##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One)x
    
    Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934for the quarterly period
ended March 31, 2004 or
 o
    
    Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934for the transition period
from 
to
 Commission file number 0-20488 PSYCHIATRIC SOLUTIONS, INC.  DELAWARE
    
    23-2491707(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)
 113 Seaboard Lane, Suite C-100
Franklin, TN 37067
(Address of Principal Executive Offices, Including Zip Code) (615) 312-5700
(Registrants Telephone Number, Including Area Code) 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 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes
o No x As of May 7, 2004, 14,324,203 shares of the registrants common stock were
outstanding.




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PSYCHIATRIC SOLUTIONS, INC. TABLE OF CONTENTS PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets as of March 31, 2004
(Unaudited) and December 31, 2003
    
    
    1Condensed Consolidated Statements of Income for the three month
periods ended March 31, 2004 and 2003 (Unaudited)
    
    
    2Condensed Consolidated Statements of Cash Flows for the three
month periods ended March 31, 2004 and 2003 (Unaudited)
    
    
    3Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    23Item 4. Controls and Procedures
    
    
    24PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    24Item 6. Exhibits and Reports on Form 8-K
    
    
    24Ex-10.1 CREDIT AGREEMENTEx-10.2 INTEREST RATE SWAP AGREEMENTEX-31.1  SECTION 302 CEO CERTIFICATIONEX-31.2  SECTION 302 CFO CERTIFICATIONEX-32.1 SECTION 906 CERTIFICATION OF THE CEO & CFO




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS PSYCHIATRIC SOLUTIONS, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS 
(In thousands, except per share amounts)
 March 31,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    34,176
    
    
    $
    44,832Accounts receivable, less allowance for doubtful accounts of
$8,707(unaudited)and$7,491,respectively
    
    
    65,278
    
    
    
    60,055Prepaids and other
    
    
    6,762
    
    
    
    8,529Total current assets
    
    
    106,216
    
    
    
    113,416Property and equipment, net of accumulated depreciation
    
    
    175,851
    
    
    
    149,757Cost in excess of net assets acquired
    
    
    70,501
    
    
    
    68,970Contracts, net
    
    
    2,614
    
    
    
    2,850Other assets
    
    
    16,685
    
    
    
    13,642Total assets
    
    $
    371,867
    
    
    $
    348,635LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    12,190
    
    
    $
    11,637Salaries and benefits payable
    
    
    16,634
    
    
    
    13,642Other accrued liabilities
    
    
    23,743
    
    
    
    20,168Current portion of long-term debt
    
    
    1,100
    
    
    
    1,023Total current liabilities
    
    
    53,667
    
    
    
    46,470Long-term debt, less current portion
    
    
    190,816
    
    
    
    173,980Deferred tax liability
    
    
    6,681
    
    
    
    6,762Other liabilities
    
    
    4,120
    
    
    
    4,779Total liabilities
    
    
    255,284
    
    
    
    231,991Series A convertible preferred stock, $0.01 par value, 6,000 shares
authorized; 4,545 shares issued and outstanding
    
    
    25,617
    
    
    
    25,316Stockholders equity:Common stock, $0.01 par value, 48,000 shares authorized;
11,995 and 11,937 issued and outstanding, respectively
    
    
    120
    
    
    
    119Additional paid-in capital
    
    
    91,412
    
    
    
    91,423Notes receivable from stockholders
    
    
    (338
    )
    
    
    (338
    )Accumulated unrealized gains (losses)
    
    
    4
    
    
    
    (4
    )Accumulated (deficit) earnings
    
    
    (232
    )
    
    
    128Total stockholders equity
    
    
    90,966
    
    
    
    91,328Total liabilities and stockholders equity
    
    $
    371,867
    
    
    $
    348,635
 See notes to condensed consolidated financial statements 1




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME 
(Unaudited, in thousands except for per share amounts)
 Three Months Ended March 31,2004
    
    2003Revenue
    
    $
    107,584
    
    
    $
    37,104Salaries, wages and employee benefits
    
    
    58,995
    
    
    
    17,785Professional fees
    
    
    12,056
    
    
    
    4,451Supplies
    
    
    6,941
    
    
    
    1,691Rentals and leases
    
    
    1,783
    
    
    
    248Other operating expenses
    
    
    12,862
    
    
    
    7,159Provision for doubtful accounts
    
    
    2,027
    
    
    
    1,322Depreciation and amortization
    
    
    2,117
    
    
    
    667Interest expense
    
    
    4,456
    
    
    
    1,420Loss on refinancing long-term debt
    
    
    6,407
    
    
    
    Change in valuation of put warrants
    
    
    
    
    
    
    960Change in reserve on stockholder notes
    
    
    
    
    
    
    (461
    )107,644
    
    
    
    35,242(Loss) income before income taxes
    
    
    (60
    )
    
    
    1,862(Benefit from)provision
for income taxes
    
    
    (23
    )
    
    
    1,073Net (loss) income
    
    
    (37
    )
    
    
    789Accrued preferred stock dividends
    
    
    323
    
    
    
    Net (loss) income available to common stockholders
    
    $
    (360
    )
    
    $
    789Earnings per common share:Basic
    
    $
    (0.03
    )
    
    $
    0.10Diluted
    
    $
    (0.03
    )
    
    $
    0.10Shares used in computing per share amounts:Basic
    
    
    11,958
    
    
    
    7,739Diluted
    
    
    11,958
    
    
    
    8,209
 See notes to condensed consolidated financial statements 2




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PSYCHIATRIC SOLUTIONS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 Three Months Ended March 31,2004
    
    2003Operating ActivitiesNet (loss) income
    
    $
    (37
    )
    
    $
    789Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    2,117
    
    
    
    667Provision for doubtful accounts
    
    
    2,027
    
    
    
    1,322Accretion of detachable warrants
    
    
    
    
    
    
    77Non-cash stock compensation expense
    
    
    
    
    
    
    5Amortization of loan costs
    
    
    199
    
    
    
    160Loss on refinancing long-term debt
    
    
    6,407
    
    
    
    Change in valuation of put warrants
    
    
    
    
    
    
    960Change in reserve on stockholder notes
    
    
    
    
    
    
    (461
    )Long-term interest accrued
    
    
    
    
    
    
    81Changes in operating assets and liabilities:Accounts receivable
    
    
    (3,195
    )
    
    
    (3,986
    )Prepaids and other assets
    
    
    1,981
    
    
    
    (973
    )Accounts payable
    
    
    (2,320
    )
    
    
    148Salaries and benefits payable
    
    
    2,065
    
    
    
    (1,178
    )Accrued liabilities and other liabilities
    
    
    5,745
    
    
    
    3,514Net cash provided by operating activities
    
    
    14,989
    
    
    
    1,125Investing activities:Cash paid for acquisitions, net of cash acquired
    
    
    (33,211
    )
    
    
    Capital purchases of property and equipment
    
    
    (3,058
    )
    
    
    (628
    )Other assets
    
    
    (1,505
    )
    
    
    (180
    )Net cash used in investing activities
    
    
    (37,774
    )
    
    
    (808
    )Financing activities:Net principal borrowings on long-term debt
    
    
    16,856
    
    
    
    1,336Refinancing of long-term debt
    
    
    (3,844
    )
    
    
    Payment of loan and issuance costs
    
    
    (987
    )
    
    
    Proceeds from issuance of common stock
    
    
    104
    
    
    
    Net cash provided by financing activities
    
    
    12,129
    
    
    
    1,336Net (decrease) increase in cash
    
    
    (10,656
    )
    
    
    1,653Cash at beginning of the period
    
    
    44,832
    
    
    
    2,392Cash at end of the period
    
    $
    34,176
    
    
    $
    4,045Significant Non-cash Transactions:Loss on refinancing long-term debt
    
    $
    (2,563
    )
    
    $
    Effect of Acquisitions:Assets acquired, net of cash acquired
    
    $
    31,682
    
    
    $
    Cash payment for prior-year acquisition
    
    
    3,350
    
    
    
    Liabilities assumed
    
    
    (1,821
    )
    
    
    Cash paid for acquisitions, net of cash acquired
    
    $
    33,211
    
    
    $
    
 See notes to condensed consolidated financial statements 3




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PSYCHIATRIC SOLUTIONS, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
 1. Recent Developments On March 1, 2004, we acquired two inpatient psychiatric facilities from
Brentwood Behavioral Health (Brentwood) for $29.8 million cash with an
earn-out of up to $5.0 million contingent upon future financial results. We drew
down $17.0 million on our revolving line of credit and paid the remainder of
the acquisition price with cash on hand. The inpatient facilities, which have an aggregate of 311
licensed beds, are located in Shreveport, Louisiana and Jackson, Mississippi. On January 26, 2004, we entered into an interest rate swap agreement to manage
our exposure to fluctuations in interest rates. The swap agreement effectively
converts $20.0 million of fixed-rate long-term debt to a LIBOR indexed variable
rate instrument plus an agreed upon interest rate spread of 5.86%. On January 6, 2004, we terminated our senior credit facility with CapitalSource
Finance LLC (CapSource) and entered into a new credit agreement with Bank of
America, N.A. (Bank of America) that provides for a revolving credit facility
of up to $50.0 million. As a result of the termination of our senior credit
facility with CapSource, we recorded a loss on refinancing long-term debt of
$6.4 million for the quarter ended March 31, 2004. 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, 2003 has been derived from
the audited financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation of our financial position have
been included. The majority of our expenses are cost of revenue items.
General and administrative expenses were approximately 2% of net revenue for
the three months ended March 31, 2004. Operating results for the three months
ended March 31, 2004 are not necessarily indicative of the results that may be
expected for the full year. For further information, refer to the financial
statements and footnotes thereto included in our Annual Report on Form 10-K for
the year ended December 31, 2003 filed on March 25, 2004. 3. Earnings Per Share Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per
Share, requires dual presentation of basic and diluted earnings per share by
entities with complex capital structures. Basic earnings per share include no
dilution and are computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding for
the period. Diluted earnings per share reflect the potential dilution of
outstanding securities that, upon exercise or conversion, could share in our
earnings. We have calculated our earnings per share in accordance with SFAS No.
128 for all periods presented. 4




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 The following table sets forth the computation of basic and diluted earnings
per share (dollars in thousands, except per share amounts): Three months ended March 31,2004
    
    2003Numerator:Net (loss) income available to common stockholders
    
    $
    (360
    )
    
    $
    789Denominator:Weighted average shares outstanding for basic earnings per share
    
    
    11,958
    
    
    
    7,739Effects of dilutive stock options and warrants outstanding
    
    
    
    
    
