##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 for the quarterly period ended March 31, 2005 or
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 for the transition period from  to
 Commission file number 0-20488 PSYCHIATRIC SOLUTIONS, INC.  DELAWARE
    
    23-2491707(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)
 840 Crescent Centre Drive, Suite 460
Franklin, TN 37067
(Address of Principal Executive Offices, Including Zip Code) (615) 312-5700
(Registrants Telephone Number, Including Area Code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes þ No o As of May 5, 2005, 20,508,949 shares of the registrants common stock were outstanding.




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PSYCHIATRIC SOLUTIONS, INC. TABLE OF CONTENTS  
 PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004 (Unaudited)
    
    
    1Condensed Consolidated Statements of Income for the three month periods ended March 31, 2005 and 2004 (Unaudited)
    
    
    2Condensed Consolidated Statements of Cash Flows for the three month periods ended March 31, 2005 and 2004
(Unaudited)
    
    
    3Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    20PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    21Item 6. Exhibits
    
    
    21EX-2.1 STOCK PURCHASE AGREEMENT 03/10/05EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERIFICATION OF THE CAOEX-32.1 SECTION 906 CERTIFICATION OF THE CEO & CAO




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS PSYCHIATRIC SOLUTIONS, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited, in thousands except per share amounts)
 March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,500
    
    
    $
    33,255Accounts receivable, less allowance for doubtful accounts of
$10,581 and $10,639, respectively
    
    
    80,996
    
    
    
    77,539Prepaids and other
    
    
    16,700
    
    
    
    16,412Total current assets
    
    
    112,196
    
    
    
    127,206Property and equipment, net of accumulated depreciation
    
    
    220,762
    
    
    
    218,231Cost in excess of net assets acquired
    
    
    130,134
    
    
    
    130,079Other assets
    
    
    21,377
    
    
    
    22,330Total assets
    
    $
    484,469
    
    
    $
    497,846LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    12,355
    
    
    $
    10,529Salaries and benefits payable
    
    
    28,106
    
    
    
    27,355Other accrued liabilities
    
    
    27,473
    
    
    
    28,668Current portion of long-term debt
    
    
    478
    
    
    
    20,764Total current liabilities
    
    
    68,412
    
    
    
    87,316Long-term debt, less current portion
    
    
    153,483
    
    
    
    153,572Deferred tax liability
    
    
    8,526
    
    
    
    8,020Other liabilities
    
    
    5,465
    
    
    
    4,423Total liabilities
    
    
    235,886
    
    
    
    253,331Stockholders equity:Common stock, $0.01 par value, 48,000 shares authorized;
20,508 and 20,468 issued and outstanding, respectively
    
    
    205
    
    
    
    205Additional paid-in capital
    
    
    228,784
    
    
    
    228,044Accumulated earnings
    
    
    19,594
    
    
    
    16,266Total stockholders equity
    
    
    248,583
    
    
    
    244,515Total liabilities and stockholders equity
    
    $
    484,469
    
    
    $
    497,846
 See notes to condensed consolidated financial statements 1




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PSYCHIATRIC SOLUTIONS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 (Unaudited, in thousands except for per share amounts)
 Three Months Ended March 31,2005
    
    
    2004Revenue
    
    $
    138,730
    
    
    $
    103,430Salaries, wages and employee benefits
    
    
    76,367
    
    
    
    55,707Professional fees
    
    
    14,256
    
    
    
    11,691Supplies
    
    
    8,584
    
    
    
    6,580Rentals and leases
    
    
    2,340
    
    
    
    1,767Other operating expenses
    
    
    15,645
    
    
    
    12,516Provision for doubtful accounts
    
    
    2,668
    
    
    
    2,027Depreciation and amortization
    
    
    2,902
    
    
    
    2,107Interest expense
    
    
    3,523
    
    
    
    4,456Loss on refinancing long-term debt
    
    
    6,990
    
    
    
    6,407133,275
    
    
    
    103,258Income from continuing operations before
income taxes
    
    
    5,455
    
    
    
    172Provision for income taxes
    
    
    2,127
    
    
    
    65Income from continuing operations
    
    
    3,328
    
    
    
    107Loss from discontinued operations, net of income
tax benefit of $88 for 2004
    
    
    
    
    
    
    (144
    )Net income (loss)
    
    
    3,328
    
    
    
    (37
    )Accrued preferred stock dividends
    
    
    
    
    
    
    323Net income (loss) available to common stockholders
    
    $
    3,328
    
    
    $
    (360
    )Basic earnings per share:Income (loss) from continuing operations
    
    $
    0.16
    
    
    $
    (0.02
    )Loss from discontinued operations
    
    
    
    
    
    
    (0.01
    )$
    0.16
    
    
    $
    (0.03
    )Diluted earnings per share:Income (loss) from continuing operations
    
    $
    0.16
    
    
    $
    (0.02
    )Loss from discontinued operations
    
    
    
    
    
    
    (0.01
    )$
    0.16
    
    
    $
    (0.03
    )Shares used in computing per share amounts:Basic
    
    
    20,482
    
    
    
    11,958Diluted
    
    
    21,173
    
    
    
    11,958
 See notes to condensed consolidated financial statements 2




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PSYCHIATRIC SOLUTIONS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited, in thousands)
 Three Months Ended March 31,2005
    
    
    2004Operating Activities:Net income (loss)
    
    $
    3,328
    
    
    $
    (37
    )Adjustments to reconcile net income (loss) to net cash
provided by operating activities:Loss from discontinued operations, net of taxes
    
    
    
    
    
    
    144Depreciation and amortization
    
    
    2,902
    
    
    
    2,107Provision for doubtful accounts
    
    
    2,668
    
    
    
    2,027Amortization of loan costs
    
    
    174
    
    
    
    199Loss on refinancing long-term debt
    
    
    6,990
    
    
    
    6,407Change in income tax assets and liabilities
    
    
    (3,169
    )
    
    
    (187
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (6,125
    )
    
    
    (3,497
    )Prepaids and other assets
    
    
    (728
    )
    
    
    1,987Accounts payable
    
    
    1,826
    
    
    
    (2,249
    )Salaries and benefits payable
    
    
    1,450
    
    
    
    2,454Accrued liabilities and other liabilities
    
    
    4,022
    
    
    
    5,366Net cash provided by operating activities
    
    
    13,338
    
    
    
    14,721Investing activities:Acquisitions, net of cash acquired
    
    
    (500
    )
    
    
    (33,211
    )Capital purchases of property and equipment
    

    
    (5,255
    )
    
    
    (3,055
    )Investment in equity method investee
    
    
    (840
    )
    
    
    Other
    
    
    (482
    )
    
    
    (1,264
    )Net cash used in investing activities
    
    
    (7,077
    )
    
    
    (37,530
    )Financing activities:Net principal (payments) borrowings on long-term debt
    
    
    (20,375
    )
    
    
    16,856Refinancing of long-term debt
    
    
    (5,316
    )
    
    
    (3,844
    )Payment of loan and issuance costs
    
    
    (129
    )
    
    
    (987
    )Proceeds from issuance of common stock
    
    
    804
    
    
    
    104Net cash (used in) provided by financing activities
    
    
    (25,016
    )
    
    
    12,129Net decrease in cash
    
    
    (18,755
    )
    
    
    (10,680
    )Cash at beginning of the period
    
    
    33,255
    
    
    
    44,954Cash at end of the period
    
    $
    14,500
    
    
    $
    34,274Significant Non-cash Transactions:Loss on refinancing long-term debt
    
    $
    1,674
    
    
    $
    2,563Effect of Acquisitions:Assets acquired, net of cash acquired
    
    $
    
    
    
    $
    31,682Cash payment for prior-year acquisition
    
    
    500
    
    
    
    3,350Liabilities assumed
    
    
    
    
    
    
    (1,821
    )Acquisitions, net of cash acquired
    
    $
    500
    
    
    $
    33,211
 See notes to condensed consolidated financial statements 3




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PSYCHIATRIC SOLUTIONS, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 MARCH 31, 2005
 1. Recent Developments On March 10, 2005, we entered into a Stock Purchase Agreement with Ardent Health Services LLC, a
Delaware limited liability company (Seller), and Ardent Health Services, Inc., a Delaware
corporation and wholly-owned subsidiary of Seller (AHS), pursuant to which we will acquire all of
the outstanding capital stock of AHS for approximately $560 million. The purchase price will be
paid $500 million in cash and $60 million in shares of our common stock. AHS owns and operates,
through its subsidiaries, 20 inpatient behavioral health care facilities with approximately 2,000
inpatient beds, which generated approximately $300 million in revenues in 2004. We anticipate
financing the cash portion of the purchase price through the issuance of new debt. Closing of the
transaction is conditioned upon satisfaction of customary closing conditions, including the receipt
of all necessary governmental permits and approvals and the expiration or early termination of the
Hart-Scott-Rodino Act waiting period. It is anticipated that closing will occur during the second
quarter of 2005. On January 14, 2005, we redeemed $50 million of our 10 5/8% senior subordinated notes. As part of
the redemption we paid a 10 5/8% penalty and accrued interest. We borrowed $30 million under our
revolving line of credit and used cash on hand for the remainder of the redemption. We recorded a
loss on refinancing long-term debt of approximately $7.0 million during the first quarter of 2005
in connection with this redemption. 2. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by accounting principles
generally accepted in the United States for audited financial statements. The condensed
consolidated balance sheet at December 31, 2004 has been derived from the audited financial
statements at that date, but does not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation of our financial position have been included. The majority of our
expenses are cost of revenue items. General and administrative expenses were approximately 3% of
net revenue for the three months ended March 31, 2005. Operating results for the three months ended
March 31, 2005 are not necessarily indicative of the results that may be expected for the full
year. For further information, refer to the financial statements and footnotes thereto included in
our Annual Report on Form 10-K for the year ended December 31, 2004 filed on March 15, 2005. 3. Earnings Per Share Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per Share, requires dual
presentation of basic and diluted earnings per share by entities with complex capital structures.
Basic earnings per share include no dilution and are computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding for the period.
Diluted earnings per share reflect the potential dilution of outstanding securities that, upon
exercise or conversion, could share in our earnings. We have calculated our earnings per share in
accordance with SFAS No. 128 for all periods presented. The following table sets forth the computation of basic and diluted earnings per share (dollars in
thousands, except per share amounts): 4




