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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
SCHEDULE 14A INFORMATION

Filed by the Registrant  x

Check the appropriate box:

PSYCHIATRIC SOLUTIONS, INC.
(Name of Registrant as Specified In Its Charter)
(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)

Payment of Filing Fee (Check the appropriate box):

x	No fee required.
o	Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

(1)	Title of each class of securities to which transaction applies:
(2)	Aggregate number of securities to which transaction applies:
(3)	Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined):
(4)	Proposed maximum aggregate value of transaction:
(5)	Total fee paid:

o	Fee paid previously with preliminary materials.
o	Check box if any part of the fee is offset as provided by Exchange Act Rule  0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing.

(1)	Amount Previously Paid:
(2)	Form, Schedule or Registration Statement No.:
(3)	Filing Party:
(4)	Date Filed:

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PSYCHIATRIC SOLUTIONS, INC.
113 Seaboard Lane, Suite C-100
Franklin, TN 37067

NOTICE OF SPECIAL MEETING OF SHAREHOLDERS

TO BE HELD ON FEBRUARY 4, 2003

To the Shareholders of Psychiatric Solutions, Inc.:

NOTICE IS HEREBY GIVEN that a Special Meeting of Shareholders (“Meeting”) of Psychiatric Solutions, Inc. (“Company”) will be held at the office of Harwell Howard Hyne Gabbert & Manner, P.C., located at 315 Deaderick Street, Suite 1800, Nashville, Tennessee 37238, on February 4, 2003, at 10:00 a.m., local time, to consider and act upon the following matters:

	1.		An amendment to Article V(A) of the Company’s Amended and Restated Certificate of Incorporation, as amended, to increase the authorized number of shares of the Company’s preferred stock, par value $.01 per share, from 2,000,000 shares to 6,000,000 shares.
	2.		The issuance and sale of 4,545,454 shares of Series A Convertible Preferred Stock in a private placement.
	3.		Transaction of such other business as may properly come before the Meeting or any adjournment or postponement thereof.

     Your attention is directed to the Proxy Statement accompanying this Notice which more fully describes the foregoing proposals.

     The Board of Directors has fixed the close of business on December 6, 2002 as the record date for the determination of Company shareholders entitled to receive notice of and to vote at the Meeting or any adjournment or postponement thereof. Shares can be voted at the Meeting only if the holder is present at the Meeting in person or by valid proxy.

     The officers and directors of the Company cordially invite you to attend the Meeting. However, to ensure your representation at the Meeting, you are urged to mark, date, sign and return the enclosed proxy as promptly as possible in the postage-prepaid envelope enclosed for that purpose.

YOU MAY REVOKE YOUR PROXY IN THE MANNER DESCRIBED IN THE
ACCOMPANYING PROXY STATEMENT AT ANY TIME BEFORE IT HAS BEEN VOTED
AT THE MEETING. ANY SHAREHOLDER ATTENDING THE MEETING MAY VOTE IN
PERSON EVEN IF HE, SHE OR IT HAS RETURNED A PROXY.

By Order of the Board of Directors,

Steven T. Davidson, Secretary

Nashville, Tennessee
January 22, 2003

IMPORTANT

SHAREHOLDERS ARE REQUESTED TO DATE, SIGN AND MAIL THE ENCLOSED PROXY, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING. A POSTAGE PAID ENVELOPE IS PROVIDED FOR MAILING.

PSYCHIATRIC SOLUTIONS, INC.
113 Seaboard Lane, Suite C-100
Franklin, TN 37067

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TABLE OF CONTENTS

Appendix A – Proposed Charter Amendment
Appendix B – Purchase Agreement
Appendix C – Registration Rights Agreement
Appendix D – Proposed Certificate of Designations
Appendix E – Opinion of Brentwood Capital

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QUESTIONS AND ANSWERS

     Although we encourage you to read the Proxy Statement in its entirety, we include this Question and Answer section to provide some background information and brief answers to several questions you might have about the enclosed proposals. In this Question and Answer section and in the Proxy Statement, Psychiatric Solutions, Inc. is referred to as “Company,” “we,” “our,” and “us.”

Q.		WHAT PROPOSALS ARE COMPANY SHAREHOLDERS BEING ASKED TO CONSIDER AND APPROVE AT THE SPECIAL MEETING?
A.		We are seeking approval of two proposals.
		Proposal 1 relates to the amendment of our Amended and Restated Certificate of Incorporation, as amended (“Charter”), to increase the number of authorized shares of preferred stock from 2,000,000 to 6,000,000.
		Proposal 2 relates to our private placement of Series A Convertible Preferred Stock, par value $.01 per share (“Series A Stock”), which is convertible into our common stock, par value $.01 per share (“Common Stock”), and will vote with the Common Stock as a single class with one vote per share of Series A Stock.
Q.		WHO ARE THE INVESTORS IN THIS PRIVATE PLACEMENT?
A.		Oak Investment Partners X, Limited Partnership, and Oak X Affiliates Fund, Limited Partnership (collectively, “Oak X”) are the lead purchasers in this private placement. Oak Investment Partners, which manages Oak X is an experienced venture capital firm with over $4.2 billion in committed capital. Entities managed by Salix Ventures (collectively, “Salix”) and The 1818 Mezzanine Fund II, L.P. (“1818 Fund”) will also purchase shares in this private placement (Oak X, Salix and 1818 Fund, collectively, the “Investors”). The Investors and/or certain of their affiliates are current shareholders of Common Stock.
Q.		HOW IS THE PRIVATE PLACEMENT STRUCTURED?
A.		The private placement will be completed in two steps. In the first step, 2,272,727 shares of Series A Stock will be issued for an aggregate gross purchase price of approximately $12.5 million on March 31, 2003. In the second step, the remaining 2,272,727 shares will be issued for an aggregate gross purchase price of approximately $12.5 million on June 30, 2003. We intend to issue a total of 4,545,454 shares of Series A Stock for an aggregate gross purchase price of approximately $25 million. The Series A Stock will initially be convertible into 4,545,454 shares of Common Stock.
Q.		WHY IS THE COMPANY SEEKING SHAREHOLDER APPROVAL FOR PROPOSALS 1 AND 2?
A.		Under Delaware law, we need shareholder approval to amend our Charter to increase the number of authorized shares of preferred stock.

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		We are also subject to the Nasdaq Stock Market rules because our Common Stock is listed on the Nasdaq National Market. These rules require shareholder approval of any issuance of stock that could result in a change of control of the issuer. The transaction described in Proposal 2, if it occurs, may be considered a change of control of the Company because following the transaction, Oak X, together with other entities managed by Oak Investment Partners, will own approximately 43.2% of the outstanding capital stock of the Company assuming the conversion of all outstanding shares of Series A Stock into Common Stock at a $5.50 conversion price. In addition, Salix, together with its affiliates, will own approximately 7.6% of the outstanding capital stock of the Company, and 1818 Fund will own approximately 4.5% of the outstanding capital stock of the Company, in each case assuming the conversion of all outstanding shares of Series A Stock into Common Stock at a $5.50 conversion price. 1818 Fund also has a Board designee and a warrant to purchase an additional 2.9% of the Company’s Common Stock. See “Proposal II – Relationship of the Investor to Company”. The Investors will also have the right to elect two members of the Board. There is no specific test provided by the Nasdaq Stock Market rules to determine the amount of securities that the Company may issue to a person without triggering the change of control provisions under these market rules. While we do not believe the proposed transaction constitutes a change in control, Nasdaq may interpret its change of control rules differently.
		Furthermore, the Nasdaq Stock Market rules require stockholder approval of any issuance of stock at a price below the book value or market value of the issuer’s stock, where the amount of stock being issued is equal to 20% or more of the total common stock outstanding or equal to 20% or more of the voting power outstanding.
		Our Common Stock issuable upon conversion of the Series A Stock to be purchased by the Investors would exceed 20% of our total Common Stock outstanding and the voting power of the Series A Stock (which will vote with the Common Stock as a single class with one vote per share of Series A Stock) to be purchased by the Investors exceeds 20% of the voting power outstanding. The Series A Stock is being issued at a price of $5.50 per share. As of November 30, 2002, the book value of our Common Stock was $4.07 and the closing market price reported on Nasdaq National Market on January 6, 2003 was $5.35. The Series A Stock accrues dividends and has certain anti-dilution protection features. These anti-dilution protection features could cause the effective per share price of shares of Common Stock issued upon conversion of the Series A Stock to be below the book or market value at the time such shares of Common Stock are issued.
Q.		WHY IS THE COMPANY PURSUING THE PRIVATE PLACEMENT?
A.		We plan to execute our growth strategy by making strategic acquisitions. A primary purpose of completing the private placement is to provide funds to allow us to be in a position to quickly fund such acquisitions. We do not currently have any identified acquisitions that are probable. Although we have a number of potential acquisitions currently being considered, the Company is not a party to any signed letters of intent with respect to any acquisition. The net proceeds from the proposed private placement will enhance our liquidity, strengthen our balance sheet and facilitate the execution of our acquisition strategy. The proposed private placement will enable us to access additional senior and subordinated debt available under our existing credit facilities without violating financial or other covenants governing these facilities. The proposed additional equity will also enable us to effectively consider and compete for transactions involving multiple behavioral healthcare facilities.

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Q.		WHAT IF PROPOSALS 1 AND 2 ARE NOT APPROVED?
A.		If our shareholders do not approve Proposals 1 and 2, the Series A Stock will not be issued. Management believes if the shareholders do not authorize the proposed private placement, it may be difficult for us to obtain alternative sources of financing on a timely basis or at all. Even if we are able to timely obtain such an alternative source of financing, there can be no assurance that the terms will be as favorable as the terms of the private placement with the Investors, or acceptable to us at all.
Q.		ARE DISSENTERS’ RIGHTS OF APPRAISAL AVAILABLE?
A.		No.

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PROXY STATEMENT

     This Proxy Statement and the accompanying proxy card are furnished to the holders of Common Stock in connection with the solicitation of proxies by the Board of Directors (“Board”) of the Company for use at the Company’s Special Meeting of Shareholders to be held at the office of Harwell Howard Hyne Gabbert & Manner, P.C., located at 315 Deaderick Street, Suite 1800, Nashville, Tennessee 37238, on February 4, 2003, at 10:00 a.m., local time, and at any and all adjournments or postponements thereof (“Meeting”).

THE ENCLOSED PROXY IS SOLICITED BY THE BOARD.

     The purpose of the Meeting will be to consider and vote upon the following proposals (“Proposals”):

	1.		An amendment to Article V(A) of the Company’s Charter to increase the authorized number of shares of the Company’s undesignated preferred stock, par value $.01 per share, from 2,000,000 shares to 6,000,000 shares.
	2.		The issuance and sale of 4,545,454 shares of Series A Stock in a private placement (“Transaction”).
	3.		Transaction of such other business as may properly come before the Meeting or any adjournment or postponement thereof.

