant estimates and assumptions, which are derived from information obtained from the management of the acquired businesses and the Company’s business plans for the acquired businesses in determining the value ascribed to the assets acquired.  Critical estimates and assumptions used in the initial valuation of goodwill and other intangible assets include, but are not limited to:  (i) future expected cash flows from services to be provided, customer contracts and relationships, and (ii) the acquired market position.  These estimates and assumptions may be incomplete or inaccurate because unanticipated events and circumstances may occur.  If estimates and assumptions used to initially value goodwill and intangible assets prove to be inaccurate, ongoing reviews of the carrying values of such goodwill and intangible assets may indicate impairment which will require the Company to record an impairment charge in the period in which the Company identifies the impairment.




Investment in unconsolidated subsidiaries




Included in other assets as of June 30, 2011 and 2010 is the Company’s investment in Seven Hills Psych Center, LLC of $302,244 and $325,384, respectively.  This LLC holds the assets of the Seven Hills Hospital completed in May, 2008, being leased and operated by the Company’s subsidiary Seven Hills Hospital, Inc.  Also included, as of June 30, 2011 and 2010, is the Company’s investment in Behavioral Health Partners, LLC of $687,972 and $711,947, respectively.  This LLC constructed an out-patient clinic which was completed in the fourth fiscal quarter of 2009 and occupied as a fourth site to the Company’s Harmony subsidiary on July 1, 2009 to replace it’s Longford site which was closed in fiscal 2010.  This site has additional land available for construction of another hospital to be operated by the Company.  Both investments are accounted for based on the equity method of accounting.  Accordingly, the Company records its share of the investor companies’ income/loss as an increase/decrease to the carrying value of these investments.





Results of Operations





During the fiscal year ended June 30, 2011, the Company experienced continued increases in census and patient treatment revenue while contract Services revenue decreased with changes in contracts.





The following table illustrates our consolidated results of operations for the years ended June 30, 2011 and 2010 (in thousands):


2011
2010Statements of Operations Data:
($ in thousands)Amount
%
Amount
%Revenues
$
62,008
100.0
$
53,077
100.0Cost and Expenses:Patient care expenses

30,235
48.8

26,307
49.5Contract expenses

3,618
5.8

2,965
5.6Provision for doubtful accounts

3,406
5.5

2,131
4.0Administrative expenses

22,206
35.8

19,111
36.0Legal settlement

446
0.7

--
--Interest expense

311
0.5

326
0.6Other incomeincluding interest income, net

(202)
(0.3)

(289)
(0.5)Total expenses

60,020
96.8

50,551
95.2Income before income taxes

1,988
3.2

2,526
4.8Provision for income taxes

1,408
2.3

1,106
2.1Net income applicable tocommon shareholders
$
580
0.9
$
1,420
2.7








31





Year ended June 30, 2011 as compared to year ended June 30, 2010





The Company experienced continued profit from operations during fiscal 2011 with increases in census and revenue at Seven Hills and the Harbor Oaks chemical dependency and rehabilitation unit and a significant increase in one of our call center contracts.  These increases were off-set by several one-time charges to income from operations including a litigation settlement of $446,320 and a 401 (k) compliance testing failure of approximately $185,000 in the third quarter and approximately $1,600,000 in merger and acquisition costs related to the MeadowWood acquisition completed on July 1, 2011 and the pending Merger with Acadia Healthcare.  The Company’s income from operations decreased to income of $2,096,323 for the fiscal year ended June 30, 2011 from $2,563,747 for the fiscal year ended June 30, 2010. Net income decreased to $580,005 for the fiscal year ended June 30, 2011 compared to $1,419,662 for the fiscal year ended June 30, 2010.  Income from operations before taxes decreased to $1,987,941 for the fiscal year ended June 30, 2011 from $2,525,762 for the fiscal year ended June 30, 2010.  This decrease in profit is the result of approximately $708,000 in losses stemming from the start up of Renaissance Recovery and the one-time charges outlined above.  Without these charges income from operations would have increased by approximately $2,900,000 or greater than 94%.





Total revenues increased 16.8% to $62,007,879 for the year ended June 30, 2011 from $53,077,226 for the year ended June 30, 2010.




Total net patient care revenue from all facilities increased 15.8% to $57,495,735 for the year ended June 30, 2011 as compared to $49,647,395 for the year ended June 30, 2010.  Patient days increased 4,336 days for the fiscal year ending June 30, 2011 over the fiscal year ended June 30, 2010, the majority of the increase in bed days was at Seven Hills Hospital, partially as a result of CMS licensure, and Harbor Oaks Hospital’s chemical dependency unit off-set by a decrease in census at Capstone Academy as a result of a slow-down of admissions in the Michigan Medicaid patients overall.





Net inpatient care revenue from inpatient psychiatric services increased 23.4% to $36,693,784 for the fiscal year ended June 30, 2011 from $29,743,377 the fiscal year ended June 30, 2010.  This increase is due to a change in payor mix to payors with more favorable approved rates and increases in census noted above.  Net partial hospitalization and outpatient care revenue increased 4.5% to $20,801,951 for the fiscal year ended June 30, 2011 from $19,904,018 for the year ended June 30, 2010.  This increase is primarily due to a more favorable payor mix and the increased utilization of these step down programs by managed care as a treatment alternative to inpatient care.  Wellplace revenues increased 31.6% to $4,512,144 for the fiscal year ended June 30, 2011 from $3,429,831 for the year ended June 30, 2010 due to a significant increase in the services provided under the Wayne County call center contract in Michigan.  All revenues reported in the accompanying consolidated statements of operations are shown net of estimated contractual adjustments and charity care provided.  When payment is made, if the contractual adjustment is found to have been understated or overstated, appropriate adjustments are made in the period the payment is received in accordance with the AICPA Audit and Accounting Guide for Health Care Organizations.





Patient care expenses increased by $3,928,001, or 14.9%, to $30,234,829 for the year ended June 30, 2011 from $26,306,828 for the year ended June 30, 2010 due to the increase in census at Seven Hills and Harbor Oaks and the start up of Renaissance Recovery in the last quarter of this fiscal year and increased utilization under our capitated contracts.  Inpatient census increased by 4,336 patient days, 6.3%, for the year ended June 30, 2011 compared to the year ended June 30, 2010.  Contract expense, which includes the cost of outside service providers for our capitated contracts, increased 2.2% to $5,418,010 for the year ended June 30, 2011 from $5,300,747 for the year ended June 30, 2010 due to higher utilization under the capitated contracts.  Payroll and service related consulting expenses, including agency nursing, increased 16.0% to $24,968,560 for the year ended June 30, 2011 from $21,533,585 for the year ended June 30, 2010.  These staffing increases relate to increased census and the higher staffing costs related to the start up of Renaissance Recovery.  Food and dietary expense increased 4.7% to $1,160,903 for the year ended June 30, 2011 from $1,108,691 for the year ended June 30, 2010, which is in line with the increased census.  Lab fees increased 28.6% to $383,318 for the year ended June 30, 2011 from $298,068 for the year ended June 30, 2010.  All of these increases were a result of increased patient census and the start-up of the Renaissance Recovery program.  We continue to closely monitor the ordering of all hospital supplies, food and pharmaceutical supplies, but these expenses all relate directly to the number of days of inpatient services we provide and are expected to increase with higher patient census and outpatient visits. (see “Operating Statistics” Part I, Item 1).





32





Cost of contract support services related to Wellplace increased 22.0% to $3,617,509 for the year ended June 30, 2011 from $2,964,621 for the year ended June 30, 2010.  Payroll expense increased 58.6% to $1,714,510 for the year ended June 30, 2011 from $1,081,109 for the year ended June 30, 2010 and related payroll tax expense increased 54.9% to $222,704 for the year ended June 30, 2011 from $143,767 for the year ended June 30, 2010.  Other employee benefits increased 73.7% to $23,052 for the year ended June 30, 2011 from $13,274 for the year ended June 30, 2010.  These increases in employee related expenses directly relate to the increased services required under the Wayne County contract expansion.  Office expense increased 21.5% to $47,480 for the year ended June 30, 2011 from $39,091 for the year ended June 30, 2010.  Postage increased 86.7% to $36,116 for the year ended June 30, 2011 from $19,340 for the year ended June 30, 2010. And printing expense increased to $20,385 for the year ended June 30, 2011 from $1,423 for the year ended June 30, 2010.  These increases in expense are all related to the increased contract requirements under the expansion of the Michigan call center Wayne County contract.




Provision for doubtful accounts increased 59.8% to $3,406,443 for the fiscal year ended June 30, 2011 from $2,131,392 for the fiscal year ended June 30, 2010.  This increase is a result of increases in accounts receivable stemming from increases in revenue and the increase in aged accounts as the economic situation makes co-payments more difficult to collect timely.  The policy of the Company is to provide an allowance for doubtful accounts based on the age of receivables resulting in higher bad debt expense as receivables age.  The goal of the Company, given this policy, is to keep any changes in the provision for doubtful accounts at a rate lower than changes in aged accounts receivable.





The environment the Company operates in today makes collection of receivables, particularly older receivables, more difficult than in previous years.  Accordingly, the Company has increased staff, standardized some procedures  for collecting receivables and instituted a more aggressive collection policy, which has for the most part resulted in an overall decrease in the age of its accounts receivable.    The Company’s gross receivables from direct patient care increased 37.0% to $16,155,900 for the year ended June 30, 2011 from $11,796,154 for the year ended June 30, 2010.  The Company strives to keep bad debt expense under 5% and believes its reserve of approximately 30% of accounts receivable is sufficient based on the age of the receivables.  We continue to reserve for bad debt based on managed care denials and past difficulty in collections.  The growth of managed care has negatively impacted reimbursement for behavioral health services with higher contractual adjustments and a higher rate of denials creating slower payment requiring higher reserves and write offs.





Total administrative expenses increased 16.3% to $22,206,445 for the year ended June 30, 2011 from $19,110,638 for the year ended June 30, 2010.  This increase includes previously mentioned costs related to acquisition and merger of $1,600,000 and a one-time charge of $185,000 related to the 401 (k) compliance testing failure.  Payroll expense increased 7.0% to $8,159,091 for the year ended June 30, 2011 from $7,623,957 for the year ended June 30, 2010.  Employee benefits increased 23.0% to $1,362,092 for the year ended June 30, 2011 from $1,107,740 for the year ended June 30, 2010.  All of these increases in payroll and employee related expenses are a result of an increase in staff to facilitate increased operations.  Maintenance expense increased 22.3% to $824,224 for the year ended June 30, 2011 from $674,129 for the year ended June 30 2010 as we added maintenance expenses to ready Renaissance Recovery for operation and costs to maintain file servers and other equipment was higher than usual.





Legal Settlement expense of $446,320 resulted when an ongoing employee wrongful termination suit against the Company was settled in favor of the employee in April 2011.  This litigation was initially settled through binding arbitration.  When calculating the settlement awarded the employee, the Company believes the Arbitrator erroneously took into consideration an employment agreement that was not in question and not terminated by the Company.  Based on this miscalculation, the Company’s attorney recommended an appeal, which the Company initiated.  Since the Company believed this judgment would be reversed on appeal, the Company did not make a provision for this settlement at the time of the appeal.  In April 2011, the Michigan Supreme Court found in favor of the terminated employee requiring the Company to pay $446,320, which included accrued interest, to the terminated employee to satisfy this judgment.  This amount is shown as a legal settlement expense in operations for the year ended June 30, 2011.  Recording this transaction also eliminated the amount shown as restricted cash on the June 30, 2010 balance sheet.





Interest expense decreased 4.9% to $310,673 for the year ended June 30, 2011 from $326,582 for the year ended June 30, 2010.  This decrease is due to a decrease in long term debt.





33





The Company recorded income tax expense of $1,407,936 for the year ended June 30, 2011 based on an estimated combined tax rate of approximately 71% for both Federal and State taxes.  This higher combined tax rate is the result of merger and acquisition costs included in administrative expenses that are not tax deductable.  The Company recorded a tax expense of $1,106,100 for the fiscal year ended June 30, 2010.  Without large non-deductable charges, the Company expects the combined effective income tax rate to be approximately 50% as our highest revenue producing facilities are located in States with higher tax rates.





Liquidity and Capital Resources





As of June 30, 2011, the Company had working capital of $9,896,344, including cash and cash equivalents of $3,668,521, compared to working capital of $8,197,236, including cash and cash equivalents of $4,540,278 at June 30, 2010.





The Company’s net cash provided by operating activities was $1,739,120 for the year ended June 30, 2011, compared to $2,193,930 for the year ended June 30, 2010.  Cash flow provided by operations in fiscal 2011 consists of net income of $580,005, increased by non-cash activity including depreciation and amortization of $1,105,249, non-cash interest expense of $146,531, change in deferred tax asset of $73,708, non-cash share based charges of $164,916, warrant valuation of $11,626, provision for doubtful accounts of $3,406,443, offset by a non-cash gain on investments in unconsolidated subsidiaries of $25,864.  Further offset by an increase in accounts receivable of $6,256,335 and an increase in prepaid expenses of $70,382, offset by an increase in income taxes payable of $105,169, an increase in accounts payable of $670,548, an increase in accrued expenses and other liabilities of $1,408,237 and a decrease in other assets of $524,438.




Cash used in investing activities in fiscal 2011 of $1,900,545 consisted of $1,081,810 used for capital expenditures for the acquisition of property and equipment, $52,466 used in the purchase of software licenses, $1,001,934 used in the acquire notes receivable, offset by payments of $162,685 on the note receivable and $72,980 in distributions from the equity investments in unconsolidated subsidiaries.





Cash used in financing activities in fiscal 2011 of $710,332 consisted of $317,800 in net borrowings under the Company’s debt facilities, $295,052 in deferred financing costs and $215,327 used in the repurchase of 173,495 shares of the Company’s Class A common stock, offset by $117,847 in proceeds from the issuance of stock as a result of the exercise of options and the issue of shares under the employee stock purchase plan.  On July 1, 2011, in connection with the Company’s purchase of MeadowWood Behavioral Health (See Note P), the Company entered into a term loan and revolving credit agreement in the amount of $23.5 million and $3 million, respectively.





A significant factor in the liquidity and cash flow of the Company is the timely collection of its accounts receivable. As of June 30, 2011, accounts receivable from patient care, net of allowance for doubtful accounts, increased approximately 26.6% to $11,106,008 from $8,793,831 on June 30, 2010.  This increase is a result of increased revenue and slower payments from insurance payors.  The Company monitors increases in accounts receivable closely and based on the aging of the accounts receivable outstanding, is confident that the increase is not indicative of a payor problem.  Better accounts receivable management due to increased staff, standardization of some procedures for collecting receivables and a more aggressive collection policy has made this possible in behavioral health, which is typically a difficult collection environment.  The increased staff has allowed the Company to concentrate on current accounts receivable and resolve any problem issues before they become uncollectible.  The Company’s collection policy calls for earlier contact with insurance carriers with regard to payment, use of fax and registered mail to follow-up or resubmit claims and earlier employment of collection agencies to assist in the collection process.  The Company’s collectors will also seek assistance through every legal means, including the State Insurance Commissioner’s office, when appropriate, to collect claims.  In light of the current economy, the Company has redoubled its efforts to collect accounts early.  The Company will continue to closely monitor reserves for bad debt based on potential insurance denials and past difficulty in collections.





34





Contractual Obligations




The Company’s future minimum payments under contractual obligations related to capital leases, operating leases and term notes as of June 30, 2011 are as follows (in thousands):





YEAR ENDING



OPERATINGJune 30,

TERM NOTES

CAPITAL LEASES

LEASES

TOTAL*Principal

Interest

Principal

Interest2012
$
348
$
8
$
20
$
--
$
3,481
$
3,8572013

57

3

--

--

3,067

3,1272014

--

--

--

--

2,832

2,8322015

--

--

--

--

2,533

2,5332016

--

--

--

--

2,379

2,379Thereafter

--

--

--

--

5,279

5,279Total
$
405
$
11
$
20
$
--
$
19,571
$
20,007








*   Total does not include the amount due under the revolving credit note of $1,814,877.  This amount represents accounts receivable funding as described below and is shown as a current note payable in the accompanying financial statements.





In October 2004, the Company entered into a revolving credit, term loan and security agreement with CapitalSource Finance, LLC to replace the Company’s primary lender and provide additional liquidity.  Each of the Company’s material subsidiaries is a co-borrower under the agreement. This agreement was amended on June 13, 2007 to increase the amount available under the term loan, extend the term, decrease the interest rates and modify the covenants based on the Company’s current financial position.  The agreement now includes a term loan in the amount of $3,000,000, with a balance of $297,500 at June 30, 2011, and an accounts receivable funding revolving credit agreement with a maximum loan amount of $3,500,000 and a current balance of $1,814,877.  In conjunction with this refinancing, the Company paid $32,500 in commitment fees and approximately $53,000 in legal fees and issued a warrant to purchase 250,000 shares of Class A Common Stock at $3.09 per share valued at $456,880.  The relative fair value of the warrants was recorded as deferred financing costs and is being amortized over the period of the loan as additional interest.





The term loan note carries interest at prime plus .75%, but not less than 6.25%, with twelve monthly reductions in available credit of $50,000 beginning July 1, 2007 and increasing to $62,500 on July 1, 2009 until the expiration of the loan.   As of June 30, 2011, as the term loan nears its end, the Company had no funds available under the term loan.  The Company believes refinancing of this term loan would be available if required for acquisitions.