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 Three months ended March 31,2005
    
    
    2004Numerator:Income from continuing operations
    
    $
    3,328
    
    
    $
    107Accrued dividends on series A convertible preferred stock
    
    
    
    
    
    
    323Income (loss) from continuing operations used in computing earnings per share
    
    
    3,328
    
    
    
    (216
    )Loss from discontinued operations, net of taxes
    
    
    
    
    
    
    (144
    )Net income (loss) available to common stockholders
    
    $
    3,328
    
    
    $
    (360
    )Denominator:Weighted average shares outstanding for basic earnings per share
    
    
    20,482
    
    
    
    11,958Effects of dilutive stock options and warrants outstanding
    
    
    691
    
    
    
    Shares used in computing diluted earnings per common share
    
    
    21,173
    
    
    
    11,958Basic earnings per share:Income (loss) from continuing operations
    
    $
    0.16
    
    
    $
    (0.02
    )Loss from discontinued operations, net of taxes
    
    
    
    
    
    
    (0.01
    )$
    0.16
    
    
    $
    (0.03
    )Diluted earnings per share:Income (loss) from continuing operations
    
    $
    0.16
    
    
    $
    (0.02
    )Loss from discontinued operations, net of taxes
    
    
    
    
    
    
    (0.01
    )$
    0.16
    
    
    $
    (0.03
    )
 The computation of diluted earnings per share for the three months ended March 31, 2004 does not
include approximately 4.7 million shares representing the weighted average of common shares into
which our series A preferred stock is convertible and approximately 540,000 shares representing
stock options and warrants outstanding during the period as the effects would have been
anti-dilutive. 4. Stock-Based Compensation We account for our stock option plans using the intrinsic value method in accordance with the
provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. Pursuant to APB Opinion No. 25, compensation expense would
be recorded on the date of grant only if the current market price of the underlying stock exceeded
the exercise price. We plan to adopt the fair-value method of accounting for stock options and
begin expensing stock options pursuant to SFAS No. 123R,
Share-Based Payment, as amended, beginning on January 1, 2006. Pro forma information regarding interim net income and earnings per share is required by SFAS No.
148, Accounting for Stock-Based Compensation-Transition and
Disclosure, and has been determined as if we had accounted for our employee stock options under the fair
value method. The fair value of options we have granted was estimated using the Black-Scholes
option pricing model. Option valuation models require the input of highly subjective assumptions. Because our employee
stock options have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the fair value estimate,
in managements opinion, the existing models do not necessarily provide a reliable single measure
of the fair value of our employee stock options. For purposes of pro forma disclosure, the estimated fair value of the options at grant date is
amortized to expense over the options vesting period. The pro forma information follows (in
thousands, except per share amounts): 5




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 For the three months ended March 31,2005
    
    
    2004Net income (loss) available to common stockholders
    
    $
    3,328
    
    
    $
    (360
    )Pro forma compensation expense from stock options
    
    
    495
    
    
    
    290Pro forma net (loss) income available to common
stockholders
    
    $
    2,833
    
    
    $
    (650
    )Basic earnings (loss) per share, as reported
    
    $
    0.16
    
    
    $
    (0.03
    )Diluted earnings (loss) per share, as reported
    
    $
    0.16
    
    
    $
    (0.03
    )Basic pro forma earnings (loss) per share
    
    $
    0.14
    
    
    $
    (0.05
    )Diluted pro forma earnings (loss) per share
    
    $
    0.13
    
    
    $
    (0.05
    )
 5. Mergers and Acquisitions Acquiring free-standing psychiatric facilities is a key part of our business strategy. Because we
have grown through mergers and acquisitions accounted for as purchases, it is difficult to make
meaningful comparisons between our financial statements for the fiscal periods presented. On June 30, 2004, we completed the acquisition of substantially all of the assets of Alliance
Behavioral Health Group (Alliance Behavioral), a system of inpatient behavioral health care
facilities with 144 beds located near El Paso, Texas, for approximately $12.5 million. On June 11, 2004, we completed the acquisition of substantially all of the assets of Piedmont
Behavioral Health Center LLC (Piedmont), a 77 bed inpatient behavioral health care facility
located in Leesburg, Virginia, for approximately $10.7 million. On June 1, 2004, we completed the acquisition of four inpatient behavioral health care facilities
from Heartland Healthcare (Heartland) for approximately $49.9 million. The four inpatient
facilities, located in Summit, New Jersey, Ft. Lauderdale, Florida, Arlington, Texas and Eden
Prairie, Minnesota, have a total of 360 beds. On November 1, 2004, we purchased the real estate
housing the operations of the inpatient facility located in Summit, New Jersey for approximately
$15.9 million. On May 1, 2004, we completed the acquisition of all of the membership interests of Palmetto
Behavioral Health System, L.L.C. (Palmetto), an operator of two inpatient behavioral health care
facilities, for approximately $6.4 million. The two leased inpatient facilities, located in
Charleston and Florence, South Carolina, have 161 beds. On December 1, 2004, we purchased the real
estate of the Charleston facility for approximately $4.0 million. On March 1, 2004, we acquired two inpatient psychiatric facilities from Brentwood Behavioral Health
(Brentwood) for approximately $30.4 million cash with an earn-out of approximately $5 million
expected to be paid in the second quarter of 2005. The inpatient facilities, which have an
aggregate of 311 licensed beds, are located in Shreveport, Louisiana and Jackson, Mississippi. 6. Long-term debt Long-term debt consists of the following (in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Senior credit facility:Revolving line of credit, expiring on December 21, 2009
and bearing interest of 4.3% at March 31, 2005
    
    $
    30,000
    
    
    $
    10 5/8% senior subordinated notes
    
    
    100,000
    
    
    
    150,000Mortgage loans on facilities, maturing in 2037 and 2038
bearing fixed interest rates of 5.65% to 5.95%
    
    
    23,554
    
    
    
    23,611Subordinated seller notes with varying maturities
    
    
    144
    
    
    
    369Other
    
    
    263
    
    
    
    356153,961
    
    
    
    174,336Less current portion
    
    
    478
    
    
    
    20,764Long-term debt
    
    $
    153,483
    
    
    $
    153,572
 6




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 Senior Credit Facility On January 6, 2004, we terminated our senior credit facility with CapitalSource Finance LLC
(CapSource) and entered into a new credit agreement (the Credit Agreement) with Bank of
America, N.A. (Bank of America) that provided for a revolving credit facility of up to $50
million. As a result of the termination of our senior credit facility with CapSource, we recorded a
loss on refinancing long-term debt of $6.4 million for the quarter ended March 31, 2004, including
approximately $3.8 million paid as a termination fee to CapSource. On December 21, 2004, our credit
agreement with Bank of America was amended and restated to provide for a revolving credit facility
of up to $150 million. Our credit facility with Bank of America is secured by substantially all of
the personal property owned by us or our subsidiaries, substantially all real property owned by us
or our subsidiaries that has a value in excess of $2.5 million and the stock of our operating
subsidiaries. In addition, the credit facility is fully and unconditionally guaranteed by
substantially all of our operating subsidiaries. The revolving line of credit accrues interest at
our choice of the Base Rate or the Eurodollar Rate (as defined in the Credit Agreement) and is
due December 21, 2009. The Base Rate and Eurodollar Rate fluctuate based upon market rates and
certain leverage ratios, as defined in the Credit Agreement. At March 31, 2005, we had $30 million
in borrowings outstanding under the revolving credit facility. Until the maturity date, we may
borrow, repay and re-borrow an amount not to exceed $150 million. We pay a quarterly commitment fee
of 0.5% per annum on the unused portion of our
revolving credit facility. Prior to the execution of the amended and restated credit agreement on
December 21, 2004, we were required to pay a utilization fee of 0.25% per annum on the unused
portion of the revolving credit facility when the balance of outstanding borrowings under the
revolving credit facility was less than one-third of the borrowings allowed under the agreement.
Commitment and utilization fees were approximately $150,000 for the three months ended March 31,
2005. Our revolving credit facility contains customary covenants that include: (1) a limitation on
capital expenditures and investments, sales of assets, mergers, changes of ownership, new principal
lines of business, indebtedness, dividends and redemptions; (2) various financial covenants; and
(3) cross-default covenants triggered by a default of any other indebtedness of at least $3.0
million. As of March 31, 2005, we were in compliance with all debt covenant requirements. If we
violate one or more of these covenants, amounts outstanding under the revolving credit facility
could become immediately payable and additional borrowings could be restricted. 10 5/8% Senior Subordinated Notes On June 30, 2003, we issued $150 million in 10 5/8% senior subordinated notes, which are fully and
unconditionally guaranteed on a senior subordinated basis by substantially all of our existing
operating subsidiaries. Proceeds from the issuance of the senior subordinated notes and the
issuance of $12.5 million in series A convertible preferred stock were used to finance the
acquisition of Ramsay Youth Services (Ramsay) and pay down substantially all of our previously
existing long-term debt. Interest on the senior subordinated notes accrues at the rate of 10.625%
per annum and is payable semi-annually in arrears on June 15 and December 15, commencing on
December 15, 2003. The senior subordinated notes will mature on June 15, 2013. On January 14, 2005, we redeemed $50 million of our 10 5/8% senior subordinated notes and paid a 10
5/8% penalty and related accrued interest on the amount redeemed. We borrowed $30 million under our
revolving line of credit and used cash on hand for the remainder of the redemption. We classified
$20 million of the 10 5/8% senior subordinated notes as current portion of long-term debt on
December 31, 2004. Mortgage Loans During 2002 and 2003, we borrowed approximately $23.8 million under mortgage loan agreements
insured by the U.S. Department of Housing and Urban Development (HUD). These mortgage loans are
secured by real estate located at Holly Hill Hospital in Raleigh, North Carolina, West Oaks
Hospital in Houston, Texas, and Riveredge Hospital near Chicago, Illinois. Interest accrues on the
Holly Hill, West Oaks and Riveredge HUD loans at 5.95%, 5.85% and 5.65%, respectively, and
principal and interest are payable in 420 monthly installments through December 2037, September
2038 and December 2038, respectively. The carrying amount of assets held as collateral approximated
$22 million as of March 31, 2005. Subordinated Seller Notes In connection with an acquisition in 2000, we issued a promissory note payable in the amount of
$400,000 bearing interest at 9% for the year ended December 31,
2000. Principal on this note was
payable in five equal annual installments beginning April 1,
2001. Accrued interest was due and
payable on the first day of each calendar quarter beginning July 1, 2000. We paid the remaining
principal balance of $80,000 in the first quarter of 2005. In connection with an acquisition in 2001, we issued a promissory note of $2.0 million that bears
interest at 9% per annum and matures June 30, 2005. The principal amount we owe on this note is
approximately $144,000 at March 31, 2005. 7