     This Proxy Statement, together with the Notice of Special Meeting of Shareholders and the accompanying proxy card, is first mailed to Company shareholders on or about January 22, 2003.

     The solicitation of proxies will initially be made by mail and may thereafter be made in person or by mail, telephone, telecopy, telegram, facsimile or other means of communication by the directors, officers and regular employees of the Company for no additional or special compensation. In addition, brokerage houses, banks, nominees, trustees, custodians and other fiduciaries will be requested by the Company to forward proxy solicitation materials for shares of Common Stock held of record by them to the beneficial owners of such shares, and such fiduciaries will, upon request, be reimbursed by the Company for their reasonable out-of-pocket expenses incurred in connection therewith. The cost of the solicitation of proxies for use at the Meeting will be borne by the Company.

VOTING RIGHTS AND PROCEDURES

     Only Company shareholders of record as of the close of business on December 6, 2002 (“Record Date”) are entitled to notice of and to vote at the Meeting. As of the Record Date, there were issued and outstanding 7,738,643 shares of Common Stock. Each holder of Common Stock issued and outstanding on the Record Date is entitled to one vote for each such share held on each matter to be considered at the Meeting.

     The holders of a majority of the voting power of all issued and outstanding shares of the Company’s capital stock entitled to vote, present in person or represented by proxy, shall constitute a quorum at the Meeting. Treasury shares, if any, will not be voted and are not counted in determining the number of outstanding shares for voting purposes.

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     The affirmative vote of the holders of a majority of the voting power of the outstanding shares of Common Stock, voting in person or by proxy, is required to approve and ratify Proposal 1.

     The affirmative vote of the Company’s shareholders having a majority of the voting power of all shares present, in person or by proxy and entitled to vote at the Meeting is required to approve and ratify Proposal 2.

     In the event the Company’s shareholders approve Proposal 1 and do not approve the Transaction described in Proposal 2, the Charter will be amended but the Transaction will not occur. In the event the Company’s shareholders approve the Transaction described in Proposal 2 and do not approve Proposal 1, the Transaction will not occur.

     Abstentions and “broker non-votes” (shares held of record by brokers or nominees which are not voted on a particular matter because the broker or nominee has not received voting instructions from the beneficial owner of such shares and does not have discretionary voting power with respect to that matter) will be treated as present for purposes of determining the presence of a quorum for the transaction of business at the Meeting. Abstentions will be treated as a vote against Proposal 1 and Proposal 2. Broker non-votes will not be counted for purposes of determining the number of votes cast.

     If a proxy card is properly signed and returned to the Company at or prior to the Meeting, unless subsequently properly revoked, the shares represented by that proxy card will be voted at the Meeting in accordance with the instructions specified thereon. If a proxy card is properly signed and returned to the Company at or prior to the Meeting without voting instructions, it will be voted “FOR” the Proposals and, if any other matters are properly presented at the Meeting, the persons appointed as proxies in the proxy card will have the discretionary authority to vote or act thereon in accordance with their best judgment.

     Any Company shareholder may revoke a proxy at any time before it is exercised, either by delivering to the Secretary of the Company a written notice of revocation or a properly signed proxy bearing a later date, or by attending the Meeting and voting in person. Attendance at the Meeting will not in and of itself constitute the revocation of a proxy.

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SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS
AND MANAGEMENT

     The following table sets forth, as of December 6, 2002, the number and percentage of outstanding shares of Common Stock beneficially owned by (a) each person known by the Company to beneficially own more than 5% of such stock, (b) each director of the Company, (c) each of the executive officers of the Company required to be disclosed pursuant to Item 403(b) of Regulation S-K, and (d) all directors and executive officers of the Company as a group. Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares shown as beneficially owned.

* Represents beneficial ownership of less than 1%.

(1)		Shares of Common Stock subject to options exercisable within 60 days of December 6, 2002 (“Currently Exercisable Options”) are deemed outstanding for computing the percentage of the person holding such options but are not deemed outstanding for computing the percentage of any other person.
(2)		Based solely on a Schedule 13D, dated August 5, 2002, Oak Investment Partners VII, Limited Partnership (“Oak VII Partners”) & Oak VII Affiliates Fund, Limited Partnership (“Oak VII Affiliates” and together with Oak VII Partners, “Oak VII”) are record holders of an aggregate of 1,673,772 shares. By virtue of their relationship as affiliated partnerships, Oak VII Partners and Oak VII Affiliates may be deemed to share voting and investment control over such shares. Therefore, each of Oak VII Partners and Oak VII Affiliates may be deemed to beneficially own all of such shares. Each of Oak VII Partners and Oak VII Affiliates disclaims beneficial ownership of any shares, which it does not hold of record.

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(3)		Includes 1,201 shares issuable pursuant to Currently Exercisable Options.
(4)		Includes 1,641,669 shares owned by Acacia Venture Partners, L.P. (“Acacia”) and South Pointe Venture Partners (“South Pointe”). Mr. Heer, a director of the Company, is the board designee for Acacia and South Pointe. By virtue of this position, Mr. Heer may be deemed to share voting and investment control over the shares owned by Acacia and South Pointe. Therefore, Mr. Heer may be deemed a beneficial owner of those shares. Mr. Heer disclaims any beneficial ownership of such shares.
(5)		Includes warrants to purchase 372,412 shares issued to the 1818 Fund. Mr. Donlan, a director of the Company, is the board designee for 1818 Fund. By virtue of this position, Mr. Donlan may be deemed to share voting and investment control over the warrants issuable to 1818 Fund. Therefore, Mr. Donlan may be deemed a beneficial owner of those shares. Mr. Donlan disclaims beneficial ownership of such shares.
(6)		Includes 151,886 shares issuable pursuant to Currently Exercisable Options.
(7)		Includes 207,031 shares owned by CGJR Group. Mr. Grant, a director of the Company, is the board designee for CGJR Group. By virtue of this position, Mr. Grant may be deemed to share voting and investment control over the shares owned by CGJR Group. Therefore, Mr. Grant may be deemed a beneficial owner of those shares. Mr. Grant disclaims any beneficial ownership of such shares.
(8)		Includes 24,035 shares issuable pursuant to Currently Exercisable Options.
(9)		Includes 168,943 shares owned by Proactive Partners, L.P. Charles C. McGettigan, a director of the Company, is a general partner of Proactive Partners, L.P. Also include 13,584 shares held by Mr. McGettigan. Mr. McGettigan disclaims beneficial ownership of any shares held by Proactive Partners, L.P., except to the extent of his respective interest in such shares arising from his pecuniary interest in such partnership.
(10)		Includes 8,644 shares owned by Mr. Jacobs’ sons. By virtue of their relationship, Mr. Jacobs may be deemed to share voting and investment control over the shares owned by his sons. Therefore, Mr. Jacobs may be deemed a beneficial owner of those shares. Mr. Jacobs disclaims any beneficial ownership of such shares.
(11)		Includes 46,050 shares issuable pursuant to Currently Exercisable Options.
(12)		Includes 20,109 shares issuable pursuant to Currently Exercisable Options.
(13)		Includes 20,723 shares issuable pursuant to Currently Exercisable Options.
(14)		Includes 8,579 shares issuable pursuant to Currently Exercisable Options.
(15)		Includes 7,196 shares issuable pursuant to Currently Exercisable Options.
(16)		Includes 654,593 shares issuable pursuant to Currently Exercisable Options.

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CHANGE IN CONTROL TRANSACTION

     On August 5, 2002, pursuant to a definitive Merger Agreement dated May 6, 2002, PMR Corporation, a Delaware corporation (predecessor to the Company, “PMR”) caused its newly formed, wholly owned subsidiary, PMR Acquisition Corporation, to merge with and into Psychiatric Solutions, Inc., a Delaware corporation (“PSI”). PSI, the surviving corporation in the merger (the “Merger”), became a direct subsidiary of PMR and changed its name to Psychiatric Solutions Hospitals, Inc. (“PSH”). Concurrently, PMR changed its name to Psychiatric Solutions, Inc. In exchange for each outstanding share of common stock, Series A Preferred Stock and Series B Preferred Stock in PSH, common, Series A and Series B stockholders of PSH received 0.115125, 0.246951 and 0.312864 shares, respectively, of newly-issued shares of Common Stock. Options to acquire PSH common stock were converted into options to purchase shares of Common Stock based on the common stock exchange ratio used in the Merger. Then existing warrants of PSH were either cancelled or converted into warrants to purchase Common Stock, such conversion being based on the applicable exchange ratio. After giving effect to the exercise of all outstanding options and warrants following the Merger, the former PSH stockholders received approximately 72% of the Common Stock, thereby effecting a change in control of the Company.

PROPOSAL 1

AMENDMENT TO THE COMPANY’S CHARTER TO INCREASE THE NUMBER OF
AUTHORIZED SHARES OF PREFERRED STOCK

     The Charter provides that the Company is authorized to issue two classes of stock, consisting of 48,000,000 shares of Common Stock and 2,000,000 shares of preferred stock. On December 5, 2002, the Board unanimously approved an amendment to the Charter (the “Proposed Charter Amendment”), subject to shareholder approval, to increase the authorized number of shares of preferred stock to 6,000,000 shares. The Proposed Charter Amendment does not change the authorized number of shares of the Company’s Common Stock.

     The Board unanimously recommends that the shareholders of the Company approve the increase of the Company’s authorized shares of preferred stock. The text of the Proposed Charter Amendment is attached to this Proxy Statement as Appendix A and is incorporated herein by this reference.

The Company’s Existing Preferred Stock

     As of the date of this Proxy Statement, the Company’s two million (2,000,000) authorized shares of preferred stock were undesignated and unissued.

Purpose and Effect of Increasing the Authorized Number of Preferred Shares

     Subject to approval of Proposal 1 by the Company’s shareholders, prior to the Transaction the Company will designate 4,545,454 shares of preferred stock as Series A Stock, leaving a total of 1,454,546 shares of preferred stock authorized for future issuances.

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     As of the date of this Proxy Statement, the Board has no agreement, arrangement or intention to issue any shares of preferred stock for which approval is sought, except pursuant to the Transaction. Nevertheless, authorizing additional shares of preferred stock in excess of the 4,545,454 shares designated as Series A Stock may allow the Board to: raise additional capital through the sale of securities; acquire another company or its business or assets in exchange for shares of preferred stock; establish strategic relationships with corporate partners who are compensated with shares of preferred stock; provide equity incentives to employees, officers or directors or; pursue other matters as it deems appropriate. If the increase in the number of authorized shares of preferred stock is approved by the Company’s shareholders, the Board does not intend to solicit further shareholder approval prior to the issuance of any additional shares of preferred stock, except as may be required by applicable law, Nasdaq or other applicable stock exchange requirements or the terms of any series of outstanding shares of preferred stock, and the terms of such preferred stock will have the rights and preferences determined by the Board.

