HORIZON HEALTH CORP /DE/ - 10-Q Quarterly Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

The number of shares outstanding of the registrant’s Common Stock, $0.01 par value, as of March 31, 2005, was 7,372,299.

Horizon Health Corporation (“the Company”), d/b/a Horizon Health, is a diversified health care services provider. It is a leading contract manager of clinical and related services, primarily of behavioral health and physical rehabilitation programs, offered by acute care hospitals in the United States. The management contracts are generally for initial terms ranging from three to five years, the majority of which have automatic renewal provisions. The Company owns/leases and operates three behavioral health care hospitals and related facilities, which provide behavioral health care programs for children, adolescents, and adults. The Company also offers employee assistance programs (“EAP”) and managed behavioral health services under contracts to employers and managed care organizations. In addition, the Company provides specialized temporary nurse staffing services to acute care hospitals. The Company currently has offices in the Orlando, Florida; Denver, Colorado; Philadelphia, Pennsylvania; Nashville, Tennessee; San Diego, California; Los Angeles, California; and Detroit, Michigan metropolitan areas, and behavioral health care facilities in Plymouth, Indiana; Petersburg, Virginia; and Willoughby, Ohio. The Company’s National Support Center is in the Dallas suburb of Lewisville, Texas.

The accompanying consolidated balance sheet at February 28, 2005, the consolidated statements of operations for the three and six months ended February 28, 2005 and February 29, 2004, and the consolidated statements of cash flows for the six months ended February 28, 2005 and February 29, 2004 are unaudited. These financial statements should be read in conjunction with the Company’s audited financial statements for the year ended August 31, 2004. In the opinion of Company management, the unaudited consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair statement of the financial position of the Company as of February 28, 2005, and the results of operations for the three and six months ended February 28, 2005 and February 29, 2004.

Operating results for the three and six month periods are not necessarily indicative of the results that may be expected for a full year or portions thereof.

In December 2004, FASB issued revised Financial Accounting Standards No. (“SFAS”) 123R, Share-Based Payment. This statement amends SFAS 123, Accounting for Stock-Based Compensation. The statement eliminates the alternative to use APB Opinion No. 25, Accounting for Stock Issued to Employees, that was provided in SFAS 123 as previously issued. SFAS 123R requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. The statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005 and encourages early adoption. This statement will be effective for the Company for its fiscal year ending August 31, 2006.

The consolidated financial statements and accompanying notes have been prepared in accordance with generally accepted accounting principles applied on a consistent basis. The preparation of these financial statements requires the use of estimates, judgements and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The actual results experienced by the Company may differ materially from management’s estimates.

The Company continually evaluates its accounting policies and the estimates it uses to prepare the consolidated financial statements. In general, the estimates are based on historical experience, on information from third party

professionals and on various other assumptions that are believed to be reasonable under the facts and circumstances. There have been no significant changes in assumptions, estimates and judgements in the preparation of these quarterly financial statements from the assumptions, estimates and judgements used in the preparation of the Company’s latest audited financial statements presented in the Company’s August 31, 2004 Annual Report on Form 10-K. See the captioned “Significant Accounting Policies and Estimates” described in Note 2 to the consolidated financial statements presented in the Company’s August 31, 2004 Annual Report on Form 10-K incorporated herein by reference, for information concerning those accounting policies and estimates considered significant by the Company.

Use of Estimates: The Company has made certain estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the amounts of revenues and expenses recorded for the reporting period in order to prepare the financial statements in conformity with generally accepted accounting principles. Future actual results could differ from those estimates.

Reclassifications: Certain prior period amounts have been reclassified to conform to the current year presentation.

In accordance with FASB Statement No.5, Accounting for Contingencies and further, pursuant to FASB Interpretation 39, Offsetting of Amounts Related to Certain Contracts, the Company records liabilities for estimated losses at the gross amount of expected claims and records corresponding receivables related to amounts expected to be received for claims exceeding applicable deductible or stop-loss limits. The Company has reclassified the balance sheet at August 31, 2004 related to these expected claims and receivables, which has resulted in an increase in “Other Receivables” and “Accrued Expenses and Unearned Revenue” of approximately $810,000.

Additionally, in February 2005, a reclass was made from “selling, general and administrative expense” to “interest expense” for costs related to the Company’s existing credit facility. The costs included the amortization of capitalized costs, unused commitment fees, and the annual administrative fee. For comparative purposes, prior year balances were also reclassed.

On January 21, 2005, the stockholders of the Company approved the Horizon Health Corporation 2005 Omnibus Incentive Plan (the “Plan”), pursuant to a proposal that was submitted to the stockholders for approval at the Company’s 2005 Annual Meeting of Stockholders, as detailed in the current report on Form 8-K filed January 21, 2005 and incorporated by reference herein. Under the plan, performance based awards, including stock options, may be granted from time to time as approved by the Compensation Committee of the Board of Directors. The maximum number of new shares of Common Stock that can be issued under the Plan is 300,000.

As of February 28, 2005, 7,500 shares have been reserved for stock options awarded under the Plan. In addition, the CEO and other executives were awarded deferred incentive bonuses for fiscal year 2005. These bonuses are based on the attainment of the corporate performance target for fiscal year 2005 and vest ratably over four years. If attained, these bonuses will be paid 50% in common stock and 50% in cash equally over fiscal year 2005 through fiscal year 2008. The number of shares related to these awards cannot be determined until the conclusion of fiscal year 2005.

The 1989, 1995 and 1998 Stock Option Plans for employees and the 1995 Stock Option Plan for Eligible Outside Directors are collectively referred to as the “Prior Plans”. In accordance with the “prior plans”, as amended, 2,981,843 shares of common stock had been reserved of which only 95,642 remained unissued for stock options previously granted and outstanding to key employees, directors and consultants. The 1989 Plan has terminated in accordance with its terms and no further stock options may be granted under this plan. Upon approval of the 2005 Omnibus Incentive Plan, the remaining “prior plans” were terminated except with respect to stock options previously granted and outstanding under the “prior plans” and no further stock options may be granted under those plans. Future grants of stock options may be made only under the 2005 Omnibus Incentive Plan.

The exercise prices of the options granted equaled or exceeded the market value of the common stock at the date of the grant. The options generally vest ratably over five years from the date of grant and terminate ten years from the date of grant.

The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share of the Company had the Company applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, relating to stock-based employee compensation.

The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share computations for net income:

During fiscal years 2005 and 2004, certain options to acquire common stock were not included in certain computations of diluted EPS because the option exercise price was greater than the average market price of the common shares for the quarter. The computation for the quarter ended February 28, 2005 excluded 13,867 shares subject to options, with an exercise price of $29.80. The computation for the quarter ended February 29, 2004 excluded 5,159 shares subject to options, with exercise prices ranging from $23.30 to $23.75. The computation for the six months ended February 28, 2005 excluded an average of 110,984 shares subject to options, with exercise prices ranging from $22.05 to $29.80. The computation for the six months ended February 29, 2004 excluded an average of 6,322 shares subject to options, with exercise prices ranging from $23.30 to $23.75.

On December 30, 2004, the Company entered into a long-term operating lease agreement of Laurelwood Hospital, a 160-bed psychiatric hospital located in Willoughby, Ohio, a suburb of Cleveland. The hospital was leased from Lake Hospital System, Inc. Lake Hospital System, Inc. is a non-profit health care provider operating two hospitals and other health care facilities in Lake County, Ohio. The lease term commenced on January 1, 2005 and has an initial fifteen (15) year term that expires on December 31, 2019. The Company also has an option to extend the lease for an additional fifteen-year term. Rent under the lease during the initial lease term consists of quarterly rental payments of $200,433 payable in advance on the first day of January, April, July and October. In addition, the Company agreed to make a contribution to the Lake Hospital Foundation in the amount of $41,666 on December 31, 2007 and each December 31st thereafter to and including December 31, 2012.

Effective June 1, 2004, the Company acquired the assets of PSH Acquisition Corporation (“PSH”), which operated five behavioral facilities with a total licensed capacity of 187 beds, in the central Virginia region, for approximately $29.7 million. The agreement also provides for additional variable payments in future years based on the future performance of the facilities. The Company accounted for the acquisition by the purchase method as required by generally accepted accounting principles. As of February 28, 2005, tangible assets acquired and liabilities assumed totaled $16,507,815 and $626,776, respectively. The purchase price of approximately $29.7 million exceeded the fair value of PSH’s net tangible assets by $13,788,024 of which $13,459,024 is recorded as goodwill, and $329,000 is recorded as the value of certain indefinite life assets. The purchase price and goodwill increased $18,074 as a result of additional acquisition costs that were capitalized during the six months ended February 28, 2005. The cash purchase price of approximately $29.7 million was funded under the Company’s revolving credit facility. The three owned and two leased facilities include:

Unaudited pro-forma information is presented for illustrative purposes only and is not necessarily indicative of the financial position or results of operations that would have actually been reported had the acquisition occurred at the beginning of the periods presented, nor is it necessarily indicative of future financial position or results of operations. The unaudited pro-forma financial information with respect to the PSH Acquisition Corporation acquisition was based upon the respective historical consolidated financial statements of Horizon Health Corporation and PSH Acquisition Corporation. This unaudited pro forma information does not include nor does it assume any benefits from cost savings or synergies of operations of the combined companies.

The following unaudited pro forma financial information gives effect to the acquisition of PSH Acquisition Corporation by the Company as if the acquisition occurred on September 1, 2003.

At February 28, 2005, the Company had indefinite life intangible assets, which are not subject to amortization, of $1,124,988. The costs of certain management contracts and other intangible assets acquired by the Company remain subject to amortization. Amortization of recorded values for contracts, non-compete agreements, and trade names for the quarter ended February 28, 2005 was $178,628, $56,750 and $8,380, respectively.