The revolving credit note carries interest at prime (3.25% at June 30, 2011) plus 0.25%, but not less than 4.75% paid through lockbox payments of third party accounts receivable.  The revolving credit term is three years, renewable for two additional one-year terms.  The balance on the revolving credit agreement as of June 30, 2011 was $1,814,877.  For additional information regarding this transaction, see the Company’s current report on Form 8-K filed with the Securities and Exchange Commission on October 22, 2004.  The balance outstanding as of June 30, 2010 for the revolving credit note is not included in the above table.  The average interest rate paid on the revolving credit loan, which includes the amortization of deferred financing costs related to the financing of the debt, was 7.56%.





This agreement was amended on June 13, 2007 to modify the terms of the agreement.  Advances are available based on a percentage of accounts receivable and the payment of principal is payable upon receipt of proceeds of the accounts receivable.  The amended term of the agreement is for two years, automatically renewable for two additional one year terms.  Upon expiration, all remaining principal and interest are due.  The revolving credit note is collateralized by substantially all of the assets of the Company’s subsidiaries and guaranteed by PHC.  Availability under this agreement is based on eligible accounts receivable and fluctuates with the accounts receivable balance and aging.





35





Subsequent to year-end, in order to facilitate the acquisition of MeadowWood Behavioral Health, the CaptialSource term loan and revolving credit debt were replaced by a term loan and revolving credit agreement with Jefferies Finance, LLC.





The terms of the Credit Agreement provide for (i) a $23,500,000 senior secured term loan facility (the “Term Loan Facility”) and (ii) up to $3,000,000 senior secured revolving credit facility (the “Revolving Credit Facility”), both of which were fully borrowed on the Closing Date in order to finance the MeadowWood purchase, to pay off PHC’s existing loan facility with CapitalSource Finance LLC, for miscellaneous costs, fees and expenses related to the Credit Agreement and the MeadowWood purchase, and for general working capital purposes.





The Term Loan Facility and Revolving Credit Facility mature on July 1, 2014, and 0.25% of the principal amount of the Term Loan Facility will be required to be repaid each quarter during the term.  PHC’s current and future subsidiaries are required to jointly and severally guarantee PHC’s obligations under the Credit Agreement, and PHC and its subsidiaries’ obligations under the Credit Agreement are secured by substantially all of their assets.





The Term Loan Facility and the Revolving Credit Facility bear interest, at the option of PHC, at (a) the Adjusted LIBOR Rate (will in no event be less than 1.75%) plus the Applicable Margin (as defined below) or (b) the highest of (x) the U.S. prime rate, (y) the Federal Funds Effective Rate plus 0.50% and (z) the Adjusted LIBOR Rate plus 1% per annum (the “Alternate Base Rate”), plus the Applicable Margin.  The “Applicable Margin” shall mean 5.5% per annum, in the case of Eurodollar loans, and 4.5% per annum, in the case of Alternate Base Rate loans.  .  (For additional information regarding these transactions, please see our report on Form 8-K, filed with the Securities and Exchange Commission on July 8, 2011).




Off Balance Sheet Arrangements





The Company has no off-balance-sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to the Company.





Aging of accounts receivable could result in our inability to collect receivables. As our accounts receivable age and become uncollectible our cash flow is negatively impacted.Our accounts receivable from patient accounts (net of allowance for bad debts) were $11,106,008 at June 30, 2011 compared with $8,793,831 at June 30, 2010.  As we expand, we will be required to seek payment from a larger number of payors and the amount of accounts receivable will likely increase.  We have focused on better accounts receivable management through increased staff, standardization of some procedures for collecting receivables and a more aggressive collection policy in order to keep the change in receivables consistent with the change in revenue.  We have also established a more aggressive reserve policy, allowing greater amounts of reserves as accounts age from the date of billing.  If the amount of receivables, which eventually become uncollectible, exceeds such reserves, we could be materially adversely affected.  The following chart represents our Accounts Receivable and Allowance for Doubtful Accounts at June 30, 2011 and 2010, respectively, and Bad Debt Expense for the years ended June 30, 2011 and 2010:





Accounts
Allowance for
Bad DebtReceivable
doubtful accounts
ExpenseJune 30, 2011
$
16,155,900
$
5,049,892
$
3,406,443June 30, 2010
$
11,796,154
$
3,002,323
$
2,131,392





The Company relies on contracts with more than ten clients to maintain patient census at its inpatient facilities and the loss of any of such contracts would impact our ability to meet our fixed costs.  We have entered into relationships with large employers, health care institutions and labor unions to provide treatment for psychiatric disorders, chemical dependency and substance abuse in conjunction with employer sponsored employee assistance programs.  The employees of such institutions may be referred to us for treatment, the cost of which is reimbursed on a per diem or per capita basis.  Approximately 20% of our total revenue is derived from these clients.  No one of these large employers, health care institutions or labor unions individually accounts for 10% or more of our consolidated





36





revenues, but the loss of any of these clients would require us to expend considerable effort to replace patient referrals and would result in revenue losses and attendant loss in income.





Recent accounting pronouncements:





Recently Adopted Standards





In April 2010, the FASB issued ASU No. 2010-13, Compensation — Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades, or ASU 2010-13. ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010, with early adoption permitted. The adoption of this standard did not have any impact on the Company’s consolidated financial statements.





In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition — Milestone Method (Topic 605): Milestone Method of Revenue Recognition, or ASU 2010-17. ASU 2010-17 allows the milestone method as an acceptable revenue recognition methodology when an arrangement includes substantive milestones. ASU 2010-17 provides a definition of substantive milestone, and should be applied regardless of whether the arrangement includes single or multiple deliverables or units of accounting. ASU 2010-17 is limited to transactions involving milestones relating to research and development deliverables. ASU 2010-17 also includes enhanced disclosure requirements about each arrangement, individual milestones and related contingent consideration, information about substantive milestones, and factors considered in the determination. ASU 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010, with early adoption permitted. The adoption of this standard did not have any impact on the Company’s consolidated financial statements.




In March 2010, the FASB issued ASU No. 2010-11, Derivatives and Hedging (ASC Topic 815): Scope Exception Related to Credit Derivatives, or ASU 2010-11. ASU 2010-11 clarifies that embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another are not subject to potential bifurcation and separate accounting. ASU 2010-11 also provides guidance on whether embedded credit-derivative features in financial instruments issued by structures such as collateralized debt obligations are subject to bifurcations and separate accounting. ASU 2010-11 is effective at the beginning of a company’s first fiscal quarter beginning after June 15, 2010, with early adoption permitted. The adoption of this guidance did not have any impact on the Company’s consolidated financial statements.





Recently Issued Accounting Standards





In June 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-05, Comprehensive Income(Topic 220): Presentation of Comprehensive Income, or ASU 2011-05. The amendments in this ASU require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2011, with early adoption permitted.  The Company does not expect the adoption of ASU 2011-05 to have a material impact on its consolidated financial statements.





In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. This ASU reflects the decision reached in EITF Issue No. 10-G. The amendments in this ASU affect any public entity, as defined by Topic 805 Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The





37





amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  The Company does not expect the adoption of this ASU will have a material effect on its consolidated financial statements.





In December 2010, the FASB issued ASU No. 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. This ASU reflects the decision reached in EITF Issue No. 10-A. The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The Company does not expect the adoption of this ASU will have a material effect on its consolidated financial statements.





In July 2011, the FASB issued ASU 2011-07, Healthcare Entities (Topic 954), which requires healthcare organizations that perform services for patients for which the ultimate collection of all or a portion of the amounts billed or billable cannot be determined at the time services are rendered to present all bad debt expense associated with patient service revenue as an offset to the patient service revenue line item in the statement of operations. The ASU also requires qualitative disclosures about the Company’s policy for recognizing revenue and bad debt expense for patient service transactions and quantitative information about the effects of changes in the assessment of collectability of patient service revenue. This ASU is effective for fiscal years beginning after December 15, 2011, and will be adopted by the Company in the first quarter of 2012. The Company is currently assessing the potential impact the adoption of this ASU will have on its consolidated results of operations and consolidated financial position.








Item 7A. Quantitative and Qualitative Disclosures About Market Risk





The market price of our common stock could be volatile and fluctuate significantly in response to various factors, including:



Differences in actual and estimated earnings and cash flows;



Operating results differing from analysts’ estimates;



Changes in analysts’ earnings estimates;



Quarter-to-quarter variations in operating results;



Changes in market conditions in the behavioral health care industry;



Changes in general economic conditions; and



Fluctuations in securities markets in general.





Financial 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 is subject to rates at prime plus .25% and prime plus .75%, which makes interest expense increase with changes in the prime rate. On this debt, each 25 basis point increase in the prime rate will affect an annual increase in interest expense of approximately $4,300; however, the prime rate is currently lower than the base interest rate of 4.50% therefore the Prime rate would have to increase 1.25% before there would be any interest expense increase.






Failure to meet targeted revenue projections could cause us to be out of compliance with covenants in our debt agreements requiring a waiver from our lender.  A waiver of the covenants may require our lender to perform additional audit procedures to assure the stability of their security, which could require additional fees.





38





Item 8.           Financial Statements and Supplementary Data.





Financial statements and supplementary data required pursuant to this Item 8 begin on page 39 of this Annual Report on Form 10-K.




PAGEIndex
39Report of Independent Registered Public Accounting Firm
40Consolidated Balance Sheets
41Consolidated Statements of Operations
42Consolidated Statements of Changes in Stockholders' Equity
43-44Consolidated Statements of Cash Flows
45-46Notes to Consolidated Financial Statements
47-70


























































































































39








REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








Board of Directors and Stockholders of


PHC, Inc.:











We have audited the accompanying consolidated balance sheets of PHC, Inc. and subsidiaries as of June 30, 2011 and 2010 and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended.  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 the standards of the Public Company Accounting Oversight Board (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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of PHC, Inc. and subsidiaries at June 30, 2011 and 2010 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.























/s/ BDO USA, LLP








Boston, Massachusetts


August 18, 2011












































40





PHC, INC.  AND SUBSIDIARIES


Consolidated Balance Sheets


June 30,2011
2010ASSETSCurrent assets:Cash and cash equivalents
$
3,668,521
$
4,540,278Accounts receivable, net of allowance for doubtful accounts of $5,049,892and $3,002,323 at June 30, 2011 and 2010, respectively

11,078,840

8,776,283Prepaid expenses

561,044

490,662Other receivables and advances

2,135,435

743,454Deferred tax assets

1,919,435

1,145,742Total current assets

19,363,275

15,696,419Restricted cash

--

512,197Accounts receivable, non-current

27,168

17,548Other receivables

43,152

58,169Property and equipment, net

4,713,132

4,527,376Deferred financing costs, net of amortization of $729,502 and $582,971 at June 30,2011 and 2010, respectively

549,760

189,270Goodwill

969,098

969,098Deferred tax assets- long term

647,743

1,495,144Other assets

1,968,662

2,184,749Total assets
$
28,281,990
$
25,649,970LIABILITIESCurrent liabilities:Current maturities of long-term debt
$
348,081
$
796,244Revolving credit note

1,814,877

1,336,025Current portion of obligations under capital leases

19,558

112,909Accounts payable

2,890,362

2,036,803Accrued payroll, payroll taxes and benefits

2,026,911

2,152,724Accrued expensesand other liabilities

2,237,982

1,040,487Income taxes payable

129,160

23,991Total current liabilities

9,466,931

7,499,183Long-term debt, less current maturities

56,702

292,282Obligations under capital leases

--

19,558Long-term accrued liabilities

843,296

582,953Total liabilities

10,366,929

8,393,976Commitments and contingent liabilities (Note I)STOCKHOLDERS’ EQUITYPreferred stock, 1,000,000 shares authorized, none issued

--

--Class A Common Stock, $.01 par value; 30,000,000 shares authorized, 19,978,211and 19,867,826 shares issued at June 30, 2011 and 2010, respectively

199,782

198,679Class B Common Stock, $.01 par value; 2,000,000 shares authorized, 773,717 and775,021 issued and outstanding at June 30, 2011 and 2010, respectively, eachconvertible into one share of Class A Common Stock

7,737

7,750Additional paid-in capital

28,220,835

27,927,536Treasury stock, 1,214,093 and 1,040,598 Class A common shares at cost atJune 30, 2011 and 2010, respectively

(1,808,734)

(1,593,407)Accumulated deficit

(8,704,559)

(9,284,564)Total stockholders’ equity

17,915,061

17,255,994Total liabilities and stockholders’ equity
$
28,281,990
$
25,649,970


See accompanying notes to consolidated financial statements.





41





PHC, INC.  AND SUBSIDIARIES


Consolidated Statements of Income





For the Years Ended June 30,2011
2010Revenues:Patient care, net
$
57,495,735
$
49,647,395Contract support services

4,512,144

3,429,831Total revenues

62,007,879

53,077,226Operating expenses:Patient care expenses

30,234,829

26,306,828Cost of contract support services

3,617,509

2,964,621Provision for doubtful accounts

3,406,443

2,131,392Administrative expenses

22,206,455

19,110,638Legal settlement

446,320

--Total operating expenses

59,911,556

50,513,479Income from operations

2,096,323

2,563,747Other income (expense):Interest income

263,523

142,060Interest expense

(310,673)

(326,582)Other income, net

(61,232)

146,537Total other expense, net

(108,382)

(37,985)Income before income taxes

1,987,941

2,525,762Provision for income taxes

1,407,936

1,106,100Net income applicable to common shareholders
$
580,005
$
1,419,662Basic net income per common share
$
0.03
$
0.07Basic weighted average number of shares outstanding

19,504,943

19,813,783Fully diluted net income per common share
$
0.03
$
0.07Fully diluted weighted average number of shares outstanding

19,787,461

19,914,954











See accompanying notes to consolidated financial statements.





42


PHC, INC.  AND SUBSIDIARIES





Consolidated Statements of Changes in Stockholders’ Equity


Class A
Class B
AdditionalCommon Stock
Common Stock
Paid-inShares
Amount
Shares
Amount
CapitalBalance – June 30, 2009
19,840,793
$
198,408

775,080
$
7,751
$
27,667,597Stock-based compensation expense








221,404Issuance of shares for optionsexercised
2,000

20





1,600Issuance of employee stock purchaseplan shares
24,974

250





36,935Purchase of treasury sharesConversion from Class B to Class A
59

1

(59)

(1)Net incomeBalance – June 30, 2010
19,867,826

198,679

775,021

7,750

27,927,536Stock-based compensation expense








164,916Issuance of shares for optionsexercised
95,000

950





102,790Fair value of warrants issued








11,626Issuance of employee stock purchaseplan shares
14,081

140





13,967Purchase of treasury sharesConversion from Class B to Class A
1,304

13

(1,304)

(13)Net incomeBalance – June 30, 2011
19,978,211
$
199,782

773,717
$
7,737
$
28,220,835



































See accompanying notes to consolidated financial statements.





43





PHC, INC.  AND SUBSIDIARIES (continued)





Consolidated Statements of Changes in Stockholders’ Equity





Class ATreasury Stock
AccumulatedShares

Amount
Deficit

TotalBalance – June 30, 2009
626,541
$
(1,125,707)
$
(10,704,226)
$
16,043,823Stock-based compensation expense






221,404Issuance of shares for optionsexercised






1,620Issuance of employee stock purchaseplan shares






37,185Purchase of treasury shares
414,057

(467,700)



(467,700)Conversion from Class B to Class A






--Net income




1,419,662

1,419,662Balance – June 30, 2010
1,040,598

(1,593,407)

(9,284,564)

17,255,994Stock-based compensation expense






164,916Issuance of shares for optionsexercised






103,740Fair value of warrants issued






11,626Issuance of employee stock purchaseplan shares






14,107Purchase of treasury shares
173,495

(215,327)



(215,327)Conversion from Class B to Class A






--Net income




580,005

580,005Balance – June 30, 2011
1,214,093
$
(1,808,734)
$
(8,704,559)
$
17,915,061




























See accompanying notes to consolidated financial statements.





44


PHC, INC.  AND SUBSIDIARIES
 Consolidated Statements of Cash Flows
 For the Years Ended June 30,2011

2010Cash flows from operating activities:Net income
$
580,005
$
1,419,662Adjustments to reconcile net income to net cash provided by

operating activities:Non-cash (gain)/loss on equity method investments

(25,864)

(17,562)Loss on disposal of property and equipment

--

3,831Depreciation and amortization

1,105,249

1,156,569Non-cash interest expense

146,531

146,531Deferred income taxes

73,708

185,093Fair value of warrants

11,626

--Stock-based compensation

164,916

221,404Provision for doubtful accounts

3,406,443

2,131,392Changes in operating assets and liabilities:Accounts and other receivables

(6,256,335)

(4,475,536)Prepaid expenses and other current assets

(70,382)

(15,136)Other assets

524,438

12,910Accounts payable

670,548

656,755Accrued expenses and other liabilities

1,408,237

768,017Net cash provided by operations

1,739,120

2,193,930Cash flows from investing activities:Acquisition of property and equipment

(1,081,810)

(751,843)Purchase of licenses

(52,466)

(22,208)Equity investment in unconsolidated subsidiary

72,980

33,528Investment in note receivable

(1,001,934)

--Principal receipts on note receivable

162,685

--Net cash used in investing activities

(1,900,545)

(740,523)Cash flows from financing activities:Repayment on revolving debt, net

478,852

472,621Principal payments on long-term debt and capital lease obligations

(796,652)

(156,199)Cash paid for deferred financing costs

(295,052)

--Purchase of treasury stock

(215,327)

(467,700)Proceeds from issuance of common stock, net

117,847

38,805Net cash used in financing activities

(710,332)

(112,473)Net (decrease) increase in cash and cash equivalents

(871,757)

1,340,934Beginning cash and cash equivalents

4,540,278

3,199,344Cash and cash equivalents, end of year
$
3,668,521
$
4,540,278
 
 See accompanying notes to consolidated financial statements.