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 These subordinated seller notes contain customary covenants which include a cross-default covenant
with the occurrence of a default of any indebtedness of at least $1,000,000 held by any creditor.
As of March 31, 2005, we were in compliance with these covenants. 7. Income Taxes The provision recorded for the three months ended March 31, 2005 and 2004 reflects an effective tax
rate of approximately 39% and 38%, respectively. The increase in the effective tax rate is due to
an increase in our overall effective state income tax rate. 8. Discontinued Operations SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires that all
components of an entity that have been disposed of (by sale, by abandonment or in a distribution to
owners) or are held for sale and whose cash flows can be clearly distinguished from the rest of the
entity be presented as discontinued operations. During 2004, we exited three of our contracts to
manage state-owned facilities in Florida. Accordingly, the operations of these contracts, net of
applicable income taxes, have been presented as discontinued operations and prior period
consolidated financial statements have been reclassified. The components of loss from discontinued operations, net of taxes, are as follows (in thousands): Three Months EndedMarch 31, 2004Revenue
    
    $
    4,155Salaries, wages and employee benefits
    
    
    3,289Professional fees
    
    
    365Supplies
    
    
    361Rentals and leases
    
    
    16Other operating expenses
    
    
    346Depreciation and amortization
    
    
    104,387Loss from discontinued operations before income taxes
    
    
    (232
    )Benefit from income taxes
    
    
    (88
    )Loss from discontinued operations, net of income taxes
    
    $
    (144
    )
 9. Disclosures About Reportable Segments In accordance with the criteria of SFAS No. 131, Disclosures About Segments of an Enterprise and
Related Information, we operate two reportable segments: (1) owned and leased facilities and (2)
management contracts. Each of our inpatient facilities and inpatient management contracts qualifies
as an operating segment under SFAS No. 131; however, none is individually material. We have
aggregated our operations into two reportable segments based on characteristics of the services
provided. As of March 31, 2005, the owned and leased facilities segment provides inpatient mental
and behavioral health services in its 27 owned and 7 leased facilities in 19 states. The management
contracts segment provides inpatient psychiatric management and development services to 41
behavioral health units in third party medical/surgical hospitals and clinics in 16 states and
provides mental and behavioral health services to 8 inpatient facilities for state government
agencies. Activities classified as Corporate and Other in the following schedule relate primarily
to unallocated home office items. Adjusted EBITDA is a non-GAAP financial measure and is defined as net income (loss) before interest
expense (net of interest income), income taxes, depreciation, amortization, stock compensation and
other items included in the caption labeled Other expenses. These other expenses may occur in
future periods, but the amounts recognized can vary significantly from period to period and do not
directly relate to the ongoing operations of our health care facilities. Our management relies on
adjusted EBITDA as the primary measure to review and assess the operating performance of our
inpatient facilities and their management teams. We believe it is useful to investors to provide
disclosures of our operating results on the same basis as that used by management. Management and
investors also review adjusted EBITDA to evaluate our overall performance and to compare our
current operating results with corresponding periods and with other companies in the health care
industry. You should not consider adjusted EBITDA in isolation or as a substitute for net income,
operating cash flows or other cash flow statement data determined in accordance with accounting 8




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 principles generally accepted in the United States. Because adjusted EBITDA is not a measure of
financial performance under accounting principles generally accepted in the United States and is
susceptible to varying calculations, it may not be comparable to similarly titled measures of other
companies. The following is a financial summary by business segment for the periods indicated
(dollars in thousands): Owned andLeased
    
    
    Management
    
    
    CorporateFacilities
    
    
    Contracts
    
    
    and Other
    
    
    ConsolidatedThree months ended March 31, 2005Revenue
    
    $
    121,682
    
    
    $
    17,048
    
    
    $
    
    
    
    $
    138,730Adjusted EBITDA
    
    $
    20,597
    
    
    $
    2,750
    
    
    $
    (4,477
    )
    
    $
    18,870Interest expense
    
    
    8,298
    
    
    
    19
    
    
    
    (4,794
    )
    
    
    3,523Depreciation and amortization
    
    
    2,566
    
    
    
    193
    
    
    
    143
    
    
    
    2,902Provision for income taxes
    
    
    399
    
    
    
    
    
    
    
    1,728
    
    
    
    2,127Inter-segment expenses
    
    
    3,537
    
    
    
    615
    
    
    
    (4,152
    )
    
    
    Other expenses:Loss on refinancing long-term debt
    
    
    
    
    
    
    
    
    
    
    6,990
    
    
    
    6,990Income (loss) from continuing operations
    
    $
    5,797
    
    
    $
    1,923
    
    
    $
    (4,392
    )
    
    $
    3,328Segment assets
    
    $
    415,655
    
    
    $
    30,410
    
    
    $
    38,404
    
    
    $
    484,469
 Owned andLeased
    
    
    Management
    
    
    CorporateFacilities
    
    
    Contracts
    
    
    and Other
    
    
    ConsolidatedThree months ended March 31, 2004Revenue
    
    $
    86,560
    
    
    $
    16,870
    
    
    $
    
    
    
    $
    103,430Adjusted EBITDA
    
    $
    13,502
    
    
    $
    2,565
    
    
    $
    (2,925
    )
    
    $
    13,142Interest expense
    
    
    3,559
    
    
    
    (5
    )
    
    
    902
    
    
    
    4,456Depreciation and amortization
    
    
    1,745
    
    
    
    303
    
    
    
    59
    
    
    
    2,107Provision for (benefit from) income taxes
    
    
    662
    
    
    
    
    
    
    
    (597
    )
    
    
    65Inter-segment expenses
    
    
    2,187
    
    
    
    697
    
    
    
    (2,884
    )
    
    
    Other expenses:Loss on refinancing
long-term debt
    
    
    
    
    
    
    
    
    
    
    6,407
    
    
    
    6,407Income (loss) from continuing operations
    
    $
    5,349
    
    
    $
    1,570
    
    
    $
    (6,812
    )
    
    $
    107Segment assets
    
    $
    255,714
    
    
    $
    35,415
    
    
    $
    79,655
    
    
    $
    370,784
 10. Recent Pronouncements In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, which requires
companies to measure and recognize the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value. SFAS No. 123R eliminates the ability to
account for the award of these instruments under the intrinsic value method prescribed by APB
Opinion No. 25, and allowed under the original provisions of SFAS No. 123. On April 15, 2005, the
Securities and Exchange Commission extended the effective date of SFAS No. 123R to the first
interim reporting period of the first fiscal year beginning on or after June 15, 2005. We are
currently evaluating pricing models and the transition provisions of this standard and will begin
expensing stock options in accordance with SFAS No. 123R in the
first quarter of 2006. As a result of grants of stock options which
occurred during the first quarter of 2005, we believe the impact of
adopting SFAS No. 123R on our 2006 results will be approximately 50%
more than the annualized amount disclosed as pro forma expense for
the first quarter of 2005 in Note 4. However, because of the
uncertainty surrounding future grants and the variables necessary to
value them, actual expense recorded in
2006 upon adoption of SFAS No. 123R may differ materially. 9




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 11. Financial Information for Psychiatric Solutions and Its Subsidiaries We conduct substantially all of our business through our subsidiaries. Presented below is condensed
consolidating financial information for us and our subsidiaries as of March 31, 2005 and December
31, 2004, and for the three months ended March 31, 2005 and 2004. The information segregates the
parent company (Psychiatric Solutions, Inc.), the combined wholly-owned subsidiary guarantors, the
combined non-guarantors, and eliminations. All of the subsidiary guarantees are both full and
unconditional and joint and several. Condensed Consolidating
Balance Sheet
As of March 31, 2005
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    
    Combined Non-
    
