UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended March 31, 2006.
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ____________ to
___________
Commission file number 0-22916
PHC, INC.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2601571
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Lake Street, Suite 102, Peabody MA 01960
(Address of principal executive offices) (Zip Code)
978-536-2777
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the 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___
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer _____ Accelerated filer ______ Non accelerated filer X
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes ____ No X
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Number of shares outstanding of each class of common equity, as of May 4, 2006:
Class A Common Stock 17,674,666
Class B Common Stock 776,962
-- 1 --
PHC, Inc.
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements.
Condensed Consolidated Balance Sheets - March 31, 2006 (unaudited) and
June 30, 2005.
Condensed Consolidated Statements of Operations (unaudited) - Three and
nine months ended March 31, 2006 and March 31, 2005.
Condensed Consolidated Statements of Cash Flows (unaudited)- Nine months
months ended March 31, 2006 and March 31, 2005.
Notes to Condensed Consolidated Financial Statements - March 31, 2006.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Item 3. Quantitative and Qualitative Disclosure About Market Risk.
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits
Signatures
-- 2 --
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PHC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, June 30,
ASSETS 2006 2005
___________ ___________
(unaudited)
Current assets:
Cash and cash equivalents $ 957,437 $ 917,630
Accounts receivable, net of allowance
for doubtful accounts of $3,117,247
at March 31,2006 and $1,956,984 at
June 30, 2005 6,601,905 6,265,381
Pharmaceutical receivables 1,977,983 1,414,340
Prepaid expenses 521,297 146,988
Other receivables and advances 612,196 638,654
Deferred income tax asset 1,415,344 1,375,800
___________ ___________
Total current assets 12,086,162 10,758,793
Accounts receivable, non-current 45,000 65,000
Other receivable 97,350 84,422
Property and equipment, net 1,865,042 1,516,114
Deferred financing costs, net of
amortization of $110,910 at March 31,
2006 and $76,234 June 30, 2005 126,262 145,938
Customer relationships, net of
amortization of $230,000 at March 31,
2006 and $140,000 at June 30, 2005 2,170,000 2,260,000
Goodwill 2,704,389 2,648,209
Other assets 506,139 417,172
___________ ___________
Total assets $19,600,344 $17,895,648
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $1,618,948 $ 907,569
Current maturities of long-term debt 881,832 769,599
Revolving credit note 2,040,605 2,385,629
Deferred revenue 225,290 85,061
Current portion of obligations under
capital leases 59,265 29,777
Accrued payroll, payroll taxes and benefits 1,414,659 1,411,653
Accrued expenses and other liabilities 763,093 1,063,189
___________ ___________
Total current liabilities 7,003,692 6,652,477
Long-term debt 1,281,275 1,900,022
Obligations under capital leases 75,446 12,210
Deferred tax liability 244,874 229,000
___________ ___________
Total liabilities 8,605,287 8,793,709
___________ ___________
Stockholders' equity:
Preferred Stock, 1,000,000 shares
authorized, none issued or outstanding -- --
Class A common stock, $.01 par value,
30,000,000 shares authorized,
17,617,764 and 17,490,818 shares
issued at March 31, 2006 and June
30, 2005, respectively 176,178 174,908
Class B common stock, $.01 par value,
2,000,000 shares authorized,
776,962 and 776,991 issued and
outstanding at March 31, 2006 and
June 30, 2005, respectively, each
convertible into one share of Class
A common Stock 7,769 7,770
Additional paid-in capital 23,623,983 23,377,059
Treasury stock, 199,098 shares and 181,738
shares of Class A common stock at March 31,
2006 and June 30, 2005 respectively, at cost (191,700) (155,087)
Accumulated deficit (12,621,173) (14,302,711)
___________ ___________
Total stockholders' equity 10,995,057 9,101,939
Total liabilities and stockholders' equity $19,600,344 $17,895,648
=========== ===========
See Notes to Condensed Consolidated Financial Statements
-- 3 --
PHC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
2006 2005 2006 2005
________________________________________________
Revenues:
Patient care, net $7,292,804 $6,734,949 $20,471,140 $18,895,774
Pharmaceutical studies 1,523,277 1,103,205 3,913,370 3,384,347
Contract support services 1,137,878 925,528 3,216,788 2,510,277
___________ ___________ ___________ ___________
Total revenues 9,953,959 8,763,682 27,601,298 24,790,398
___________ ___________ ___________ ___________
Operating expenses:
Patient care expenses 3,787,166 3,533,279 10,341,470 9,541,581
Patient care expenses,
pharmaceutical 552,477 444,999 1,626,465 1,247,106
Cost of contract support
services 713,438 520,475 1,898,300 1,595,478
Provision for doubtful
accounts 334,248 217,756 1,466,903 800,503
Administrative expenses 2,815,164 2,410,474 8,193,940 7,008,636
Administrative expenses,
pharmaceutical 638,486 653,827 1,810,776 2,049,492
___________ ___________ ___________ ___________
Total operating expenses 8,840,979 7,780,810 25,337,854 22,242,796
___________ ___________ ___________ ___________
Income from operations 1,112,980 982,872 2,263,444 2,547,602
___________ ___________ ___________ ___________
Other income (expense):
Interest income 11,281 15,004 49,542 49,535
Other income 25,309 31,568 57,357 58,060
Interest expense (153,594) (148,988) (483,150) (491,840)
___________ ___________ ___________ ___________
Total other expenses,
net (117,004) (102,416) (376,251) (384,245)
___________ ___________ ___________ ___________
Income before provision for taxes 995,976 880,456 1,887,193 2,163,357
Provision for income taxes 45,427 -- 205,655 98,469
___________ ___________ ___________ ___________
Net income $ 950,549 $ 880,456 $ 1,681,538 $2,064,888
=========== =========== =========== ===========
Basic net income per common
share $ 0.05 $ 0.05 $ 0.09 $ 0.12
=========== =========== =========== ===========
Basic weighted average number of
shares outstanding 18,187,750 17,648,412 18,145,789 17,474,155
=========== =========== =========== ===========
Fully diluted net income per
common share $ 0.05 $ 0.05 $ 0.09 $ 0.11
=========== =========== =========== ===========
Fully diluted weighted average
number of shares outstanding 19,212,589 18,690,012 19,242,777 18,234,480
=========== =========== =========== ===========
See Notes to Condensed Consolidated Financial Statements.