The following table sets forth the estimated amortization expense for intangibles subject to amortization for the remaining six months in the 2005 fiscal year and for each of the four succeeding fiscal years.

The following table sets forth by business service group of the Company, as described in Note 11 elsewhere herein, the amount of goodwill and certain indefinite life intangible assets as of August 31, 2004 that are subject to impairment tests rather than amortization and the adjustments, if any, to the amount of such goodwill and certain indefinite life intangible assets during the six months ended February 28, 2005.

The Company conducts annual impairment testing during its fiscal year third quarter. As a result of the May 31, 2004 impairment testing, no impairment adjustments were deemed necessary.

See Note 11, elsewhere herein, for a description of the Company’s business service groups.

At February 28, 2005 and August 31, 2004, the Company had long-term debt comprised of a revolving credit facility with outstanding balances of $34.5 million and $40.0 million, respectively. At February 28, 2005, $45.5 million of the $90 million credit facility was available to the Company after letter of credit obligations. On May 23, 2002, the Company entered into a Second Amended and Restated Credit Agreement (the “Second Amended Credit Agreement”), with JPMorgan Chase Bank, as Agent, and Bank of America, NA to fund ongoing working capital requirements, refinance existing debt, finance future acquisitions by the Company, and for other general corporate purposes. On August 29, 2003, the Company amended the agreement to allow for its expansion to a $60 million facility and added Wells Fargo Bank Texas as an equal bank participant in the facility. On May 4, 2004, the Company again amended the agreement to extend the term by one year and to increase the amount of the revolving credit facility to $90 million (with an expansion feature under which the amount of the credit facility can be increased to $120 million, subject to the satisfaction of certain conditions) and to add KeyBank National Association as a participant in the facility.

The revolving credit facility bears interest at (1) the Base Rate plus the Base Rate Margin, as defined or (2) the Adjusted Eurodollar Rate, plus the Eurodollar Margin, as defined. At February 28, 2005 the weighted average interest rate on outstanding indebtedness under the credit facility was 4.66%. The Eurodollar Margin varies depending on the debt coverage ratio of the Company. The revolving credit facility, as amended, matures on May 31, 2006, at which time it converts to a two-year amortizing term loan.

As of October 4, 2002, April 4, 2003, and August 29, 2003, the Credit Agreement was amended to allow the Company to finance the redemption or repurchase of its capital stock, subject to certain conditions. The amendments currently allow the Company to expend, from August 29, 2003 through May 31, 2006, up to $7.5 million for the repurchase of shares, of which $1.6 million has been expended.

The Company leases various office facilities and equipment under operating leases. The following is a schedule of minimum rental payments under these leases, which expire at various dates:

The long-term operating lease associated with Laurelwood Hospital, effective January 1, 2005, increased the total minimum rental payments by $11.8 million.

The above minimum rental payments do not take into account $388,366 of expected receipts for four sublet clinic locations in Florida resulting from the reorganization and centralization of the Company’s EAP-Services group.

Rent expense for the six months ended February 28, 2005 and February 29, 2004 totaled $1,693,108 and $1,316,800, respectively.

The Company’s liability and property risk management program involves a balance of insured risks and self-insured retentions. The Company carries general, professional, and malpractice liability, comprehensive property damage, workers’ compensation, directors and officers and other insurance coverages that management considers cost-effective and reasonable and adequate for the protection of the Company’s assets, operations and employees. There can be no assurance, however, that the coverage limits of such policies will be adequate. A successful claim against the Company in excess of its insurance coverage or several claims for which the Company’s self-insurance components are significant in the aggregate could have a material adverse effect on the Company.

Estimates of the aggregate or portions of claims pursuant to the Company’s self-insurance retentions, and liability for uninsured claims incurred are determined and accrual reserves and associated expenses recorded, by using actuarial assumptions followed in the insurance industry and historical experience. In estimating the liability for claims, the Company obtains estimates from third party actuarial firms.

During the quarter, in connection with the civil qui tam lawsuit styled United States ex rel. Debra Hockett, M.D., Linda Thompson, M.D., and Chyrissa Staley, R.N., Plaintiffs v. Columbia/HCA Healthcare Corp., Indian Path Hospital, Inc., Horizon Mental Health Management, Inc. and Superior Home Health of East Tennessee, Inc., Defendants, 01-MS-50 (RCL) (part of Civil Action No. 99-3311 (RCL) pending in the United States District Court for the District of Columbia described in Item 3 of Part I of the Company’s Annual Report on Form 10-K for the year ended August 31, 2004, the court granted the Plaintiffs the right to conduct limited additional discovery regarding similar psychiatric units at other Columbia/HCA hospitals. The complaint alleges that the alleged improper actions also occurred at other Columbia/HCA hospitals.

During the quarter, there were no significant developments in connection with the civil qui tam lawsuit styled United States of America, ex rel. Michael M. Meyer, Patricia J. Szerlip and Vicki Weatherford, Plaintiffs, v. Horizon Health Corporation, Summit Medical Center and Sukhdeep Grewal, M.D., Defendants, Civil Action No. 00-01-1303 MEJ, pending in the United States District court for the Northern District of California described in Item 3 of Part I of the Company’s Annual Report on Form 10-K for the year ended August 31, 2004.

The Company is, and may be in the future, party to litigation arising in the ordinary course of its business. While the Company has no reason to believe that any such pending claims are material, there can be no assurance that the Company’s insurance coverage will be adequate to substantially cover liabilities arising out of such claims or that any such claims will be covered by the Company’s insurance. Any material claim that is not covered by insurance may have an adverse effect on the Company’s business. Claims against the Company, regardless of their merit or outcome, may also have an adverse effect on the Company’s reputation and business.

The Board of Directors adopted in October 1999 the Horizon Health Corporation Employee Stock Purchase Plan (“the Plan”). The Plan offers eligible employees the ability to purchase Company stock at a 15% discount to the current market price at designated periods. Eligible employees are able to contribute up to 10% of their base salary pursuant to two, six-month offering periods, which are defined as January 1 – June 30 and July 1 – December 31. Pursuant to the Plan the Company issued 9,352 and 13,887 shares of Common Stock from treasury for the six months ended February 28, 2005 and for the fiscal year ended August 31, 2004, respectively.

During the time period of September 1998 through February 2001 the Board of Directors of the Company authorized the repurchase of up to 2,525,000 shares of its common stock. As of August 31, 2002 the Company had repurchased 2,292,863 shares of its common stock pursuant to such authorizations, which had previously expired.

On October 7, 2002 the Board of Directors authorized the repurchase of up to 800,000 shares of its common stock. As of February 28, 2005, the company had repurchased 714,591 shares in total of the 800,000 share authorization, which remains in effect. A total of 1,481,496 and 1,298,779 treasury shares had been reissued pursuant to the exercise of certain stock options and in connection with the Employee Stock Purchase Plan as of February 28, 2005 and August 31, 2004, respectively.

For the six months ended February 28, 2005 the net difference between the cost price and the option price on the issuance of treasury stock was a loss of $114,226 which has been charged to retained earnings.

The Company has determined that its reportable segments, or service groups, are appropriately based on its method of internal reporting which disaggregates its business by services category in a manner consistent with the Company’s consolidated statements of operations format. The Company’s reportable service groups are Behavioral Health Services, Physical Rehabilitation Services, EAP-Services, and ProCare One Nurses. See notes (A) through (D) below for a description of the services provided by each of the identified service groups. The Company’s business is conducted solely in the United States.

The following schedule represents revenues and operating results for the periods indicated by service groups:

In the second quarter of 2005, the Company announced that it was commencing a reorganization of its EAP Services Group. The reorganization will involve the centralization of most of the business functions of the service group in Lewisville, Texas, where the national support center of the Company is located. The reorganization will also involve focusing on employee assistance programs and terminating the managed behavioral health care at-risk contracts of the services group. The Company expects the reorganization to be completed by August 31, 2005. The reorganization will involve personnel changes as well as office location changes.

The Company anticipates incurring some one-time expenses associated with certain real estate lease obligations at some affected locations. The Company anticipates subleasing most of these locations; however, the amount of the subleases cannot currently be determined. As of August 31, 2005, the remaining obligation under all the leases that might be affected is approximately $2.2 million, prior to potential subleases.

The company does not anticipate any material severance or related benefit costs associated with the reorganization.

Effective March 16, 2005, the Company closed on a follow-on public offering of 1,725,000 shares of its common stock at a price of $36.25 per share. The aggregate net proceeds to the Company (after deducting underwriters discounts and estimated expenses) were $58.3 million. The Company will utilize approximately $34.5 million of the proceeds to repay all outstanding debt under its revolving credit facility. The balance of the net proceeds will be used for general corporate purposes including acquisitions.

Horizon Health Corporation is a diversified health care services provider. The Company is (i) a contract manager of behavioral health and physical rehabilitation clinical programs offered by acute care hospitals in the United States, (ii) an owner/operator of freestanding behavioral health hospitals providing behavioral health care for children, adolescents, and adults, (iii) a provider of employee assistance programs and behavioral services to employers and managed care organizations, and (iv) a provider of specialized temporary nurse staffing services for acute care hospitals.