    
    Consolidating
    
    
    ConsolidatedParent
    
    
    Guarantors
    
    
    Guarantors
    
    
    Adjustments
    
    
    AmountsCurrent Assets:Cash and cash equivalents
    

    $
    
    
    
    $
    11,001
    
    
    $
    3,499
    
    
    $
    
    
    
    $
    14,500Accounts receivable, net
    
    
    
    
    
    
    80,996
    
    
    
    
    
    
    
    
    
    
    
    80,996Prepaids and other
    
    
    
    
    
    
    13,120
    
    
    
    3,580
    
    
    
    
    
    
    
    16,700Total current assets
    
    
    
    
    
    
    105,117
    
    
    
    7,079
    
    
    
    
    
    
    
    112,196Property and equipment, net of accumulated depreciation
    
    
    
    
    
    
    198,868
    
    
    
    29,909
    
    
    
    (8,015
    )
    
    
    220,762Cost in excess of net assets acquired
    
    
    
    
    
    
    130,134
    
    
    
    
    
    
    
    
    
    
    
    130,134Investment in subsidiaries
    
    
    137,381
    
    
    
    
    
    
    
    
    
    
    
    (137,381
    )
    
    
    Other assets
    
    
    5,019
    
    
    
    12,569
    
    
    
    3,789
    
    
    
    
    
    
    
    21,377Total assets
    
    $
    142,400
    
    
    $
    446,688
    
    
    $
    40,777
    
    
    $
    (145,396
    )
    
    $
    484,469Current Liabilities:Accounts payable
    
    $
    
    
    
    $
    12,355
    
    
    $
    
    
    
    $
    
    
    
    $
    12,355Salaries and benefits payable
    
    
    
    
    
    
    28,106
    
    
    
    
    
    
    

    
    
    
    
    28,106Other accrued liabilities
    
    
    3,493
    
    
    
    21,143
    
    
    
    5,284
    
    
    
    (2,447
    )
    
    
    27,473Current portion of long-term debt
    
    
    240
    
    
    
    
    
    
    
    238
    
    
    
    
    
    
    
    478Total current liabilities
    
    
    3,733
    
    
    
    61,604
    
    
    
    5,522
    
    
    
    (2,447
    )
    
    
    68,412Long-term debt, less current portion
    
    
    130,167
    
    
    
    
    
    
    
    23,316
    
    
    
    
    
    
    
    153,483Deferred tax liability
    
    
    
    
    
    
    8,526
    
    
    
    
    
    
    
    
    
    
    
    8,526Other liabilities
    
    
    3,041
    
    
    
    (23
    )
    
    
    
    
    
    
    2,447
    
    
    
    5,465Total liabilities
    
    
    136,941
    
    
    
    70,107
    
    
    
    28,838
    
    
    
    
    
    
    
    235,886Stockholders equity:Total stockholders equity
    
    
    5,459
    
    
    
    376,581
    
    
    
    11,939
    
    
    
    (145,396
    )
    
    
    248,583Total liabilities and stockholders equity
    
    $
    142,400
    
    
    $
    446,688
    
    
    $
    40,777
    
    
    $
    (145,396
    )
    
    $
    484,469
 10




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 Condensed Consolidating Balance Sheet
As of December 31, 2004
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    
    Combined Non-
    
    
    Consolidating
    
    
    ConsolidatedParent
    
    
    Guarantors
    
    
    Guarantors
    
    
    Adjustments
    
    
    AmountsCurrent Assets:Cash and cash equivalents
    
    $
    
    
    
    $
    30,792
    
    
    $
    2,463
    
    
    $
    
    
    
    $
    33,255Accounts receivable, net
    
    
    
    
    
    
    77,539
    
    
    
    
    
    
    
    
    
    
    
    77,539Prepaids and other
    
    
    
    
    
    
    15,437
    
    
    
    975
    
    
    
    
    
    
    
    16,412Total current assets
    
    
    
    
    
    
    123,768
    
    
    
    3,438
    
    
    
    
    
    
    
    127,206Property and equipment, net of accumulated depreciation
    
    
    
    
    
    
    196,152
    
    
    
    30,155
    
    
    
    (8,076
    )
    
    
    218,231Cost in excess of net assets acquired
    
    
    
    
    
    
    130,079
    
    
    
    
    
    
    
    
    
    
    
    130,079Investment in subsidiaries
    
    
    160,065
    
    
    
    
    
    
    
    
    
    
    
    (160,065
    )
    
    
    Other assets
    
    
    6,791
    
    
    
    11,974
    
    
    
    3,565
    
    
    
    
    
    
    
    22,330Total assets
    
    $
    166,856

    
    
    $
    461,973
    
    
    $
    37,158
    
    
    $
    (168,141
    )
    
    $
    497,846Current Liabilities:Accounts payable
    
    $
    
    
    
    $
    10,529
    
    
    $
    
    
    
    $
    
    
    
    $
    10,529Salaries and benefits payable
    
    
    
    
    
    
    27,355
    
    
    
    
    
    
    
    
    
    
    
    27,355Other accrued liabilities
    
    
    1,162
    
    
    
    27,383
    
    
    
    1,682
    
    
    
    (1,559
    )
    
    
    28,668Current portion of long-term debt
    
    
    20,529
    
    
    
    
    
    
    
    235
    
    
    
    
    
    
    
    20,764Total current liabilities
    
    
    21,691
    
    
    
    65,267
    
    
    
    1,917
    
    
    
    (1,559
    )
    
    
    87,316Long-term debt, less current portion
    
    
    130,195
    
    
    
    
    
    
    
    23,377
    
    
    
    
    
    
    
    153,572Deferred tax liability
    
    
    
    
    
    
    8,020
    
    
    
    
    
    
    
    
    
    
    
    8,020Other liabilities
    
    
    3,325
    
    
    
    (461
    )
    
    
    
    
    
    
    1,559
    
    
    
    4,423Total liabilities
    
    
    155,211
    
    
    
    72,826
    
    
    
    25,294
    
    
    
    
    
    
    
    253,331Stockholders equity:Total stockholders equity
    
    
    11,645
    
    
    
    389,147
    
    
    
    11,864
    
    
    
    (168,141
    )
    
    
    244,515Total liabilities and stockholders equity
    
    $
    166,856
    
    
    $
    461,973
    
    
    $
    37,158
    
    
    $
    (168,141
    )
    
    $
    497,846
 Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2005
(Dollars in thousands) Combined
    
    
    Combined
    
    
    
    
    
    
    TotalSubsidiary
    
    
    Non-
    
    
    Consolidating
    
    
    ConsolidatedParent
    
    
    Guarantors
    
    
    Guarantors
    
    
    Adjustments
    
    
    AmountsRevenue
    
    $
    
    
    
    $
    138,730
    
    
    $
    1,626
    
    
    $
    (1,626
    )
    
    $
    138,730Salaries, wages and employee benefits
    
    
    
    
    
    
    76,367
    
    
    
    
    
    
    
    
    
    
    
    76,367Professional fees
    
    
    
    
    
    
    14,215
    
    
    
    41
    
    
    
    
    
    
    
    14,256Supplies
    
    
    
    
    
    
    8,584
    
    
    
    
    
    
    
    
    
    
    
    8,584Rentals and leases
    
    
    
    
    
    
    2,340
    
    
    
    
    
    
    
    
    
    
    
    2,340Other operating expenses
    
    
    
    
    
    
    15,642
    
    
    
    891
    
    
    
    (888
    )
    
    
    15,645Provision for doubtful accounts
    
    
    
    
    
    
    2,668
    
    
    
    
    
    
    
    
    
    
    
    2,668Depreciation and amortization
    
    
    
    
    
    
    2,717
    
    
    
    246
    
    
    
    (61
    )
    
    
    2,902Interest expense
    
    
    3,150
    
    
    
    
    
    
    
    373
    
    
    
    
    
    
    
    3,523Loss on refinancing of long-term debt
    
    
    6,990
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,99010,140
    
    
    
    122,533
    
    
    
    1,551
    
    
    
    (949
    )
    
    
    133,275(Loss) income before income taxes
    
    
    (10,140
    )
    
    
    16,197
    
    
    
    75
    
    
    
    (677
    )
    
    
    5,455(Benefit from) provision for income taxes
    
    
    (3,954
    )
    
    
    6,081
    
    
    
    
    
    
    
    
    
    
    
    2,127Net (loss) income
    
    $
    (6,186
    )
    
    $
    10,116
    
    
    $
    75
    
    
    $
    (677
    )
    
    $
    3,328
 11




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2004
(Dollars in thousands) Combined
    
    
    Combined
    
    
    
    
    
    
    TotalSubsidiary
    
    
    Non-
    
    
    Consolidating
    
    
    ConsolidatedParent
    
    
    Guarantors
    
    
    Guarantors
    
    
    Adjustments
    
    
    AmountsRevenue
    
    $
    
    
    
    $
    103,430
    
    
    $
    892
    
    
    $
    (892
    )
    
    $
    103,430Salaries, wages and employee benefits
    
    
    
    
    
    
    55,707
    
    
    
    
    
    
    
    
    
    
    
    55,707Professional fees
    
    
    
    
    
    
    11,691
    
    
    
    
    
    
    
    
    
    
    
    11,691Supplies
    
    
    
    
    
    
    6,580
    
    
    
    
    
    
    
    
    
    
    
    6,580Rentals and leases
    
    
    
    
    
    
    1,767
    
    
    
    
    
    
    
    
    
    
    