Potential Effect of Increasing the Number of Authorized Preferred Shares on Holders of Common Stock

     The holders of Common Stock do not have any preemptive or similar rights to purchase any shares of preferred stock. Although the increase in the authorized number of shares of preferred stock will not, in and of itself, have any immediate effect on the rights of the holders of shares of Common Stock, the issuance of shares of one or more series of preferred stock could, depending on the nature of the rights and preferences granted to a newly issued series of preferred stock, affect the holders of shares of Common Stock in a number of respects, including the following:

	•		By diluting the voting power of the holders of Common Stock, to the extent that a new series of preferred stock has voting rights;
	•		By reducing the amount otherwise available for payment of dividends on Common Stock, to the extent dividends are payable on shares of a new series of preferred stock;
	•		By restricting the payment of dividends on Common Stock;
	•		By decreasing the market price of the Common Stock, to the extent that a new series of preferred stock provides for the conversion of such preferred stock into Common Stock at prices that could be below the fair market value of the Common Stock (either initially or following implementation of anti-dilution or other adjustment provisions);
	•		By reducing the amount otherwise available for payment upon liquidation of the Company to holders of Common Stock, to the extent of any liquidation preference on a new series of preferred stock; and
	•		By diluting the earnings per share and book value per share of outstanding shares of Common Stock and preferred stock.

     In addition, although increasing the number of authorized shares of the Company’s preferred stock is not motivated by takeover concerns and is not considered or intended by the Board to be an anti-takeover measure, the availability of additional authorized shares of preferred stock could enable the Board to make more difficult, discourage or prevent an attempt by a

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person, group or entity to obtain control of the Company by a merger, tender offer, proxy contest or other means. For example, the Board could issue shares of preferred stock defensively upon favorable terms in response to a takeover attempt. Such issuances could deter the types of transactions which may be proposed or could discourage or limit the participation of Common Stock in certain types of transactions that might be proposed (such as a tender offer), whether or not such transactions were favored by the majority of the shareholders, and could enhance the ability of officers and directors to retain their positions. The Board has no present intention to use the preferred stock in order to impede a takeover attempt.

Implementing the Increase in Shares of Authorized Preferred Stock

     If approved by the Company’s shareholders at the Meeting, the increase in the number of authorized preferred shares will become effective upon the filing of a Certificate of Amendment to the Charter with the Secretary of State of the State of Delaware. Although the Board intends to file such amendment as soon as practicable following the date of the Meeting, if, in the judgment of the Board, any circumstances exist which would make such filing inadvisable, then, in accordance with Delaware law and notwithstanding the approval by the Company’s shareholders, the Board may abandon such amendment, either before or after approval and authorization thereof by the shareholders, at any time prior to the effectiveness of the filing of the amendment.

No Appraisal Rights

     Under Delaware law, the Company’s shareholders are not entitled to appraisal rights with respect to the proposed increase in the number of authorized shares of preferred stock.

Required Vote

     The affirmative vote of the holders of a majority of the voting power of the outstanding shares of Common Stock, voting in person or by proxy, is required to approve and ratify Proposal 1.

THE BOARD UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THE ADOPTION AND APPROVAL OF THE PROPOSED AMENDMENT TO ARTICLE V(A) OF THE COMPANY’S CHARTER.

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PROPOSAL 2

APPROVAL AND RATIFICATION OF THE
PRIVATE PLACEMENT PROPOSAL

     Pursuant to the Series A Stock Purchase Agreement, dated as of January 6, 2003 (“Purchase Agreement”) and subject to approval of the Company’s shareholders, the Company agreed to issue to the Investors and the Investors agreed to purchase from the Company a total of 4,545,454 shares of Series A Stock at a purchase price of $5.50 per share. On December 5, 2002, the Board unanimously approved the terms of the Transaction. Director Joseph Donlan, the representative of 1818 Fund, and Director Christopher Grant, the representative of Salix, abstained from the discussion and vote.

Why We Need Shareholder Approval

     The Common Stock is listed on the Nasdaq National Market. Rule 4350 of the Nasdaq Marketplace Rules (“Nasdaq Rule 4350”), requires shareholder approval for any issuance of stock that could result in a change of control of the issuer. Following the closing of the Transaction, the Series A Stock will represent approximately 37% of the outstanding capital stock of the Company. Oak X, together with Oak VII, will own approximately 43.2%, 1818 Fund will own approximately 4.5% and holds a warrant to purchase an additional 2.9%, and Salix, together with its affiliates, will own approximately 7.6% of the outstanding capital stock of the Company, assuming the conversion of all shares of Series A Stock into Common Stock at a $5.50 conversion price. The Investors will also have the right to elect two members to the Board. Although the Company does not believe that any change of control (whether for purposes of the Nasdaq Rule 4350 or otherwise) is occurring as a result of the Transaction, there is no concrete test to determine the amount of securities that the Company may issue to a person without triggering the change of control provisions of Nasdaq Rule 4350. Depending upon the facts and circumstances then existing, the issuance by the Company of securities representing less than a majority of the Company’s voting power may result in a change of control of the Company for purposes of Nasdaq Rule 4350. Oak X has agreed that it will not purchase additional shares of our Common Stock from a third party if such purchase would trigger the change of control provisions in the Certificate of Designation for the Series A Stock. Although the other Investors are not prohibited from purchasing additional shares of our capital stock, they have advised us that they do not currently intend to acquire additional shares of our capital stock other than the additional warrants that may be issued to 1818 Fund under the Company’s subordinated debt agreement.

     Furthermore, Nasdaq Rule 4350 requires shareholder approval prior to the issuance of securities under certain circumstances, including in connection with a transaction involving the sale or issuance by the Company of Common Stock, or securities convertible into or exercisable for Common Stock at a price below the book value or market value, where the amount of the stock being issued is equal to 20% or more of the Common Stock or 20% or more of the issuer’s voting power outstanding before such issuance.

     Our Common Stock issuable upon conversion of the Series A Stock to be purchased by the Investors would exceed 20% of our total Common Stock outstanding and the voting power of the Series A Stock (which will vote with the Common Stock as a single class with one vote per share of Series A Stock) to be purchased by the Investors exceeds 20% of the voting power

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outstanding. The Series A Stock is being issued at a price of $5.50 per share. As of November 30, 2002, the book value of our Common Stock was $4.07 and the closing market price reported on Nasdaq National Market on January 6, 2003 was $5.35. The Series A Stock also accrues dividends and has certain anti-dilution protection features. These anti-dilution protection features could cause the effective per share price of shares of Common Stock issued upon conversion of the Series A Stock to be below the book or market value at the time such shares of Common Stock are issued.

     The Company is seeking shareholder approval and ratification of the issuance of the Series A Stock pursuant to the Purchase Agreement (including any securities of the Company issued as dividends or otherwise in respect of the Series A Stock in accordance with the terms thereof) in order to ensure compliance with Nasdaq Rule 4350. Shareholder approval of the Transaction is not otherwise required as a matter of Delaware law or other applicable laws or rules or by the Company’s Charter or Bylaws.

Summary

     The following is a summary of the provisions of the Purchase Agreement and the Registration Rights Agreement between the Company and the Investors as well as the rights and preferences of the Series A Stock. Each summary is qualified in its entirety by the Purchase Agreement and the Registration Rights Agreement attached as Appendices B and C and incorporated herein.

Reasons for the Proposed Private Placement

     We decided to pursue the proposed private placement following an evaluation and review of our financial condition, funding requirements and prospects in light of our business strategy. We believe the proposed private placement will result in more long-term value for our shareholders as it will allow us to pursue our acquisition strategy and provide greater financial flexibility.

     Our current business plan requires us to make significant expenditures to finance acquisitions. The Company is actively looking for and considering potential acquisitions and maintains a list of possible acquisition targets. As of the date of this proxy, the Company does not have any identified acquisitions that are probable and is not a party to any letters of intent with respect to any specific acquisition. The net proceeds from the proposed private placement will enhance our liquidity, strengthen our balance sheet and facilitate the execution of our acquisition strategy. The proposed private placement will enable us to access additional senior and subordinated debt available under our existing credit facilities without violating financial or other covenants governing these facilities. The proposed additional equity will also enable us to effectively consider and compete for transactions involving multiple behavioral healthcare facilities.

Purchase Agreement

     Pursuant to the Purchase Agreement, the Company has agreed to issue a total of 4,545,454 shares of Series A Stock to the Investors at a purchase price of $5.50 per share. Each share of Series A Stock, upon issuance, is currently convertible (at a conversion price of $5.50 per share) into one share of Common Stock. As of the Record Date, the Series A Stock would be convertible into approximately 37.0% of the Company’s issued and outstanding shares of Common Stock.

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     We will issue, and the Series A Stock will be purchased by the Investors, on two separate funding dates. The first funding is scheduled to occur on March 31, 2003 (such date, or the date upon which the First Funding actually occurs, the “First Funding Date”), subject to the terms and conditions of the Purchase Agreement. On the First Funding Date, the Investors will purchase an aggregate of 2,272,727 shares of Series A Stock for gross proceeds of approximately $12.5 million. Provided the first funding occurs, the second funding is scheduled to occur on June 30, 2003 (such date, or the date upon which the Second Funding actually occurs, the “Second Funding Date”), subject to the terms and conditions of the Purchase Agreement. On the Second Funding Date, the Investors will purchase an aggregate of 2,272,727 shares of Series A Stock for gross proceeds of approximately $12.5 million.

     Representations, Warranties and Covenants. The Purchase Agreement contains representations and warranties relating to our organization and qualification, capitalization, authorization and enforceability of the Purchase Agreement, the issuance and sale of the Series A Stock, our filings with the SEC, regulatory compliance and other matters common in transactions of this kind. The Purchase Agreement also contains covenants by us to use commercially reasonable efforts to effect the transactions contemplated by the Purchase Agreement, notify the Investors of certain developments, maintain our listing on Nasdaq and other similar covenants common in transactions of this kind.

     Corporate Governance. In the Purchase Agreement, the Company agreed that prior to the First Funding Date it will increase the number of Board members by one and elect Ann H. Lamont to the Board. The Company further agreed to take reasonable actions to ensure that Christopher Grant remains a Board member. Following the First Funding Date, and pursuant to the rights of the holders of Series A Stock, Oak X, as the majority holder of the Series A Stock, will have the option to elect at least two of its nominees as members of the Board, one of whom will initially be Ann H. Lamont.

     Lock-up. Subject to usual conditions and exceptions for transfers to family members, affiliates, partners, members, former partners, former members, shareholders and others in private transactions in which the transferee agrees to the lock-up provisions, the Investors may not sell or transfer any shares of Series A Stock or Common Stock issued upon the conversion thereof (collectively, the “Lock-Up Shares”) until the 12-month anniversary of the First Funding Date. For six months following the 12-month anniversary of the First Funding Date, the Investors may sell or transfer up to 50% of the total number of Lock-Up Shares, computed on a fully-diluted basis. After 18-months from the First Funding Date, the lock-up restrictions shall expire; provided, however, the lock-up restrictions may expire earlier if the Company is acquired, breaches a material obligation to the Investors or other similar events occur.

