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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q

(Mark One)

x   
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

OR

o   
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to                      to

Commission file number 0-20488

PSYCHIATRIC SOLUTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)

|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                       |  | 23-2491707                       
|(State or Other Jurisdiction of
Incorporation or Organization) |  | (IRS Employer
Identification No.)
|                                                               |  |                                  
|113 Seaboard Lane, Suite C-100,
Franklin, Tennessee            |  | 37067                            
|(Address of Principal Executive Offices)                       |  | (Zip Code)                       

(615) 312-5700
(Registrants Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
   
Yes   x   
No   o

As of October 31, 2002, Psychiatric Solutions, Inc. had 7,738,643 shares
of common stock outstanding.





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TABLE OF CONTENTS



|                                                                                              |  |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                                                                
|ITEM 1. FINANCIAL STATEMENTS                                                                 
|CONDENSED CONSOLIDATED BALANCE SHEETS                                                        
|CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                              
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                              
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                             
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                          
|ITEM 4. CONTROLS AND PROCEDURES.                                                             
|OTHER INFORMATION                                                                            
|ITEM 1. LEGAL PROCEEDINGS                                                                    
|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                                                                   
|Section 906 Certification of the CEO                                                         
|Section 906 Certification of the CFO                                                         



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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.

TABLE OF CONTENTS

|                                                                                                                            |  |  |    | 
|--------------------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|PART I. FINANCIAL INFORMATION                                                                                               |  |  |    | 
|Item 1. Financial Statements                                                                                                |  |  |    | 
|Condensed Consolidated Balance Sheets as of September 30, 2002 (Unaudited) and
December 31, 2001                            |  |  | 1  | 
|Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2002 and 2001 (Unaudited) |  |  | 2  | 
|Condensed Consolidated Statements of Cash Flows for the nine months ended
September, 2002 and 2001 (Unaudited)              |  |  | 3  | 
|Notes to Condensed Consolidated Financial Statements (Unaudited)                                                            |  |  | 4  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations                               |  |  | 10 | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risks                                                         |  |  | 18 | 
|Item 4. Controls and Procedures                                                                                             |  |  | 18 | 
|PART II. OTHER INFORMATION                                                                                                  |  |  |    | 
|Item 1. Legal Proceedings                                                                                                   |  |  | 19 | 
|Item 4. Submission of Matters to a Vote of Security Holders                                                                 |  |  | 19 | 
|Item 6. Exhibits and Reports on Form 8-K                                                                                    |  |  | 19 | 





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##### Table of Contents






PART I. FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS




PSYCHIATRIC SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)

|                                                        |                                                                                                                                                         |   |               |        |              |   |        |        |  
|------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ------------- | ------ | ------------ | - | ------ | ------ | -
|                                                        |                                                                                                                                                         |   | September 30, |        | December 31,
|                                                        |                                                                                                                                                         |   | 2002          |        | 2001        
|                                                        |                                                                                                                                                         |   |               |        |             
|                                                        |                                                                                                                                                         |   | (Unaudited)   |        |              |   |       
|ASSETS                                                  |                                                                                                                                                         |   |               |        |              |   |        |       
|Current assets:                                         |                                                                                                                                                         |   |               |        |              |   |        |       
|                                                        | Cash                                                                                                                                                    |   | $             | 2,862  |              |   | $      | 1,262  |  
|                                                        | Accounts receivable, less allowance for doubtful accounts of
$3,358 (unaudited) and $3,940, respectively                                                |   |               | 19,641 |              |   |        | 17,477 |  
|                                                        | Prepaids and other                                                                                                                                      |   |               | 1,451  |              |   |        | 819    |  
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|Total current assets                                    |                                                                                                                                                         |   | 23,954        |        |              |   | 19,558 |       
|Property and equipment, net of accumulated depreciation |                                                                                                                                                         |   | 23,728        |        |              |   | 17,980 |       
|Cost in excess of net assets acquired                   |                                                                                                                                                         |   | 36,423        |        |              |   | 15,208 |       
|Contracts, net                                          |                                                                                                                                                         |   | 684           |        |              |   | 914    |       
|Other assets                                            |                                                                                                                                                         |   | 2,260         |        |              |   | 634    |       
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|Total assets                                            |                                                                                                                                                         | $ | 87,049        |        |              | $ | 54,294 |       
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|LIABILITIES AND STOCKHOLDERS EQUITY                    |                                                                                                                                                         |   |               |        |              |   |        |       
|Current liabilities:                                    |                                                                                                                                                         |   |               |        |              |   |        |       
|                                                        | Accounts payable                                                                                                                                        |   | $             | 4,919  |              |   | $      | 2,641  |  
|                                                        | Accrued liabilities                                                                                                                                     |   |               | 9,306  |              |   |        | 5,154  |  
|                                                        | Revolving line of credit                                                                                                                                |   |               | 6,093  |              |   |        | 11,150 |  
|                                                        | Current portion of long-term debt                                                                                                                       |   |               | 1,231  |              |   |        | 4,237  |  
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|Total current liabilities                               |                                                                                                                                                         |   | 21,549        |        |              |   | 23,182 |       
|Long-term debt, less current portion                    |                                                                                                                                                         |   | 34,989        |        |              |   | 20,951 |       
|Deferred tax liability                                  |                                                                                                                                                         |   | 383           |        |              |   | 383    |       
|Other liabilities                                       |                                                                                                                                                         |   | 783           |        |              |   | 540    |       
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|Total liabilities                                       |                                                                                                                                                         |   | 57,704        |        |              |   | 45,056 |       
|Stockholders equity:                                   |                                                                                                                                                         |   |               |        |              |   |        |       
|                                                        | Common stock, $0.01 par value, 35,000 shares authorized;
7,708 (unaudited) and 4,993 issued and outstanding
at September 30, 2002 and December 31, 2001 |   |               | 77     |              |   |        | 50     |  
|                                                        | Additional paid-in capital                                                                                                                              |   |               | 36,646 |              |   |        | 19,149 |  
|                                                        | Notes receivable from stockholders                                                                                                                      |   |               | (635   | )            |   |        |       |  
|                                                        | Accumulated deficit                                                                                                                                     |   |               | (6,743 | )            |   |        | (9,961 | )
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|Total stockholders equity                              |                                                                                                                                                         |   | 29,345        |        |              |   | 9,238  |       
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       
|Total liabilities and stockholders equity              |                                                                                                                                                         | $ | 87,049        |        |              | $ | 54,294 |       
|                                                        |                                                                                                                                                         |   |               |        |              |   |        |       

See notes to condensed consolidated financial statements

1



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PSYCHIATRIC SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except for per share amounts)

|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |       | 
|------------------------------------------------------- | ------- | - | -------------------------------- | ----- | ------------------------------- | - | ----- | ----- | ---- | - | ------ | ----- |  | - | ------ | ----- | 
|                                                        |         |   | Three Months Ended September 30, |       | Nine Months Ended September 30,
|                                                        |         |   |                                  |       |                                
|                                                        |         |   | 2002                             |       | 2001                            |   | 2002  |       | 2001
|                                                        |         |   |                                  |       |                                 |   |       |       |     
|Revenue                                                 |         | $ | 32,280                           |       |                                 | $ | 9,944 |       |      | $ | 78,090 |       |  | $ | 24,338 |      
|Salaries, wages and employee benefits                   |         |   | 17,131                           |       |                                 |   | 5,762 |       |      |   | 44,625 |       |  |   | 14,277 |      
|Professional fees                                       |         |   | 3,897                            |       |                                 |   | 1,619 |       |      |   | 10,284 |       |  |   | 3,882  |      
|Supplies                                                |         |   | 1,432                            |       |                                 |   | 231   |       |      |   | 3,664  |       |  |   | 335    |      
|Rentals and leases                                      |         |   | 260                              |       |                                 |   | 87    |       |      |   | 637    |       |  |   | 175    |      
|Other operating expenses                                |         |   | 5,037                            |       |                                 |   | 570   |       |      |   | 8,314  |       |  |   | 1,471  |      
|Provision for bad debts                                 |         |   | 903                              |       |                                 |   | 182   |       |      |   | 2,038  |       |  |   | 325    |      
|Depreciation and amortization                           |         |   | 425                              |       |                                 |   | 265   |       |      |   | 1,222  |       |  |   | 734    |      
|Interest expense                                        |         |   | 1,589                            |       |                                 |   | 444   |       |      |   | 4,088  |       |  |   | 1,609  |      
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        |         |   | 30,674                           |       |                                 |   | 9,160 |       |      |   | 74,872 |       |  |   | 22,808 |      
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|Income from continuing operations                       |         |   | 1,606                            |       |                                 |   | 784   |       |      |   | 3,218  |       |  |   | 1,530  |      
|Income from discontinued operations                     |         |   |                                 |       |                                 |   | 1,429 |       |      |   |       |       |  |   | 1,645  |      
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|Net income                                              |         | $ | 1,606                            |       |                                 | $ | 2,213 |       |      | $ | 3,218  |       |  | $ | 3,175  |      
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|Earnings per common share from
continuing operations:   |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Basic   |   | $                                | 0.24  |                                 |   | $     | 0.16  |      |   | $      | 0.58  |  |   | $      | 0.31  | 
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Diluted |   | $                                | 0.22  |                                 |   | $     | 0.15  |      |   | $      | 0.54  |  |   | $      | 0.31  | 
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|Earnings per common share from
discontinued operations: |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Basic   |   | $                                |      |                                 |   | $     | 0.29  |      |   | $      |      |  |   | $      | 0.33  | 
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Diluted |   | $                                |      |                                 |   | $     | 0.25  |      |   | $      |      |  |   | $      | 0.28  | 
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|Earnings per common share:                              |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Basic   |   | $                                | 0.24  |                                 |   | $     | 0.44  |      |   | $      | 0.58  |  |   | $      | 0.63  | 
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Diluted |   | $                                | 0.22  |                                 |   | $     | 0.40  |      |   | $      | 0.54  |  |   | $      | 0.60  | 
|                                                        |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|Shares used in computing per share amounts:             |         |   |                                  |       |                                 |   |       |       |      |   |        |       |  |   |        |      
|                                                        | Basic   |   |                                  | 6,687 |                                 |   |       | 4,997 |      |   |        | 5,563 |  |   |        | 5,015 | 
|                                                        | Diluted |   |                                  | 7,561 |                                 |   |       | 5,678 |      |   |        | 5,934 |  |   |        | 5,697 | 