    
    470Shares used in computing diluted earnings per common share
    
    
    11,958
    
    
    
    8,209Earnings per common share, basic
    
    $
    (0.03
    )
    
    $
    0.10Earnings per common share, diluted
    
    $
    (0.03
    )
    
    $
    0.10
 The computation of diluted earnings per share for the three months ended March
31, 2004 does not include approximately 4.7 million shares representing the
weighted average of common shares into which our series A preferred stock is
convertible and approximately 540,000 shares representing stock options and
warrants outstanding during the period as the effects would have been
anti-dilutive. The computation of diluted earnings per share for the three
months ended March 31, 2003 does not include interest on convertible debt of
$81,000 and approximately 422,000 shares representing the weighted average of
convertible debt outstanding during the period as the effects would have been
anti-dilutive. 4. Stock-Based Compensation We account for our stock option plans using the intrinsic value method in
accordance with the provisions of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Pursuant to APB Opinion No. 25, compensation expense would be
recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. We do not plan to adopt the
fair-value method of accounting for stock options at the current time. Pro forma information regarding interim net income and earnings per share is
required by SFAS No. 148, and has been determined as if we had accounted for
our employee stock options under the fair value method. The fair value of
options we have granted was estimated using the Black-Scholes option pricing
model. Option valuation models require the input of highly subjective assumptions.
Because our employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in
managements opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of our employee stock options. 5




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 For purposes of pro forma disclosure, the estimated fair value of the options
at grant date is amortized to expense over the options vesting period. The pro
forma information follows (in thousands, except per share amounts): For the three months ended March 31,2004
    
    2003Net (loss) income available to common stockholders
    
    $
    (360
    )
    
    $
    789Pro forma compensation expense from stock options
    
    
    290
    
    
    
    93Pro forma net (loss) income available to common
stockholders
    
    $
    (650
    )
    
    $
    696Basic earnings per share, as reported
    
    $
    (0.03
    )
    
    $
    0.10Diluted earnings per share, as reported
    
    $
    (0.03
    )
    
    $
    0.10Basic pro forma earnings per share
    
    $
    (0.05
    )
    
    $
    0.09Diluted pro forma earnings per share
    
    $
    (0.05
    )
    
    $
    0.08
 5. Mergers and Acquisitions Acquiring free-standing psychiatric facilities is a key part of our business
strategy. Because we have grown through mergers and acquisitions accounted for
as purchases, it is difficult to make meaningful comparisons between our
financial statements for the fiscal periods presented. On March 1, 2004, we acquired two inpatient psychiatric facilities from
Brentwood for $29.8 million cash with an earn-out of up to $5.0 million
contingent upon future financial results. We drew down $17.0 million on our
revolving line of credit and paid the remainder of the acquisition price in
cash. The facilities, which have an aggregate of 311 licensed beds, are located
in Shreveport, Louisiana and Jackson, Mississippi. On November 1, 2003, we acquired the 109-bed Alliance Health Center located in
Meridian, Mississippi for approximately $13.0 million. The acquisition was
entirely financed through our then-existing line of credit. Alliance Health
Center is a licensed acute care hospital that provides psychiatric care for
children, adolescents and adults. In addition, we recently completed
the construction of a 60-bed residential treatment
center which opened in May 2004. On June 30, 2003, we consummated the acquisition of Ramsay Youth Services, Inc.
(Ramsay), a public company that traded on the Nasdaq SmallCap Market under
the symbol RYOU, for approximately $81.3 million, consisting of $56.2 million
in cash, or $5.00 per share, $22.3 million in net assumed debt that was repaid
in connection with the acquisition and $2.8 million in fees and expenses. We
financed the acquisition of Ramsay with proceeds from the issuance of $150
million in 10 5/8% senior subordinated notes and the private placement of $12.5
million of our series A convertible preferred stock. The 11 owned or leased
inpatient behavioral health care facilities we acquired from Ramsay, which have
an aggregate of 1,292 beds, are located primarily in the Southeastern region of
the United States with locations also in Michigan, Missouri and Utah. In the
acquisition, we also assumed 10 contracts to manage behavioral health care
facilities for government agencies in Florida, Georgia and Puerto Rico. In April 2003, we consummated the acquisition of six inpatient behavioral
health care facilities from The Brown Schools, Inc. (The Brown Schools) for
$63.0 million in cash. The six facilities, which have an aggregate of 895
licensed beds, are located in Austin, San Antonio and San Marcos, Texas;
Charlottesville, Virginia; Colorado Springs, Colorado; and Tulsa, Oklahoma. The
Brown Schools offer a full continuum of care for troubled adolescents and
adults. We financed the acquisition of The Brown Schools with proceeds
from the private placement of $12.5 million of our series A convertible
preferred stock and an increase in funding under our senior credit facility. 6




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 The purchase price allocation for Brentwood is preliminary as of March 31,
2004, pending receipt of asset appraisals. The following represents the unaudited pro forma results of consolidated
operations as if the acquisition of Brentwood had occurred at the beginning of
the periods presented, after giving effect to certain adjustments, including
the depreciation and amortization of the assets acquired based upon their
estimated fair values and changes in interest expense resulting from changes in
consolidated debt (dollars in thousands, except per share data): For the three months ended March 31,2004
    
    2003Revenue
    
    $
    113,220
    
    
    $
    43,925Net (loss) income available to
common stockholders
    
    
    (59
    )
    
    
    880Earnings per common share, basic
    
    $
    
    
    
    $
    0.11Earnings per
diluted share, diluted
    
    $
    
    
    
    $
    0.11
 The pro forma information given does not purport to be indicative of what our
results of operations would have been if the acquisitions had in fact occurred
at the beginning of the periods presented, and is not intended to be a
projection of the impact on our future results or trends. The pro forma information
given includes a $6.4 million loss from refinancing long-term debt for the
three months ended March 31, 2004, expense of $960,000 to revalue put warrants
for the three months ended March 31, 2003 and income of $461,000 to release
reserves on stockholder notes for the three months ended March 31, 2003. 6. Long-term debt Long-term debt consists of the following (in thousands): March 31,
    
    December 31,2004
    
    2003Senior credit facilities:Revolving line of credit, expired on January 6, 2004
and bearing interest at 6.25% at December 31, 2003
    
    $
    
    
    
    $
    Revolving line of credit, entered into on January 6, 2004,
expiring on January 6, 2007 and bearing interest of
3.625% at March 31, 2004
    
    
    17,000
    
    
    
    10 5/8% senior subordinated notes
    
    
    150,000
    
    
    
    150,000Mortgage loans on facilities, maturing in 2037 and 2038
bearing fixed interest rates of 5.65% to 5.95%
    
    
    23,778
    
    
    
    23,833Subordinated seller notes with varying maturities
    
    
    1,023
    
    
    
    1,170Other
    
    
    115
    
    
    
    191,916
    
    
    
    175,003Less current portion
    
    
    1,100
    
    
    
    1,023Long-term debt
    
    $
    190,816
    
    
    $
    173,980
 7




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 Senior Credit Facility On January 6, 2004, we terminated our senior credit facility with CapSource and
entered into a new credit agreement with Bank of America that provides for a
revolving credit facility of up to $50.0 million. As a result of the termination
of our senior credit facility with CapSource, we recorded a loss on refinancing
long-term debt of $6.4 million for the quarter ended March 31, 2004, including
approximately $3.8 million paid as a termination fee to CapSource. Our credit
facility with Bank of America is secured by substantially all of the personal property owned by us
or our subsidiaries, substantially all real property owned by us or our subsidiaries that has
a value in excess of $2.5 million and the stock of our operating subsidiaries.
In addition, the credit facility is fully and unconditionally
guaranteed by substantially all of our operating subsidiaries. The revolving line of credit accrues interest at our choice of the Base Rate
or the Eurodollar Rate (as defined in the Credit Agreement) and is due in
January 2007. The Base Rate and Eurodollar Rate fluctuate based upon market
rates and certain leverage ratios, as defined in the Credit Agreement. At March
31, 2004, the interest rate under the revolving line of credit was 3.625%.
Until the maturity date, we may borrow, repay and re-borrow an amount not to
exceed the lesser of $50.0 million or the borrowing base (as defined in the
Credit Agreement). As of March 31, 2004, we had $17.0 million of borrowings
outstanding and $33.0 million available under the revolving line of credit. We
must pay on a quarterly basis a commitment fee in the amount of 0.5% per annum
on the unused portion of our revolving credit facility and a utilization fee in
the amount of 0.25% per annum on the unused portion of the revolving credit
facility when borrowings under the revolving credit facility are less than
$16.5 million. Such fees were approximately $65,000 for the three months ended
March 31, 2004. Our revolving credit facility contains customary covenants which include: (1) a
limitation on capital expenditures and investments, sales of assets, mergers, changes of
ownership, new principal lines of business, indebtedness, dividends and
redemptions; (2) various financial covenants; and (3) cross-default covenants
triggered by a default of any other indebtedness of at least $3.0 million. As
of March 31, 2004, we were in compliance with all debt covenant requirements.
If we violate one or more of these covenants, amounts outstanding under the
revolving credit facility could become immediately payable and additional
borrowings could be restricted. 10 5/8% Senior Subordinated Notes On June 30, 2003, we issued $150 million in 10 5/8% senior subordinated notes,
which are fully and unconditionally guaranteed on a senior subordinated basis
by substantially all of our operating subsidiaries. Proceeds from the
issuance of the senior subordinated notes and the private placement of $12.5
million in series A convertible preferred stock were used to finance the
acquisition of Ramsay and pay down substantially all of our long-term debt.
Interest on the senior subordinated notes accrues at the rate of 10.625% per
annum and is payable semi-annually in arrears on June 15 and December 15,
which commenced on December 15, 2003. The senior subordinated notes will mature on
June 15, 2013. Mortgage Loans During 2002 and 2003, we borrowed approximately $23.8 million under mortgage
loan agreements insured by the U.S. Department of Housing and Urban Development
(HUD). These mortgage loans are secured by real estate located at Holly Hill
Hospital in Raleigh, North Carolina, West Oaks Hospital in Houston, Texas, and
Riveredge Hospital near Chicago, Illinois. Interest accrues on the Holly Hill,
West Oaks and Riveredge HUD loans at 5.95%, 5.85% and 5.65%, respectively, and
principal and interest are payable in 420 monthly installments through December
2037, September 2038 and December 2038, respectively. We used the proceeds from
the mortgage loans to repay approximately $4.4 million in 2002 and $17.0
million in 2003 of our term debt under our former senior credit facility with
CapSource, pay certain financing costs, and fund required escrow amounts for
future improvements to the property. The carrying amount of assets held as
collateral approximated $23.9 million as of March 31, 2004. 8




