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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

Commission File Number: 0-20372

RES-CARE, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (502) 394-2100

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X   No        .

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes   X   No        .

The number of shares outstanding of the registrant’s common stock, no par value, as of October 31, 2002, was 24,418,336.

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INDEX

RES-CARE, INC. AND SUBSIDIARIES

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PART I. FINANCIAL INFORMATION

ITEM 1. Unaudited Financial Statements

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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Res-Care, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
September 30, 2002
(Unaudited)

Note 1. Basis of Presentation

     Res-Care, Inc. is primarily engaged in the delivery of residential, training, educational and support services to those with developmental and other disabilities and young people with special needs. All references in these financial statements to “ResCare,” “we,” “us,” or “our” mean Res-Care, Inc. and unless the context otherwise requires, its consolidated subsidiaries.

     The accompanying unaudited condensed consolidated financial statements of ResCare have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial condition and results of operations for the interim periods have been included. Operating results for the three-month and nine-month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

     Certain amounts in the 2001 financial statements have been reclassified to conform with the 2002 presentation. Such reclassifications have no effect on previously reported net income or shareholders’ equity.

     For further information, refer to the consolidated financial statements and footnotes thereto in our annual report on Form 10-K for the year ended December 31, 2001.

Note 2. Long-term Debt

     Long-term debt consists of the following:

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     On November 14, 2002, our $80 million credit facility was amended. The amendment contains a waiver of a technical violation at September 30, 2002 of the financial covenant contained in the previous agreement requiring a minimum ratio of consolidated EBITDA to consolidated interest expense. The amendment revises each of the financial covenants contained in the credit agreement and includes changes in the interest rates charged on any borrowings. Interest rates under the amended agreement are based on margins over LIBOR and vary based on our ratio of total net funded debt to consolidated EBITDA. The borrowing margin will increase by 25 basis points as a result of this amendment. Additionally, the amendment allows for certain acquisitions and dispositions. There are outstanding letters-of-credit of approximately $43.6 million issued under the credit facility. There are no borrowings against the credit facility at September 30, 2002.

     During the third quarter of 2002, we completed transactions to redeem approximately $4.6 million of our 6% convertible subordinated notes, resulting in a pretax gain of approximately $1.0 million. During the nine months ended September 30, 2002, we redeemed $6.0 million of our 6% convertible notes for a gain of approximately $1.3 million. The gains are included in other income in the accompanying condensed consolidated statement of income.

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Note 3. Earnings Per Share

     The following table sets forth the computation of basic and diluted earnings per share:

     The average shares listed below were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented:

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Note 4. Segment Information

     The following table sets forth information about our reportable segments. During 2001, we disclosed information for two reportable operating segments, comprised of Disabilities Services and Youth Services. Effective January 1, 2002, in connection with changes in our management structure, the Youth Services division was split into two segments: (i) Training Services (consisting of the Job Corps operations) and (ii) Youth Services (consisting of all other youth services programs), which were brought under the direction of separate presidents. The information for prior periods presented has been restated to reflect this change.

Note 5. Goodwill and Intangible Assets

     In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (Statement) No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no

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longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of Statement 142. Such test will be made on or before year end. In addition, Statement 142 provides that intangible assets with definite lives should be amortized over their useful lives and reviewed for impairment in accordance with existing guidelines. We adopted the provisions of Statement 141 upon its issuance in July 2001 and the provisions of Statement 142 effective January 1, 2002. No impairment loss was recognized as a result of the transitional impairment tests required under Statement 142 as of January 1, 2002.

     A summary of changes to goodwill during the year follows:

     Intangible assets are as follows:

     Covenants not to compete are comprised of contractual agreements with stated values and terms and are amortized over the term of the agreements.

     Amortization expense for the nine months ended September 30, 2002, was approximately $1.4 million. Estimated amortization expense for the next five years is as follows:

     A reconciliation of net income and diluted earnings per share for the three-months and nine-months ended September 30, 2001, as if we had adopted Statement 142 effective January 1, 2001, follows:

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Note 6. Recently Issued Accounting Pronouncements

     In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. Under Statement 145, gains and losses on extinguishments of debt are to be classified as income or loss from continuing operations rather than extraordinary items. Adoption of this Statement is required for fiscal years beginning after May 15, 2002. We have elected to adopt Statement 145 during the second quarter of 2002. Adoption of this Statement resulted in classifying a pretax gain of approximately $1.3 million on the redemption of a portion of our 6% convertible subordinated notes as other income in the accompanying Condensed Consolidated Statement of Income for the nine months ended September 30, 2002.

     In July 2002, the FASB issued Statement 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities. Statement 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. This Statement also establishes that fair value is the objective for initial measurement of the liability. Severance pay under Statement 146, in many cases, would be recognized over time rather than up front. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. As of this date, there have been no transactions to which Statement 146 would apply.