See notes to condensed consolidated financial statements

2



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PSYCHIATRIC SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, In Thousands)

|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |            |     | 
|------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------- | --------------------------------- | ------- | ------------------------------- | ------ | ---- | ------ | ---------- | --- | 
|                                                                                                       |                                                                             |                                   |         | Nine Months Ended September 30,
|                                                                                                       |                                                                             |                                   |         |                                
|                                                                                                       |                                                                             |                                   |         | 2002                            |        | 2001
|                                                                                                       |                                                                             |                                   |         |                                 |        |     
|Operating Activities                                                                                   |                                                                             |                                   |         |                                 |        |      |        |           
|Net income                                                                                             |                                                                             | $                                 | 3,218   |                                 |        | $    | 3,175  |           
|Adjustments to reconcile net income to net cash
provided by (used in) continuing operating activities: |                                                                             |                                   |         |                                 |        |      |        |           
|                                                                                                       | Depreciation and amortization                                               |                                   |         | 1,222                           |        |      |        | 734        |    
|                                                                                                       | Provision for doubtful accounts                                             |                                   |         | 2,038                           |        |      |        | 325        |    
|                                                                                                       | Accretion of detachable warrants                                            |                                   |         | 592                             |        |      |        | 528        |    
|                                                                                                       | Non-cash stock compensation expense                                         |                                   |         | 114                             |        |      |        |           |    
|                                                                                                       | Amortization of loan costs                                                  |                                   |         | 250                             |        |      |        | 109        |    
|                                                                                                       | Income from discontinued operations                                         |                                   |         |                                |        |      |        | (1,645     | )  
|                                                                                                       | Long-term interest accrued                                                  |                                   |         | 243                             |        |      |        | 243        |    
|                                                                                                       | Changes in operating assets and liabilities, net of effect of acquisitions: |                                   |         |                                 |        |      |        |            |    
|                                                                                                       |                                                                             | Accounts receivable               |         |                                 | 127    |      |        |            | 118 | 
|                                                                                                       |                                                                             | Prepaids and other current assets |         |                                 | 369    |      |        |            | 66  | 
|                                                                                                       |                                                                             | Accounts payable                  |         |                                 | (1,407 | )    |        |            | 106 | 
|                                                                                                       |                                                                             | Accrued liabilities               |         |                                 | 496    |      |        |            | 207 | 
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Net cash provided by continuing operating activities                                                   |                                                                             |                                   | 7,262   |                                 |        |      | 3,966  |           
|Investing activities:                                                                                  |                                                                             |                                   |         |                                 |        |      |        |           
|Cash acquired (paid) for acquisitions, net of cash paid or acquired                                    |                                                                             |                                   | 6,243   |                                 |        |      | (155   | )         
|Capital purchases of property and equipment                                                            |                                                                             |                                   | (864    | )                               |        |      |       |           
|Change in net assets of discontinued operations                                                        |                                                                             |                                   |        |                                 |        |      | 2,668  |           
|Other assets                                                                                           |                                                                             |                                   | 21      |                                 |        |      |       |           
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Net cash provided by investing activities                                                              |                                                                             |                                   | 5,400   |                                 |        |      | 2,513  |           
|Financing activities:                                                                                  |                                                                             |                                   |         |                                 |        |      |        |           
|Net principal payments on long-term debt                                                               |                                                                             |                                   | (9,205  | )                               |        |      | (5,327 | )         
|Payment of loan costs                                                                                  |                                                                             |                                   | (1,878  | )                               |        |      | (200   | )         
|Proceeds from issuance of common stock                                                                 |                                                                             |                                   | 21      |                                 |        |      | 1      |           
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Net cash used in financing activities                                                                  |                                                                             |                                   | (11,062 | )                               |        |      | (5,526 | )         
|Net increase in cash                                                                                   |                                                                             |                                   | 1,600   |                                 |        |      | 953    |           
|Cash at beginning of the period                                                                        |                                                                             |                                   | 1,262   |                                 |        |      | 336    |           
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Cash at end of the period                                                                              |                                                                             | $                                 | 2,862   |                                 |        | $    | 1,289  |           
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Effect of Acquisitions:                                                                                |                                                                             |                                   |         |                                 |        |      |        |           
|                                                                                                       | Assets acquired, net of cash acquired                                       |                                   | $       | 33,076                          |        |      | $      | 14,168,076 |    
|                                                                                                       | Liabilities assumed                                                         |                                   |         | (7,383                          | )      |      |        | (2,105     | )  
|                                                                                                       | Notes payable issued                                                        |                                   |         |                                |        |      |        | (2,000     | )  
|                                                                                                       | Common stock and stock options issued                                       |                                   |         | (15,072                         | )      |      |        |           |    
|                                                                                                       | Long-term debt issued                                                       |                                   |         | (16,864                         | )      |      |        | (9,908     | )  
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|                                                                                                       | Cash (acquired) paid for acquisitions, net of cash paid or acquired         |                                   | $       | (6,243                          | )      |      | $      | 155        |    
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Significant Non-cash Transactions:                                                                     |                                                                             |                                   |         |                                 |        |      |        |           
|Issuance of detachable stock warrants as consideration for Bridge Loan                                 |                                                                             | $                                 | 299     |                                 |        | $    | 479    |           
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           
|Issuance of detachable stock warrants as consideration for subordinated
debt financing                 |                                                                             | $                                 | 2,018   |                                 |        | $    |       |           
|                                                                                                       |                                                                             |                                   |         |                                 |        |      |        |           

See notes to condensed consolidated financial statements

3



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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002

1. MERGER WITH PMR CORPORATION

On August 5, 2002, pursuant to a definitive Merger Agreement dated May 6, 2002
and with respective stockholder and regulatory approvals, PMR Acquisition
Corporation, a newly formed, wholly-owned subsidiary of PMR Corporation, merged
with and into Psychiatric Solutions, Inc., a Delaware corporation whose name,
subsequent to the merger, was changed to Psychiatric Solutions Hospitals, Inc.
(PSH). Concurrently, the name of PMR Corporation was changed to Psychiatric
Solutions, Inc. (PSI or the Company). The surviving corporation in the
merger was PSH, which has become a wholly-owned subsidiary of the Company. In
exchange for their outstanding shares of common stock or preferred stock in
PSH, stockholders of PSH received newly-issued shares of Company common stock.
Options to acquire PSH common stock were converted into options to purchase
shares of Company common stock based on the common stock exchange ratio used in
the merger. Warrants of PSH will enable the holders to exercise these
securities into shares of Company common stock. After giving effect to the
exercise of all outstanding options and warrants of PSH following the merger,
the former PSH stockholders and the Companys pre-merger stockholders received
approximately 72% and 28% of the common stock of the Company, respectively. The
headquarters of the combined company has been relocated to Franklin, Tennessee.
In addition, effective August 6, 2002, the shares of the Company were approved
for listing on the Nasdaq National Market under the ticker symbol PSYS. The
Merger Agreement is on file with the Securities and Exchange Commission (SEC)
as an exhibit to Amendment No. 1 to the Companys Registration Statement on
Form S-4 filed on June 12, 2002, as amended July 11, 2002.

Inasmuch as the former PSH stockholders own more than half of the surviving
corporations outstanding common stock pursuant to the merger, PSH has been
treated as the acquiring company for accounting purposes. The condensed
consolidated financial statements located herein relate to PSH only prior to
August 5, 2002, and to the merged company on and subsequent to August 5, 2002.
Historical financial information relating to PMR Corporation just prior to the
merger can be found in the Companys quarterly report on Form 10-Q for the
quarter ended July 31, 2002, as filed with the SEC on September 16, 2002.

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, 2001 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 the financial position of the
Company have been included. Operating results for the three and nine months
ended September 30, 2002 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 the Companys Registration
Statement on Form S-4 filed on June 12, 2002, as amended July 11, 2002.

PSHs Series A Preferred Stock, Series B Preferred Stock and Common Stock were
converted to post merger Common Stock on August 5, 2002 at rates pursuant to
the merger agreement with PMR Corporation of 0.246951, 0.312864 and 0.115125,
respectively. All periods prior to August 5, 2002 have been retroactively
restated to reflect conversion at the applicable conversion rates. The
following table sets forth the effect of retroactive conversion as of December
31, 2001 (in thousands):

|                                                       |  |                                           |     |            |  |                    |        |                    |  |                 |        |         |  |     |         |        |  |  |         |   |  |        |        |   |  |  |        |  
|------------------------------------------------------ |  | ----------------------------------------- | --- | ---------- |  | ------------------ | ------ | ------------------ |  | --------------- | ------ | ------- |  | --- | ------- | ------ |  |  | ------- | - |  | ------ | ------ | - |  |  | ------ | -
|                                                       |  | Effect of Conversion at December 31, 2001
|                                                       |  |                                          
|                                                       |  |                                           |     |            |  |                    |        |                    |  | Additional Paid |        |         |  |     |         |        |  |  |         |   |  |       
|                                                       |  | Common Stock                              |     | in Capital |  | Series A Preferred |        | Series B Preferred
|                                                       |  |                                           |     |            |  |                    |        |                   
|                                                       |  |                                           |     |            |  | Shares             |        |                    |  |                 |        |         |  |     |         | Shares |  |  |         |   |  | Shares
|                                                       |  | Balance                                   |     | O/S        |  | Balance            |        | Balance            |  | O/S             |        | Balance |  | O/S
|                                                       |  |                                           |     |            |  |                    |        |                    |  |                 |        |         |  |    
|Balances prior to conversion                           |  |                                           | 73  |            |  |                    | 7,328  |                    |  |                 | 74     |         |  |     | 10,497  |        |  |  | 10,497  |   |  |        | 8,555  |   |  |  | 4,976  |  
|Conversion of Common Stock to
post merger Common Stock |  |                                           | (65 | )          |  |                    | (6,484 | )                  |  |                 | 65     |         |  |     |         |        |  |  |         |   |  |        |        |   |  |  |        |  
|Conversion of Series A Preferred
to post merger Common |  |                                           | 26  |            |  |                    | 2,592  |                    |  |                 | 10,471 |         |  |     | (10,497 | )      |  |  | (10,497 | ) |  |        |        |   |  |  |        |  
|Conversion of Series B Preferred
to post merger Common |  |                                           | 16  |            |  |                    | 1,557  |                    |  |                 | 8,539  |         |  |     |         |        |  |  |         |   |  |        | (8,555 | ) |  |  | (4,976 | )
|                                                       |  |                                           |     |            |  |                    |        |                    |  |                 |        |         |  |     |         |        |  |  |         |   |  |        |        |   |  |  |        |  
|Balances post conversion                               |  |                                           | 50  |            |  |                    | 4,993  |                    |  |                 | 19,149 |         |  |     |        |        |  |  |        |   |  |        |       |   |  |  |       |  
|                                                       |  |                                           |     |            |  |                    |        |                    |  |                 |        |         |  |     |         |        |  |  |         |   |  |        |        |   |  |  |        |  

4



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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002

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 includes no
dilution and is computed by dividing net income by the weighted average number
of common shares outstanding for the period. Diluted earnings per share
reflects the potential dilution of securities that could share in the earnings
of the entity. The Company has calculated its 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 (in thousands, except per share amounts):

|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |       | 
|---------------------------------- | ---------------------------------------------------------------- | - | -------------------------------- | ----- | ------------------------------- | - | ---- | ----- | ---- | - | ---- | ----- |  | - | ---- | ----- | 
|                                   |                                                                  |   | Three months ended September 30, |       | Nine months ended September 30,
|                                   |                                                                  |   |                                  |       |                                
|                                   |                                                                  |   | 2002                             |       | 2001                            |   | 2002 |       | 2001
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |     
|Numerator:                         |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|                                   | Net income available to common
stockholders                      |   | $                                | 1,606 |                                 |   | $    | 2,213 |      |   | $    | 3,218 |  |   | $    | 3,175 | 
|                                   | Interest expense on convertible debt
outstanding                 |   |                                  | 81    |                                 |   |      | 81    |      |   |      |      |  |   |      | 243   | 
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|                                   | Net income used in computing diluted
earnings per common share   |   | $                                | 1,687 |                                 |   | $    | 2,294 |      |   | $    | 3,218 |  |   | $    | 3,418 | 
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|Denominator:                       |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|                                   | Weighted average shares outstanding
for basic earnings per share |   |                                  | 6,687 |                                 |   |      | 4,997 |      |   |      | 5,563 |  |   |      | 5,015 | 
|                                   | Effects of dilutive stock options and
warrants outstanding       |   |                                  | 452   |                                 |   |      | 198   |      |   |      | 371   |  |   |      | 199   | 
|                                   | Effect of dilutive convertible debt
outstanding                  |   |                                  | 422   |                                 |   |      | 483   |      |   |      |      |  |   |      | 483   | 
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|                                   | Shares used in computing diluted
earnings per common share       |   |                                  | 7,561 |                                 |   |      | 5,678 |      |   |      | 5,934 |  |   |      | 5,697 | 
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|Earnings per common share, basic   |                                                                  | $ | 0.24                             |       |                                 | $ | 0.44 |       |      | $ | 0.58 |       |  | $ | 0.63 |      
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      
|Earnings per common share, diluted |                                                                  | $ | 0.22                             |       |                                 | $ | 0.40 |       |      | $ | 0.54 |       |  | $ | 0.60 |      
|                                   |                                                                  |   |                                  |       |                                 |   |      |       |      |   |      |       |  |   |      |      

Diluted earnings per share for the nine months ended September 30, 2002, does
not include debt outstanding which is convertible into 422,000 shares, as its
effect would be antidilutive.