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 Subordinated Seller Notes In connection with an
acquisition in 2000, we issued a promissory note payable in the amount
of $400,000 bearing interest at 9%. The principal amount we owe on
this note is $160,000 at March 31, 2004, which is due in two equal
installments on April 1, 2004 and 2005. Accured interest is due and
payable on the first day of each calendar quarter. We issued two promissory notes totaling $4.5 million in connection with our
acquisitions of three facilities in 2001. At March 31, 2004, one note with a
current principal balance of $863,000 remained outstanding. This note accrues
interest at 9% per annum and is due June 30, 2005. Among other customary
covenants, the note contains cross-default covenants triggered by a default of
any other indebtedness of at least $1.0 million. We were in compliance with
these covenants as of March 31, 2004. 7. Mezzanine Equity and Stockholders Equity We issued 4,545,454 shares of our series A convertible preferred stock during
the quarter ended June 30, 2003. Each share of series A convertible preferred
stock is convertible into one share of our common stock. Holders of our series
A convertible preferred stock are entitled to receive pay-in-kind dividends,
compounded quarterly, equal to 5% per share of the original share price through
March 31, 2005. Thereafter, pay-in-kind dividends will compound quarterly at 7%
per share of the original share price. Because we may be required to redeem the
series A convertible preferred stock upon certain change of control events that
may not be within our control, the series A convertible preferred stock has
been classified outside of our permanent stockholders equity. As a part of the merger with PMR, we became the holder of promissory notes with
certain stockholders of PMR. A certain provision of the stockholder notes
allowed the stockholders to repay those notes with our common stock at the
higher of a stated price or the market value of our common stock. As the stated
price was higher than the market value at December 31, 2002, we recorded a
reserve on the promissory notes equal to the difference between the stated
price and market value. Due to the increase in the market price of our common
stock during the three months ended March 31, 2003, we released $461,000 of the
reserve on the stockholder notes. At December 31, 2003, we did not maintain a
reserve balance on our stockholder notes because the market value exceeded the
stated price. The right to repay the stockholder notes with our common stock
expired on December 31, 2003. The current outstanding balance of these notes is
$338,000. 8. Income Taxes The benefit recorded for the three months ended March 31, 2004 reflects an
effective tax rate of approximately 38%. The provision recorded for the three
months ended March 31, 2003 reflects an effective tax rate of approximately
57.6% due to the non-deductible nature of the change in valuation of the put
warrants during the period. 9. Disclosures About Reportable Segments In accordance with the criteria of SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information, we operate two reportable segments: (1)
owned and leased facilities and (2) management contracts. Each of our inpatient
facilities and inpatient management contracts qualifies as an operating segment
under SFAS No. 131; however, none is individually material. We have aggregated
our operations into two reportable segments based on characteristics of the
services provided. As of March 31, 2004, the
owned and leased facilities segment provides inpatient mental and behavioral
health services in its 22 owned and 4 leased facilities in 15 states. The
management contracts segment provides inpatient psychiatric management and
development services to 42 behavioral health units in third party
medical/surgical hospitals and clinics in 15 states and provides mental and
behavioral health services to 11 inpatient facilities for state government
agencies. Activities classified as Corporate and Other in the following
schedule relate primarily to unallocated home office items. Adjusted EBITDA is a non-GAAP financial measure and is defined as net income
(loss) before interest expense (net of interest income), income taxes,
depreciation, amortization, stock compensation and other 9




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PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 items included in the
caption labeled Other expenses. These other expenses may occur in future
periods, but the amounts recognized can vary significantly from period to
period and do not directly relate to the ongoing operations of our health care
facilities. Our management relies on adjusted EBITDA as the primary measure to
review and assess the operating performance of our inpatient facilities and
their management teams. We believe it is useful to investors to provide
disclosures of our operating results on the same basis as that used by
management. Management and investors also review adjusted EBITDA to evaluate
our overall performance and to compare our current operating results with
corresponding periods and with other companies in the health care industry. You
should not consider adjusted EBITDA in isolation or as a substitute for net
income, operating cash flows or other cash flow statement data determined in
accordance with accounting principles generally accepted in the United States.
Because adjusted EBITDA is not a measure of financial performance under
accounting principles generally accepted in the United States and is
susceptible to varying calculations, it may not be comparable to similarly
titled measures of other companies. The following is a financial summary by
business segment for the periods indicated (dollars in thousands): Owned andLeased
    
    Management
    
    CorporateFacilities
    
    Contracts
    
    and Other
    
    ConsolidatedThree months ended March 31, 2004Revenue
    
    $
    86,443
    
    
    $
    21,141
    
    
    $
    
    
    
    $
    107,584Adjusted EBITDA
    
    $
    12,992
    
    
    $
    2,369
    
    
    $
    (2,441
    )
    

    $
    12,920Interest expense
    
    
    3,559
    
    
    
    (5
    )
    
    
    902
    
    
    
    4,456Depreciation and amortization
    
    
    1,744
    
    
    
    314
    
    
    
    59
    
    
    
    2,117Provision for income taxes
    
    
    662
    
    
    
    
    
    
    
    (685
    )
    
    
    (23
    )Inter-segment expenses
    
    
    1,347
    
    
    
    801
    
    
    
    (2,148
    )
    
    
    Other expenses:Loss on refinancing long-term debt
    
    
    
    
    
    
    
    
    
    
    6,407
    
    
    
    6,407Net income (loss)
    
    $
    5,680
    
    
    $
    1,259
    
    
    $
    (6,976
    )
    
    $
    (37
    )Segment assets
    
    $
    255,938
    
    
    $
    38,524
    
    
    $
    77,405
    
    
    $
    371,867
 Owned andLeased
    
    Management
    
    CorporateFacilities
    
    Contracts
    
    and Other
    
    ConsolidatedThree months ended March 31, 2003Revenue
    
    $
    26,087
    
    
    $
    11,017
    
    
    $
    
    
    
    $
    37,104Adjusted EBITDA
    
    $
    4,090
    
    
    $
    1,839
    
    
    $
    (1,476
    )
    
    $
    4,453Interest expense
    
    
    907
    
    
    
    81
    
    
    
    432
    
    
    
    1,420Depreciation and amortization
    
    
    385
    
    
    
    265
    
    
    
    17
    
    
    
    667Provision for income taxes
    
    
    
    
    
    
    40
    
    
    
    1,033
    
    
    
    1,073Inter-segment expenses
    
    
    940
    
    
    
    674
    
    
    
    (1,614
    )
    
    
    Other expenses:Non-cash stock compensation expense
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    5Change in valuation of put warrants
    
    
    
    
    
    
    
    
    
    
    960
    
    
    
    960Change in reserve on stockholder notes
    
    
    
    
    
    
    (461
    )
    
    
    
    
    
    
    (461
    )Total other expenses
    
    
    
    
    
    
    (461
    )
    
    
    965
    
    
    
    504Net income (loss)
    
    $
    1,858
    
    
    $
    1,240
    
    
    $
    (2,309
    )
    
    $
    789Segment assets
    
    $
    53,727
    
    
    $
    34,449
    
    
    $
    8,444
    
    
    $
    96,620
 10




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 10. Recent Pronouncements In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51(FIN 46). FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after December 15, 2003. The adoption of FIN 46 has not had a
material effect on our results of operations or financial position. 11. Financial Information for Psychiatric Solutions and Its Subsidiaries We conduct substantially all of our business through our subsidiaries.
Presented below is condensed consolidated financial information for us and our
subsidiaries as of March 31, 2004 and December 31, 2003, and for the three
months ended March 31, 2004 and 2003. The information segregates the parent
company (Psychiatric Solutions, Inc.), the combined wholly-owned subsidiary
guarantors, the combined non-guarantors, and eliminations. All of the
subsidiary guarantees are both full and unconditional and joint and several. Psychiatric Solutions, Inc.
Condensed Consolidating Balance Sheet
March 31, 2004
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsCurrent Assets:Cash
    
    $
    
    
    
    $
    32,511
    
    
    $
    1,665
    
    
    $
    
    
    
    $
    34,176Accounts receivable, net
    
    
    
    
    
    
    65,278
    
    
    
    
    
    
    
    
    
    
    
    65,278Prepaids and other
    
    
    
    
    
    
    6,406
    
    
    
    356
    
    
    
    
    
    
    
    6,762Total current assets
    
    
    
    
    
    
    104,195
    
    
    
    2,022
    
    
    
    
    
    
    
    106,216Property and
equipment, net of accumulated depreciation
    
    
    
    
    
    
    153,382
    
    
    
    30,788
    
    
    
    (8,258
    )
    
    
    175,851Cost in excess of net assets acquired
    
    
    
    
    
    
    70,501
    
    
    
    
    
    
    
    
    
    
    
    70,501Contracts, net
    
    
    
    
    
    
    2,614
    
    
    
    
    
    
    
    
    
    
    
    2,614Investment in subsidiaries
    
    
    99,048
    
    
    
    
    
    
    
    
    
    
    
    (99,048
    )
    
    
    Other assets
    
    
    5,863
    
    
    
    6,508
    
    
    
    4,314
    
    
    
    
    
    
    
    16,685Total assets
    
    $
    104,911
    
    
    $
    337,200
    
    
    $
    37,124
    
    
    $
    (107,306
    )
    
    $
    371,867Current Liabilities:Accounts payable
    
    $
    
    
    
    $
    12,190
    
    
    $
    
    
    
    $
    
    
    
    $
    12,190Salaries and benefits payable
    
    
    
    
    
    
    16,634
    
    
    
    
    
    
    
    
    
    
    
    16,634Other accrued liabilities
    
    
    5,173
    
    
    
    18,449
    
    
    
    1,087
    
    
    
    (966
    )
    
    
    23,743Current portion of long-term debt
    
    
    
    
    
    
    875
    
    
    
    225
    
    
    
    
    
    
    
    1,100Total current liabilities
    
    
    5,173
    
    
    
    48,148
    
    
    
    1,312
    
    
    
    (966
    )
    
    
    53,667Long-term debt, less current portion
    
    
    
    
    
    
    167,262
    
    
    
    23,554
    
    
    
    
    
    
    
    190,816Deferred tax liability
    
    
    
    
    
    
    6,681
    
    
    
    
    
    
    
    
    
    
    
    6,681Other liabilities
    
    
    3,031
    
    
    
    123
    
    
    
    
    
    
    
    966
    
    
    
    4,120Total liabilities
    
    
    8,204
    
    
    
    222,214
    
    
    
    24,866
    
    
    
    
    