Note 7. Changes in Estimates

     Effective January 1, 2002, we changed our accounting estimates related to depreciation of certain assets. The estimated useful lives of the assets associated with our billing and time and attendance systems were extended four years. The change was based on our expected useful lives of the respective systems. Both of these systems are currently being deployed. As a result of the change, net income for the nine-months ended September 30, 2002 was increased by approximately $338,000, or $0.01 per diluted share.

     During the third quarter of 2002, we revised the estimated annual effective tax rate for 2002 from 37.5% to 36.0%. The revision was made primarily as a result of changes in estimates of profitability in 2002. As a result of the change, net income for the three- and nine-months ended September 30, 2002 was increased by approximately $229,000, or $0.01 per diluted share.

Note 8. Contingencies

     In July 2000, American International Specialty Lines Insurance Company, or AISL, filed a Complaint for Declaratory Judgment against us and certain of our subsidiaries in the U.S. District Court for the Southern District of Texas, Houston Division. In the Complaint, AISL sought a declaration of what insurance coverage was available to ResCare in Cause No. 299291-401; In re: Estate of Trenia Wright, Deceased, et al. v. Res-Care, Inc., et al., which was filed in Probate Court No. 1 of Harris County, Texas (the Lawsuit). After the filing, we entered into an agreement with AISL whereby any settlement reached in the Lawsuit would not be dispositive of whether the claims in the Lawsuit were covered under the insurance policies issued by AISL. AISL thereafter settled the Lawsuit for $9 million. It is our position that the Lawsuit initiated coverage under policies of insurance in more than one policy year, thus affording adequate coverage to settle the Lawsuit within coverage and policy limits and that AISL waived any applicable exclusions for punitive damages. On November 23, 2001, a summary judgment was granted in favor of AISL, which was reduced to a final judgment on February 26, 2002. On March 8, 2002, we filed a motion for new trial and to alter judgment which is pending before the trial judge. In our opinion, after consulting with outside trial counsel and special counsel engaged to review the decision, substantial grounds exist for a successful appeal. We have not made any provision in our consolidated financial statements for any potential liability that may result

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from final adjudication of this matter. We do not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

     In October 2000, ResCare and one of our subsidiaries, Res-Care Florida, Inc., f/k/a Normal Life Florida, Inc., entered into an agreement with AISL to resolve through binding arbitration a dispute as to the amount of coverage available to settle a lawsuit that had previously been filed in Pinellas County Circuit Court, Florida and subsequently settled after we entered into the agreement. AISL contended that a portion of the settlement reached was comprised of punitive damages and, therefore, not the responsibility of AISL. Our position was that the settlement was an amount that a reasonable and prudent insurer would pay for the actual damages alleged and that AISL had opportunities to settle all claims within available coverage limits. Binding arbitration was held on January 15 and 16, 2002, and on February 14, 2002, a decision was entered in our favor stating that the underlying settlement was within the coverage limits of our policy and also awarding us attorney fees and costs. In July 2002, we were informed by plaintiff’s counsel that AISL had approved payment in the amount of approximately $171,000 to satisfy the entire judgment and approximately $114,000 to reimburse all attorneys’ fees and costs. These amounts have been received.

     On September 2, 2001, in a case styled Nellie Lake, Individually as an Heir-at-Law of Christina Zellner, deceased; and as Personal Representative of the Estate of Christina Zellner v. Res-Care, Inc., et al., in the U.S. District Court of the District of Kansas at Wichita, a jury awarded noneconomic damages to Ms. Lake in the amount of $100,000, the statutory maximum, as well as $5,000 for economic loss. In addition, the jury awarded the Estate of Christina Zellner $5,000 of noneconomic damages and issued an advisory opinion recommending an award of $2.5 million in punitive damages. The judge, however, was not required to award the amount of punitive damages recommended by the jury and on February 4, 2002, entered a punitive damage judgment in the amount of $1 million. Based on the advice of counsel, we appealed the award of punitive damages, based on numerous appealable errors at trial. Based on the advice of counsel, we believe any damages resulting from this matter are covered by insurance and, accordingly, we have not made any provision in our consolidated financial statements for any potential liability that may result from final adjudication of this matter. We do not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