4. DEBT

In conjunction with its hospital acquisition in November 2001, Psychiatric
Solutions entered into a senior credit facility of $33.2 million (2001 Senior
Credit Facility). The 2001 Senior Credit Facility was amended on June 28, 2002
to provide for an additional $7.95 million pursuant to a new non-revolving term
note. The 2001 Senior Credit Facility, as revised, includes two lines of credit
for a total credit facility of $41.15 million, made up of $23.65 million of
non-revolving term loans and a $17.5 million revolving working capital line of
credit. Both lines are secured by substantially all of Psychiatric Solutions
assets and stock of its subsidiaries. The term loans accrue interest at the
Citibank, N.A. prime rate plus 4.25% to 4.75%. The revolving line of credit
accrues interest at the Citibank, N.A. prime rate plus 2% and is due in
November 2004. At September 30, 2002, the interest rate was 7.25%. Until the
due date, Psychiatric Solutions may borrow, repay and re-borrow an amount not
to exceed the lesser of $17.5 million or the borrowing base (as defined in the
2001 Senior Credit Facility). As of September 30, 2002 the Company had $6.5
million available under the revolving line of credit. On July 1, 2002,
Psychiatric Solutions drew $2.9 million on the revolving line of credit in
connection with its purchase of Riveredge Hospital. Following the acquisition
of Riveredge Hospital on July 1, 2002, there was $2.2 million available under
the revolving line of credit. Under the revolving line of credit, all of
Psychiatric Solutions collections, except for Medicare and Medicaid payments,
are deposited into lockbox accounts controlled by the lender. The funds
deposited in the lockbox are applied to outstanding borrowings with the lender
on a daily basis. As a result, the outstanding borrowings under the revolving
line of credit are classified as short term as of December 31, 2001 and
September 30, 2002. Psychiatric Solutions must pay an unused fee in the amount
of 0.05% per month of the monthly unused portion of the 2001 Senior Credit
Facility. Such fees were approximately $34,000 as of September 30, 2002.

5



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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002

The 2001 Senior Credit Facility contains customary covenants which include: (i)
a specified monthly patient census for any owned, operated or leased hospitals,
(ii) a limitation on capital expenditures, sales of assets, mergers, changes of
ownership and management, new lines of business and dividends and (iii) various
financial covenants. As of September 30, 2002, Psychiatric Solutions was in
compliance with all applicable debt covenant requirements. Should Psychiatric
Solutions results of operations or cash flows decline and result in violation
of one or more of these covenants, amounts outstanding under the 2001 Senior
Credit Facility could become immediately payable and additional borrowings
could be restricted. As of September 30, 2002, approximately $22.0 million was
outstanding.

In connection with the 2001 Senior Credit Facility, Psychiatric Solutions was
required to expense the remaining deferred loan costs associated with its prior
credit facility in the amount of $419,000 and incurred early termination
penalties of $818,000 in the fourth quarter of 2001.

In October 2000 Psychiatric Solutions issued subordinated notes totaling $1.0
million with certain of its stockholders (the Bridge Loan). In connection
with the Bridge Loan, Psychiatric Solutions issued warrants to purchase a total
of 398,579 shares of its Series B preferred stock. The Bridge Loan was used to
fund short-term working capital requirements and accrued interest at 10% per
annum, payable monthly. The Bridge Loan was paid in full in April 2002. The
warrants were exercised on August 1, 2002, and, in conjunction with the PMR
merger, converted to 124,700 common shares on August 5, 2002.

In connection with the acquisition of Sunrise in May 2000, Psychiatric
Solutions issued subordinated convertible notes in the amount of $3.6 million.
These convertible notes are due May 1, 2005 and accrue interest at 9% per
annum. The principal amount of these convertible notes is convertible into
shares of the Companys common stock based on conversion prices of $8.53 to
$9.59 per share.

Psychiatric Solutions also issued promissory notes totaling $4.5 million in
connection with its acquisitions of three hospitals. One note in the amount of
$2.5 million accrues interest at 9% per annum and matured on June 30, 2002.
Psychiatric Solutions paid off this note in full with a portion of the proceeds
of its subordinated debt offering described below. The remaining $2.0 million
note accrues interest at 9% per annum and is due June 30, 2005. Among other
customary covenants, both notes contain cross default covenants triggered by a
default of any other indebtedness of at least $1.0 million. Psychiatric
Solutions was in compliance with these covenants as of September 30, 2002.

On June 28, 2002, Psychiatric Solutions entered into a securities purchase
agreement with 1818 Mezzanine Fund II, L.P. to issue up to $20 million of
senior subordinated notes with detachable nominal warrants. At the closing on
June 28, 2002, a total of $10 million of the senior subordinated notes were
issued. Approximately $7.5 million of the proceeds were used to fund a portion
of the acquisition of Riveredge Hospital, and approximately $2.5 million of the
proceeds were used to reduce current indebtedness. The remaining $10 million of
senior subordinated notes may be issued to fund additional acquisitions of
free-standing psychiatric hospitals and for general working capital purposes,
subject generally to approval by the 1818 Fund. The notes have a term of seven
years and bear interest at 12% annually, payable quarterly. The notes provide
for a prepayment penalty of 6%, 3% and 1% if the notes are prepaid prior to the
first anniversary, second anniversary and third anniversary of the closing
date, respectively. The notes grant the holders the right to require prepayment
in the event of a change of control of Psychiatric Solutions, subject to a
prepayment penalty of 1% if redeemed on or before the third anniversary of the
closing date. The notes also require Psychiatric Solutions to comply with
financial and other covenants.

5. ACQUISITIONS

Acquiring free-standing psychiatric hospitals is a key part of Psychiatric
Solutions business strategy. Since Psychiatric Solutions has grown through
mergers and acquisitions accounted for as purchases, it is difficult to make
meaningful comparisons between its financial statements for the fiscal periods
presented. In addition, since Psychiatric Solutions owns a relatively small
number of hospitals, an individual acquisition may have a material effect on
its overall operating performance. At the time a hospital is acquired, a number
of measures to lower costs are implemented and significant investments may also
be made in the facility. Therefore, the financial performance of a newly
acquired hospital may adversely affect its overall performance in the
short-term.

On September 1, 2001, Psychiatric Solutions acquired the assets of Cypress
Creek Hospital and West Oaks Hospital in Houston, Texas for approximately $14.2
million. The acquisition was financed through a seller-financed subordinated
convertible note as well as other long-term borrowings.

Effective November 1, 2001, Psychiatric Solutions acquired the assets of Texas
NeuroRehab Hospital in Austin, Texas for approximately $8.4 million, which was
financed through a seller-financed subordinated convertible note and additional
long-term borrowings.

On December 1, 2001, Psychiatric Solutions acquired the assets of Holly Hill
Hospital in Raleigh, North Carolina for approximately $8.4 million which was
financed through long-term borrowings under a line of credit.

6



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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002

On July 1, 2002, Psychiatric Solutions acquired all of the capital stock of
Aeries Healthcare Corporation and its wholly owned subsidiary, Aeries
Healthcare of Illinois, Inc. for $16.1 million, prior to certain adjustments.
Aeries Healthcare of Illinois owns the assets and operations of Riveredge
Hospital located near Chicago, Illinois. The acquisition was financed in part
through an amendment to Psychiatric Solutions Senior Credit Facility. The
allocation of purchase price reflected in the September 30, 2002 condensed
consolidated balance sheet is preliminary. Final purchase price will be
determined once certain conditions are met to relieve funds held in escrow.

On August 5, 2002, Psychiatric Solutions merged with PMR Corporation, an
operator of case management programs in Tennessee and a manager of two
outpatient psychiatric programs with one acute care hospital in California. For
accounting purposes the merger was treated as a purchase of PMR Corporation by
Psychiatric Solutions. PMR Corporation shareholders were issued approximately
2.4 million shares of Psychiatric Solutions common stock. The Company acquired
approximately $6.0 million in cash in the PMR transaction. Psychiatric
Solutions was guaranteed approximately $5.2 million in cash as a part of the
PMR transaction. Any additional monies above the $5.2 million as well as
subsequent collections of certain legacy receivables of PMR, if any, received
by Psychiatric Solutions are payable to certain former PMR shareholders as
defined in the Contingent Value Rights Agreement (CVR). The Company has
accrued approximately $770,000 at September 30, 2002, for payment to CVR
holders. The Company expects to make a payment to CVR holders during the
fourth quarter of 2002. Additional future payments to CVR holders may be
necessary, however, the Company cannot anticipate the amount or timing of such
payments as they are contingent upon the Company collecting certain legacy
receivables of PMR.

The pro forma unaudited results of operations for the three and nine months
ended September 30, 2002 and September 30, 2001, assuming the acquisitions of
Riveredge (actual acquisition date of July 1, 2002) and PMR (actual acquisition
date of August 5, 2002) occurred as of January 1, 2001, are as follows (in
thousands, except per share amounts):

|                                                              |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |       | 
|------------------------------------------------------------- | ------- | - | -------------------------------- | ----- | ------------------------------- | - | ------ | ----- | ---- | - | ------- | ----- |  | - | ------ | ----- | 
|                                                              |         |   | Three months ended September 30, |       | Nine months ended September 30,
|                                                              |         |   |                                  |       |                                
|                                                              |         |   | 2002                             |       | 2001                            |   | 2002   |       | 2001
|                                                              |         |   |                                  |       |                                 |   |        |       |     
|Revenue                                                       |         | $ | 34,280                           |       |                                 | $ | 20,402 |       |      | $ | 105,253 |       |  | $ | 57,087 |      
|Income from continuing operations                             |         |   | 1,990                            |       |                                 |   | 1,144  |       |      |   | 10,460  |       |  |   | (3,337 | )    
|Net income                                                    |         | $ | 1,990                            |       |                                 | $ | 2,573  |       |      | $ | 10,460  |       |  | $ | (1,692 | )    
|                                                              |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |      
|Earnings from continuing operations per common share, basic   |         | $ | 0.26                             |       |                                 | $ | 0.15   |       |      | $ | 1.36    |       |  | $ | (0.43  | )    
|                                                              |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |      
|Earnings from continuing operations per common share, diluted |         | $ | 0.24                             |       |                                 | $ | 0.15   |       |      | $ | 1.26    |       |  | $ | (0.43  | )    
|                                                              |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |      
|Earnings per common share, basic                              |         | $ | 0.26                             |       |                                 | $ | 0.33   |       |      | $ | 1.36    |       |  | $ | (0.22  | )    
|                                                              |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |      
|Earnings per common share, diluted                            |         | $ | 0.24                             |       |                                 | $ | 0.32   |       |      | $ | 1.26    |       |  | $ | (0.22  | )    
|                                                              |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |      
|Shares used in computing per share amounts:                   |         |   |                                  |       |                                 |   |        |       |      |   |         |       |  |   |        |      
|                                                              | Basic   |   |                                  | 7,706 |                                 |   |        | 7,708 |      |   |         | 7,704 |  |   |        | 7,726 | 
|                                                              | Diluted |   |                                  | 8,543 |                                 |   |        | 8,229 |      |   |         | 8,528 |  |   |        | 7,726 | 

For further detail on the pro forma unaudited results of operations for the
nine months ended September 30, 2002 refer to the Managements Discussion and
Analysis of Financial Condition and Results of Operations in Part 1, Item 2 of
this quarterly report on Form 10-Q for September 30, 2002.