     Indemnification. The Investors shall be entitled to indemnification from the Company for all liabilities to which the Investors may become subject by reason of the breach by the Company of any representation, warranty, covenant or agreement made by it contained in the Purchase Agreement or any other document related to the Transaction.

Registration Rights Agreement

     The Company agreed to file with the SEC, at the expense of the Company, a registration

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statement related to the Common Stock issued or issuable upon the conversion of the Series A Stock on the earlier to occur of (i) 90 days prior to the first anniversary of the First Funding Date or (ii) 30 days or 60 days (depending on whether registration on form S-3 or S-1 is applicable) after the early termination of the lock-up provisions in the Purchase Agreement. The Company has agreed to use its best efforts to have such registration statement declared effective by the SEC as soon as reasonably practicable, but in no event later than the first anniversary of the date of the First Funding Date. The Registration Rights Agreement contains usual and customary terms, including without limitation those related to the selection of underwriters, opinions of legal counsel and accountants, registration expenses, indemnification and other similar provisions.

Terms of the Series A Stock

     The following summary of the rights and preferences of the Series A Stock is qualified in its entirety by the Proposed Certificate of Designations attached hereto as Appendix D and incorporated herein.

     Amount. The Company will designate a total of 4,545,454 shares of Series A Stock.

     Dividends. The holders of Series A Stock will be entitled to receive dividends equal to five percent (5%) per share of the original per share price of the Series A Stock (which dividends are compounded quarterly) through the second anniversary of the First Funding Date and seven percent (7%) per share thereafter, prior to and in preference to any declaration or payment of a dividend to the holders of Common Stock. Although the dividends accrue, the Company does not currently expect to declare or pay the dividends in cash. Until accrued and unpaid dividends on the Series A Stock are paid or declared and set apart, no dividends or other distributions in respect of any other capital stock of the Company shall be declared, other than payments due under those certain Contingent Value Rights Agreements dated August 2, 2002 (“CVR Payments”) and certain other outstanding rights of the Company’s primary lender and 1818 Fund.

     Liquidation Rights. Upon liquidation, dissolution or winding up of the Company, the holders of Series A Stock shall be first entitled to receive, in preference to holders of Common Stock, an amount equal to the original per share price of the Series A Stock, plus accrued and unpaid dividends.

     Conversion at Option of Holder. Each share of Series A Stock is convertible, in whole or in part, into shares of Common Stock at any time at the option of the holder thereof.

     Automatic Conversion. The Series A Stock shall be automatically converted into shares of Common Stock if, at any time after the 18-month anniversary of the First Funding Date, the Common Stock price on the Nasdaq National Market (computed on a volume-weighted average basis) exceeds $15.00 per share (as adjusted) for thirty consecutive trading days.

     Anti-Dilution Protection. For 12 months following the First Funding Date, the conversion price of each share of Series A Stock will be subject to full ratchet anti-dilution adjustment in the event that the Company issues additional shares at or below the then applicable conversion price for such shares; provided, however, the foregoing adjustment does not apply unless and until the Company issues shares that, when aggregated with all shares issued after the First Funding Date, have an aggregate offer or issue price exceeding $5 million. Thus, if the

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Company issues additional shares at a price below $5.50 per share, the conversion price will drop to effectively the lowest price that the Company issues stock (once the $5 million aggregate price is met). The anti-dilution provisions are subject to exclusions which include without limitation, exclusions for (i) issuances to employees pursuant to plans approved by the Board, (ii) issuances to vendors and banks in certain transactions, (iii) the potential issuance of additional warrants to purchase up 372,412 shares of Common Stock to 1818 Fund, (iv) the exercise of outstanding warrants held by 1818 Fund or to be held by 1818 Fund, and (v) issuances of Common Stock as consideration in connection with the acquisition of assets or mergers. After 12 months following the First Funding Date, the conversion price of each share of Series A Stock will be subject to anti-dilution protection based on the weighted average purchase price of the Company’s outstanding stock.

     Each share of Series A Stock is initially convertible into one share of Common Stock based on the initial conversion price. However, because the conversion rate is adjusted for the dividends accrued on the Series A Stock and in the event of any issuances of stock by the Company that trigger the anti-dilution protections described above, there is no limit on the aggregate number of shares of Common Stock that could be issued upon conversion of the Series A Stock.

     Voting Rights. Each holder of Series A Stock is entitled to one vote per share of Series A Stock (subject to adjustment for stock splits, reverse stock splits, stock dividends and similar transactions with respect to the Common Stock), with respect to all matters submitted for shareholder approval. Except as provided by law or by the express terms of the Series A Stock, holders of Series A Stock will vote together with holders of the Common Stock as a single class.

     In addition, the majority vote of the Series A Stock, voting as a single class, shall be required to take the following actions:

	•		amend, add or repeal any provision of the Charter or the Company’s Bylaws if such action would adversely alter or change the preferences, rights, privileges or powers of, or the restrictions provided for the benefit of, the Series A Stock or otherwise adversely affect the holders of Series A Stock as a class;
	•		offer, sell, designate, authorize or issue shares of any class or series of stock having any preference or priority as to dividends or redemption rights, liquidation preferences, conversion rights or voting rights, superior to or on a parity with any preference or priority of the Series A Stock;
	•		authorize or issue any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having option rights to purchase, any shares of stock of the Company having any preference or priority as to dividends or redemption rights, liquidation preferences, conversion rights or voting rights, superior to or on a parity with any preference or priority of the Series A Stock;
	•		reclassify any shares of capital stock of the Company into shares having any preference or priority as to dividends or redemption rights, liquidation preferences, conversion rights, or voting rights, superior to or on a parity with any preference or priority of the Series A Stock;

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	•		increase the number of authorized shares of Series A Stock or, except at a funding date pursuant to the Purchase Agreement, issue any shares of Series A Stock; or
	•		pay or declare any dividend, whether in cash or property, or make any other distribution on, any Common Stock or other equity securities (including other preferred stock) of the Company other than the CVR Payments and other outstanding rights.

     Board Members. Following the First Funding Date, the holders of shares of Series A Stock, voting as a class, shall be entitled to nominate and elect two members of the Board. At such time as a majority of the holders of Series A Stock have converted their shares into Common Stock, the foregoing right to nominate and elect two directors shall cease and the term of the then current directors nominated and elected by the holders of Series A Stock shall immediately terminate.

Impact of the Private Placement on Existing Shareholders

     Factors. The holders of the Series A Stock will have certain rights which are senior to those of the holders of our Common Stock. Shareholders should consider the following non-exclusive factors, among others, in determining whether to vote for the Transaction:

	•		The issuance of the Series A Stock, the ability of the holders of such shares to convert their shares into Common Stock, and the conversion price adjustment provisions of the Series A Stock may impact the trading patterns and adversely affect the market price of our Common Stock.
	•		The holders of Series A Stock will have a claim against the Company’s assets senior to the holders of Common Stock in the event of the Company’s liquidation or bankruptcy.
	•		The holders of Series A Stock will be entitled to receive certain preferred dividends out of funds legally available therefor. The payment of these preferred dividends will take priority over the payment of dividends, if any, on the Company’s Common Stock.
	•		Shareholders are subject to the risk of substantial dilution to their interests which may result from the issuance of shares of Common Stock upon conversion of the Series A Stock. As a result of the issuance of such Common Stock, the current shareholders will own a smaller percentage of the outstanding Common Stock of the Company. In addition, certain events triggering the anti-dilution provisions of the Series A Stock reducing the conversion price will cause an increase in the number of shares of Common Stock issuable upon conversion of the Series A Stock. Because the conversion rate is adjusted for the dividends accrued on the Series A Stock and in the event of any issuances of stock by the Company that trigger the anti-dilution protections, there is no limit on the aggregate number of shares of Common Stock that could be issued upon conversion of the Series A Stock.

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	•		The holders of Series A Stock will have other substantial rights and preferences described in this Proxy Statement, including the right to veto certain corporate transactions, even those that are authorized by the Board or approved by the holders of Common Stock. These rights may give the holders of the Series A Stock the ability to influence the Company’s management and may allow the holders of Series A Stock to prevent transactions that holders of Common Stock deem beneficial.
	•		All shares of Common Stock issuable upon the conversion of Series A Stock will be entitled to certain registration rights. Consequently, if such shares are registered, such shares will be freely transferable without restriction under the Securities Act of 1933, as amended (but may be subject to the short-swing profit rules and other restrictions under the Exchange Act). Such free transferability could materially and adversely affect the market price of our Common Stock if a sufficient number of such shares are sold into the market. In addition, even if the shares of Common Stock are not registered, the Investors may be eligible to sell some of the Common Stock pursuant to Rule 144.

     Appraisal Rights. Under Delaware law, shareholders are not entitled to appraisal rights with respect to the Transaction.

Required Vote

     The affirmative vote of the Shareholders having a majority of the voting power of all shares present, in person or by proxy, and entitled to vote at the Meeting, voting as a single class, is required to approve and ratify Proposal 2.

Evaluation of Financing Alternatives

     In an effort to pursue our business plan and maximize shareholder value, our Board has routinely considered the Company’s ongoing capital needs. Beginning in September 2002, we began to explore various financing alternatives in earnest. After evaluating a wide range of funding alternatives, our Board concluded it was in the best interests of the Company to investigate the possibility of a private placement of preferred stock to a limited group of investors. Accordingly, on October 4, 2002, our Board engaged Brentwood Capital Advisors LLC (“Brentwood Capital”) in its capacity as a financial advisor to explore this alternative.

     Brentwood Capital began marketing the proposed transaction on October 16, 2002. During the marketing process, Brentwood Capital contacted 24 private equity firms that focus on making investments of this size in healthcare services companies. Of the 24 private equity firms contacted, 17 executed a confidentiality agreement and received a financing memorandum detailing the Company and its operating and growth strategy. As a result of these initial marketing efforts, management made presentations in person to three private equity firms. Two other private equity firms expressed interest in the transaction and in meeting management but were not able to pursue the proposed transaction on a timely basis. After receiving detailed terms sheets, we terminated the marketing process on November 19, 2002. After extensively negotiating with the most interested parties, and extensive consideration of the proposed terms of the Transaction and other factors, we executed a term sheet on November 22, 2002.

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Opinion of Financial Advisor

     In October 2002, we retained Brentwood Capital to act as our exclusive financial advisor in connection with the proposed sale, in a private placement, of minority equity interests in the Company. At the December 5, 2002 meeting of the Board, Brentwood Capital delivered its oral opinion that, as of December 3, 2002 (the last trading day preceding the finalization of its analysis) and subject to the various considerations in its opinion, the consideration to be received by the Company in the private placement was fair to the Company from a financial point of view. Brentwood Capital confirmed its oral opinion by subsequently delivering to the Board a written opinion dated December 5, 2002. Brentwood Capital reaffirmed its opinion by letter dated January 6, 2003 before the execution of the Purchase Agreement.