    1,767Other operating expenses
    
    
    310
    
    
    
    13,098
    
    
    
    
    
    
    
    (892
    )
    
    
    12,516Provision for doubtful accounts
    
    
    
    
    
    
    2,027
    
    
    
    
    
    
    
    
    
    
    
    2,027Depreciation and amortization
    
    
    
    
    
    
    1,866
    
    
    
    241
    
    
    
    
    
    
    
    2,107Interest expense
    
    
    4,085
    
    
    
    
    
    
    
    371
    
    
    
    
    
    
    
    4,456Loss on refinancing of long-term debt
    
    
    6,407
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,40710,802
    
    
    
    92,736
    
    
    
    612
    
    
    
    (892
    )
    
    
    103,258(Loss) income from continuing operations before
income taxes
    
    
    (10,802
    )
    
    
    10,694
    
    
    
    280
    
    
    
    
    
    
    
    172Provision for income taxes
    
    
    
    
    
    
    65
    
    
    
    
    
    
    
    
    
    
    
    65(Loss) income from continuing operations
    
    
    (10,802
    )
    
    
    10,629
    
    
    
    280
    
    
    
    
    
    
    
    107Loss from discontinued operations
    
    
    
    
    
    
    (144
    )
    
    
    
    
    
    
    
    
    
    
    (144
    )Net (loss) income
    
    
    (10,802
    )
    
    
    10,485
    
    
    
    280
    
    
    
    
    
    
    
    (37
    )Accrued preferred stock dividends
    
    
    
    
    
    
    323
    
    
    
    
    
    
    
    
    
    
    
    323Net (loss) income available to common shareholders
    
    $
    (10,802
    )
    
    $
    10,162
    
    
    $
    280
    
    
    $
    
    
    
    $
    (360
    )
 12




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2005
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    
    Combined Non-
    
    
    Consolidating
    
    
    ConsolidatedParent
    
    
    Guarantors
    
    
    Guarantors
    
    
    Adjustments
    
    
    AmountsOperating Activities:Net (loss) income
    
    $
    (6,186
    )
    
    $
    10,116
    
    
    $
    75
    
    
    $
    (677
    )
    
    $
    3,328Adjustments to reconcile net (loss) income to net
cash provided by (used in) operating activities:Depreciation and amortization
    
    
    
    
    
    
    2,717
    
    
    
    246
    
    
    
    (61
    )
    
    
    2,902Provision for doubtful accounts
    
    
    
    
    
    
    2,668
    
    
    
    
    
    
    
    
    
    
    
    2,668Amortization of loan costs
    
    
    163
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    174Loss on refinancing long-term debt
    
    
    6,990
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,990Change in income tax assets and liabilities
    
    
    
    
    
    
    (3,169
    )
    
    
    
    
    
    
    
    
    
    
    (3,169
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    
    
    
    
    (6,125
    )
    
    
    
    
    
    
    
    
    
    
    (6,125
    )Prepaids and other current assets
    
    
    
    
    
    
    1,877
    
    
    
    (2,605
    )
    
    
    
    
    
    
    (728
    )Accounts payable
    
    
    
    
    
    
    1,826
    
    
    
    
    
    
    
    
    
    
    
    1,826Accrued liabilities and other liabilities
    
    
    2,047
    
    
    
    (176
    )
    
    
    3,601
    
    
    
    
    
    
    
    5,472Net cash provided by (used in) continuing operating activities
    
    
    3,014
    
    
    
    9,734
    
    
    
    1,328
    
    
    
    (738
    )
    
    
    13,338Investing Activities:Acquisitions, net of cash acquired
    
    
    (500
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (500
    )Capital purchases of property and equipment
    
    
    
    
    
    
    (5,255
    )
    
    
    
    
    
    
    
    
    
    
    (5,255
    )Investment in equity method investee
    
    
    (840
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (840
    )Other assets
    
    
    
    
    
    
    (247
    )
    
    
    (235
    )
    
    
    
    
    
    
    (482
    )Net cash used in investing activities
    
    
    (1,340
    )
    
    
    (5,502
    )
    
    
    (235
    )
    
    
    
    
    
    
    (7,077
    )Financing Activities:Net principal payments on long-term debt
    
    
    (20,318
    )
    
    
    
    
    
    
    (57
    )
    
    
    
    
    
    
    (20,375
    )Net transfers to and from members
    
    
    24,089
    
    
    
    (24,827
    )
    
    
    
    
    
    
    738
    
    
    
    Refinancing of long-term debt
    
    
    (5,316
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,316
    )Payment of loan and issuance costs
    
    
    (129
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (129
    )Proceeds from issuance of common stock
    
    
    
    
    
    
    804
    
    
    
    
    
    
    
    
    
    
    
    804Net cash (used in) provided by financing activities
    
    
    (1,674
    )
    
    
    (24,023
    )
    
    
    (57
    )

    
    
    738
    
    
    
    (25,016
    )Net (decrease) increase in cash
    
    
    
    
    
    
    (19,791
    )
    
    
    1,036
    
    
    
    
    
    
    
    (18,755
    )Cash and cash equivalents at beginning of period
    
    
    
    
    
    
    30,792
    
    
    
    2,463
    
    
    
    
    
    
    
    33,255Cash and cash equivalents at end of period
    
    $
    
    
    
    $
    11,001
    
    
    $
    3,499
    
    
    $
    
    
    
    $
    14,500
 13




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2005 Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2004
(Dollars in thousands) Combined
    
    
    Combined
    
    
    
    
    
    
    TotalSubsidiary
    
    
    Non-
    
    
    Consolidating
    
    
    ConsolidatedParent
    
    
    Guarantors
    
    
    Guarantors
    
    
    Adjustments
    
    
    AmountsOperating Activities:Net (loss) income
    
    $
    (10,802
    )
    
    $
    10,485
    
    
    $
    280
    
    
    $
    
    
    
    $
    (37
    )Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:Loss from discontinued operations
    
    
    
    
    
    
    144
    
    
    
    
    
    
    
    
    
    
    
    144Depreciation and amortization
    
    
    
    
    
    
    1,866
    
    
    
    241
    
    
    
    
    
    
    
    2,107Provision for doubtful accounts
    
    
    
    
    
    
    2,027
    
    
    
    
    
    
    
    
    
    
    
    2,027Amortization of loan costs
    
    
    190
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    199Loss on refinancing long-term debt
    
    
    6,407
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,407Change in income tax assets and liabilities
    
    
    
    
    
    
    (187
    )
    
    
    
    
    
    
    
    
    
    
    (187
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    
    
    
    
    (3,497
    )
    
    
    
    
    
    
    
    
    
    
    (3,497
    )Prepaids and other current assets
    
    
    
    
    
    
    1,649
    
    
    
    338
    
    
    
    
    
    
    
    1,987Accounts payable
    
    
    
    
    
    
    (2,249
    )
    
    
    
    
    
    
    
    
    
    
    (2,249
    )Accrued liabilities and other liabilities
    
    
    3,801
    
    
    
    4,022
    
    
    
    (3
    )
    
    
    
    
    
    
    7,820Net cash (used in) provided by operating activities
    
    
    (404
    )
    
    
    14,260
    
    
    
    865
    
    
    
    
    
    
    
    14,721Investing Activities:Acquisitions, net of cash acquired
    
    
    (29,861
    )
    
    
    (3,350
    )
    
    
    
    
    
    
    
    
    
    
    (33,211
    )Capital purchases of property and equipment
    
    
    
    
    
    
    (3,055
    )
    
    
    
    
    
    
    
    
    
    
    (3,055
    )Other assets
    
    
    
    
    
    
    (674
    )
    
    
    (590
    )
    
    
    
    
    
    
    (1,264
    )Net used in investing activities
    
    
    (29,861
    )
    
    
    (7,079
    )
    
    
    (590
    )
    
    
    
    
    
    
    (37,530
    )Financing Activities:Net principal borrowings (payments) on long-term debt
    
    
    16,910
    
    
    
    
    
    
    
    (54
    )
    
    
    
    
    
    
    16,856Net transfers to and from members
    
    
    16,810
    
    
    
    (16,758
    )
    
    
    (52
    )
    
    
    
    
    
    
    Payment of loan and issuance costs
    
    
    (987
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (987
    )Refinancing of long-term debt
    
    
    (2,572
    )
    
    
    (1,272
    )
    
    
    
    
    
    
    
    
    
    
    (3,844
    )Proceeds from issuance of common stock
    
    
    104
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104Net cash provided by (used in) financing activities
    
    
    30,265
    
    
    
    (18,030
    )
    
    
    (106
    )
    
    
    
    
    
    
    12,129Net (decrease) increase in cash
    
    
    
    
    
    
    (10,849
    )
    
    
    169
    
    
    
    
    
    
    
    (10,680
    )Cash at beginning of period
    
    
    
    
    
    
    43,456
    
    
    
    1,498
    
    
    
    
    
    
    
    44,954Cash at end of period
    
    $
    
    
    
    $
    32,607
    
    
    $
    1,667
    
    
    $
    
    
    