45





PHC, INC.  AND SUBSIDIARIES


Consolidated Statements of Cash Flows (continued)





For the Years Ended June 30,2011
2010Supplemental cash flow information:Cash paid during the period for:Interest
$
164,141
$
180,048Income taxes

1,248,147

864,525Supplemental disclosure of non-cash financing andinvesting transactions:Conversion of Class B to Class A common stock
$
13
$
59Accrued and unpaid deferred financing costs

211,922

--






























































See accompanying notes to consolidated financial statements.





46





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A - THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Operations and business segments:





PHC, Inc. and subsidiaries,  (“PHC” or the “Company”) is incorporated in the Commonwealth of Massachusetts.  The Company is a national healthcare company which operates subsidiaries specializing in behavioral health services including the treatment of substance abuse, which includes alcohol and drug dependency and related disorders and the provision of psychiatric services.  The Company also operates help lines for employee assistance programs, call centers for state and local programs and provides management, administrative and online behavioral health services.  The Company primarily operates under three business segments:





(1)
Behavioral health treatment services, including two substance abuse treatment facilities:  Highland Ridge Hospital, located in Salt Lake City, Utah, which also treats psychiatric patients, Mount Regis Center, located in Salem, Virginia and Renaissance Recovery and eleven psychiatric treatment locations which include Harbor Oaks Hospital, a 71-bed psychiatric hospital located in New Baltimore, Michigan, Detroit Behavioral Institute, a 66-bed residential facility in Detroit, Michigan, a 55-bed psychiatric hospital in Las Vegas, Nevada and eight outpatient behavioral health locations (one in New Baltimore, Michigan operating in conjunction with Harbor Oaks Hospital, three in Las Vegas, Nevada as Harmony Healthcare, three locations operating as Pioneer Counseling Center in the Detroit, Michigan metropolitan area) and one location in Pennsylvania operating as Wellplace;





(2)
Call center and help line services (contract services), including two call centers, one operating in Midvale, Utah and one in Detroit, Michigan.  The Company provides help line services through contracts with major railroads and a call center contract with Wayne County, Michigan.  The call centers both operate under the brand name Wellplace; and





(3)
Behavioral health administrative services, including delivery of management and administrative and online services.  The parent company provides management and administrative services for all of its subsidiaries and online services for its behavioral health treatment subsidiaries and its call center subsidiaries.  It also provides behavioral health information through its website, Wellplace.com.







Principles of consolidation:




The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.  All material intercompany accounts and transactions have been eliminated in consolidation.  In January 2007, the Company purchased a 15.24% membership interest in the Seven Hills Psych Center, LLC, the entity that is the landlord of the Seven Hills Hospital subsidiary.  In March 2008, the Company, through its subsidiary PHC of Nevada, Inc., purchased a 25% membership interest in Behavioral Health Partners, LLC, the entity that is the landlord of a new outpatient location for Harmony Healthcare.  These investments are accounted for under the equity method of accounting and are included in other assets on the accompanying consolidated balance sheets.  (Note F)












47





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Revenues and accounts receivable:





Patient care revenues and accounts receivable are recorded at established billing rates or at the amount realizable under agreements with third-party payors, including Medicaid and Medicare.  Revenues under third-party payor agreements are subject to examination and contractual adjustment, and amounts realizable may change due to periodic changes in the regulatory environment.  Provisions for estimated third party payor settlements are provided in the period the related services are rendered.  Differences between the amounts provided and subsequent settlements are recorded in operations in the period of settlement.  Amounts due as a result of cost report settlements are recorded and listed separately on the consolidated balance sheets as “Other receivables”.  The provision for contractual allowances is deducted directly from revenue and the net revenue amount is recorded as accounts receivable.  The allowance for doubtful accounts does not include the contractual allowances.





Medicare reimbursements are based on established rates depending on the level of care provided and are adjusted prospectively.  Effective for fiscal years beginning after January 1, 2005, the prospective payment system (“PPS”) was brought into effect for all psychiatric services paid through the Medicare program.  The new system changed the TEFRA-based (Tax Equity and Fiscal Responsibility Act of 1982) system to the new variable per diem-based system.  The new rates are based on a statistical model that relates per diem resource use for beneficiaries to patient and facility characteristics available from “Center for Medicare and Medicaid Services” (“CMS’s”), administrative data base (cost reports and claims data).  Patient-specific characteristics include, but are not limited to, principal diagnoses, comorbid conditions, and age.  Facility specific variables include an area wage index, rural setting, and the extent of teaching activity.  This change was phased in over three fiscal years with a percentage of payments being made at the old rates and a percentage at the new rates.  The Company has been operating fully under PPS since fiscal 2009.




Although Medicare reimbursement rates are based 100% on PPS, the Company will continue to file cost reports annually as required by Medicare to determine ongoing rates and recoup any adjustments for Medicare bad debt.  These cost reports are routinely audited on an annual basis.  The Company believes that adequate provision has been made in the financial statements for any adjustments that might result from the outcome of Medicare audits.  Approximately 27% of the Company’s total revenue is derived from Medicare and Medicaid payors for each of the years ended June 30, 2011 and 2010.  Differences between the amounts provided and subsequent settlements are recorded in operations in the year of the settlement.  To date, settlement adjustments have not been material.





Patient care revenue is recognized as services are rendered, provided there exists persuasive evidence of an arrangement, the fee is fixed or determinable and collectability of the related receivable is reasonably assured.  Pre–admission screening of financial responsibility of the patient, insurance carrier or other contractually obligated payor, provides the Company the net expected collectable patient revenue to be recorded based on contractual arrangements with the payor or pre-admission agreements with the patient.  Revenue is not recognized for emergency provision of services for indigent patients until authorization for the services can be obtained.








48





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES      (CONTINUED)





Revenues and accounts receivable (continued):





Contract support service revenue is a result of fixed fee contracts to provide telephone support.  Revenue for these services is recognized ratably over the service period.





Long-term assets include non-current accounts receivable, other receivables and other assets (see below for description of other assets).  Non-current accounts receivable consist of amounts due from former patients for service.  This amount represents estimated amounts collectable under supplemental payment agreements, arranged by the Company or its collection agencies, entered into because of the patients’ inability to pay under normal payment terms.  All of these receivables have been extended beyond their original due date.  Reserves are provided for accounts of former patients that do not comply with these supplemental payment agreements and accounts are written off when deemed unrecoverable.  Other receivables included as long-term assets include the non-current portion of loans provided to employees and amounts due on a contractual agreement.


Charity care amounted to approximately $231,000 and $305,000 for the years ended June 30, 2011 and 2010, respectively.  Patient care revenue is presented net of charity care in the accompanying consolidated statements of income.





The Company had accounts receivable from Medicaid and Medicare of approximately $3,447,240 at June 30, 2011 and $2,333,300 at June 30, 2010.  Included in accounts receivable is approximately $1,212,460 and $1,255,000 in unbilled receivables at June 30, 2011 and 2010, respectively.





Allowance for doubtful accounts:





The Company records an allowance for uncollectible accounts which reduces the stated value of receivables on the balance sheet.  This allowance is calculated based on a percentage of each aged accounts receivable category beginning at 0-5% on current accounts and increasing incrementally for each additional 30 days the account remains outstanding until the account is over 300 days outstanding, at which time the provision is 100% of the outstanding balance.  These percentages vary by facility based on each facility’s experience in and expectations for collecting older receivables.  The Company compares this required reserve amount to the current “Allowance for doubtful accounts” to determine the required bad debt expense for the period.  This method of determining the required “Allowance for doubtful accounts” has historically resulted in an allowance for doubtful accounts of 20% or greater of the total outstanding receivables balance, which the Company believes to be a reasonable valuation of its accounts receivable.





Estimates and assumptions:





The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Such estimates include patient care billing rates, realizability of receivables from third-party payors, rates for Medicare and Medicaid, the realization of deferred tax benefits and the valuation of goodwill, which represents a significant portion of the estimates made by management.

















49





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Reliance on key clients:





The Company relies on contracts with more than ten clients to maintain patient census at its inpatient facilities and patients for our outpatient operations and our employee assistance programs.  The loss of any of such contracts would impact the Company’s ability to meet its fixed costs.  The Company has entered into relationships with large employers, health care institutions, insurance companies and labor unions to provide treatment for psychiatric disorders, chemical dependency and substance abuse in conjunction with employer sponsored employee assistance programs.  The employees of such institutions may be referred to the Company for treatment, the cost of which is reimbursed on a per diem or per capita basis.  Approximately 20% of the Company’s total revenue is derived from these clients for all periods presented.  No one of these large employers, health care institutions or labor unions individually accounts for 10% or more of the Company’s consolidated revenues, but the loss of any of these clients would require the Company to expend considerable effort to replace patient referrals and would result in revenue and attendant losses.





Cash equivalents:





Cash equivalents include short-term highly liquid investments with original maturities of less than three months.





Property and equipment:





Property and equipment are stated at cost.  Depreciation is provided over the estimated useful lives of the assets using the straight-line method.  The estimated useful lives are as follows:





Assets
Estimated Useful LifeBuildings
39 yearsFurniture and equipment
3 through 10 yearsMotor vehicles
5 yearsLeasehold improvements
Lesser of useful life or term of lease (2 to 10 years)





Other assets:





Other assets consists of deposits, deferred expenses advances, investment in Seven Hills LLC, investment in Behavioral Health Partners, LLC, software license fees, and acquired software which is being amortized over three to seven years based on its estimated useful life.





Long-lived assets:





The Company reviews the carrying values of its long-lived assets, other than goodwill, for possible impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable.  Any long-lived assets held for disposal are reported at the lower of their carrying amounts or fair value less costs to sell.  The Company believes that the carrying value of its long-lived assets is fully realizable at June 30, 2011.





50





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Fair Value Measurements:





Accounting Standards Codification (“ASC”) 820-10-65, “Fair Value Measurements and Disclosures”, defines fair value, provides guidance for measuring fair value and requires certain disclosures. This statement applies under other accounting pronouncements that require or permit fair value measurements. The statement indicates, among other things, that a fair value measurement assumes that a transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. ASC 820-10-65 defines fair value based upon an exit price model.  ASC 820-10-65 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:






Level 1:  Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.



Level 2: Inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.



Level 3:  Unobservable inputs that reflect the reporting entity’s own assumptions.





The Company had money market funds stated at fair market value, of $516,573 and $2,504,047 at June 30, 2011 and 2010, respectively, that were measured using Level 1 inputs.





Basic and diluted income per share:




Income per share is computed by dividing the income applicable to common shareholders by the weighted average number of shares of both classes of common stock outstanding for each fiscal year.  Class B Common Stock has additional voting rights.  All dilutive common stock equivalents have been included in the calculation of diluted earnings per share for the fiscal years ended June 30, 2011 and 2010 using the treasury stock method.





The weighted average number of common shares outstanding used in the computation of earnings per share is summarized as follows:





Years Ended June 30,2011
2010Weighted average shares outstanding –  basic
19,504,943
19,813,783Employee stock options and warrants
282,518
101,171Weighted average shares outstanding – fully diluted
19,787,461
19,914,954








51





PHC, INC. AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





The following table summarizes securities outstanding as of June 30, 2011 and 2010, but not included in the calculation of diluted net earnings per share because such shares are antidilutive:





Years Ended June 30,2011

2010Employee stock options
502,250

921,500Warrants
363,000

343,000Total
865,250

1,264,500


The Company repurchased 173,495 and 414,057 shares of its Class A Common Stock during fiscal 2011 and 2010, respectively.





Income taxes:





ASC 740, “Income Taxes”, prescribes an asset and liability approach, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of the assets and liabilities.  In accordance with ASC 740, the Company may establish reserves for tax uncertainties that reflect the use of the comprehensive model for the recognition and measurement of uncertain tax positions.  Tax authorities periodically challenge certain transactions and deductions reported on our income tax returns.  The Company does not expect the outcome of these examinations, either individually or in the aggregate, to have a material adverse effect on our financial position, results of operations, or cash flows.





Comprehensive income:





The Company’s comprehensive income is equal to its net income for all periods presented.




Stock-based compensation:




The Company issues stock options to its employees and directors and provides employees the right to purchase stock pursuant to stockholder approved stock option and stock purchase plans.  The Company follows the provisions of ASC 718, “Compensation – Stock Compensation”.




Under the provisions of ASC 718, the Company recognizes the fair value of stock compensation in net income (loss), over the requisite service period of the individual grantees, which generally equals the vesting period. All of the Company’s stock based awards are accounted for as equity instruments.




Under the provisions of ASC 718, the Company recorded $164,916 and $221,404 of stock-based compensation in its consolidated statements of income for the years ended June 30, 2011 and 2010, respectively, which is included in administrative expenses as follows:














52








PHC, INC. AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Stock-based compensation: (continued)


Year ended

Year endedJune 30, 2011

June 30, 2010Directors fees
$
75,845
$
63,870Employee compensation

89,071

157,534Total
$
164,916
$
221,404


The Company utilizes the Black-Scholes valuation model for estimating the fair value of the stock-based compensation. The weighted-average grant date fair values of the options granted under the stock option plans of $1.15 and $0.63 for the years ended June 30, 2011 and 2010, respectively, were calculated using the following weighted-average assumptions:





Year ended June 30,2011
2010Risk free interest rate
2.50%
2.30% - 3.48%Expected dividend yield
--
--Expected lives
5 - 10 years
5 - 10 yearsExpected volatility
61.61% - 72.06%
60.66% - 61.63%





The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with the expected life of the options. The risk-free interest rate is the U.S. Treasury rate on the date of grant. The expected life was calculated using the Company’s historical experience for the expected term of the option.





Based on the Company’s historical voluntary turnover rates for individuals in the positions who received options, there was no forfeiture rate assessed.  It is assumed these options will remain outstanding for the full term of issue.  Under the true-up provisions of ASC 718, a recovery of prior expense will be recorded if the actual forfeiture rate is higher than estimated or additional expense if the forfeiture rate is lower than estimated.  To date,  any required true-ups have not been material.





In August 2010, 7,679 shares of common stock were issued under the employee stock purchase plan.  The Company recorded stock-based compensation expense of $1,304.  In March 2011, 6,402 shares of common stock were issued under the employee stock purchase plan.  The Company recorded stock-based compensation expense of $1,216.





As of June 30, 2011, there was $168,117 in unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under existing stock option plans.  This cost is expected to be recognized over the next three years.





Advertising Expenses:





Advertising costs are expensed when incurred.  Advertising expenses for the years ended June 30, 2011 and 2010 were $167,549 and $136,183, respectively.





53





PHC, INC. AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Subsequent Events:





The Company has evaluated material subsequent events through the date of issuance of this report and we have included all such disclosures in the accompanying footnotes. (See Note P).





Reclassifications:





Certain June 30, 2010 balance sheet amounts have been reclassified to be consistent with the June 30, 2011 presentation, which affect certain balance sheet classifications only.





Recent accounting pronouncements:





Recently Adopted Standards





In April 2010, the FASB issued ASU No. 2010-13, Compensation — Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades, or ASU 2010-13. ASU 2010-13 clarifies that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. ASU 2010-13 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010, with early adoption permitted. The adoption of this standard did not have any impact on the Company’s consolidated financial statements.








In April 2010, the FASB issued ASU No. 2010-17, Revenue Recognition — Milestone Method (Topic 605): Milestone Method of Revenue Recognition, or ASU 2010-17. ASU 2010-17 allows the milestone method as an acceptable revenue recognition methodology when an arrangement includes substantive milestones. ASU 2010-17 provides a definition of substantive milestone, and should be applied regardless of whether the arrangement includes single or multiple deliverables or units of accounting. ASU 2010-17 is limited to transactions involving milestones relating to research and development deliverables. ASU 2010-17 also includes enhanced disclosure requirements about each arrangement, individual milestones and related contingent consideration, information about substantive milestones, and factors considered in the determination. ASU 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010, with early adoption permitted. The adoption of this standard did not have any impact on the Company’s consolidated financial statements.








In March 2010, the FASB issued ASU No. 2010-11, Derivatives and Hedging (ASC Topic 815): Scope Exception Related to Credit Derivatives, or ASU 2010-11. ASU 2010-11 clarifies that embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another are not subject to potential bifurcation and separate accounting. ASU 2010-11 also provides guidance on whether embedded credit-derivative features in financial instruments issued by structures such as collateralized debt obligations are subject to bifurcations and separate accounting. ASU 2010-11 is effective at the beginning of a company’s first fiscal quarter beginning after June 15, 2010, with early adoption permitted. The adoption of this guidance did not have any impact on the Company’s consolidated financial statements.








54





PHC, INC. AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE A – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)





Recently Issued Accounting Standards





In June 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-05, Comprehensive Income(Topic 220): Presentation of Comprehensive Income, or ASU 2011-05. The amendments in this ASU require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2011, with early adoption permitted.  The Company does not expect the adoption of ASU 2011-05 to have a material impact on its consolidated financial statements.





In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. This ASU reflects the decision reached in EITF Issue No. 10-G. The amendments in this ASU affect any public entity, as defined by Topic 805 Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  The Company does not expect the adoption of this ASU will have a material effect on its consolidated financial statements.





In December 2010, the FASB issued ASU No. 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. This ASU reflects the decision reached in EITF Issue No. 10-A. The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples, which require that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The Company does not expect the adoption of this ASU will have a material effect on its consolidated financial statements.





In July 2011, the FASB issued ASU 2011-07, Healthcare Entities (topic 954), which requires healthcare organizations that perform services for patients for which the ultimate collection of all or a portion of the amounts billed or billable cannot be determined at the time services are rendered to present all bad debt expense associated with patient service revenue as an offset to the patient service revenue line item in the statement of operations. The ASU also requires qualitative disclosures about the Company’s policy for recognizing revenue and bad debt expense for patient service transactions and quantitative information about the effects of changes in the assessment of collectibility of patient service revenue. This ASU is effective for fiscal years beginning after December 15, 2011, and will be adopted by the Company in the first quarter of 2012. The Company is currently assessing the potential impact the adoption of this ASU will have on its consolidated results of operations and consolidated financial position.