     The full text of the opinion of Brentwood Capital, which sets forth the assumptions made, matters considered, and qualifications and limitations on the review undertaken by Brentwood Capital, is attached as Appendix E hereto, and this summary is qualified in its entirety by reference to the full text of such opinion. Brentwood Capital’s opinion is directed to the Board and addresses only the fairness of the consideration to be received by the Company pursuant to the private placement from a financial point of view as of December 3, 2002. It does not address any other aspect of the investment and is not an opinion or a recommendation as to how any shareholder of the Company should vote. Shareholders are urged to read the full opinion of Brentwood Capital carefully and in its entirety.

     In rendering its opinion, Brentwood Capital performed a variety of financial analyses, including those summarized below. These analyses were presented to the Board at the meeting held on December 5, 2002. The summary set forth below does not purport to be a complete description of the analyses underlying the Brentwood Capital fairness opinion or the presentation made by Brentwood Capital to the Board. The preparation of a fairness opinion is a complex analytical process involving various determinations as to the most appropriate and relevant methods of financial analysis and the application of these methods to the particular circumstances and, therefore, such an opinion is not readily susceptible to partial analysis or summary description. Accordingly, notwithstanding the separate analyses summarized below, Brentwood Capital believes that its analyses must be considered as a whole and that selecting portions of its analyses and factors considered by it, without considering all of its analyses and factors, or attempting to ascribe relative weights to some or all of its analyses and factors, could create an incomplete view of the evaluation process underlying its opinion.

     In performing its analyses, numerous assumptions were made with respect to industry performance, general business, economic, market and financial conditions and other matters, many of which are beyond the control of Brentwood Capital or the Company. Any estimates contained in the analyses performed by Brentwood Capital are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by the analyses. Additionally, estimates of the value of businesses or securities do not purport to be appraisals or to reflect the prices at which the businesses or securities might actually be sold. Accordingly, the analyses and estimates are inherently subject to substantial uncertainty.

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     In connection with its opinion, Brentwood Capital, among other things:

	•		Reviewed a draft of the Purchase Agreement dated November 27, 2002, a draft of the Proposed Certificate of Designations dated November 27, 2002 and a draft of the Registration Rights Agreement dated November 27, 2002 and in connection with its reaffirmation of its opinion on January 6, 2003, Brentwood Capital reviewed the Purchase Agreement, Certificate of Designations and Registration Rights Agreement each dated January 6, 2003;
	•		Reviewed certain publicly available and internally generated historical and projected financial statements of the Company;
	•		Compared certain financial and other information of the Company with similar information with respect to certain other companies in the behavioral healthcare management contract and facilities-based behavioral healthcare services industries;
	•		Reviewed the reported prices and trading activity for the Company’s common stock;
	•		Conducted extensive discussions with the Company’s management concerning the operations of the Company, and its financial condition and prospects;
	•		Conducted on-site visits to certain freestanding psychiatric hospitals of the Company to inspect the physical characteristics of the properties, to assess the quality and range of services offered at these properties and to meet with on-site management of the facilities;
	•		Performed such other analyses and considered such other factors as was deemed appropriate.

     In arriving at its opinion, in addition to reviewing the matters listed above, Brentwood Capital performed the following valuation analyses:

	•		Compared financing terms of recently completed “public investment in private equity” (“PIPE”) transactions similar to the Transaction for (i) all issuers of preferred stock PIPEs during the six months ended November 27, 2002, and (ii) issuers of common stock healthcare PIPEs during the six months ended November 27, 2002 with the financial terms of the proposed investment by the Investors in the Company;
	•		Compared the trading multiples for comparable publicly traded companies in the behavioral healthcare management contract and facilities-based behavioral healthcare services industries with the Company’s implied enterprise value;
	•		Compared completed precedent transaction multiples for control acquisitions in the behavioral healthcare management contract and facilities-based behavioral healthcare services industries with the Company’s implied enterprise value;
	•		Conducted such other financial studies, analyses and investigations and reviewed such other factors as was deemed appropriate for purposes of its written opinion.

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     In rendering its opinion, Brentwood Capital assumed and relied on the accuracy and completeness of the financial, legal, tax, operating, and other information provided to it by the Company, including, without limitation, the financial statements and related notes of the Company. Brentwood Capital has not assumed any responsibility for independently verifying such information or undertaken an independent evaluation or appraisal of any of the assets or liabilities of the Company or been furnished with any such evaluation or appraisal. Brentwood Capital assumed the private placement would be consummated substantially in accordance with the terms set forth in the draft Purchase Agreement, as proposed to be amended at the Board meeting. Brentwood Capital was not engaged to, and in arriving at its opinion did not, evaluate nor solicit transactions which may be available to the Company other than minority equity investments. With respect to the financial forecast information furnished to or discussed with Brentwood Capital by the Company, Brentwood Capital assumed that such information was rationally and reasonably prepared and reflected the best currently available estimates and judgment of the Company’s management as to the expected future financial performance of the Company.

     The opinion of Brentwood Capital speaks only as of the date it was rendered, is based on the conditions as they existed and information which it was supplied, as of December 3, 2002 (the last trading day preceding the finalization of its analysis), and is without regard to any market, economic, financial, legal, or other circumstances or event of any kind or nature which may exist or occur after such date.

     The financial forecasts furnished to Brentwood Capital and used by it in some of its analyses were prepared by the management of the Company. The Company does not publicly disclose financial forecasts of the type provided to Brentwood Capital in connection with its review of the investment, and as a result, these financial forecasts were not prepared with a view towards public disclosure. The financial forecasts were based on numerous variables and assumptions which are inherently uncertain, including, without limitation, factors related to general economic and competitive conditions, and accordingly, actual results could vary significantly from those set forth in such financial forecasts.

     The following is a summary of the material analyses performed by Brentwood Capital in connection with its opinion. For this summary of Brentwood Capital’s opinion, the term “EBITDA” means earnings before interest, taxes, depreciation and amortization, and the term “Enterprise Value” means the sum of (i) equity market capitalization, or market equity value, plus (ii) minority interests, plus (iii) preferred stock plus (iv) net debt, which equals total debt less cash and cash equivalents. Future earnings for the comparable companies used in the analyses were based on publicly available estimates.

     Selected PIPE Transaction Analysis. Using publicly available information, Brentwood Capital reviewed and analyzed the financial terms of selected PIPE transactions. The transactions reviewed included: (i) 55 preferred stock investments completed during the six months ended November 27, 2002, and (ii) 38 common stock investments for healthcare companies completed during the six months ended November 27, 2002. In evaluating the selected transactions, Brentwood Capital reviewed among other things: gross proceeds, market capitalizations, purchase price premiums/discounts, dividend rates, warrant coverages and industry sectors. The following table compares the financial terms of the investment in the Company with the median financial terms of the selected PIPE transactions:

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     No transaction utilized in the selected PIPE transactions analysis is identical to the investment in the Company. In analyzing the selected transactions, Brentwood Capital made assumptions about industry performance, general business, economic, market and financial conditions, many of which are beyond the control of Brentwood Capital and the Company. Mathematical analysis, such as computation of averages or medians, is not in itself a meaningful method of using selected transactions data unless other factors are also taken into consideration.

     Historical Stock Performance Analysis. Brentwood Capital’s analysis of the performance of the Common Stock consisted of a historical analysis of both (i) closing prices and trading volumes and (ii) volume weighted average prices from the earliest trading date following the Merger through and including December 3, 2002. During this period, the Common Stock achieved a high price of $6.60 and a low price of $5.00, based on its closing share prices. Brentwood Capital also calculated the following average closing share prices, volume weighted average prices for the Common Stock as of December 3, 2002, the last trading day preceding the finalization of Brentwood Capital’s analysis, and the premiums/discounts implied by the transaction price:

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     Selected Comparable Public Company Analysis. Brentwood Capital compared certain financial and operating statistics to analyze the Company’s implied transaction valuation relative to a group of publicly-traded behavioral healthcare services companies that Brentwood Capital deemed to be comparable in whole or in part to the Company. Using publicly available information, Brentwood Capital compared the implied enterprise valuation of the Company prior to the private placement to the respective low, high, median and average multiples of enterprise values of comparable companies implied by the public trading price of their respective common stock.

     Because the Company may reasonably be considered, at least in part, both a behavioral healthcare management contract company and a facilities-based behavioral healthcare services company, Brentwood Capital conducted its comparable company analysis by examining both types of companies. The behavioral healthcare management contract company Brentwood Capital considered comparable to the Company was:

•

Horizon Health Services Corp.

     The facility-based behavioral healthcare services companies Brentwood Capital considered comparable to the Company were:

	•		Ramsay Youth Services, Inc.;
	•		Res-Care, Inc.; and
	•		Universal Health Services, Inc.

     The following table compares, as of December 3, 2002, the implied transaction multiples of the Company for the transaction with the low, high, median and average multiples for the selected comparable public companies as an aggregate group:

     For purposes of its analysis, Brentwood Capital compared the last twelve-month (“LTM”) trading multiples of the comparable companies to the pro forma 2002 results of the Company. Brentwood Capital noted that analyzing the Company’s pro forma results was a more accurate comparison due to (i) the five freestanding specialty psychiatric hospital acquisitions completed since September 2001 and (ii) the Merger. Mathematical analysis, such as computation of averages or medians, is not in itself a meaningful method of using selected transactions data unless other factors are also taken into consideration.

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     Selected Comparable Transaction Analysis. Using publicly available information, Brentwood Capital reviewed the purchase prices and multiples paid in selected control acquisitions of public and private behavioral healthcare companies that were deemed to be reasonably similar to the Company in whole or in part. Specifically, Brentwood Capital reviewed the following behavioral healthcare company transactions:

     For each transaction, Brentwood Capital calculated transaction multiples at announcement based on the Enterprise Value over the LTM revenue and EBITDA, where data was available and meaningful. It should be noted that none of the comparable precedent transactions are identical to the contemplated private placement and that, therefore, there are numerous factors that may have impacted the resulting transaction multiples that would not affect the implied valuation of the Company. Financial data regarding the comparable precedent transactions was taken from filings with the SEC and press releases.

     The following table compares the implied transaction multiples of the Company for the transaction with the low, high, median and average multiples for the selected comparable transactions:

     For purposes of its analysis, Brentwood Capital compared the LTM multiples of the comparable transactions to the pro forma 2002 results of the Company. Brentwood Capital noted that analyzing the Company’s pro forma results was a more accurate comparison due to (i) the five freestanding specialty psychiatric hospital acquisitions completed since September 2001 and (ii) the Merger. Mathematical analysis, such as computation of averages or medians, is not in itself a meaningful method of using selected transactions data unless other factors are also taken into consideration.