-- 4 --
PHC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended
March 31
2006 2005
___________ ____________
Cash flows from operating activities:
Net income $1,681,538 $2,064,888
Adjustments to reconcile net income to net
cash provided by (used in)operating
activities:
Depreciation and amortization 543,991 324,397
Non-cash interest expense 41,796 41,796
Deferred income tax provision (23,670) --
Non-cash stock-based compensation 118,286 78,656
Changes in:
Accounts receivable (866,637) (2,313,451)
Prepaid expenses and other current assets (374,309) (133,921)
Other assets (103,277) (144,057)
Accounts payable 711,379 52,777
Accrued expenses and other liabilities (156,861) 199,942
___________ ____________
Net cash provided by operating activities 1,572,236 171,027
___________ ____________
Cash flows from investing activities:
Acquisition of property and equipment (753,933) (359,407)
Costs related to business acquisition -- (62,258)
___________ ____________
Net cash used in investing activities (753,933) (421,665)
___________ ____________
Cash flows from financing activities:
Revolving debt, net (345,024) 806,709
Proceeds from borrowings on long-term debt 7,309 1,406,201
Principal payments on long-term debt (462,895) (1,986,847)
Deferred financing costs (15,000) (164,348)
Costs related to issuance of capital stock -- (30,000)
Issuance of common stock 73,727 190,854
Purchase of treasury stock (36,613) (13,880)
___________ ____________
Net cash (used in) provided by financing
activities (778,496) 208,689
___________ ____________
Net increase (decrease) in cash and cash
equivalents 39,807 (41,949)
Beginning cash and cash equivalents 917,630 594,823
___________ ____________
Ending cash and cash equivalents $ 957,437 $ 552,874
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 483,150 $ 485,659
Income taxes 253,109 118,550
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Pivotal Acquisition Note A earn out
consideration recorded $ -- $1,169,832
Issuance of common stock in cashless
exercise of warrants 24,242 14,250
Issuance of common stock in cashless
exercise of options 18,577 --
Value of warrants issued in connection
with the Pivotal acquisition 51,860 --
See Notes to Condensed Consolidated Financial Statements.
-- 5 --
PHC, INC. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
March 31, 2006
Note A - The Company
PHC, Inc. (the "Company") is a national health care company, which operates
subsidiaries specializing in behavioral health services including the treatment
of substance abuse, which includes alcohol and drug dependency and related
disorders and the provision of psychiatric services. The Company also conducts
pharmaceutical research studies, operates help lines for employee assistance
programs, call centers for state and local programs and provides management,
administrative and online behavioral health services. The Company primarily
operates under four business segments:
Behavioral health treatment services, including two substance abuse
treatment facilities: Highland Ridge Hospital, located in Salt Lake City, Utah,
which also treats psychiatric patients, and Mount Regis Center, located in
Salem, Virginia, and eight psychiatric treatment locations which include Harbor
Oaks Hospital, a 64-bed psychiatric hospital located in New Baltimore, Michigan,
Detroit Behavioral Institute, a 50-bed psychiatric facility dedicated to
adjudicated juveniles located in Detroit, Michigan and six outpatient behavioral
health locations (one in New Baltimore, Michigan operating in conjunction with
Harbor Oaks Hospital, two in Las Vegas, Nevada operating as Harmony Healthcare
and three locations operating as Pioneer Counseling Center in the Detroit,
Michigan metropolitan area);
Pharmaceutical study services, including four clinical study sites: two in
Arizona, in Peoria and Mesa, one in Royal Oak, Michigan and one in Midvale,
Utah. These research sites conduct studies of the effects of specified
pharmaceuticals on a controlled population through contracts with major
manufacturers of the pharmaceuticals. All of the Company's research sites
operate as Pivotal Research Centers;
Call center and help line services (contract services), including two call
centers: one operating in Midvale, Utah and one in Detroit, Michigan. The
Company provides help line services through contracts with major railroads, a
smoking cessation contract with a major defense contractor and a call center
contract with Wayne County Michigan. The call centers both operate under the
name Wellplace; and
Behavioral health administrative services, including delivery of management
and administrative and online services. The parent company provides management
and administrative services for all of its subsidiaries and online services for
its behavioral health treatment subsidiaries and its call center subsidiaries.
It also provides behavioral health information through its website
Wellplace.com.
Note B - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the nine months ended
March 31, 2006 are not necessarily indicative of the results that may be
expected for the year ending June 30, 2006. The accompanying financial
statements should be read in conjunction with the June 30, 2005 consolidated
financial statements and footnotes thereto included in the Company's 10-K filed
on September 28, 2005.
The Company bills for its behavioral healthcare services at its inpatient
and outpatient facilities using different software platforms for each type of
service; however, in all cases the charges are contractually adjusted at the
time of billing using adjustment factors based on agreements or contracts with
the insurance carriers and the specific plans held by the individuals. This
method may still require additional adjustment based on ancillary services
provided and deductibles and copays due from the individuals which are estimated
at the time of admission based on information received from the individual.
Adjustments to these estimates are recognized as adjustments to revenue during
the period identified, usually when payment is received.
The Company's policy is to collect estimated co-payments and deductibles at
the time of admission. Payments are made by way of cash, check or credit card.
If the patient does not have sufficient resources to pay the estimated
co-payment in advance, the Company's policy is to allow payment to be made in
three installments one third due upon admission, one third due upon discharge
and the balance due 30 days after discharge. At times the patient is not
physically or mentally stable enough to comprehend or agree to any financial
-- 6 --
arrangement. In this case the Company will make arrangements with the patient
once his or her condition is stabilized. At times, this situation will require
the Company to extend payment arrangements beyond the three payment method
previously outlined. Whenever extended payment arrangements are made, the
patient, or the individual who is financially responsible for the patient, is
required to sign a promissory note to the Company, which includes interest on
the balance due.
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.
The Company's days sales outstanding ("DSO") are significantly different
for each type of service and each facility based on the payors for each service.
Overall, the DSO for the combined operations of the Company were 92 days for the
nine months ended March 31, 2006 and 90 days the fiscal year ended June 30,
2005. The table below shows the DSO by segment for the same periods.
Period Treatment Pharmaceutical Contract
End Services Services Services
03/31/2006 87 139 46
06/30/2005 89 114 62
This increase in the Pharmaceutical Services DSO's is related to the high
DSO's normally associated with research receivables coupled with the recent
start up of a large research contract. Contract Services DSO's fluctuate
dramatically by the delay in payment of a few days for any of our large
contracts. There was such a delay in payments for the Michigan call center at
the end of fiscal 2005, artificially inflating the DSO's for the period.
Note C- Stock Based Compensation
The Company has three active stock plans: a stock option plan, an employee
stock purchase plan and a non-employee directors' stock option plan.
The stock option plan provides for the issuance of a maximum of 1,300,000
shares of Class A common stock of the Company pursuant to the grant of incentive
stock options to employees or nonqualified stock options to employees,
directors, consultants and others whose efforts are important to the success of
the Company. Subject to the provisions of this plan, the compensation committee
of the Board of Directors has the authority to select the optionees and
determine the terms of the options including: (i) the number of shares, (ii)
option exercise terms, (iii) the exercise or purchase price (which in the case
of an incentive stock option will not be less than the market price of the Class
A common stock as of the date of grant), (iv) type and duration of transfer or
other restrictions and (v) the time and form of payment for restricted stock
upon exercise of options.
