U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] Annual report under section 13 or 15(d) of the Securities Exchange Act of
1934 for the fiscal year ended June 30, 2004 [ ] Transition report under section
13 or 15(d) of the Securities Exchange Act of 1934 for the transition period
from to
Commission file number: 0-22916
PHC, INC.
(Name of small business issuer in its charter)
MASSACHUSETTS 04-2601571
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
200 LAKE STREET, SUITE 102, PEABODY, MA 01960
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (978) 536-2777
Securities registered under Section 12(b) of the Act:
NONE
Securities registered under Section 12(g) of the Act:
CLASS A COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 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
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
No Disclosure X
The issuer's revenues for the fiscal year ended June 30, 2004 were $26,648,845.
The aggregate market value of the voting stock held by non-affiliates computed
by reference to the price at which the stock was sold, or the average bid and
asked prices of such stock, as of July 28, 2004, was $18,337,590.88. (See
definition of affiliate in Rule 12b-2 of Exchange Act).
At July 28, 2004, 16,576,712 shares of the issuer's Class A Common Stock and
776,991 shares of the issuer's Class B Common Stock were outstanding.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT:
Yes No X
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
INTRODUCTION
Our Company is a national healthcare company, which, through wholly owned
subsidiaries, provides psychiatric services to individuals who have behavioral
health disorders including alcohol and drug dependency and to individuals in the
gaming and transportation industries. Our subsidiaries operate substance abuse
treatment facilities in Utah and Virginia, three outpatient psychiatric
facilities in Michigan, two outpatient psychiatric facilities in Nevada and an
inpatient psychiatric facility in Michigan. We provide management,
administrative and help line services through contracts with major railroads, a
smoking cessation contract with the State of Kansas and a call center contract
with Wayne County, Michigan. Through another subsidiary, we conduct studies on
the effects of psychiatric pharmaceuticals on a controlled population through
contracts with the manufacturers of these pharmaceuticals. We recently expanded
our operations related to pharmaceutical studies through the acquisition of
Pivotal Research Centers, LLC. We also operate a website, Wellplace.com, which
provides education, training and products for the behavioral health professional
and internet support services to all of our subsidiaries.
Our Company provides behavioral health services and products through
inpatient and outpatient facilities and online to behavioral health
professionals. Our substance abuse facilities provide specialized treatment
services to patients who typically have poor recovery prognoses and who are
prone to relapse. These services are offered in small specialty care facilities,
which permit us to provide our clients with efficient and customized treatment
without the significant costs associated with the management and operation of
general acute care hospitals. We tailor these programs and services to
"safety-sensitive" industries and concentrate our marketing efforts on the
transportation, oil and gas exploration, heavy equipment, manufacturing, law
enforcement, gaming and health services industries. Our psychiatric facility
provides inpatient psychiatric care and intensive outpatient treatment, referred
to as partial hospitalization, to children, adolescents and adults. Our
outpatient mental health clinics provide services to employees of major
employers, as well as to managed care, Medicare and Medicaid clients. The
psychiatric services are offered in a larger, more traditional setting than
PHC's substance abuse facilities, enabling PHC to take advantage of economies of
scale to provide cost-effective treatment alternatives.
The Company treats employees who have been referred for treatment as a
result of compliance with Subchapter D of the Anti-Drug Abuse Act of 1988
(commonly known as the Drug Free Workplace Act), which requires employers who
are Federal contractors or Federal grant recipients to establish drug-free
awareness programs which, among other things, inform employees about available
drug counseling, rehabilitation and employee assistance programs. We also
provide treatment under the Department of Transportation implemented
regulations, which broaden the coverage and scope of alcohol and drug testing
for employees in "safety sensitive" positions in the transportation industry.
The Company was incorporated in 1976 and is a Massachusetts corporation.
Our corporate offices are located at 200 Lake Street, Suite 102, Peabody, MA
01960 and our telephone number is (978) 536-2777. As used herein, our Company
refers to and includes the Company and each of its subsidiaries through which
substantially all of our business and operations are conducted.
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PSYCHIATRIC SERVICES INDUSTRY
Substance Abuse Facilities
Industry Background
The demand for substance abuse treatment services increased rapidly in the
last decade. The Company believes that the increased demand is related to
clinical advances in the treatment of substance abuse, greater societal
willingness to acknowledge the underlying problems as treatable illnesses,
improved health insurance coverage for addictive disorders and chemical
dependencies and governmental regulation which requires certain employers to
provide information to employees about drug counseling and employee assistance
programs.
To contain costs associated with behavioral health issues in the 1980s,
many private payors instituted managed care programs for reimbursement, which
included pre-admission certification, case management or utilization review and
limits on financial coverage or length of stay. These cost containment measures
have encouraged outpatient care for behavioral problems, resulting in a
shortening of the length of stay and revenue per day in inpatient chemical abuse
facilities. The Company believes that it has addressed these cost containment
measures by specializing in treating relapse-prone patients with poor prognoses
who have failed in other treatment settings. These patients require longer
lengths of stay and come from a wide geographic area. The Company continues to
develop alternatives to inpatient care including partial day and evening
programs in addition to onsite and offsite outpatient programs.
The Company believes that because of the apparent unmet need for certain
clinical and medical services, its strategy has been successful despite national
trends towards outpatient treatment, shorter inpatient stays and rigorous
scrutiny by managed care organizations.
Company Operations
The Company has been able to secure insurance reimbursement for longer-term
inpatient treatment as a result of its success with poor prognosis patients. The
Company's two substance abuse facilities work together to refer patients to the
center that best meets the patient's clinical and medical needs. Each facility
caters to a slightly different patient population including high-risk,
relapse-prone chronic alcoholics, drug addicts, Native Americans and dual
diagnosis patients (those suffering from both substance abuse and psychiatric
disorders). The Company concentrates on providing services to insurers, managed
care networks and health maintenance organizations for both adults and
adolescents. The Company's clinicians often work directly with managers of
employee assistance programs to select the best treatment facility possible for
their clients.
Each of the Company's facilities operates a case management program for
each patient including a clinical and financial evaluation of a patient's
circumstances to determine the most cost-effective modality of care from among
outpatient treatment, detoxification, inpatient, day care, specialized relapse
treatment and others. In addition to any care provided at one of the Company's
facilities, the case management program for each patient includes aftercare.
Aftercare may be provided through the outpatient services provided by a
facility. Alternatively, the Company may arrange for outpatient aftercare, as
well as family and mental health services, through its numerous affiliations
with clinicians located across the country once the patient is discharged.
In general, the Company does not accept patients who do not have either
insurance coverage or adequate financial resources to pay for treatment. Each of
the Company's substance abuse facilities does, however, provide treatment free
of charge to a small number of patients each year who are unable to pay for
treatment, but who meet certain clinical criteria and who are believed by the
Company to have the requisite degree of motivation for treatment to be
successful. In addition, the Company provides follow-up treatment free of charge
to relapse patients who satisfy certain criteria. The number of patient days
attributable to all patients who receive treatment free of charge in any given
fiscal year is less than 5%.
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The Company believes that it has benefited from an increased awareness of
the need to make substance abuse treatment services accessible to the nation's
workforce. For example, Subchapter D of the Anti-Drug Abuse Act of 1988
(commonly known as The Drug Free Workplace Act), requires employers who are
Federal contractors or Federal grant recipients to establish drug free awareness
programs to inform employees about available drug counseling, rehabilitation and
employee assistance programs and the consequences of drug abuse violations. In
response to the Drug Free Workplace Act, many companies, including many major
national corporations and transportation companies, have adopted policies that
provide for treatment options as an alternative to termination of employment.
Although the Company does not directly provide federally approved mandated
drug testing, the Company treats employees who have been referred to the Company
as a result of compliance with the Drug Free Workplace Act, particularly from
companies that are part of the gaming industry as well as safety sensitive
industries such as railroads, airlines, trucking firms, oil and gas exploration
companies, heavy equipment companies, manufacturing companies and health
services.
HIGHLAND RIDGE - Highland Ridge is a 41-bed, freestanding alcohol and drug
treatment hospital, which the Company has been operating since 1984. The
hospital increased its bed capacity to 41 from 32 in November 2003. It is the
oldest facility dedicated to substance abuse in Utah. Highland Ridge is
accredited by the Joint Commission on Accreditation of Healthcare Organizations
("JCAHO") and is licensed by the Utah Department of Health. Highland Ridge is
recognized nationally for its excellence in treating substance abuse disorders.
Most patients are from Utah and surrounding states. Individuals typically
access Highland Ridge's services through professional referrals, family members,
employers, employee assistance programs or contracts between the Company and
health maintenance organizations located in Utah.
Highland Ridge was the first private for-profit hospital to address
specifically the special needs of chemically dependent women in Salt Lake
County. In addition, Highland Ridge has contracted with Salt Lake County to
provide medical detoxification services targeted to women. The hospital also
operates a specialized continuing care support group to address the unique needs
of women and minorities.
A pre-admission evaluation, which involves an evaluation of psychological,
cognitive and situational factors, is completed for each prospective patient. In
addition, each prospective patient is given a physical examination upon
admission. Diagnostic tools, including those developed by the American
Psychological Association, the American Society of Addiction Medicine and the
Substance Abuse Subtle Screening Inventory are used to develop an individualized
treatment plan for each client. The treatment regimen involves an
interdisciplinary team which integrates the twelve-step principles of self-help
organizations, medical detoxification, individual and group counseling, family
therapy, psychological assessment, psychiatric support, stress management,
dietary planning, vocational counseling and pastoral support. Highland Ridge
also offers extensive aftercare assistance at programs strategically located in
areas of client concentration throughout the United States. Highland Ridge
maintains a comprehensive array of professional affiliations to meet the needs
of discharged patients and other individuals not admitted to the hospital for
treatment.
Highland Ridge periodically conducts or participates in research projects.
Highland Ridge was the site of a research project conducted by the University of
Utah Medical School. The research explored the relationship between individual
motivation and treatment outcomes. The research was regulated and reviewed by
the Human Subjects Review Board of the University of Utah and was subject to
federal standards that delineated the nature and scope of research involving
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human subjects. Highland Ridge benefited from this research by expanding its
professional relationships within the medical school community and by applying
the findings of the research to improve the quality of services the Company
delivers. In the past, Highland Ridge has also contracted with a major
pharmaceutical manufacturer to participate in a research study in cooperation
with a local nursing home. In the future all pharmaceutical research will be
provided through our newest subsidiary, Pivotal Research Centers, Inc.