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     About Brentwood Capital. The Company retained Brentwood Capital to act as its exclusive financial advisor because Brentwood Capital’s investment bankers have substantial experience in transactions similar to the contemplated private placement of equity and because its bankers are familiar with the Company and its business. Brentwood Capital, as part of its investment banking services, engages in the valuation of businesses and securities in connection with mergers and acquisitions, leveraged buyouts, private placements, and valuations for corporate and other purposes.

     In October 2002, the Company retained Brentwood Capital to act as its exclusive financial advisor with respect to a potential private placement of equity securities. Pursuant to the terms of the engagement letter, Psychiatric Solutions has agreed to pay Brentwood Capital a monthly advisory fee for these services, until the consummation of the private placement or the termination of the Brentwood Capital engagement, as well as a reasonable and customary transaction fee for such services, less any advisory fees paid. In addition, the Company has agreed to indemnify Brentwood Capital and its affiliates, the respective directors, officers, agents, and employees against certain losses, claims, damages or liabilities relating to or arising out of the proposed transaction, including liabilities under federal securities law. In the past, Brentwood Capital has provided financial advisory services to the Company and has received fees for the rendering of these services.

Relationship of the Investors to Company

     Oak VII and Salix were original investors in the Company. At that time, both Oak VII and Salix obtained a position on the Company’s Board. Oak VII and Salix have since made additional investments in The Company. In 2002 and pursuant to the Company’s merger with PMR Corporation, all shares of stock and warrants held by Oak VII and Salix converted into shares of common stock of the combined entity. After the merger, Oak VII’s representation on the Board ceased. Christopher Grant, a founder and general partner of Salix, continues to serve on the Board.

     On June 28, 2002, the Company entered into a securities purchase agreement with 1818 Fund to issue up to $20 million of senior subordinated notes with detachable nominal warrants. At the closing on June 28, 2002, a total of $10 million of the senior subordinated notes were issued. The remaining $10 million of senior subordinated notes may be issued to fund additional acquisitions of free-standing psychiatric hospitals and for general working capital purposes, subject generally to approval by 1818 Fund. The notes have a term of seven years and bear interest at 12% annually, payable quarterly. The notes provide for a prepayment penalty of 6%, 3% and 1% if the notes are prepaid prior to the first anniversary, second anniversary and third anniversary of the closing date, respectively. The notes grant the holders the right to require prepayment in the event of a change of control of the Company (which right is not triggered by this Transaction), subject to a prepayment penalty of 1% if redeemed on or before the third anniversary of the closing date. The notes also require the Company to comply with financial and other covenants. In connection with the initial $10 million of notes issued, the Company issued a warrant to purchase approximately 372,412 shares of Common Stock at a nominal price. The Company will be required to issue additional warrants of up to 372,412 shares of Common Stock from time to time upon the issuance of the remaining $10 million of senior subordinated notes. The warrants provide for anti-dilution protection, pre-emptive rights and registration rights. The securities purchase agreement also allows the holders of the notes to designate one director to the board of directors of the Company. The holders have designated Joseph P. Donlan as their board representative.

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THE BOARD UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THE APPROVAL AND RATIFICATION OF THE TRANSACTION.

OTHER INFORMATION

The Board is not aware of any other matters, except for those incident to the conduct of the Meeting, that are to be presented to Shareholders for formal action at the Meeting. If, however, any other matters properly come before the Meeting, the persons named in the enclosed proxy intend to vote such proxy in accordance with their judgment.

By Order of the Board of Directors

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APPENDIX A

PROPOSED CHARTER AMENDMENT

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CERTIFICATE OF AMENDMENT
TO
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF PSYCHIATRIC SOLUTIONS, INC.

(Incorporated on January 8, 1988)

(Pursuant to Section 242 of the General
Corporation Law of the State of Delaware)

     PSYCHIATRIC SOLUTIONS, INC., a corporation organized and existing under the General Corporation Law of the State of Delaware (the “Corporation”), does hereby certify:

“A. This Corporation is authorized to issue two classes of shares to be designated, respectively, “Common Stock” and “Preferred Stock.” The total number of shares of stock that the Corporation is authorized to issue is Fifty-Four Million (54,000,000), of which Forty-Eight Million (48,000,000) shares shall be Common Stock, each having a par value of one cent ($0.01) per share, and Six Million (6,000,000) shares shall be Preferred Stock, each having a par value of one cent ($0.01) per share.”

     IN WITNESS WHEREOF, the undersigned has executed this certificate on this       day of January 2003.

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APPENDIX B

PURCHASE AGREEMENT

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STOCK PURCHASE AGREEMENT

by and among

PSYCHIATRIC SOLUTIONS, INC.

and

THE PURCHASERS NAMED HEREIN

January 6, 2003

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i

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ii

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iii

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STOCK PURCHASE AGREEMENT

     STOCK PURCHASE AGREEMENT (the “Agreement”), dated as of January 6, 2003, by and among PSYCHIATRIC SOLUTIONS, INC., a Delaware corporation, with headquarters located at 113 Seaboard Lane, Suite C-100, Franklin, Tennessee 37067, formerly known as PMR Corporation (the “Company”), and the investors listed on the Schedule of Purchasers attached hereto (individually, a “Purchaser” and collectively, the “Purchasers”). Capitalized terms used herein and not otherwise defined shall have the meanings ascribed thereto in Section 9(r) hereof.

RECITALS

     The Company and the Purchasers are executing and delivering this Agreement in reliance upon the exemption from securities registration afforded by Rule 506 of Regulation D (“Regulation D”) as promulgated by the United States Securities and Exchange Commission (the “SEC”) under the Securities Act of 1933, as amended (the “Securities Act”). (Unless otherwise indicated, capitalized terms used in this Agreement shall have the meanings ascribed to such terms herein.)

     The Company’s Board of Directors has authorized an amendment to the Certificate of Incorporation of the Company, as currently in effect (the “Charter Amendment”), in substantially the form attached hereto as Exhibit A, to increase the number of authorized shares of preferred stock (“Preferred Stock”) from 2,000,000 shares to 6,000,000 shares.

     Conditioned upon approval of the Charter Amendment by the Company’s stockholders pursuant to applicable law and filing of the Charter Amendment with the Secretary of State of the State of Delaware, the Company has authorized a series of its preferred stock, par value $0.01 per share denominated as the Company’s Series A Convertible Preferred Stock (the “Series A Preferred Stock”), which shall be convertible into shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), in accordance with the terms of the Company’s Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock, substantially in the form attached hereto as Exhibit B (the “Certificate of Designations”).

     Subject to the terms and conditions set forth in this Agreement, the Purchasers wish to purchase at the Fundings (as defined herein) an aggregate of up to 4,545,454 shares of the Series A Preferred Stock (the “Preferred Shares”), in the respective amounts set forth opposite each such Purchaser’s name on the Schedule of Purchasers, at a purchase price per share of $5.50 (the “Purchase Price”). All of the shares of Common Stock which are potentially issuable upon conversion of the Preferred Shares are referred to herein as the “Conversion Shares.”

     Contemporaneously with the execution and delivery of this Agreement, the Company and the Purchasers are executing and delivering a Registration Rights Agreement substantially in the form attached hereto as Exhibit C (the “Registration Rights Agreement”) pursuant to which the Company has agreed to provide certain registration rights under the Securities Act and the rules and regulations promulgated thereunder, and applicable state securities laws.

     NOW THEREFORE, the Company and the Purchasers hereby agree as follows:

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1. PURCHASE AND SALE OF PREFERRED SHARES.

     (a)  Purchase of Preferred Shares.

          (i) Subject to the terms and conditions of this Agreement, including, without limitation, the satisfaction (or waiver) of the conditions set forth in Sections 6(b) and 7(b) below, the Company shall issue and sell to each Purchaser, and each Purchaser severally agrees to purchase from the Company, at a purchase price per share equal to the Purchase Price, the respective number of Preferred Shares set forth in the column titled “Number of Preferred Shares-First Funding” opposite such Purchaser’s name on the Schedule of Purchasers (the “First Funding”).

          (ii) Subject to the terms and conditions of this Agreement, including, without limitation, the satisfaction (or waiver) of the conditions set forth in Sections 6(c) and 7(b) below, the Company shall issue and sell to each Purchaser, and each Purchaser severally agrees to purchase from the Company, at a purchase price per share equal to the Purchase Price, the respective number of Preferred Shares set forth in the column titled “Number of Preferred Shares-Second Funding” opposite such Purchaser’s name on the Schedule of Purchasers (the “Second Funding”). The First Funding and the Second Funding collectively are referred to in this Agreement as the “Fundings”.

     (b)  The Funding Dates; Fundings.

          (i) The date and time of the First Funding (the “First Funding Date”) shall be 10:00 a.m., Eastern Time on March 31, 2003 (provided that if such date is not a Business Day, the next Business Day thereafter), subject to the satisfaction (or waiver) of the conditions to the First Funding set forth in Sections 6(b) and 7(b) (or such later date as is mutually agreed to by the Company and Oak Investment Partners X, Limited Partnership and Oak X Affiliates Fund, Limited Partnership (collectively, “Oak”)).

          (ii) Only if the First Funding has previously occurred, the date and time of the Second Funding (the “Second Funding Date”) shall be 10:00 a.m., Eastern Time on June 30, 2003 (provided that if such date is not a Business Day, the next Business Day thereafter), subject to the satisfaction (or waiver) of the conditions to the Second Funding set forth in Sections 6(c) and 7(b) (or such later date as is mutually agreed to by the Company and Oak). Each of the First Funding Date and the Second Funding Date may also be referred to in this Agreement as a “Funding Date”.

          (iii) Each Funding shall occur on the applicable Funding Date at the offices of Harwell Howard Hyne Gabbert & Manner P.C., counsel to the Company, at 315 Deaderick Street, Suite 1800, Nashville, Tennessee 37238, or at such other location as the Company and Oak may mutually agree.

     (c)  Form of Payment. On the applicable Funding Date, (i) each Purchaser shall pay the Purchase Price to the Company for the applicable Preferred Shares by wire transfer of immediately available funds in accordance with the Company’s written wire instructions (to be delivered not less than two (2) Business Days prior to the applicable Funding), less any amount withheld by Oak for expenses of Oak pursuant to Section 4(h), and (ii) the Company shall

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deliver to each Purchaser stock certificates (in the denominations as such Purchaser shall request) (the “Preferred Stock Certificates”) representing such number of the Preferred Shares which such Purchaser is then purchasing hereunder, duly executed on behalf of the Company and registered in the name of such Purchaser or its designee.

