Psychiatric Solutions, Inc.

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Psychiatric Solutions, Inc.

113 Seaboard Lane, Suite C100
Franklin, Tennessee 37067
U.S.A.
Telephone: (615) 312-5700
Toll Free: (800) 848-9090
Fax: (615) 312-5711
Web site: http://www.psysolutions.com

Public Company
Incorporated: 1988 as PMR Corporation
Employees: 6.780
Sales: $293.66 million (2003)
Stock Exchanges: NASDAQ
Ticker Symbol: PSYS
NAIC: 541611 Administrative Management and General Management Consulting

Psychiatric Solutions, Inc. (PSI) is a leading provider of behavioral health programs through hospitals owned or leased by the company and through management programs offered at acute-care facilities owned by other companies. PSI owns or leases 34 freestanding psychiatric inpatient facilities with more than 4,000 beds in approximately 20 states. The company derives roughly 75 percent of its revenue from the inpatient facilities it manages. The remaining 25 percent of the company's revenue is generated through management contracts with government agencies and medical surgical hospitals. Under the terms of the management contracts, PSI develops, organizes, and manages behavioral health care programs. PSI is one of three companies competing for national dominance in inpatient psychiatric care, employing a strategy underpinned by acquiring inpatient facilities and leading the consolidation of a fragmented industry.

Origins

The 2002 merger between PSI and PMR Corporation joined two companies with different strategic approaches to providing mental health care. The merger also created a company with two branches of history. Of the two companies, PMR was the older enterprise, established in 1988 to provide outpatient psychiatric services, although it later expanded into other areas of the behavioral care business. The company operated its outpatient programs under management contracts with local health care providers, forging agreements with acute-care hospitals and community mental health centers. PMR focused on providing care to individuals diagnosed with what it classified as "serious mental illness," an often chronic condition afflicting just over 1 percent of the U.S. population. The majority of the patients treated under PMR's outpatient programs were diagnosed with schizophrenia and bipolar disorder (manic depression). As the company matured, it delved into other facets of the mental health care industry, taking its direction from its chairman, chief executive officer, and president, Allen Tepper. Tepper, a graduate of Temple University, where he earned his undergraduate degree, and Northwestern University, where he earned his Masters of Business Administration degree, joined PMR in October 1989. Before taking the helm at PMR, Tepper founded Consolidated Medical Corp., a company that provided outpatient clinic management services to acute care hospitals in the Philadelphia area.

During his tenure, Tepper shepherded PMR into other areas of the mental health care market. Perhaps the most significant diversifying move was made in 1993, when the company began offering case management services. PMR's case management services relied on a proprietary service system for managing the treatment and rehabilitation of patients, one that used detailed plans for delivering and managing their care. The company's case management program enabled its users—typically case management agencies and community mental health centers—to assess and to manage the financial risk associated with providing health care treatment. PMR initially operated its case management programs in Tennessee, deriving the majority of its business from the Nashville and Memphis markets. By 1996, the company had begun to extend its case management services to clients in Arkansas.

By the time PMR began to open case management programs in Arkansas, it also had a third line of business it was developing. Through a wholly owned affiliate, the company offered programs to treat chemical dependency and substance abuse, selling its services to managed care organizations in southern California. PMR also offered ambulatory detoxification programs in Arkansas, catering its services to patients covered by Medicaid and other government-funded programs.

PMR Struggles in the Late 1990s

As PMR prepared for the late 1990s, it regarded its outpatient and case management business lines as its two primary growth engines, with its chemical dependency programs playing a subsidiary role in future plans. As the company progressed through the late 1990s, however, neither its outpatient programs nor its case management programs proved to possess sufficient strength to deliver financial vitality. To blame were the ills of the industry the company served, as conditions within the mental health care market conspired to hobble PMR's financial growth. The negative affect of the market conditions eventually led PMR to look to PSI as its savior, resulting in the 2002 merger that brought PMR and PSI together.

PMR's problems in the late 1990s stemmed from events in the 1980s. During the 1980s, a plethora of new hospitals were opened in the United States, the establishment of which sent hospital rates spiraling upwards. At the time, reimbursement rates—the amount paid by Medicare, Medicaid, and other insurance providers—were based on the cost structure of new facilities. As the number of costly, new hospitals proliferated, the construction costs caused a sharp increase in the fees to treat patients, eventually escalating to the point that traditional payers such as Medicare and Medicaid balked at paying the fees. Business was lost as a result, causing many of the facilities to shut down, leaving PMR in a precarious position as its sources of revenue dried up. PMR posted $3.1 million net income in 1997, $1.8 million the following year, and afterward fell into a pattern of losing money every year, racking up more than $22 million in losses by the beginning of the 2000s.