    
    
    255,284Series A convertible preferred stock
    
    
    25,617
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,617Stockholders equity:Total stockholders equity
    
    
    71,090
    
    
    
    114,986
    
    
    
    12,258
    
    
    
    (107,306
    )
    
    
    90,966Total liabilities and stockholders
equity
    
    $
    104,911
    
    
    $
    337,200
    
    
    $
    37,124
    
    
    $
    (107,306
    )
    
    $
    371,867
 11




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 Psychiatric Solutions, Inc.
Condensed Consolidating Balance Sheet
As of December 31, 2003
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsCurrent Assets:Cash
    
    $
    
    
    
    $
    43,334
    
    
    $
    1,498
    
    
    $
    
    
    
    $
    44,832Accounts receivable, net
    
    
    
    
    
    
    60,055
    
    
    
    
    
    
    
    
    
    
    
    60,055Prepaids and other
    
    
    
    
    
    
    8,510
    
    
    
    19
    
    
    
    
    
    
    
    8,529Total current assets
    
    
    
    
    
    
    111,899
    
    
    
    1,517
    
    
    
    
    
    
    
    113,416Property and
equipment, net of accumulated depreciation
    
    
    
    
    
    
    127,047
    
    
    
    31,029
    
    
    
    (8,319
    )
    
    
    149,757Cost in excess of net assets acquired
    
    
    
    
    
    
    68,970
    
    
    
    
    
    
    
    
    
    
    
    68,970Contracts, net
    
    
    
    
    
    
    2,850
    
    
    
    
    
    
    
    
    
    
    
    2,850Investment in subsidiaries
    
    
    199,154
    
    
    
    
    
    
    
    
    
    
    
    (199,154
    )
    
    
    Other assets
    
    
    7,731
    
    
    
    1,958
    
    
    
    3,953
    
    
    
    
    
    
    
    13,642Total assets
    
    $
    206,885
    
    
    $
    312,724
    
    
    $
    36,499
    
    
    $
    (207,473
    )
    
    $
    348,635Current Liabilities:Accounts payable
    
    $
    
    
    
    $
    11,637
    
    
    $
    
    
    
    $
    
    
    
    $
    11,637Salaries and benefits payable
    
    
    
    
    
    
    13,642
    
    
    
    
    
    
    
    
    
    
    
    13,642Other accrued liabilities
    
    
    871
    
    
    
    19,176
    
    
    
    1,090
    
    
    
    (969
    )
    
    
    20,168Current portion of long-term debt
    
    
    
    
    
    
    801
    
    
    
    222
    
    
    
    
    
    
    
    1,023Total current liabilities
    
    
    871
    
    
    
    45,256
    
    
    
    1,312
    
    
    
    (969
    )
    
    
    46,470Long-term debt, less current portion
    
    
    150,369
    
    
    
    
    
    
    
    23,611
    
    
    
    
    
    
    
    173,980Deferred tax liability
    
    
    
    
    
    
    6,762
    
    
    
    
    
    
    
    
    
    
    
    6,762Other liabilities
    
    
    3,218
    
    
    
    592
    
    
    
    
    
    
    
    969
    
    
    
    4,779Total liabilities
    
    
    154,458
    
    
    
    52,610
    
    
    
    24,923
    
    
    
    
    
    
    
    231,991Series A convertible preferred stock
    
    
    25,316
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,316Stockholders equity:Total stockholders equity
    
    
    27,111
    
    
    
    260,114
    
    
    
    11,576
    
    
    
    (207,473
    )
    
    
    91,328Total liabilities and stockholders equity
    
    $
    206,885
    
    
    $
    312,724
    
    
    $
    36,499
    
    
    $
    (207,473
    )
    
    $
    348,635
 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2004
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsRevenue
    
    $
    
    
    
    $

    107,584
    
    
    $
    892
    
    
    $
    (892
    )
    
    $
    107,584Salaries, wages and employee benefits
    
    
    
    
    
    
    58,995
    
    
    
    
    
    
    
    
    
    
    
    58,995Professional fees
    
    
    
    
    
    
    12,056
    
    
    
    
    
    
    
    
    
    
    
    12,056Supplies
    
    
    
    
    
    
    6,941
    
    
    
    
    
    
    
    
    
    
    
    6,941Rentals and leases
    
    
    
    
    
    
    1,783
    
    
    
    
    
    
    
    
    
    
    
    1,783Other operating expenses
    
    
    310
    
    
    
    13,444
    
    
    
    
    
    
    
    (892
    )
    
    
    12,862Provision for bad debts
    
    
    
    
    
    
    2,027
    
    
    
    
    
    
    
    
    
    
    
    2,027Depreciation and amortization
    
    
    
    
    
    
    1,876
    
    
    
    241
    
    
    
    
    
    
    
    2,117Interest expense
    
    
    4,085
    
    
    
    
    
    
    
    371
    
    
    
    
    
    
    
    4,456Loss on refinancing of long-term debt
    
    
    6,407
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,40710,802
    
    
    
    97,122
    
    
    
    612
    
    
    
    (892
    )
    
    
    107,644(Loss) income before income taxes
    
    
    (10,802
    )
    
    
    10,462
    
    
    
    280
    
    
    
    
    
    
    
    (60
    )Benefit from income taxes

    
    
    
    
    
    
    (23
    )
    
    
    
    
    
    
    
    
    
    
    (23
    )Net (loss) income
    
    
    (10,802
    )
    
    
    10,485
    
    
    
    280
    
    
    
    
    
    
    
    (37
    )Accrued preferred stock dividends
    
    
    
    
    
    
    323
    
    
    
    
    
    
    
    
    
    
    
    323Net (loss) income available to common
shareholders
    
    $
    (10,802
    )
    
    $
    10,162
    
    
    $
    280
    
    
    $
    
    
    
    $
    (360
    )
 12




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Operations
For the Three Months Ended March 31, 2003
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsRevenue
    
    $
    
    
    
    $
    37,104
    
    
    $
    400
    
    
    $
    (400
    )
    
    $
    37,104Salaries, wages and employee benefits
    
    
    
    
    
    
    17,785
    
    
    
    
    
    
    
    
    
    
    
    17,785Professional fees
    
    
    
    
    
    
    4,451
    
    
    
    
    
    
    
    
    
    
    
    4,451Supplies
    
    
    
    
    
    
    1,691
    
    
    
    
    
    
    
    
    
    
    
    1,691Rentals and leases
    
    
    
    
    
    
    248
    
    
    
    
    
    
    
    
    
    
    
    248Other operating expenses
    
    
    (118
    )
    
    
    7,432
    
    
    
    245
    
    
    
    (400
    )
    
    
    7,159Provision for bad debts
    
    
    
    
    
    
    1,322
    
    
    
    
    
    
    
    
    
    
    
    1,322Depreciation and amortization
    
    
    
    
    
    
    609
    
    
    
    58
    
    
    
    
    
    
    
    667Interest expense
    
    
    1,266
    
    
    
    81
    
    
    
    73
    
    
    
    
    
    
    
    1,420Change in
reserve of stockholder notes
    
    
    (461
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (461
    )Change in valuation of put warrants
    
    
    960
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9601,647
    
    
    
    33,619
    
    
    
    376
    
    
    
    (400
    )
    
    
    35,242Income (loss) before income taxes
    
    
    (1,647
    )
    
    
    3,485
    
    
    
    24
    
    
    
    
    
    
    
    1,862Provision for income taxes
    
    
    
    
    
    
    1,073
    
    
    
    
    
    
    
    
    
    
    
    1,073Net (loss) income
    
    $
    (1,647
    )
    
    $
    2,412
    
    
    $
    24
    
    
    $
    
    
    
    $
    789
 Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2004
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsOperating ActivitiesNet (loss) income
    
    $
    (10,802
    )
    
    $
    10,487
    
    
    $
    278
    
    
    $
    
    
    
    $
    (37
    )Adjustments to reconcile net (loss)
income to net
cash provided by (used in) operating
activities:Depreciation and amortization
    
    
    
    
    
    
    1,876
    
    
    
    241
    
    
    
    
    
    
    
    2,117Provision for doubtful accounts
    
    
    
    
    
    
    2,027
    
    
    
    
    
    
    
    
    
    
    
    2,027Amortization of loan costs
    
    
    190
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    199Loss on refinancing long-term debt
    
    
    6,407
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,407Changes in operating assets and
liabilities,
net of
effect of acquisitions:Accounts receivable
    
    
    
    
    
    
    (1,318
    )
    
    
    
    
    
    
    
    
    
    
    (1,318
    )Prepaids and other current assets
    
    
    
    
    
    
    1,643
    
    
    
    338
    
    
    
    
    
    
    
    1,981Accounts payable
    
    
    
    
    
    
    (411
    )
    
    
    
    
    
    
    
    
    
    
    (411
    )Accrued liabilities and other
liabilities
    
    
    3,801
    
    
    
    1,230
    
    
    
    (3
    )
    
    
    
    
    
    
    5,028Net cash (used in) provided by operating
activities
    
    
    (404
    )
    
    
    15,534
    
    
    
    863
    
    
    
    
    
    
    
    15,993Investing Activities:Cash paid for acquisitions, net of cash
acquired
    
    
    (29,861
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,861
    )Capital purchases of property and
equipment
    
    
    
    
    
    
    (3,058
    )
    
    
    
    
    
    
    
    
    
    
    (3,058
    )Other assets
    
    
    
    
    
    
    (6,541
    )
    
    
    (590
    )
    
    
    
    
    
    
    (7,131
    )Net used in investing activities
    
    
    (29,861
    )
    
    
    (9,599
    )
    
    
    (590
    )
    
    
    
    
    
    
    (40,050
    )Financing Activities:Net principal borrowings on long-term
debt
    
    
    16,910
    
    
    
    
    
    
    
    (54
    )
    
    
    
    
    
    
    16,856Net transfers to and from members
    
    
    16,810
    
    
    
    (16,758
    )
    
    
    (52
    )
    
    
    
    
    
    
    Payment of loan and issuance costs
    
    
    (987
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (987
    )Refinancing of long-term debt
    
    
    (2,572
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,572
    )Proceeds from issuance of common stock
    
    
    104
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104Net cash provided by (used in) financing
activities
    
    
    30,265
    
    
    
    (16,758
    )
    
    
    (106
    )
    
    
    
    
    
    
    13,401Net (decrease) increase in cash
    
    
    
    
    
    
    (10,823
    )
    
    
    167
    
    
    
    
    
    
    
    (10,656
    )Cash at beginning of year
    
    
    
    
    
    
    43,334
    
    
    
    1,498
    
    
    