The employee stock purchase plan provides for the purchase of Class A
common stock at 85 percent of the fair market value at specific dates, to
encourage stock ownership by all eligible employees. A maximum of 500,000 shares
may be issued under this plan.
The non-employee directors' stock option plan provides for the grant of
nonstatutory stock options automatically at the time of each annual meeting of
the Board. Under the plan a maximum of 350,000 shares may be issued. Each
outside director is granted an option to purchase 20,000 shares of Class A
common stock annually at fair market value on the date of grant, vesting 25%
immediately and 25% on each of the first three anniversaries of the grant and
expiring ten years from the grant date.
The Company issues stock options to its employees and directors and
provides employees the right to purchase stock pursuant to stockholder approved
stock option and stock purchase plans. Effective July 1, 2005, the Company
adopted the provisions of SFAS No. 123 (revised 2004), "Share-Based Payment"
(SFAS No. 123R), using the Statement's modified prospective application method.
Prior to July 1, 2005, the Company followed Accounting Principles Board ("APB")
Opinion 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its stock compensation.
-- 7 --
Under the provisions of SFAS No. 123R, the Company recognizes the fair
value of stock compensation in net income, over the requisite service period of
the individual grantees, which generally equals the vesting period. All of the
Company's stock compensation is accounted for as an equity instrument and there
have been no liability awards granted. Any income tax benefit related to stock
compensation will be shown under the financing section of the Cash Flow
Statement. Based on experience the Company has not adjusted the compensation
expense for estimated forfeitures. Any forfeitures in the future will be
recognized when they occur.
At June 30, 2005, the Company accelerated the vesting on all previously
granted options. Therefore, as of the date of adoption there is no unrecognized
expense of these options and the expense recorded in the nine months ended March
31, 2005 is for options issued and vested during that period. The unrecognized
expense of awards not yet vested will be recognized in net income in the periods
in which they vest. Under the provisions of SFAS 123R, the Company recorded
$27,413 of stock-based compensation on its consolidated condensed statement of
operations for the three months ended March 31, 2006 and $112,625 for the nine
months ended March 31, 2006, which is included in administrative expenses as
follows:
Three Months Ended Nine Months Ended
March 31, 2006 March 31, 2006
Directors fees $21,000 $ 21,000
Employee compensation 6,413 91,625
_________ ________
Total $27,413 $112,625
========= ========
Based on the Company's historical voluntary turnover rates for individuals
in the positions who received options in the period, there was no forfeiture
rate assessed. It is assumed these options will remain outstanding for the full
term of issue. Under the true-up provisions of SFAS 123R, a recovery of prior
expense will be recorded if the actual forfeiture is higher than estimated.
SFAS 123R requires the presentation of pro forma information for the
comparative period prior to the adoption as if all of the Company's employee
stock options had been accounted for under the fair value method of the original
SFAS 123. The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS 123 to stock-based employee compensation to the prior-year period.
Three Months Ended Nine Months Ended
March 31, 2005 March 31, 2005
Net income, as reported $ 880,456 $2,064,888
Less: Stock-based compensation
expense determined under fair value
based method for all awards, net of
related tax effects (23,200) (105,850)
Less: Stock-based compensation expense
determined under fair value based method
for all awards, net of related tax
effects $ 857,256 $1,959,038
========= ==========
Net income per share:
Basic - as reported $ 0.05 $ 0.12
========= ==========
Basic - pro forma $ 0.05 $ 0.11
========= ==========
Diluted - as reported $ 0.05 $ 0.11
========= ==========
Diluted - pro forma $ 0.05 $ 0.11
========= ==========
-- 8 --
The Company had the following activity in its stock option plans for the
nine months ended March 31, 2006:
Number Weighted-Average Intrinsic Value
of Exercise Price at
Shares Per Share March 31, 2006
__________ ________________ ______________
Balance - June 30, 2005 1,138,250 $0.85
Granted 345,000 $2.44
Exercised (47,250) $0.83
Expired (30,000) $1.73
__________ ________________ ______________
Balance - March 31, 2006 1,406,000 $1.22 $ 1,518,480
==========
The total intrinsic value of options exercised during the nine-months ended
March 31, 2006 was $79,967.
The following summarizes the activity of the Company's stock options that
have not vested for the nine months ended March 31, 2006.
Number Weighted-
of Average
Shares Fair Value
__________ __________
Nonvested at July 1, 2005 0 $0.00
Granted 258,750 $1.19
Expired 0 $0.00
Vested 0 $0.00
_________
Nonvested at March 31, 2006 258,750 $1.19
=========
The compensation cost related to the fair value of these shares of
$308,000.00 will be recognized when these options vest.
The Company utilized the Black-Scholes valuation model for estimating the
fair value of the stock compensation granted after the adoption of SFAS 123R.
The weighted-average fair values of the options granted under the stock option
plans for the three months and nine months ended March 31, 2006 was $1.29 and
$1.19, respectively using the following:
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
March 31, March 31, March 31, March 31,
2006 2005 2006 2005
_________ _________ _________ _________
Average risk-free
interest rate 4.50% 4.00% 4.44% 4.44%
Expected dividend yield None None None None
Expected life 8.52 years 8.64 years 5.87 years 5.69 years
Expected volatility 50.0% 47.0% 47.8% 50.7%
The dividend yield of zero is based on the fact that the Company has never
paid cash dividends and has no present intention to pay cash dividends. Expected
volatility is based on the historical volatility of our common stock over the
period commensurate with the expected life of the options. The risk-free
interest rate is the U.S. Treasury rate on the date of grant. The expected life
was calculated using the Company's historical experience for the expected term
of the option.
-- 9 --
Note D - Business Segment Information
The Company's behavioral health treatment services have similar economic
characteristics, services, patients and clients. Accordingly, all behavioral
health treatment services are reported on an aggregate basis under one segment.