6. INCOME TAXES

During prior years, the Company generated net operating loss (NOL)
carryforwards for federal and state income tax purposes. The NOL carryforwards
are applicable to both discontinued and continuing operations. As a result of
each periods loss and existing NOL carryforwards, the Company has not recorded
a provision for current federal income tax during the year ended December 31,
2001 or the nine months ended September 30, 2002. The Company does not
anticipate exhausting its NOL carryforward for federal income tax purposes
until the first quarter of 2003.

7. DISCLOSURES ABOUT REPORTABLE SEGMENTS

In accordance with the criteria of SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information,the Company determined that, as of
September 30, 2002, it operates in two reportable segments: (1) Psychiatric
Unit Management, and (2) Freestanding Specialty Hospitals. The Psychiatric Unit
Management division provides psychiatric management and development services to
behavioral health units in hospitals and clinics. The Freestanding Specialty
Hospitals division includes owned psychiatric hospitals. As of September 30,
2002, the Company managed 48 behavioral health units and owned five psychiatric
hospitals in three states. Activities classified as Other in the following
schedule relate primarily to unallocated home office items.

7



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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002

The following is a financial summary by business segment for the periods
indicated. EBITDA represents income from continuing operations before interest
expense (net of interest income), income taxes, depreciation, and amortization.
EBITDA is commonly used as an analytical indicator within the healthcare
industry and serves as a measure of leverage capacity and debt service ability.
EBITDA should not be considered as a measure of financial performance under
accounting principles generally accepted in the United States, and the items
excluded in determining EBITDA are significant components in understanding and
assessing financial performance. Because neither is a measurement determined in
accordance with accounting principles generally accepted in the United States,
it is susceptible to varying calculations, and as a result our calculation of
EBITDA as presented may not be comparable to EBITDA or other similarly titled
measures used by other companies (in thousands):

|                                                             |  |              |        |             |  |           |        |              |  |   |        |   |  |   |        | 
|------------------------------------------------------------ |  | ------------ | ------ | ----------- |  | --------- | ------ | ------------ |  | - | ------ | - |  | - | ------ | 
|                                                             |  | Freestanding |        | Psychiatric |  |           |        |              |  |   |        |  
|                                                             |  | Specialty    |        | Unit        |  | Corporate |        |              |  |  
|                                                             |  | Hospitals    |        | Management  |  | and Other |        | Consolidated
|                                                             |  |              |        |             |  |           |        |             
|Three Months ended September 30, 2002                        |  |              |        |             |  |           |        |              |  |   |        |   |  |   |        | 
|Revenue                                                      |  | $            | 22,864 |             |  | $         | 9,407  |              |  | $ | 9      |   |  | $ | 32,280 | 
|EBITDA                                                       |  |              | 2,643  |             |  |           | 2,001  |              |  |   | (949   | ) |  |   | 3,695  | 
|Income (loss) from continuing operations before income taxes |  |              | 662    |             |  |           | 1,439  |              |  |   | (495   | ) |  |   | 1,606  | 
|Segment assets                                               |  |              | 49,218 |             |  |           | 31,867 |              |  |   | 5,964  |   |  |   | 87,049 | 
|Three Months ended September 30, 2001                        |  |              |        |             |  |           |        |              |  |   |        |   |  |   |        | 
|Revenue                                                      |  | $            | 3,101  |             |  | $         | 6,850  |              |  | $ | (7     | ) |  | $ | 9,944  | 
|EBITDA                                                       |  |              | 319    |             |  |           | 1,739  |              |  |   | (565   | ) |  |   | 1,493  | 
|Income (loss) from continuing operations before income taxes |  |              | 281    |             |  |           | 1,014  |              |  |   | (511   | ) |  |   | 784    | 
|Segment assets                                               |  |              | 2,452  |             |  |           | 20,878 |              |  |   | 12,320 |   |  |   | 35,650 | 
|Nine Months ended September 30, 2002                         |  |              |        |             |  |           |        |              |  |   |        |   |  |   |        | 
|Revenue                                                      |  | $            | 56,465 |             |  | $         | 21,609 |              |  | $ | 16     |   |  | $ | 78,090 | 
|EBITDA                                                       |  |              | 6,052  |             |  |           | 5,290  |              |  |   | (2,446 | ) |  |   | 8,896  | 
|Income (loss) from continuing operations before income taxes |  |              | 1,011  |             |  |           | 3,928  |              |  |   | (1,721 | ) |  |   | 3,218  | 
|Segment assets                                               |  |              | 49,218 |             |  |           | 31,867 |              |  |   | 5,964  |   |  |   | 87,049 | 
|Nine Months ended September 30, 2001                         |  |              |        |             |  |           |        |              |  |   |        |   |  |   |        | 
|Revenue                                                      |  | $            | 3,101  |             |  | $         | 21,236 |              |  | $ | 1      |   |  | $ | 24,338 | 
|EBITDA                                                       |  |              | 319    |             |  |           | 5,130  |              |  |   | (1,576 | ) |  |   | 3,873  | 
|Income (loss) from continuing operations before income taxes |  |              | 281    |             |  |           | 3,080  |              |  |   | (1,831 | ) |  |   | 1,530  | 
|Segment assets                                               |  |              | 2,452  |             |  |           | 20,878 |              |  |   | 12,320 |   |  |   | 35,650 | 

8. DISCONTINUED OPERATIONS

Discontinued operations relate to the Companys implementation of plans during
2000 to exit its physician practice management and Employee Assistance Programs
businesses. During the year ended December 31, 2001, the Company reported
income from discontinued operations of $1.6 million primarily the result of the
sale of its Employee Assistance Programs division.

9. RECENT PRONOUNCEMENTS

During July 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No. 141, Business Combinations
(SFAS 141) and No. 142, Goodwill and Other Intangible Assets(SFAS 142).
SFAS 141 is effective for transactions completed subsequent to June 30, 2001
and SFAS 142 is effective for years beginning after December 15, 2001. Under
the provisions of SFAS 142, goodwill is no longer amortized but is subject to
annual impairment tests. Other intangible assets will continue to be amortized
over their useful lives. The Company completed the transitional impairment test
during the quarter ended June 30, 2002, which resulted in no goodwill
impairment. A reconciliation of previously reported net income to the pro forma
amounts adjusted for the exclusion of goodwill amortization follows (in
thousands, except per share amounts):
8Table of Contents

PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002

|                                                     |  |                                  |       |                                 |  |      |       |      |  |   |       |  |  |   |       | 
|---------------------------------------------------- |  | -------------------------------- | ----- | ------------------------------- |  | ---- | ----- | ---- |  | - | ----- |  |  | - | ----- | 
|                                                     |  | Three months ended September 30, |       | Nine months ended September 30,
|                                                     |  |                                  |       |                                
|                                                     |  | 2002                             |       | 2001                            |  | 2002 |       | 2001
|                                                     |  |                                  |       |                                 |  |      |       |     
|Reported net income                                  |  | $                                | 1,606 |                                 |  | $    | 2,213 |      |  | $ | 3,218 |  |  | $ | 3,175 | 
|Add: goodwill amortization                           |  |                                  |      |                                 |  |      | 164   |      |  |   |      |  |  |   | 495   | 
|                                                     |  |                                  |       |                                 |  |      |       |      |  |   |       |  |  |   |       | 
|Proforma adjusted net income                         |  | $                                | 1,606 |                                 |  | $    | 2,377 |      |  | $ | 3,218 |  |  | $ | 3,670 | 
|                                                     |  |                                  |       |                                 |  |      |       |      |  |   |       |  |  |   |       | 
|Proforma adjusted earnings per
common share, basic   |  | $                                | 0.24  |                                 |  | $    | 0.48  |      |  | $ | 0.58  |  |  | $ | 0.73  | 
|                                                     |  |                                  |       |                                 |  |      |       |      |  |   |       |  |  |   |       | 
|Proforma adjusted earnings per
common share, diluted |  | $                                | 0.22  |                                 |  | $    | 0.43  |      |  | $ | 0.54  |  |  | $ | 0.69  | 
|                                                     |  |                                  |       |                                 |  |      |       |      |  |   |       |  |  |   |       | 

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets(SFAS
144), which supersedes SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Effects of Disposal
of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions. SFAS 144 removes goodwill from its scope and
clarifies other implementation issues related to SFAS 121. SFAS 144 also
provides a single framework for evaluating long-lived assets to be disposed of
by sale. The Company does not expect SFAS 144 to have a material effect on its
results of operations or financial position.

In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections(SFAS 145). SFAS 145 prohibits
the classification of gains or losses from debt extinguishments as
extraordinary items unless the criteria outlined in APB Opinion No. 30,
Reporting the Results of Operations  Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, are met. SFAS 145 also eliminates an inconsistency
between the required accounting for sale-leaseback transactions and the
required accounting for certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. SFAS 145 is effective for
fiscal years beginning after May 15, 2002, with early adoption encouraged. The
Company intends to adopt the provisions of SFAS 145 during fiscal 2003 and
restate its prior audited consolidated financial statements for the
reclassification of extraordinary loss on extinguishment of debt.

9



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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 on Form 10-Q contains 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 intent, belief or
current expectations of Psychiatric Solutions, Inc. (the Company) and its
management. Such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties that may cause the Companys
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) potential competition which
alters or impedes the Companys acquisition strategy by decreasing the
Companys ability to acquire additional hospitals on favorable terms; (2) the
ability of the Company to improve the operations of acquired hospitals; (3) the
ability to maintain favorable and continuing relationships with physicians who
use the Companys facilities; (4) the limited operating history of the Company;
(5) the ability to receive timely additional financing on terms acceptable to
the Company to fund the Companys 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
the operations of Psychiatric Solutions, Inc. with PMR. The forward-looking
statements herein are qualified in their entirety by the risk factors set forth
in the Companys joint proxy statement/prospectus on Form S-4, dated July 11,
2002, under the caption Risk Factors. A copy of the Form S-4 may be obtained
from the Public Reference Branch of the SEC at 450 Fifth Street NW, Washington,
DC at prescribed rates.

OVERVIEW

Psychiatric Solutions was organized in September 1996. It currently has two
operating divisions: (i) the ownership and operation of freestanding inpatient
psychiatric hospitals and (ii) the operation of psychiatric units in facilities
owned by third parties.

As of September 30, 2002, Psychiatric Solutions owned and operated five
free-standing psychiatric hospitals which provided psychiatric services to
patients in and around the Houston, Texas, Austin, Texas, Raleigh, North
Carolina, and Chicago, Illinois areas and managed 48 psychiatric units for
third party acute care hospitals in 14 states. Psychiatric Solutions objective
is to provide high-quality, cost-effective psychiatric services in the
communities it serves. Through its managed and freestanding psychiatric
hospitals, Psychiatric Solutions offers an extensive continuum of behavioral
health programs to critically ill children, adolescents and adults.

On August 5, 2002, pursuant to a definitive Merger Agreement dated May 6, 2002
and with respective stockholder and regulatory approvals, PMR Acquisition
Corporation, a newly formed, wholly-owned subsidiary of PMR Corporation, merged
with and into Psychiatric Solutions, Inc., a Delaware corporation whose name,
subsequent to the merger, was changed to Psychiatric Solutions Hospitals, Inc.
(PSH). Concurrently, the name of PMR Corporation was changed to Psychiatric
Solutions, Inc. (PSI or the Company). The surviving corporation in the
merger was PSH, which has become a wholly-owned subsidiary of the Company. In
exchange for their outstanding shares of common stock or preferred stock in
PSH, stockholders of PSH received newly-issued shares of Company common stock.
Options to acquire PSH common stock were converted into options to purchase
shares of Company common stock based on the common stock exchange ratio used in
the merger. Warrants of PSH will enable the holders to exercise these
securities into shares of Company common stock. After giving effect to the
exercise of all outstanding options and warrants of PSH following the merger,
the former PSH stockholders and the Companys pre-merger stockholders received
approximately 72% and 28% of the common stock of the Company, respectively. The
headquarters of the combined company has been relocated to Nashville,
Tennessee. In addition, effective August 6, 2002, the shares of the Company
were approved for listing on the Nasdaq National Market under the ticker symbol
PSYS. The Merger Agreement is on file with the Securities and Exchange
Commission (SEC) as an exhibit to Amendment No. 1 to the Companys
Registration Statement on Form S-4 filed on July 11, 2002.