MOUNT REGIS - Mount Regis is a 26-bed, freestanding alcohol and drug
treatment center located in Salem, Virginia, near Roanoke. The Company acquired
the center in 1987. It is the oldest of its kind in the Roanoke Valley. Mount
Regis is accredited by the JCAHO and licensed by the Department of Mental
Health, Mental Retardation and Substance Abuse Services of the Commonwealth of
Virginia. In addition, Mount Regis operates Changes, an outpatient clinic, at
its Salem, Virginia location. The Changes clinic provides structured intensive
outpatient treatment for patients who have been discharged from Mount Regis and
for patients who do not need the formal structure of a residential treatment
program. The program is licensed by the Commonwealth of Virginia and approved
for reimbursement by major insurance carriers.
Mount Regis Center's programs are sensitive to the needs of women and
minorities. The majority of Mount Regis clients are from Virginia and
surrounding states. In addition, because of its relatively close proximity and
accessibility to New York, Mount Regis has been able to attract an increasing
number of referrals from New York-based labor unions. Mount Regis has
established programs that allow the Company to better treat dual diagnosis
patients (those suffering from both substance abuse and psychiatric disorders),
cocaine addiction and relapse-prone patients. The multi-disciplinary case
management, aftercare and family programs are key to the prevention of relapse.
General Psychiatric Facilities
Introduction
The Company believes that its proven ability to provide high quality,
cost-effective care in the treatment of substance abuse has enabled it to grow
in the related behavioral health field of psychiatric treatment. The Company's
main advantage is its ability to provide an integrated delivery system of
inpatient and outpatient care. As a result of integration, the Company is better
able to manage and track patients.
The Company offers inpatient and partial hospitalization psychiatry
services through Harbor Oaks Hospital. The Company also currently operates five
outpatient psychiatric facilities.
The Company's philosophy at these facilities is to provide the most
appropriate and efficacious care with the least restrictive modality of care. An
attending physician and a case manager with continuing oversight of the patient
as the patient receives care in different locations or programs handle case
management. The integrated delivery system allows for better patient tracking
and follow-up, and fewer repeat procedures and therapeutic or diagnostic errors.
Qualified, dedicated staff members take a full history on each new patient and
through test and evaluation procedures they provide a thorough diagnostic
write-up of the patient's condition. In addition a physician does a complete
physical examination for each new patient. This information allows the
caregivers to determine which treatment alternative is best suited for the
patient and to design an individualized recovery program for the patient.
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Managed health care organizations, state agencies, physicians and patients
themselves refer patients to our facilities. These facilities have a patient
population ranging from children as young as 5 years of age to senior citizens.
Compared to the substance abuse facilities, the psychiatric facilities treat a
larger percentage of female patients.
HARBOR OAKS - The Company acquired Harbor Oaks Hospital, a 64-bed psychiatric
hospital located in New Baltimore, Michigan, approximately 20 miles northeast of
Detroit, in September 1994. Harbor Oaks Hospital is licensed by the Michigan
Department of Commerce, Medicare certified and accredited by JCAHO. Harbor Oaks
provides inpatient psychiatric care, partial hospitalization and outpatient
treatment to children, adolescents and adults. Harbor Oaks Hospital has serviced
clients from Macomb, Oakland and St. Clair Counties and has expanded its
coverage area to include Wayne, Sanilac and Livingston Counties.
Harbor Oaks has become a primary provider for Medicaid patients from Wayne,
Macomb and St. Clair counties. Utilization of a short-term crisis management
model in conjunction with strong case management has allowed Harbor Oaks to
successfully enter this segment of the market. Reimbursement for these services
is comparable to traditional managed care payors. Given the current climate of
public sector treatment availability, Harbor Oaks anticipates continued growth
in this sector of the business.
On February 10, 1997, Harbor Oaks Hospital opened an 8-bed residential unit
serving adolescents with a substance abuse problem and a co-existing mental
disorder who have been adjudicated to have committed criminal acts and who have
been referred or required to undergo psychiatric treatment by a court or family
service agency. The patients in the program range from 13 to 18 years of age.
The program provides patients with educational and recreational activities and
adult life functioning skills as well as treatment. Typically, a patient is
admitted to the unit for an initial period of 30 days to six months. A case
review is done for any patient still in the program at six months, and each
subsequent six-month period thereafter, to determine if additional treatment is
required. State authorization allowed the Company to increase the number of beds
in the adjudicated residential unit to twelve on May 1, 1998 and twenty on June
26, 1998.
HARMONY HEALTHCARE - Harmony Healthcare, which consists of two psychiatric
clinics in Nevada, provides outpatient psychiatric care to children, adolescents
and adults in the local area. Harmony also operates employee assistance programs
for railroads, health care companies and several large gaming companies
including Boyd Gaming Corporation, the MGM Grand and the Venetian with a rapid
response program to provide immediate assistance 24 hours a day. Harmony also
provides outpatient psychiatric care and inpatient psychiatric case management
through a capitated rate behavioral health carve-out with Pacific Care
Insurance.
NORTH POINT-PIONEER, INC. - NPP consists of three psychiatric clinics in
Michigan. The clinics provide outpatient psychiatric and substance abuse
treatment to children, adolescents and adults operating under the name Pioneer
Counseling Center. The three clinics are located in close proximity to the
Harbor Oaks facility, which allows for more efficient integration of inpatient
and outpatient services and provides for a larger coverage area and the ability
to share personnel which results in cost savings.
Call Center Operations
WELLPLACE, INC. - In the spring of 1994, the Company began to operate a crisis
hotline service under contract with a major transportation client. The hotline,
Wellplace, formerly known as Pioneer Development Support Services, or PDS2,
shown as contract support services on the accompanying statement of operations,
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is a national, 24-hour telephone service, which supplements the services
provided by the client's Employee Assistance Programs. The services provided
include information, crisis intervention, critical incidents coordination,
employee counselor support, client monitoring, case management and health
promotion. The hotline is staffed by counselors who refer callers to the
appropriate professional resources for assistance with personal problems. Four
major transportation companies subscribed to these services as of June 30, 2004.
Wellplace also contracts with Wayne County Michigan to operate its call center.
This call center is located in downtown Detroit, Michigan. Wellplaces' primary
focus is now placed on growing its operations to take advantage of current
opportunities and capitalize on the economies of scale in providing similar
services to other companies and government units. Wellplace operated the smoking
cessation quitline for the State of Nebraska until the contract expiration in
May 2004. Wellplace currently operates the smoking cessation quitline for the
State of Kansas under a similar contract. This operation is physically located
in Highland Ridge Hospital, but a staff dedicated to Wellplace provides the
services from a separate designated area of the Hospital.
Research Operations
PIVOTAL RESEARCH CENTERS, INC. - (formerly PIONEER PHARMACEUTICAL RESEARCH, INC.
- - PPR) works with major manufacturers of psychiatric pharmaceuticals to assist
in the study of the effects of certain pharmaceuticals in the treatment of
specific mental illness. We recently expanded our operations related to
pharmaceutical studies through the acquisition of 100% of the membership
interest in Pivotal Research Centers, LLC. Pivotal performs all phases of
clinical research for Phase I-IV drugs under development through two dedicated
research sites, including one of the largest single psychiatric sites in the
country. Pivotal currently has approximately 22 enrolling studies and an
additional 31 ongoing studies with approximately 75-80 percent of Pivotal's
research activity in central nervous system (CNS) research. With a current
client base including AstraZeneca, Bristol Meyers Squibb, Cephalon, Forest,
GlaxoSmithKline, Lilly, Merck, Mylan, Novartis, Organon, Sepracor and Wyeth, the
Company currently has protocols in Alzheimer's disease, ADHD, Diabetes Type II,
Generalized Anxiety Disorder, Insomnia, Major Depressive Disorder, Obesity,
Pain, Parkinson's Disease, and Shift Work Sleep Disorder. Although our other
facilities may still provide study patients, all future studies will be
supervised by our research arm, Pivotal Research Centers, Inc.
Internet Operations
BEHAVIORAL HEALTH ONLINE, INC. - Behavioral Health Online designs, develops and
maintains the Company's web site, Wellplace.com, in addition to providing
Internet support services and maintaining the web sites of all of the other
subsidiaries of the Company. The Company's web sites provide behavioral health
professionals with the educational tools required to keep them abreast of
behavioral health breakthroughs and keeps individuals informed of current issues
in behavioral health of interest to them.
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Operating Statistics
The following table reflects selected financial and statistical information
for all psychiatric services.
Year Ended June 30,
2004 2003
_____________________________________
Inpatient
Net patient service revenues $ 14,845,163 $ 14,430,069
Net revenues per patient day (1) $ 414 $ 417
Average occupancy rate (2) 76.7% 77.7%
Total number of licensed beds
at end of period 130 122
Source of Revenues:
Private (3) 61.62% 62.20%
Government (4) 38.38% 37.80%
Partial Hospitalization
and Outpatient
Net Revenues:
Individual $ 5,647,752 $ 4,865,392
Contract $ 1,925,440 $ 1,947,716
Sources of revenues:
Private 97.7% 98.0%
Government 2.3% 2.0%
Other Services:
Wellplace (5) $ 2,984,477 $1,649,374
Pharmaceutical Studies (6) $ 1,246,013 $ 940,772
(1) Net revenues per patient day equals net patient service revenues divided by
total patient days.
(2) Average occupancy rates were obtained by dividing the total number of
patient days in each period by the number of beds available in such period.
(3) Private pay percentage is the percentage of total patient revenue derived
from all payors other than Medicare and Medicaid.
(4) Government pay percentage is the percentage of total patient revenue
derived from the Medicare and Medicaid programs.
(5) Wellplace, formerly PDS2, Pioneer Development and Support Services,
provides clinical support, referrals management and professional services
for a number of the Company's national contracts and a smoking cessation
help line for the state of Kansas and operates the Wayne County Michigan
call center.
(6) Pharmaceutical Studies includes research studies of the Company prior to
the acquisition of 100% of the membership interest in Pivotal Research
Centers, LLC on April 30, 2004 and two months operations of the newly
acquired Pivotal Research Centers, LLC for the current year.