    
    
    
    
    44,832Cash at end of year
    
    $
    
    
    
    $
    32,511
    
    
    $
    1,665
    
    
    $
    
    
    
    $
    34,176
 13




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##### Table of Contents



PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004 PSYCHIATRIC SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Psychiatric Solutions, Inc.
Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2003
(Dollars in thousands) Combined
    
    
    
    
    
    
    
    
    
    TotalSubsidiary
    
    Combined Non-
    
    Consolidating
    
    ConsolidatedParent
    
    Guarantors
    
    Guarantors
    
    Adjustments
    
    AmountsOperating
ActivitiesNet (loss) income
    
    $
    (1,647
    )
    
    $
    2,412
    
    
    $
    24
    
    
    $
    
    
    
    $
    789Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:Depreciation and amortization
    
    
    
    
    
    
    609
    
    
    
    58
    
    
    
    
    
    
    
    667Provision for doubtful accounts
    
    
    
    
    
    
    1,322
    
    
    
    
    
    
    
    
    
    
    
    1,322Accretion of detachable warrants
    
    
    
    
    
    
    77
    
    
    
    
    
    
    
    
    
    
    
    77Non-cash stock compensation expense
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    5Amortization of loan costs
    
    
    160
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    160Change in deferred tax liability
    
    
    
    
    
    
    1,033
    
    
    
    
    
    
    
    
    
    
    
    1,033Change in valuation of put warrants
    
    
    960
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    960Change in reserve on stockholder notes
    
    
    (461
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (461
    )Long-term interest accrued
    
    
    
    
    
    
    81
    
    
    
    
    
    
    
    
    
    
    
    81Changes in operating assets and liabilities, net of
effect of acquisitions:Accounts receivable
    
    
    
    
    
    
    (3,986
    )
    
    
    
    
    
    
    
    
    
    
    (3,986
    )Prepaids and other current assets
    
    
    
    
    
    
    (714
    )
    
    
    (259
    )
    
    
    
    
    
    
    (973
    )Accounts payable
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    
    
    
    
    148Accrued liabilities and other liabilities
    
    
    324
    
    
    
    787
    
    
    
    192
    
    
    
    
    
    
    
    1,303Net cash (used in) provided by operating activities
    
    
    (664
    )
    
    
    1,774
    
    
    
    15
    
    
    
    
    
    
    
    1,125Investing activities:Capital purchases of property and equipment
    
    
    
    
    
    
    (628
    )
    
    
    
    
    
    
    
    
    
    
    (628
    )Other assets
    
    
    
    
    
    
    (180
    )
    
    
    
    
    
    
    
    
    
    
    (180
    )Net cash used in investing activities
    
    
    
    
    
    
    (808
    )
    
    
    
    
    
    
    
    
    
    
    (808
    )Financing activities:Net principal borrowings on long-term debt
    
    
    2,375
    
    
    
    (1,027
    )
    
    
    (12
    )
    
    
    
    
    
    
    1,336Net transfers to and from members
    
    
    (1,711
    )
    
    
    1,711
    
    
    
    
    
    
    
    
    
    
    
    Net cash provided by (used in) financing activities
    
    
    664
    
    
    
    684
    
    
    
    (12
    )
    
    
    
    
    
    
    1,336Net increase in cash
    
    
    
    
    
    
    1,650
    
    
    
    3
    
    
    
    
    
    
    
    1,653Cash at beginning of year
    
    
    
    
    
    
    1,175
    
    
    
    1,217
    
    
    
    
    
    
    
    2,392Cash at end of year
    
    $
    
    
    
    $
    2,825
    
    
    $
    1,220
    
    
    $
    
    
    
    $
    4,045
 12. Subsequent Events On April 1, April 2 and May 5, 2004, certain holders of our series A
convertible preferred stock converted 2,181,818 shares of series A convertible
preferred stock and related accrued dividends into 2,292,972 shares of our
common stock. On April 23, 2004, we entered
into an interest rate swap agreement to manage our exposure to
fluctuations in interest rates. The swap agreement effectively
converts $30.0 million of fixed-rate long-term debt to a LIBOR
indexed variable rate instrument plus an agreed upon interest rate
spread of 5.51%. On April 27, 2004, we announced the signing of a definitive agreement to
purchase four inpatient behavioral health care facilities from Heartland
Healthcare for $47.0 million. The four facilities, located in Summit, New Jersey,
Ft. Lauderdale, Florida, Arlington, Texas and Eden Prairie, Minnesota, have a
total of 360 beds. The transaction is expected to be completed by June 1, 2004,
pending certain regulatory approvals. On May 1, 2004, we
completed the acquisition of all of the membership interests of
Palmetto Behavioral Health System, LLC, an operator of two inpatient behavioral
health care facilities, for approximately $6.0 million. The two
inpatient facilities,
located in Charleston and Florence, South Carolina, have 159 beds. 14




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. This Quarterly Report onForm 10-Qcontains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements include statements regarding the intent, belief or
current expectations of Psychiatric Solutions and its management. Such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties that may cause our actual results to differ materially
from the results discussed in the forward-looking statements. Risks and
uncertainties that might cause such differences include, but are not limited
to: (1) potential competition that alters or impedes our acquisition strategy
by decreasing our ability to acquire additional facilities on favorable terms;
(2) our ability to improve the operations of acquired facilities; (3) our
ability to maintain favorable and continuing relationships with physicians who
use our facilities; (4) our limited operating history as a public company; (5)
our ability to receive timely additional financing on terms acceptable to us to
fund our acquisition strategy and capital expenditure needs; (6) risks inherent
to the health care industry, including the impact of unforeseen changes in
regulation, reimbursement rates from federal and state health care programs or
managed care companies and exposure to claims and legal actions by patients and
others; and (7) potential difficulties in integrating our operations with
recently acquired operations. The forward-looking statements herein are
qualified in their entirety by the risk factors set forth in our filings with
the Securities and Exchange Commission, including the factors listed in our
Annual Report onForm 10-Kfiled on March 25, 2004 under the caption Risk
Factors. A copy of our filings may be obtained from the Public Reference Room
of the Securities and Exchange Commission at 450 Fifth Street NW, Washington,
D.C. at prescribed rates. Overview During the quarter ended March 31, 2004, we continued with our goals of
making accretive acquisitions, expanding revenues and reducing expenses in our
existing inpatient behavioral health care operations. On March 1, 2004, we
acquired two inpatient psychiatric facilities from Brentwood Behavioral Health
(Brentwood) for $29.8 million cash with an earn-out
of up to $5.0 million
contingent upon future financial results. The inpatient facilities, which have an
aggregate of 311 licensed beds, are located in Shreveport, Louisiana and
Jackson, Mississippi. Through the acquisition of Brentwood, we increased our
inpatient facility operations to 26 facilities and approximately 3,200 beds at
March 31, 2004. On January 6, 2004, we entered into a revolving credit facility with Bank
of America, N.A. (Bank of America) of up to $50 million and terminated our
credit facility with CapitalSource Finance LLC (CapitalSource). On January
26, 2004, we entered into an interest rate swap agreement that effectively
converts $20.0 million of fixed-rate long-term debt to a LIBOR indexed variable
rate instrument plus an agreed upon interest rate spread. We strive to improve the operating results of new and existing inpatient
behavioral health care operations by providing the highest quality service,
expanding referral networks and marketing initiatives and meeting increased
demand for our services by expanding our services and developing new services.
We also improve operating results by optimizing staffing ratios, controlling
contract labor costs and reducing supply costs through group purchasing. During
the quarter ended March 31, 2004, we increased revenue from owned and leased
inpatient facilities by approximately 7.3% through same-facility growth.
Same-facility growth also produced gains in owned and leased inpatient facility
admissions and patient days of approximately 6.3% and 4.5%, respectively, for
the quarter ended March 31, 2004 as compared to the quarter ended March 31,
2003. We owned five inpatient facilities throughout the quarter ended March 31,
2003. 15




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##### Table of Contents



Recent Acquisitions On
May 1, 2004, we completed the acquisition of all of the
membership interests of
Palmetto Behavioral Health System, LLC, an operator of two inpatient behavioral
health care facilities, for approximately $6.0 million. The two facilities,
located in Charleston and Florence, South Carolina, have 159 beds. On April 27, 2004, we announced the signing of a definitive agreement to
purchase four inpatient behavioral health care facilities from Heartland
Healthcare for $47.0 million. The four facilities, located in Summit, New Jersey,
Ft. Lauderdale, Florida, Arlington, Texas and Eden Prairie, Minnesota, have a
total of 360 beds. The transaction is expected to be completed by June 1, 2004,
pending certain regulatory approvals. On March 1, 2004, we acquired two inpatient psychiatric facilities from
Brentwood for $29.8 million cash with an earn-out of up to $5.0 million
contingent upon future financial results. We drew down $17.0 million on our
revolving line of credit and paid the remainder of the acquisition
price with cash on hand. The facilities, which have an aggregate of 311 licensed beds, are located
in Shreveport, Louisiana and Jackson, Mississippi. On November 1, 2003, we acquired the 109-bed Alliance Health Center
located in Meridian, Mississippi, for approximately $13.0 million. Alliance
Health Center is a licensed acute care hospital that provides psychiatric care
for children, adolescents and adults. In addition, we recently
completed the construction of a 60-bed residential
treatment center which opened in May 2004. On June 30, 2003, we consummated the acquisition of Ramsay Youth Services,
Inc. (Ramsay), a public company that traded on the Nasdaq SmallCap Market
under the symbol RYOU, for approximately $81.3 million, consisting of $56.2
million in cash, or $5.00 per share, $22.3 million in net assumed debt that was
repaid in connection with the acquisition and $2.8 million in fees and
expenses. We financed the acquisition of Ramsay with proceeds from the issuance
of $150 million in 10 5/8% senior subordinated notes and an issuance of $12.5
million of our series A convertible preferred stock. The 11 owned or leased
inpatient behavioral health care facilities we acquired from Ramsay, which have
an aggregate of 1,292 beds, are located primarily in the Southeastern region of
the United States with locations also in Michigan, Missouri and Utah. In the
acquisition, we also assumed 10 contracts to manage inpatient behavioral health
care facilities for government agencies in Florida, Georgia and Puerto Rico. In April 2003, we consummated the acquisition of six inpatient behavioral
health care facilities from The Brown Schools, Inc. (The Brown Schools) for
$63.0 million in cash. The six facilities, which have an aggregate of 895
licensed beds, are located in Austin, San Antonio and San Marcos, Texas;
Charlottesville, Virginia; Colorado Springs, Colorado; and Tulsa, Oklahoma. The
Brown Schools offer a full continuum of care for troubled adolescents and
adults. We financed the acquisition of The Brown Schools with proceeds from the
private placement of $12.5 million of our series A convertible preferred stock
and an increase in funding under our credit facility. Acquiring inpatient behavioral health care facilities is a key part of our
business strategy. Because we have grown through acquisitions accounted for as
purchases, it is difficult to make meaningful comparisons between our financial
statements for the fiscal periods presented. Sources of Revenue Patient Service Revenue Patient service revenue is generated by our inpatient facilities as a
result of services provided to patients within the inpatient behavioral health
care facility setting. Patient service revenue is reported on an accrual basis
in the period in which services are rendered, at established rates, regardless
of whether collection in full is expected. Patient service revenue includes
amounts estimated by management to be 16