Inasmuch as the former PSH stockholders own more than half of the surviving
corporations outstanding common stock pursuant to the merger, PSH has been
treated as the acquiring company for accounting purposes. The condensed
consolidated financial statements located herein relate to PSH only prior to
August 5, 2002, and to merged company on and subsequent to August 5, 2002.
Historical financial information relating to PMR Corporation just prior to the
merger can be found in the Companys quarterly report on Form 10-Q for the
quarter ended July 31, 2002, as filed with the SEC on September 16, 2002.

IMPACT OF MERGERS AND ACQUISITIONS

Acquiring free-standing psychiatric hospitals is a key part of Psychiatric
Solutions business strategy. Since Psychiatric Solutions has grown through
mergers and acquisitions accounted for as purchases, it is difficult to make
meaningful comparisons between its financial statements for the fiscal periods
presented. In addition, since Psychiatric Solutions owns a relatively small
number of hospitals, an individual acquisition may have a material effect on
its overall operating performance. At the time a hospital is acquired, a number
of measures to lower costs are implemented and significant investments may also
be made in the facility. Therefore, the financial performance of a newly
acquired hospital may adversely affect its overall performance in the
short-term.

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On September 1, 2001, Psychiatric Solutions acquired the assets of Cypress
Creek Hospital and West Oaks Hospital in Houston, Texas for approximately $14.2
million. The acquisition was financed through a seller-financed subordinated
convertible note as well as other long-term borrowings.

Effective November 1, 2001, Psychiatric Solutions acquired the assets of Texas
NeuroRehab Hospital in Austin, Texas for approximately $8.4 million, which was
financed through a seller-financed subordinated convertible note and additional
long-term borrowings.

On December 1, 2001, Psychiatric Solutions acquired the assets of Holly Hill
Hospital in Raleigh, North Carolina for approximately $8.4 million which was
financed through long-term borrowings under a line of credit.

On July 1, 2002, Psychiatric Solutions acquired all of the capital stock of
Aeries Healthcare Corporation and its wholly owned subsidiary, Aeries
Healthcare of Illinois, Inc. for $16.1 million, prior to certain adjustments.
Aeries Healthcare of Illinois owns the assets and operations of Riveredge
Hospital located near Chicago, Illinois. The acquisition was financed in part
through an amendment to Psychiatric Solutions Senior Credit Facility.

On August 5, 2002, Psychiatric Solutions merged with PMR Corporation, an
operator of case management programs in Tennessee and a manager of two
outpatient psychiatric programs with one acute care hospital in California.
For accounting purposes the merger was treated as purchase of PMR Corporation
by Psychiatric Solutions. PMR Corporation shareholders were issued
approximately 2.4 million shares of Psychiatric Solutions common stock. The
Company acquired approximately $6.0 million in cash in the PMR transaction.
Psychiatric Solutions was guaranteed approximately $5.2 million in cash as a
part of the PMR transaction. Any additional monies above the $5.2 million as
well as subsequent collections of certain legacy receivables of PMR, if any,
received by Psychiatric Solutions are payable to certain former PMR
shareholders as defined in the Contingent Value Rights Agreement (CVR). The
Company has accrued approximately $770,000 at September 30, 2002, for payment
to CVR holders. The Company expects to make a payment to CVR holders during
the fourth quarter of 2002. Additional future payments to CVR holders may be
necessary, however, the Company cannot anticipate the amount or timing of such
payments as they are contingent upon the Company collecting certain legacy
receivables of PMR.

Unaudited Pro Forma Condensed Consolidated Statement of Earnings

The unaudited pro forma condensed combined consolidated statement of earnings
for the nine months ended September 30, 2002 is based on the following:



| |  |  | The historical results of operations for the nine months ended
September 30, 2002 for Psychiatric Solutions, including results from PMR
and Riveredge Hospital, subsequent to their dates of acquisition;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The historical results of operations of PMR as if such were acquired
by Psychiatric Solutions on January 1, 2002 (actual merger date was
August 5, 2002);                                                
|
| |  |  | The results of operations of Riveredge Hospital as if such were
acquired by Psychiatric Solutions on January 1, 2002 (actual acquisition
date for this hospital was July 1, 2002).                       

The unaudited pro forma condensed combined consolidated statement of earnings
should be read in conjunction with the historical consolidated financial
statements and accompanying notes of PMR and Psychiatric Solutions and the
summary selected historical consolidated financial data included in the joint
proxy statement/prospectus filed with the Securities and Exchange Commission on
Form S-4 on July 11, 2002. The unaudited pro forma condensed combined
consolidated statement of earnings is not intended to represent or be
indicative of the consolidated results of operations that would have been
reported had the merger been completed as of the dates presented, and should
not be taken as representative of future consolidated results of operations of
the combined company.

11



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##### Table of Contents



Unaudited Pro Forma Condensed Combined Consolidated Statement of Earnings
of PMR and Psychiatric Solutions

Nine Months ended September 30, 2002
(In thousands, except per share amounts)

|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |        |        | 
|------------------------------------------------------------- | --------------------------------------------- | -------------- | ------ | ------------- | ------ | ---------- | ------ | ----------- | ------ | --------- | ----- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                              |                                               |                |        | PSI           |        | Historical |        | Pro Forma   |        | Pro Forma
|                                                              |                                               |                |        | Pro Forma (1) |        | PMR        |        | Adjustments |        | Combined 
|                                                              |                                               |                |        |               |        |            |       
|Revenue                                                       |                                               | $              | 92,242 |               |        | $          | 13,011 |             |        | $         |      |        |        | $ | 105,253 |       
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|Expenses:                                                     |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|                                                              | Salaries, wages and employee benefits         |                |        | 52,265        |        |            |        | 1,513       |        |           |       |       |        |   |         | 53,778 |       
|                                                              | Professional fees                             |                |        | 11,555        |        |            |        | 1,814       |        |           |       | (1,044 | )(2)   |   |         | 12,325 |       
|                                                              | Rentals and leases                            |                |        | 689           |        |            |        | 264         |        |           |       |       |        |   |         | 953    |       
|                                                              | Other operating expenses                      |                |        | 14,533        |        |            |        | 9,532       |        |           |       |       |        |   |         | 24,065 |       
|                                                              | Provision for (recovery of) doubtful accounts |                |        | 2,249         |        |            |        | (1,964      | )      |           |       |       |        |   |         | 285    |       
|                                                              | Depreciation and amortization                 |                |        | 1,362         |        |            |        | 181         |        |           |       |       |        |   |         | 1,543  |       
|                                                              | Special charge                                |                |        |              |        |            |        | 1,425       |        |           |       | (2,034 | )(3)   |   |         | (609   | )     
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|                                                              |                                               | Total expenses |        |               | 82,653 |            |        |             | 12,765 |           |       |        | (3,078 | ) |         |        | 92,340 | 
|Interest expense                                              |                                               |                | (5,638 | )             |        |            | (4     | )           |        |           |      |        |        |   | (5,642  | )     
|Other income  interest                                       |                                               |                |       |               |        |            | 209    |             |        |           | (209  | )(4)   |        |   |        |       
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|Earnings from continuing operations before taxes              |                                               |                | 3,951  |               |        |            | 451    |             |        |           | 2,869 |        |        |   | 7,271   |       
|Provision (benefit) for taxes                                 |                                               |                | 66     |               |        |            | (3,255 | )           |        |           |      | (5)    |        |   | (3,189  | )     
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|Net earnings from continuing operations                       |                                               | $              | 3,885  |               |        | $          | 3,706  |             |        | $         | 2,869 |        |        | $ | 10,460  |       
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|Net earnings per common share from continuing operations (6): |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|                                                              | Basic                                         |                | $      | 0.50          |        |            | $      | 0.48        |        |           |       |        |        |   | $       | 1.36   |       
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|                                                              | Diluted                                       |                | $      | 0.48          |        |            | $      | 0.46        |        |           |       |        |        |   | $       | 1.26   |       
|                                                              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|Shares used in computing earnings per share (6):              |                                               |                |        |               |        |            |        |             |        |           |       |        |        |   |         |       
|                                                              | Basic                                         |                |        | 7,704         |        |            |        | 7,704       |        |           |       |        |        |   |         | 7,704  |       
|                                                              | Diluted                                       |                |        | 8,528         |        |            |        | 8,528       |        |           |       |        |        |   |         | 8,528  |       



|(1) |  | Includes 6 months pro forma income statement for Riveredge Hospital,
acquired 7/1/02, as stated in the 8-K/A dated 10/7/02.                                                                                                                                                                                                                                                                                                                                 
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | To eliminate merger transaction related costs incurred in the 3rd
quarter.                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(3) |  | To eliminate the effect of severance payments to former PMR employees
made as a result of the PSI acquisition.                                                                                                                                                                                                                                                                                                                                              
|   
|(4) |  | To reflect lost interest income due to reduction in cash, cash
equivalents and short-term investments balances.                                                                                                                                                                                                                                                                                                                                             
|   
|(5) |  | PMR tax net operating loss carryforwards will be subject to limitation
under change in ownership provisions of Internal Revenue Code Section 382
and, as a result, the ability to recognize the tax net operating losses
will be dependent upon future earnings of the company.                                                                                                                                                                             
|   
|(6) |  | The pro forma basic and diluted net earnings (loss) per share is computed
by dividing the pro forma net earnings (loss) by the pro forma basic and
diluted weighted average number of shares outstanding, assuming
Psychiatric Solutions and PMR had merged at the beginning of the period
presented. The following table sets forth the computation of basic and
diluted earnings per share at September 30, 2002 (in thousands, except per
share amounts):

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|                           |                                                                  |   |           |        | 
|-------------------------- | ---------------------------------------------------------------- | - | --------- | ------ | 
|                           |                                                                  |   | Pro forma
|                           |                                                                  |   | Combined 
|                           |                                                                  |   |          
|Numerator:                 |                                                                  |   |           |       
|                           | Net earnings from continuing operations                          |   | $         | 10,460 | 
|                           | Interest expense on convertible debt outstanding                 |   |           | 243    | 
|                           |                                                                  |   |           |       
|                           | Net earnings used in computing diluted earnings per share        |   | $         | 10,703 | 
|                           |                                                                  |   |           |       
|Denominator:               |                                                                  |   |           |       
|                           | Weighted-average shares outstanding for basic earnings per share |   |           | 7,704  | 
|                           | Effects of dilutive stock options and warrants outstanding       |   |           | 402    | 
|                           | Effect of dilutive convertible debt outstanding                  |   |           | 422    | 
|                           |                                                                  |   |           |       
|                           | Shares used in computing diluted earnings per common share       |   |           | 8,528  | 
|                           |                                                                  |   |           |       
|Basic earnings per share   |                                                                  | $ | 1.36      |       
|                           |                                                                  |   |           |       
|Diluted earnings per share |                                                                  | $ | 1.26      |       
|                           |                                                                  |   |           |       

The PMR operating results for the nine months ended September 30, 2002 include
certain items which are not expected to recur. These items include: (a)
$1,964,000 in recoveries allowance for doubtful accounts from collection of
fully reserved accounts receivable relating to closed outpatient programs and
(b) $609,000 in gains on sales of assets sold prior to the merger with PSI. The
following sets forth pro forma earnings excluding the effect of these
non-recurring items (in thousands, except per share amounts):

|                                                                                    |                                            |   |       |        |  
|----------------------------------------------------------------------------------- | ------------------------------------------ | - | ----- | ------ | -
|Pro-forma earnings from continuing operations before taxes                          |                                            | $ | 7,271 |       
|                                                                                    | Less non-recurring recoveries of bad debts |   |       | (1,964 | )
|                                                                                    | Less gain on sale of assets                |   |       | (609   | )
|                                                                                    |                                            |   |       |       
|Pro-forma Earnings from continuing operations before taxes less non-recurring items |                                            |   | 4,698 |       
|                                                                                    | Income taxes                               |   |       | (1,879 | )
|                                                                                    |                                            |   |       |       
|Pro-forma net income from continuing operations less non-recurring items            |                                            | $ | 2,819 |       
|                                                                                    |                                            |   |       |       
|Basic earnings per share, adjusted for non-recurring items                          |                                            | $ | 0.37  |       
|                                                                                    |                                            |   |       |       
|Diluted earnings per share, adjusted for non-recurring items                        |                                            | $ | 0.35  |       
|                                                                                    |                                            |   |       |       
|Shares used in computing earnings per share, adjusted for non-recurring items:      |                                            |   |       |       
|                                                                                    | Basic                                      |   |       | 7,704  |  
|                                                                                    | Diluted                                    |   |       | 8,106  |  

Pro forma diluted earnings per share, adjusted for non-recurring items does not
include debt outstanding which is convertible into 422,000 shares, as its
effect would be antidilutive.