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Business Strategy
The Company's objective is to become the leading national provider of
behavioral health services.
The Company focuses its marketing efforts on "safety-sensitive" industries
such as transportation and medical. This focus results in customized outcome
oriented programs that the Company believes produce overall cost savings to the
patients and/or client organizations. The Company intends to leverage experience
gained from providing services to customers in certain industries that it
believes will enhance its selling efforts within these certain industries.
Marketing and Customers
The Company markets its substance abuse, inpatient and outpatient
psychiatric health services both locally and nationally, primarily to safety
sensitive industries, including transportation, oil and gas exploration, heavy
machinery and equipment, manufacturing and healthcare services. Additionally,
the Company markets its services in the gaming industry both in Nevada and
nationally and its help line services nationally.
The Company employs six individuals dedicated to marketing the Company's
facilities. Each facility performs marketing activities in its local region. The
Senior Vice President of the Company coordinates the Company's national
marketing efforts. In addition, employees at certain facilities perform local
marketing activities independent of the Senior Vice President. The Company, with
the support of its owned integrated outpatient systems and management services,
continues to pursue more at-risk contracts and outpatient, managed health care
fee-for-service contracts. "At risk" contracts require that the Company provide
all the clinically necessary behavioral health services for a group of people
for a set fee per person per month. The Company currently has one at risk
contract with a large insurance carrier, which requires the Company to provide
behavioral health services to all of its insured in the state of Nevada for a
fixed fee. This at risk contract represents less than 5% of the Company's total
gross revenues. In addition to providing excellent services and treatment
outcomes, the Company will continue to negotiate pricing policies to attract
patients for long-term intensive treatment which meet length of stay and
clinical requirements established by insurers, managed health care organizations
and the Company's internal professional standards.
The Company's integrated systems of comprehensive outpatient mental health
programs complement the Company's inpatient facilities. These outpatient
programs are strategically located in Nevada, Virginia, Michigan, and Utah. They
make it possible for the Company to offer wholly integrated, comprehensive,
mental health services for corporations and managed care organizations on an
at-risk or exclusive fee-for-service basis. Additionally, the Company operates
Wellplace located in the Highland Ridge facility in Salt Lake City, Utah and in
Detroit, Michigan. Wellplace provides clinical support, referrals, management
and professional services for a number of the Company's national contracts. It
gives the Company the capacity to provide a complete range of fully integrated
mental health services.
The Company provides services to employees of a variety of corporations
including: Boyd Gaming, Conrail, CSX, the IUE, MCC, MGM, Union Pacific Railroad,
Union Pacific Railroad Hospital Association, VBH, and others.
In addition to its direct patient care services; the Company maintains its
web site, Wellplace.com, which provides articles and information of interest to
the general public as well as the behavioral health professional. The Company's
internet company also provides the added benefit of web availability of
information for various EAP contracts held and serviced by those subsidiaries
providing direct treatment services.
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Competition
The Company's substance abuse programs compete nationally with other health
care providers, including general and chronic care hospitals, both non-profit
and for-profit, other substance abuse facilities and short-term detoxification
centers. Some competitors have substantially greater financial resources than
the Company. The Company believes, however, that it can compete successfully
with such institutions because of its success in treating poor-prognosis
patients. The Company will compete through its focus on such patients, its
willingness to negotiate appropriate rates and its capacity to build and service
corporate relationships.
The Company's psychiatric facilities and programs compete primarily within
the respective geographic area serviced by them. The Company competes with
private doctors, hospital-based clinics, hospital-based outpatient services and
other comparable facilities. The main reasons that the Company competes well are
its integrated delivery and dual diagnosis programming. Integrated delivery
provides for more efficient follow-up procedures and reductions in length of
stay. Dual diagnosis programming provides a niche service for clients with a
primary mental health and a secondary substance abuse diagnosis. The Company
developed its dual diagnosis service in response to demand from insurers,
employers and treatment facilities. The Company's internet company provides the
competitive edge for service information and delivery for our direct patient
care programs.
The Company's pharmaceutical research operations compete for studies with
other research companies located in the same areas as our research offices in
Arizona and Michigan.
Revenue Sources and Contracts
The Company has entered into relationships with numerous employers, labor
unions and third-party payors to provide services to their employees and members
for the treatment of substance abuse and psychiatric disorders. In addition, the
Company admits patients who seek treatment directly without the intervention of
third parties and whose insurance does not cover these conditions in
circumstances where the patient either has adequate financial resources to pay
for treatment directly or is eligible to receive free care at one of the
Company's facilities. The Company's psychiatric patients either have insurance
or pay at least a portion of treatment costs based on their ability to pay. Most
of our patients are covered by insurance. Free treatment provided each year
amounts to less than 5% of the Company's total patient days.
Each contract is negotiated separately, taking into account the insurance
coverage provided to employees and members, and, depending on such coverage, may
provide for differing amounts of compensation to the Company for different
subsets of employees and members. The charges may be capitated, or fixed with a
maximum charge per patient day, and, in the case of larger clients, frequently
result in a negotiated discount from the Company's published charges. The
Company believes that such discounts are appropriate as they are effective in
producing a larger volume of patient admissions. The Company treats non-contract
patients and bills them on the basis of the Company's standard per diem rates
and for any additional ancillary services provided to them by the Company.
Insurance companies and managed care organizations are entering into sole
source contracts with healthcare providers, which could limit our ability to
obtain patients. Private insurers, managed care organizations and, to a lesser
extent, Medicaid and Medicare, are beginning to carve-out specific services,
including mental health and substance abuse services, and establish small,
specialized networks of providers for such services at fixed reimbursement
rates. We are not aware of any lost business as a result of sole source
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contracts to date, as we have not been advised by any payor that we have been
eliminated as a provider from their system based on an exclusivity contract with
another provider. Continued growth in the use of carve-out systems could
materially adversely affect our business to the extent we are not selected to
participate in such smaller specialized networks or if the reimbursement rate is
not adequate to cover the cost of providing the service.
Quality Assurance and Utilization Review
The Company has established comprehensive quality assurance programs at all
of its facilities. These programs are designed to ensure that each facility
maintains standards that meet or exceed requirements imposed upon the Company
with the objective of providing high-quality specialized treatment services to
its patients. To this end, the Joint Commission on Accreditation of Healthcare
Organizations ("JCAHO") surveys and accredits the Company's inpatient facilities
and the Company's outpatient facilities comply with the standards of National
Commission on Quality Assurance ("NCQA") although the facilities are not NCQA
certified. The Company's outpatient facilities in Michigan are certified by the
American Osteopathic Association ("AOA"), which is nationally recognized by all
payers as the measure of quality in outpatient treatment. The Company's
professional staff, including physicians, social workers, psychologists, nurses,
dietitians, therapists and counselors, must meet the minimum requirements of
licensure related to their specific discipline, in addition to each facility's
own internal quality assurance criteria. The Company participates in the
federally mandated National Practitioners Data Bank, which monitors professional
accreditation nationally.
In response to the increasing reliance of insurers and managed care
organizations upon utilization review methodologies, the Company has adopted a
comprehensive documentation policy to satisfy relevant reimbursement criteria.
Additionally, the Company has developed an internal case management system,
which provides assurance that services rendered to individual patients are
medically appropriate and reimbursable. Implementation of these internal
policies has been integral to the success of the Company's strategy of providing
services to relapse-prone, higher acuity patients.
Government Regulation
The Company's business and the development and operation of the Company's
facilities are subject to extensive federal, state and local government
regulation. In recent years, an increasing number of legislative proposals have
been introduced at both the national and state levels that would affect major
reforms of the health care system if adopted. Among the proposals under
consideration are reforms to increase the availability of group health
insurance, to increase reliance upon managed care, to bolster competition and to
require that all businesses offer health insurance coverage to their employees.
The Company cannot predict whether any such legislative proposals will be
adopted and, if adopted, what effect, if any, such proposals would have on the
Company's business.
In addition, both the Medicare and Medicaid programs are subject to
statutory and regulatory changes, administrative rulings, interpretations of
policy, intermediary determinations and governmental funding restrictions, all
of which may materially increase or decrease the rate of program payments to
health care facilities. Since 1983, Congress has consistently attempted to limit
the growth of federal spending under the Medicare and Medicaid programs and will
likely continue to do so. Additionally, congressional spending reductions for
the Medicaid program involving the issuance of block grants to states is likely
to hasten the reliance upon managed care as a potential savings mechanism of the
Medicaid program. As a result of this reform activity the Company can give no
assurance that payments under such programs will in the future remain at a level
comparable to the present level or be sufficient to cover the costs allocable to
such patients.
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Control of the healthcare industry exercised by federal, state and local
regulatory agencies can increase costs, establish maximum reimbursement levels
and limit expansion. Our Company and the health care industry are subject to
rapid regulatory change with respect to licensure and conduct of operations at
existing facilities, construction of new facilities, acquisition of existing
facilities, the addition of new services, compliance with physical plant safety
and land use requirements, implementation of certain capital expenditures,
reimbursement for services rendered and periodic government inspections.
Governmental budgetary restrictions have resulted in limited reimbursement rates
in the healthcare industry including our Company. As a result of these
restrictions we cannot be certain that payments under government programs will
remain at a level comparable to the present level or be sufficient to cover the
costs allocable to such patients. In addition, many states, including the State
of Michigan where the majority of our Medicaid Revenue is generated, are
considering reductions in state Medicaid budgets
Health Planning Requirements
Most of the states in which the Company operates have health planning
statutes which require that prior to the addition or construction of new beds,
the addition of new services, the acquisition of certain medical equipment or
certain capital expenditures in excess of defined levels, a state health
planning agency must determine that a need exists for such new or additional
beds, new services, equipment or capital expenditures. These state
determinations of need or certificate of need ("DoN") programs are designed to
enable states to participate in certain federal and state health related
programs and to avoid duplication of health services. DoN's typically are issued
for a specified maximum expenditure, must be implemented within a specified time
frame and often include elaborate compliance procedures for amendment or
modification, if needed.
Licensure and Certification
All of the Company's facilities must be licensed by state regulatory
authorities. The Company's Harbor Oaks facility is certified for participation
as a provider in the Medicare and Medicaid programs.