    $
    34,274
 14




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. This Quarterly Report onForm 10-Qcontains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements include statements regarding the intent,
belief or current expectations of Psychiatric Solutions and its management. Such forward-looking
statements are not guarantees of future performance and involve risks and uncertainties that may
cause our actual results to differ materially from the results discussed in the forward-looking
statements. Risks and uncertainties that might cause such differences include, but are not limited
to: (1) our ability to complete the acquisition of 20 inpatient psychiatric facilities from Ardent
Health Services LLC; (2) potential competition that alters or impedes our acquisition strategy by
decreasing our ability to acquire additional facilities on favorable terms; (3) our ability to
improve the operations of acquired facilities; (4) our ability to maintain favorable and continuing
relationships with physicians who use our facilities; (5) our ability to receive timely additional
financing on terms acceptable to us to fund our acquisition strategy and capital expenditure needs;
(6) risks inherent to the health care industry, including the impact of unforeseen changes in
regulation, reimbursement rates from federal and state health care programs or managed care
companies and exposure to claims and legal actions by patients and others; and (7) potential
difficulties in integrating our operations with recently acquired operations, including the
inpatient psychiatric facilities to be acquired from Ardent Health Services LLC. The
forward-looking statements herein are qualified in their entirety by the risk factors set forth in
our filings with the Securities and Exchange Commission, including the factors listed in our Annual
Report onForm 10-Kfiled on March 15, 2005 under the caption Risk Factors. A copy of our filings
may be obtained from the Public Reference Room of the Securities and Exchange Commission at 450
Fifth Street NW, Washington, D.C. at prescribed rates. Overview On March 10, 2005, we entered into a Stock Purchase Agreement with Ardent Health Services LLC,
a Delaware limited liability company (Seller), and Ardent Health Services, Inc., a Delaware
corporation and wholly-owned subsidiary of Seller (AHS), pursuant to which we will acquire all of
the outstanding capital stock of AHS for approximately $560 million. AHS owns and operates through
its subsidiaries 20 inpatient behavioral health care facilities, which include approximately 2,000
inpatient beds and generated approximately $300 million in revenues in 2004. It is anticipated that
the acquisition will close during the second quarter of 2005. With the acquisition of AHS, we will
increase our inpatient facility operations to 54 facilities and over 6,000 licensed beds. We
believe that our singular focus on the provision of behavioral health care services allows us to
operate more efficiently and provide higher quality care than our competitors. Our business is
characterized by diverse sources of revenue, stable cash flows and low capital expenditure
requirements. Our business strategy is to acquire inpatient behavioral health care facilities and improve
operating results within new and existing inpatient facilities and our other managed inpatient
behavioral health care operations. We completed our first significant acquisition in 2000 when we
acquired Sunrise Behavioral Health, Ltd. and its inpatient behavioral health care management
contracts. We continued implementing our acquisition strategy in 2001 with the acquisition of four
inpatient behavioral health care facilities. In 2002, we acquired one inpatient behavioral health
care facility and merged with PMR Corporation, a public company and operator of inpatient
behavioral health care management contracts. 2003 marked our largest acquisitions to date with the
purchase of six inpatient behavioral health care facilities from The Brown Schools, Inc., the
acquisition of Ramsay Youth Services, Inc. (Ramsay), an operator of 11 owned or leased inpatient
behavioral health care facilities and 10 contracts to manage inpatient behavioral health care
facilities for certain state governmental agencies, and the acquisitions of two other inpatient
behavioral health care facilities from other sellers. In 2004, we acquired 10 inpatient behavioral
health care facilities in five separate transactions, the most significant being the acquisition of
four inpatient behavioral health care facilities from Heartland Healthcare (Heartland). We strive to improve the operating results of new and existing inpatient behavioral health
care operations by providing the highest quality service, expanding referral networks and marketing
initiatives and meeting increased demand for our services by expanding our services and developing
new services. We also improve operating results by optimizing staffing ratios, controlling contract
labor costs and reducing supply costs through group purchasing. During the first quarter of 2005,
our same-facility revenue from owned and leased inpatient facilities increased by 6.4% as compared
to our first quarter of 2004. Same-facility growth also produced gains in owned and leased
inpatient facility patient days of 5.4% in the first quarter of 2005 as compared to the first
quarter of 2004. Same-facility growth refers to the comparison of each inpatient facility owned
during 2004 with the comparable period in 2005. 15




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##### Table of Contents



Sources of Revenue Patient Service Revenue Patient service revenue is generated by our inpatient facilities as a result of services
provided to patients on an inpatient and outpatient basis within the inpatient behavioral health
care facility setting. Patient service revenue is reported on an accrual basis in the period in
which services are rendered, at established rates, regardless of whether collection in full is
expected. Patient service revenue includes amounts estimated by management to be reimbursable by
Medicare and Medicaid under provisions of cost or prospective reimbursement formulas in effect.
Amounts received are generally less than the established billing rates of the inpatient facilities
and the differences are reported as deductions from patient service revenue at the time the service
is rendered. For the three months ended March 31, 2005, patient service revenue comprised
approximately 88% of our total revenue. Management Fee Revenue Management contract revenue is earned by our inpatient management contract division. The
inpatient management contract division receives contractually determined management fees from
hospitals and clinics for providing psychiatric unit management and development services as well as
management fees for managing inpatient behavioral health care facilities for government agencies.
For the three months ended March 31, 2005, management contract revenue comprised approximately 12%
of our total revenue. Results of Operations The following table sets forth, for the periods indicated, our operating results (dollars in
thousands): Three Months Ended March 31,2005
    
    
    2004Amount
    
    
    %
    
    
    Amount
    
    
    %Revenue
    
    $
    138,730
    
    
    
    100.0
    %
    
    $
    103,430
    
    
    
    100.0
    %Salaries, wages, and employee benefits
    
    
    76,367
    
    
    
    55.1
    %
    
    
    55,707
    
    
    
    53.8
    %Professional fees
    
    
    14,256
    
    
    
    10.3
    %
    
    
    11,691
    
    
    
    11.3
    %Supplies
    

    
    8,584
    
    
    
    6.2
    %
    
    
    6,580
    
    
    
    6.4
    %Provision for bad debts
    
    
    2,668
    
    
    
    1.9
    %
    
    
    2,027
    
    
    
    2.0
    %Other operating expenses
    
    
    17,985
    
    
    
    13.0
    %
    
    
    14,283
    
    
    
    13.8
    %Depreciation and amortization
    
    
    2,902
    
    
    
    2.1
    %
    
    
    2,107
    
    
    
    2.0
    %Interest expense, net
    
    
    3,523
    
    
    
    2.5
    %
    
    
    4,456
    
    
    
    4.3
    %Other expenses:Loss on refinancing long-term debt
    
    
    6,990
    
    
    
    5.0
    %
    
    
    6,407
    
    
    
    6.2
    %Income from continuing operations
before income taxes
    
    
    5,455
    
    
    
    3.9
    %
    
    
    172
    
    
    
    0.2
    %Provision for income taxes
    
    
    2,127
    
    
    
    1.5
    %
    
    
    65
    
    
    
    0.1
    %Income from continuing operations
    
    $
    3,328
    
    
    
    2.4
    %
    
    $
    107
    
    
    
    0.1
    %
 Three Months Ended March 31,2005
    
    
    2004
    
    
    % ChangeConsolidated:Number of facilities at period end
    
    
    34
    
    
    
    26
    
    
    
    30.8
    %Admissions
    
    
    14,836
    
    
    
    10,231
    
    
    
    45.0
    %Patient days
    
    
    277,527
    
    
    
    211,563
    
    
    
    31.2
    %Same-facility (1):Number of facilities at period end
    
    
    26
    
    
    
    26
    
    
    
    0.0
    %Admissions
    
    
    10,229
    
    
    
    10,231
    
    
    
    0.0
    %Patient days
    
    
    222,935
    
    
    
    211,563
    
    
    
    5.4
    %
   (1)
    
    For the three months ended March 31, 2005, includes statistics of
facilities that had operations in the comparable period of 2004. 16