PATIENT SERVICE REVENUE

Patient service revenue is generated by Psychiatric Solutions hospitals as a
result of services provided to patients within the hospital setting. Patient
service revenue is reported on the 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 facilities and the differences
are reported as deductions from patient service revenue at the time the service
is rendered. For the quarter ended September 30, 2002, patient service revenue
comprised approximately 71% of total revenue.

MANAGEMENT FEE REVENUE

Management fee revenue is earned by Psychiatric Solutions unit management
division. The Psychiatric Unit Management division receives contractually
determined management fees and director fees from hospitals and clinics for
providing psychiatric management and development services. For the quarter
ended September 30, 2002, management fee revenue comprised approximately 29% of
total revenue.

13



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##### Table of Contents



RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, Psychiatric
Solutions operating results (unaudited, dollars in thousands):

|                                       |  |                                  |        |                                 |  |        |       |      |  |        |       |   |  |        |       |   |  |   |        |  |  |  |       |   |  |   |        |  |  |  |       |  
|-------------------------------------- |  | -------------------------------- | ------ | ------------------------------- |  | ------ | ----- | ---- |  | ------ | ----- | - |  | ------ | ----- | - |  | - | ------ |  |  |  | ----- | - |  | - | ------ |  |  |  | ----- | -
|                                       |  | Three Months Ended September 30, |        | Nine Months Ended September 30,
|                                       |  |                                  |        |                                
|                                       |  | 2002                             |        | 2001                            |  | 2002   |       | 2001
|                                       |  |                                  |        |                                 |  |        |       |     
|                                       |  | Amount                           |        | %                               |  | Amount |       | %    |  | Amount |       | % |  | Amount |       | %
|                                       |  |                                  |        |                                 |  |        |       |      |  |        |       |   |  |        |       |  
|Revenue                                |  | $                                | 32,280 |                                 |  |        | 100.0 | %    |  | $      | 9,944 |   |  |        | 100.0 | % |  | $ | 78,090 |  |  |  | 100.0 | % |  | $ | 24,338 |  |  |  | 100.0 | %
|Salaries, wages, and employee benefits |  |                                  | 17,127 |                                 |  |        | 53.1  | %    |  |        | 5,762 |   |  |        | 58.0  | % |  |   | 44,512 |  |  |  | 57.0  | % |  |   | 14,277 |  |  |  | 58.7  | %
|Professional fees                      |  |                                  | 3,897  |                                 |  |        | 12.1  | %    |  |        | 1,619 |   |  |        | 16.3  | % |  |   | 10,284 |  |  |  | 13.2  | % |  |   | 3,882  |  |  |  | 15.9  | %
|Supplies                               |  |                                  | 1,432  |                                 |  |        | 4.4   | %    |  |        | 231   |   |  |        | 2.3   | % |  |   | 3,664  |  |  |  | 4.7   | % |  |   | 335    |  |  |  | 1.4   | %
|Provision for bad debts                |  |                                  | 903    |                                 |  |        | 2.8   | %    |  |        | 182   |   |  |        | 1.8   | % |  |   | 2,038  |  |  |  | 2.6   | % |  |   | 325    |  |  |  | 1.3   | %
|Other operating expenses               |  |                                  | 5,226  |                                 |  |        | 16.2  | %    |  |        | 657   |   |  |        | 6.6   | % |  |   | 8,696  |  |  |  | 11.1  | % |  |   | 1,646  |  |  |  | 6.8   | %
|                                       |  |                                  |        |                                 |  |        |       |      |  |        |       |   |  |        |       |   |  |   |        |  |  |  |       |   |  |   |        |  |  |  |       |  
|EBITDA (1)                             |  |                                  | 3,695  |                                 |  |        | 11.4  | %    |  |        | 1,493 |   |  |        | 15.0  | % |  |   | 8,896  |  |  |  | 11.4  | % |  |   | 3,873  |  |  |  | 15.9  | %
|Depreciation and amortization          |  |                                  | 425    |                                 |  |        | 1.3   | %    |  |        | 265   |   |  |        | 2.6   | % |  |   | 1,222  |  |  |  | 1.6   | % |  |   | 734    |  |  |  | 3.0   | %
|Interest expense                       |  |                                  | 1,589  |                                 |  |        | 4.9   | %    |  |        | 444   |   |  |        | 4.5   | % |  |   | 4,088  |  |  |  | 5.2   | % |  |   | 1,609  |  |  |  | 6.6   | %
|Other non-operating expenses           |  |                                  | 75     |                                 |  |        | 0.2   | %    |  |        |      |   |  |        | 0.0   | % |  |   | 368    |  |  |  | 0.5   | % |  |   |       |  |  |  | 0.0   | %
|                                       |  |                                  |        |                                 |  |        |       |      |  |        |       |   |  |        |       |   |  |   |        |  |  |  |       |   |  |   |        |  |  |  |       |  
|Income from continuing operations      |  | $                                | 1,606  |                                 |  |        | 5.0   | %    |  | $      | 784   |   |  |        | 7.9   | % |  | $ | 3,218  |  |  |  | 4.1   | % |  | $ | 1,530  |  |  |  | 6.3   | %
|                                       |  |                                  |        |                                 |  |        |       |      |  |        |       |   |  |        |       |   |  |   |        |  |  |  |       |   |  |   |        |  |  |  |       |  



---

|(1) |  | EBITDA is defined as income from continuing operations before interest
expense (net of interest income), income taxes, depreciation,
amortization, and extraordinary items. While you should not consider
EBITDA in isolation or as a substitute for net income, operating cash
flows or other cash flow statement data determined in accordance with
accounting principles generally accepted in the United States, management
understands that EBITDA is a commonly used analytical indicator within the
health care industry and also serves as a measure of leverage capacity and
debt service ability. EBITDA, as presented, may not be comparable to
similarly titled measures of other companies.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Quarters Ended September 30, 2002 and 2001

Revenue. Revenue from continuing operations was $32.3 million for the quarter
ended September 30, 2002, compared to $9.9 million for the quarter ended
September 30, 2001, an increase of $22.4 million or 226.3%. This increase is
related to acquisitions completed during the third and fourth quarters of 2001
and third quarter of 2002.

Salaries, wages, and employee benefits. Salaries, wages, and employee benefits
were $17.1 million for the quarter ended September 30, 2002, compared to $5.8
million for the quarter ended September 30, 2001, an increase of $11.3 million
or 194.8%. This increase is related to acquisitions completed during the third
and fourth quarters of 2001 and third quarter of 2002.

Professional fees. Professional fees were $3.9 million for the quarter ended
September 30, 2002, compared to $1.6 million for the quarter ended September
30, 2001, an increase of $2.3 million or 143.8%. This increase is related to
acquisitions completed during the third and fourth quarters of 2001 and third
quarter of 2002.

Supplies.Supplies were $1.4 million for the quarter ended September 30, 2002,
compared to $231,000 for the quarter ended September 30, 2001, and increase of
$1.2 million or 506.1%. This increase is related to acquisitions completed
during the third and fourth quarters of 2001 and the third quarter of 2002.

Provision for doubtful accounts. The provision for doubtful accounts was
$903,000 for the quarter ended September 30, 2002, compared to $182,000 for the
quarter ended September 30, 2001, an increase of $721,000 or 396.2%. This
increase is related to acquisitions completed during the third and fourth
quarters of 2001 and third quarter of 2002.

Other operating expenses. Other operating expenses were $5.3 million for the
quarter ended September 30, 2002, compared to $657,000 for the quarter ended
September 30, 2001, an increase of $4.6 million or 706.7%. Acquisitions during
the third and fourth quarters of 2001 and third quarter of 2002 accounted for
the increase.

Depreciation and amortization. Depreciation and amortization expense was
$425,000 for the quarter ended September 30, 2002, compared to $265,000 for the
quarter ended September 30, 2001, an increase of approximately $160,000 or
60.4%. Acquisitions during the third and fourth quarters of 2001 and third
quarter of 2002 accounted for the increase.

Interest expense. Interest expense was $1.6 million for the quarter ended
September 30, 2002, compared to $444,000 for the quarter ended September 30,
2001, an increase of $1.2 million or 360.4%. The increase in interest expense
is due to borrowings under Psychiatric Solutions line of credit, senior and
subordinate term loans as well as seller-financed notes to fund acquisitions
during the
third and fourth quarters of 2001 and third quarter of 2002.

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Nine Months Ended September 30, 2002 and 2002

Revenue. Revenue from continuing operations was $78.1 million for the nine
months ended September 30, 2002, compared to $24.3 million for the nine months
ended September 30, 2001, an increase of $53.8 million or 221.4%. Acquisitions
during the third and fourth quarters of 2001 and third quarter of 2002
accounted for the increase.

Salaries, wages, and employee benefits. Salaries, wages, and employee benefits
were $44.6 million for the nine months ended September 30, 2002, compared to
$14.3 million for the nine months ended September 30, 2001, an increase of
$30.3 million or 211.9%. This increase is related to acquisitions completed
during the third and fourth quarters of 2001 and third quarter of 2002.

Professional fees. Professional fees were $10.3 million for the nine months
ended September 30, 2002, compared to $3.9 million for the nine months ended
September 30, 2001, an increase of $6.4 million or 164.1%. Acquisitions during
the third and fourth quarters of 2001 and third quarter of 2002 accounted for
the increase.

Supplies.Supplies were $3.7 million for the nine months ended September 30,
2002, compared to $335,000 for the nine months ended September 30, 2001, and
increase of $3.4 million or 1,014.9%. This increase is related to acquisitions
completed during the third and fourth quarters of 2001 and the third quarter of
2002.

Provision for doubtful accounts. The provision for doubtful accounts was $2.0
million for the nine months ended September 30, 2002, compared to $325,000 for
the nine months ended September 30, 2001, an increase of $1.7 million or
523.1%. This increase is related to acquisitions completed during the third and
fourth quarters of 2001 and third quarter of 2002.

Other operating expenses. Other operating expenses were $8.9 million for the
nine months ended September 30, 2002, compared to $1.6 million for the nine
months ended September 30, 2001, an increase of $7.3 million or 456.3%.
Acquisitions during the third and fourth quarters of 2001 and third quarter of
2002 accounted for the increase.