The Company's initial and continued licensure of its facilities, and
certification to participate in the Medicare and Medicaid programs, depends upon
many factors, including accommodations, equipment, services, patient care,
safety, personnel, physical environment, the existence of adequate policies,
procedures and controls and the regulatory process regarding the facility's
initial licensure. Federal, state and local agencies survey facilities on a
regular basis to determine whether such facilities are in compliance with
governmental operating and health standards and conditions for participating in
government programs. Such surveys include review of patient utilization and
inspection of standards of patient care. The Company has procedures in place to
ensure that its facilities are operated in compliance with all such standards
and conditions. To the extent these standards are not met, however, the license
of a facility could be restricted, suspended or revoked, or a facility could be
decertified from the Medicare or Medicaid programs.
Medicare Reimbursement
Currently, the only facility of the Company that receives Medicare
reimbursement is Harbor Oaks. For the fiscal year ended June 30, 2004, 14.70% of
revenues for Harbor Oaks were derived from Medicare programs.
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The Medicare program generally reimburses psychiatric facilities pursuant
to its prospective payment system ("PPS"), in which each facility receives an
interim payment of its allowable costs during the year which is later adjusted
to reflect actual allowable direct and indirect costs of services based upon the
submission of a cost report at the end of each year. However, current Medicare
payment policies allow certain psychiatric service providers an exemption from
PPS. In order for a facility to be eligible for exemption from PPS, the facility
must comply with numerous organizational and operational requirements.
PPS-exempt providers are cost reimbursed, receiving the lower of reasonable
costs or reasonable charges. The Medicare program fiscal intermediary pays a per
diem rate based upon prior year costs, which may be retroactively adjusted upon
the submission of annual cost reports.
Since the Harbor Oaks facility is currently PPS-exempt, it is not subject
to the cost-based reimbursement limitations of the Tax Equity and Fiscal
Responsibility Act of 1982 ("TEFRA") and regulations promulgated under the Act.
Generally, TEFRA limits the amount of reimbursement a facility may receive to a
target amount per discharge, adjusted annually for inflation. The facility's
reasonable Medicare operating costs divided by Medicare discharges, plus a per
diem allowance for capital costs during its base year of operations determines
the target amount. It is not possible to predict the ability of Harbor Oaks to
remain PPS-exempt or to anticipate the impact of TEFRA upon the reimbursement
received by Harbor Oaks in future periods.
In order to receive Medicare reimbursement, each participating facility
must meet the applicable conditions of participation set forth by the federal
government relating to the type of facility, its equipment, its personnel and
its standards of medical care, as well as compliance with all state and local
laws and regulations. In addition, Medicare regulations generally require that
entry into such facilities be through physician referral. The Company must offer
services to Medicare recipients on a non-discriminatory basis and may not
preferentially accept private pay or commercially insured patients.
Medicaid Reimbursement
Currently, the only facility of the Company that receives reimbursement
under any state Medicaid program is Harbor Oaks. A portion of Medicaid costs is
paid by states under the Medicaid program and the federal matching payments are
not made unless the state's portion is made. Accordingly, the timely receipt of
Medicaid payments by a facility may be affected by the financial condition of
the relevant state.
Harbor Oaks is a participant in the Medicaid program administered by the
State of Michigan. The Company receives reimbursement on a per diem basis,
inclusive of ancillary costs. The state determines the rate and adjusts it
annually based on cost reports filed by the Company.
Fraud and Abuse Laws
Various federal and state laws regulate the business relationships and
payment arrangements between providers and suppliers of health care services,
including employment or service contracts, and investment relationships. These
laws include the fraud and abuse provisions of the Medicare and Medicaid
statutes as well as similar state statutes (collectively, the "Fraud and Abuse
Laws"), which prohibit the payment, receipt, solicitation or offering of any
direct or indirect remuneration intended to induce the referral of patients, the
ordering, arranging, or providing of covered services, items or equipment.
Violations of these provisions may result in civil and criminal penalties and/or
exclusion from participation in the Medicare, Medicaid and other
government-sponsored programs. The federal government has issued regulations
that set forth certain "safe harbors," representing business relationships and
payment arrangements that can safely be undertaken without violation of the
federal Fraud and Abuse Laws. Failure to fall within a safe harbor does not
constitute a per se violation of the federal fraud and abuse laws. The Company
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believes that its business relationships and payment arrangements either fall
within the safe harbors or otherwise comply with the Fraud and Abuse Laws.
The Company has an active compliance program in place with a corporate
compliance officer and compliance liaisons at each facility and a toll free
compliance hotline. Compliance in-services and trainings are conducted on a
regular basis.
Employees
As of July 30, 2004, the Company had 404 employees of whom six were
dedicated to marketing, 131 (19 part time and 1 contingent) to finance and
administration and 267 (31 part time and 40 contingent) to patient care. Until
January of 2003, all of the Company's employees were leased through Team
America, a national employee-leasing firm. The Company elected to discontinue
the use of the leasing Company and begin processing payroll in-house or using a
more traditional payroll service while providing more employee services when the
benefit of using a leasing company began to diminish.
The Company believes that it has been successful in attracting skilled and
experienced personnel. Competition for such employees is intense, however, and
there can be no assurance that the Company will be able to attract and retain
necessary qualified employees in the future. On July 31, 2003, the Company's
largest facility, Harbor Oaks Hospital, with approximately 125 Union eligible
nursing and administrative employees, voted for union (UAW) representation.
Contract negotiations are in progress at this time.
The limited number of healthcare professionals in the areas in which we
operate may create staffing shortages. Our success depends, in large part, on
our ability to attract and retain highly qualified personnel, particularly
skilled health care personnel, which are in short supply. We face competition
for such personnel from governmental agencies, health care providers and other
companies and are constantly increasing our employee benefit programs, and
related costs, to maintain required levels of skilled professionals. As a result
of staffing shortages, we use professional placement services to supply us with
a pool of professionals from which to choose. These individuals generally are
higher skilled, seasoned individuals who require higher salaries, richer benefit
plans, and in some instances, require relocation. We have also entered into
contracts with agencies to provide short-term interim staffing in addition to
placement services. These additional costs impact our profitability.
Insurance
Each of the Company's facilities maintains separate professional liability
insurance policies. Harbor Oaks, Highland Ridge Hospital, Mount Regis Center,
Harmony Healthcare, Total Concept and Pivotal, Inc. each have coverage of
$1,000,000 per claim and $3,000,000 in the aggregate. In addition, the Company
has maintained the insurance coverage in place for Pivotal Research Centers, LLC
of $3,000,000 per claim and $3,000,000 in the aggregate. In addition to this
coverage, Harbor Oaks and Mount Regis Center each maintain an umbrella policy of
$1,000,000. In addition, these entities maintain general liability insurance
coverage in similar amounts.
The parent Company maintains $1,000,000 of directors' and officers'
liability insurance coverage, general liability coverage of $1,000,000 per claim
and $2,000,000 in aggregate and an umbrella policy of $1,000,000. The Company
believes, based on its experience, that its insurance coverage is adequate for
its business and, although cost has escalated in recent years, that it will
continue to be able to obtain adequate coverage.
- 14 -
Acquisition and Expansion
If we acquire new businesses or expand our businesses, the operating costs
may be far greater than revenues for a significant period of time. The operating
losses and negative cash flow associated with start-up operations or
acquisitions could have a material adverse effect on our profitability and
liquidity unless and until such facilities are fully integrated with our other
operations and become self sufficient. Until such time we may be required to
borrow at higher rates and less favorable terms to supplement short term
operating cash flow shortages. The acquisition of Pivotal Research Centers, LLC
in April 2004 has impacted our net operating results positively by approximately
$131,000 for the months of May and June 2004. Since no receivables were
purchased in the acquisition, the operations of May and June have impacted the
Company's cash flow negatively by approximately $290,000, which will be reversed
as we collect the receivables.
ITEM 2. DESCRIPTION OF PROPERTY
Executive Offices
The Company's executive offices are located in Peabody, Massachusetts. The
Company's lease agreement in Peabody covers approximately 4,800 square feet for
a 60-month term, which expires September 16, 2009. The current annual payment
under the lease is $76,800. The Company believes that this facility will be
adequate to satisfy its needs for the foreseeable future.
Highland Ridge Hospital
The Highland Ridge premises consist of approximately 24,000 square feet of
space occupying the majority of the first floor of a two-story hospital owned by
Valley Mental Health. The lease is for a six-year term expiring December 31,
2009, which provides for monthly rental payments of approximately $21,500.
Changes in rental payments each year are based on increases or decreases in the
CPI. The Company believes that these premises are adequate for its current and
anticipated needs and does not anticipate any difficulty in renewing or securing
alternate space on expiration of the lease.
Mount Regis Center
The Company owns the Mount Regis facility, which consists of a three-story
wooden building located on an approximately two-acre site in a residential
neighborhood. The building consists of over 14,000 square feet and is subject to
a mortgage in the approximate amount of $358,800. The facility is used for both
inpatient and outpatient services. The Company believes that these premises are
adequate for its current and anticipated needs.
Psychiatric Facilities
The Company owns or leases premises for each of its psychiatric facilities.
Harmony, North Point Pioneer and Pivotal Research lease their premises. The
Company believes that each of these premises is leased at fair market value and
could be replaced without significant time or expense if necessary. The Company
believes that all of these premises are adequate for its current and anticipated
needs.
The Company owns the building in which Harbor Oaks operates, which is a
single story brick and wood frame structure comprising approximately 32,000
square feet situated on an approximately three acre site. The Company has a
$1,500,000 mortgage on this property. The Company believes that these premises
are adequate for its current and anticipated needs.
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ITEM 3. LEGAL PROCEEDINGS.
A medical malpractice claim was filed by a former patient against the
Company's subsidiary, North Point-Pioneer, Inc. and a former clinician, alleging
sexual abuse by a former clinician that first manifested itself prior to the
Company's acquisition of the subsidiary in 1996. At trial in December 2002, a
jury returned a verdict in favor of the plaintiff in the amount of approximately
$9 million plus interest and taxable costs and attorney's fee for conduct. The
clinician declared bankruptcy and was not a party to the proceeding. After
numerous successful motions by the Company to reduce the amount of the verdict,
a judgment in the amount of $3,079,741 was entered on October 24, 2003.
The Company's subsidiary, North Point-Pioneer, Inc., is covered by
malpractice insurance in the amount of $1 million provided by Frontier Insurance
Company, which is insolvent and is being administered by the State of New York.