55





PHC, INC. AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE B – NOTE RECEIVABLE





On November 13, 2010, the Company, through its subsidiary, Detroit Behavioral Institute, Inc., d/b/a Capstone Academy, a wholly owned subsidiary of the Company (“Capstone Academy”), purchased the rights under certain identified notes (the “Notes”) held by Bank of America and secured by the property leased by Capstone Academy for $1,250,000.  The Notes were in default at the time of the purchase and the Company has initiated foreclosure proceedings in the courts.  The Notes were purchased using cash flow from operations.  The Company has recorded the value of the Notes in other receivables, current of $1,124,240, in the accompanying consolidated financial statements.  The Company believes the value of the Notes are fully recoverable based on the current value of the property securing the Notes.





NOTE C – OTHER EXPENSE





During the current fiscal year, the Company identified a failure with respect to prior year Average Deferral Percentage ("ADP") and Actual Contribution Percentage ("ACP") testing in the 401(k) plan.  The Company does not consider this to be a material operational failure and is correcting by filing under the IRS' Employee Plans Compliance Resolution Program (Rev Proc 2008-50), with the assistance of counsel.  During the fiscal year 2011, the Company determined that approximately $185,000 will be the non-voluntary contribution to the 401(k) plan required by the IRS in connection with this compliance failure and recorded this expense as other expense in the accompanying consolidated statements of income.





NOTE D - PROPERTY AND EQUIPMENT





Property and equipment is composed of the following:





As of June 30,2011


2010Land
$
69,259
$
69,259Buildings

1,136,963

1,136,963Furniture and equipment

4,285,785

3,913,670Motor vehicles

173,492

152,964Leasehold improvements

5,020,183

4,332,77010,685,682

9,605,626Less accumulated depreciation and amortization

5,972,550

5,078,250Property and equipment, net
$
4,713,132
$
4,527,376





Total depreciation and amortization expenses related to property and equipment were $895,650 and $907,746 for the fiscal years ended June 30, 2011 and 2010, respectively.





NOTE E - GOODWILL AND OTHER INTANGIBLE ASSETS:





Goodwill and other intangible assets are initially created as a result of business combinations or acquisitions.  Critical estimates and assumptions used in the initial valuation of goodwill and other intangible assets include, but are not limited to:  (i) future expected cash flows from services to be provided, customer contracts and relationships, and (ii) the acquired market position.  These estimates and assumptions may be incomplete or inaccurate because unanticipated events and circumstances may occur.  If estimates and assumptions used to initially value goodwill and intangible assets prove to be inaccurate, ongoing reviews of the carrying values of such goodwill and intangible assets may indicate impairment which will require the Company to record an impairment charge in the period in which the Company identifies the impairment.





56





PHC, INC. AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE E - GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED):





ASC 350, “Goodwill and Other Intangible Assets” requires, among other things, that companies not amortize goodwill, but instead test goodwill for impairment at least annually.  In addition, ASC 350 requires that the Company identify reporting units for the purpose of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life.





The Company’s goodwill of $969,098 relating to the treatment services reporting unit of the Company was evaluated under ASC 350 as of June 30, 2011.  As a result of the evaluation, the Company determined that no impairment exists related to the goodwill associated with the treatment services reporting unit. The Company will continue to test goodwill for impairment, at least annually, in accordance with the guidelines of ASC 350.  There were no changes to the goodwill balance during fiscal 2011 or 2010.




NOTE F - OTHER ASSETS





Included in other assets are investments in unconsolidated subsidiaries.  As of June 30, 2011, this includes the Company’s investment in Seven Hills Psych Center, LLC of $302,244 (this LLC holds the assets of the Seven Hills Hospital which is being leased by a subsidiary of the Company) and the Company’s investment in Behavioral Health Partners, LLC, of $687,972 (this LLC holds the assets of an out-patient clinic which is being leased by PHC of Nevada, Inc, the Company’s outpatient operations in Las Vegas, Nevada).





The following table lists amounts included in other assets, net of any accumulated amortization:





Description
As of June 30,2011

2010Software development & license fees
$
790,225
$
947,358Investment in unconsolidated subsidiary

990,216

1,037,331Deposits and other assets

188,221

200,060Total
$
1,968,662
$
2,184,749





Total accumulated amortization of software license fees was $1,016,291 and $806,962 as of June 30, 2011 and 2010, respectively.  Total amortization expense related to software license fees was $209,599 and $248,823 for the fiscal years ended June 30, 2011 and 2010, respectively.





The following is a summary of expected amortization expense of software licensure fees for the succeeding fiscal years and thereafter as of June 30, 2011:





Year EndingJune 30,

Amount2012
$
183,9432013

172,3892014

169,3272015

48,2742016

2,322Thereafter

213,970$
790,225





57





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE G – NOTES PAYABLE AND LONG-TERM DEBT





Notes payable and long-term debt is summarized as follows:
As of June 30,2011

2010Term mortgage note payable with monthly principal installments of  $50,000 beginning July 1, 2007 increasing to $62,500 July 1, 2009 until the loan terminates.  The note bears interest at prime (3.25% at June 30, 2011) plus 0.75% but not less than 6.25% and is collateralized by all of the assets of the Company and its material subsidiaries.
$
297,500
$
935,000Mortgage note due in monthly installments of $4,850 including interest at 9% through July 1, 2012, when the remaining principal balance is payable, collateralized by a first mortgage on the PHC of Virginia, Inc, Mount Regis Center facility

107,283

153,526Total

404,783

1,088,526Less current maturities

348,081

796,244Long-term portion
$
56,702
$
292,282





Maturities of notes payable and long-term debt are as follows as of June 30, 2011:





Year EndingJune 30,

Amount2012
$
348,0812013

56,702$
404,783




The Company’s amended revolving credit note allows the Company to borrow a maximum of $3,500,000.  The outstanding balance on this note was $1,814,877 and $1,336,025 at June 30, 2011 and 2010, respectively.  This agreement was amended on June 13, 2007 to modify the terms of the agreement.  Advances are available based on a percentage of accounts receivable and the payment of principal is payable upon receipt of proceeds of the accounts receivable.  Interest is payable monthly at prime (3.25% at June 30, 2011) plus 0.25%, but not less than 4.75%.  The average interest rate paid during the fiscal year ended June 30, 2011 was 7.56%, which includes the amortization of deferred financing costs related to the initial financing.  The amended term of the agreement is for two years, renewable for two additional one year terms.  The Agreement was automatically renewed June 13, 2010 to effect the term through June 13, 2011.  This agreement was not renewed.  On July 1, 2011, in connection with the Company’s purchase of MeadowWood Behavioral Health (See Note P), all of the Company’s outstanding long-term debt and revolving credit facility were repaid.  The revolving credit note is collateralized by substantially all of the assets of the Company’s subsidiaries and guaranteed by PHC.





As of June 30, 2011, the Company was in compliance with all of its financial covenants under the revolving line of credit note.  These covenants include only a debt coverage ratio and a minimum EBITDA.











58





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE H - CAPITAL LEASE OBLIGATION





At June 30, 2011, the Company was obligated under various capital leases for equipment providing for aggregate monthly payments of approximately $7,157 and terms expiring through June 2014.





The carrying value of assets under capital leases included in property and equipment and other assets are as follows:


June 30,2011

2010Equipment and software
$
321,348
$
338,936Less accumulated amortization and depreciation

(183,627)

(153,774)$
137,721
$
185,162





Amortization and depreciation expense related to these assets for the years ended June 30, 2011 and 2010 was $45,906 and $48,977 respectively.





The remaining balance of the Company’s obligations under capital lease of $19,558 is due in fiscal 2012.





NOTE I – ACCRUED EXPENSES AND OTHER LIABILITIES





Accrued expenses and other long-term liabilities consist of the following:


June 30,2011

2010Accrued contract expenses
$
702,054
$
503,636Accrued legal and accounting

1,127,623

313,313Accrued operating expenses

1,251,601

806,491Total

3,081,278

1,623,440Less long-term accrued expenses

843,296

582,953Accrued expenses current
$
2,237,982
$
1,040,487





Other long-term liabilities includes the long-term portion of rent obligations associated with the Company’s leases at certain locations.








59





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE J - INCOME TAXES





The Company has the following deferred tax assets included in the accompanying balance sheets:


Years Ended June 30,2011

2010Deferred tax asset:Stock based compensation
$
37,800
$
33,382Allowance for doubtful accounts

1,918,939

1,140,871Transaction costs

193,791

--Depreciation

24,827

446,825Difference between book and tax bases ofintangible assets

391,325

855,786Credits

--

210,186Operating loss carryforward

--

99,068Other

496

4,871Gross deferred tax asset
$
2,567,178
$
2,790,989Less valuation allowance

--

(150,103)Net deferred tax asset
$
2,567,178
$
2,640,886





These amounts are shown on the accompanying consolidated balance sheets as follows:




Years Ended June 30,2011

2010Net deferred tax asset:Current portion
$
1,919,435
$
1,145,742Long-term portion

647,743

1,495,144$
2,567,178
$
2,640,886





As of June 30, 2011, the Company believes that all deferred tax assets are more likely than not to be realized.





The components of the income tax provision (benefit) for the years ended June 30, 2011 and 2010 are as follows:





2011

2010CurrentFederal
$
772,611
$
313,232State

561,617

607,7751,334,228

921,007DeferredFederal

(62,768)

330,222State

136,476

(145,129)73,708

185,093Income tax provision
$
1,407,936
$
1,106,100








60





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE J - INCOME TAXES (CONTINUED)





A reconciliation of the federal statutory rate to the Company’s effective tax rate for the years ended June 30, 2011 and 2010 is as follows:


2011
2010Income tax provision at federal statutory rate
34.0%
34.0%Increase (decrease) in tax resulting from:State tax provision, net of federal benefit
23.16
11.77Non-deductible expenses
1.93
3.65Transaction costs
18.77
0.00Change in valuation allowance
(7.55)
0.35Prior year refunds
(0.62)
(8.49)Other, net
1.11
2.49Effective income tax rate
70.80%
43.77%





During fiscal 2011, the Company incurred approximately $1,607,700 of transaction costs associated with the MeadowWood acquisition and the Acadia merger (See Note P). The Company has disallowed these costs for tax purposes.




The Company adopted certain provisions of ASC 740 “Income Taxes” on July 1, 2007 as it relates to uncertain tax positions.  As a result of the implementation of ASC 740, the Company recognized no material adjustment in the liability for unrecognized tax benefits.





The Company recognizes interest and penalties related to uncertain tax positions in general and administrative expense. As of June 30, 2011, the Company has not recorded any provisions for uncertain tax positions or for accrued interest and penalties related to uncertain tax positions.




Tax years 2006-2010 remain open to examination by the major taxing authorities to which the Company is subject.





NOTE K - COMMITMENTS AND CONTINGENT LIABILITIES





Operating leases:





The Company leases office and treatment facilities, furniture and equipment under operating leases expiring on various dates through June 2019.  Rent expense for the years ended June 30, 2011 and 2010 was $3,449,016 and $3,650,278, respectively.  Rent expense includes certain short-term rentals.  Minimum future rental payments under non-cancelable operating leases, having remaining terms in excess of one year as of June 30, 2011 are as follows:





Year EndingJune 30,

Amount2012
$
3,480,8382013

3,066,9262014

2,831,5492015

2,533,0142016

2,379,368Thereafter

5,279,168$
19,570,863








61





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE K - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)





Litigation:





During the current fiscal year, the Michigan Court of Appeals upheld an appeal involving the company and a terminated employee requiring the Company to pay $446,320, which included accrued interest, to the terminated employee to satisfy this judgment.  This amount is shown as a legal settlement expense in the accompanying statements of income for the year ended June 30, 2011.





On June 2, 2011, a putative stockholder class action lawsuit was filed in Massachusetts state court, MAZ Partners LP v. Bruce A. Shear, et al., C.A. No. 11-1041, against the Company, the members of the Company’s board of directors, and Acadia Healthcare Company, Inc. The MAZ Partners complaint asserts that the members of the Company’s board of directors breached their fiduciary duties by causing the Company to enter into the merger agreement and further asserts that Acadia aided and abetted those alleged breaches of fiduciary duty. Specifically, the MAZ Partners complaint alleged that the process by which the merger agreement was entered into was unfair and that the agreement itself is unfair in that, according to the plaintiff, the compensation to be paid to the Company’s Class A shareholders is inadequate, particularly in light of the proposed cash payment to be paid to Class B shareholders and the anticipated pre-closing payment of a dividend to Arcadia shareholders and the anticipated level of debt to be held  by the merged entity. The complaint sought, among other relief, an order enjoining the consummation of the merger and rescinding the merger agreement.





On June 13, 2011, a second lawsuit was filed in federal district court in Massachusetts, Blakeslee v. PHC, Inc., et al., No. 11-cv-11049, making essentially the same allegations against the same defendants. On June 21, 2011, the Company removed the MAZ Partners case to federal court (11-cv-11099). On July 7, 2011, the parties to the MAZ Partners case moved to consolidate that action with the Blakeslee case and asked the court to approve a schedule for discovery and a potential hearing on plaintiff's motion for a preliminary injunction,.




On August 11, 2011, the plaintiffs in the MAZ Partners case filed an amended class action complaint. Like the original complaint, the amended complaint asserts claims of breach of fiduciary duty against the Company, members of the Company’s board of directors, and claims of aiding and abetting those alleged breaches of fiduciary duty against Acadia. The amended complaint alleges that both the merger process and the provisions of the merger are unfair, that the directors and executive officers of the Company have conflicts of interests with regard to the merger, that the dividend to be paid to Acadia shareholders is inappropriate, that a special committee or independent director should have been appointed to represent the interest of the Class A shareholders, that the merger consideration is grossly inadequate and the exchange ratio is unfair, and that the preliminary proxy filed by the Company contains material misstatements and omissions. The amended complaint also seeks, among other things, an order enjoining the consummation of the merger and rescinding the merger agreement.





PHC and Acadia believe that these lawsuits are without merit and intend to defend against them vigorously.  PHC and Acaida have recently filed motions to dismiss in each case.  Regardless of the disposition of the motions to dismiss, PHC and Acadia do not anticipate the outcome to have a material impact on the progress of the merger.


Additionally, the Company is subject to various claims and legal action that arise in the ordinary course of business.  In the opinion of management, the Company is not currently a party to any proceeding that would have a material adverse effect on its financial condition or results of operations.





62





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE L – STOCKHOLDERS’ EQUITY AND STOCK PLANS





Preferred Stock





The Board of Directors is authorized, without further action of the shareholders, to issue up to 1,000,000 shares in one or more classes or series and to determine, with respect to any series so established, the preferences, voting powers, qualifications and special or relative rights of the established class or series, which rights may be in preference to the rights of common stock.  No shares of the Company’s preferred stock are currently issued.





Common Stock





The Company has authorized two classes of common stock, the Class A Common Stock and the Class B Common Stock.  Subject to preferential rights in favor of the holders of the Preferred Stock, the holders of the common stock are entitled to dividends when, as and if declared by the Company’s Board of Directors. Holders of the Class A Common Stock and the Class B Common Stock are entitled to share equally in such dividends, except that stock dividends (which shall be at the same rate) shall be payable only in Class A Common Stock to holders of Class A Common Stock and only in Class B Common Stock to holders of Class B Common Stock.





Class A Common Stock





The Class A Common Stock is entitled to one vote per share with respect to all matters on which shareholders are entitled to vote, except as otherwise required by law and except that the holders of the Class A Common Stock are entitled to elect two members to the Company’s Board of Directors.





The Class A Common Stock is non-redeemable and non-convertible and has no pre-emptive rights.





All of the outstanding shares of Class A Common Stock are fully paid and nonassessable.





Class B Common Stock





The Class B Common Stock is entitled to five votes per share with respect to all matters on which shareholders are entitled to vote, except as otherwise required by law and except that the holders of the Class A Common Stock are entitled to elect two members to the Company’s Board of Directors.  The holders of the Class B Common Stock are entitled to elect all of the remaining members of the Board of Directors.





The Class B Common Stock is non-redeemable and has no pre-emptive rights.





Each share of Class B Common Stock is convertible, at the option of its holder, into a share of Class A Common Stock.  In addition, each share of Class B Common Stock is automatically convertible into one fully-paid and non-assessable share of Class A Common Stock (i) upon its sale, gift or transfer to a person who is not an affiliate of the initial holder thereof or (ii) if transferred to such an affiliate, upon its subsequent sale, gift or other transfer to a person who is not an affiliate of the initial holder.  Shares of Class B Common Stock that are converted into Class A Common Stock will be retired and cancelled and shall not be reissued.





All of the outstanding shares of Class B Common Stock are fully paid and nonassessable.





63





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE L – STOCK HOLDERS’ EQUITY AND STOCK PLANS (CONTINUED)





Stock Plans





The Company has three active stock plans: a stock option plan, an employee stock purchase plan and anon-employee directors’ stock option plan, and three expired plans, the 1993 Employee and Directors Stock Option plan, the 1995 Non-employee Directors’ stock option plan and the 1995 Employee Stock Purchase Plan.