Depreciation and amortization. Depreciation and amortization expense was $1.2
million for the nine months ended September 30, 2002, compared to $734,000 for
the nine months ended September 30, 2001, an increase of approximately $500,000
or 68.1%. Acquisitions during the third and fourth quarters of 2001 and third
quarter of 2002 accounted for substantially all of this increase.

Interest expense. Interest expense was $4.1 million for the nine months ended
September 30, 2002, compared to $1.6 million for the nine months ended
September 30, 2001, an increase of $2.5 million or 156.3%. The increase in
interest expense is due to borrowings under Psychiatric Solutions line of
credit, senior and subordinate term loans as well as seller-financed notes to
fund acquisitions during the third and fourth quarters of 2001 and third
quarter of 2002.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2002, Psychiatric Solutions had working capital of $2.4
million, including cash and cash equivalents of $2.9 million. The Company had a
working capital deficit at December 31, 2001 of $3.6 million. Working capital
includes amounts due under terms of Psychiatric Solutions revolving credit
agreement of $6.1 million and $11.1 million at September 30, 2002 and December
31, 2001, respectively. The revolving credit agreement requires that all
non-governmental cash receipts be applied to reduce the outstanding balance
under the revolving line of credit agreement. Such amounts can then be
re-borrowed to the extent that borrowing capacity remains under the revolving
line of credit. The decrease in the working capital deficit is primarily due to
cash acquired of approximately $6.0 million in the PMR transaction.

Cash provided by operating activities increased from $4.0 million for the nine
months ended September 30, 2001, to cash provided by operating activities of
$7.3 million for the nine months ended September 30, 2002. The increase in cash
flows from operating activities was due to the acquisition of the hospitals in
the third and fourth quarters of 2001 and third quarter of 2002. Cash provided
by investing activities increased from approximately $2.5 million for the nine
months ended September 30, 2001 to cash provided by investing activities of
$5.4 million for the nine months ended September 30, 2002. This increase was
due to cash acquired of approximately $6.0 million in the PMR transaction.
Psychiatric Solutions was guaranteed approximately $5.2 million in cash as a
part of the PMR transaction. Any additional monies above the $5.2 million as
well as subsequent collections of certain legacy receivables of PMR, if any,
received by Psychiatric Solutions are payable to certain former PMR
shareholders as defined in the Contingent Value Rights Agreement (CVR). The
Company has accrued approximately $770,000 at September 30, 2002, for payment
to CVR holders. The Company expects to make a payment to CVR holders during
the fourth quarter of 2002. Additional future payments to CVR holders may be
necessary, however the Company cannot anticipate the amount or timing of such
payments as they are contingent upon the Company collecting certain legacy
receivables of PMR.

Cash used in financing activities decreased from $5.5 million for the nine
months ended September 30, 2001 to cash used in financing activities of $11.1
million for the nine months ended September 30, 2002. This increase was due to
additional financing required for
the Riveredge hospital acquisition.

15



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In conjunction with its hospital acquisition in November 2001, Psychiatric
Solutions entered into a senior credit facility of $33.2 million (2001 Senior
Credit Facility). The 2001 Senior Credit Facility was amended on June 28, 2002
to provide for an additional $7.95 million pursuant to a new non-revolving term
note. The 2001 Senior Credit Facility, as revised, includes two lines of credit
for a total credit facility of $41.15 million, made up of $23.65 million of
non-revolving term loans and a $17.5 million revolving working capital line of
credit. Both lines are secured by substantially all of Psychiatric Solutions
assets and stock of its subsidiaries. The term loans accrue interest at the
Citibank, N.A. prime rate plus 4.25% to 4.75%. The revolving line of credit
accrues interest at the Citibank, N.A. prime rate plus 2% and is due in
November 2004. At September 30, 2002, the interest rate was 7.25%. Until the
due date, Psychiatric Solutions may borrow, repay and re-borrow an amount not
to exceed the lesser of $17.5 million or the borrowing base (as defined in the
2001 Senior Credit Facility). As of September 30, 2002 the Company had $6.5
million available under the revolving line of credit. On July 1, 2002,
Psychiatric Solutions drew $2.9 million on the revolving line of credit in
connection with its purchase of Riveredge Hospital. Following the acquisition
of Riveredge Hospital on July 1, 2002, there was $2.2 million available under
the revolving line of credit. Under the revolving line of credit, all of
Psychiatric Solutions collections, except for Medicare and Medicaid payments,
are deposited into lockbox accounts controlled by the lender. The funds
deposited in the lockbox are applied to outstanding borrowings with the lender
on a daily basis. As a result, the outstanding borrowings under the revolving
line of credit are classified as short term as of December 31, 2001 and
September 30, 2002. Psychiatric Solutions must pay an unused fee in the amount
of 0.05% per month of the monthly unused portion of the 2001 Senior Credit
Facility. Such fees were approximately $34,000 as of September 30, 2002.

The 2001 Senior Credit Facility contains customary covenants which include: (i)
a specified monthly patient census for any owned, operated or leased hospitals,
(ii) a limitation on capital expenditures, sales of assets, mergers, changes of
ownership and management, new lines of business and dividends and (iii) various
financial covenants. As of September 30, 2002, Psychiatric Solutions was in
compliance with all applicable debt covenant requirements. Should Psychiatric
Solutions results of operations or cash flows decline and result in violation
of one or more of these covenants, amounts outstanding under the 2001 Senior
Credit Facility could become immediately payable and additional borrowings
could be restricted. As of September 30, 2002, approximately $22.0 million was
outstanding.

In connection with the 2001 Senior Credit Facility, Psychiatric Solutions was
required to expense the remaining deferred loan costs associated with its prior
credit facility in the amount of $419,000 and incurred early termination
penalties of $818,000 in the fourth quarter of 2001.

In October 2000 Psychiatric Solutions issued subordinated notes totaling $1.0
million with certain of its stockholders (the Bridge Loan). In connection
with the Bridge Loan, Psychiatric Solutions issued warrants to purchase a total
of 398,579 shares of its Series B preferred stock. These warrants expire in
October 2005. The Bridge Loan was used to fund short-term working capital
requirements and accrued interest at 10% per annum, payable monthly. The Bridge
Loan was paid in full in April 2002. The warrants were exercised on August 1,
2002, and, in conjunction with the PMR merger, converted to 124,700 common
shares on August 5, 2002.

In connection with the acquisition of Sunrise in May 2000, Psychiatric
Solutions issued subordinated convertible notes in the amount of $3.6 million.
These convertible notes are due May 1, 2005 and accrue interest at 9% per
annum. The principal amount of these convertible notes is convertible into
shares of the Companys common stock based on conversion prices of $8.53 to
$9.59 per share.

Psychiatric Solutions also issued promissory notes totaling $4.5 million in
connection with its acquisitions of three hospitals. One note in the amount of
$2.5 million accrues interest at 9% per annum and matured on June 30, 2002.
Psychiatric Solutions paid off this note in full with a portion of the proceeds
of its subordinated debt offering described below. The remaining $2.0 million
note accrues interest at 9% per annum and is due June 30, 2005. Among other
customary covenants, both notes contain cross default covenants triggered by a
default of any other indebtedness of at least $1.0 million. Psychiatric
Solutions was in compliance with these covenants as of September 30, 2002.

On June 28, 2002, Psychiatric Solutions entered into a securities purchase
agreement with 1818 Mezzanine Fund II, L.P. to issue up to $20 million of
senior subordinated notes with detachable nominal warrants. At the closing on
June 28, 2002, a total of $10 million of the senior subordinated notes were
issued. Approximately $7.5 million of the proceeds were used to fund a portion
of the acquisition of Riveredge Hospital, and approximately $2.5 million of the
proceeds were used to reduce current indebtedness. The remaining $10 million of
senior subordinated notes may be issued to fund additional acquisitions of
free-standing psychiatric hospitals and for general working capital purposes,
subject generally to approval by the 1818 Fund. The notes have a term of seven
years and bear interest at 12% annually, payable quarterly. The notes provide
for a prepayment penalty of 6%, 3% and 1% if the notes are prepaid prior to the
first anniversary, second anniversary and third anniversary of the closing
date, respectively. The notes grant the holders the right to require prepayment
in the event of a change of control of Psychiatric Solutions, subject to a
prepayment penalty of 1% if redeemed on or before the third anniversary of the
closing date. The notes also require Psychiatric Solutions to comply with
financial and other covenants.

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Psychiatric Solutions believes that its working capital on hand and the
availability under the existing line of credit are sufficient to meet operating
and capital needs for the next 12 months. Psychiatric Solutions intends to
acquire additional psychiatric hospitals and is actively seeking acquisitions
that fit its corporate growth strategy. These acquisitions may, however,
require financing in addition to the working capital on hand and future cash
flows from operations. Management continually assesses its capital needs and
may seek additional financing, including debt or equity, as considered
necessary to fund potential acquisitions or for other corporate purposes.

|                             |          |  |                                                 |       |           |  |           |       |         |  |       |       |       |  |        |        |  |  |        |        | 
|---------------------------- | -------- |  | ----------------------------------------------- | ----- | --------- |  | --------- | ----- | ------- |  | ----- | ----- | ----- |  | ------ | ------ |  |  | ------ | ------ | 
|                             |          |  | Payments due by period as of September 30, 2002
|                             |          |  |                                                
|                             |          |  | Less than                                       |       |           |  |           |       |         |  |       |       | After |  |        |        | 
|                             |          |  | 1 year                                          |       | 1-3 years |  | 4-5 years |       | 5 years |  | Total
|                             |          |  |                                                 |       |           |  |           |       |         |  |      
|                             |          |  | (in thousands)                                 
|Contractual Cash Obligation: |          |  |                                                 |       |           |  |           |       |         |  |       |       |       |  |        |        |  |  |        |       
|Long term debt               |          |  | 7,303                                           |       |           |  | 4,036     |       |         |  | 5,317 |       |       |  | 25,657 |        |  |  | 42,313 |       
|Operating leases             |          |  | 516                                             |       |           |  | 591       |       |         |  | 145   |       |       |  | 179    |        |  |  | 1,431  |       
|                             |          |  |                                                 |       |           |  |           |       |         |  |       |       |       |  |        |        |  |  |        |       
|                             | Subtotal |  |                                                 | 7,819 |           |  |           | 4,627 |         |  |       | 5,462 |       |  |        | 25,836 |  |  |        | 43,744 | 
|                             |          |  |                                                 |       |           |  |           |       |         |  |       |       |       |  |        |        |  |  |        |       

|                   |                                   |  |                                            |       |           |  |           |       |         |  |       |       |       |  |   |        |  |  |     |        | 
|------------------ | --------------------------------- |  | ------------------------------------------ | ----- | --------- |  | --------- | ----- | ------- |  | ----- | ----- | ----- |  | - | ------ |  |  | --- | ------ | 
|                   |                                   |  | Amount of commitment expiration per period
|                   |                                   |  |                                           
|                   |                                   |  | Less than                                  |       |           |  |           |       |         |  |       |       | After |  |   |        | 
|                   |                                   |  | 1 year                                     |       | 1-3 years |  | 4-5 years |       | 5 years |  | Total
|                   |                                   |  |                                            |       |           |  |           |       |         |  |      
|                   |                                   |  | (in thousands)                            
|Other Commitments: |                                   |  |                                            |       |           |  |           |       |         |  |       |       |       |  |   |        |  |  |     |       
|Letter of credit   |                                   |  | 100                                        |       |           |  |          |       |         |  |      |       |       |  |  |        |  |  | 100 |       
|                   |                                   |  |                                            |       |           |  |           |       |         |  |       |       |       |  |   |        |  |  |     |       
|                   | Subtotal                          |  |                                            | 100   |           |  |           |      |         |  |       |      |       |  |   |       |  |  |     | 100    | 
|                   |                                   |  |                                            |       |           |  |           |       |         |  |       |       |       |  |   |        |  |  |     |       
|                   | Total obligations and commitments |  |                                            | 7,919 |           |  |           | 4,627 |         |  |       | 5,462 |       |  |   | 25,836 |  |  |     | 43,844 | 
|                   |                                   |  |                                            |       |           |  |           |       |         |  |       |       |       |  |   |        |  |  |     |       

The carrying value of our total long-term debt, including current maturities,
of $42.3 million and $36.3 million at September 30, 2002 and December 31, 2001,
respectively, approximated fair value. We had $28.0 million of variable rate
debt outstanding at September 30, 2002. At the September 30, 2002 borrowing
level, a hypothetical 10% adverse change in interest rates, would decrease net
income and cash flows by $260,000.