Representatives of Frontier's receiver acknowledged to the Company, Frontier's
obligations under the policy and the Company has recovered a small portion of
the legal fees expended to date on this matter.
In April 2004, the Company successfully resolved this medical malpractice
lawsuit. As a result of the settlement, the Company made a payment of
approximately $463,000, which compares to the previous judgment of approximately
$3 million. The Company has not released other parties, including an insurance
company. Payments made by insurance and other related parties, if collected,
could significantly reduce the Company's financial burden below the $463,000
payment.
The financial impact of this settlement and related legal fees is reflected
in the operating results during the year ended June 30, 2004. The Company will
continue to seek reimbursement from all sources for amounts expended on this
case.
In fiscal 2004, the State of Nebraska asked the Company to provide the
history of payments received from the State of Nebraska and the payments made to
a consultant in Nebraska for his work on the smoking cessation contract. In the
fourth quarter of fiscal 2004, the Company became aware that the State and the
Federal governments are investigating the consultant. The Company is cooperating
fully with the investigating agencies on this matter and to date has expended
approximately $120,000 in legal fees.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of the fiscal year ended June 30, 2004.
- 16 -
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since the Company's public offering which was declared effective on March
3, 1994, until December 2000 the Company's Units, Class A Common Stock and Class
A Warrants were traded on the NASDAQ National Market under the symbols "PIHCU,"
"PIHC" and "PIHCW," respectively. In December 2000, the Company's stock was
delisted due to failure to meet listing criteria. Currently, the Company's Class
A Common Stock is traded on the NASDAQ Bulletin Board under the symbol
"PIHC-BB." There is no public trading market for the Company's Class B Common
Stock. The following table sets forth, for the periods indicated, the high and
low sale price of the Company's Class A Common Stock, as reported by NASDAQ
Bulletin Board.
HIGH LOW
________ ________
2003
First Quarter $ .89 $ .56
Second Quarter $ .85 $ .65
Third Quarter $ .95 $ .69
Fourth Quarter $ .94 $ .72
2004
First Quarter $ .98 $ .72
Second Quarter $ 1.39 $ .83
Third Quarter $ 1.71 $ 1.17
Fourth Quarter $ 1.37 $ .87
2005
First Quarter (through August 31, 2004) $ 1.19 $ .93
On August 31, 2004, the last reported sale price of the Class A Common
Stock was $1.05. On July 30, 2004, there were 715 holders of record of the
Company's Class A Common Stock and 312 holders of record of the Company's Class
B Common Stock.
DIVIDEND POLICY
The Company has never paid any cash dividends on its Common Stock. The
Company anticipates that, in the future, earnings will be retained for use in
the business or for other corporate purposes, and it is not anticipated that
cash dividends in respect to Common Stock will be paid in the foreseeable
future. Any decision as to the future payment of dividends will depend on the
results of operations, the financial position of the Company and such other
factors, as the Company's Board of directors, in its discretion, deems relevant.
MARKET RISKS
The Company's failure to meet listing requirements resulted in the
delisting of the Company's stock from the Nasdaq Stock Market in December 2000.
Since then, the Company's stock has been a bulletin board traded stock. The cost
of trading on the bulletin board can be more than the cost of trading on the
SmallCap market and since there may be an absence of market makers on the
bulletin board the price may be more volatile and it may be harder to sell the
securities. The shares have sold at prices varying between a low of $.56 and a
high of $1.71 from July 2002 through July 2004. If our common stock is not
actively traded, the small number of transactions can result in significant
swings in the market price, and it may be difficult for stockholders to dispose
of stock in a timely way at a desirable market price or may result in purchasing
of shares for a higher price.
Our right to issue convertible preferred stock may adversely affect the
rights of the common stock. Our Board of Directors has the right to establish
the preferences for and issue up to 1,000,000 shares of preferred stock without
further stockholder action. The terms of any series of preferred stock, which
may include priority claims to assets and dividends and special voting rights,
could adversely affect the market price of and the ability to sell common stock.
- 17 -
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following is a discussion and analysis of the financial condition and
results of operations of the Company for the quarters and years ended June 30,
2004 and 2003 . It should be read in conjunction with the consolidated financial
statements and notes thereto appearing elsewhere herein.
Overview
The Company presently provides behavioral health care services through two
substance abuse treatment centers, a psychiatric hospital and five outpatient
psychiatric centers (collectively called "treatment facilities"). The Company's
revenue for providing behavioral health services through these facilities is
derived from contracts with managed care companies, Medicare, Medicaid, state
agencies, railroads, gaming industry corporations and individual clients. The
profitability of the Company is largely dependent on the level of patient census
and the payor mix at these treatment facilities. Patient census is measured by
the number of days a client remains overnight at an inpatient facility or the
number of visits or encounters with clients at outpatient clinics. Payor mix is
determined by the source of payment to be received for each client being
provided billable services. The Company's administrative expenses do not vary
greatly as a percentage of total revenue but the percentage tends to decrease
slightly as revenue increases. Although the Company has changed the focus and
reduced expenses of its internet operation, Behavioral Health Online, Inc.
continues to provide technology and internet support for the Company's other
operations. It also continues to provide behavioral health information and
education through its web site at Wellplace.com. The expenses of the internet
operation decreased approximately 25% for the fiscal year ended June 30, 2004,
as the total effect of cost cuts were realized. The Company's research division,
Pivotal Research Centers, Inc., contracts with major manufacturers of
pharmaceuticals to assist in the study of the effects of certain pharmaceuticals
in the treatment of specific illness through its clinics in Michigan and
Arizona.
The healthcare industry is subject to extensive federal, state and local
regulation governing, among other things, licensure and certification, conduct
of operations, audit and retroactive adjustment of prior government billings and
reimbursement. In addition, there are on-going debates and initiatives regarding
the restructuring of the health care system in its entirety. The extent of any
regulatory changes and their impact on the Company's business is unknown. The
current administration has put forth proposals to mandate equality in the
benefits available to those individuals suffering from mental illness. If
passed, this legislation will improve access to the Company's programs. Managed
care has had a profound impact on the Company's operations, in the form of
shorter lengths of stay, extensive certification of benefits requirements and,
in some cases, reduced payment for services.
Critical Accounting Policies
The preparation of our financial statements in accordance with accounting
principles generally accepted in the United States of America, requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, expenses and related disclosures. On an on-going
basis, we evaluate our estimates and assumptions, including but not limited to
those related to revenue recognition, accounts receivable reserves, income tax
valuation allowances, and the impairment of goodwill and other intangible
assets. We base our estimates on historical experience and various other
assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
- 18 -
Revenue recognition and accounts receivable:
Patient care revenues and accounts receivable are recorded at established
billing rates or at the amount realizable under agreements with third-party
payors, including Medicaid and Medicare. Revenues under third-party payor
agreements are subject to examination and contractual adjustment, and amounts
realizable may change due to periodic changes in the regulatory environment.
Provisions for estimated third party payor settlements are provided in the
period the related services are rendered. Differences between the amounts
provided and subsequent settlements are recorded in operations in the year of
settlement. Amounts due as a result of cost report settlements is recorded and
listed separately on the consolidated balance sheets as "Other receivables,
third party". The provision for contractual allowances is deducted directly from
revenue and the net revenue amount is recorded as accounts receivable. The
allowance for doubtful accounts does not include the contractual allowances.
The Company currently has one "at-risk" contract. The contract calls for
the Company to provide for all of the inpatient and outpatient behavioral health
needs of the insurance carrier's enrollees in Nevada for a fixed monthly fee per
member per month. Revenues are recorded monthly based on this formula and the
expenses related to providing the services under this contract are recorded as
incurred. The Company provides most of the outpatient care directly and, through
utilization review, monitors closely, and pre-approves all inpatient and
outpatient services not provided directly. The contract is considered "at-risk"
because the payments to third-party providers for services rendered could equal
or exceed the total amount of the revenue recorded.
Pharmaceutical study revenue is recognized only after a pharmaceutical
study contract has been awarded and the patient has been selected and accepted
based on study criteria and billable units of service are provided. Where a
contract requires completion of the study by the patient, no revenue is
recognized until the patient completes the study program.
Contract support service revenue is a result of fixed fee contracts to
provide telephone support. Revenue for these services is recognized ratably over
the service period.
All revenues reported by the Company are shown net of estimated allowances
and charity care provided. When payment is made, if the contractual adjustment
is found to have been understated or overstated, appropriate adjustments are
made in the period the payment is received in accordance with the AICPA "Audit
and Accounting Guide for Health Care Organizations."
Allowance for doubtful accounts:
The provision for bad debt is calculated based on a percentage of each aged
accounts receivable category beginning at 0-5% on current accounts and
increasing incrementally for each additional 30 days the account remains
outstanding until the account is over 360 days outstanding, at which time the
provision is 70-100% of the outstanding balance. These percentages vary by
facility based on each facility's experience in and expectations for collecting
older receivables. The Company compares this required reserve amount to the
current "Allowance for doubtful accounts" to determine the required bad debt
expense for the period. This method of determining the required "Allowance for
doubtful accounts" has historically resulted in an allowance for doubtful
accounts of 30% or greater of the total outstanding receivables balance.
Income Taxes:
The Company follows the liability method of accounting for income taxes, as
set forth in SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109
prescribes an asset and liability approach, which requires the recognition of
- 19 -
deferred tax liabilities and assets for the expected future tax consequences of
temporary differences between the carrying amounts and the tax basis of the
assets and liabilities. The Company's policy is to record a valuation allowance
against deferred tax assets unless it is more likely than not that such assets
will be realized in future periods. The Company considers estimated future
taxable income or loss and other available evidence when assessing the need for
its deferred tax valuation allowance.
Valuation of Goodwill and Other Intangible Assets
Goodwill and other intangible assets are initially created as a result of
business combinations or acquisitions. The values the Company records for
goodwill and other intangible assets represent fair values calculated by
independent third-party appraisers. Such valuations require the Company to
provide significant estimates and assumptions which are derived from information
obtained from the management of the acquired businesses and the Company's
business plans for the acquired businesses. Critical estimates and assumptions
used in the initial valuation of goodwill and other intangible assets include,
but are not limited to: (i) future expected cash flows from services to be
provided, customer contracts and relationships, and (ii) the acquired market
position. These estimates and assumptions may be incomplete or inaccurate
because unanticipated events and circumstances may occur. If estimates and
assumptions used to initially value goodwill and intangible assets prove to be
inaccurate, ongoing reviews of the carrying values of such goodwill and
intangible assets may indicate impairment which will require the Company to
record an impairment charge in the period in which the Company identifies the
impairment.