The stock option plan, dated December 2003 and expiring in December 2013, as amended in October 2007, provides for the issuance of a maximum of 1,900,000 shares of Class A Common Stock of the Company pursuant to the grant of incentive stock options to employees or nonqualified stock options to employees, directors, consultants and others whose efforts are important to the success of the Company.  Subject to the provisions of this plan, the compensation committee of the Board of Directors has the authority to select the optionees and determine the terms of the options including: (i) the number of shares, (ii) option exercise terms, (iii) the exercise or purchase price (which in the case of an incentive stock option will not be lessthan the market price of the Class A Common Stock as of the date of grant), (iv) type and duration of transfer or other restrictions and (v) the time and form of payment for restricted stock upon exercise of options.  As of June 30, 2011, 1,714,500 options were granted under this plan, of which 754,563 expired leaving 940,063 options available for grant under this plan.





On October 18, 1995, the Board of Directors voted to provide employees who work in excess of 20 hours per week and more than five months per year rights to elect to participate in an Employee Stock Purchase Plan (the “Plan”), which became effective February 1, 1996.  The price per share shall be the lesser of 85% of the average of the bid and ask price on the first day of the plan period or the last day of the plan period to encourage stock ownership by all eligible employees.  The plan was amended on December 19, 2001 and December 19, 2002 to allow for a total of 500,000 shares of Class A Common Stock to be issued under the plan.  Before its expiration on October 18, 2005, 157,034 shares were issued under the plan.  On January 31, 2006 the stockholders approved a replacement Employee Stock Purchase Plan to replace the 1995 plan.  A maximum of 500,000 shares may be issued under the January 2006 plan (the “2006 Plan”).  The new plan is identical to the old plan and expires on January 31, 2016.  As of June 30, 2011, 71,936 shares have been issued under this plan.  During fiscal 2008, the Board of Directors authorized a new offering for a six month contribution term instead of the former one year term.  At June 30, 2011, there were 428,064 shares available for issue under the 2006 Plan.





The non-employee directors’ stock option plan provides for the grant of non-statutory stock options automatically at the time of each annual meeting of the Board.  Under this plan, a maximum of 950,000 shares may be issued.  Each outside director is granted an option to purchase 20,000 shares of Class A Common Stock annually at fair market value on the date of grant, vesting 25% immediately and 25% on each of the first three anniversaries of the grant and expiring ten years from the grant date.  As of June 30, 2011, a total of 420,000 options were issued under the plan and there were 530,000 options available for grant under this plan.





64





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE L – STOCK HOLDERS’ EQUITY AND STOCK PLANS (CONTINUED)





The Company had the following activity in its stock option plans for fiscal 2011 and 2010:


Number
Weighted-Averageof
Exercise
Remaining
AggregateShares
Price
Contractual Term
Intrinsic ValueOutstanding balance – June 30, 2009
1,544,250
$
1.98Granted
235,000

1.09Exercised
(2,000)

0.81

$
680Expired
(218,750)

1.70Outstanding balance – June 30, 2010
1,558,500

1.89Granted
112,000

1.65Exercised
(95,000)

1.09

$
98,560Expired
(288,250)

2.32Outstanding balance – June 30, 2011
1,287,250

1.83
3.83 years
$
1,887,125Exercisable at June 30, 2011
1,034,186

1.96
3.29 years
$
1,388,225Exercisable at June 30, 2010
1,189,372
$
2.01
3.02 years
$
58,773





In addition to the outstanding options under the Company’s stock plans, the Company has the following warrants outstanding at June 30, 2011:





Date of

Number of
Exercise Price
ExpirationIssuance
Description
Shares
Per Share
Date06/13/2007
Warrants issued in conjunction with long-term debttransaction, $456,880 recorded as deferred financing costs
250,000
$3.09
June 201709/01/2007
Warrants issued for consulting services $7,400 charged to professional fees
6,000
$3.50
Sept 201210/01/2007
Warrants issued for consulting services $6,268 charged to professional fees
6,000
$3.50
Oct 201211/01/2007
Warrants issued for consulting services $6,013 charged to professional fees
6,000
$3.50
Nov 201212/01/2007
Warrants issued for consulting services $6,216 charged to professional fees
6,000
$3.50
Dec 201201/01/2008
Warrants issued for consulting services $7,048 charged to professional fees
6,000
$3.50
Jan 201302/01/2008
Warrants issued for consulting services $5,222 charged to professional fees
6,000
$3.50
Feb 201303/01/2008
Warrants issued for consulting services $6,216 charged to professional fees
6,000
$3.50
Mar 201304/01/2008
Warrants issued for consulting services $5,931 charged to professional fees
6,000
$3.50
Apr 201305/01/2008
Warrants issued for consulting services $6,420 charged to professional fees
6,000
$3.50
May 201306/01/2008
Warrants issued for consulting services $6,215 charged to professional fees
6,000
$3.50
June 201307/01/2008
Warrants issued for consulting services $5,458 charged to professional fees
6,000
$3.50
Jul 201308/01/2008
Warrants issued for consulting services $4,914 charged to professional fees
6,000
$3.50
Aug 201309/01/2008
Warrants issued for consulting services $5,776 charged to professional fees
6,000
$3.50
Sep 201310/01/2008
Warrants issued for consulting services $2,603 charged to professional fees
3,000
$3.50
Oct 201311/01/2008
Warrants issued for consulting services $1,772 charged to professional fees
3,000
$3.50
Nov 201312/01/2008
Warrants issued for consulting services $780 charged to professional fees
3,000
$3.50
Dec 201301/01/2009
Warrants issued for consulting services $725 charged to professional fees
3,000
$3.50
Jan 201402/01/2009
Warrants issued for consulting services $639 charged to professional fees
3,000
$3.50
Feb 201408/16/2010
Warrants issued for consulting services $11,626 charged to professional fees
20,000
$1.24
Aug 2013








65




PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE L – STOCK HOLDERS’ EQUITY AND STOCK PLANS (CONTINUED)




The Company had the following warrant activity during fiscal 2011 and 2010:





Outstanding balance – June 30, 2009
343,000Warrants issued
--Exercised
--Expired
--Outstanding balance – June 30, 2010
343,000Warrants issued
20,000Exercised
--Expired
--Outstanding balance – June 30, 2011
363,000





During fiscal 2011, the Company issued warrants to purchase 20,000 shares of Class A common stock as part of a consulting agreement for marketing services.  The fair value of these warrants of $11,626 was recorded as professional fees when each warrant was issued as reflected in the table above.  No warrants were issued in fiscal 2010.





During the fiscal year ended June 30, 2011, the Company acquired 173,495 shares of Class A common stock for $215,327 under Board approved plans.





NOTE M - BUSINESS SEGMENT INFORMATION





BehavioralHealthTreatment
Contract
AdministrativeServices
Services
Services
Eliminations
TotalFor the year endedJune 30, 2011Revenues - externalcustomers
$
57,495,735
$
4,512,144
$
--
$
--
$
62,007,879Revenues–intersegment

4,175,005

--

5,193,356

(9,368,361)

--Segment net income(loss)

7,392,658

915,754

(7,728,407)

--

580,005Total assets

19,523,739

1,250,903

7,507,348

--

28,281,990Capital expenditures

852,359

215,089

14,362

--

1,081,810Depreciation &amortization

856,220

92,615

156,413

--

1,105,248Goodwill

969,098

--

--

--

969,098Interest expense

155,926

--

154,747

--

310,673Net income (loss) fromequity methodinvestments

7,340

--

18,524

--

25,864Equity from equitymethod investments

72,980

--

--

--

72,980Income tax expense

--

--

1,407,936

--

1,407,936








66





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE M - BUSINESS SEGMENT INFORMATION (CONTINUED)


BehavioralHealthTreatment
Contract
AdministrativeServices
Services
Services
Eliminations
TotalFor the year endedJune 30, 2010Revenues-externalcustomers
$
49,647,395
$
3,429,831
$
--
$
--
$
53,077,226Revenues–intersegment

4,002,558

--

4,999,992

(9,002,550)

--Segment net income(loss)

6,607,215

465,297

(5,652,850)

--

1,419,662Total assets

16,214,982

630,558

8,804,430

--

25,649,970Capital expenditures

630,867

19,128

101,848

--

751,843Depreciation &amortization

827,811

79,835

248,923

--

1,156,569Goodwill

969,098

--

--

--

969,098Interest expense

161,065

--

165,517

--

326,582Net income (loss) fromequity methodinvestments

4,484

--

13,078

--

17,562Equity from equitymethod investments

33,528

--

--

--

33,528Income tax expense

--

--

1,106,100

--

1,106,100





All revenues from contract services provided for the treatment services segment and treatment services provided to other facilities included in the treatment services segment are eliminated in the consolidation and shown on the table above under the heading “Revenues intersegment”.





NOTE N – QUARTERLY INFORMATION (Unaudited)





The following presents selected quarterly financial data for each of the quarters in the years ended June 30, 2011 and 2010.


2011
1stQuarter
2ndQuarter
3rdQuarter
4thQuarterRevenue
$
15,071,420
$
14,631,938
$
15,455,635
$
16,848,886Income (loss) from operations

1,236,392

728,522

529,882

(398,473)Provision for income taxes

557,027

251,270

299,266

300,373Net income (loss) available to commonshareholders

678,615

502,986

64,525

(666,121)*Basic net income per common share

$0.03

$0.03

--

($0.03)Basic weighted average number ofshares outstanding

19,532,095

19,462,818

19,500,873

19,524,104Fully diluted net income per commonshare

$0.03

$0.03

--

($0.03)Fully diluted weighted average numberof shares outstanding

19,603,138

19,593,689

19,872,067

19,524,104


104 During the quarter ended June 30, 2011, the Company incurred approximately $1,607,700 of transaction costs associated with the MeadowWood acquisition and Acadia merger (See Note P).





67





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE N – QUARTERLY INFORMATION (Unaudited)





2010
1stQuarter
2ndQuarter
3rdQuarter
4thQuarterRevenue
$
12,647,428
$
12,864,563
$
13,532,174
$
14,033,061Income from operations

355,898

513,705

781,440

921,704Provision for income taxes

133,431

248,619

289,031

435,019Net income available to commonshareholders

223,604

288,239

469,172

438,647Basic net income per common share

$0.01

$0.01

$0.02

$0.02Basic weighted average number ofshares outstanding

19,997,549

19,800,509

19,762,241

19,692,391Fully diluted net income per commonshare

$0.01

$0.01

$0.02

$0.02Fully diluted weighted average number ofshares outstanding

20,141,989

19,855,419

19,861,449

19,766,855





NOTE O – EMPLOYEE RETIREMENT PLAN





The PHC 401 (k) RETIREMENT SAVINGS PLAN   (the “401(k) Plan”) is a qualified defined contribution plan in accordance with Section 401(k) of the Internal Revenue Code (the “code”).  All eligible employees over the age of 21 may begin contributing on the first day of the month following their completion of two full months of employment or any time thereafter.  Eligible employees can make pretax contributions up to the maximum allowable by Code Section 401(k).  The Company may make matching contributions equal to a discretionary percentage of the employee’s salary reductions, to be determined by the Company.  During the years ended June 30, 2011 and 2010 the Company made no matching contributions.





NOTE P – SUBSEQUENT EVENTS





MeadowWood Acquisition





On July 1, 2011, the Company completed the acquisition of MeadowWood Behavioral Health, a behavioral health facility located in New Castle, Delaware (“MeadowWood”) from Universal Health Services, Inc. (the “Seller”) pursuant to the terms of an Asset Purchase Agreement, dated as of March 15, 2011, between the Company and the Seller (the “Purchase Agreement”).  In accordance with the Purchase Agreement, PHC MeadowWood, Inc., a Delaware corporation and subsidiary of the Company (“PHC MeadowWood”) acquired substantially all of the operating assets (other than cash) and assumed certain liabilities associated with MeadowWood.  The purchase price was $21,500,000, and is subject to a working capital adjustment.  At closing, PHC MeadowWood hired Seller’s employees currently employed at MeadowWood and assumed certain obligations with respect to those transferred employees.  Also at closing, PHC MeadowWood and the Seller entered into a transition services agreement to facilitate the transition of the business.








68





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE P – SUBSEQUENT EVENTS (continued)





The consideration will be allocated to assets and liabilities based on their relative fair values as of the closing date of the MeadowWood acquisition.  The purchase price consideration and allocation of purchase price was as follows:





Calculation of allocable purchase price:





Cash purchase price (subject to adjustment)
$
21,500,000Accounts Receivables (net)
$
1,796,781Prepaid expenses and other current assets

97,134Land

1,420,000Building and Improvements

7,700,300Furniture and Equipment

553,763Licenses

700,000Goodwill

9,541,046Accounts Payable

(157,484)Accrued expenses and other current liabilities

(151,540)$
21,500,000


The allocation of consideration paid for the acquired assets and liabilities of MeadowWood is based on management’s best preliminary estimates.  The actual allocation of the amount of the consideration may differ from that reflected after a third party valuation and these procedures have been finalized.





The following presents the pro forma net income and net income per common share for the years ended June 30, 2011 and 2010 of the Company’s acquisition of MeadowWood assuming the acquisition occurred as of July 1, 2009.





Year Ended June 30,(unaudited)2011

2010Revenues
$
76,621,243
$
66,820,062Net income
$
1,019,112
$
2,104,228Net income per common share
$
0.05
$
0.11Fully diluted weighted average shares outstanding

19,787,461

19,914,954





This unaudited pro forma condensed combined financial information is not necessarily indicative of the results of operations that would have been achieved had the acquisition actually taken place at the dates indicated and do not purport to be indicative of future position or operating results.





Also on July 1, 2011 (the “Closing Date”), and concurrently with the closing under the Purchase Agreement, the Company and its subsidiaries entered into a Credit Agreement with the lenders party thereto (the “Lenders”), Jefferies Finance LLC, as administrative agent, arranger, book manager, collateral agent, and documentation agent for the Lenders, and as syndication agent and swingline lender, and Jefferies Group, Inc., as issuing bank (the “Credit Agreement”).  The terms of the Credit Agreement provide for (i) a $23,500,000 senior secured term loan facility (the “Term Loan Facility”) and (ii) up to $3,000,000 senior secured revolving credit facility (the “Revolving Credit Facility”), both of which were fully borrowed on the Closing Date in order to finance the MeadowWood purchase, to pay off the Company’s existing loan facility with CapitalSource Finance LLC, for miscellaneous costs, fees and expenses related to the Credit Agreement and the MeadowWood purchase, and for general working capital purposes.





69





PHC, INC.  AND SUBSIDIARIES





Notes to Consolidated Financial Statements


June 30, 2011





NOTE P – SUBSEQUENT EVENTS (continued)





The Term Loan Facility and Revolving Credit Facility mature on July 1, 2014, and 0.25% of the principal amount of the Term Loan Facility will be required to be repaid each quarter during the term.  The Company’s current and future subsidiaries are required to jointly and severally guarantee the Company’s obligations under the Credit Agreement, and the Company and its subsidiaries’ obligations under the Credit Agreement are secured by substantially all of their assets.





Acadia Merger





In addition, on May 23, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Acadia Healthcare Company, Inc., a Delaware corporation (“Acadia”), and Acadia Merger Sub, LLC, a Delaware limited liability company and wholly-owned subsidiary of Acadia (“Merger Sub”), pursuant to which, subject to the satisfaction or waiver of the conditions therein, the Company will merge with and into Merger Sub, with Merger Sub continuing as the surviving company (the “Merger”).  Upon the completion of the Merger, Acadia stockholders will own approximately 77.5% of the combined company and PHC’s stockholders will own approximately 22.5% of the combined company. The Merger is intended to qualify for federal income tax purposes as a reorganization under the provisions of Section 368 of the Internal Revenue Code of 1986, as amended. Acadia operates a network of 19 behavioral health facilities with more than 1,700 beds in 13 states. (For additional information regarding this transaction, please see our report on Form 8-K, filed with the Securities and Exchange Commission on May 25, 2011 and our preliminary proxy statement filed with the Securities and Exchange Commission on July 13, 2011).




Subsequent to year end, in connection with the proposed transaction, Acadia filed with the SEC a registration statement that containing the proxy statement concurrently filed by PHC which will constitute an Acadia prospectus.








70





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





We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified within the SEC’s Rules and Forms, and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was necessarily required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.





Our management does not expect that our disclosure controls or our internal controls over financial reporting will prevent all error and fraud.  A control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of a control system are met.  Further, any control system reflects limitations on resources and the benefits of a control system must be considered relative to its costs.  These limitations also include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of a simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of a control.  A design of a control system is also based upon certain assumptions about potential future conditions and over time controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.





At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures to meet the criteria referred to above.  Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective.





Change in Internal Controls





There were no changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluations.





Management’s Report on Internal Control over Financial Reporting





Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.  Management has employed a framework consistent with Exchange Act Rule 13a-15(c) to evaluate our internal control over financial reporting described below.  Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States.





Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Projections of an evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





71





Management conducted an evaluation of the design and operations of our internal control over financial reporting as of June 30, 2011 based on the criteria set forth in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  As a result of this assessment, management concluded that, as of June 30, 2011, our internal control over financial reporting was effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.





This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s independent registered public accounting firm in accordance with recent amendments to Section 404 of the Sarbanes-Oxley Act of 2002 pursuant to Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act that permits a smaller reporting company to provide only management’s report in their annual report.





72





PART III





Item 10.     Directors, Executive Officers, Promoters and Control Persons





DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT





The directors and officers of the Company as of the date of the Company’s Annual Report on Form 10-K are as follows:





Name
Age
PositionBruce A. Shear
56
Director, President and Chief Executive OfficerRobert H. Boswell
63
Senior Vice PresidentPaula C. Wurts
62
Treasurer, Chief Financial Officer and ClerkDonald E. Robar (1)(2)(3)
74
DirectorHoward W. Phillips
81
DirectorWilliam F. Grieco (1)(2)(3)
57
DirectorDavid E. Dangerfield (1)(3)
70
DirectorDouglas J. Smith
63
Director





(1)   Member of Audit Committee.