The Company's segments are more fully described in Note A above. Residual income
and expenses from closed facilities are included in the administrative services
segment. The following summarizes the Company's segment data:
Treatment Pharmaceutical Contract Administrative
Services Study Services Services Services Eliminations Total
__________________________________________________________________________
For the three months ended:
March 31, 2006
Revenues - external
customers $7,292,804 $1,523,277 $1,137,878 $ -- $ -- $ 9,953,959
Revenues - intersegment 16,600 -- 22,615 816,000 (855,215) --
Net income (loss) 1,129,901 317,240 416,891 (913,483) -- 950,549
Capital Expenditures 52,939 14,738 53,474 5,006 -- 126,157
Depreciation & Amortization 121,764 42,738 19,304 13,513 -- 197,319
Interest Expense 123,801 15,074 1,246 13,473 -- 153,594
Income tax expense 39,000 -- 6,303 124 -- 45,427
March 31, 2005
Revenues - external
customers $ 6,734,949 $1,103,205 $ 925,528 $ -- $ -- $ 8,763,682
Revenues - intersegment 5,940 -- 15,437 690,000 (711,377) --
Net income (loss) 1,186,896 59,042 399,053 (764,535) -- 880,456
Capital Expenditures 46,065 5,194 794 -- -- 52,053
Depreciation & Amortization 65,098 35,979 966 12,829 -- 114,872
Interest Expense 115,830 2,337 -- 30,821 -- 148,988
Income tax expense (7,600) -- 6,000 1,600 -- --
For the nine months ended:
March 31, 2006
Revenues - external
customers $20,471,140 $3,913,370 $3,216,788 $ -- $ -- $27,601,298
Revenues - intersegment 34,250 -- 66,895 2,448,000 (2,549,145) --
Net income (loss) 2,382,277 407,712 1,287,953 (2,396,404) -- 1,681,538
Capital Expenditures 510,642 41,029 138,618 63,644 -- 753,933
Depreciation & Amortization 313,555 123,548 38,551 68,337 -- 543,991
Interest Expense 379,651 64,577 3,675 35,247 -- 483,150
Income tax expense 171,231 3,840 26,860 3,724 -- 205,655
Identifiable Assets 10,247,509 6,165,910 734,846 2,452,079 -- 19,600,344
Goodwill 969,099 1,735,290 -- -- -- 2,704,389
-- 10 --
Note D - Business Segment Information (continued):
Treatment Pharmaceutical Contract Administrative
Services Study Services Services Services Eliminations Total
__________________________________________________________________________
March 31, 2005
Revenues - external
customers $18,895,774 $3,384,347 $2,510,277 $ -- $ -- $24,790,398
Revenues - intersegment 5,940 -- 40,132 2,034,000 (2,080,072) --
Net income (loss) 3,182,988 211,794 896,799 (2,226,693) -- 2,064,888
Capital Expenditures 293,881 10,137 1,836 50,161 -- 356,015
Depreciation & Amortization 169,157 105,785 2,829 46,626 -- 324,397
Interest Expense 349,559 46,955 -- 85,326 -- 481,840
Income tax expense 76,400 -- 18,000 4,069 -- 98,469
For the period ended
June 30, 2005:
Identifiable assets 9,333,260 5,596,917 669,229 2,296,242 -- 17,895,648
Goodwill 969,099 1,679,110 -- -- -- 2,648,209
Note E - Debt covenants
For the quarter ended March 31, 2006, the Company was not in compliance
with one of its long term debt covenants related to the Harbor Oaks operations.
The Company continues to make progress in recovering from the software failure
at this facility, which delayed billing and postponed collection effort while
the system was being recovered and the water damage at the facility which slowed
admissions and reduced revenue. CapitalSource, the Company's lender, has
provided the Company with a waiver of this covenant for the period.
Note G - Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (revised 2004), "Share-Based Payment," which is a revision of SFAS
No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 (R) supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and amends SFAS
No. 95, "Statement of Cash Flows." Generally, the approach in SFAS No. 123 (R)
is similar to the approach described in SFAS No. 123. However, SFAS No. 123 (R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the statement of operations based on their
fair values. Pro-forma disclosure is no longer an alternative. The Company
implemented SFAS No. 123 (R) on July 1, 2005. As a result of its implementation,
the Company expensed $27,413, $15,375 and $69,837 in compensation cost in the
quarters ended March 31, 2006, December 31, 2005 and September 30, 2005,
respectively, based on the Black-Scholes value of the 85,000 options issued in
the quarter ended March 31, 2006, 30,000 options issued in the quarter ended
December 31, 2005 and 230,000 options issued in the quarter ended September 30,
2005. Transactions involving the employee stock purchase plan are not recorded
until the stock is issued as they are immaterial.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections," which replaces APB Opinion No. 20 "Accounting Changes," and FASB
Statement No. 3 "Reporting Accounting Changes in Interim Financial Statements,"
and changes the requirements for the accounting for and reporting of a change in
accounting principle. SFAS No. 154 requires retrospective application to prior
periods' financial statements of changes in accounting principle, unless it is
impracticable to determine either the period specific effects or the cumulative
effect of the change. SFAS No. 154 shall be effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
Early adoption is permitted for accounting changes and corrections of errors
made in fiscal years beginning after the date SFAS No. 154 was issued. At the
present time, we do not believe that adoption of SFAS No. 154 will have a
material effect on our financial position, results of operations or cash flows.
Note H - Subsequent Events
On April 20, 2006, in conjunction with the agreement the Company entered
into with Medical Information Technologies, Inc., ("Meditech"), as previously
disclosed, the Company signed a Master Lease Agreement with Bank of America to
finance the acquisition of the software and the required hardware which will
provide the Company with enhanced billing, collection and clinical reporting
capabilities.
-- 11 --
The agreement provides separate components for hardware and software:
* Under the first component Bank of America has agreed to purchase
hardware that is necessary for the Company to use the Meditech
software. This hardware is expected to be delivered in August 2006.
The Company has agreed to lease the hardware from Bank of America with
36 payments beginning in July 2006. Scheduled lease payments on the
hardware are $6,065.11 with the final payment made in advance upon the
signing of the lease. The lease includes an option for the Company to
purchase the hardware at fair market value at the lease termination.
Based on required disbursements by Bank of America in the amount of
$200,000 to purchase the hardware, and the expected fair market value
at lease termination, the lease payments over the term are equivalent
to financing the purchase of the hardware at an annual interest rate
of 6.13%.
* Under the second component Bank of America has agreed to disburse
$462,431 to Meditech to purchase software that the Company would
otherwise be obligated to purchase under its agreement with Meditech.
The schedule of Bank of America's purchase is based on the software
delivery and implementation plan included in the Meditech agreement
with the Company. The Company has entered into a capital lease with
Bank of America to lease the software for a total of 60 payments
beginning in October 2006. Scheduled payments under the lease begin
with four payments of $3,000 followed by 56 payments of $9,868.71 with
the final payment made in advance upon the signing of the lease. The
Company has an option to purchase the software for one dollar at lease
termination. The lease payments over the term are equivalent to
financing the purchase of the software at an annual interest rate of
8.03%.
The Company expects full implementation of the software at its treatment
facilities by March 2007.
-- 12 --
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995.
In addition to historical information, this report contains statements
relating to future events or our future results. These statements are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as
amended (the "Exchange Act") and are subject to the Safe Harbor provisions
created by the statute. Generally words such as "may", "will", "should",
"could", "anticipate", "expect", "intend", "estimate", "plan", "continue", and
"believe" or the negative of or other variation on these and other similar
expressions identify forward-looking statements. These forward-looking
statements are made only as of the date of this report. We do not undertake to
update or revise the forward-looking statements, whether as a result of new
information, future events or otherwise. Forward-looking statements are based on
current expectations and involve risks and uncertainties and our future results
could differ significantly from those expressed or implied by our
forward-looking statements.