     2.     EACH PURCHASER’S REPRESENTATIONS AND WARRANTIES.

     Each Purchaser represents and warrants, severally and not jointly, with respect to only itself that:

     (a)  Investment Purpose. Such Purchaser is acquiring (i) the Preferred Shares and (ii) upon conversion of the Preferred Shares, the Conversion Shares (the Preferred Shares and the Conversion Shares collectively are referred to herein as the “Securities”), for its own account and not with a view towards, or for resale in connection with, the distribution thereof, except pursuant to sales registered or exempted under the Securities Act; provided, however, that by making the representations herein, such Purchaser does not agree to hold any of the Securities for any minimum or other specific term and reserves the right to dispose of the Securities at any time in accordance with or pursuant to a registration statement or an exemption under the Securities Act.

     (b)  Accredited Investor Status. Such Purchaser is an “accredited investor” as that term is defined in Rule 501(a) of Regulation D and a “qualified institutional buyer” as that term is defined in Rule 144A promulgated under the Securities Act.

     (c)  Reliance on Exemptions. Such Purchaser understands that the Securities are being offered and sold to it in reliance on specific exemptions from the registration requirements of the United States federal and state securities laws and that the Company is relying in part upon the truth and accuracy of, and such Purchaser’s compliance with, the representations, warranties, agreements, acknowledgments and understandings of such Purchaser set forth herein in order to determine the availability of such exemptions and the eligibility of such Purchaser to acquire the Securities.

     (d)  Information. Such Purchaser and its advisors, if any, have been furnished with all materials relating to the business, finances and operations of the Company and materials relating to the offer and sale of the Securities which have been requested by such Purchaser. Such Purchaser and its advisors, if any, have been afforded the opportunity to ask questions of the Company. Such Purchaser understands that its investment in the Securities involves a high degree of risk. Such Purchaser has sought such accounting, legal and tax advice as it has considered necessary to make an informed investment decision with respect to its acquisition of the Securities. Nothing contained in this Section 2(d) (nor any of the inquiries described herein nor any other due diligence investigations conducted by such Purchaser or its advisors, if any, or its representatives) shall modify, amend or affect such Purchaser’s right to rely on the Company’s representations and warranties contained in Sections 3 and 9(l) below or in any certificate delivered hereunder.

(e) No Governmental Review. Such Purchaser understands that no court, administrative agency or commission or other governmental or quasi-governmental authority or

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instrumentality, domestic or foreign, Federal, state, county or local (each a “Governmental Entity”) has passed on or made any recommendation or endorsement of the Securities or the fairness or suitability of the investment in the Securities nor have such authorities passed upon or endorsed the merits of the offering of the Securities.

     (f)  Transfer or Resale. Such Purchaser understands that except as provided in the Registration Rights Agreement: (i) the Securities have not been and are not being registered under the Securities Act or any state securities laws, and may not be offered for sale, sold, assigned or transferred unless (A) subsequently registered thereunder, (B) such Purchaser shall have delivered to the Company an opinion of counsel (or such other evidence reasonably acceptable to the Company), in a generally acceptable form, to the effect that such Securities to be sold, assigned or transferred may be sold, assigned or transferred pursuant to an exemption from such registration, or (C) such Purchaser provides the Company with reasonable assurance that such Securities can be sold, assigned or transferred pursuant to Rule 144 promulgated under the Securities Act, as amended (or a successor rule thereto) (“Rule 144”); and (ii) neither the Company nor any other person is under any obligation to register the Securities under the Securities Act or any state securities laws or to comply with the terms and conditions of any exemption thereunder. Notwithstanding the foregoing, no such registration statement or opinion of counsel shall be necessary for a transfer by a Purchaser (A) to an Affiliate, (B) that is a partnership to a liquidating trust for the benefit of its partners, to its partners or former partners in accordance with partnership interests or to the estate of any such partner or former partner, (C) that is a limited liability company to its members or former members in accordance with their interest in the limited liability company, (D) that is a corporation to its majority owned subsidiaries or affiliates or (E) that is an individual to the Purchaser’s family member or trust for the benefit of such Purchaser or his or her family members or an entity whose equity owners consist solely of the Purchaser and his or her family members; provided that in each case the transferee will be subject to the terms of this Agreement to the same extent as if he, she or it were an original Purchaser hereunder.

     (g)  Legends. Such Purchaser understands that the certificates or other instruments representing the Preferred Shares and, until such time as the sale of the Conversion Shares have been registered under the Securities Act as contemplated by the Registration Rights Agreement, the stock certificates representing the Conversion Shares, except as set forth below, shall bear a restrictive legend in substantially the following form (in addition to any legend required under applicable state securities laws):

THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR APPLICABLE STATE SECURITIES LAWS. THE SECURITIES MAY NOT BE OFFERED FOR SALE, SOLD, TRANSFERRED OR ASSIGNED (I) IN THE ABSENCE OF (A) AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR APPLICABLE STATE SECURITIES LAWS OR (B) AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS UNDER SAID ACT OR (II) UNLESS SOLD PURSUANT TO RULE 144 UNDER SAID ACT.

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The legend set forth above shall be removed and the Company shall issue a certificate without such legend to the holder of the Securities upon which it is stamped, if, unless otherwise required by state securities laws, (i) such Securities are registered for resale under the Securities Act, (ii) in connection with a sale transaction, such holder provides the Company with an opinion of counsel, in a generally acceptable form, to the effect that a public sale, assignment or transfer of the Securities may be made without registration under the Securities Act, or (iii) such holder provides the Company with reasonable assurances that the Securities can be sold pursuant to Rule 144 without any restriction as to the number of securities acquired as of a particular date that can then be immediately sold.

     (h)  Authorization; Enforcement; Validity. This Agreement and the Registration Rights Agreement have been duly and validly authorized, executed and delivered on behalf of such Purchaser and are valid and binding agreements of such Purchaser enforceable against such Purchaser in accordance with their terms, subject as to enforceability to general principles of equity and to applicable bankruptcy, insolvency, reorganization, moratorium, liquidation and other similar laws relating to, or affecting generally, the enforcement of applicable creditors’ rights and remedies.

     (i)  Residency. Such Purchaser is a resident of, or has its principal executive offices located in, that jurisdiction specified in its address on the Schedule of Purchasers.

3. REPRESENTATIONS AND WARRANTIES OF THE COMPANY.

     The Company represents and warrants to each of the Purchasers as follows in this Section 3, except to the extent (i) disclosed with reasonable specificity on the schedules to this Agreement, with respect to Sections 3(b), 3(e) and 3(o), and (ii) with respect to all other subsections in this Section 3, disclosed with reasonable specificity on the schedules to this Agreement or the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2002, Quarterly Report on Form 10-Q for the Quarter ended July 31, 2002 and Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (the “2002 Filings”) filed by the Company (other than (x) those sections of the 2002 Filings entitled or captioned “Risk Factors” and (y) specific disclosures in those documents which are filed as exhibits to, or incorporated by reference in, such 2002 Filings). Without limiting the generality of the foregoing clause (y), the mere filing or incorporation by reference of an exhibit to such 2002 Filings shall not be deemed to adequately disclose an exception to a representation or warranty made herein (unless the representation or warranty has to do with the existence of the exhibit itself, as opposed to the contents thereof).

     (a)  Organization and Qualification. The Company and its “Subsidiaries” (which for purposes of this Agreement means any Person in which the Company, directly or indirectly, owns fifty percent (50%) or more of the outstanding voting securities) are corporations, limited partnerships, or limited liability companies duly organized and validly existing in good standing under the laws of the jurisdiction in which they are incorporated or formed, as applicable, and have the requisite corporate, limited partnership, or limited liability company power and authorization to own their respective properties and to carry on their respective business as now being conducted. Each of the Company and its Subsidiaries is duly qualified to do business and is in good standing in every jurisdiction in which its ownership of property or the nature of the

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business conducted by it makes such qualification necessary, except to the extent that the failure to be so qualified or be in good standing would not have a Material Adverse Effect. As used in this Agreement, “Material Adverse Effect” means any material adverse effect on the business, properties, assets, operations, prospects, results of operations or financial condition of the Company and its Subsidiaries, if any, taken as a whole, or on the authority or ability of the Company to perform its obligations under the Transaction Documents (as hereinafter defined) or the Certificate of Designations. The Company has no Subsidiaries except as set forth on Schedule 3(a).

     (b)  Authorization; Enforcement; Validity. The Company has the requisite corporate power and authority to enter into and perform its obligations under this Agreement, the Registration Rights Agreement, the Irrevocable Transfer Agent Instructions (as hereinafter defined) and each of the other agreements entered into by the parties hereto in connection with the transactions contemplated by this Agreement (collectively, the “Transaction Documents”), to execute and file the Charter Amendment and the Certificate of Designations after receipt of the stockholder approval described in clause (i) of the second following sentence, and to issue the Securities in accordance with the terms hereof and thereof. The Charter Amendment has been duly authorized by the Company’s Board of Directors, which has recommended that the Company’s stockholders approve the Charter Amendment. The execution and delivery of the Transaction Documents by the Company and the execution and filing of the Certificate of Designations by the Company and the consummation by it of the transactions contemplated hereby and thereby, including, without limitation, the issuance of the Preferred Shares and the reservation for issuance and the issuance of all Conversion Shares issuable upon conversion of the Preferred Shares, have been duly authorized by the Company’s Board of Directors and no further consent or authorization is required by the Company, its Board of Directors or its stockholders, except (i) stockholder approval of the Charter Amendment by the holders of a majority of the outstanding shares of Common Stock and (ii) such stockholder approval as may be required by NASDAQ in connection with the transactions contemplated by the Transaction Documents and the Certificate of Designation (including, without limitation, the issuance or potential issuance of a number of shares of Common Stock which is greater than or equal to 20% of the number of shares outstanding on the date of this Agreement and/or any potential change of control (as currently defined or as proposed to be defined under the rules of NASDAQ)), all of which shall be obtained prior to the First Funding. The Transaction Documents have been duly executed and delivered by the Company, and constitute the valid and binding obligations of the Company enforceable against the Company in accordance with their terms, except that any rights to indemnity or contribution under the Registration Rights Agreement may be subject to limitation by public policy under federal securities laws. Upon receipt of the foregoing stockholder approval, the Charter Amendment and the Certificate of Designations will be filed as promptly as practicable with the Secretary of State of the State of Delaware and will be in full force and effect as of the First Funding Date, enforceable against the Company in accordance with their terms. None of the Charter Amendment, the Certificate of Incorporation or the Certificate of Designations shall have been amended prior to either Funding Date.

     (c)  Capitalization.

          (i) As of the date hereof, the authorized capital stock of the Company consists of (A) 48,000,000 shares of Common Stock, of which as of January 3, 2003, 7,738,641 shares

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are issued and outstanding and (B) 2,000,000 shares of Preferred Stock (to be increased to 6,000,000 upon stockholder approval of the Charter Amendment and the filing thereof), of which no shares are issued and outstanding. All of such outstanding or issuable shares have been, or upon issuance will be, validly issued and are fully paid and nonassessable. As of the First Funding Date, no shares of Preferred Stock shall be authorized or outstanding and as of each Funding Date the Series A Preferred Stock shall be the sole authorized or designated series of Preferred Stock.