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##### Table of Contents



Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 Revenue. Revenue from continuing operations was $138.7 million for the three months ended
March 31, 2005 compared to $103.4 million for the three months ended March 31, 2004, an increase of
$35.3 million or 34.1%. Revenue from our owned and leased inpatient facilities segment accounted
for $121.7 million of the 2005 results compared to $86.6 million of the 2004 results, an increase
of $35.1 million or 40.6%. The increase in revenues from our owned and leased inpatient facilities
segment relates primarily to revenue generated by facilities acquired in 2004. Acquisitions
accounted for the following increases in revenue during 2005 as compared to 2004: $5.8 million for
Brentwood Behavioral Health (Brentwood), $12.9 million for Heartland and $10.9 million for other
acquisitions during 2004. The remainder of the increase in revenues from owned and leased inpatient
facilities is primarily attributable to same-facility growth in patient days of 5.4%. Revenue from
our inpatient management contracts segment accounted for $17.0 million of the 2005 results compared
to $16.9 million of the 2004 results. Salaries, wage, and employee benefits. Salaries, wages and employee benefits (SWB) expense
was $76.4 million for the three months ended March 31, 2005, or 55.1% of our total revenue,
compared to $55.7 million for the three months ended March 31, 2004, or 53.8% of our total revenue.
SWB expense for our owned and leased inpatient facilities segment was $66.0 million in 2005, or
54.2% of segment revenue. Same-facility SWB expense for our owned and leased inpatient facilities
segment was $49.9 million in 2005, or 54.2% of segment revenue, compared to $46.4 million in 2004,
or 53.6% of segment revenue. This increase in SWB expense as a percent of segment revenue was
primarily the result of the hiring of additional employees to replace tasks formerly performed on a
contract basis. Contract labor costs, included in professional fees in our condensed
consolidated statement of income, were 1.9% of segment revenue on a
same-facility basis in 2005 compared to 3.2% of segment revenue in
2004. SWB
expense for our inpatient management contracts segment was $7.6 million in 2005 compared to $7.5
million in 2004. SWB expense for our corporate office was $2.8 million for 2005 compared to $1.7
million for 2004 as the result of the hiring of additional staff necessary to manage the inpatient
facilities and inpatient management contracts acquired during 2004. Professional fees. Professional fees were $14.3 million for the three months ended March 31,
2005, or 10.3% of our total revenue, compared to $11.7 million for the three months ended March 31,
2004, or 11.3% of our total revenue. Professional fees for our owned and leased inpatient
facilities segment were $12.3 million in 2005, or 10.1% of segment revenue. Same-facility
professional fees for our owned and leased inpatient facilities segment were $9.6 million in 2005,
or 10.5% of segment revenue, compared to $10.0 million in 2004, or 11.6% of segment revenue. This
decrease in same-facility professional fees as a percent of revenue was primarily the result of the
hiring of additional employees to replace tasks formerly performed on
a contract basis, as discussed in SWB. Professional fees for our
inpatient management contracts segment were $1.2 million in 2005 and in 2004. Professional fees for
our corporate office were approximately $800,000 in 2005 compared to approximately $500,000 in
2004. The increase in professional fees in our corporate office relates to accounting, legal and
other services required to meet the needs of a public company and achieving our acquisition
strategy. Supplies.Supplies expense was $8.6 million for the three months ended March 31, 2005, or 6.2%
of our total revenue, compared to $6.6 million for the three months ended March 31, 2004, or 6.4%
of our total revenue. Supplies expense for our owned and leased inpatient facilities segment was
$8.1 million in 2005, or 6.6% of segment revenue. Same-facility supplies expense for our owned and
leased inpatient facilities segment was $6.3 million in 2005, or 6.8% of segment revenue, compared
to $6.0 million in 2004, or 7.0% of segment revenue. Supplies expense for our inpatient management
contracts segment was approximately $500,000 in 2005 and in 2004. Supplies expense for our
corporate office consists of office supplies and is negligible to supplies expense overall. Provision for bad debts. The provision for bad debts was $2.7 million for the three months
ended March 31, 2005, or 1.9% of our total revenue, compared to $2.0 million for the three months
ended March 31, 2004, or 2.0% of our total revenue. The provision for bad debts at our owned and
leased inpatient facilities segment comprises the majority of our provision for bad debts as a
whole. Other operating expenses. Other operating expenses were approximately $18.0 million for the
three months ended March 31, 2005, or 13.0% of our total revenue, compared to $14.3 million for the
three months ended March 31, 2004, or 13.8% of our total revenue. Other operating expenses for our
owned and leased inpatient facilities segment were $12.1 million in 2005, or 9.9% of segment
revenue. Same-facility other operating expenses for our owned and leased inpatient facilities
segment were $8.9 million in 2005, or 9.7% of segment revenue, compared to $8.7 million in 2004, or
10.0% of segment revenue. Other operating expenses for our inpatient management contracts segment
were $5.0 million in 2005 compared to $4.9 million in 2004. Other operating expenses at our
corporate office increased to approximately $900,000 in 2005 from approximately $700,000 in 2004. Depreciation and amortization. Depreciation and amortization expense was $2.9 million for the
three months ended March 31, 2005 compared to $2.1 million for the three months ended March 31,
2004, an increase of approximately $800,000. This increase in depreciation and amortization expense
is primarily the result of the numerous acquisitions of inpatient facilities during 2004. Interest expense. Interest expense was $3.5 million for the three months ended March 31, 2005
compared to $4.5 million for the 17




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##### Table of Contents



three months ended March 31, 2004, a decrease of approximately
$1.0 million or 20.9%. The decrease in interest expense is primarily attributable to the redemption
of $50 million of our 10 5/8% senior subordinated notes on January 14, 2005. Other expenses.Other expenses totaled $7.0 million for the three months ended March 31, 2005
compared to $6.4 million for the three months ended March 31, 2004. Other expenses in 2005 and 2004
were losses on the refinancing of our long-term debt. Loss from discontinued operations, net of taxes. The loss from discontinued operations (net of
income tax effect) of approximately $144,000 for the three months ended March 31, 2004 is from the
operations of three contracts to manage inpatient facilities for the Florida Department of Juvenile
Justice. These contracts were assumed in the Ramsay acquisition in 2003 and exited in 2004. Liquidity and Capital Resources As of March 31, 2005, we had working capital of $43.8 million, including cash and cash
equivalents of $14.5 million, compared to working capital of $39.9 million at December 31, 2004.
The increase in working capital is primarily due to cash provided by operating activities offset by
cash used in investing activities during the three months ended March 31, 2005. Cash provided by operating activities was $13.3 million for the three months ended March 31,
2005 compared to $14.7 million for the three months ended March 31, 2004. The decrease in cash
flows from operating activities was primarily due to cash paid for income taxes during 2005 of
approximately $5.3 million offset by cash generated by our facilities acquired in 2004. Cash used in investing activities was $7.1 million for the three months ended March 31, 2005
compared to $37.5 million for the three months ended March 31, 2004. Cash used in investing
activities for the three months ended March 31, 2005 was primarily the result of cash paid for the
purchases of property and equipment of approximately $5.3 million. Cash used in investing
activities for the three months ended March 31, 2004 was the result of $29.8 million paid for the
acquisition of Brentwood, $3.3 million used to make the final payment on a prior-year acquisition
and $3.1 million used for capital expenditures. Cash used in financing activities was approximately $25.0 million for the three months ended
March 31, 2005 compared to cash provided by financing activities of approximately $12.1 million for
the three months ended March 31, 2004. Cash used by financing activities for the three months ended
March 31, 2005 consisted primarily of $50.0 million used to redeem a portion of our 10 5/8% senior
subordinated notes, offset by $30.0 million borrowed under our revolving line of credit to make the
redemption. As part of this redemption, we paid $5.3 million during the first quarter of 2005 for
its associated costs. Cash provided by financing activities for the three months ended March 31,
2004 was primarily the result of $17.0 million borrowed under our revolving line of credit to
purchase Brentwood, offset by cash paid to exit our credit facility with CapitalSource Finance LLC
of approximately $3.8 million. On January 14, 2005, we redeemed $50 million of our 10 5/8% senior subordinated notes, leaving
$100 million outstanding after the redemption. We paid bondholders a 10 5/8% penalty and accrued
interest in connection with the redemption and recorded a loss on refinancing long-term debt of
approximately $7.0 million during the first quarter of 2005. We paid the redemption with borrowings
under our revolving credit facility of $30 million and the remainder with cash on hand. On December 21, 2004, we amended and restated our revolving credit facility with Bank of
America, N.A. (Bank of America) to increase the borrowings available to us to $150 million,
extend the term of the agreement until December 2009 and lower the applicable interest rate, as
defined in the credit agreement. We initially entered into a revolving credit facility with Bank of
America of up to $50 million on January 6, 2004. We subsequently amended and increased the
revolving credit facility to $125 million in June 2004. On December 20, 2004, we closed on the sale of 3,450,000 shares of our common stock at $33.70
per share. Of these shares, 450,000 were sold through the full exercise of the underwriters
over-allotment option. We sold 3,285,000 shares for approximately $105 million after underwriting
discounts and other issuance costs. Certain stockholders sold 165,000 shares in the offering. We
did not receive any proceeds from the sale of common stock by the selling stockholders.
Approximately $82 million of the net proceeds were used to pay down borrowings under our revolving
line of credit. On January 26, 2004, we entered into an interest rate swap agreement to manage our exposure to
fluctuations in interest rates. The swap agreement effectively converts $20 million of fixed-rate
long-term debt to a LIBOR indexed variable rate instrument plus an agreed upon interest rate spread
of 5.86%. On April 23, 2004, we entered into another interest rate swap agreement. This swap
agreement effectively converts $30.0 million of fixed rate debt to a LIBOR indexed variable rate
instrument plus an agreed upon interest rate spread of 5.51%. We believe that our working capital on hand, cash flows from operations and funds available
under our revolving line of credit will be sufficient to fund our operating needs, planned capital
expenditures and debt service requirements for the next 12 months. 18




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In connection with our proposed acquisition of the capital stock of AHS, we anticipate
financing the $500 million cash portion of the purchase price with new debt. We have entered into a
commitment letter with Citigroup Global Markets, Inc. to provide such financing subject to the
terms and conditions of such letter. In addition, we are actively seeking other acquisitions that
fit our corporate growth strategy and may acquire additional inpatient psychiatric facilities.
Management continually assesses our capital needs and, should the need arise, we will seek
additional financing, including debt or equity, to fund potential acquisitions or for other
corporate purposes. In negotiating such financing, there can be no assurance that we will be able
to raise additional capital on terms satisfactory to us. Failure to obtain additional financing on
reasonable terms could have a negative effect on our plans to acquire additional inpatient
psychiatric facilities Contractual Obligations Payments Due by Period (in thousands)Less than
    
    
    
    
    
    
    
    
    
    
    AfterTotal
    
    
    1 year
    
    
    1-3 years
    
    
    4-5 years
    
    
    5 yearsLong-term debt (1)
    
    $
    153,698
    
    
    $
    382
    
    
    $
    519
    
    
    $
    30,582
    
    
    $
    122,215Lease obligations
    
    
    37,884
    
    
    
    6,503
    
    
    
    8,626
    
    
    
    6,583
    
    
    
    16,172$
    191,582
    
    
    $
    6,885
    
    
    $
    9,145
    
    
    $
    37,165
    
    
    $
    138,387
   (1)
    