(2)   Member of Compensation Committee.


(3)   Member of the Nominating/Corporate Governance Committee.





Directors may be nominated by the Board of Directors or by stockholders in accordance with the Company’s Amended and Restated Articles of Incorporation and Bylaws.  All of the directors hold office until the next annual meeting of stockholders following their election, or until their successors are elected and qualified.  The primary duties of the various committees of the Board are shown below.  The Board appoints officers of the Company for undefined terms.  There are no family relationships among any of the directors or officers of the Company.





Information with respect to the business experience and affiliations of the directors and officers of the Company is set forth below.





BRUCE A. SHEAR has been President, Chief Executive Officer and a Director of the Company since 1980 and Treasurer of the Company from September 1993 until February 1996. From 1976 to 1980, he served as Vice President, Financial Affairs, of the Company. Mr. Shear has served on the Board of Governors of the Federation of American Health Systems for over fifteen years and is currently a member of the Board of Directors of the National Association of Psychiatric Health Systems. Mr. Shear received an M.B.A. from Suffolk University in 1980 and a B.S. in Accounting and Finance from Marquette University in 1976.  Since November 2003, Mr. Shear has been a member of the Board of Directors of Vaso Active Pharmaceuticals, Inc., a company marketing and selling over-the-counter pharmaceutical products that incorporate Vaso’s transdermal drug delivery technology.





The Board of Directors has concluded, based on Mr. Shear’s business and financial expertise, senior management experience and education that he should serve as the CEO and Chairman of the Board of Directors of the Company.





ROBERT H. BOSWELL has served as the Senior Vice President of the Company since February 1999 and as Executive Vice President of the Company from 1992 to 1999.  From 1989 until the spring of 1994, Mr. Boswell served as the Administrator of the Company’s Highland Ridge Hospital facility where he is based. Mr. Boswell is principally involved with the Company’s substance abuse facilities. From 1981 until 1989, he served as the Associate Administrator at the Prevention Education Outpatient Treatment Program--the Cottage Program, International. Mr. Boswell graduated from Fresno State University in 1975 and from 1976 until 1978 attended Rice University’s doctoral program in philosophy.  Mr. Boswell is a Board Member of the National Foundation for Responsible Gaming and the Chair for the National Center for Responsible Gaming.





73








PAULA C. WURTS has served as the Chief Financial Officer and Controller of the Company since 1989, as Assistant Clerk from January 1996 until February 2006, when she became Clerk, as Assistant Treasurer from 1993 until April 2000 when she became Treasurer.  Ms. Wurts served as the Company’s Accounting Manager from 1985 until 1989.  Ms. Wurts received an Associate’s degree in Accounting from the University of South Carolina in 1980, a B.S. in Accounting from Northeastern University in 1989 and passed the examination for Certified Public Accountants.  She received a Master’s Degree in Accounting from Western New England College in 1996.





DONALD E. ROBAR has served as a Director of the Company since 1985 and as the Treasurer from February 1996 until April 2000.  He served as the Clerk of the Company from 1992 to 1996. Dr. Robar has been a professor of Psychology at Colby-Sawyer College in New London, New Hampshire from 1967 to 1997 and is now Professor Emeritus.  Dr. Robar received an Ed.D. (Counseling) from the University of Massachusetts in 1978, an M.A. in Clinical Psychology from Boston College in 1968 and a B.A. from the University of Massachusetts in 1960.





The Board of Directors has concluded that based on Mr. Robar’s experience and education in the Behavioral Health field that he should serve as a Director of the Company.





HOWARD W. PHILLIPS has served as a Director of the Company since August 1996 and has been employed by the Company as a public relations specialist since August 1995.  From 1982 until 1995, Mr. Phillips was the Director of Corporate Finance for D.H. Blair Investment Corp.  From 1969 until 1981, Mr. Phillips was associated with Oppenheimer & Co. where he was a partner and Director of Corporate Finance.





The Board of Directors has concluded that based on Mr. Phillips business and finance expertise that he should serve as a Director of the Company.





WILLIAM F. GRIECO has served as a Director of the Company since February 1997.  Since 2008, Mr. Grieco has served as the Managing Director of Arcadia Strategies, LLC, a legal and business consulting organization servicing healthcare, science and technology companies.  From 2003 to 2008 he served as Senior Vice President and General Counsel of American Science and Engineering, Inc., an x-ray inspection technology company.  From 2001 to 2002, he served as Senior Vice President and General Counsel of IDX Systems Corporation, a healthcare information technology company.  Previously, from 1995 to 1999, he was Senior Vice President and General Counsel for Fresenius Medical Care North America.  Prior to that, Mr. Grieco was a partner at Choate, Hall & Stewart, a general service law firm.  Mr. Grieco received a B.S. from Boston College in 1975, an M.S. in Health Policy and Management from Harvard University in 1978 and a J.D. from Boston College Law School in 1981.  Since May 2011, Mr. Grieco has served as the Lead Independent Director of the Board.  Since February 2011, Mr. Grieco has been a member of the Board of Directors of Echo Therapeutics, Inc., a medical device and specialty pharmaceutical company.





The Board of Directors concluded that based on Mr. Grieco’s legal and healthcare expertise, senior management, business experience and education that he should serve as a Director of the Company.





DAVID E. DANGERFIELD has served as a Director of the Company since December 2001.  He formerly served as the Chief Executive Officer for Valley Mental Health in Salt Lake City, Utah from 1977-2007.  Since 1974, he has been a partner for Professional Training Associates (PTA).  In 1989, he became a consultant across the nation for managed mental health care and the enhancement of mental health delivery services.  David Dangerfield served for a number of years as a Board member of the Mental Health Risk Retention Group and Utah Alliance for the Mentally Ill, an advocacy organization of family and friends of the mentally ill, which are privately held corporations, and the Utah Hospital Association, which is a trade organization in Utah.  Dr. Dangerfield graduated from the University of Utah in 1972 with a Doctorate of Social Work after receiving his Masters of Social Work from the University in 1967.  He currently serves as CEO, President and Chairman of the Board  of Avalon Health Care, Inc. (AHC).  AHC is a multi-state, post-acute health care provider in senior care operating nursing homes, assisted living, rehabilitation and hospice services.





The Board of Directors concluded that based on Dr. Dangerfield’s business and finance expertise, senior management experience, service as a director for other healthcare organizations and education that he should serve as a Director of the Company.





74








DOUGLAS J. SMITH has served as a Director of the Company since March 2010.  Currently retired, he was employed for 41 years with Union Pacific Railroad Company.  He held numerous positions with the Company, the last position being the Assistant Vice President of Labor Relations.  For nine years he was responsible for Employee Assistance and Peer Support Programs.  In addition, Mr. Smith served as a member of the Board of Directors of Union Pacific Railroad Employees Health Systems.  Mr. Smith has a Bachelor of Arts from the University of Wyoming and a Masters of Business Administration from the University of Nebraska at Omaha.





The Board of Directors concluded that based on Mr. Smith’s business expertise and senior management experience that he should serve as a Director of the Company.





None of the Company’s Directors have been involved in any litigation within the last ten years that was or could be considered material to an evaluation of the ability or integrity of the director or director nominee.





Board Leadership Structure





The Board includes a combined role of Chief Executive officer and Chairman of the Board.  This dual role serves to maintain continuity in our strategic direction day-to-day leadership and the performance of the company as the Chief Executive Officer and provides a constant information flow to the Board regarding day-to-day operations and overall performance of the Company.  William Greico serves as the Lead Independent Director.





Our Board of Directors is composed of four (4) independent directors and two (2) directors who are employees of the Company.  All of our directors are highly accomplished and experienced business people in their respective fields, who have demonstrated leadership in significant enterprise and are familiar with board processes.  For additional information about the backgrounds and qualifications of our directors, see the Biographies of Directors in this annual report.





BOARD'S ROLE IN RISK OVERSIGHT





The Company has a risk management program that engages the Company’s management/leadership and Board.  The Board regularly reviews information and reports from members of senior management on areas of material risk, including operational, financial, legal and regulatory, and strategic and reputational risks.  The Compensation Committee is responsible for overseeing the management of risks relating to our executive compensation plans and arrangements.  The Audit Committee oversees management of operational, financial, legal, and regulatory risks.  The Governance Committee manages risks associated with the independence of the Board of Directors and potential conflicts of interest.  While each committee is responsible for evaluating certain risks and overseeing the management of such risks, the entire Board of Directors is regularly informed through committee reports about such risks.





The full Board provides additional risk oversight in numerous ways, including but not limited to the following:





■
Annually, prior to its approval of the annual budget and long-term plan, the Board reviews the potential risks which could negatively impact the proposed budget and plan.  This review includes the types of risks, as well as pessimistic and worst case scenarios should the identified risks be realized.■
Prior to approving any significant investment or divestiture actions by the Company, the Board reviews a proposal identifying the rationale and risks involved in such action.■
The Board regularly receives written reports covering environmental, legal, and human resources matters from key management personnel directly and through the CEO.■
The full Board also engages in periodic discussions regarding risks with our Chief Executive Officer, Chief Financial Officer, General Counsel and other company officers as well as outside experts, as it deems appropriate.





Management endeavors to keep the Board fully apprised of risks facing the Company and believe that our directors provide effective oversight of the risk management function.  We believe the Board’s risk oversight function allows our directors to make well-informed decisions and increases the effectiveness of the Company’s leadership structure.





75





Meetings of the Board of Directors





During fiscal 2011, the Board of Directors held a total of eight meetings, four in person and four telephonically,  and took action by written consent two times.  Each director attended all of the meetings of the Board and committees of the Board on which such director served.





Audit Committee





The Board of Directors has appointed an audit committee to assist the Board in the oversight of the financial reports, internal controls, accounting policies and procedures.  The primary responsibilities of the Audit Committee are as follows:






Hire, evaluate and, when appropriate, replace the Company’s independent registered public accounting firm, whose duty it is to audit the books and accounts of the Company and its subsidiaries for the fiscal year in which it is appointed.



Approve all audit fees in advance of work performed.



Approve any accounting firm and fees to be charged for taxes or any other non-audit accounting fees.



Review internal controls over financial reporting with the independent accountant and a designated accounting staff member.



Review with management and the registered public accounting firm:


o
The independent accountant's audit of and report on the financial statements.


o
The accountant’s qualitative judgments about the appropriateness, not just the acceptability, of accounting principles and financial disclosures and how aggressive (or conservative) the accounting principles and underlying estimates are.


o
Any serious difficulties or disputes with management encountered during the course of the audit.


o
Anything else about the audit procedures or findings that PCAOB requires the accountants to discuss with the committee.



Consider and review with management and a designated accounting staff member:


o
Any significant findings during the year and management's responses to them.


o
Any difficulties an accounting staff member encountered while conducting audits, including any restrictions on the scope of their work or access to required information.


o
Any changes to the planned scope of management's internal audit plan that the committee thinks advisable.



Review the annual filings with the SEC and other published documents containing the Company's financial statements and consider whether the information in the filings is consistent with the information in the financial statements.



Review the interim financial reports with management, the independent registered public accounting firm and an accounting staff member.



Prepare a letter for inclusion in the annual report that describes the committee's composition and responsibilities and how the responsibilities were fulfilled.



Review the audit committee charter at least annually and modify as needed.





During fiscal 2011, the Audit Committee consisted of Dr. David Dangerfield, Dr. Donald Robar and Mr. William Grieco.  As required by the SEC, all members of the audit committee are “independent” as such term is defined pursuant to applicable SEC rules and regulations and as required under NYSE Amex listing standard Section 121.  Dr. Dangerfield serves as the chairman and is the audit committee financial expert.  The Company reviewed Dr. Dangerfield’s extensive experience managing the budget and operations for large Behavioral Healthcare organizations and determined that this industry experience qualifies him to act as the financial expert in accordance with SEC requirements.  During fiscal 2011, the Audit Committee met five times, one time in person and four times telephonically.  All of the committee members attended the meetings.





76





Nominating and Corporate Governance Committee





The Nominating and Corporate Governance Committee was established in October 2005.  This committee is appointed by the Board of Directors for the purpose of (i) identifying individuals            qualified to become Board members and to recommend that the Board select these individuals as nominees for election to the Board at the next annual meeting of the Company’s stockholders, and (ii) developing and recommending to the Board a set of effective corporate governance policies and procedures applicable to the Company.  The Nominating and Corporate Governance Committee consists of Dr. David Dangerfield, Dr. Donald Robar and Mr. William Grieco.  All members of the Nominating and Corporate Governance Committee are independent as required under NYSE Amex listing standards.





The Nominating and Corporate Governance Committee periodically reviews director independence under the standards set forth in its Charter.  During this review, the Nominating and Corporate Governance Committee considers existing and then-proposed transactions and relationships between each director or member of that director's immediate family and the Company and its subsidiaries and affiliates. The Board also examines existing and proposed transactions and relationships between directors or their affiliates and members of the Company's senior management or their affiliates. The purpose of this review is to determine whether any such relationships or transactions are inconsistent with a determination that the director is independent.





As a result of their review, the Nominating and Corporate Governance Committee affirmatively determined that as of June 30, 2011 the following Directors have no material relationship with the Company, other than as directors of the Company, and are independent:





Donald E. RobarWilliam F. GriecoDavid E. DangerfieldDouglas J. Smith





Compensation Committee





The Board of Directors has appointed the members of the Compensation Committee to review and approve officer’s compensation, formulate bonuses for management and administer the Company’s equity compensation plans.  The Compensation Committee is a chartered committee made up of independent members of the Board of Directors.  During fiscal 2011 the Compensation Committee consisted of Dr. Donald Robar and Mr. William Grieco.  Both members of the Compensation Committee are independent as required under NYSE Amex listing standards.  The Compensation Committee met three times during fiscal 2011, twice telephonically and once in person.  Mr. Shear does not participate in discussions concerning, or vote to approve, his salary.





Code of Ethics





The Company maintains a Corporate Compliance Plan, which incorporates our code of ethics that is applicable to all employees, including all officers.  The Corporate Compliance Plan incorporates our guidelines designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations.  It also incorporates our expectations of our employees that enable us to provide accurate and timely disclosure in our filings with the Securities and Exchange Commission and other public communications.  In addition, it incorporates our guidelines pertaining to topics such as health and safety compliance, diversity and non-discrimination, patient care and privacy.





The full text of our Corporate Compliance Plan is published on our website at www.phc-inc.com.  We will post any amendments to the Corporate Compliance Plan, as well as any waivers that are required to be disclosed by the rules of the SEC, on our website.





77





Compliance with Section 16(a) of the Exchange Act





Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s directors and executive officers, and persons who own more than 10% of the Company’s Common Stock, to file with the SEC reports of ownership and reports of changes in ownership of Common Stock.  SEC rules also require the reporting persons and entities to furnish the Company with a copy of the reports they file.  The Company is required to report any failure to file these reports.




Based on the review of the filings and written representations from the Company’s directors and executive officers, the Company believes that all reports required to be filed with the SEC by Section 16(a) during the most recent fiscal year were filed, however, each of the officers and directors below did not timely file a Form 4 relating to the expiration of stock options on February 16, 2011:





Robert H. Boswell
Howard Phillips





The expiration of the stock options was reported on the Form 4’s filed on April 5, 2011.





78





Item 11.    Executive Compensation





Compensation Discussion and Analysis





The Board of Directors, the Compensation Committee and senior management share responsibility for establishing, implementing and continually monitoring our executive compensation program, with the Board making the final determination with respect to executive compensation.  The goal of our executive compensation program is to provide a competitive total compensation package to our executive management team through a combination of base salary, quarterly cash incentive bonuses, long-term equity incentive compensation in the form of stock options and benefits programs.  This Compensation Discussion and Analysis explains our compensation objectives, policies and practices with respect to our Chief Executive Officer, Chief Financial Officer and one of our other most highly-compensated executive officers as determined in accordance with applicable SEC rules, who are collectively referred to in this report as the Named Executive Officers.





Objectives of our Executive Compensation Program





Our executive compensation program is designed to achieve the following objectives:



to attract and retain talented and experienced executives necessary to achieve our strategic objectives in the highly competitive industry in which we compete;



to motivate and reward executives whose knowledge, skills and performance are critical to our success;



to align the interest of our executives and stockholders by motivating executives to increase stockholder value by increasing our Company’s long-term profitability;



to provide a competitive compensation package in which a significant portion of total compensation is determined by Company and individual results and the creation of stockholder value; and,



to foster a shared commitment among executives by coordinating their Company and individual goals.





Role of the Compensation Committee





Our Compensation Committee oversees all aspects of executive compensation.  The committee plays a critical role in establishing our compensation philosophy and in setting and amending elements of the compensation package offered to our Named Executive Officers.





The members of our Compensation Committee during fiscal 2010 were Donald Robar and William Grieco.  Each current member of our Compensation Committee is an independent, non-employee director.  During fiscal 2010, the Compensation Committee met three times, twice telephonically and once in person.





On an annual basis, or in the case of promotion or hiring of an executive officer, the Compensation Committee reviews and makes recommendations to the Board of Directors regarding the compensation package to be provided to our Named Executive Officers.  On an annual basis, the Compensation Committee undertakes a review of the base salary and bonus targets of each of our named executive officers and evaluates their respective compensation based on the committee’s overall evaluation of their performance toward the achievement of our financial, strategic and other goals, with consideration given to each executive officer’s length of service and to comparative executive compensation data.  Based on its review, from time to time the Compensation Committee has increased the salary and/or potential bonus amounts for our executive officers.





COMPENSATION COMMITTEE REPORT





The compensation committee report below is not “soliciting material,” is not deemed “filed” with the Securities and Exchange Commission and is not incorporated by reference in any of our filings under the Securities Act of 1933 as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after this filing and irrespective of any general language to the contrary.