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##### Table of Contents



reimbursable by Medicare and Medicaid under provisions of cost or
prospective reimbursement formulas in effect. Amounts received are generally
less than the established billing rates of the inpatient facilities and the

differences are reported as deductions from patient service revenue at the time
the service is rendered. For the three months ended March 31, 2004, patient
service revenue comprised approximately 80% of our total revenue. Management Fee Revenue Management contract revenue is earned by our inpatient management contract
division. The inpatient management contract division receives contractually
determined management fees from third party medical/surgical hospitals and
clinics for providing psychiatric unit management and development services as
well as management fees for managing inpatient behavioral health care
facilities for government agencies. For the three months ended March 31, 2004,
management contract revenue comprised approximately 20% of our total revenue. Results of Operations The following table sets forth, for the periods indicated, our operating
results (dollars in thousands): Three Months Ended March 31,2004
    
    2003Amount
    
    %
    
    Amount
    
    %Revenue
    
    $
    107,584
    
    
    
    100.0
    %
    
    $
    37,104
    
    
    
    100.0
    %Salaries, wages, and employee benefits
    
    
    58,995
    
    
    
    54.8
    %
    
    
    17,785
    
    
    
    47.9
    %Professional fees
    
    
    12,056
    
    
    
    11.2
    %
    
    
    4,451
    
    
    
    12.0
    %Supplies
    
    
    6,941
    
    
    
    6.5
    %
    
    
    1,691
    
    
    
    4.5
    %Provision for bad debts
    
    
    2,027
    
    
    
    1.9
    %
    
    
    1,322
    
    
    
    3.6
    %Other operating expenses
    
    
    14,645
    
    
    
    13.6
    %
    
    
    7,407
    
    
    
    20.0
    %Depreciation and amortization
    
    
    2,117
    
    
    
    2.0
    %
    
    
    667
    
    
    
    1.8
    %Interest expense, net
    
    
    4,456
    
    
    
    4.1
    %
    
    
    1,420
    
    
    
    3.8
    %Other expenses:Loss on refinancing long-term debt
    
    
    6,407
    
    
    
    6.0
    %
    
    
    
    
    
    
    0.0
    %Change in valuation of put warrants
    
    
    
    
    
    
    0.0
    %
    
    
    960
    
    
    
    2.6
    %Change in reserve on stockholder notes
    
    
    
    
    
    
    0.0
    %
    
    
    (461
    )
    
    
    -1.2
    %Total other expenses
    
    
    6,407
    
    
    
    6.0
    %
    
    
    499
    
    
    
    1.4
    %(Loss) income before income taxes
    
    
    (60
    )
    
    
    0.0
    %
    
    
    1,862
    
    
    
    5.0
    %(Benefit from) provision for income taxes
    
    
    (23
    )
    
    
    0.0
    %
    
    
    1,073
    
    
    
    2.9
    %Net (loss) income
    
    $
    (37
    )
    
    
    0.0
    %
    
    $
    789
    
    
    
    2.1
    %
 17




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##### Table of Contents



Three Months Ended March 31,2004
    
    2003
    
    % ChangeConsolidated:Number of facilities at period end
    
    
    26
    
    
    
    5
    
    
    
    420.0
    %Admissions
    
    
    10,231
    
    
    
    4,344
    
    
    
    135.5
    %Patient days
    
    
    211,563
    
    
    
    45,785
    
    
    
    362.1
    %Same-facility (1):Number of facilities at period end
    
    
    5
    
    
    
    5
    
    
    
    0.0
    %Admissions
    
    
    4,619
    
    
    
    4,344
    
    
    
    6.3
    %Patient days
    
    
    47,862
    
    
    
    45,785
    
    
    
    4.5
    %
   (1)
    
    For the three months ended March 31, 2004, excludes statistics for
facilities purchased from The Brown Schools in April 2003, Ramsay
purchased in June 2003, Alliance Health Center purchased in November
2003, Calvary Center purchased in December 2003 and facilities
purchased from Brentwood in March 2004. Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003 Revenue.Revenue from operations was $107.6 million for the quarter ended
March 31, 2004 compared to $37.1 million for the quarter ended March 31, 2003,
an increase of $70.5 million or 190.0%. Revenue from owned and leased inpatient
facilities accounted for $86.4 million of the first quarter 2004 results
compared to $26.1 million of the first quarter 2003 results, an increase of
$60.3 million or 231.0%. The increase in revenues from owned and leased
inpatient facilities relates primarily to revenues of $20.7 million in the
first quarter of 2004 for the facilities acquired from The Brown Schools in April 2003, $31.0
million in the first quarter of 2004 for the owned and leased inpatient
facilities acquired from Ramsay on June 30, 2003, and $6.7 million in the first
quarter of 2004 for other acquisitions that occurred during 2003 and 2004. The
remainder of the increase in revenues from owned and leased inpatient
facilities is primarily attributable to growth in admissions and patient days
of 6.3% and 4.5%, respectively, on a same-facility basis. Revenue from
inpatient management contracts accounted for $21.1 million of the first quarter
2004 results compared to $11.0 million of the first quarter 2003 results, an
increase of $10.1 million or 91.8%. The increase in revenues from inpatient
management contracts relates primarily to revenues of $11.0 million in the
first quarter of 2004 from inpatient management contracts acquired from Ramsay
in June 2003. Salaries, wages, and employee benefits.Salaries, wages and employee
benefits expense was $59.0 million, or 54.8% of first quarter 2004 revenue, for
the quarter ended March 31, 2004 compared to $17.8 million, or 47.9% of first
quarter 2003 revenue, for the quarter ended March 31, 2003. Salaries, wages and
employee benefits expense from owned and leased inpatient facilities was $46.8
million in the first quarter of 2004, or 54.1% of first quarter 2004 revenue
from owned and leased inpatient facilities, compared to $13.7 million in the
first quarter of 2003, or 52.5% of first quarter 2003 revenue from owned and
leased inpatient facilities. On a same-facility basis, salaries, wages and
employee benefits expense from owned and leased inpatient facilities was $14.4
million in the first quarter of 2004, or 51.5% of first quarter 2004
same-facility revenue from owned and leased inpatient facilities. This decrease
in salaries, wages and employee benefits expense from owned and leased
inpatient facilities as a percentage of revenue from owned and leased inpatient
facilities, on a same-facility basis, relates to efforts within our owned and
leased inpatient facilities to maintain staffing levels on higher volumes.
Salaries, wages and employee benefits expense from inpatient management
contracts was $10.8 million in the first quarter of 2004, or 51.3% of first
quarter 2004 revenue from inpatient management contracts, compared to $3.4
million in the first quarter of 2003, or 30.9% of first quarter 2003 revenue
from inpatient management contracts. On a same-facility basis, salaries, wages
and employee benefits expense from inpatient management contracts was $2.9
million in the first quarter of 2004, or 28.8% of first quarter 2004
same-facility revenue from
inpatient management contracts. Salaries, wages and employee benefits
expense for our corporate office 18




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##### Table of Contents



was $1.4 million for the first quarter of 2004
compared to $674,000 for the first quarter of 2003 as the result of the
addition of staff necessary to manage the inpatient facilities and inpatient
management contracts acquired during 2003 and 2004. Professional fees.Professional fees were $12.1 million, or 11.2% of first
quarter 2004 revenue, for the quarter ended March 31, 2004 compared to $4.5
million, or 12.0% of first quarter 2003 revenue, for the quarter ended March
31, 2003. Professional fees from owned and leased inpatient facilities were
$9.9 million in the first quarter of 2004, or 11.5% of first quarter 2004
revenue from owned and leased inpatient facilities, compared to $3.2 million in
the first quarter of 2003, or 12.1% of first quarter 2003 revenue from owned
and leased inpatient facilities. On a same-facility basis, professional fees
from owned and leased inpatient facilities were $3.3 million in the first
quarter of 2004, or 11.9% of first quarter 2004 same-facility revenue from
owned and leased inpatient facilities. Professional fees from inpatient
management contracts were $1.6 million in the first quarter of 2004, or 7.7% of
first quarter 2004 revenue from inpatient management contracts, compared to
$881,000 in the first quarter of 2003, or 8.0% of first quarter 2003 revenue
from inpatient management contracts. Professional fees for our corporate office
were $467,000 in the first quarter of 2004 compared to $415,000 in the first
quarter of 2003. Supplies.Supplies expense was $6.9 million, or 6.5% of first quarter 2004
revenue, for the quarter ended March 31, 2004 compared to $1.7 million, or
4.5% of first quarter 2003 revenue, for the quarter ended March 31, 2003.
Supplies expense from owned and leased inpatient facilities was $6.0 million in
the first quarter of 2004, or 7.0% of first quarter 2004 revenue from owned and
leased inpatient facilities, compared to $1.7 million in the first quarter of
2003, or 6.4% of first quarter 2003 revenue from owned and leased inpatient
facilities. Same-facility supplies expense from owned and leased inpatient
facilities was $1.8 million in the first quarter of 2004, or 6.4% of first
quarter 2004 same-facility revenue from owned and leased inpatient facilities.
Supplies expense from inpatient management contracts was approximately $900,000
in the first quarter of 2004, or 4.2% of first quarter 2004 revenue from
inpatient management contracts, compared to $11,000 in the first quarter of
2003, or less than 1% of first quarter 2003 revenue from inpatient management
contracts. Supplies expense at owned and leased inpatient facilities has
historically comprised the majority of our supplies expense as a whole;
however, our inpatient management contracts segment began to utilize supplies
to a larger extent due to the assumption of ten inpatient management contracts
from Ramsay. Supplies expense for our corporate office consists of office
supplies and is negligible to our supplies expense overall. Provision for bad debts.The provision for bad debts was $2.0 million, or
1.9% of first quarter 2004 revenue, for the quarter ended March 31, 2004
compared to $1.3 million, or 3.6% of first quarter 2003 revenue, for the
quarter ended March 31, 2003. The provision for bad debts at owned and leased
inpatient facilities was $1.9 million in the first quarter of 2004, or 2.2% of
first quarter 2004 owned and leased inpatient facility revenue, compared to
$1.2 million in the first quarter of 2003, or 4.5% of first quarter 2003 owned
and leased inpatient facility revenue. This reduction in provision for bad
debts from owned and leased inpatient facilities as a percentage of owned and
leased inpatient facility revenue was driven by the acquisition of inpatient
facilities from The Brown Schools and Ramsay, which have fewer self-pay
accounts. Historically, the provision for bad debts from inpatient management
contracts has amounted to less than 1.0% of revenue from inpatient management
contracts. Other operating expenses.Other operating expenses were approximately
$14.6 million, or 13.6% of first quarter 2004 revenue, for the quarter ended
March 31, 2004 compared to $7.4 million, or 20.0% of first quarter 2003
revenue, for the quarter ended March 31, 2003. Other operating expenses for
owned and leased inpatient facilities were $8.8 million for the first quarter
of 2004, or 10.1% of first quarter 2004 owned and leased inpatient facility
revenue, compared to $2.3 million in the first quarter of 2003, or 8.8% of
first quarter 2003 owned and leased inpatient facility revenue. On a
same-facility basis, other operating expenses from owned and leased inpatient
facilities were $2.3 million in the first quarter of 2004, or 8.3% of first
quarter 2004 same-facility revenue from owned and leased inpatient facilities.
Other operating expenses for inpatient management contracts were $5.3 million in
the first quarter of 2004, or 25.1% of first quarter 2004 inpatient management
contract revenue, compared to $4.7 million in the first quarter of 2003,
or 42.9% of first quarter 2003 inpatient management contract revenue. On a
same-facility basis, other 19