Overview
The Company presently provides behavioral health care services through two
substance abuse treatment centers, two psychiatric hospitals and six 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 behavioral health information through its web site at
Wellplace.com but its primary function is technology and internet support for
the Company's other subsidiaries and their contracts. As such, the expenses
related to Behavioral Health Online, Inc. are included as corporate expenses.
Contract Support services are provided by the Company through two call centers
located in Utah and Michigan. Services provided include employee assistance
programs for major railroads, smoking cessation services, credentialing services
for professionals and mental health registration and reference services for the
residents of Wayne County, Michigan. 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 Arizona, Michigan and Utah.
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. The extent of any future 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 (The Parity Act). If passed, this legislation will
improve access to and reimbursement for 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. As part of the Government Medicare
Program's newly implemented prospective payment system, reimbursement rates for
behavioral health care have increased. When fully implemented, this increase
should have a positive impact on performance at the Company's one Medicare
facility, Harbor Oaks Hospital. The Company is exploring the possibility of
becoming a Medicare provider at its other in-patient facilities.
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
-- 13 --
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Revenue recognition and accounts receivable:
Patient care revenues and accounts receivable are recorded at established
billing rates or at the amount realizable under agreements with third-party
payors, including Medicaid and Medicare. Revenues under third-party payor
agreements are subject to examination and contractual adjustment, and amounts
realizable may change due to periodic changes in the regulatory environment.
Provisions for estimated third party payor settlements are provided in the
period the related services are rendered. Differences between the amounts
provided and subsequent settlements are recorded in operations in the year of
settlement. When amounts are due as a result of cost report settlements, they
are 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.
All revenues from treatment services reported by the Company 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 to either increase or decrease
revenue in the period the payment is received in accordance with the AICPA
"Audit and Accounting Guide for Health Care Organizations." Based on amounts
recorded as adjustment to reserves for the period listed and the company's
current DSO's for the treatment segment of 87 days, the Company estimates
adjustments to revenue recorded in the periods presented for services provided
and revenues booked in prior periods at:
$372,000 Fiscal year ended June 30, 2005
$486,000 For the nine months ended March 31, 2006
The increase for the current nine months over last year is primarily
attributable to the new rates under the Medicare prospective payment system
mentioned above, which provided higher reimbursement than the revenues booked.
Revenues for the current year are also increased by cost report settlements
for prior years. No cost report settlement was received in the fiscal year ended
June 30, 2005; however, a Medicare cost report settlement of $158,100 was
recorded during the period ended March 31, 2006.
Presented below is a breakdown of net revenue by payor for the periods
presented.
Net Revenue by Payor (in thousands)
For the three For the nine For the fiscal
months ended months ended year ended
03/31/2006 06/30/2005
Amount Percent Amount Percent Amount Percent
______ ____ _______ ____ _______ ____
Private Pay $ 326 5 $ 922 5 $ 1,212 5
Commercial 4,569 64 13,044 64 17,608 67
Medicare 227 3 671 3 999 4
Medicaid 2,013 28 5,676 28 6,268 24
______ ____ _______ ____ _______ ____
Net Revenue * $7,135 * $20,313 $26,087
====== ======= ========
* excludes Medicare cost report settlement revenue of $158,100
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.
-- 14 --
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.
Allowance for doubtful accounts:
The provision for bad debts is calculated based on a percentage of each
aged accounts receivable category beginning at 0-5% on current accounts and
increasing incrementally for each additional 30 days the account remains
outstanding until the account is over 360 days outstanding, at which time the
provision is 80-100% of the outstanding balance. These percentages vary by
facility based on each facility's experience in and expectations for collecting
older receivables. The Company compares this required reserve amount to the
current "allowance for doubtful accounts" to determine the required bad debt
expense for the period. This method of determining the required "Allowance for
doubtful accounts" has historically resulted in an allowance for doubtful
accounts of 20% or greater of the total outstanding receivables balance. The
following is a breakdown of receivables by payor net of all allowances for the
periods presented.
Accounts Receivable Aging (Net of allowance for bad debts - in thousands)
For the Nine Months Ended March 31, 2006
__________________________________________
Over Over Over Over Over Over Over
Payor Current 30 60 90 120 150 270 360 Total
_______________________________________________________________________________
Private
Pay $ 143 $ 115 $121 $ 67 $ 67 $ 473 $ 74 $ 30 $ 1,090
Commercial 1,609 721 422 226 175 680 47 120 4,000
Medicare 68 26 15 17 31 54 -- -- 211
Medicaid 696 87 81 81 62 339 -- -- 1,346
______ _____ ____ ____ ____ ______ ____ ____ ______
Total $2,516 $ 949 $639 $391 $335 $1,546 $121 $150 $6,647
Fiscal Year Ended June 30, 2005
Over Over Over Over Over Over Over
Payor Current 30 60 90 120 150 270 360 Total
_______________________________________________________________________________
Private
Pay $ 247 $ 139 $ 98 $ 64 $ 75 $154 $127 $ 32 $ 936
Commercial 1,708 645 389 239 216 379 208 26 3,810
Medicare 121 16 7 -- -- 1 -- -- 145
Medicaid 556 277 94 74 96 342 -- -- 1,439
______ _____ ____ ____ ____ ______ ____ ____ ______
Total $2,632 $1,077 $588 $377 $387 $876 $335 $ 58 $6,330
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
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. During the fiscal year ended June 30,
2005, the Company recognized a tax benefit of approximately $209,000, related to
a decrease in its valuation allowance, based on budgeted taxable income for the
next fiscal year. The Company's policy is to recognize tax benefit for only the
next fiscal year based on the uncertainties surrounding the healthcare industry.
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
-- 15 --
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. The Company uses an outside valuation expert to assess the value of
intangibles annually and will continue to do so unless circumstances require an
earlier evaluation.
The Company currently amortizes goodwill allocated to customer
relationships acquired in the acquisition of Pivotal using the straight line
method. Since there is no true "consumption" of the relationship that can be
defined, the Company believes the straight line method of amortization best
reflects the use of the intangible asset.