79





The Compensation Committee, comprised solely of independent directors, reviewed and discussed the above Compensation Discussion and Analysis with management.  Based on this review and discussions, the committee recommended to the Board of Directors, and the Board has approved, the inclusion of the Compensation Discussion and Analysis in the Company’s annual report on Form 10-K.





Compensation Committee





Donald E. Robar


William F. Grieco





Elements of Executive Compensation





Compensation for our Named Executive Officers generally consists of the following elements:


(1)
base salary;


(2)
cash bonuses;


(3)
stock-based awards;


(4)
health, dental and life insurance and disability and retirement plans; and


(5)
severance and change-in-control arrangements.





The Company does not have a policy or target for allocating compensation between long-term and short-term compensation.  Instead the Compensation Committee determines subjectively what it believes to be the appropriate level and mix of various compensation components.  The Compensation Committee’s objective in allocating between annual and long-term compensation is to ensure adequate base compensation to attract and retain personnel, while providing incentives to maximize long-term value for our Company and its stockholders.





Base Salary





Salary for our executives is generally set by reviewing compensation levels for comparable positions in the market and the historical compensation levels of our executives.  Salaries may then be adjusted from time to time, based upon market changes, actual corporate and individual performance and changes in responsibilities.





Bonuses





Bonuses are based on actual corporate and individual performances compared to targeted performance criteria and various subjective performance criteria.  Targeted financial performance for the Company is set annually by the compensation committee for each fiscal quarter.  In considering bonuses, the Compensation Committee does not rely on a formula that assigns a pre-determined value to each of the criteria, but instead evaluates each executive officer’s contribution in light of all relevant criteria.  Individual performance targets are used less frequently but may include completion of specific projects.  Individual performance targets were set for the fiscal year ended June 30 2011 and were met by one of the named executive officers.





Stock Based Awards





Compensation for executive officers also includes the long-term incentives afforded by stock options and other equity-based awards.  Our stock option program is designed to align the long-term interests of our employees and our stockholders and assist in the retention of executives.  The size of stock-based awards is generally intended to reflect the executive’s position and the executive’s expected contributions.  Although some awards may be provided as part of the hiring agreement of new executives, in general these stock-based awards follow the same benchmarks as the executive bonus element of the Named Executive Officer’s compensation.  Options are generally granted with installment-vesting over a period of three years.





Because of the direct relationship between the value of an option and the market price of our common stock, the compensation committee believes that stock options are an effective method of motivating the Named Executive Officers to manage our Company in a manner that is consistent with the interests of our Company and our stockholders.





80





In addition, the Named Executive Officers are also eligible to participate in the Company’s Employee Stock purchase plan as long as all other criteria of the plan are met.





Insurance and Other Employee Benefits





We maintain insurance benefits for all employees that include health, dental and life insurance.  The Company bears one hundred percent of the cost of these benefits for the Named Executive Officers.  In addition, the Company provides a company vehicle or an auto allowance, additional supplemental life insurance and other supplemental taxable fringe benefits for the Named Executive Officers.  In addition, the Company provides a disability pool for the Named Executive Officers based on the number of years of service.  The number of days of pay under the disability plan increases incrementally until it reaches a maximum accrual of 730 days.  This disability pool has no cash value and is not payable upon termination of employment.  The Company also provides an Executive Retirement plan, which allows for the use of the accrued disability plan bank to be distributed as an annuity over a four year period at the Named Executive Officer’s retirement providing the minimum term of employment of twenty years of service has been met.  Through the fiscal year ended June 30, 2011, no accrual has been made for this retirement plan as each of the Named Executive Officers have waived their right to the retirement plan based on the Company’s financial position at the time that the plan was approved.





Severance and Change-in-Control Arrangement





The Company has not entered into any severance agreements with any of the Named Executive Officers; however, compensation for the Named Executive Officers does include change-in-control arrangements.  These arrangements, like other elements of executive compensation, are structured with regard to practices at comparable companies for similarly situated officers and in a manner we believe is likely to attract and retain high quality executive talent.  The arrangement calls for the Named Executive Officers, in the event of a change in control, to receive payment of their average annual salary for the past five years times a multiplier based on their number of years of service in the position at the effective date as shown below.





Amount atName and position

Multiplier

June  30, 2011Bruce A. Shear, Chief Executive Officer
2.99
$
1,529,951Robert H. Boswell, Senior Vice President
2.00

461,574Paula C. Wurts, Chief Financial Officer
2.00

404,127





Changes in Executive Compensation for Fiscal 2011





In July 2010, the Compensation Committee met to discuss the compensation of the Named Executive Officers.  The meeting resulted in a proposal to the Board of Directors to increase the base salary of the Named Executive Officers and change the net earnings targets for the Named Executive officers to earn cash compensation for each quarter of fiscal 2011 and an stock option based compensation plan based on an annual earnings target.  The Board of Directors accepted the proposals of the Committee and salary increases were affected and bonus and compensation targets were set.  One of the Named Executive Officers met the bonus target for the fourth quarter of fiscal 2011.  No other targets were met.





Accounting for Executive Compensation





We account for equity based compensation paid to our employees under the rules of FASB ASC 718, which requires us to measure and record an expense over the service period of the award.  Accounting rules also require us to record cash compensation as an expense at the time the obligation is incurred.





81





Employment Agreements





The Company has not entered into any employment agreements with its executive officers.  The Company owns and is the beneficiary on a $1,000,000 key-man life insurance policy on the life of Bruce A. Shear.





Three executive officers of the Company received compensation in the 2011 fiscal year, which exceeded $100,000.  The following table sets forth the compensation paid or accrued by the Company for services rendered to these Named Executive Officers in fiscal year 2011, 2010 and 2009:





Summary Compensation TableName and



Options
All OthersPrincipal Position
Year
Salary
Bonus
Awards (10)
Compensation
Total($)
($)
($)
($)
($)(a)
(b)
(c)
(d)
(f)
(i)
(j)Bruce A. Shear
2011
$
516,650
$
49,000
$
10,760
$
40,656 (1)
$
617,066President and Chief
2010
$
468,369
$
49,000
$
17,199
$
22,719 (2)
$
557,287Executive Officer
2009
$
453,846
$
--
$
42,648
$
13,685 (3)
$
510,179Robert H. Boswell
2011
$
225,200
$
27,847
$
6,812
$
21,713 (4)
$
281,572Senior Vice President
2010
$
208,385
$
17,000
$
14,332
$
14,466 (5)
$
254,1832009
$
201,923
$
--
$
15,284
$
14,001 (6)
$
231,208Paula C. Wurts
2011
$
194,300
$
17,000
$
6,812
$
16,883(7)
$
234,995Chief Financial Officer,
2010
$
179,608
$
17,000
$
14,332
$
13,662 (8)
$
224,602Treasurer and Clerk
2009
$
174,039
$
--
$
15,284
$
13,268 (9)
$
202,591





*  The Named Executive Officers forfeited 131,250 stock options during the fiscal year ended June 30, 2011 as the current stock price was less than the option exercise price.  For information regarding the assumptions used to value these stock options, see “Note A THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Stock-based compensation” in the financial statements included in this report.




(1)
This amount represents $11,497 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Mr. Shear, $13,154 in premiums paid by the Company with respect to life and disability insurance for the benefit of Mr. Shear, $2,955 in personal use of a Company car held by Mr. Shear and $13,050 intrinsic value of stock options exercised by Mr. Shear.





(2)
This amount represents $9,837 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Mr. Shear, $3,520 in premiums paid by the Company with respect to life and disability insurance for the benefit of Mr. Shear and $9,362 in personal use of a Company car held by Mr. Shear.





(3)
This amount represents $8,894 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Mr. Shear, $3,706 in premiums paid by the Company with respect to life and disability insurance for the benefit of Mr. Shear and $1,085 in personal use of a Company car held by Mr. Shear.





(4)
This amount represents a $6,000 automobile allowance, $9,188 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Mr. Boswell and $6,525 intrinsic value of stock options exercised by Mr. Boswell.





(5)
This amount represents a $6,000 automobile allowance and $8,001 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Mr. Boswell.





82





(6)
This amount represents a $6,000 automobile allowance and $8,466 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Mr. Boswell.





(7)
This amount represents a $4,800 automobile allowance, $8,957 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Ms. Wurts, $516 in benefit derived from the purchase of shares through the employee stock purchase plan and $2,610 intrinsic value of stock options exercised by Ms. Wurts.





(8)
This amount represents a $4,800 automobile allowance, $8,268 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Ms. Wurts and, $594 in benefit derived from the purchase of shares through the employee stock purchase plan.





(9)
This amount represents a $4,800 automobile allowance, $8,001 contributed by the Company to the Company’s Executive Employee Benefit Plan on behalf of Ms. Wurts and, $467 in benefit derived from the purchase of shares through the employee stock purchase plan.





(10)
These amounts represent the aggregate cost of stock option awards vested during the fiscal year.





COMPENSATION OF DIRECTORS





Directors who are employees of the Company receive no compensation for services as members of the Board. Directors who are not employees of the Company receive a $10,000 stipend per year and $2,500 for each Board meeting they attend. The Audit Committee Chairperson receives an annual stipend of $5,000, members of the audit committee receive an annual stipend of $3,000 and compensation committee and nominating/governance committee members receive an annual stipend of $2,000.  In addition, directors of the Company are entitled to receive certain stock option grants under the Company's Non-Employee Director Stock Option Plan (the "Director Plan").  The following table presents director compensation for the fiscal year ended June 30, 2011.





DIRECTOR COMPENSATIONFees Earned or

All OtherName
Paid in Cash
Option Awards
Compensation
Total($)
($)
($)
($)(a)
(b)
(d)(1)
(g)
(h)Donald Robar
$
27,000
$
23,432
$
55,850(3)
$
106,282William Grieco
$
27,000
$
23,432
$
17,300(3)
$
67,732David Dangerfield
$
27,000
$
23,432
$
--
$
50,432Douglas J. Smith
$
15,000
$
23,432
$
--
$
38,432Howard W. Phillips (3)
$
--
$
23,432
$
30,031
$
53,463


(1)
These amounts represent the aggregate grant date fair value of stock option awards granted during the fiscal year.


(2)
Mr. Phillips is an employee of the Company, serving as a Public Relations Specialist.  Other than his salary as an employee, he receives no additional compensation as a director.


(3)
These amounts represent the intrinsic value of stock options exercised by the named director.





As of June 30, 2011, each member of the Board of Directors had the following options outstanding:  Donald Robar, 157,500 (125,000 vested); William Grieco, 195,000 (162,500 vested); David Dangerfield, 147,500 (115,000 vested); Howard Phillips, 127,000 (90,000 vested); and, Douglas Smith, 20,000 (5,000 vested).




Compensation Committee Interlocks and Insider Participation





During fiscal 2011, the Compensation Committee consisted of Dr. Donald Robar and Mr. William Grieco, neither of whom was an officer or employee of the Company during the 2011 fiscal year.  Dr. Robar served as the Company’s Treasurer from February 1996 until April 2000.  During the 2011 fiscal year, none of our executive officers served on our Compensation Committee (or equivalent) or board of directors of another entity whose executive officer(s) served on our Compensation Committee or Board of Directors.





83





OPTION PLANS





Stock Plan





The Board of Directors adopted the Company’s first stock option plan on August 26, 1993.  This stock option plan has expired; however, options to purchase 27,500 shares remain outstanding under the plan.  On September 22, 2003, the Board of Directors adopted the Company’s current stock option plan and the stockholders of the Company approved the plan on December 31, 2003.   The Stock Plan, as amended, provides for the issuance of a maximum of 2,400,000 shares of the Class A Common Stock of the Company pursuant to the grant of incentive stock options to employees and the grant of nonqualified stock options or restricted stock to employees, directors, consultants and others whose efforts are important to the success of the Company.





The Board of Directors administers the Stock Plan. Subject to the provisions of the Stock Plan, the Board of Directors has the authority to select the optionees or restricted stock recipients and determine the terms of the options or restricted stock granted, including: (i) the number of shares, (ii) option exercise terms, (iii) the exercise or purchase price (which in the case of an incentive stock option cannot be less than the market price of the Class A Common Stock as of the date of grant), (iv) type and duration of transfer or other restrictions and (v) the time and form of payment for restricted stock upon exercise of options. Generally, an option is not transferable by the option holder except by will or by the laws of descent and distribution. Also, generally, no option may be exercised more than 60 days following termination of employment. However, in the event that termination is due to death or disability, the option is exercisable for a period of one year following such termination.





During the fiscal year ended June 30, 2011, the Company issued additional options to purchase 53,100 shares of Class A Common Stock under the 2003 Stock Plan at a price per share ranging from $1.49 to $2.60.  Generally, options are exercisable upon grant for 25% of the shares covered with an additional 25% becoming exercisable on each of the first three anniversaries of the date of grant.





Employee Stock Purchase Plan





On October 18, 1995, the Board of Directors voted to provide employees who work in excess of 20 hours per week and more than five months per year rights to elect to participate in an Employee Stock Purchase Plan (the “Plan”), which became effective February 1, 1996.  The price per share was to be the lesser of 85% of the average of the bid and ask price on the first day of the plan period or the last day of the plan period.  The plan was amended on December 19, 2001 and December 19, 2002 to allow for a total of 500,000 shares of Class A Common Stock to be issued under the plan.  On January 31, 2006 the stockholders approved a replacement Employee Stock Purchase Plan to replace the 1995 plan, which expired on October 18, 2005.  The new plan is identical to the old plan and expires on January 31, 2016.




A total of 157,034 shares of Class A Common Stock were issued under the 1995 plan before its expiration and 71,936 shares have been issued under the 2005 plan.  A total of 14,081 shares were issued in the two offerings during the fiscal year ended June 30, 2011.  Future offerings have not yet been approved.





Non-Employee Director Stock Option Plan





The non-employee directors’ stock option plan provides for the grant of nonstatutory stock options automatically at the time of each annual meeting of the Board.  This plan expired in August 2005.  Before its expiration, options to purchase 145,500 shares were granted under the plan.  In January 2005, the shareholders voted to approve a new non-employee directors’ stock plan.  The new plan is identical to the plan it replaced.  Under the new plan a maximum of 350,000 shares may be issued.  On January 31, 2006, this plan was amended to increase the number of options issued to each outside director each year from 10,000 options to 20,000 options.  The plan was further amended in December 2010 to increase the number of options available under the plan to 950,000.  Each outside director is granted an option to purchase 20,000 shares of Class A Common Stock annually at fair market value on the date of grant, vesting 25% immediately and 25% on each of the first three anniversaries of the grant and expiring ten years from the grant date.  The new plan will expire in January 2015, ten years from the date of shareholder approval.  As of June 30, 2011, 420,000 options have been issued under the plan.





84





If an optionee ceases to be a member of the Board of Directors other than for death or permanent disability, the unexercised portion of the options, to the extent unvested, immediately terminate, and the unexercised portion of the options which have vested lapse 180 days after the date the optionee ceases to serve on the Board.  In the event of death or permanent disability, all unexercised options vest and the optionee or his or her legal representative has the right to exercise the option for a period of 180 days or until the expiration of the option, if sooner.





Options Exercised





During the fiscal year ended June 30, 2011, a total of 95,000 options were exercised under the plans at option prices ranging from $0.22 to $2.28.





There were no options granted to the Named Executive Officers during fiscal 2011.





The following table provides information about options outstanding, held by the Named Executive Officers at the end of fiscal 2011.





OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-ENDNumber of
Number ofSecurities
SecuritiesUnderlying
Underlying
Option
OptionUnexercised
Unexercised
Exercise
ExpirationName
Options
Options
Price
Date(#)
(#)
($)Exercisable
Unexercisable(a)
(b)
(c)
(e)
(f)Bruce A. Shear
15,000

15,000

20,000

20,000

50,000

15,000

7,500

7,500
--

--

--

--

--

5,000 (1)

7,500 (2)

7,500 (2)
$

$

$

$

$

$

$

$
2.06

2.95

2.90

2.75

1.25

1.20

1.08

1.08
10/14/2012

10/31/2012

11/14/2012

02/18/2013

11/28/2013

06/15/2014

12/14/2014

12/14/2014Robert H. Boswell
7,500

7,500

10,000

10,000

15,000

7,500

12,500
--

--

--

--

--

2,500 (1)

12,500 (2)
$

$

$

$

$

$

$
2.95

2.06

2.90

2.75

1.25

1.20

1.08
10/14/2012

10/31/2012

11/14/2012

02/18/2013

11/28/2013

06/15/2014

12/14/2014Paula C. Wurts
7,500

7,500

10,000

10,000

15,000

7,500

12,500
--

--

--

--

--

2,500(1)

12,500 (2)
$

$

$

$

$

$

$
2.95

2.06

2.90

2.75

1.25

1.20

1.08
10/14/2012

10/31/2012

11/14/2012

02/18/2013

11/28/2013

06/15/2014

12/14/2014








85








(1)
The additional 10,000 unvested options will vest in full on 6/15/2012.


(2)
The additional 40,000 unvested options will vest 20,000 on 12/14/2011; and, 20,000 on 12/14/2012.





OPTIONS EXERCISED AND STOCK VESTED





The following table provides information about options exercised, held by the Named Executive Officers during the fiscal year ended June 30, 2011.