At February 28, 2005, Horizon had 108 behavioral health program management contracts and 33 physical rehabilitation program management contracts relating to acute care hospitals located in 36 states and the District of Columbia; 115 CQI+ mental health outcomes measurement contracts; and 1,158 contracts to provide employee assistance programs and managed behavioral health services covering in excess of 3.8 million lives. The Company also operates and (i) owns a behavioral health hospital with 80-licensed beds known as Michiana Behavioral Health Center located in Plymouth, Indiana which it acquired on April 1, 2004; (ii) owns/leases Poplar Springs Hospital, that consists of five behavioral health care facilities with a combined total of 187 beds located generally in North Central Virginia, which it acquired on June 1, 2004; and (iii) has a long-term operating lease agreement that commenced on January 1, 2005 associated with Laurelwood Hospital, a 160 bed behavioral health hospital located in Willoughby, Ohio. During the quarter ended February 28, 2005, Horizon’s specialized temporary nurse staffing service group provided nurses to 85 different acute care hospitals primarily located in California and Michigan, placing an average of 335 nurses a month.

The Company plans to enhance its position as the leader (based on market share) in the contract management of behavioral health programs and its position in the contract management of physical rehabilitation programs by further expanding the range of services that it offers to its client acute care hospitals and the continuum of care it provides. A significant challenge in marketing behavioral health and physical rehabilitation clinical management contracts is overcoming the initial reservations that many hospital administrators have with outsourcing key clinical services. The Company believes its expertise in working with hospital administrators, its reputation in the industry and its existing hospital contractual relationships provide it with a significant advantage in marketing new contracts. The Company also believes it has opportunities to cross-sell management services of behavioral health and physical rehabilitation programs to client acute care hospitals. The Company has indicated that it will focus future growth, both internally and through acquisitions, in the area of its two core clinical competencies, behavioral health services and physical rehabilitation services. The Company is evaluating various alternatives as to its specialty nurse staffing business.

See Note 11 to the Consolidated Financial Statements included elsewhere herein, for additional information concerning the business segments (service groups) of the Company.

On December 30, 2004, the Company entered into a long-term operating lease agreement of Laurelwood Hospital, a 160-bed psychiatric hospital located in Willoughby, Ohio, a suburb of Cleveland. The hospital was leased from Lake Hospital System, Inc.. The lease term commenced on January 1, 2005 and has an initial fifteen (15) year term that expires on December 31, 2019. The Company also has an option to extend the lease for an additional fifteen-year term. Rent under the lease during the initial lease term consists of quarterly rental payments of $200,433 payable in advance on the first day of January, April, July and October. In addition, the Company agreed to make a contribution to the Lake Hospital Foundation in the amount of $41,666 on December 31, 2007 and each December 31st thereafter to and including December 31, 2012.

On January 21, 2005, the stockholders of the Company approved the Horizon Health Corporation 2005 Omnibus Incentive Plan pursuant to a proposal that was submitted to the stockholders for approval at the Company’s 2005 Annual Meeting of Stockholders.

In a press release dated February 23, 2005, the Company announced that it was commencing a reorganization of its EAP- Services group. The EAP-Services Group provides employee assistance programs to employers, behavioral health administrative services for employer benefit plans and third party payor plans, and managed behavioral health care at-risk services to managed care companies and employer plans. The reorganization will involve the centralization of most of the business functions of the service group in Lewisville, Texas, where the National Support Center of the Company is located. The reorganization will also involve focusing on employee assistance programs and terminating the managed behavioral health care at-risk contracts of the service group. These at-risk contracts had annual revenue of approximately $23.0 million with little or no margin associated with them. The Company has previously disclosed that it does not consider the managed behavioral health care business as part of its core competency. The termination of the managed care contracts is consistent with the Company’s renewed focus on its core competencies. The Company expects the reorganization to be completed by August 31, 2005. The reorganization will involve personnel changes as well as office location changes. It will also involve a reduction in the total number of employees in the service group.

Effective March 16, 2005, subsequent to quarter end, the Company closed on a follow-on public offering of 1,725,000 shares of its common stock at a price of $36.25 per share. The aggregate net proceeds to the Company (after deducting underwriters discounts and estimated expenses) were $58.3 million. The Company will utilize approximately $34.5 million of the proceeds to repay all outstanding debt under its revolving credit facility. The balance of the net proceeds will be used for general corporate purposes including acquisitions.

Contract Management Services (Behavioral Health Services and Physical Rehabilitation Services)

The fees received by the Company for its services under management contracts are paid directly by its client acute care hospitals. Generally, contract fees are paid on a monthly basis. The client acute care hospitals receive reimbursement under the Medicare or Medicaid programs or payments from insurers, self-funded benefit plans or other third-party payors for the behavioral health and physical rehabilitation services provided to patients of the programs managed by the Company. As a result, the availability and amount of such reimbursement, which are subject to change, impacts the decisions of acute care hospitals regarding whether to offer behavioral health and physical rehabilitation services pursuant to management contracts with the Company, as well as whether to continue such contracts (subject to contract termination provisions) and the amount of fees to be paid thereunder.

The primary factors affecting revenues in a period are the number of management contracts with treatment programs in operation in the period and the scope of services covered by each such management contract. The Company provides its management services under contracts with terms generally ranging from three to five years. Each contract is tailored to address the differing needs of each client acute care hospital and its community. The Company and the client hospital determine the programs and services to be offered by the acute care hospital and managed by the Company, which may consist of one or more behavioral health or physical rehabilitation treatment programs offering inpatient, partial hospitalization, and/or outpatient services. Under the contracts, the acute care hospital is the actual provider of the behavioral health or physical rehabilitation services and utilizes its own facilities (including beds for inpatient programs), nursing staff and support services (such as medical ancillaries, billing, dietary and housekeeping) in connection with the operation of its programs with the Company providing clinical, operating and compliance management staff and expertise. As the Company expanded the breadth of treatment programs it offers to acute care hospitals, it increased the number of contracts that included management of multiple treatment programs.

The Company has increased revenues through internal growth, as well as price escalators and higher census levels at existing contract locations. An additional factor favorably affecting revenues has been the Company’s pricing policy of establishing a minimum direct margin threshold for its management contracts.

The Company, through its contract management behavioral health services group, also provides behavioral health outcomes measurement services primarily to acute care hospital-based programs and freestanding behavioral health hospitals. The contracts for outcomes measurement services are generally for one to two years with an automatic renewal provision. The rates for the outcomes measurement services are negotiated based on the range of services provided and the number of patients and are generally paid on a monthly basis.

The Company’s business is affected by federal, state and local laws and regulations concerning, among other matters, behavioral health and physical rehabilitation facilities and reimbursement for the services offered by such facilities. These regulations impact the development and operation of behavioral health and physical rehabilitation programs managed by the Company for its client acute care hospitals as well as the Company’s owned/operated behavioral health care facilities. Licensing, certification, reimbursement and other applicable state and local government regulations vary by jurisdiction and are subject to periodic revision. The Company is not able to predict the content or impact of future changes in laws or regulations affecting the behavioral health or physical rehabilitation sectors.

The Balanced Budget Act of 1997 mandated the elimination of cost-based reimbursement of mental health partial hospitalization services (except as stated below). As a result, the Prospective Payment System (“PPS”) for Partial Hospitalization Programs (“PHP”) was implemented generally effective August 1, 2000. The resulting reimbursement for partial hospitalization services based on the Medicare outpatient PPS utilizes a fixed reimbursement amount per patient day. These rates lowered Medicare reimbursement levels to many hospitals for partial hospitalization services. This change, in general, adversely affected the ability of the Company to maintain and/or obtain management contracts for partial hospitalization services and the amount of fees paid to the Company under such contracts. The base reimbursement rate, for partial hospitalization programs operating under PPS, decreased from $287 per patient day for 2004 to $281 per patient day effective January 1, 2005. Hospitals that are in a designated rural area and have less than 100 acute care beds were able to continue cost based reimbursement for PHP services initially until December 31, 2003. However, on December 8, 2003, this was extended to December 31, 2005 with the passage of the Medicare Prescription Drug Improvement and Modernization Act of 2003. Effective January 1, 2006, they are scheduled to operate under PPS unless the law is again amended. This change in reimbursement methodology, if made, may lower Medicare reimbursement levels to this type hospital.

The Balanced Budget Refinement Act of 1999 mandated that a PPS for inpatient psychiatric services be developed. The new PPS was to include an adequate patient classification system that reflects the differences in patient resource use and costs, i.e. acuity. In addition, the law stated that the payment system must be budget neutral and be a per diem system. On November 15, 2004 CMS published final rules in the Federal Register for the psychiatric inpatient PPS. The PPS rule is effective for Medicare cost reporting years that commence on or after January 1, 2005. The final PPS rules provide for a per diem PPS system phased in over a four-year period. The per diem rate has patient specific adjustments based on age, diagnosis, comorbidities and electro convulsive therapy treatments. The per diem rate has facility adjustments based on wage index, rural designation, teaching designation, cost of living adjustments and an adjustment for psychiatric facilities with full-service Emergency Departments (“ED’s”). In addition the per diem rate is increased in days 1 through 8 of the patient’s stay, and decreases from day 11 until the conclusion of the patient’s stay. The Company believes that the new PPS rules will affect the hospitals with which it has management contracts both positively and negatively on a case-by-case basis. The new PPS rules have stop loss protection against significant decreases in reimbursement for cost reporting years beginning in calendar year 2005. The Company believes that the new PPS rules will not have a material adverse effect on its contract management business overall or on its owned free standing behavioral health hospitals in fiscal 2005. However, the Company is still reviewing the effect of the new PPS rules in future years and at this time has not ascertained specifically what the effect will be on a facility-by-facility basis. The Company cannot be definitive about the overall future effect of the new PPS rules, which could have an adverse effect on the contract management business for behavioral health units in the 2006 cost reporting year or thereafter.

Acute rehabilitation units within acute-care hospitals were previously eligible as exempt Distinct Part Units (“DPU’s”) under a cost-based reimbursement system prior to January 1, 2002. Beginning January 1, 2002, acute rehabilitation units began transitioning to the PPS. As of September 1, 2003 all physical rehabilitation services have been transitioned to the PPS.