Results of Operations
The following table sets forth for the periods indicated, our operating results
(dollars in thousands):
Selected Statements of Income Data:
For the three months ended For the nine months ended
March 31, March 31,
2006 2005 2006 2005
Amount % Amount % Amount % Amount %
____________________________________________________________________
Revenue $ 9,954 100.0 $8,764 100.0 $27,601 100.0 $24,790 100.0
Cost and Expenses:
Patient care expenses 4,340 43.6 3,978 45.4 11,968 43.4 10,789 43.6
Contract expenses 713 7.2 521 5.9 1,898 6.9 1,595 6.4
Administrative expenses 3,454 34.7 3,064 35.0 10,005 36.3 9,058 36.5
Provision for bad debts 334 3.4 218 2.5 1,467 5.3 801 3.2
Interest expense 154 1.5 149 1.7 483 1.7 492 2.0
Other (income) expenses,
net (37) (0.4) (46) (0.5) (107) (0.4) (108) (0.4)
Total Expenses 8,958 90.0 7,884 90.0 25,714 93.2 22,627 91.3
Income before provision
for taxes 996 10.0 880 10.0 1,887 6.8 2,163 8.7
Provision for income
taxes 45 0.5 -- 0.0 205 0.7 98 0.4
Net income 951 9.5 880 10.0 1,682 6.1 2,065 8.3
Results of Operations
Total net revenue from operations increased 13.6% to $9,953,959 for the
three months ended March 31, 2006 from $8,763,682 for the three months ended
March 31, 2005 and 11.3% to $27,601,298 for the nine months ended March 31, 2006
from $24,790,398 for the nine months ended March 31, 2005.
Net patient care revenue increased 8.3% to $7,292,804 for the three months
ended March 31, 2006 from $6,734,949 for the three months ended March 31, 2005
and 8.3% to $20,471,140 for the nine months ended March 31, 2006 from
$18,895,774 for the nine months ended March 31, 2005. This increase in revenue
is due to a 14.5% increase in patient days, primarily due to a 4.0% increase in
patient days at our substance abuse facilities for the three months ended March
31, 2006 over the same period last year and the addition of the 20 new beds at
our Detroit facility.
Two of the key indicators of profitability of inpatient facilities are
patient days, or census, and payor mix. Patient days is the product of the
number of patients times length of stay. Increases in the number of patient days
results in higher census, which coupled with a more favorable payor mix (more
patients with higher paying insurance contracts or paying privately) usually
results in higher profitability. Therefore, patient census and payor mix are
monitored very closely.
-- 16 --
Revenue from pharmaceutical studies increased 38.1% to $1,523,277 for the
three months ended March 31, 2006 from $1,103,205 for the three months ended
March 31, 2005 and increased 15.6% to $3,913,370 for the nine months ended March
31, 2006 from $3,384,347 for the same period last year. This increase in revenue
is due primarily to a large research contract signed and started in this
quarter. This kind of fluctuation in revenue is expected in the pharmaceutical
research business. We cannot always predict study starts or delays but attempt
to keep an adequate backlog of studies and resources to affect a more stable
revenue flow from research.
Contract support services revenue provided by Wellplace increased 22.9% to
$1,137,878 for the three months ended March 31, 2006 from $925,528 for the three
months ended March 31, 2005 and increased 28.1% to $3,216,788 for the nine
months ended March 31, 2006 from $2,510,277 for the nine months ended March 31,
2005. This increase in revenue is primarily due to the start-up of a new smoking
cessation contract in October 2005.
Patient care expenses increased by 7.2% to $3,787,166 for the three months
ended March 31, 2006 from $3,533,279 for the three months ended March 31, 2005
and 8.4% to $10,341,470 for the nine months ended March 31, 2006 from $9,541,581
for the nine months ended March 31, 2005. The increases in expenses for the
quarter is due primarily to the increase in patient days noted above with the
primary increases in expenses directly related to patient census such as
payroll, food, hospital supplies and lab fees. During the second quarter of
fiscal 2006, the Company also opened the second phase of the new inpatient
program, Detroit Behavioral Institute, at the Detroit Medical Center and has
experienced increased patient care revenue and expected increased patient care
and administrative expenses related to the start up and new operations.
Patient care expenses related to our pharmaceutical research division
increased 24.1% to $552,477 for the three months ended March 31, 2006 from
$444,999 for the three months ended March 31, 2005 and 30.4% to $1,626,465 for
the nine months ended March 31, 2006 from $1,247,106 for the nine months ended
March 31, 2005. This is due to the increased number of patient vists, with
increases in payroll, medical consultants and patient stipends related to
increased visits.
Contract support services expenses increased 37.1% to $713,438 for the
three months ended March 31, 2006 from $520,475 for the three months ended March
31, 2005 and 19.0% to $1,898,300 for the nine months ended March 31, 2006 from
$1,595,478 for the nine months ended March 31, 2005. This increase is primarily
due to the addition of a new call center contract, which required increased
staff and improved technology to adequately support the services required by the
contracts. This resulted in increased payroll, rent, telephone expenses and
increased depreciation on new equipment and the build-out of the new space.
Provision for doubtful accounts increased 53.5% to $334,248 for the three
months ended March 31, 2006 from $217,756 for the three months ended March 31,
2005 and 83.3% to $1,466,903 for the nine months ended March 31, 2006 from
$800,503 for the nine months ended March 31, 2005. The increase in the provision
for doubtful accounts is attributable to the accounts receivable software
failure at Harbor Oaks, which is our largest in-patient facility. The software
conversion, required by this software crash, slowed the billing process and
diverted staff attention from collections while we reentered the receivables
into the new software. Since the Company's policy is to maintain reserves based
on the age of its receivables, this delay in the billing and collection process
increased the amount and age of the Company's receivables thereby increasing the
reserves required by formula and the provision for doubtful accounts. The system
is now operating and we expect the reserve requirement will decrease in future
quarters as collection activity has now returned to normal. The percentage of
bad debt expense to net patient care revenue decreased from 9.8% for the quarter
ended September 30, 2005, to 7.4% for the quarter ended December 31, 2005 to
4.6% for the current quarter ended March 31, 2006.
Administrative expenses increased 16.8% to $2,815,164 for the quarter ended
March 31, 2006 from $2,410,474 for the quarter ended March 31, 2005 and 16.9% to
$8,193,940 for the nine months ended March 31, 2006 from $7,008,636 for the nine
months ended March 31, 2005. These changes are a result of the increased
administrative payroll and employee benefits partially related to the set up and
opening of Detroit Behavioral Institute and pre-construction expenses for the
Las Vegas hospital. Administrative payroll increased 42.7% for the quarter ended
March 31, 2006 and 19.6% for the nine months ended March 31, 2006. Fees and
licenses decreased 12.9% for the quarter but increased 105.9% for the nine
months ended March 31, 2006, due to fees related to the JACAHO accreditation at
Harbor Oaks and Highland Ridge and a Quality Assurance fee assessed in Michigan.
Director fees increased 160.0% for the quarter ended March 31, 2006 and 93.7%
for the nine months ended March 31, 2006 due to the recognition of expense for
options issued as required by SFAS No.123R (see Note C - Stock based
Compensation on page nine of this report). Accounting fees increased 20% for the
quarter ended March 31, 2006 and 72.7% for the nine months ended March 31, 2006
due to increased audit and review costs and more frequent audits required by the
Company's agreement with CapitalSource, the Company's primary lender. Rent
expense increased 13.9% for the quarter ended March 31, 2006 and 12.0% for the
nine months ended March 31, 2006 due to routine lease payment increases called
for by existing leases. Insurance expense increased approximately 6.5% for the
quarter ended March 31, 2006 and 10.5% for the nine months ended March 31, 2006.