Results of Operations
Quarter ended June 30, 2004 as compared to June 30, 2003
Total net revenue from all facilities, excluding the recent acquisition of
Pivotal Research Centers, LLC, increased 9.1% to $6,885,321 for the quarter
ended June 30, 2004 from $6,313,032 for the quarter ended June 30, 2003. This is
due to increased census in our inpatient facilities and an increase in contract
revenue provided by Wellplace. Total operating expenses related to this period
increased 6.8% to $6,443,509 for the quarter ended June 30, 2004 from $6,035,579
for the quarter ended June 30, 2003. This is primarily due to the costs
associated with the Wellplace contracts and additional Administrative expenses
for salaries, benefits and general insurance costs. Net income for the same
period increased 129.72% to $412,999 for the quarter ended June 30, 2004 from
$179,786 for the same period last year.
Years ended June 30, 2004 as compared to June 30, 2003
The Company's profitability from its ongoing operations, without the impact
of the litigation and settlement costs of approximately $1,030,000, decreased
for the fiscal year ended June 30, 2004. Higher expenses and less favorable
overall economic conditions resulted in the decrease. Total revenues increased
11.8% to $26,648,845 for the year ended June 30, 2004 from $23,833,323 for the
year ended June 30, 2003. Higher unemployment, reduced insurance coverage and
increases in some operating expenses, resulted in a decrease in income from
operations, before the expenses of the litigation noted above, of 18.7% to
$1,175,536 for the year ended June 30, 2004 from $1,445,689 for the year ended
June 30, 2003 and a decrease in income before taxes of 24.0% to $784,291 for the
fiscal year ended June 30, 2004 from $1,031,976 for the fiscal year ended June
30, 2003.
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Total net patient care revenue from all facilities, increased 5.5% to
$22,418,355 for the year ended June 30, 2004 as compared to $21,243,177 for the
year ended June 30, 2003. Although occupancy and net revenue per patient day
shown in "Operating Statistics" on page 7 of this report decreased, actual
patient days increased by over 1,250 days. The decrease in percentage of
occupancy is the result of the increase in available beds starting in November
2003 from 122 to 130. Net inpatient care revenue from inpatient psychiatric
services increased 2.9% to $14,845,163 for the year ended June 30, 2004 from
$14,430,069 for the fiscal year ended June 30, 2003. Net partial hospitalization
and outpatient care revenue increased 11.2% to $7,573,192 for the year ended
June 30, 2004 from $6,813,108 for the year ended June 30, 2003. This increase is
the result of utilization of these step-down programs by managed care as a
treatment alternative to inpatient care. Pharmaceutical study revenue increased
32.4% to $1,246,013 for the year ended June 30, 2004 from $940,772 for the year
ended June 30, 2003. This increase is due to the recent acquisition of Pivotal
Research Centers, LLC, which contributed $699,341 of revenue in the last two
months of the period. The largest increase in revenues for the year was from
Wellplace, formerly known as Pioneer Development and Support Services ("PDS2").
Wellplace revenues increased 80.9% to $2,984,477 for the year ended June 30,
2004 from $1,649,374 for the year ended June 30, 2003. This increase in revenue
is due to the inclusion of the Wayne County call center contract, which began in
March 2003 and the Kansas smoking cessation contract, which began in May 2003.
All revenues reported in the accompanying consolidated statements of operations
are shown net of estimated contractual adjustments and charity care provided.
When payment is made, if the contractual adjustment is found to have been
understated or overstated, appropriate adjustments are made in the period the
payment is received in accordance with the AICPA Audit and Accounting Guide for
Health Care Organizations.
Patient care expenses, excluding Pivotal, increased by $510,187 to
$12,186,386 for the year ended June 30, 2004 from $11,676,199 for the year ended
June 30, 2003 due to the increase in patient census at our inpatient facilities.
Inpatient census increased by approximately 1,250 patient days, 4%, for the year
ended June 30, 2004 compared to the year ended June 30, 2003. Direct patient
care payroll and payroll related expenses increased 6.3% to $10,553,817 for the
year ended June 30, 2004 from $9,927,554 for the year ended June 30, 2003; food
and dietary expense increased 9.4% to $524,023 for the year ended June 30, 2004
from $479,102 for the year ended June 30, 2003, hospital supplies expense
increased 24.4% to $48,667 for the year ended June 30, 2004 from $39,116 for the
year ended June 30, 2003, laundry expense increased 11.0% to $44,124 for the
year ended June 30, 2004 from $39,761 for the year ended June 30, 2003 and
Medical records expense increased 12.2% to $69,415 for the year ended June 30,
2004 from $61,865 for the year ended June 30, 2003. All of these increases were
a result of increased patient census and increased needs of the patients based
on the severity of their illness. Other patient related expenses decreased 31.3%
to $237,806 for the year ended June 30, 2004 from $345,907 for the year ended
June 30, 2003. This decrease is primarily due to the decrease in patients
participating in pharmaceutical research studies through Pivotal in Michigan.
Laboratory fees decreased 17.8% to $151,933 for the year ended June 30, 2004
from $184,810 for the year ended June 30, 2003 due to a change in service
provider and closer monitoring of tests ordered. We continue to closely monitor
the ordering of all hospital supplies, food and pharmaceutical supplies but
these expenses all relate directly to the number of days of inpatient services
we provide and are expected to increase with higher patient census. (see
"Operating Statistics" Part I, Item 1).
Website expenses increased 35.2% to $293,200 for the year ended June 30,
2004 from $216,827 for the year ended June 30, 2003. This is a result of
increased depreciation expense based on a revision of the estimated remaining
useful life of the assets. Without this change, website expenses would have
remained relatively stable. We expect Website expenses will remain at this level
while the internet Company's focus remains internal.
- 21 -
Cost of contract support services related to Wellplace increased 79.2% to
$2,391,660 for the year ended June 30, 2004 from $1,398,602 for the year ended
June 30, 2003. This increase is due to the inclusion of the Wayne County call
center contract, which began March 2003 and the Kansas smoking cessation
contract, which began in May 2003. Expenses are expected to increase as new
contracts are added. Legal fees for Wellplace increased to $133,975 for the year
ended June 30, 2004 from $12,352 for the year ended June 30, 2003. This
disproportionate increase is a result of an inquiry by the State of Nebraska.
(see "Legal Proceedings" Part 1, Item 3)
Total administrative expenses, excluding Pivotal, increased 21.5% to
$9,708,423 for the year ended June 30, 2004 from $7,987,508 for the year ended
June 30, 2003. Legal expense increased approximately $1,068,000, which accounts
for more than 62% of the increase. This is a result of the litigation and
settlement described in "Legal Proceedings" on page 13 of this report.
Administrative salaries increased 6.8% to $2,455,232 for the year ended June 30,
2004 from $2,297,918 for the year ended June 30, 2003. Greater competition for
experienced health care administrative staff resulted in these increased
salaries. Insurance expense increased 59.0% to $452,147 for the year ended June
30, 2004 from $284,306 for the year ended June 30, 2003 due to general increases
in property and liability insurance. Accounting fees, which includes non-audit
accounting services, including but not limited to cost reports and individual
contract audits, provided by firms other than our principal audit firm,
increased 3.0% to $185,626 for the year ended June 30, 2004 from $180,815 for
the year ended June 30, 2003.
Interest expense decreased 2.0% to $531,564 for the year ended June 30,
2004 from $542,269 for the year ended June 30, 2003. This decrease is due to the
decrease in the prime rate, which dictates the interest rate on the majority of
the Company's long-term debt and the decrease in outstanding debt. The Company
also expensed $114,500 of costs related to the Company's initial efforts to
finance the Pivotal acquisition through debt. This amount would have been
amortized over the term of the loan had the loan been consummated. It was
determined that equity financing would be in the best interest of the Company
and its shareholders when more favorable loan terms could not be secured.
Without this one time expense, interest expense for the year would have
decreased 23.1% to $417,064.
The Company's income taxes of $11,294 and $54,234 for the years ended June
30, 2004 and June 30, 2003, respectively, are significantly below the Federal
statutory rate of 34% primarily due to the availability of net operating loss
carry-forwards. Total income tax expense for fiscal 2004 and 2003 represents
state income taxes for certain subsidiaries with no available net operating loss
carry-forwards. The Company has provided a significant valuation allowance
against its deferred tax asset due to the uncertainty of its full recoverability
given the Company's history of operating losses that may limit the accessibility
of the loss carry-forwards.
Provision for doubtful accounts increased 22.3% to $1,355,770 for the
fiscal year ended June 30, 2004 from $1,108,498 for the fiscal year ended June
30, 2003. This increase is the result of an increase in the age of outstanding
accounts receivable with many insurance carriers delaying payment as much as 180
days as well as increased overall revenue.
The environment the Company operates in today makes collection of
receivables, particularly older receivables, more difficult than in previous
years. Accordingly, the Company has increased staff, standardized some
procedures for collecting receivables and instituted a more aggressive
collection policy, which has resulted in an overall decrease in its accounts
receivable. Although the Company's gross receivables from direct patient care
have decreased, the Company continues to reserve for bad debts based on managed
care denials and past difficulty in collections. The growth of managed care has
negatively impacted reimbursement for behavioral health services with a higher
rate of denials requiring higher reserves.
- 22 -
Liquidity and Capital Resources
The Company`s net cash used in operating activities was $149,744 for the
year ended June 30, 2004 compared to cash provided by operating activities of
$1,406,694 for the year ended June 30, 2003. Cash used in operations in fiscal
2004 consists primarily of the net loss of $257,003, increase in total net
accounts receivable of $731,540 due to increased revenue, an increase in prepaid
expenses of $99,001, an increase in other assets of $135,904, a decrease in
accrued expenses and other liabilities of $126,507 and an increase in deferred
tax asset of $34,199. These uses of cash from operations were offset by
depreciation and amortization of $321,835 and non-cash equity based charges of
$99,498, which are non cash expenditures contributing to the net loss above and
an increase in accounts payable of $813,077. The use of cash in operations
results primarily from the loss from operations resulting from the litigation
settlement and related legal fees as described in Legal Proceedings.