PMR's management searched for a solution to the company's financial woes. New sources of revenue needed to be discovered to compensate for the unwillingness of traditional payers to reimburse the company for treating individuals with serious mental disorders. In 2000, PMR launched a proprietary, Web-based pharmaceutical and prescription system called InfoScriber that suggested the beginning of a new era for the company. Instead of operating as an administrator of outpatient services for the mentally ill, PMR began to fashion itself as a pharmaceutical and health care marketing company. The metamorphosis was never completed, however. In July 2001, one year after the introduction of InfoScriber, PMR licensed the Web-based system to Conundrum Communications Inc. and returned to focusing on mental health services. Some analysts perceived the move as a prelude to courting a suitor; by licensing InfoScriber, PMR cut its costs and made itself more appealing to a potential buyer. PMR's board of directors, in fact, was exploring such strategic alternatives during the first half of 2001. Board members discussed the possible sale of the company, with PSI's name coming up frequently during discussions. PMR and PSI had talked before about forming an alliance or merging, signing a five-year confidentiality agreement in June 1999 to pursue such possibilities. By the end of 2001, the two companies began to make concrete plans about joining forces.

PSI occupied a stronger position than PMR as discussions evolved at the turn of the 21st century. PSI was founded in September 1996, starting its corporate life as provider of inpatient and outpatient behavioral health care services. The company was led by one of its founders, Joey Jacobs, who had spent two decades at Hospital Corporation of America, holding various executive titles during his stay. Initially, Jacobs and his management team were involved in psychiatric physician practice management, outpatient treatment facilities, employee assistance plans, and psychiatric contract management. PSI changed the nature of its business, however. In 1999, the company began to focus on inpatient hospital settings, adopting a business strategy that turned it into an owner and operator of freestanding, acute-care facilities. The company discontinued its physician practice management unit in 2001 and sold its employee assistance plan division the following year, choosing to keep its contract management services business. As PSI shed its unwanted businesses, it also established itself in its new line of business by acquiring four freestanding specialty hospitals in 2001. Accordingly, as the company entered 2002, its operations comprised two divisions: one focused on owning and operating freestanding psychiatric inpatient hospitals and the other focused on managing psychiatric units within hospitals owned by third parties.

Company Perspectives:

We strongly believe that our long-term success in expanding revenues through increased market share will depend on our providing the highest quality of services. We are fundamentally committed to providing this level of quality to each of our patients, and we believe this commitment is reflected by the tremendously dedicated and talented employees, physicians and other health care professionals treating patients in our facilities every day. In addition to the positive impact of increased revenues, we focus on enhancing the profitability of each facility through increased operating efficiencies. Among other steps, we bring each facility into our group-purchasing cooperative to reduce supplies expenses, and we consistently review operations to optimize staffing ratios and total compensation expense, our largest operating cost. As a result of this overall process, we expect to operate not only high quality but also highly efficient facilities that provide a consistent and significant contribution to the company's profitable growth.

Essentially, PSI was exploiting the same industry conditions that afflicted PMR. When PSI aimed its efforts at acquiring psychiatric hospitals, the number of facilities was diminishing, creating an opportunity for Jacobs to capture market share in markets abandoned by other hospital operators earlier in the decade. In Houston, for example, PSI owned two of the five freestanding psychiatric hospitals in existence at the turn of the 21st century. At one time, there were 28 freestanding psychiatric hospitals serving the Houston market. Although the company devoted much of its attention to providing behavioral health programs for critically ill children, adolescents, and adults, the core of the company's strategy was acquiring psychiatric hospitals. The prospect of merging with PMR represented a chance for PSI to broaden the spectrum of health care services it could provide at its facilities, the number of which was expected to increase substantially during the 2000s. For PMR, the merger offered potential revenue enhancement and significant value to its shareholders.

PMR and PSI Merge in 2002

In May 2002, the merger between PSI and PMR was announced, an all-stock transaction valued at an estimated $60 million. Jacobs, who used the merger as means to make privately held PSI a publicly traded company, commented on the deal in the May 7, 2002 issue of Knight Ridder/Tribune Business News. "After many years of contraction," he stated, "the psychiatric inpatient market now has favorable supply and demand fundamentals and we will now have the only public company focused on consolidating this market." The merger was completed in August 2002 in a multi-step transaction designed to integrate the two companies to make PSI a publicly traded company. On August 5, 2002, a new subsidiary of PMR called PMR Acquisition Corp. merged with PSI. Next, PSI changed its name to Psychiatric Solutions Hospitals, Inc., which became the surviving corporation of the merger. This company was made a wholly owned subsidiary of PMR. Concurrently, PMR Corporation changed its name to Psychiatric Solutions, Inc., or PSI. On August 6, 2002, the shares of PSI were approved for listing on the NASDAQ.

When the merger was announced, PSI owned and operated four freestanding psychiatric hospitals in Texas and North Carolina, and it managed 44 psychiatric units for third-party hospitals in 14 states. During the next several years, the stature of the company grew substantially, particularly in terms of the number of hospitals it owned, as Jacobs, who was appointed to lead the new merged entity, applied PSI's corporate strategy of consolidating the industry through acquisitions.