Administrative expenses related to the research division decreased 2.4% to
$638,486 for the three months ended March 31, 2006 from $653,827 for the three
months ended March 31, 2005 and 11.7% to $1,810,776 for the nine months ended
March 31, 2006 from $2,049,492 for the nine months ended March 31, 2005. This
-- 17 --
decrease is primarily due to the reduction in salary expenses related to the
elimination of the Nevada location and the reduction in the accrued bonuses and
a decrease in insurance expense.
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. During the previous two quarters, the previously mentioned
receivables software and hardware failure at our largest facility resulted in a
delay of billing and collections while the systems were restored. Largely as a
result of this delay and the increase in revenue, the Company's gross accounts
receivable from patient care have increased 17.8% over the past nine months with
corresponding increases in the aging of these receivables.
Interest income decreased 24.8% to $11,281 for the three months ended March
31, 2006 from $15,004 for the three months ended March 31, 2005 and remained
stable at approximately $49,500 for the nine months ended March 31, 2006 and
March 31, 2005. This decrease is a result of increased collections at the time
of admission leaving fewer accounts on payment plans and lower interest income
on the payment plans. Although patients requiring credit to pay for services
have always signed an agreement to pay which included finance charges, in an
effort to encourage payment at the time of service, over the last couple of
years the Company implemented the policy to charge interest on patient accounts
to discourage long term credit for services.
Other income decreased 19.8% to $25,309 for the three months ended March
31, 2006 from $31,568 for the three months ended March 31, 2005 and 1.2% to
$57,357 for the nine months ended March 31, 2006 from $58,060 for the nine
months ended March 31, 2005. This change is due to a reduced number of requests
for medical records which makes up the majority of other income.
Interest expense increased 3.1% to $153,594 for the three months ended
March 31, 2006 from $148,988 for the three months ended March 31, 2005 and
decreased 1.8% to $483,150 for the nine months ended March 31, 2006 from
$491,840 for the same period last year. These changes are minimal and are
primarily due to the changes in the prime rate which is the basis for interest
on our primary long term and revolving debt and the booking of the interest on
Promissory Note A of the Pivotal acquisition during the quarter ended December
31, 2005. The Note was contingent on the profitable operations of Pivotal from
the acquisition through December 31, 2005; therefore, the Note was not recorded
and no interest was accrued until the certainty of profitability could be
determined. Acquisition earnings for the year ended December 31, 2005 resulted
in a negative adjustment of approximately $200,000, which was recorded on April
1, 2006.
The Company's provision for income taxes of $205,655 for the nine month
period ended March 31, 2006 is significantly below the Federal statutory rate of
34% primarily due to the availability of net operating loss carry-forwards.
Total income tax expense for the quarter 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 volatility of the healthcare industry.
Liquidity and Capital Resources
The Company's net cash provided by operating activities was $1,572,236 for
the nine months ended March 31, 2006 compared to $171,027 for the same period
last year. Cash flow from operations in the nine months ended March 31, 2006
consists of net income of $1,681,538 plus depreciation and amortization of
$543,991, non-cash interest expense of $41,796, non-cash stock based
compensation of $118,286 and a $711,379 increase in accounts payable, offset by
a $23,670 increase in deferred tax asset, a $866,637 increase in accounts
receivable, $374,309 increase in prepaid expenses, $103,277 increase in other
assets and a $156,861 decrease in accrued expenses and other liabilities.
Cash used in investing activities in the nine months ended March 31, 2006
consisted of $753,933 in capital expenditures compared to $359,407 in capital
expenditures and $62,258 in business acquisitions in the same period last year.
-- 18 --
Cash used in financing activities in the nine months ended March 31, 2006
primarily consisted of $800,610 in net debt repayment, $15,000 in deferred
financing costs and $36,613 used to purchase treasury stock, offset by $73,727
from the issuance of common stock.
A significant factor in the liquidity and cash flow of the Company is the
timely collection of its accounts receivable. As of March 31, 2006, accounts
receivable from patient care, net of allowance for doubtful accounts, increased
5.0% to $6,646,905 on March 31, 2006 from $6,330,381 on June 30, 2005. This
increase is due to increases in patient care revenues and the residual increase
from the previously mentioned system failure at our largest facility, which
delayed billing and collections for several months. We have seen some progress
on the collection of these old accounts and will continue to review the status
of old accounts daily. The Company monitors increases in accounts receivable
closely and, based on the aging of the receivables outstanding, is confident
that the increase is not indicative of a payor problem. Over the years, we have
increased staff, standardized some procedures for determining insurance
eligibility and collecting receivables and established a more aggressive
collection policy. The increased staff has allowed the Company to concentrate on
current accounts receivable and resolve any issues before they become
uncollectible. The Company's collection policy calls for earlier contact with
insurance carriers with regard to payment, use of fax and registered mail to
follow-up or resubmit claims and earlier employment of collection agencies to
assist in the collection process. Our collectors will also seek assistance
through every legal means, including the State Insurance Commissioner's office,
when appropriate, to collect claims. Our collectors also focus on collecting
required patient co-payments at the time of admission whenever possible,
therefore eliminating the requirement for costly patient billing, statements and
follow-up. At the same time, the Company continues to closely monitor reserves
for bad debt based on potential insurance denials and past difficulty in
collections.
Contractual Obligations
The Company's future minimum payments under contractual obligations related
to capital leases, operating leases and term notes as of March 31, 2006 are as
follows (in thousands):
YEAR OPERATING
ENDING TERMS NOTES CAPITAL LEASES * LEASES TOTAL
March 31
Principal Interest Principal Interest
2007 $ 798 $110 $ 59 $ 9 $1,426 $2,402
2008 681 48 58 4 1,236 2,027
2009 297 22 10 1 1,213 1,543
2010 55 17 4 1 1,147 1,224
2011 213 13 4 -- 621 851
2012 49 9 -- -- -- 58
Thereafter 70 4 -- -- -- 74
Total $2,163 $223 $135 $15 $5,643 $8,179
*see Note H - Subsequent events on page 11 of this report for details on a
master lease entered into subsequent to Quarter end.
In addition to the above, 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, one for $1,000,000 and one for
$500,000, bear interest at 6% per annum. These notes are subject to additional
adjustment based on the earnings of the acquired operations. Since adjustment
can be positive or negative based on earnings, with no ceiling or floor, the
liability for only one of these notes was recorded as of March 31, 2006. 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 the $1,000,000 note began on January 1,
2005. The above table includes the outstanding balance on this note of $852,157
which represents the earn out for the Pivotal acquisition through December 31,
2004 net of payments made through March 31, 2006. The earn-out for the period
ended December 31, 2005 required a negative adjustment to the note of
approximately $200,000 and was recorded on April 1, 2005. No payment is due on
the $500,000 note as earn-out requirements have not been attained. 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 $164,647 is included in the schedule above.