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operating expenses from inpatient management
contracts were $4.3 million in the first quarter of 2004, or 43.0% of first
quarter 2004 same-facility revenue from inpatient management contracts. Other
operating expenses at our corporate office increased to $576,000 in the first
quarter of 2004 from $378,000 in the first quarter of 2003. Depreciation and amortization.Depreciation and amortization expense was
$2.1 million for the quarter ended March 31, 2004 compared to $667,000 for the
quarter ended March 31, 2003, an increase of $1.4 million or 217.4%. This
increase in depreciation and amortization expense is primarily the result of
the acquisitions of the inpatient facilities from The Brown Schools in April 2003, Ramsay in June 2003,
Alliance Health Center in November 2003 and Brentwood in March 2004. Interest expense.Interest expense was $4.5 million for the quarter ended
March 31, 2004 compared to $1.4 million for the quarter ended March 31, 2003,
an increase of $3.1 million or 221.4%. This increase is primarily attributable
to the increase in our long-term debt from $39.2 million at March 31, 2003 to
$191.9 million at March 31, 2004 due to our 10 5/8% senior subordinated note
offering and the expansion of our senior credit facility. Other expenses.Other expenses totaled $6.4 million for the quarter ended
March 31, 2004 compared to $499,000 for the quarter ended March 31, 2003. Other
expenses for the first quarter of 2004 consisted of $6.4 million in loss on the
refinancing of our long-term debt. Other expenses for the first quarter of 2003
consisted of $960,000 in expense recorded to recognize the change in fair value
of stock purchase put warrants and the release of $461,000 in reserves
related to our stockholder notes. The stock purchase put warrants related to
the issuance of debt to The 1818 Mezzanine Fund II, L.P. (the 1818 Fund) in
2002. Our requirement to mark these warrants to market ended, effective April
1, 2003, when the 1818 Fund provided us with a written consent to waive its
ability to require that we repurchase the warrants for cash. Liquidity and Capital Resources As of March 31, 2004, we had working capital of $52.5 million, including
cash and cash equivalents of $34.2 million, compared to working capital of
$66.9 million at December 31, 2003. The decrease in working capital is
primarily due to the acquisition of Brentwood during the three months ended
March 31, 2004, in which we used $29.8 million in cash and cash equivalents for
the acquisition, offset by $17.0 million borrowed under our revolving line of
credit. Cash provided by operating activities was $15.0 million for the three
months ended March 31, 2004 compared to cash provided by operating activities
of $1.1 million for the three months ended March 31, 2003. The increase in cash
flows from operating activities was primarily due to cash generated from our
acquisitions of the operations of Ramsay and the six inpatient facilities from
The Brown Schools in 2003. Cash used in investing activities was $37.8 million for the three months
ended March 31, 2004 compared to cash used in investing activities of
approximately $800,000 for the three months ended March 31, 2003. Cash used in
investing activities for the three months ended March 31, 2004 was the result
of $29.8 million paid for the acquisition of Brentwood, $3.3 million used to
make the final payment on a prior-year acquisition, $3.0 million used for
capital expenditures and $1.5 million used for purchases of other assets. Cash
used in investing activities for the three months ended March 31, 2003 was
primarily the result of cash used for capital expenditures of approximately
$630,000. Cash provided by financing activities was approximately $12.1 million for
the three months ended March 31, 2004 compared to cash provided by financing
activities of approximately $1.3 million for the three months ended March 31,
2003. Cash provided by financing activities for the three months ended March
31, 2004 was primarily the result of $17.0 million borrowed under our revolving
line of credit to purchase Brentwood, offset by cash paid to exit our credit
facility with CapSource of approximately $3.8 20




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million. Cash provided by financing activities for the three months ended
March 31, 2003 consisted of borrowings under our revolving line of credit. On January 6, 2004, we terminated our senior credit facility with
CapSource and entered into a new credit agreement (the Credit Agreement) with
Bank of America that provides for a revolving credit facility of up
to $50.0
million. As a result of the termination of our senior credit facility with
CapSource, we recorded a loss on refinancing long-term debt of $6.4 million for
the quarter ended March 31, 2004, including approximately $3.8 million paid as
a termination fee to CapSource. Our credit facility is secured by substantially
all of the personal property owned by us or our subsidiaries,
substantially all real
property owned by us or our subsidiaries that has a value in excess of $2.5
million and the stock of our operating subsidiaries. In addition, our
credit facility is fully and unconditionally guaranteed by
substantially all of our operating subsidiaries. The revolving line of
credit accrues interest at our choice of the Base Rate or the Eurodollar
Rate (as defined in the Credit Agreement) and is due in January 2007. The
Base Rate and Eurodollar Rate fluctuate based upon market rates and certain
leverage ratios, as defined in the Credit Agreement. At March 31, 2004, the
interest rate under the revolving line of credit was 3.625%. Until the maturity
date, we may borrow, repay and re-borrow an amount not to exceed the lesser of
$50.0 million or the borrowing base (as defined in the Credit Agreement). As of
March 31, 2004, we had $17.0 million of borrowings
outstanding and $33.0 million
available under the revolving line of credit. We must pay on a quarterly basis
a commitment fee in the amount of 0.5% per annum on the unused portion of our
revolving credit facility and a utilization fee in the amount of 0.25% per
annum on the unused portion of revolving facility when borrowings under the
revolving credit facility are less than $16.5 million. Such fees were
approximately $65,000 for the three months ended March 31, 2004. Our revolving credit facility contains customary covenants which include:
(1) a limitation on capital expenditures and investments, sales of assets, mergers, changes of
ownership, new principal lines of business, indebtedness, dividends and
redemptions, (2) various financial covenants and (3) cross-default covenants
triggered by a default of any other indebtedness of at least $3.0 million. As
of March 31, 2004, we were in compliance with all debt covenant requirements.
If we violate one or more of these covenants, amounts outstanding under the
revolving credit facility could become immediately payable and additional
borrowings could be restricted. On January 26, 2004, we entered into an interest rate swap agreement to
manage our exposure to fluctuations in interest rates. The swap agreement
effectively converts $20.0 million of fixed-rate long-term debt to a LIBOR
indexed variable rate instrument plus an agreed upon interest rate
spread of 5.86%. On April 23, 2004, we entered into another interest
rate swap agreement. This swap agreement effectively converts $30.0
million of fixed-rate long-term debt to a LIBOR indexed variable rate
instrument plus an agreed upon interest rate spread of 5.51%. We believe that our working capital on hand, cash flows from operations
and funds available under our revolving line of credit will be sufficient to
fund our operating needs, planned capital expenditures and debt service
requirements for the next 12 months. In addition, we are actively seeking acquisitions that fit our corporate
growth strategy and may acquire additional inpatient psychiatric facilities.
Management continually assesses our capital needs and, should the need arise,
we will seek additional financing, including debt or equity, to fund potential
acquisitions or for other corporate purposes. In negotiating such financing,
there can be no assurance that we will be able to raise additional capital on
terms satisfactory to us. Failure to obtain additional financing on reasonable
terms could have a negative effect on our plans to acquire additional inpatient
psychiatric facilities. 21




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Contractual Obligations Payments Due by Period (in thousands)Less than
    
    
    
    
    
    
    
    
    
    AfterTotal
    
    1 year
    
    1-3 years
    
    4-5 years
    
    5 yearsLong-term debt (1)
    
    $
    191,801
    
    
    $
    1,023
    
    
    $
    17,714
    
    
    $
    550
    
    
    $
    172,514Lease obligations
    
    
    23,519
    
    
    
    5,886
    
    
    
    9,016
    
    
    
    6,009
    
    
    
    2,608$
    215,320
    
    
    $
    6,909
    
    
    $
    26,730
    
    
    $
    6,559
    
    
    $
    175,122
   (1)
    
    Long-term debt excludes capital lease obligations which have been included
in lease obligations above. The fair value of our $150 million 10 5/8% senior subordinated notes was
approximately $170 million and $167 million as of March 31, 2004 and December
31, 2003, respectively. The carrying value of our other total long-term debt,
including current maturities, of $41.8 million and $25.0 million at March 31,
2004 and December 31, 2003, respectively, approximated fair value. We had $37.0
million of variable rate debt outstanding at March 31, 2004, including our
interest rate swap agreement. At the March 31, 2004 borrowing level, a
hypothetical 10% adverse change in interest rates, would decrease our net
income and cash flows by approximately $200,000. Critical Accounting Policies Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States. In
preparing our financial statements, we are required to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
and expenses included in our financial statements. Estimates are based on
historical experience and other information currently available, the results of
which form the basis of such estimates. While we believe our estimation
processes are reasonable, actual results could differ from those estimates. The
following represent the estimates considered most critical to our operating
performance and involve the most subjective and complex assumptions and
assessments. Allowance for doubtful accounts Our ability to collect outstanding patient receivables from third party
payors and receivables due under our management contracts is critical to our
operating performance and cash flows. The primary collection risk with regard to patient receivables lies with
uninsured patient accounts or patient accounts for which primary insurance has
paid but a patient portion remains outstanding. We estimate the allowance for
doubtful accounts primarily based upon the age of the accounts since the
patient discharge date. We continually monitor our accounts receivable balances
and utilize cash collection data to support our estimates of the provision for
doubtful accounts. Significant changes in payor mix or business office
operations could have a significant impact on our results of operations and
cash flows. The primary collection risk with regard to receivables due under our
inpatient management contracts is attributable to contract disputes. We
estimate the allowance for doubtful accounts for these receivables based
primarily upon the specific identification of potential collection issues. As
with our patient receivables, we continually monitor our accounts receivable
balances and utilize cash collection data to support our estimates of the
provision for doubtful accounts. 22