Cash used in investing activities in fiscal 2004 consisted of $193,185 in
capital expenditures for the acquisition of property and equipment and
$2,191,697 related to the acquisition of the membership interest in Pivotal
Research Centers, LLC compared to $226,100 in capital expenditures for the
acquisition of property and equipment in fiscal 2003. (See Note L to the
consolidated financial statements included herewith for additional detail
regarding the acquisition of Pivotal Research Centers, LLC)
Cash used in financing activities in fiscal 2004 consisted of $627,380 in
net debt repayments, $4,000 in deferred financing cost, $3,026,665 received from
the issuance of common stock and $68,827 paid in the purchase of treasury stock.
In addition to these transactions, the Company also issued 50,000 shares of
class B common stock at market value in the retirement of related party debt.
A significant factor in the liquidity and cash flow of the Company is the
timely collection of its accounts receivable. Current accounts receivable from
patient care, net of allowance for doubtful accounts increased approximately 6%
to $5,261,202 on June 30, 2004 from $4,945,301 on June 30, 2003. This increase
is a result of increased net revenue. The Company's goal is to maintain
receivables at their current levels or to have any increases result from higher
revenues and timing of receivables collection. Only better accounts receivable
management due to increased staff, standardization of some procedures for
collecting receivables and a more aggressive collection policy has made this
possible in behavioral health, which is typically a difficult collection
environment. Increased staff has allowed the Company to concentrate on current
accounts receivable and resolve any problem issues before they become
uncollectable. The Company's collection policy calls for earlier contact with
insurance carriers with regard to payment, use of fax and registered mail to
follow-up or resubmit claims and earlier employment of collection agencies to
assist in the collection process. Our collectors will also seek assistance
through every legal means, including the State Insurance Commissioner's office,
when appropriate, to collect claims. At the same time, the Company continues to
closely monitor reserves for bad debt based on potential insurance denials and
past difficulty in collections.
In order to facilitate the acquisition of the membership interest in
Pivotal Research Centers, LLC, the Company determined that it would be in the
best interest of the shareholders to finance the cash portion of the purchase
price through equity as well as raise additional working capital, since debt
with favorable terms was not available. Therefore, the Company offered 2,800,000
shares of Class A Common Stock at $1.10 per share in a private placement. The
private placement also included 25% warrant coverage at an exercise price of
$1.10 per share with a three-year term and standard anti-dilution features. This
offering was completed in two stages. As a result of the first stage of the
offering, in March 2004, the Company issued 684,999 shares of Class A Common
Stock for $753,500 and warrants to purchase 171,248 additional shares of Class A
- 23 -
Common Stock. As a result of the second stage of this offering, in April 2004,
the Company issued 1,918,196 shares of Class A Common Stock for $2,110,016 and
warrants to purchase 479,549 additional shares of Class A Common Stock. The
private placement facilitated the closing of the acquisition without incurring
any additional bank debt, and also provides the necessary working capital for
Pivotal to execute its business plan. . The Company's future minimum payments
under contractual obligations related to capital leases, operating leases and
term notes as of June 30, 2004 are as follows:
Year Ending Term Capital Operating
June 30, Notes Leases Leases Total
__________ ________ __________ __________
2005 $1,713,395 $20,540 $1,495,087 $3,229,022
2006 55,899 14,532 1,322,882 1,393,313
2007 40,913 9,495 1,008,456 1,058,864
2008 44,353 2,072 823,136 869,561
2009 192,237 -- 810,463 1,002,700
Thereafter 195,976 -- 275,215 471,191
__________ ________ __________ __________
Total minimum payments $2,242,773 $46,639 $5,735,239 $8,024,651
========== ======== ========== ==========
In addition to the above term notes, the Company also has $250,000 in
outstanding convertible debentures, which include the provision that the holders
of the debentures may put all or any portion of the debentures to the Company at
the original purchase price plus unpaid interest upon 30 days written notice.
These debentures mature in December 2004 and will, unless the holders agree to
extend the maturity date, be paid through our operating line of credit limiting
available funds for operations. The Company is also subject to three contingent
notes with a total face value of $2,500,000 as part of the Pivotal acquisition.
Of these notes, two totaling $1,500,000 bear interest at 6% per annum. These
notes are subject to adjustment based on the earnings of the acquired
operations. Since adjustment can be positive or negative based on earnings, with
no ceiling or floor, no liability for these notes, or interest on the notes has
been recorded. This treatment is in accordance with SFAS No. 141, "Business
Combinations", which states that contingent consideration should be recognized
only when determinable beyond a reasonable doubt. Payments on these two notes,
if required, are scheduled to begin January 1, 2005. The final note for
$1,000,000 does not bear interest, is also subject to adjustment based on
earnings but has a minimum value of $200,000 to be paid in PHC, Inc. class A
common stock on March 31, 2009. This minimum liability has been recorded with
imputed interest of 6% and is included in the schedule above.
The Company's current debt includes $1,500,000 due on the term loan, which
is scheduled for repayment in November 2004. The Company plans to renew or
replace this debt or extinguish it through an equity placement. Subsequent to
year end, the Company entered into an agreement to sell 526,316 shares of
preferred stock for $1,500,000 as an alternate financing plan should more
favorable financing not be available. The Company believes that, with its
revolving credit facility through its primary lender and cash flow from
operations, it will have sufficient cash and financing available to fund its
growing operations for the foreseeable future. The Company plans to expand its
core business through increased capacity at its current facilities and the
current expansion plans to add a leased facility in Detroit Michigan for up to
114 acute and long term psychiatric beds. The Company expects to open the first
30-bed unit when the build out has been completed and employees are in place,
which is expected to be in the first quarter of the current fiscal year. The
Company expanded its pharmaceutical research operations on April 30, 2004
through the acquisition of Pivotal Research Centers, LLC. Additional expansion
in this area will be through opening additional locations and signing additional
contracts. Any additional acquisitions will be funded through acquisition
specific financing instruments.
- 24 -
The Company has operated ongoing operations profitably for fourteen
consecutive quarters with the exception of the litigation settlement and related
legal costs incurred in the third quarter of fiscal year 2004. While it is
difficult to project whether the current positive business environment towards
behavioral health treatment and the new business opportunities will continue, it
gives us confidence to foresee continued improved results.
Operating Risks
Negative cash flow could arise as a result of slow government payments. The
concentration of accounts receivable due from government payors could create a
severe cash flow problem should these agencies fail to make timely payment. We
had substantial receivables from Medicaid and Medicare of approximately
$1,135,000 at June 30, 2004 and $1,078,000 at June 30, 2003, which would create
a cash flow problem should these agencies defer or fail to make reimbursement
payments as due, which would require us to borrow at unfavorable rates or pay
additional interest as overline fees on current debt instruments. This would
result in lower net income for the same services provided and lower earnings per
share.
Negative Cash flow could impact our ability to meet obligations when due.
If managed care organizations delay approving treatment, or reduce the patient
length of stay or number of visits or reimbursement, our Company's ability to
meet operating expenses is affected. As managed care organizations and insurance
companies adopt policies that limit the length of stay for substance abuse
treatment, our business is materially adversely affected since our revenues and
cash flow go down and our fixed operating expenses continue or increase based on
the additional resources required to collect accounts receivable.
Reimbursement for substance abuse and psychiatric treatment from private
insurers is largely dependent on our ability to substantiate the medical
necessity of treatment. The process of substantiating a claim often takes up to
four months and sometimes longer; as a result, we experience significant delays
in the collection of amounts reimbursable by third-party payors, which requires
us to increase staff to pursue payment and adversely affects our working capital
condition. This causes amounts borrowed on our accounts receivable revolver to
remain outstanding for longer periods of time resulting in higher interest
expense in addition to the reduced income resulting from the shorter lengths of
stay, which combined reduce net income and earnings per share.
Aging of accounts receivables could result in our inability to collect
receivalbes. As our accounts receivable age and become uncollectable our cash
flow is negatively impacted. Our accounts receivable from patient accounts (net
of allowance for bad debts) were $5,261,201 at June 30, 2004 compared with
$4,945,301 at June 30, 2003. As we expand, we will be required to seek payment
from a larger number of payors and the amount of accounts receivable will likely
increase. We have focused on better accounts receivable management through
increased staff, standardization of some procedures for collecting receivables
and a more aggressive collection policy in order to keep the change in
receivables consistent with the change in revenue. We have also established a
more aggressive reserve policy, allowing greater amounts of reserves as accounts
age from the date of billing. If the amount of receivables, which eventually
become uncollectible, exceeds such reserves, we could be materially adversely
affected. The following chart represents our Accounts Receivable, Allowance of
Doubtful Accounts at June 30, 2004 and 2003, respectively and Bad Debt Expense
for the years ended June 30, 2004 and 2003:
Accounts Receivable Allowance for doubtful Bad Debt
accounts Expense
June 30, 2004 $7,287,090 $2,025,888 $1,355,770
June 30, 2003 7,293,746 2,348,445 1,108,498
- 25 -
Due to the Company's current negative working capital and recent losses
from operations as a result of a medical malpractice litigation settlement and
related legal fees of approximately $1,030,000, if the Company needs additional
financing, it may require borrowing at unfavorable rates. We are utilizing, to
the maximum extent, our accounts receivable funding facilities, which bear
interest at the prime rate plus 2.25%, to meet our current cash needs. Should we
require additional funds to meet our cash flow requirements or to fund growth or
new investments, we may be required to meet these needs with more costly
financing. Our current financing relationship is scheduled to terminate or renew
as of November 2004. If we are unable to obtain needed financing, it could have
a material adverse effect on our financial condition, operations and business
prospects.
The Company relies on contracts with more than ten clients to maintain
patient census at its inpatient facilities and the loss of any of such contracts
would impact our ability to meet our fixed costs. We have entered into
relationships with large employers, health care institutions and labor unions to
provide treatment for psychiatric disorders, chemical dependency and substance
abuse in conjunction with employer-sponsored employee assistance programs. The
employees of such institutions may be referred to us for treatment, the cost of
which is reimbursed on a per diem or per capita basis. Approximately 30% of our
total revenue is derived from these clients. No one of these large employers,
health care institutions or labor unions individually accounts for 10% or more
of our consolidated revenues, but the loss of any of these clients would require
us to expend considerable effort to replace patient referrals and would result
in revenue losses and attendant loss in income.