Following the merger, Jacob's priority was to acquire inpatient psychiatric facilities. The company looked at both small and large acquisition candidates, intent on becoming one of the leading consolidators of a fragmented industry. In 2003, PSI completed two large acquisitions that substantially increased its stature. The company's first major acquisition following the merger was completed in April 2003, when PSI paid $63 million for six inpatient behavioral health care facilities from The Brown Schools, Inc. The acquisition gave the company 895 additional licensed beds and three hospitals in Texas, one in Virginia, one in Colorado, and one in Oklahoma. A larger acquisition followed two months later, when PSI purchased Ramsay Youth Services, Inc. PSI paid $81 million for Ramsay, obtaining 11 psychiatric hospitals with nearly 1,300 beds and ten contracts to manage inpatient psychiatric facilities for government agencies.

PSI also completed smaller acquisitions as it expanded its national portfolio of behavioral health care facilities. In November 2003, the company acquired the 109-bed Alliance Health Center in Meridian, Mississippi. In March 2004, PSI acquired two hospitals from Brentwood Behavioral Health, which gave the company an additional 311 beds. By targeting both small and large properties, PSI grew robustly, quickly emerging as one of the most powerful psychiatric care companies in the nation. In the 12 months leading up to August 2004, PSI completed eight acquisitions, paying slightly more than $200 million to assert itself as a contender for national dominance. During that same 12-month period, the number of beds owned or leased by the company leaped from 2,800 to more than 4,000. The financial community liked what it saw, noting that PSI was the only publicly held company exclusively focused on consolidating the fragmented inpatient psychiatric care industry. The company's stock value reflected Wall Street's enthusiasm, as PSI's share price increased 189 percent during the first eight months of 2004.

As PSI entered the mid-2000s, the company ranked as the third-largest company of its kind, trailing Universal Health Services and Ardent Health Services, both private companies. "These three large players will continue to get bigger," an analyst said in a July 27, 2004 interview with Investor's Business Daily. Industry pundits did not expect PSI to acquire psychiatric facilities at the pace shown during the first years following the merger of PSI and PMR, and further acquisitions were on the horizon. Observers expected PSI to acquire between four and six behavioral health care facilities annually for the remainder of the decade.

Key Dates:

1988:: PMR Corporation is established.
1996:: PSI is formed.
1999:: PSI begins to focus on acquiring psychiatric hospitals.
2002:: PSI and PMR Corp. merge.
2003:: PSI acquires The Brown Schools, Inc. and Ramsay Youth Services, Inc.

Principal Subsidiaries

Aeries Health Care Corporation; Aeries Health care of Illinois, Inc.; Bountiful Psychiatric Hospital, Inc.; Brentwood Acquisition, Inc.; Brentwood Acquisition-Shreveport, Inc.; Collaborative Care Corporation; Cypress Creek Real Estate, L.P.; East Carolina Psychiatric Services Corporation; Great Plains Hospital, Inc.; Gulf Coast Treatment Center, Inc.; Havenwyck Hospital Inc.; H.C. Corporation; H.C. Partnership; Holly Hill Real Estate, LLC; HSA Hill Crest Corporation; HSA of Oklahoma, Inc.; InfoScriber Corporation; Laurelwood Center, Inc.; Michigan Psychiatric Services, Inc.; Neuro Institute of Austin, L.P.; Neuro Rehab Real Estate, L.P.; Premier Behavioral Solutions, Inc.; Premier Behavioral Solutions of Alabama, Inc.; PSI Cedar Springs Hospital, Inc.; PSI Cedar Springs Hospital Real Estate, Inc.; PSI Community Mental Health Agency Management, Inc.; PSI Hospitals, Inc.; PSI Surety, Inc.; PSI Texas Hospitals, LLC; PSI-EAP, Inc.; Psychiatric Management Resources, Inc.; Psychiatric Practice Management of Arkansas, Inc.; Psychiatric Solutions Hospitals, Inc.; Psychiatric Solutions of Alabama, Inc.; Psychiatric Solutions of Arizona, Inc.; Psychiatric Solutions of Florida, Inc.; Psychiatric Solutions of North Carolina, Inc.; Psychiatric Solutions of Oklahoma, Inc.; Psychiatric Solutions of Oklahoma Real Estate, Inc.; Psychiatric Solutions of Tennessee, Inc.; Ramsay Managed Care, Inc.; Ramsay Treatment Services, Inc.; Ramsay Youth Services of Florida, Inc.; Ramsay Youth Services of Georgia, Inc.; Ramsay Youth Services of South Carolina, Inc.; Ramsay Youth Services Puerto Rico, Inc.; RHCI San Antonio, Inc.; Riveredge Real Estate, Inc.; Solutions Center of Little Rock, Inc.; Sunstone Behavioral Health, Inc.; Texas Cypress Creek Hospital, L.P.; Texas Laurel Ridge Hospital, L.P.; Texas Laurel Ridge Hospital Real Estate, L.P.; Texas Oaks Psychiatric Hospital, L.P.; Texas Oaks Psychiatric Hospital Real Estate, L.P.; Texas San Marcos Treatment Center, L.P.; Texas San Marcos Treatment Center Real Estate, L.P.; Texas West Oaks Hospital, L.P.; The Counseling Center of Middle Tennessee, Inc.; Therapeutic School Services, L.L.C.; Transitional Care Ventures, Inc.; Transitional Care Ventures (Texas), Inc.; West Oaks Real Estate, L.P.