CMS published final rules in the May 7, 2004 Federal Register to modify the criteria for classification as an inpatient rehabilitation facility. The final rule, known as the “75% Rule”, generally requires that in order to meet the qualification requirement, 75% of the patients of a physical rehabilitation services unit must have certain qualifying medical conditions. The final rule has a 4-year phase-in period to allow inpatient rehabilitation facilities time to adjust to the new rule. The first year compliance percentage is 50%; the second year percentage is 60%; the third year percentage is 65% and in the fourth year and thereafter, the compliance percentage is 75%. The final rule also eliminates polyarthritis as a qualifying medical condition and adds three other arthritis diagnoses that are more restrictive. As a result, patients that previously met the polyarthritis conditions may no longer meet the specific qualifying medical condition required under the new rule. The final rule also added a new restrictive category for certain knee or hip joint replacements. The

effective date for these final rules was for cost reporting periods beginning on or after July 1, 2004. CMS is prohibited from using the 75% rule to remove the rehab designation from any facility that was considered an inpatient rehab facility on or before June 30, 2004 until after the General Accounting Office completes a study on the impact of the 75% rule. The General Accounting Study is expected to be completed in early to mid 2005. Based on this study, CMS may or may not develop revised criteria for determining whether a facility is classified as an Inpatient Rehabilitation Facility. The final rules as adopted, unless suspended or modified as proposed, could have an adverse effect on the rehabilitation programs managed by the Company.

While the Company is generally not experiencing material adverse consequences as a result of recent changes in reimbursement under federal health care programs, at this time, the Company cannot meaningfully predict the ultimate impact that reimbursement changes may have on the programs it currently manages or the facilities it owns or on its ability to obtain new management contracts.

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 was signed into law. This law contains provisions that allow Critical Access Hospitals (“CAHs”) to open and operate a 10 bed psychiatric DPU, a 10-bed rehabilitation DPU, or both, which previously was not allowed. The effective date of this provision is for cost reporting periods beginning on or after October 1, 2004. CAHs qualifications include that they must be in a designated rural area, meet certain distance requirements from other hospitals, have 25 beds or less (excluding the DPU’s listed above), and have an average length of stay for the non-DPU beds of 96 hours or less. A CAH will have the ability to treat psychiatric and rehabilitation patients for the clinically appropriate period of time based on the patient’s acuity independent of the 96-hour rule.

With the April 1, 2004 acquisition of Michiana Behavioral Health Center; the June 1, 2004 acquisition of Poplar Springs Hospital; and the commencement of the long-term operating lease associated with Laurelwood Hospital effective January 1, 2005, the Company now owns and operates multiple behavioral health facilities with 80 licensed beds in Plymouth, Indiana; 187 licensed beds in the central Virginia region; and 160 beds in Willoughby, Ohio. Patient service revenue is reported on the accrual basis in the period in which services are provided at established rates. Amounts received are generally less than the established billing rates of the facility and the differences (contractual allowances) are reported as deductions from patient service revenue at the time the service is rendered. Net patient services revenue includes amounts the Company estimates to be reimbursable by Medicare and Medicaid under provisions of cost or prospective reimbursement formulas in effect.

The behavioral health facilities provide care without charge to patients who are financially unable to pay for the behavioral services they receive. As a result, the facilities do not pursue collection of amounts determined to qualify as charity care and they are not reported in revenues. Settlements under cost reimbursement agreements with third party payors are estimated and recorded in the period in which the related services are rendered and are adjusted in future periods as final settlements are determined. Final determination of amounts earned under the Medicare and Medicaid programs often occur in subsequent years because of audits by the programs, rights of appeal and the application of numerous technical provisions.

Employee Assistance Programs and Managed Behavioral Health Care Services (EAP-Services)

Through its EAP-Services group, the Company offers an array of behavioral health care products to corporate clients, self-funded employer groups, government agencies, and third-party administrators. Revenues are derived from employee assistance program services (“EAP”), administrative services only services, and managed behavioral health services. Generally fees are paid on a monthly basis pursuant to contracts that typically are renewable annually, although contracts vary as to term and provisions with some being multi-year, some containing automatic renewal provisions, and some containing termination provisions under specified conditions.

Revenues from EAP contracts are typically based on a specified fee per month per employee based on the range and breadth of services provided to the employer, which may include work life services (including child and elder care consultation), referral resource and critical incident debriefings and intervention, and the method(s) in which those services are provided. Each plan is specifically designed to fulfill the clients’ needs.

Revenues for administrative services only contracts relate to the administration of behavioral health benefits and are dependent upon the number of contracts and the services provided. Fees are usually a case rate or a per member per month fee applied to the number of eligible members. The client remains financially liable for direct costs associated with providing the medical services. The client is able to benefit from the Company’s expertise in clinical case management, the behavioral health professionals employed by the Company, the independent health care providers contracted by the Company at favorably discounted rates and the administrative efficiencies provided by the Company.

Revenues derived from at risk managed behavioral health care services are primarily affected by the scope of behavioral health benefits provided and the number and type of members covered. Fees are based on a per member per month fee applied to the number of eligible members. The rate is dependent upon the benefit designs and actuarially determined anticipated utilization of the customer’s covered members. The Company is responsible for the cost of the medical services provided to the members under these contracts.

A significant client of EAP-Behavioral Services did not renew its contract that expired on December 31, 2004. The contract had revenues of $4.4 million during fiscal year 2004. Due to cost saving initiatives enacted that have been affected, the Company does not believe the loss of this contract will have a material unfavorable impact on income from continuing operations. In addition, the Company sublet the four clinic locations to a third party.

The Company’s acquisition of ProCare, in June 2002, expanded the Company’s operations in healthcare services by entering into the specialized temporary nurse staffing industry. The Company provides an on-call, twenty-four hour per day, seven days a week, specialized temporary nurse staffing service to acute care hospitals with a focus on the labor & delivery, neonatal, ICU, and emergency room areas. The fees received by the Company for its services related to specialized temporary nurse staffing services are paid directly by its client acute care hospitals. Generally, temporary nurse-staffing fees are determined by the number of hours worked and are billed and paid on a weekly basis. Hourly rates vary based on the specialty of nurse required, day of the week, and time of shift to be filled. Fees are generally billed based on predetermined rates as specified in a fee schedule with the client acute care hospital. Revenues are recognized in the month in which services are rendered, at the estimated net realizable amounts.

The Company does not intend to pursue acquisitions or other investments related to its specialty nurse staffing business, which it deems not to be in its core competencies. The Company will continue its efforts to improve ProCare’s operations and profitability. However, the Company will continue to explore strategic alternatives for its specialty nurse staffing business, which could include a sale of the business at a loss.

In addition to the respective primary expense factors described below, other operating expenses generally incurred by each of the Company’s service groups include items such as training, continuing professional education and credentialing services, marketing costs and expenses, consulting, accounting and legal fees and expenses, employee recruitment and relocation expenses, rent, utilities, telecommunications costs, and property taxes, as well as bad debt expense.

Contract Management Services (Behavioral Health Services and Physical Rehabilitation Services)

The primary factors affecting operating expenses for the Company’s contract management business in any period is the number of programs in operation in the period and the volume of patients at those locations. Operating expenses consist primarily of salaries and benefits paid to program management, clinicians, therapists and supporting personnel. Behavioral health programs managed by the Company generally have a program director that is usually a psychologist or a social worker, a community education manager and additional social workers or therapists as needed. Physical rehabilitation programs managed by the Company generally have a program director and additional clinical staff tailored to meet the needs of the program and the client hospital, which may include physical and occupational therapists, a speech pathologist, a social worker and other appropriate supporting personnel. In addition, for both types of programs the Company contracts with a medical director on an independent contractor basis under which on-site administrative and clinical oversight services needed to administer the program are provided. The nursing staff is typically provided and employed by the hospital.

Operating expenses for the Company’s behavioral health facilities are primarily comprised of the volume and mix of wage rates, including overtime, for clinical staff and nurses, as well as pharmacy and dietary supplies which are affected by the levels of patient census and acuity.

Employee Assistance Programs and Managed Behavioral Health Care (EAP-Services)

Operating expenses for the Company’s employee assistance programs and managed behavioral health care services are primarily comprised of medical claims from clinical providers and salaries and benefits for its clinical, operations and supporting personnel. Medical claims include payments to independent health care professionals providing services to the covered enrollees under the employee assistance programs and the managed behavioral healthcare contracts offered by the Company.

The primary factor affecting operating expenses for the Company’s specialized temporary nurse staffing business in any period is the number of shifts filled in the period and the mix of wage rates, including overtime, for the placed nurses. Operating expenses consist primarily of salaries and benefits paid to the Company’s nursing pool.

As of February 28, 2005 the licensed bed mix consisted of 271 Acute and 156 RTC.

For the quarter ended February 28, 2005, the Company’s temporary nurse staffing group placed, on average, 335 nurses per month in temporary and travel nurse staffing positions at 85 different general acute care hospitals.

The following table sets forth for the three and six months ended February 28, 2005 and February 29, 2004, the percentage relationship to total revenues of certain costs, expenses and income.

Three Months Ended February 28, 2005 Compared to the Three Months Ended February 29, 2004

Revenue. Total revenue between the quarters increased $12.3 million or 29.2%. Revenue for Behavioral Health Services increased $13.2 million as a result of the operation of two freestanding behavioral health hospitals and their related facilities, the long-term operating lease agreement associated with Laurelwood Hospital and an increase in same store sales for the Company’s contract management of behavioral health programs. Physical Rehabilitation Services revenue decreased $673,000, primarily due to a decrease in the average number of physical rehabilitation locations in operation. EAP-Services revenue decreased $330,000 due to the termination of a significant managed care contract and the discontinuance of the Florida clinic operations, which was partially offset by the commencement of a significant EAP contract.