CRITICAL ACCOUNTING POLICIES

Psychiatric Solutions consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
In preparing its financial statements, Psychiatric Solutions is required to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, and expenses included in the financial statements.
Estimates are based on historical experience and other information currently
available, the results of which form the basis of such estimates. While
Psychiatric Solutions believes its estimation processes are reasonable, actual
results could differ from those estimates. The following represent the
estimates considered most critical to Psychiatric Solutions operating
performance and involve the most subjective and complex assumptions and
assessments.

Allowance for doubtful accounts

Psychiatric Solutions ability to collect outstanding patient receivables from
third party payors and receivables due under its management contracts is
critical to its operating performance and cash flows.

With regard to patient receivables, the allowance for doubtful accounts is
approximately 14% of the accounts receivable balance net of contractual
discounts as of September 30, 2002. The primary collection risk for these
receivables lies with uninsured patient accounts or patient accounts for which
primary insurance has paid but a patient portion remains outstanding.
Psychiatric Solutions estimates the allowance for doubtful accounts primarily
based upon the age of the accounts since patient discharge date. Psychiatric
Solutions continually monitors its accounts receivable balances and utilizes
cash collection data to support its estimates of the provision for doubtful
accounts. Significant changes in payor mix or business office operations could
have a significant impact on Psychiatric Solutions results of operations and
cash flows.

With regard to receivables due under management contracts, the allowance for
doubtful accounts is approximately 24% of the accounts receivable balance at
September 30, 2002. The primary collection risk is attributable to contractual
disputes. Psychiatric Solutions estimates the allowance for doubtful accounts
for these receivables based primarily upon the specific identification of
potential collection issues. As with its patient receivables, Psychiatric
Solutions continually monitors its accounts receivable balances and utilizes
cash collection data to support its estimates of the provision for doubtful
accounts.

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##### Table of Contents



Allowances for contractual discounts

The Medicare regulations and various managed care contracts are often complex
and may include multiple reimbursement mechanisms for different types of
services provided in Psychiatric Solutions facilities and cost settlement
provisions requiring complex calculations and assumptions subject to
interpretation. Psychiatric Solutions estimates the allowance for contractual
discounts on a payer-specific basis given its 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 Psychiatric Solutions estimates. Additionally, updated
regulations and contract renegotiations occur frequently necessitating
continual review and assessment of the estimation process by management.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

The information included in this Item 3 is considered to constitute
forward-looking statements for purposes of the statutory safe harbor provided
in Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the Securities Act of 1934, as amended. The additional information
called for by this item is provided under
Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations.

IMPACT OF INFLATION

Although inflation has not had a material impact on Psychiatric Solutions
results of operations, the health care industry is very labor intensive and
salaries and benefits are subject to inflationary pressures as are rising
supply costs which tend to escalate as vendors pass on the rising costs through
price increases. Some of Psychiatric Solutions freestanding specialty
psychiatric hospitals are experiencing the effects of the tight labor market,
including a shortage of nurses, which has caused and may continue to cause an
increase in its salaries, wages and benefits expense in excess of the inflation
rate. Although Psychiatric Solutions cannot predict its ability to cover future
cost increases, management believes that through adherence to cost containment
policies, labor management and reasonable price increases, the effects of
inflation on future operating margins should be manageable. Psychiatric
Solutions ability to pass on increased costs associated with providing health
care to Medicare and Medicaid patients is limited due to various federal, state
and local laws which have been enacted that, in certain cases, limit its
ability to increase prices. In addition, as a result of increasing regulatory
and competitive pressures and a continuing industry wide shift of patients into
managed care plans, Psychiatric Solutions ability to maintain margins through
price increases to non-Medicare patients is limited.

The psychiatric health care industry is typically not directly impacted by
periods of recession, erosions of consumer confidence or other general economic
trends as most health care services are not considered a component of
discretionary spending. However, Psychiatric Solutions facilities may be
indirectly negatively impacted to the extent such economic conditions result in
decreased reimbursements by federal or state governments or managed care
payers. Psychiatric Solutions is not aware of any economic trends that would
lead it to believe that Psychiatric Solutions will not be able to remain in
compliance with all debt covenants and meet all required obligations and
commitments in the near future.




ITEM 4. CONTROLS AND PROCEDURES.

Within the 90 days prior to the date of this report, 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 pursuant to Exchange Act Rule 13a-14. Based upon that evaluation,
the Chief Executive Officer and Chief Accounting Officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in our periodic SEC filings. There have
been no significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of our most
recent evaluation.

18



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##### Table of Contents









ITEM 1. LEGAL PROCEEDINGS

From time to time, the Company has been involved in routine litigation
incidental to the conduct of its business. There are currently no material
pending litigation proceedings to which the Company is a party.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

PMR held a special meeting of shareholders on August 5, 2002 to consider and
vote on the following matters: (1) approval of an agreement and plan of merger
by and among PMR, PMR Acquisition Corporation and Psychiatric Solutions, Inc.,
and the transactions contemplated by the merger agreement, including the
merger; (2) approval of an amendment to the Companys charter to effect (a) an
increase the number of authorized shares of the Companys common stock, (b) a
one-for-three stock split of its common stock and (c) to change the name of the
Company to Psychiatric Solutions, Inc.

The results of the Special Meeting were as follows:



|1. |  | Approval of the Merger with Psychiatric Solutions
|-- |  | -------------------------------------------------

|    |  |              |  |         |  |       |  |         |  |     |  |  |  |  |  | 
|--- |  | ------------ |  | ------- |  | ----- |  | ------- |  | --- |  |  |  |  |  | 
|For |  | 5,333,037.56 |  | Against |  | 6,453 |  | Abstain |  | 820



|2. |  | Approval of the Charter Amendment
|-- |  | ---------------------------------

|    |  |              |  |         |  |        |  |         |  |       |  |  |  |  |  | 
|--- |  | ------------ |  | ------- |  | ------ |  | ------- |  | ----- |  |  |  |  |  | 
|For |  | 5,315,681.56 |  | Against |  | 23,609 |  | Abstain |  | 1,020

Psychiatric Solutions, Inc. also held a special meeting of shareholders on
August 5, 2002 to consider and vote on the approval of an agreement and plan of
merger by and among PMR, PMR Acquisition Corporation and Psychiatric Solutions,
Inc., and the transactions contemplated by the merger agreement, including the
merger.

The results of the Special Meeting were as follows:



|1. |  | Approval of the Merger with PMR Corporation
|-- |  | -------------------------------------------

|                |  |            |  |         |  |   |  |         |  |         |  |  |  |  |  | 
|--------------- |  | ---------- |  | ------- |  | - |  | ------- |  | ------- |  |  |  |  |  | 
|Preferred Class
|For             |  | 14,769,136 |  | Against |  | 0 |  | Abstain |  | 703,600

|                              |  |            |  |         |  |   |  |         |  |           |  |  |  |  |  | 
|----------------------------- |  | ---------- |  | ------- |  | - |  | ------- |  | --------- |  |  |  |  |  | 
|Combined Preferred and Common
|For                           |  | 21,010,949 |  | Against |  | 0 |  | Abstain |  | 1,789,414




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

|     |  |                                                                                                                        
|---- |  | -----------------------------------------------------------------------------------------------------------------------
|99.1 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|99.2 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)  Reports on Form 8-K

On August 5, 2002, the Company filed an 8-K which announced the execution
of a contingent value rights agreement dated August 2, 2002, by and among
PMR, Fred D. Furman, as Representative, and StockTrans, Inc., as Trustee,
and the establishment of the record date for the contingent value rights,
or CVRs, as August 2, 2002, each in anticipation of its proposed merger
with Psychiatric Solutions, Inc. (Psychiatric Solutions). The CVR
agreement provides for the distribution of certificated CVRs to each holder
of PMR common stock as of the record date.

On August 6, 2002, the Company filed an 8-K which announced the completion
of the previously announced merger between Psychiatric Solutions, Inc. and
PMR Corp. The 8-K also provided guidance for anticipated 2002 and 2003
earnings.

On October 7, 2002, the Company filed an 8-K/A which amended the 8-K filed
on August 6, 2002 to include condensed consolidated financial statements
for Psychiatric Solutions, Inc. for the periods ended June 30, 2002 and
2001. The 8-K/A also included Pro Forma condensed combined consolidated
financial statements for the period ended June 30, 2002.

On November 12, 2002, The Company filed an 8-K announcing results of operations
for the periods ended September 30, 2002.

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##### Table of Contents






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             
|                         |  |                                        
|Dated: November 14, 2002 |  | /s/ Joey A. Jacobs                     
|                         |  |                                        
|                         |  | Joey A. Jacobs
Chief Executive Officer 
|                         |  |                                        
|Dated: November 14, 2002 |  | /s/ Jack E. Polson                     
|                         |  |                                        
|                         |  | Jack E. Polson
Chief Accounting Officer

I, Joey A. Jacobs, certify that:



| | 1. |  | I have reviewed this quarterly report on Form 10-Q of Psychiatric
Solutions, Inc.;                                                                                                                                                                                                                                                     
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the issuer as of, and for, the periods presented in this
quarterly report;                                
|
| | 4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                              

|   |  |                                                                                                                                                                                                                                                                                                
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this quarterly report is being prepared;
|   |  |                                                                                                                                                                                                                                                                                                
|b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the Evaluation
Date); and                                                                                                  
|   |  |                                                                                                                                                                                                                                                                                                
|c) |  | presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        



| | 5. |  | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of the registrants board of directors (or persons
fulfilling the equivalent function):
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|   |  |                                                                                                                                                                                                                                                                                               
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data
and have identified for the registrants auditors any material
weaknesses in internal controls; and
|   |  |                                                                                                                                                                                                                                                                                               
|b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        



| | 6. |  | The registrants other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                  |  |                                       
|----------------- |  | --------------------------------------
|                  |  |                                       
|November 14, 2002 |  | /s/ Joey A. Jacobs                    
|                  |  |                                       
|                  |  | Joey A. Jacobs
Chief Executive Officer

20



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##### Table of Contents



I, Jack E. Polson, certify that:



| | 1. |  | I have reviewed this quarterly report on Form 10-Q of Psychiatric
Solutions, Inc.;                                                                                                                                                                                                                                                     
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the issuer as of, and for, the periods presented in this
quarterly report;                                
|
| | 4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                              

|   |  |                                                                                                                                                                                                                                                                                                
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this quarterly report is being prepared;
|   |  |                                                                                                                                                                                                                                                                                                
|b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the Evaluation
Date); and                                                                                                  
|   |  |                                                                                                                                                                                                                                                                                                
|c) |  | presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        



| | 5. |  | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of the registrants board of directors (or persons
fulfilling the equivalent function):
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|   |  |                                                                                                                                                                                                                                                                                               
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data
and have identified for the registrants auditors any material
weaknesses in internal controls; and
|   |  |                                                                                                                                                                                                                                                                                               
|b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        



| | 6. |  | The registrants other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                  |  |                                        
|----------------- |  | ---------------------------------------
|November 14, 2002 |  |                                        
|                  |  |                                        
|                  |  | /s/Jack E. Polson                      
|                  |  |                                        
|                  |  | Jack E. Polson
Chief Accounting Officer

21