    Long-term debt excludes capital lease obligations which have been included in lease obligations above. The fair value of our $100 million 10 5/8% senior subordinated notes was approximately $111
million as of March 31, 2005. The fair value of our $150 million 10 5/8% senior subordinated notes
was approximately $173 million as of December 31, 2004. The carrying value of our other long-term
debt, including current maturities, of $54.0 million and $24.3 million at March 31, 2005 and
December 31, 2004, respectively, approximated fair value. We had $30 million of variable rate debt
outstanding under our revolving credit facility as of March 31, 2005. In addition, interest rate
swap agreements effectively convert $50 million of fixed rate debt into variable rate debt at March
31, 2005. At our March 31, 2005 borrowing level, a hypothetical 10% increase in interest rates
would decrease our annual net income and cash flows by approximately $370,000. Critical Accounting Policies Our consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States. In preparing our financial statements, we are
required to make estimates and assumptions that affect the reported amounts of assets, liabilities,
revenues, and expenses included in our financial statements. Estimates are based on historical
experience and other information currently available, the results of which form the basis of such
estimates. While we believe our estimation processes are reasonable, actual results could differ
from those estimates. The following represent the estimates considered most critical to our
operating performance and involve the most subjective and complex assumptions and assessments. Allowance for doubtful accounts Our ability to collect outstanding patient receivables from third party payors and receivables
due under our management contracts is critical to our operating performance and cash flows. The primary collection risk with regard to patient receivables lies with uninsured patient
accounts or patient accounts for which primary insurance has paid but a patient portion remains
outstanding. We estimate the allowance for doubtful accounts primarily based upon the age of the
accounts since the patient discharge date. We continually monitor our accounts receivable balances
and utilize cash collection data to support our estimates of the provision for doubtful accounts.
Significant changes in payor mix or business office operations could have a significant impact on
our results of operations and cash flows. The primary collection risk with regard to receivables due under our inpatient management
contracts is attributable to contract disputes. We estimate the allowance for doubtful accounts for
these receivables based primarily upon the specific identification of potential collection issues.
As with our patient receivables, we continually monitor our accounts receivable balances and
utilize cash collection data to support our estimates of the provision for doubtful accounts. Allowances for contractual discounts The Medicare and Medicaid regulations are complex and various managed care contracts may
include multiple reimbursement mechanisms for different types of services provided in our inpatient
facilities and cost settlement provisions requiring complex calculations and assumptions subject to
interpretation. We estimate the allowance for contractual discounts on a payer-specific basis 19




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given
our interpretation of the applicable regulations or contract terms. The services authorized and
provided and related reimbursement are often subject to interpretation that could result in
payments that differ from our estimates. Additionally, updated regulations and contract
renegotiations occur frequently necessitating continual review and assessment of the estimation
process by our management. Professional and General Liability We are subject to medical malpractice and other lawsuits due to the nature of the services we
provide. Due to our acquisition of Ramsay, we had two distinct insurance programs that covered our
inpatient facilities. Prior to December 31, 2004, all of our inpatient facilities except those
acquired from Ramsay had professional and general liability insurance in umbrella form for claims
in excess of $3.0 million with an insured limit of $20.0 million. For the inpatient facilities
acquired from Ramsay, we had professional and general liability insurance in umbrella form for
claims in excess of $500,000 with an insured limit of $26.0 million. These plans were combined in
2005 to cover all of our operations for professional and general liability insurance in umbrella
form for claims in excess of $2.0 million with an insured limit of $35.0 million. The self-insured
reserves for professional and general liability risks are calculated based on historical claims,
demographic factors, industry trends, severity factors, and other actuarial assumptions calculated
by an independent third party. This self-insurance reserve is discounted to its present value using
a 5% discount rate. This estimated accrual for professional and general liabilities could be
significantly affected should current and future occurrences differ from historical claim trends
and expectations. We have utilized our captive insurance company to manage this additional
self-insured retention. While claims are monitored closely when estimating professional and general
liability accruals, the complexity of the claims and wide range of potential outcomes often hampers
timely adjustments to the assumptions used in these estimates. Income taxes As part of the process of preparing our consolidated financial statements, we are required to
determine our income tax liabilities in each of the jurisdictions in which we operate. This process
involves recognizing the amount of income taxes payable or refundable for the current period,
together with recognizing deferred tax assets and liabilities for the future tax consequences of
events that have been recognized in our financial statements or tax returns. We are also required
to assess the realizable value of our deferred tax assets and reduce the deferred tax assets by a
valuation allowance if, based on the weight of available evidence, it is more likely than not
that any portion of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income in the tax
jurisdictions and during the periods in which the deferred tax assets are recoverable. In
evaluating sources of future taxable income, we consider the reversal of taxable temporary
differences, future earnings from operations and tax planning strategies, where applicable. We
recorded a valuation allowance against deferred tax assets as of March 31, 2005 and March 31, 2004
totaling $3.4 million and $11.3 million, respectively. We revise our assessment of the
recoverability of deferred tax assets periodically, and will adjust the valuation allowance as
circumstances require. The valuation allowance recorded as of March 31, 2005 and March 31, 2004
relates primarily to pre-acquisition net operating loss carryovers from certain acquisitions.
Accordingly, future reductions in the valuation allowance will primarily reduce goodwill related to
these respective acquisitions. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The information required by this item is provided under Part I, Item 2 of this Quarterly
Report under the captions Managements Discussion and Analysis of Financial Condition and Results
of Operations  Liquidity and Capital Resources and Managements Discussion and Analysis of
Financial Condition and Results of Operations  Liquidity and Capital Resources  Contractual
Obligations. 
 ITEM 4. CONTROLS AND PROCEDURES Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures We carried out an evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Accounting Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of
the end of the period covered by this report pursuant to Exchange Act Rule 13a-15. Based upon that
evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that our disclosure
controls and procedures were effective in ensuring that information required to be disclosed by us
(including our consolidated subsidiaries) in reports that we file or submit under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and reported on a timely
basis. Changes in Internal Control Over Financial Reporting There has been no change in our internal control over financial reporting during the quarter
ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting. 20




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PART II  OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS We are subject to various claims and legal actions that arise in the ordinary course of our
business. In the opinion of management, Psychiatric Solutions is not currently a party to any
proceeding that would have a material adverse effect on its financial condition or results of
operations. 
 ITEM 6. EXHIBITS (a) Exhibits ExhibitNumber
    
    Description2.1*
    
    Stock Purchase Agreement, dated March 10, 2005, by
and among Ardent Health Services LLC, Ardent Health
Services, Inc. and Psychiatric Solutions, Inc., as
amended by Amendment No. 1 to Stock Purchase
Agreement dated April 28, 2005.3.1
    
    Amended and Restated Certificate of Incorporation of
PMR Corporation, filed with the Delaware Secretary
of State on March 9, 1998 (incorporated by reference
to Exhibit 3.1 to the Companys Annual Report on
Form 10-K for the fiscal year ended April 30, 1998).3.2
    
    Certificate of Amendment to Amended and Restated
Certificate of Incorporation of PMR Corporation,
filed with the Delaware Secretary of State on August
5, 2002 (incorporated by reference to Exhibit 3.2 to
the Companys Quarterly Report on Form 10-Q for the
quarter ended July 31, 2002).3.3
    
    Certificate of Amendment to Amended and Restated
Certificate of Incorporation of Psychiatric
Solutions, Inc., filed with the Delaware Secretary
of State on March 21, 2003 (incorporated by
reference to Appendix A of the Companys Definitive
Proxy Statement, filed on January 22, 2003).3.4
    
    Amended and Restated Bylaws (incorporated by
reference to Exhibit 3.2 to the Companys Annual
Report on Form 10-K for the fiscal year ended April
30, 1997) (the 1997 10-K)).4.2
    
    Common Stock Specimen Certificate (incorporated by
reference to Exhibit 4.2 to the Companys Annual
Report on Form 10-K for the fiscal year ended
December 31, 2002) (the 2002 10-K)).4.3
    
    Certificate of Designations, Preferences and Rights
of Series A Convertible Preferred Stock, filed with
the Delaware Secretary of State on March 24, 2003
(incorporated by reference to Appendix D of the
Companys Definitive Proxy Statement, filed January
22, 2003).4.4
    
    Indenture, dated as of June 30, 2003, among
Psychiatric Solutions, Inc., the Guarantors named
therein and Wachovia Bank, National Association, as
Trustee (incorporated by reference to the Companys
Registration Statement on Form S-4, filed on July
30, 2003 (Registration No. 333-107453) (the 2003
S-4)).4.5
    
    Form of Notes (included in Exhibit 4.4).4.6
    
    Purchase Agreement, dated as of June 19, 2003, among
Psychiatric Solutions, Inc., the Guarantors named
therein, Lehman Brothers Inc., Merrill Lynch,
Pierce, Fenner & Smith Incorporated and Jefferies &
Company, Inc. (incorporated by reference to Exhibit
4.12 to the 2003 S-4).10.1
    
    Psychiatric Solutions, Inc. Cash Bonus Policy
(incorporated by reference to the Companys Current
Report on Form 8-K, filed on April 22, 2005).
 21




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ExhibitNumber
    
    Description31.1*
    
    Certification of the Chief Executive Officer of
Psychiatric Solutions, Inc. Pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as
amended, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of the Chief Accounting Officer of
Psychiatric Solutions, Inc. Pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as
amended, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1*
    
    Certifications of the Chief Executive Officer and
Chief Accounting Officer of Psychiatric Solutions,
Inc. Pursuant to Rule 13a-14(b) of the Securities
Exchange Act of 1934, as amended, and 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
   *
    
    Filed herewith. 22




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PSYCHIATRIC SOLUTIONS, INC.May 9, 2005
    Dated:/s/ Jack E. PolsonJack E. PolsonChief Accounting Officer