Revenue associated with the contract management of physical rehabilitation services decreased $673,000 or 13.3% between the quarters. This decrease was primarily attributable to a decrease in the average number of physical rehabilitation locations in operation from 29.0 for the three months ended February 29, 2004 to 25.0 for the three months ended February 28, 2005.

Revenue associated with employee assistance programs and managed behavioral services decreased by $330,000, or 2.5% between the quarters. A decrease of $729,000 is primarily attributable to the termination of a significant managed care contract on December 31, 2004. An additional decrease of $108,000 is due to the discontinuance of the Florida clinic operations on December 31, 2004. These decreases are partially offset by an increase of $300,000 that is related to the commencement of a significant EAP contract on June 1, 2004.

Revenue associated with nurse staffing services increased $70,000, or 1.5% between the quarters. This increase is primarily attributable to an increase in the average revenue per shift, as a result of an increase in the number of long-term assignments, which generally command higher fees. This increase is partially offset by an overall decrease in the number of shifts worked between the periods.

Revenue associated with other services decreased by $26,000 or 27.7% between the quarters.

Cost of Services. Total costs of services provided between the quarters increased $9.5 million, or 29.2%. This increase is primarily the result of the cost of services associated with the operation of two freestanding behavioral health hospitals and their related facilities, and the long-term operating lease agreement associated with Laurelwood Hospital. This increase is also attributable to an increase in medical claims expense in the EAP-Services group. These increases were partially offset by decreases in the EAP-Services group as a result of the discontinuance of the Florida clinic operations and cost savings as a result of the elimination of expenses associated with the termination of a significant managed care contract. In addition, the Company’s Physical Rehabilitation Services group had a decrease in the average physical rehabilitation locations in operation.

Cost of services provided associated with behavioral health services consisting of the contract management of behavioral health programs and the operation of the Company’s freestanding behavioral health care facilities increased $10.7 million, or 82.4%, between the quarters. This increase is primarily attributable to the operation of Michiana Behavioral Health Center and Poplar Springs Hospital, acquired April 1, 2004 and June 1, 2004, respectively, and the

long-term operating lease agreement associated with Laurelwood Hospital effective January 1, 2005, which were $10.8 million for the three months ended February 28, 2005. As a percent of revenue, gross profits decreased from 33.1% for the three months ended February 29, 2004 to 27.3% for the three months ended February 28, 2005.

Cost of services provided associated with the contract management of physical rehabilitation services decreased by $406,000, or 11.0%, between the quarters. This decrease is primarily due to a decrease in operating expenses as a result of the decrease in the average number of physical rehabilitation locations in operation, from 29.0 for the three months ended February 29, 2004 to 25.0 for the three months ended February 28, 2005. As a percent of revenue, gross profit decreased to 25.6% for the three months ended February 28, 2005 from 27.5% for the three months ended February 29, 2004.

Cost of services provided associated with employee assistance programs and managed behavioral services decreased by $711,000, or 6.2%, between the quarters. A decrease of approximately $596,000 in salaries and benefits is due to a 19.6% decrease in full-time equivalents as a result of the cost saving initiatives related to the termination of a significant contract as previously mentioned. An additional decrease of $513,000 is related to the discontinuance of the Florida clinic operations on December 31, 2004. These decreases are partially offset by an increase of $415,000 in medical claims expense due to an increase in existing client utilization and costs per unit of service. As a percent of revenue, gross profits increased to 15.1% for the three months ended February 28, 2005 from 11.8% for the three months ended February 29, 2004.

Cost of services provided associated with specialized temporary nurse staffing services was essentially level at $4.3 million between the quarters. As a percent of revenue, gross profits increased to 8.1% for the three months ended February 28, 2005 from 6.1% for three months ended February 29, 2004.

Cost of Services provided associated with other services decreased by $177,000, or 229.9%, between the quarters. This decrease is primarily due to the phase out of the PsychScope Phase IV projects.

Selling, General, and Administrative. Total selling, general, and administrative expenses, on a net basis, increased $1.2 million, or 27.9%, between the quarters. Salaries & benefits increased $362,000, the majority of which is primarily attributable to the expansion of several support center departments and the addition of in-house legal counsel. Legal fees increased $217,000 primarily due to $80,000 in expenses associated with the Laurelwood Hospital long-term operating lease agreement and a prior year recovery of $84,000 in legal expenses. Consulting fees increased $68,000 for the three months ended February 28, 2005, as compared to the three months ended February 29, 2004 due to support center related consulting projects. Auditing & accounting fees increased $112,000 due to increased expenses related to the company’s annual audit as well as to Sarbanes-Oxley compliance efforts.

Provision for Doubtful Accounts. The provision for doubtful accounts increased $402,000 between the quarters. A $550,000 increase is primarily attributable to the bad debt provisions associated with the operation of Michiana Behavioral Health Center and Poplar Springs Hospital, acquired on April 1, 2004 and June 1, 2004, respectively, and the long-term operating lease agreement associated with Laurelwood Hospital, effective January 1, 2005. An additional increase of $205,000 is related to recording bad debt reserves for one terminated contract location and one contract location still in operation in which collectability is uncertain. These increase were partially offset by bad debt recoveries of $361,000 during the period.

Depreciation and Amortization. Depreciation and amortization expense increased approximately $152,000, or 23.5%, between the quarters. An increase in depreciation expense of $300,000 is primarily due to the addition of the facilities associated with the acquisitions of Michiana Behavioral Health Center and Poplar Springs Hospital effective April 1, 2004 and June 1, 2004, respectively. This increase was partially offset by a decrease in contract amortization expense of approximately $128,000 associated with intangible assets that became fully amortized either during the current period or during the prior fiscal year.

Interest and Other Income (Expense), Net. Interest expense, interest income and other income for the three months ended February 28, 2005 resulted in a net expense of $603,000 as compared to a net expense of $230,000 for the corresponding period in the prior fiscal year. The variance between the periods is primarily attributable to an increase in interest expense of approximately $336,000 related to the increase in the weighted average principal balance outstanding under the credit facility between the quarters. The weighted average outstanding credit facility balance for the three months ending February 28, 2005 was $36.0 million with an ending balance of $34.5 million. The weighted average outstanding credit facility balance for the three months ended February 29, 2004 was $9.1 million with an ending balance of $9.5 million.

Income Tax Expense. Income tax expense increased $311,000 or 18.8% between the quarters. This increase in income tax expense was largely due to a corresponding increase in pre-tax earnings. The effective tax rates for the quarters ended February 28, 2005 and February 29, 2004 were 39.0% and 38.3%, respectively.

Six Months Ended February 28, 2005 Compared to the Six Months Ended February 29, 2004

Revenue. Total revenue between the year-to-date periods increased $22.3 million or 26.5%. Revenue for Behavioral Health Services increased $23.1 million as a result of the operation of two freestanding behavioral health hospitals and their related facilities, the long-term operating lease agreement associated with Laurelwood Hospital and an increase in same store sales in Company’s contract management of behavioral health programs. Physical Rehabilitation Services revenue decreased $473,000, primarily due to a decrease in the average number of physical rehabilitation locations in operation. EAP-Services revenue decreased $352,000 due to the termination of a significant managed care contract and the discontinuance of the Florida clinic operations, which was offset by the commencement of a significant EAP contract. Revenue for ProCare One Nurses increased $282,000 primarily due to an increase in the average revenue per shift. Additionally, revenue for Other Services decreased $225,000 primarily attributable to the phase out of the Company’s PsychScope Phase IV projects.

Revenue associated with Behavioral Health Services, consisting of the contract management of behavioral health programs and the operation of the Company’s freestanding behavioral health facilities increased $23.1 million, or 59.2%, between the year-to-date periods. $21.3 million of this increase is primarily attributable to the operation of Michiana Behavioral Health Center and Poplar Springs Hospital acquired on April 1, 2004 and June 1, 2004, respectively, and the long-term operating lease agreement associated with Laurelwood Hospital effective January 1, 2005. Although the average number of behavioral health care locations in operation decreased from 104.9 for the six months ended February 29, 2004 to 103.5 for the six months ended February 28, 2005, the average revenue per behavioral healthcare location increased $22,000 which represents $2.3 million, or 10.0%, of the increase in revenue for the six months ended February 28, 2005 as compared to the six months ended February 29, 2004. This was partially offset by the phase out of the Company’s consulting operations that contributed $700,000 in revenue during the six months ended February 29, 2004.

Revenue associated with the contract management of physical rehabilitation services decreased $473,000, or 4.8%, between the year-to-date periods. This decrease was primarily attributable to a decrease in the average number of physical rehabilitation locations in operation from 28.7 for the six months ended February 29, 2004 to 25.2 for the six months ended February 28, 2005. This decrease was partially offset by an increase in the average revenue per location from $340,000 for the six months ended February 29, 2004 to $370,000 for the six months ended February 28, 2005, primarily as a result of the commencement of a significant contact in August 2004.

Revenue associated with employee assistance programs and managed behavioral services decreased by $352,000, or 1.3%, between the year-to-date periods. A decrease of $683,000 is primarily attributable to the termination of a significant managed care contract on December 31, 2004. An additional decrease of $164,000 is due to the discontinuance of the Florida clinic operations on December 31, 2004. These decreases are partially offset by an increase of $390,000 that is related to the commencement of a significant EAP contract on June 1, 2004.

Revenue associated with nurse staffing services increased $282,000, or 3.1%, between the year-to-date periods. This increase is primarily attributable to an increase in the average revenue per shift, as a result of an increase in the number of long-term assignments, which generally command higher fees. This increase is partially offset by an overall decrease in the number of shifts worked between the periods.