Recent accounting pronouncements
In December 2003, the Securities and Exchange Commission ("SEC") published
SAB No. 104, "Revenue Recognition." SAB No. 104 was effective upon issuance. The
adoption of SAB No. 104 did not have a material effect on the Company's
financial position, results of operations, or cash flows.
In November 2002, the Emerging Issues Task Force ("EITF") reached consensus
on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables". Revenue
arrangements with multiple deliverables include arrangements which provide for
the delivery or performance of multiple products, services and/or rights to use
assets where performance may occur at different points in time or over different
periods of time. EITF Issue No. 00-21 is effective for revenue arrangements
entered into in fiscal periods beginning after June 15, 2003. The adoption of
the guidance under this consensus did not have an impact on the Company's
financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 is the first phase of the FASB's project on liabilities and equity. SFAS
No. 150 provides guidance on how an entity classifies and measures certain
financial instruments with characteristics of both liabilities and equity. For
publicly held companies, SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003. SFAS No. 150 requires companies to
record the cumulative effect of financial instruments existing at the adoption
date. The adoption of SFAS 150 did not have an effect on the Company's
operations, financial position or cash flows.
In December 2003, the FASB issued a revision to FIN No. 46, "Consolidation
of Variable Interest Entities." The revised FIN No. 46, which replaces the
original FIN No. 46 issued in January 2003, clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements", to
- 26 -
certain entities in which equity investors 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. While this interpretation exempts certain entities from its
requirements, it also expands the definition of a variable interest entity
("VIE") to a broader group of entities than those previously considered
special-purpose entities ("SPE's") and specifies the criteria under which it is
appropriate for an investor to consolidate VIE's. Application of the revised FIN
No. 46 is required in financial statements of public entities that have interest
in structures that are commonly referred to as SPE's for periods ending after
December 15, 2003. For all other types of VIE's, application of the revised FIN
No. 46 by public entities is required for periods ending after March 15, 2004.
The application of this interpretation did not have an impact on the Company's
financial position, results of operations, or cash flows.
- 27 -
ITEM 7. FINANCIAL STATEMENTS. PAGE
Index F-1
Report of Independent Registered Public Accounting Firm F-2
Consolidated balance sheets F-3
Consolidated statements of operations F-4
Consolidated statements of changes in stockholders' equity F-5
Consolidated statements of cash flows F-6,
Notes to consolidated financial statements F-8 - F-27
F-1
- 28 -
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
PHC, Inc.
Peabody, Massachusetts
We have audited the accompanying consolidated balance sheets of PHC, Inc. and
subsidiaries as of June 30, 2004 and 2003, and the related consolidated
statements of operations, changes in stockholders' equity, and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PHC,
Inc. and subsidiaries at June 30, 2004 and 2003, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
/s/ BDO Seidman, LLP
Boston, Massachusetts
August 12, 2004 (except with respect to the matter
discussed in Note M as to which the date is September 20, 2004)
F-2
- 29 -
PHC, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
June 30,
2004 2003
_____________ ___________
ASSETS (Note C)
Current assets: (Note A)
Cash and cash equivalents (Note A) $ 594,823 $ 494,991
Accounts receivable, net of allowance for
doubtful accounts of $2,025,888
and $2,348,445 at June 30, 2004
and 2003, respectively (Note A) 5,165,150 4,345,301
Pharmaceutical research receivables 549,974 157,454
Prepaid expenses 168,542 69,541
Other receivables and advances 310,221 97,552
Deferred tax assets (Note F) 842,806 808,607
Other receivables, third party (Note A) -- 172,043
_____________ ___________
Total current assets 7,631,516 6,145,489
Accounts receivable, non-current (Note A) 96,052 600,000
Other receivables (Note A) 94,469 111,976
Property and equipment, net (Notes A, B, C, D
and L) 1,353,975 1,295,113
Deferred financing costs, net of amortization
of $134,109 and $130,109 at June 30, 2004
and 2003, respectively -- 4,000
Customer relationships, net of amortization of
$20,000 at June 30, 2004 (Notes A & L) 2,380,000 --
Goodwill (Notes A and L) 1,416,119 969,099
Other assets (Note A) 339,438 286,046
_____________ ___________
Total assets $13,311,569 $9,411,723
============= ===========
LIABILITIES
Current liabilities:
Accounts payable $ 1,668,509 $ 860,952
Notes payable - related parties (Note E) -- 100,000
Current maturities of long-term debt (Note C) 1,713,395 883,659
Revolving credit note (Note C) 1,714,380 1,103,561
Deferred revenue 38,151 160,720
Current portion of obligations under capital
leases (Note D) 18,169 50,805
Accrued payroll, payroll taxes and benefits 1,305,490 1,016,088
Accrued expenses and other liabilities (Note K) 682,567 958,527
Convertible debentures (Notes C) 250,000 275,000
_____________ ___________
Total current liabilities 7,390,661 5,409,312
Long-term debt, less current maturities (Note C) 529,378 2,030,285
Obligations under capital leases (Note D) 24,493 36,869
_____________ ___________
Total liabilities 7,944,532 7,476,466
_____________ ___________
Commitments and contingent liabilities
(Notes D, G, H, I and L)
STOCKHOLDERS' EQUITY (Notes A, E, G, H, I and L)
Preferred stock, 1,000,000 shares authorized,
none issued and outstanding -- --
Class A common stock, $.01 par value;
20,000,000 shares authorized, 16,744,848
and 13,437,067 shares issued at June 30,
2004 and 2003, respectively. 167,448 134,371
Class B common stock, $.01 par value;
2,000,000 shares authorized, 776,991 and
726,991 issued and outstanding at June 30, 2004
and 2003, respectively, each convertible into
one share of class A common stock 7,770 7,270
Additional paid-in capital 22,791,637 19,147,604
Treasury stock, 168,136 and 97,804 class A
common shares at cost at June 30, 2004 and
2003, respectively. (141,207) (72,380)
Notes receivable - common stock -- (80,000)
Accumulated deficit (17,458,611) (17,201,608)
_____________ ___________
Total stockholders' equity 5,367,037 1,935,257
_____________ ___________
Total liabilities and stockholders'
equity $13,311,569 $ 9,411,723
============ ===========
See accompanying notes to consolidated financial statements. F-3
- 30 -
PHC, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Year Ended June 30,
2004 2003
___________ ___________
Revenues: (Note A)
Patient care, net $22,418,355 $21,243,177
Pharmaceutical study 1,246,013 940,772
Contract support services 2,984,477 1,649,374
___________ ___________
Total revenues 26,648,845 23,833,323
___________ ___________
Operating expenses:
Patient care expenses 12,422,627 11,829,799
Cost of contract support services 2,391,660 1,398,602
Provision for doubtful accounts 1,355,770 1,108,498
Website expenses 293,200 216,827
Administrative expenses 10,040,052 7,833,908
___________ ___________
Total operating expenses 26,503,309 22,387,634
___________ ___________
Income from operations 145,536 1,445,689
___________ ___________
Other income (expense):
Interest income 44,731 13,133
Interest expense (531,564) (542,269)
Other income, net 95,588 115,423
___________ ___________
Total other expense, net (391,245) (413,713)
___________ ___________
Income (loss) before income taxes (245,709) 1,031,976
Provision for income taxes (Notes A and F) 11,294 54,234
___________ ___________
Net income (loss) $(257,003) $ 977,742
=========== ===========
Basic income (loss) per common share (Note A) $ (.02) $ .07
=========== ===========
Basic weighted average number of shares
outstanding (Note A) 14,731,395 13,944,047
=========== ===========
Fully diluted income (loss) per common share
(Note A) $ (.02) $ .07
=========== ===========
Fully diluted weighted average number of
shares outstanding (Note A) 14,731,395 14,564,078
============ ===========
See accompanying notes to consolidated financial statements. F-4
- 31 -
PHC, INC. AND SUBSIDIARIES
Consolidated Statements of Changes In Stockholders' Equity (See Notes A, E, G,
H, I and L)
Class A Class B Additional
Common Stock Common Stock Paid-in
Shares Amount Shares Amount Capital
_____________________________________________________
Balance - June 30, 2002 12,919,042 $129,190 726,991 $7,270 $18,769,863
Costs related to private
placements (7,212)
Issuance of shares for options
exercised 408,025 4,081 346,060
Issuance of warrants for services 3,185
Shares issued for employee
bonuses 28,623 286 18,726
Issuance of shares for warrants
exercised 62,363 624 9,376
Issuance of employee stock
purchase plan shares 19,014 190 7,606
Purchase of shares from former
employee
Net income-year ended June 30,
2003
_____________________________________________________
Balance - June 30, 2003 13,437,067 134,371 726,991 7,270 19,147,604
Costs related to private
placements (46,578)
Issuance of shares for options
exercised 46,165 461 50,169
Issuance of warrants for services 76,664
Shares issued for employee
bonuses 11,016 110 10,279
Issuance of shares for warrants
exercised 155,000 1,550 95,050
Issuance of employee stock
purchase plan shares 8,238 83 6,383
Purchase of shares from former
employee
Net value of repriced options 5,425
Forgiveness of stock purchase
debt
Private placement 2,660,012 26,600 2,899,414
Shares issued in acquisition 427,350 4,273 495,727
Conversion of debt into Class B
common stock 50,000 500 51,500
Net loss year ended June 30, 2004____________________________________________________
Balance - June 30, 2004 16,744,848 $167,448 776,991 $7,770 $22,791,637
====================================================
See accompanying notes to consolidated financial statements.
- 32 -
PHC, INC. AND SUBSIDIARIES (con't)
Consolidated Statements of Changes In Stockholders' Equity (See Notes A, E, G,
H, I and L)
Notes
Receivable
Treasury Stock Common Stock Accumulated
Shares Amount Purchase Deficit Total
___________________________________________________________
Balance - June 30, 2002 38,126 $(30,988) $(80,000) $(18,179,350) $615,985
Costs related to private
placements (7,212)
Issuance of shares for
options exercised 350,141
Issuance of warrants for
services 3,185
Shares issued for
employee bonuses 19,012
Issuance of shares for
warrants exercised 10,000
Issuance of employee stock
purchase plan shares 7,796
Purchase of shares from
former employee 59,678 (41,392) (41,392)
Net income-year ended June
30, 2003 977,74