          (ii) Except as set forth in Schedule 3(c), no shares of the Company’s capital stock are subject to preemptive rights or any other similar rights. Except as set forth in Schedule 3(c), and except for (a) warrants to purchase 744,824 shares of Common Stock which are issued or issuable pursuant to that certain Securities Purchase Agreement, dated as of June 28, 2002, by and between Psychiatric Solutions Hospitals, Inc., a Delaware corporation (f/k/a Psychiatric Solutions, Inc.) and The 1818 Mezzanine Fund II, L.P., (b) warrants held by CapitalSource Holdings, LLC to purchase 20,766 shares of Common Stock, (c) warrants held by Donald L. Morris to purchase 7,822 shares of Common Stock, (d) warrants held by Todd Morris to purchase 1,564 shares of Common Stock, (e) options to purchase 206,016 shares of Common Stock issued or issuable pursuant to the Company’s 1997 Incentive and Nonqualified Stock Option Plan for Key Personnel, (f) options to purchase 676,395 shares of Common Stock issued or issuable pursuant to PMR Corporation 1997 Equity Incentive Plan, (g) options to purchase 83,748 shares of Common Stock issued or issuable pursuant to the PMR Corporation Outside Directors Non-Qualified Stock Option Plan of 1992, (h) options to purchase 82,225 shares of Common Stock issued or issuable outside of other PMR plans, and (i) subordinated notes listed on Schedule 3(c) with an aggregate principal amount of $3,600,000 which are convertible into 421,842 shares of Common Stock (the “Sunrise Seller Notes”), (A) there are no outstanding debt instruments issued by the Company; (B) there are no outstanding options, warrants, scrip, rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities or rights convertible into or exercisable for, any shares of capital stock of the Company or any of its Subsidiaries, or contracts, commitments, understandings or arrangements by which the Company or any of its Subsidiaries is or may become bound to issue additional shares of capital stock of the Company or any of its Subsidiaries or options, warrants, scrip, rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities or rights convertible into or exercisable for, any shares of capital stock of the Company or any of its Subsidiaries; (C) there are no outstanding securities or instruments of the Company or any of its Subsidiaries which contain any redemption or similar provisions, and there are no contracts, commitments, understandings or arrangements by which the Company or any of its Subsidiaries is or may become bound to redeem a security of the Company or any of its Subsidiaries; (D) there are no securities or instruments containing anti-dilution or similar provisions that will be triggered by the issuance of the Securities as described in this Agreement; and (E) the Company does not have any stock appreciation rights or “phantom stock” plans or agreements or any similar plan or agreement.

          (iii) The Company has furnished or made available to each Purchaser true and correct copies of the Company’s Amended and Restated Certificate of Incorporation, as amended and as in effect on the date hereof (the “Certificate of Incorporation”), and a copy of the Charter Amendment, as approved by the Company’s Board of Directors, and the Company’s Amended and Restated Bylaws, as amended and as in effect on the date hereof and as of the

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applicable Funding (the “Bylaws”), and the terms of all securities convertible into, or exercisable or exchangeable for, Common Stock and the material rights of the holders thereof in respect thereto. The Company does not have any certificate of designations in effect as of the date hereof or as of either Funding Date (other than the Certificate of Designations, which will be effective prior to the First Funding Date).

     (d)  Issuance of Securities. Upon the filing of the Charter Amendment and the Certificate of Designations with the Secretary of State of the State of Delaware, as of each Funding, the applicable Preferred Shares will be duly authorized and, upon issuance in accordance with the terms hereof, shall be (i) validly issued, fully paid and non-assessable, (ii) free from all taxes, liens and charges with respect to the issuance thereof and (iii) entitled to the rights and preferences set forth in the Certificate of Designations. Upon the filing of the Charter Amendment and the Certificate of Designations with the Secretary of State of the State of Delaware, as of each Funding, 5,000,000 shares of Common Stock (subject to adjustment pursuant to the Company’s covenant set forth in Section 4(f) below) shall be duly authorized and reserved for issuance upon conversion of the Preferred Shares. Upon conversion in accordance with the Certificate of Designations, the Conversion Shares will be validly issued, fully paid and nonassessable and free from all taxes, liens and charges with respect to the issue thereof, with the holders being entitled to all rights accorded to a holder of Common Stock. Subject only to accuracy of the representations set forth in Section 2, the issuance by the Company of the Securities is exempt from registration under the Securities Act and all applicable state securities laws.

     (e)  No Conflicts.

          (i) Except as set forth on Schedule 3(e), the execution, delivery and performance of the Transaction Documents by the Company, the performance by the Company of its obligations under the Certificate of Designations and the consummation by the Company of the transactions contemplated hereby and thereby (including, without limitation, the reservation for issuance and issuance of the Conversion Shares) will not:

               (A) result in a violation of the Certificate of Incorporation (after giving effect to the Charter Amendment and the Certificate of Designations), or the Bylaws;

               (B) conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, or incremental, additional or varied rights under, any material agreement, indenture or instrument (including, without limitation, any stock option, employee stock purchase or similar plan or any employment or similar agreement) to which the Company or any of its Subsidiaries is a party (including, without limitation, triggering the application of any change of control or similar provision (whether “single trigger” or “double trigger”)); or

               (C) result in a violation of any law, rule, regulation, order, judgment or decree (including federal and state securities laws and regulations and the rules and regulations of the Principal Market (as hereinafter defined)) applicable to the Company or

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any of its Subsidiaries or by which any property or asset of the Company or any of its Subsidiaries is bound or affected.

          (ii) Neither the Company nor its Subsidiaries is in violation of any term of its Certificate of Incorporation or Bylaws or, in the case of Subsidiaries, their organizational charter or bylaws, respectively.

          (iii) The business of the Company and its Subsidiaries is not being conducted, and shall not be conducted, in violation of any law, ordinance or regulation of any Governmental Entity, except where such violations would not result, either individually or in the aggregate, in a Material Adverse Effect.

          (iv) Except for (A) compliance with the HSR Act (as hereinafter defined), if required, (B) the filing of a proxy statement relating to the Stockholder Approval as required under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the rules and regulations promulgated thereunder, (C) as may be required by any applicable state securities laws, or (D) the filing of the Charter Amendment and the Certificate of Designations with the Secretary of State of the State of Delaware, the Company is not required to obtain any consent, authorization or order of, or make any filing or registration with, any Governmental Entity in order for it to execute, deliver or perform any of its obligations under or contemplated by the Transaction Documents or to perform its obligations under the Certificate of Designations, in each case in accordance with the terms hereof or thereof. All consents, authorizations, orders, filings and registrations which the Company is required to obtain as described in the preceding sentence shall have been obtained or effected on or prior to each Funding Date and shall not be the subject of any pending or, to the knowledge of the Company, threatened attack by appeal, direct proceeding or otherwise. The Company is not, and as of each Funding Date will not be, in violation of the listing requirements of the Principal Market, and the Conversion Shares shall be authorized for listing thereon.

     (f)  SEC Documents; Financial Statements.

          (i) Since April 30, 2002, the Company has filed all reports, schedules, forms, statements and other documents required to be filed by it with the SEC pursuant to the reporting requirements of the Exchange Act (all of the foregoing (including all exhibits included therein and financial statements and schedules thereto and documents incorporated by reference therein) and all forms, documents and instruments filed by the Company with the SEC pursuant to the Securities Act (including all exhibits included therein and financial statements and schedules thereto and documents incorporated by reference therein) being hereinafter referred to as the “SEC Documents”). As of their respective dates, the SEC Documents complied in all material respects with the requirements of the Securities Act or Exchange Act and the rules and regulations of the SEC promulgated thereunder applicable to the SEC Documents. None of the SEC Documents, at the time they were or are filed with the SEC, contained or will contain any untrue statement of a material fact or omitted or will omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading.

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          (ii) As of their respective dates, the financial statements of the Company included in the SEC Documents complied as to form (and will comply as to form) in all material respects with U.S. generally accepted accounting principles (“GAAP”) and the published rules and regulations of the SEC with respect thereto. Such financial statements have been prepared in accordance with GAAP, consistently applied, during the periods involved (except (A) as may be otherwise specifically indicated in such financial statements or the notes thereto, or (B) in the case of unaudited interim statements, to the extent they may exclude footnotes or may be condensed or summary statements or as otherwise, in each case, may be permitted by the SEC on Form 10-Q under the Exchange Act) and fairly present in all material respects the consolidated financial position of the Company as of the dates thereof and the consolidated results of its operations and cash flows for the periods then ended (subject, in the case of unaudited statements, to normal year-end audit adjustments). Ernst & Young LLP, which has examined certain of such financial statements, is an independent certified public accounting firm within the meaning of the Securities Act. As of the date of this Agreement and as of each Funding Date, the Company meets the requirements for use of Form S-3 for registration of the resale of Registrable Securities (as defined in the Registration Rights Agreement

          (iii) Prior to the date hereof, the Company delivered to the Purchasers financial projections (the “Projections”). The assumptions used in preparation of the Projections were reasonable when made and continue to be reasonable. The Projections have been prepared in good faith and the Projections give effect to the transactions contemplated by the Transaction Documents. The Purchasers acknowledge that the Projections contain assumptions about future events and that actual results during the period or periods covered may differ materially from the data and results contained in such Projections.

          (iv) Since April 30, 2002, except as specified in the 2002 Filings, the Company has not incurred or suffered any liability or obligation, matured or unmatured, contingent or otherwise, except in the ordinary course of business and except any such liability or obligation that has not had and could not reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect. Without limiting the foregoing, except as specified in the 2002 Filings, the Company has no material liabilities or obligations that would reasonably be expected to be disclosed in order to comply with Section 13(j) of the Exchange Act or any proposed rules promulgated by the SEC thereunder, including the rules regarding contractual commitments and contingent liabilities and commitments proposed in SEC Release No. 33-8144; 34-46767.

     (g)  Absence of Certain Changes. Since April 30, 2002, there has been no event constituting, or which could reasonably be expected to cause or give rise to, a material adverse change or material adverse development in the business, properties, assets, operations, prospects, results of operations or financial conditions of the Company and its Subsidiaries, if any, taken as a whole. Neither the Company nor any of its Subsidiaries has taken any steps, and does not expect to take any steps, to seek protection pursuant to any bankruptcy law. Without limiting the generality of the foregoing, since April 30, 2002, except as specifically contemplated by the Transaction Documents or described on Schedule 3(g):

          (i) the Company has not:

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	(A) made, paid or declared any dividend or distribution to any equity holder (in such capacity) or redeemed any of its capital stock;

	(B) varied its business plan or practices, in any material respect, from past practices;

	(C) entered into any financing, joint venture, license or similar arrangement that would limit or restrict its ability to perform its obligations hereunder and under each of the other Transaction Documents; or