Revenue associated with other services decreased by $225,000 or 71.2%, between the year-to-date periods. This decrease is primarily attributable to the phase out of the PsychScope Phase IV projects.

Cost of Services. Total costs of services provided between the periods increased $16.3 million, or 25.1%. This increase is primarily the result of the cost of services associated with the operation of Michiana Behavioral Health Center, Poplar Springs Hospital and the long-term operating lease agreement associated with Laurelwood Hospital. This increase is also attributable to an increase in medical claims expense in the EAP-Services group. These increases were partially offset by decreases in the EAP-Services group as a result of the discontinuance of the Florida clinic operations and cost savings as a result of the elimination of expenses associated with the termination of a significant managed care contract. In addition, the Company’s Physical Rehabilitation Services group had a decrease in the average number of physical rehabilitation locations in operation.

Cost of services provided associated with the contract management of mental health programs and the operations of the Company’s freestanding behavioral health care facilities increased $18.0 million, or 69.8%, between the year-to-date periods. This increase is primarily attributable to the operation of Michiana Behavioral Health Center and Poplar Springs Hospital, acquired on April 1, 2004 and June 1, 2004, respectively, and the long-term operating lease agreement associated with Laurelwood Hospital effective January 1, 2005, which were $17.9 million during the six months ended February 28, 2005. As a percent of revenue, gross profits decreased from 33.7% for the six months ended February 29, 2004 to 29.3% for the six months ended February 28, 2005.

Cost of services provided associated with the contract management of physical rehabilitation services decreased by $808,000, or 11.0%, between the year-to-date periods. This decrease is primarily due to a decrease in operating expenses as a result of the decrease in the average number of physical rehabilitation locations in operation, from 28.7 for the six months ended February 29, 2004 to 25.2 for the six months ended February 28, 2005. As a percent of revenue, gross profit increased to 29.4% for the six months ended February 28, 2005 from 24.6% for the six months ended February 29, 2004.

Cost of services provided associated with employee assistance programs and managed behavioral services decreased by $709,000, or 3.1%, between the year-to-date periods. A decrease of approximately $1.2 million in salaries and benefits is due to a 17.5% decrease in full-time equivalents as a result of the cost saving initiatives related to the termination of a significant contract as previously mentioned. An additional decrease of $544,000 is related to the discontinuance of the Florida clinic operations on December 31, 2004. These decreases are partially offset by an increase of $1.1 million in medical claims expense due to an increase in existing client utilization and costs per unit of service. As a percent of revenue, gross profits increased to 12.9% for the six months ended February 28, 2005 from 11.3% for the six months ended February 29, 2004.

Cost of services provided associated with specialized temporary nurse staffing services was essentially level at $8.6 million. As a percent of revenue, gross profits increased to 9.4% for the six months ended February 28, 2005 from 7.6% for the six months ended February 29, 2004.

Cost of Services provided associated with other services decreased by $361,000, or 138.3%, between the year-to-date periods. This decrease is primarily due to the phase out of the PsychScope Phase IV projects.

Selling, General, and Administrative. Total selling, general, and administrative expenses, on a net basis, increased $2.0 million, or 22.0%, between the year-to-date periods. Salaries & benefits increased $1.2 million primarily due to the expansion of several support center departments including the additions of a dedicated acquisitions & development department and in-house legal counsel. Legal fees increased $254,000 primarily due to $80,000 in expenses associated with the Laurelwood Hospital long-term operating lease agreement and a prior year recovery of $127,000 in legal expenses. Consulting fees increased $169,000 for the six months ended February 28, 2005, as compared to the six months ended February 29, 2004 due to support center related consulting projects. Auditing & accounting fees increased $266,000 due to increased expenses related to the company’s annual audit as well as to Sarbanes-Oxley compliance efforts.

Provision for Doubtful Accounts. The provision for doubtful accounts was a net expense of $1.4 million for the six months ended February 28, 2005, as compared to a net recovery of $115,000 for the six months ended February 29, 2004. The increase is primarily attributable to bad debt of $1.1 million associated with the operation of Michiana Behavioral Health Center and Poplar Springs Hospital, acquired on April 1, 2004 and June 1, 2004, respectively, and the long-term operating lease agreement associated with Laurelwood Hospital, effective January 1, 2005. Also included in this expense are bad debt reserves recorded in the amount of $641,000 for two terminated contract locations and two contract locations still in operation in which collectability is uncertain. These expenses were partially offset by bad debt recoveries of $351,000. The net recovery for the six months ended February 29, 2004 was primarily the result of the recovery of amounts expensed in prior periods due to receiving payments related to old receivables of $357,000 for one contract location still in operation and $147,000 related to three contract locations that were previously terminated. These recoveries were partially offset by bad debt reserves recorded for contract locations in which collectability was uncertain.

Depreciation and Amortization. Depreciation and amortization expense increased approximately $377,000, or 28.8%, between the year-to-date periods. An increase in depreciation expense of $581,000 is primarily due to the addition of the facilities associated with the acquisitions of Michiana Behavioral Health Center and Poplar Springs Hospital effective April 1, 2004 and June 1, 2004, respectively. This increase was partially offset by a decrease in contract amortization expense of approximately $173,000 associated with intangible assets that became fully amortized either during the current period or during the prior fiscal year.

Interest and Other Income (Expense), Net. Interest expense, interest income and other income for the six months ended February 28, 2005 resulted in a net expense of approximately $1.2 million as compared to a net expense of $465,000 for the corresponding period in the prior fiscal year. The variance between the periods is primarily the result of an increase in interest expense of approximately $623,000 related to the increase in the weighted average principal balance outstanding under the credit facility between the periods. The weighted average outstanding credit facility balance for the six months ending February 28, 2005 was $37.4 million with an ending balance of $34.5 million. The weighted average outstanding credit facility balance for the corresponding period in the prior fiscal year was $10.6 million with an ending balance of $9.5 million.

Income Tax Expense. Income tax expense increased $615,000, or 18.9%, between the year-to-date periods. This increase in income tax expense was largely due to a corresponding increase in pre-tax earnings. The effective tax rates for the six-month periods ended February 28, 2005 and February 29, 2004 were 39.0% and 38.3%, respectively.

See in Note 1, Organization, the caption “Basis of Presentation and New Accounting Standards” in the notes to the consolidated financial statements included elsewhere herein for a discussion of newly issued accounting standards.

The Sarbanes-Oxley Act of 2002, which became law in July 2002 requires changes in certain of the Company’s corporate governance practices. In addition, related rules have been made by the Securities and Exchange Commission and NASDAQ. These new rules and regulations will increase the Company’s legal and financial compliance costs, and make some activities more difficult, time consuming and/or costly. These new rules and regulations are expected to make it more expensive to obtain director and officer liability insurance. These new rules and regulations could also make it more difficult for the Company to attract and retain qualified members for its board of directors, particularly to serve on its audit committee, and qualified executive officers. Additional costs related to compliance with the new requirements of Sarbanes-Oxley Rule Section 404 are expected for the remainder of 2005 and in future fiscal periods.

The Company’s initiatives to comply with Section 404 of the Sarbanes-Oxley Act and related regulations regarding management’s required assessment of its internal control over financial reporting and the independent auditors’ attestation of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. In part to prepare for compliance with Section 404, as well as to generally improve its internal control environment, the Company has undertaken substantial measures, including among other things, projects to strengthen both its accounting and information technology systems, including initiatives related to recent acquisitions. These projects, which represent both operational and compliance risks, require significant resources and must be completed in a timely manner in order to enable the Company to comply with the Section 404 requirements. Although management believes that ongoing efforts to improve its internal control over financial reporting will enable management to provide the required report, and its independent auditors to provide the required attestations, under Section 404 as of August 31, 2005, the Company can give no assurance that such efforts will be completed on a timely and successful basis to enable management and independent auditors to provide the required report and attestation. Moreover, because of the new and changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to disclosure and governance practices.

The Company believes that its future cash flows from operations (which were $5.9 million for the six months ended February 28, 2005), along with cash of $2.7 million at February 28, 2005, and its credit facility of $90 million with an accordion feature allowing additional increases to $120 million, subject to satisfaction of certain conditions, will be sufficient to cover operating cash requirements over the next 12 months. The Company’s cash flows from operations were $4.3 million for the three months ended February 28, 2005, and $12.4 million for the fiscal year ended August 31, 2004. At February 28, 2005, $45.5 million of the $90 million credit facility was available to the Company after letter of credit obligations. As a result of its strong and consistent cash flows generated from operations, its significant amount of available funds under the existing credit facility, and its relatively low ordinary and customary capital expenditure requirements, including legal and financial compliance costs with new governmental regulatory requirements, the Company expects to be able to continue to fund operating cash requirements.

Cash outlays for property and equipment purchases in the normal course of business totaled approximately $794,000 for the six months ended February 28, 2005. The Company anticipates its normal property and equipment expenditures for the remainder of the fiscal year to be approximately $1.0 million.

The Company repurchased $455,000 of its common stock during the six months ended February 28, 2005. Under the existing credit facility, the Company may repurchase up to $7.5 million of its common stock in the period beginning, August 29, 2003 through the maturity of the revolving credit facility, which is May 31, 2006. On October 7, 2002 the Board of Directors authorized the repurchase of up to 800,000 shares of its common stock. As of February 28, 2005, the company had repurchased 719,965 shares in total of the 800,000 share authorization, which remains in effect.

Effective May 23, 2002, the Company entered into a Second Amended and Restated Credit Agreement. See Note 7, “Long-Term Debt” to the Notes to the Consolidated Financial Statements included elsewhere herein for a general discussion including a summary of certain material provisions of the Credit Agreement which does not purport to be complete, and is subject to, and qualified in its entirety by reference to, the Second Amended Credit Agreement, a copy of which was previously filed as Exhibit 10.1 in the May 2002 Form 10-Q.