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Allowances for contractual discounts The Medicare and Medicaid regulations are complex and various managed care
contracts may include multiple reimbursement mechanisms for different types of
services provided in our inpatient facilities and cost settlement provisions
requiring complex calculations and assumptions subject to interpretation. We
estimate the allowance for contractual discounts on a payer-specific basis
given our interpretation of the applicable regulations or contract terms. The
services authorized and provided and related reimbursement are often subject to
interpretation that could result in payments that differ from our estimates.
Additionally, updated regulations and contract renegotiations occur frequently
necessitating continual review and assessment of the estimation process by our
management. Professional and General Liability We are subject to medical malpractice and other lawsuits due to the nature
of the services we provide. Due to our acquisition of Ramsay, we have two
distinct insurance programs that cover our inpatient facilities. For our
inpatient facilities that were not acquired from Ramsay, we have obtained
professional and general liability insurance for claims in excess of
$3.0 million
with an insured limit of $10.0 million. In December 2003, we increased the
insured limit to $20.0 million. For the inpatient facilities acquired from
Ramsay, we have obtained professional and general liability insurance for
claims in excess of $500,000 with an insured limit of $25.0 million. These
policies include umbrella coverage of $20.0 million and $25.0 million,
respectively. The self-insured reserves for professional and general liability
risks are calculated based on historical claims, demographic factors, industry
trends, severity factors, and other actuarial assumptions calculated by an
independent third party. This self-insurance reserve is discounted to its
present value using a 5% discount rate. This estimated accrual for professional
and general liabilities could be significantly affected should current and
future occurrences differ from historical claim trends and expectations. We
have established a captive insurance company to manage this additional
self-insured retention for our inpatient facilities not acquired from Ramsay.
We plan to merge these plans in the near future. While claims are monitored
closely when estimating professional and general liability accruals, the
complexity of the claims and wide range of potential outcomes often hampers
timely adjustments to the assumptions used in these estimates. Income taxes As part of our process for preparing consolidated financial statements,
our management is required to compute income taxes in each of the jurisdictions
in which we operate. This process involves estimating the current tax benefit
or expense of future deductible and taxable temporary differences. The future
deductible and taxable temporary differences are recorded as deferred tax
assets and liabilities that are components of our balance sheet. Management
then assesses our ability to realize the deferred tax assets based on reversals
of deferred tax liabilities and, if necessary, estimates of future taxable
income. If management determines that some or all of a deferred tax asset will
more likely than not be realized, then a valuation allowance is recorded
against the deferred tax asset. Management must also assess the impact of our
acquisitions on the realization of deferred tax assets subject to a valuation
allowance to determine if all or a portion of the valuation allowance will be
offset by reversing taxable differences or future taxable income of
acquired entities. To the extent the valuation allowance can be reversed due to
the estimated future taxable income of acquired entities, then our valuation
allowance is reduced accordingly as an adjustment to purchase price. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The information required by
this item is provided under Part I, Item 2 of this Quarterly Report under the
captions Managements Discussion and Analysis of Financial Condition and
Results of Operations  Liquidity and Capital 23




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Resources and Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Liquidity and Capital Resources - Contractual Obligations. 
 ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our chief executive officer and chief accounting officer have reviewed and
evaluated the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities
Exchange Act of 1934 (the Exchange Act)) as of the end of the period covered
by this quarterly report. Based on that evaluation, the chief executive officer
and chief accounting officer have concluded that our disclosure controls and
procedures effectively and timely provide them with material information
relating to Psychiatric Solutions and its consolidated subsidiaries required to
be disclosed in the reports we file or submit under the Exchange Act. Changes in Internal Controls Over Financial Reporting During the period covered by this report, there have been no changes in
our internal control over financial reporting that have materially affected or
are reasonable likely to materially affect our internal control over financial
reporting. 
 PART II  OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS We are subject to various claims and legal actions that arise in the
ordinary course of our business. In the opinion of management, we are not
currently a party to any proceeding which would have a material adverse effect
on our financial condition or results of operations. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 2.1
    
    Asset Purchase Agreement, dated February 23, 2004, by and among
Psychiatric Solutions, Inc., Brentwood Health Management, L.L.C.,
Brentwood, A Behavioral Health Company, L.L.C. and River Rouge, Inc.
(incorporated by reference to Exhibit 2.1 of the Companys Current
Report on Form 8-K, filed on March 3, 2004).2.2
    
    Asset Purchase Agreement, dated February 23, 2004, by and among
Psychiatric Solutions, Inc., Brentwood Health Management of MS, LLC,
and Turner-Windham of Mississippi, LLC (incorporated by reference to
Exhibit 2.2 of the Companys Current Report on Form 8-K, filed on
March 3, 2004).3.1
    
    Amended and Restated Certificate of Incorporation of PMR
Corporation, filed with the Delaware Secretary of State on March 9,
1998 (incorporated by reference to Exhibit 3.1 to the Companys
Annual Report on Form 10-K for the fiscal year ended April 30, 1998
(the 1998 10-K)).3.2
    
    Certificate of Amendment to Amended and Restated Certificate of
Incorporation of PMR Corporation, filed with the Delaware Secretary
of State on August 5, 2002 (incorporated by reference to Exhibit 3.2
to the Companys Quarterly Report on Form 10-Q for the quarter ended
July 31, 2002).3.3
    
    Certificate of Amendment to Amended and Restated Certificate of
Incorporation of Psychiatric
 24




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Solutions, Inc., filed with the
Delaware Secretary of State on March 21, 2003 (incorporated by
reference to Appendix A of the Companys Definitive Proxy Statement
filed January 22, 2003).3.4
    
    Amended and Restated Bylaws (incorporated by reference to Exhibit
3.2 to the Companys Annual Report on Form 10-K for the fiscal year
ended April 30, 1997 (the 1997 10-K)).4.1
    
    Reference is made to Exhibits 3.1 through 3.4.4.2
    
    Common Stock Specimen Certificate (incorporated by reference to
Exhibit 4.2 to the Companys Annual Report on Form 10-K for the
fiscal year ended December 31, 2002 (the 2002 10-K)).4.3
    
    Contingent Value Rights Agreement, dated August 2, 2002
(incorporated by reference to Exhibit 4.1 to the Companys Current
Report on Form 8-K, filed on August 5, 2002).4.4
    
    Stock Purchase Agreement, dated as of January 6, 2003, by and among
Psychiatric Solutions, Inc. and the Purchasers named therein
(incorporated by reference to Appendix B of the Companys Definitive
Proxy Statement, filed January 22, 2003).4.5
    
    Registration Rights Agreement, dated as of January 6, 2003, by and
among Psychiatric Solutions, Inc. and the Purchasers named therein
(incorporated by reference to Appendix C of the Companys Definitive
Proxy Statement, filed January 22, 2003).4.6
    
    Certificate of Designations, Preferences and Rights of Series A
Convertible Preferred Stock of the Company (Incorporated by
reference to Appendix D of the Companys Definitive Proxy Statement
filed January 22, 2003).4.7
    
    Indenture, dated as of June 30, 2003, between Psychiatric Solutions,
Inc., the Guarantors named therein and Wachovia Bank, National
Association, as Trustee (incorporated by reference to the Companys
Registration Statement on Form S-4, filed on July 30, 2003 (Reg. No.
333-107453) (the 2003 S-4)).4.8
    
    Form of Notes (included in Exhibit 4.7).4.9
    
    Purchase Agreement, dated as of June 19, 2003, between Psychiatric
Solutions, Inc., the Guarantors named therein, Lehman Brothers Inc.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated and Jefferies &
Company, Inc. (incorporated by reference to Exhibit 4.12 to the 2003
S-4).4.10
    
    Exchange and Registration Rights Agreement, dated as of June 30,
2003, among Psychiatric Solutions, Inc., the Guarantors named
therein, Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith
Incorporated and Jefferies & Company, Inc. (incorporated by
reference to Exhibit 4.13 to the 2003 S-4).10.1*
    
    Credit Agreement, dated as of January 6, 2004, among Psychiatric
Solutions, Inc., the Guarantors named therein, Bank of America,
N.A., as administrative agent, swing line lender and l/c issuer, and
the Lenders thereunder.10.2*
    
    Interest Rate Swap Agreement, dated
January 28, 2004, between Bank of America, N.A. and Psychiatric
Solutions, Inc.31.1*
    
    Certification of the Chief Executive Officer of Psychiatric
Solutions, Inc. Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of the Chief Accounting Officer of Psychiatric
Solutions, Inc. Pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
 25




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32.1*
    
    Certifications of the Chief Executive Officer and Chief Accounting
Officer of Psychiatric Solutions, Inc. Pursuant to Rule 13a-14(b) of
the Securities Exchange Act of 1934, as amended, and 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
   *
    
    Filed herewith. (b) Reports on Form 8-K  1.
    
    On March 3, 2004, we filed a Report on Form 8-K, which
reported the issuance of a press release announcing
the completion of the acquisition of two freestanding
psychiatric facilities from Brentwood Behavioral
Health.2.
    
    On March 11, 2004, we furnished pursuant to Item 12 of
Form 8-K, a copy of our press release announcing our
operating results for the fourth quarter and year
ended December 31, 2003. Notwithstanding the foregoing, information furnished under Item 9 and
Item 12 of our Current Reports on Form 8-K, including the related
exhibits, shall not be deemed to be filed for purposes of Section 18
of the Securities Exchange Act of 1934, as amended (the Exchange
Act), or incorporated by reference in any filing under the Securities
Act of 1933, as amended, or the Exchange Act, except as shall be
expressly set forth by specific reference in such a filing. 26




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. PSYCHIATRIC SOLUTIONS, INC.Dated: May 14, 2004
    
    /s/ Jack E. Polson
Jack E. Polson
Chief Accounting Officer