Option AwardsNumber of

ValueShares

Realized onName

Acquired on Exercise

Exercise(#)

($)(a)

(b)

(c)Bruce A. Shear

15,000
$
13,050Robert H. Boswell

7,500

6,525Paula C. Wurts

3,000

2,610








86





Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS





The following table sets forth certain information regarding the ownership of shares of the Company’s Class A Common Stock and Class B Common Stock (the only classes of common stock of the Company currently outstanding) as of July 16, 2011 by each person known by the Company to beneficially own more than 5% of any class of the Company’s voting securities, each director of the Company, each of the Named Executive Officers and all directors and officers of the Company as a group.  Shares of common stock subject to stock options vesting on or before September 15, 2011 (within 60 days of July 16, 2011) are deemed to be outstanding and beneficially owned for purposes of computing the percentage ownership of such person but are not treated as outstanding for purposes of computing the percentage ownership of others.  Unless otherwise indicated below, to the knowledge of the Company, all persons listed below have sole voting and investment power with respect to their shares of common stock, except to the extent authority is shared by spouses under applicable law.  In preparing the following table, the Company has relied on the information furnished by the persons listed below:





Beneficial Owners 5%


Name and Address
Amount and Nature
Percent ofTitle of Class
of Beneficial Owner
of Beneficial Ownership (11)
ClassClass A Common Stock
Marathon Capital Mgmt, LLC

4 North Park Drive, Suite 106

Hunt Valley, MD  21030
2,022,700
10.4%Camden Partners Capital Management LLC

500 East Pratt Street, Suite 1200

Baltimore, MD 21202
1,365,428
6.9%RENN Capital Group

8080 N. Central Expy, Suite 210 LB 59

Dallas, TX  75206
1,049,900
5.5%





Beneficial Ownership of Named Executive Officers and Directors


Amount and Nature
Percent ofTitle of Class
Name of Beneficial Owner
of Beneficial Ownership(11)
ClassClass A Common Stock
Bruce A. Shear
764,755(1)
4.0%Robert H. Boswell
276,682(2)
1.5%Paula C. Wurts
225,816(3)
1.2%Howard W. Phillips
243,750(4)
1.3%Donald E. Robar
229,167(5)
1.2%William F. Grieco
324,500(6)
1.7%David E. Dangerfield
144,940(7)
*Douglas J. Smith
5,000(8)
*All Directors and Officers as a Group
2,214,610(9)
11.3%(8 persons)Class B Common Stock (10)
Bruce A. Shear
721,357
93.2%All Directors and Officers as a Group
721,357
93.2%(8 persons)





87





1.
Includes 150,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $1.08 to $2.95 per share.


2.
Includes 70,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options at an exercise price range of $1.08 to $2.95 per share.


3.
Includes 70,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $1.08 to $2.95 per share.


4.
Includes 90,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options having an exercise price range of $1.08 to $3.18 per share.


5.
Includes 125,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options having an exercise price range of $1.08 to $3.18 per share.


6.
Includes 162,500 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $.55 to $3.18 per share.


7.
Includes 115,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price range of $1.08 to $3.18 per share.


8.
Includes 5,000 shares of Class A Common Stock issuable pursuant to currently exercisable stock options, having an exercise price of $1.65 per share.


9.
Includes an aggregate of 787,500 shares of Class A Common Stock issuable pursuant to currently exercisable stock options.  Of those options, 80,000 have an exercise price of $3.18 per share, 30,000 have an exercise price of $2.95 per share, 40,000 have an exercise price of $2.90 per share, 80,000 have an exercise price of $2.84 per share, 30,000 have an exercise price of $2.83 per share, 40,000 have an exercise price of $2.75 per share, 60,000 have an exercise price of $2.11 per share, 30,000 have an exercise price of $2.06 per share, 25,000 have an exercise price of $1.65 per share, 60,000 have an exercise price of $1.50 per share, 30,000 have an exercise price of $1.48 per share, 20,000 have an exercise price of $1.33 per share, 80,000 have an exercise price of $1.25 per share, 60,000 have an exercise price of $1.20 per share, 85,000 have an exercise price of $1.08 per share, 10,000 have an exercise price of $.75 per share, 10,000 have an exercise price of $.74 per share and 17,500 have an exercise price of $.55 per share.


10.
Each share of Class B Common Stock is convertible into one share of Class A Common Stock automatically upon any sale or transfer or at any time at the option of the holder.


11.
“Amount and Nature of Beneficial Ownership”.  Each share of Class A Common Stock is entitled to one vote per share and each share of Class B Common Stock is entitled to five votes per share on all matters on which stockholders may vote (except that the holders of the Class A Common Stock are entitled to elect two members of the Company’s Board of Directors and holders of the Class B Common Stock are entitled to elect all the remaining members of the Company’s Board of Directors).





By virtue of the fact that Mr. Shear owns 93% of the Class B Common Stock and the holders of Class B Common Stock have the right to elect all of the directors except the two directors elected by the holders of Class A Common Stock, Mr. Shear has the right to elect the majority of the members of the Board of Directors and may be deemed to be in control of the Company.




Based on the number of shares listed under the column headed “Amount and Nature of Beneficial Ownership,” the following persons or groups held the following percentages of voting rights for all shares of common stock combined as of September 15, 2011:





Bruce A. Shear
19.19%All Directors and Officers as a Group   (8 persons)
24.85%








88








SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS as of JUNE 30, 2011





(a)
(b)
( c)Number ofSecuritiesRemainingavailable forfuture issuanceNumber of securities
Weighted-average
under equityto be issued upon
exercise price of
Compensationexercise of
outstanding
plans (excludingoutstanding options,
options, warrants
securities reflectedPLAN

warrants and rights
and rights
in column (a))1993 Option plan
27,500
$
0.62
--2003 Option plan
819,750
$
1.82
1,440,0632006 Employee stock purchase plan
--
$
0.00
428,0641995 Director plan
30,000
$
1.13
--2005 Director plan
410,000
$
2.00

530,000Total Shares and Options authorized
1,287,250
$
1.84

2,398,127


All equity compensation plans were approved by the security holders.





Item 13.    CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS AND DIRECTOR INDEPENDENCE





There were no related party transactions in the current fiscal year or through the date of this report.





Before entering into any contract or agreement involving a related party the Board of Directors reviews and approves the transaction.  In the event one of the related parties is a member of the Board of Directors, that member of the Board recuses himself from participation in the discussion or approval of the transaction.









Item 14.  Principal Accountant Fees and Services





INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FEES





The following table presents fees for professional audit services rendered for the Company’s annual financial statements and quarterly review services and other related services for the fiscal years ended June 30, 2011 and 2010:





2011

2010BDO USA, LLPAudit fees:
$
394,600
$
394,908Audit related fees:

12,000

--Tax services*

51,700

30,000All other fees

105,925

--Total fees
$
564,225
$
424,908





* In addition to the above, firms other than the Company’s registered public accounting firm provide tax and other accounting services.





The amounts listed as “Audit fees” in the above table refers to fees directly related to the annual audit, quarterly reviews of financial statements and auditor consents and the amounts listed as “Audit related fees” refers to 401(k) audits.





89





The amounts listed as tax fees include fees billed for professional services for tax compliance.





All other services represent fees billed for due diligence in connection with the Company’s potential merger transaction.





The Company’s Audit Committee considered the non-audit services rendered by the Company’s independent registered public accounting firms during the two fiscal years presented and determined that such services were compatible with the firm’s independence.  Other fees listed above were primarily provided for services related to the pending merger transaction.





BDO USA, LLP does not directly or indirectly, operate, or supervise the operation of, the Company’s information systems or manage the Company’s local area network, nor did they design or implement a hardware or software system that aggregates source data underlying the financial statements of the Company or generates information that is significant to the Company’s financial statements taken as a whole.





The charter of the Audit Committee provides that the Audit Committee must pre-approve all auditing and non-auditing services to be provided by the independent registered public accounting firm.  In addition, any services exceeding pre-approved cost levels will require specific pre-approval by the Audit Committee.  All services shown in the table above were pre-approved by the Audit Committee.

















90





PART IV





Item 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





(a)
The following documents are filed as part of this Annual Report on Form 10-K.





1)
Consolidated Financial Statements:





Page NumberReport of Independent Registered Public Accounting Firm
40Consolidated balance sheets
41Consolidated statements of operations
42Consolidated statements of changes in stockholders’ equity
43-44Consolidated statements of cash flows
45-46Notes to consolidated financial statements
47-70





2)
Financial Statement Schedules:  All schedules are included in the consolidated financial statements and footnotes thereto.


(b)
Exhibits





Exhibit No.
Description3.1
Restated Articles of Organization of the Registrant, as amended.  (Filed as exhibit 3.1 to the Company’s report on Form 10-K filed with the Securities and Exchange Commission on September 30, 2008, and hereby incorporated by reference.  Commission file number 1-33323).3.2
Amended and Restated By-laws of the Registrant  (Filed as exhibit 3.3 to the Company’s report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2007, and hereby incorporated by reference.  Commission file number 0-22916).4.1
Form of Subscription Agreement and Warrant.  (Filed as exhibit 4.20 to the Company’s report on Form 8-K filed with the Securities and Exchange Commission on May 13, 2004, and hereby incorporated by reference.  Commission file number 0-22916).4.2
Warrant Agreement issued to CapitalSource Finance, LLC to purchase 250,000 Class A Common shares dated June 13, 2007. (Filed as exhibit 4.4 to the Company’s report on Form 10-K filed with the Securities and Exchange Commission on September 28, 2007 and hereby incorporated by reference. Commission file number 0-22916).10.1
Deed of Trust Note of Mount Regis Center Limited Partnership in favor of Douglas M. Roberts, dated July 28, 1987, in the amount of $560,000, guaranteed by PHC, Inc., with Deed of Trust executed by Mount Regis Center, Limited Partnership of even date.  (Filed as exhibit 10.1 to the Company’s registration statement on Form SB-2 filed with the Securities and Exchange Commission on March 2, 1994 and hereby incorporated by reference.)**10.2
The Company’s 1993 Stock Purchase and Option Plan, as amended December 2002.  (Filed as exhibit 10.23 to the Company’s registration statement on Form S-8 filed with the Securities and Exchange Commission on January 8, 2003 and hereby incorporated by reference.  Commission file number 333-102402).**10.3
The Company’s 1995 Non-Employee Director Stock Option Plan, as amended December 2002.  (Filed as exhibit 10.24 to the Company’s registration statement on Form S-8 filed with the Securities and Exchange Commission on January 8, 2003 and hereby incorporated by reference.  Commission file number 333-102402).








91








Exhibit No.
Description**10.4
The Company’s 1995 Employee Stock Purchase Plan, as amended December 2002.  (Filed as exhibit 10.25 to the Company’s registration statement on Form S-8 filed with the Securities and Exchange Commission on January 8, 2003 and hereby incorporated by reference.  Commission file number 333-102402).10.5
Revolving Credit, Term Loan and Security Agreement, dated October 19, 2004, by and between PHC, Inc, PHC of Utah, Inc., PHC of Virginia, Inc. and PHC of Michigan, Inc., PHC of Nevada, Inc., North Point Pioneer, Inc, Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance, LLC.  (Filed as exhibit 10.38 to the Company's report on Form 8-K filed with the Securities and Exchange Commission on October 22, 2004 and hereby incorporated by reference.  Commission file number 0-22916).10.6
Term Loan Note, dated October 19, 2004, by and between PHC, Inc, PHC of Utah, Inc., PHC of Virginia, Inc. and PHC of Michigan, Inc., PHC of Nevada, Inc., North Point Pioneer, Inc, Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance, LLC in the amount of $1,400,000.  (Filed as exhibit 10.39 to the Company's report on Form 8-K filed with the Securities and Exchange Commission on October 22, 2004 and hereby incorporated by reference.  Commission file number 0-22916).10.7
Revolving Note dated October 19, 2004, by and between PHC, Inc, PHC of Utah, Inc., PHC of Virginia, Inc. and PHC of Michigan, Inc., PHC of Nevada, Inc., North Point Pioneer, Inc, Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance, LLC in the amount of $3,500,000.  (Filed as exhibit 10.40 to the Company's report on Form 8-K filed with the Securities and Exchange Commission on October 22, 2004 and hereby incorporated by reference.  Commission file number 0-22916).10.8
One of two (2) Revolving Credit Notes in the amount of $1,500,000 issued to replace the $3,500,000 note signed in favor of Capital Source dated October 19, 2004 by and between PHC of Michigan, Inc., PHC of Nevada, Inc., PHC of Utah, Inc., PHC of Virginia, Inc., North Point – Pioneer, Inc., Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance LLC.  (Filed as exhibit 10.47 to the Company’s report on Form 10-QSB filed with the Securities and Exchange Commission on May 13, 2005 and hereby incorporated by reference.  Commission file number 0-22916).10.9
One of two (2) Revolving Credit Notes in the amount of $2,000,000 issued to replace the $3,500,000 note signed in favor of Capital Source dated October 19, 2004 by and between PHC of Michigan, Inc., PHC of Nevada, Inc., PHC of Utah, Inc., PHC of Virginia, Inc., North Point – Pioneer, Inc., Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance LLC.   (Filed as exhibit 10.48 to the Company’s report on Form 10-QSB filed with the Securities and Exchange Commission on May 13, 2005 and hereby incorporated by reference.  Commission file number 0-22916).10.10
First Amendment to Revolving Credit, Term Loan and Security Agreement, dated October 19, 2004, by and between PHC, Inc, PHC of Utah, Inc., PHC of Virginia, Inc., PHC of Michigan, Inc., PHC of Nevada, Inc., North Point Pioneer, Inc, Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance, LLC., adjusting the covenants for census and EBITDAM.  (Filed as exhibit 10.25 to the Company’s report on Form 10-K filed with the Securities and Exchange Commission on October 13, 2006 and hereby incorporated by reference.  Commission file number 0-22916).10.11
Second Amendment to Revolving Credit, Term Loan and Security Agreement, dated October 19, 2004, by and between PHC, Inc, PHC of Utah, Inc., PHC of Virginia, Inc., PHC of Michigan, Inc., PHC of Nevada, Inc., North Point Pioneer, Inc, Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance, LLC., extending the term of the agreement through October 19, 2008.  (Filed as exhibit 10.26 to the Company’s report on Form 10-K filed with the Securities and Exchange Commission on October 13, 2006 and hereby incorporated by reference.  Commission file number 0-22916).





92








Exhibit No.
Description**10.12
The Company's 2004 Non-Employee Director Stock Option Plan.  (Filed as exhibit 10.42 to the Company’s registration statement on Form S-8 filed with the Securities and Exchange Commission on April 5, 2005 and hereby incorporated by reference.  Commission file number 333-123842).**10.13
The Company's 2005 Employee Stock Purchase Plan.  (Filed as exhibit 10.29 to the Company’s registration statement on Form S-8 filed with the Securities and Exchange Commission on March 6, 2008 and hereby incorporated by reference.  Commission file number 333-149579).**10.14
The Company's 2003 Stock Purchase and Option Plan, as amended December 2007.  (Filed as exhibit 10.30 to the Company’s registration statement on Form S-8 filed with the Securities and Exchange Commission on March 6, 2008 and hereby incorporated by reference.  Commission file number 333-149579).10.15
Amendment to Revolving Credit, Term Loan and Security Agreement, dated October 19, 2004, by and between PHC, Inc, PHC of Utah, Inc., PHC of Virginia, Inc., PHC of Michigan, Inc., PHC of Nevada, Inc., North Point Pioneer, Inc, Wellplace, Inc., Detroit Behavioral Institute, Inc. and CapitalSource Finance, LLC. To modify the agreement to increase the amount available under the term loan, extend the agreement through June 13, 2010, reduce the interest rates on the notes and adjust the covenants under the agreement.  (Filed as exhibit 10.28 to the Company’s report on Form 10-K filed with the Securities and Exchange Commission on September 28, 2007 and hereby incorporated by reference.  Commission file number 1-33323).10.16
Loan Sale Agreement by and between Bank of America, N.A. and Detroit Behavioral Institute, Inc. (Filed as exhibit 10.30 to the Company’s report on Form 10-Q filed with the Securities and Exchange Commission on February 14 2011 and hereby incorporated by reference.  Commission file number 1-33323).10.17
Asset Purchase Agreement between Universal Health Services, Inc. and PHC, Inc. dated as of March 15, 2011.  (Filed as exhibit 10.31 to the Company’s report on Form 8-K filed with the Securities and Exchange Commission on March 18, 2011 and hereby incorporated by reference.  Commission file number 1-33323).*10.18
Credit Agreement by and between PHC, Inc., as Borrower, and all its subsidiaries as Guarantors and Jefferies Finance LLC and Jefferies Group, Inc., dated July 1, 2011.14.1
Code of Ethics.  (Filed as exhibit 14.1 to the Company’s report on Form 10-K filed with the Securities and Exchange Commission on October 13, 2006 and hereby incorporated by reference.  Commission file number 0-22916).*21.1
List of Subsidiaries.*23.1
Consent of BDO USA, LLP, an independent registered public accounting firm.*31.1
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*31.2
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*32.1
Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.





*    Filed herewith


**  Management contract or compensatory plan








93








SIGNATURES





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.




PHC, INC.Date:  August  18 , 2011
By:/s/ BRUCE A. SHEARBruce A. Shear, Presidentand Chief Executive Officer





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(S)
DATE/s/ BRUCE A. SHEAR
President, Chief
August 18, 2011Bruce A. Shear
Executive Officer andDirector  (principalexecutive officer)/s/ PAULA C. WURTS
Chief Financial Officer
August 18, 2011Paula C. Wurts
Treasurer and Clerk(principal  financialand accounting officer)/s/ DONALD E. ROBAR
Director
August 18, 2011Donald E. Robar/s/ HOWARD W. PHILLIPS
Director
August 18, 2011Howard  W. Phillips/s/ WILLIAM F. GRIECO
Director
August 18, 2011William F. Grieco/s/ DAVID E. DANGERFIELD
Director
August 18, 2011David E. Dangerfield/s/ DOUGLAS J. SMITH
Director
August 18, 2011Douglas J. Smith