Effective May 4, 2004 the Company amended the credit agreement. The amendment increased the facility size from $60 million to $90 million (including an accordion expansion feature up to $120 million). See Note 7, “Long-Term Debt” to the Notes to the Consolidated Financial Statements included elsewhere herein.

The June 1, 2004 purchase agreement associated with the acquisition of the assets of PSH Acquisition Corporation (“PSH”) provides for additional variable payments in future years based on the future performance of the facilities. The first payment is due on or before March 31, 2005 (for the calendar year ended December 31, 2004) and is anticipated to be approximately $380,000.

See the section captioned “Critical Accounting Policies” in “Management’s Discussion and Analysis” as well as “Significant Accounting Policies and Estimates” described in Note 2 to the consolidated financial statements presented in the Company’s August 31, 2004 Annual Report on Form 10-K, both of which are incorporated herein by reference, for information concerning those accounting policies and estimates considered critical by the Company.

Certain written and oral statements made or incorporated by reference from time to time by the Company or its representatives in this report, other reports, filings with the Commission, press releases, conferences, or otherwise, are “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,” “will be,” “will continue,” “will likely result,” or words or phrases of similar meaning. Such statements involve risks, uncertainties or other factors which may cause actual results to differ materially from the future results, performance or achievements expressed or implied by such forward looking statements. Certain risks, uncertainties and other important factors are detailed in this report and will be detailed from time to time in reports filed by the Company with the Commission, including Forms 8-K, 10-Q, and 10-K, and include, among others, the following: general economic and business conditions which are less favorable than expected; unanticipated changes in industry trends; decreased demand by acute care hospitals for the Company’s services; the Company’s inability to retain existing management contracts or to obtain additional contracts or maintain customer relationships; adverse changes in reimbursement to by Medicare, Medicaid or other third-party payers for costs of providing behavioral health or physical rehabilitation or nursing services; adverse changes to other regulatory requirements relating to the provision of behavioral health or physical rehabilitation or nursing services; adverse consequences of investigations by governmental regulatory agencies; adverse judgments rendered in the qui tam lawsuits pending against the Company; fluctuations and difficulty in forecasting operating results; the ability of the Company to sustain, manage or forecast its growth; the ability of the Company to successfully integrate acquired businesses on a cost effective basis; heightened competition, including specifically the intensification of price competition; the entry of new competitors and the development of new products or services by new and existing competitors; changes in business strategy or development plans; inability to carry out marketing and sales plans; business disruptions; liability and other claims asserted against the Company; loss of key executives; the ability to attract and retain qualified personnel; adverse publicity; demographic changes; and other factors referenced or incorporated by reference in this report and other reports or filings with the Commission. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the

Company’s business or the extent to which any factor may cause actual results to differ materially from those contained in any forward looking statements. These forward-looking statements represent the estimates and assumptions of management only as of the date of this report. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward looking statement contained herein to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

In its normal operations, the Company has market risk exposure to interest rates due to its interest bearing debt obligations, which were entered into for purposes other than trading purposes. To manage its exposure to changes in interest rates, the Company uses both variable rate debt and fixed rate debt of short duration with maturities ranging from 30 to 180 days. The Company has estimated its market risk exposure using sensitivity analyses assuming a 10% change in market rates.

At February 28, 2005, the Company had approximately $34.5 million of debt obligations outstanding with a weighted average interest rate of 4.66%. A hypothetical 10% change in the effective interest rate for these borrowings, assuming debt levels as of February 28, 2005, would change interest expense by approximately $160,000 annually. This would be funded out of cash flows from operations, which were approximately $11.3 million for the twelve most recent months ended February 28, 2005.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commissions’ rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that are filed under the Exchange Act is accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Under the supervision of and with the participation of management, including the chief executive officer and chief financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of February 28, 2005 and based on its evaluation, the Company’s chief executive officer and chief financial officer have concluded that these controls and procedures are effective.

There have been no significant changes in disclosure controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation described above, including any corrective actions with regard to significant deficiencies and material weaknesses.

During the period covered by this report on Form 10-Q, there have been no changes in our internal control over financial reporting that has materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

The annual meeting of stockholders of the Company was held on January 21, 2005. At the meeting, all seven directors of the Company were re-elected. Following are the totals of the votes cast at the meeting:

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.


HORIZON HEALTH CORPORATION

By:		/S/ JOHN E. PITTS
		John E. Pitts Senior Vice President –Finance and Principal Financial Officer


PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS		3

Horizon Health Corporation

Consolidated Balance Sheets as of February 28, 2005 and August 31, 2004 (each unaudited)		3

Consolidated Statements of Operations for the three and six months ended February 28, 2005 and February 29, 2004 (each unaudited)		5

Consolidated Statements of Cash Flows for the six months ended February 28, 2005 and February 29, 2004 (each unaudited)		7

Notes to Consolidated Financial Statements (unaudited)		8
Organization		8
Significant Accounting Policies and Procedures		8
Stock Options and Other Stock Awards		9
Earnings Per Share		10
Acquisitions		11
Goodwill and Other Intangible Assets		12
Long Term Debt		13
Commitments and Contingencies		14
Shareholders’ Equity		15
Segment Information		16
Reorganization Program		17
Subsequent Event		17

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		18
Overview		18
Recent Developments		18
Revenues		19
Operating Expenses		22
Summary Statistical Data		24
Results of Operations		24
Newly Issued Accounting Standards		31
Sarbanes-Oxley and Related Compliance		31
Liquidity and Capital Resources		31
Critical Accounting Policies and Estimates		32
Disclosure Regarding Forward Looking Statements		32

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		33

ITEM 4. CONTROLS AND PROCEDURES		33

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS		34

ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS		34

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K		35


	February 28, 2005		August 31, 2004
CURRENT ASSETS:
Cash and cash equivalents	$	2,691,219	$	1,907,708
Accounts receivable less allowance for doubtful accounts of $3,566,933 at February 28, 2005 and $2,412,152 at August 31, 2004		26,627,634		22,058,989
Prepaid expenses and supplies		1,491,849		573,230
Other receivables		1,184,911		964,969
Other assets		766,477		806,019
Income taxes receivable		212,614		51,886
Deferred taxes		2,435,238		2,426,199

TOTAL CURRENT ASSETS		35,409,942		28,789,000

Property and equipment, net		28,476,480		28,801,497
Goodwill		83,412,962		83,723,888
Other indefinite life intangibles		1,124,988		795,988
Contracts, net of accumulated amortization of $6,624,160 at February 28, 2005, and $6,184,217 at August 31, 2004		1,965,584		2,405,526
Other intangibles, net of accumulated amortization of $588,702 at February 28, 2005, and $458,460 at August 31, 2004		188,312		318,554
Other non-current assets		185,157		430,434

TOTAL ASSETS	$	150,763,425	$	145,264,887


	February 28, 2005			August 31, 2004
CURRENT LIABILITIES:
Accounts payable	$	3,422,510		$	2,772,608
Employee compensation and benefits		8,768,430			9,244,235
Medical claims payable		2,742,108			2,461,535
Accrued expenses and unearned revenue		9,933,796			8,750,459

TOTAL CURRENT LIABILITIES		24,866,844			23,228,837
Other noncurrent liabilities		2,179,326			1,570,386
Long-term debt		34,500,000			40,000,000
Deferred income taxes		5,317,025			4,641,257

TOTAL LIABILITIES		66,863,195			69,440,480

Commitments and contingencies

STOCKHOLDERS’ EQUITY:
Preferred stock, $.10 par value, 500,000 shares authorized; none issued or outstanding		—			—
Common stock, $.01 par value, 40,000,000 shares authorized; 7,267,750 shares issued and 5,639,399 shares outstanding at February 28, 2005 and 7,267,750 shares issued and 5,471,739 shares outstanding at August 31, 2004		72,678			72,678
Additional paid-in capital		23,907,015			23,083,887
Retained earnings		75,865,267			69,919,007
Treasury stock, at cost, 1,628,351 shares at February 28, 2005 and 1,796,011 shares at August 31, 2004		(15,944,730	)		(17,251,165	)

		83,900,230			75,824,407

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	150,763,425		$	145,264,887


	Three Months Ended February
	2005			2004
Revenue	$	54,432,543		$	42,138,796
Cost of services (exclusive of depreciation shown separately below)		41,918,819			32,455,627

Gross profit		12,513,724			9,683,169
Selling, general and administrative		5,514,933			4,329,842
Provision for doubtful accounts		553,133			151,307
Depreciation and amortization		796,900			645,353

Operating income		5,648,758			4,556,667

Other income (expense):
Interest expense		(596,669	)		(236,189	)
Interest income and other		(5,857	)		5,917

Income before income taxes		5,046,232			4,326,395
Income tax provision		1,968,024			1,657,009

Net income	$	3,078,208		$	2,669,386

Earnings per common share:
Basic	$	.55		$	.49

Diluted	$	.53		$	.47

Weighted average shares outstanding:
Basic		5,606,394			5,401,225

Diluted		5,826,493			5,674,117


	Six Months Ended February
	2005			2004
Revenue	$	106,510,505		$	84,185,442
Cost of services (exclusive of depreciation shown separately below)		81,215,843			64,939,890

Gross profit		25,294,662			19,245,552
Selling, general and administrative		11,089,536			9,078,837
Provision for (recovery of) doubtful accounts		1,417,054			(115,203	)
Depreciation and amortization		1,684,809			1,307,789

Operating income		11,103,263			8,974,129

Other income (expense):
Interest expense		(1,168,224	)		(492,806	)
Interest income and other		179			28,139

Income before income taxes		9,935,218			8,509,462
Income tax provision		3,874,731			3,259,125