In October 2004, the Company entered into a revolving credit, term loan and
security agreement with CapitalSource Finance, LLC to replace the Company's
primary lender and provide additional liquidity. Each of the Company's material
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subsidiaries, other than Pivotal Research Centers, Inc, is a co-borrower under
the agreement. The agreement includes a term loan in the amount of $1,400,000
and an accounts receivable funding revolving credit agreement with a maximum
loan amount of $3,500,000, including $900,000 available as an overline for
growth.
The term loan note carries interest at prime plus 3.5%, but not less than
9%, with twelve monthly principal payments of $25,000, 12 monthly principal
payments of $37,500, and eleven monthly principal payments of $50,000 beginning
November 1, 2004 with balance due at maturity, on October 1, 2007 and is
included in the above table at its March 31, 2006 balance of $761,408. The
revolving credit note carries interest at prime plus 2.25%, but not less than
6.75% paid through lock box payments of third party accounts receivable. The
revolving credit term is three years, renewable for two additional one-year
terms. The balance on the revolving credit agreement as of March 31, 2006 was
$2,040,605. down from $2,385,629 on June 30, 2006. For additional information
regarding this transaction, see the Company's report on Form 8-K filed with the
Securities and Exchange Commission on October 22, 2004.
On the term loan and the revolving credit note, each 25 basis point
increase in the prime rate will affect an annual increase in interest expense of
approximately $7,100.
For the quarter ended March 31, 2006, the Company was not in compliance
with financial covenants of this agreement primarily due to the software failure
at the Harbor Oaks facility, which delayed billing and postponed collection
effort while the system was being recovered. CapitalSource, the Company's
lender, has provided the Company with a waiver of these covenants for the
period.
The Company has operated ongoing operations profitably for twenty-one
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, if the current positive business environment towards
behavioral health treatment and new business opportunities continue, we are
confident that we will see continued improved results.
Off Balance Sheet Arrangements
The Company has no off-balance-sheet arrangements that have or are
reasonably likely to have a current or future effect on the Company's financial
condition, changes in financial condition, revenue or expenses, results of
operations, liquidity, capital expenditures or capital resources that is
material to the Company.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The market price of our common stock could be volatile and fluctuate
significantly in response to various factors, including:
o Differences in actual and estimated earnings and cash flows;
o Operating results differing from analysts' estimates;
o Changes in analysts' earnings estimates;
o Quarter-to-quarter variations in operating results;
o Changes in interest rates effecting the interest expense of the
company
o Changes in market conditions in the behavioral health care industry; o
Changes in market conditions in the research industry;
o Changes in general economic conditions; and
o Fluctuations in securities markets in general.
Our interest expense is sensitive to changes in the general level of
interest rates. With respect to our interest-bearing liabilities, all of our
long-term debt outstanding is subject to rates at prime plus 2.25% and prime
plus 3.5%, which makes interest expense increase with increases in the prime
rate. On these notes, each 25 basis point increase in the prime rate will result
in an annual increase in interest expense of approximately $7,100. Failure to
meet targeted revenue projections could cause us to be out of compliance with
covenants in our debt agreements. (For additional information see Item 2
"Management's Discussion and Analysis of Financial Condition and Results of
Operations").
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
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We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified within the
SEC's Rules and Forms and that such information is accumulated and communicated
to our management to allow timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management was necessarily required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures to meet the
criteria referred to above. Based on the foregoing, our chief executive officer
and chief financial officer concluded that our disclosure controls and
procedures were effective.
Subsequent to quarter end we became aware of a loss from a theft of funds
by an individual in our smallest in-patient facility who had responsibility for
the collection of patient payments. We immediately began an investigation to
determine the extent of the theft and to gauge the adequacy of our internal
controls. We do not believe the total amount of the theft is material; we have,
however, taken an additional provision for bad debt of $20,000 as a precaution.
While our investigation is being conducted, in order to avoid any similar event,
we have strengthened our internal controls at that facility by establishing dual
responsibility for processing of patient payments and making bank deposits. This
is already the practice at our other facilities. At the conclusion of our
investigation, we may implement additional measures beyond those we have taken
since the discovery of the theft, to mitigate the risk of a similar event.
Change in Internal Controls
Except as noted above, there were no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their most recent evaluation.
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PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of stockholders was held on December 20, 2005.
In regards to the election of class B directors, with regards to which (i)
proxies were solicited pursuant to Regulation 14A under the Securities and
Exchange Act of 1934, as amended, (ii) there was no solicitation in opposition
to the management's nominees as listed on the proxy statement.
Because sufficient proxies related to class A shares were not received to
hold the vote on the election of the class A directors and the approval of the
new employee stock plan to replace the plan which expired in October 2005 and
the increase in the annual grant of options to board members, the meeting was
adjourned and re-convened on January 31, 2006 at which time the nominated class
A directors were elected and the 2005 Employee Stock Purchase Plan and the
change in the 2005 Non-Employee Director Stock Option Plan (the "Plan") were
approved. Under the new Employee Stock Purchase Plan 500,000 shares of Class A
Common Stock are available for issuance to eligible employees.
(a) Annual Meeting of Shareholders, December 20, 2005 and re-convened on
January 31, 2006
(b) Directors elected to serve one year terms:
Bruce A. Shear
William F. Greico
David E. Dangerfield
Donald E. Robar
Howard W. Phillips
(c) (1) Election of Class B directors on December 20, 2005 to serve one
year terms
Bruce A. Shear 721,756 for 0 withheld
William F. Grieco 721,756 for 0 withheld
David E. Dangerfield 721,756 for 0 withheld
Election of Class A directors to serve one year terms:
Donald E. Robar 14,855,563 for 51,920 withheld
Howard W. Phillips 14,855,573 for 51,910 withheld
(2) Proposal to approve a new employee stock purchase plan to replace
the current plan, which expired on October 18, 2005.
8,443,149 for 729,778 against 16,850 abstained 9,326,486
broker non-vote
(3) Proposal to approve the increase in the grant of options to
directors under the Non-Employee Director option plan from 10,000
to 20,000.
8,163,804 for 995,573 against 30,400 abstained 9,189,777
broker non-vote
Item 6. Exhibits
Exhibit List
Exhibit No. Description
10.49 Agreement to purchase licensed software by and between PHC, Inc., and
Medical Information Technology, Inc., dated March 31, 2006.
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10.50 Master lease agreement by and between PHC, Inc., and Banc of America
Leasing & Capital, LLC, dated April 20, 2006, effective April 1, 2006.
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. 1350, as adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHC, Inc.
Registrant
Date: May 22, 2006 /s/ Bruce A. Shear
__________________________
Bruce A. Shear
President
Chief Executive Officer
Date: May 22, 2006 /s/ Paula C. Wurts
__________________________
Paula C. Wurts
Treasurer
Chief Financial Officer
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