Net income	$	6,060,487		$	5,250,337

Earnings per common share:
Basic	$	1.09		$	.98

Diluted	$	1.05		$	.93

Weighted average shares outstanding:
Basic		5,569,686			5,383,679

Diluted		5,764,508			5,661,855

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	Three Months Ended February				Six Months Ended February
	2005		2004		2005		2004
Net Income, as reported	$	3,078,208	$	2,669,386	$	6,060,487	$	5,250,337
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		293,449		193,027		523,589		375,411

Pro forma net income	$	2,784,759	$	2,476,359	$	5,536,898	$	4,874,926


Earnings per share:
Basic-as reported	$	.55	$	.49	$	1.09	$	.98

Basic-pro forma	$	.50	$	.46	$	.99	$	.91


Diluted-as reported	$	.53	$	.47	$	1.05	$	.93

Diluted-pro forma	$	.48	$	.44	$	.96	$	.86


	2005					2004
	Net Income Numerator		Shares Denominator	Per Share Amount		Net Income Numerator		Shares Denominator	Per Share Amount
For the three months ended February
Basic EPS	$	3,078,208	5,606,394	$	.55	$	2,669,386	5,401,225	$	.49

Effect of Dilutive Securities Options			220,099					272,892

Diluted EPS	$	3,078,208	5,826,493	$	.53	$	2,669,386	5,674,117	$	.47


	2005					2004
	Net Income Numerator		Shares Denominator	Per Share Amount		Net Income Numerator		Shares Denominator	Per Share Amount
For the six months ended February
Basic EPS	$	6,060,487	5,569,686	$	1.09	$	5,250,337	5,383,679	$	.98

Effect of Dilutive Securities Options			194,822					278,176

Diluted EPS	$	6,060,487	5,764,508	$	1.05	$	5,250,337	5,661,855	$	.93


	Three Months Ended February, 2004		Six Months Ended February, 2004
Revenue	$	47,189,493	$	93,640,286

Net Income	$	2,905,089	$	5,419,067

Net Income per common share:
Basic	$	.53	$	1.01

Diluted	$	.51	$	.96


Six months ending August 31, 2005	$	378,338
For the year ending August 31, 2006		492,910
For the year ending August 31, 2007		443,937
For the year ending August 31, 2008		409,429
For the years ending August 31, 2009 and thereafter		429,282

	$	2,153,896


	Behavioral Health Services (1)			Physical Rehabilitation Services		EAP-Services		ProCare One Nurses		Consolidated
Goodwill & certain indefinite life intangible asset as of August 31, 2004	$	30,611,122		$	1,703,665	$	42,216,494	$	9,988,595	$	84,519,876
Goodwill adjusted during the period		(310,926	)		—		—		—		(310,926	)
Certain indefinite life intangible
assets adjusted during the period		329,000			—		—		—		329,000

Goodwill and certain indefinite life intangible asset as of February 28, 2005	$	30,629,196		$	1,703,665	$	42,216,494	$	9,988,595	$	84,537,950


Six months ending August 31, 2005	$	1,723,524
For the year ending August 31, 2006		2,824,042
For the year ending August 31, 2007		2,060,155
For the year ending August 31, 2008		1,820,577
For the years ending August 31, 2009 and thereafter		10,424,095

	$	18,852,393


Three months ended February 28, 2005	(A) Behavioral Health Services		(B) Physical Rehabilitation Services		(C) EAP- Services		(D) ProCare One Nurses		(E) Other			Eliminations			Consolidated
Revenues	$	32,704,677	$	4,404,849	$	12,535,217	$	4,720,002	$	67,798		$	—		$	54,432,543
Intercompany revenues		8,093		—		93,954		7,094		—			(109,141	)		—
Cost of services		23,784,955		3,277,626		10,721,448		4,343,931		(100,000	)		(109,141	)		41,918,819
EBITDA (F)		7,606,687		859,821		1,292,859		320,599		(3,634,308	)		—			6,445,658
Total assets		149,537,654		16,383,408		47,465,404		16,231,731		30,870,757			(109,725,529	)		150,763,425

February 29, 2004
Revenues	$	19,501,415	$	5,077,683	$	12,904,214	$	4,561,672	$	93,812			—		$	42,138,796
Intercompany revenues		—		—		55,416		94,087		—		$	(149,503	)		—
Cost of services		13,042,175		3,683,400		11,432,571		4,369,978		77,006			(149,503	)		32,455,627
EBITDA (F)		5,994,003		1,159,691		1,154,675		224,950		(3,331,299	)		—			5,202,020
Total assets	$	107,075,429	$	14,167,707	$	48,790,519	$	15,207,755	$	35,109,814		$	(116,393,811	)	$	103,957,413

Six months ended February 28, 2005	(A) Behavioral Health Services		(B) Physical Rehabilitation Services		(C) EAP- Services		(D) ProCare One Nurses		(E) Other			Eliminations			Consolidated
Revenues	$	62,036,843	$	9,312,555	$	25,557,784	$	9,512,389	$	90,934		$	—		$	106,510,505
Intercompany revenues		11,502		—		174,652		13,019		—			(199,173	)		—
Cost of services		43,891,611		6,571,215		22,425,274		8,626,916		(100,000	)		(199,173	)		81,215,843
EBITDA (F)		15,952,529		1,856,662		2,168,617		760,865		(7,950,498	)		(103	)		12,788,072
Total assets		149,537,654		16,383,408		47,465,404		16,231,731		30,870,757			(109,725,529	)		150,763,425

February 29, 2004
Revenues	$	38,978,402	$	9,785,327	$	25,983,801	$	9,122,420	$	315,492			—		$	84,185,442
Intercompany revenues		—		—		100,366		121,009		—		$	(221,375	)		—
Cost of services		25,844,134		7,379,480		23,134,390		8,542,034		261,227			(221,375	)		64,939,890
EBITDA (F)		12,069,426		1,944,242		2,146,048		671,426		(6,549,224	)		—			10,281,918
Total assets	$	107,075,429	$	14,167,707	$	48,790,519	$	15,207,755	$	35,109,814		$	(116,393,811	)	$	103,957,413


	February 28, 2005			November 30, 2004			August 31, 2004			August 31, 2003	August 31, 2002
Number of Contract Locations (1):
Contract locations in operation		127			128			132		127	131
Contract locations signed and unopened		14			11			8		15	11

Total contract locations		141			139			140		142	142

Services Covered by Contracts in Operation (1):
Inpatient		125			126			129		126	127
Partial hospitalization		11			15			17		25	31
Outpatient		23			23			24		21	21
Home health		2			2			2		3	3
CQI+		109			109			105		109	144

Types of Treatment Programs in Operation (1):
Geropsychiatric		80			85			85		87	106
Adult psychiatric		45			44			49		48	44
Substance abuse		3			4			4		4	2
Physical rehabilitation		32			32			33		32	28
Other mental health		4			4			4		8	2

EAP and Managed Behavioral Heath Care Services:
Covered Lives (000’s)		3,847			3,709			3,567		3,217	2,349

Owned/Leased Freestanding Behavioral Health Hospitals:
Total net revenues (000’s)	$	12,175		$	9,114		$	10,069		—	—
Number of facilities at period end		3			2			2		—	—
Licensed Beds		427			267			267		—	—
Weighted average available beds		316			241			177		—	—
Patient days		21,196			17,756			19,639		—	—
Admissions		1,314			847			1,041		—	—
Average length of stay		16.1			21.0			18.9		—	—
Revenue per patient day	$	574		$	513		$	513		—	—
Occupancy based on weighted average available beds		74.5	%		81.0	%		72.5	%	—	—


	Three Months Ended February				Six Months Ended February
	2005		2004		2005		2004
Revenues	100.0	%	100.0	%	100.0	%	100.0	%
Cost of Services	77.0		77.0		76.3		77.1

Gross Profit	23.0		23.0		23.7		22.9
Selling, general and administrative	10.1		10.3		10.4		10.8
Provision for (recovery of) doubtful accounts	1.0		0.4		1.3		(0.1	)
Depreciation and amortization	1.5		1.5		1.6		1.5

Income from operations	10.4		10.8		10.4		10.7
Interest and other income (expense), net	(1.1	)	(0.6	)	(1.1	)	(0.6	)

Income before income taxes	9.3		10.2		9.3		10.1
Income tax provision	3.6		3.9		3.6		3.9

Net income	5.7	%	6.3	%	5.7	%	6.2	%


Director	Number of Votes for Re-Election	Number of Votes Withheld
James Ken Newman	4,105,826	1,257,168
George Bello	4,105,869	1,257,125
Michael R. Bowlin	4,881,879	481,115
James E. Buncher	4,106,057	1,256,937
Robert A. Lefton	3,917,058	1,445,936
William H. Longfield	4,106,118	1,258,876
Donald E. Steen	4,106,118	1,258,876


NUMBER		EXHIBIT

3.1		Certificate of Incorporation of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K dated August 11, 1997).

3.2		Amended and Restated Bylaws of the Company, as amended (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K dated February 23, 2005.)

4.1		Specimen certificate for the Common Stock, $.01 par value of the Company (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K dated August 11, 1997).

4.2		Rights Agreement, dated February 6, 1997, between the Company and American Stock Transfer & Trust Company, as Rights Agent (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A, Registration No. 000-22123, as filed with the Commission on February 7, 1997).

10.1		Long-term operating lease agreement of Laurelwood Hospital dated December 30, 2004 between the Company and Lake Hospital System Inc. (filed herewith).

10.2		Horizon Health Corporation 2005 Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated January 21, 2005).

31.1		Certification of Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14(a) or 15d-14(a).

31.2		Certification of Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14(a) or 15d-14(a).

32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.