     In September 1997, a lawsuit, styled Cause No. 98-00740, Nancy Chesser v. Normal Life of Texas, Inc., and Normal Life, Inc. District Court of Travis County, Texas was filed against a Texas facility operated by the former owners of Normal Life, Inc. and Normal Life of North Texas, Inc., one of our subsidiaries, asserting causes of action for negligence, intentional infliction of emotional distress and retaliation regarding the discharge of residents of the facility. In May 2000, a judgment was entered in favor of the plaintiff awarding the plaintiff damages, prejudgment interest and attorneys’ fees totaling $4.8 million. In October 2000, ResCare and AISL entered into an agreement whereby any settlement reached in Chesser and a related lawsuit also filed in the District Court of Travis County, Texas would not be dispositive of whether the claims in those suits were covered under the policies issued by AISL. AISL thereafter settled the suits and filed a Complaint for Declaratory Judgment against Normal Life of North Texas, Inc. and Normal Life, Inc. in the U.S. District Court for the Northern District of Texas, Dallas Division. In the Complaint, AISL seeks a declaration of what insurance coverage is available to ResCare in the lawsuits. It is our position that the lawsuits initiated coverage under the primary policies of insurance, thus affording adequate coverage to settle the lawsuits within coverage and policy limits. The trial of this declaratory judgment action previously scheduled in March 2002 has been rescheduled for December 9, 2002. We do not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

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     In December 1999, a lawsuit styled James Michael Godfrey and Sherry Jo Lusk v. Res-Care, Inc., was filed by the former owners of Access, Inc., one of our subsidiaries, claiming fraud and unfair and deceptive trade practices. On July 29, 2002, a judgment was entered in favor of the plaintiff awarding the plaintiff damages of $990,000 with interest on $330,000 from December 1, 1999. Based on the advice of counsel, we have appealed the award of damages, based on numerous appealable errors at trial. In our opinion, after consulting with outside trial counsel, substantial grounds exist for a successful appeal. We have not made any provision in our consolidated financial statements for any potential liability that may result from final adjudication of this matter. We do not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

     On June 21, 2002, we were notified that our mental health services subsidiary was the subject of an investigation concerning allegations relating to services provided by the subsidiary under various programs sponsored by Medicaid. The subsidiary under investigation is a non-core operation that provides skills training to persons with severe mental illness in five Texas counties. The mental health operation is managed by its founders under a management contract and represents less than 1% of the total revenues of the Disabilities Services division. During the third quarter, we received a Civil Investigative Demand from the Texas Attorney General (TAG) requesting the production of a variety of documents relating to the subsidiary. We are cooperating with the TAG in providing the requested documents and have engaged special counsel to conduct an internal investigation of the allegations. Based on the results of our investigation, we believe that the subsidiary has complied with the applicable rules and regulations governing the provision of mental health services in the State of Texas. Although we cannot predict the outcome of the investigation with certainty, and we have incurred and could continue to incur significant legal expenses in connection with document production and our response to the investigation, we do not believe the ultimate resolution of the investigation should have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

     In July 2002, Lexington Insurance Company (Lexington) filed a Complaint for Declaratory Action against one of our subsidiaries in the U.S. District Court for the Southern District of Texas, Houston Division. In the Complaint, Lexington sought a declaration of what insurance coverage was available in Cause No. 14763-BH01; William Thurber and Kathy Thurber, et al v. Educare Community Living Corporation – Gulf Coast (EduCare), which was filed in the 23rd Judicial District Court of Brazoria County, Texas. After the filing, we entered into an agreement with Lexington whereby any settlement reached in Thurber would not be dispositive of whether the claims were covered by insurance. Lexington and Educare thereafter contributed $1.0 million and $1.5 million, respectively, and settled the lawsuit. We expect our contribution to the settlement to be reimbursed by Lexington under the applicable policies. It is our position, after consulting with outside counsel, that the Thurber lawsuit is covered by the primary and umbrella policies issued by Lexington. We have not made any provision in the consolidated financial statements for any potential liability that may result from final adjudication of this matter. We do not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

     In addition, we are a party to various other legal and/or administrative proceedings arising out of the operation of our facilities and programs and arising in the ordinary course of business. We believe that, generally, these claims are without merit. Further, many of such claims may be covered by insurance. We do not believe the results of these proceedings or claims, individually or in the aggregate, will have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

     Res-Care, Inc. receives revenues primarily from the delivery of residential, training, educational and support services to populations with special needs. All references in this Quarterly Report on Form 10-Q to “ResCare,” “we,” “our,” or “us” mean Res-Care, Inc. and, unless the context otherwise requires, its consolidated subsidiaries. We have three reportable operating segments: (i) Disabilities Services, (ii) Youth Services and (iii) Training Services. Further information regarding each of these segments, including the disclosure of required segment financial information, is included in Note 4 of the Notes to Condensed Consolidated Financial Statements. Effective in the first quarter of 2002, with a restructuring within the Youth Services division and the appointment of a separate president for the Job Corps unit and one for the other youth services business unit, we split the Youth Services reporting segment into two segments: (i) Training Services (consisting of Job Corps operations) and (ii) Youth Services (consisting of other youth services operations). Accordingly, beginning in 2002, we have three reportable segments.

Significant Developments in 2002

     On November 14, 2002, our $80 million credit facility was amended. The amendment contains a waiver of a technical violation at September 30, 2002 of the financial covenant contained in the previous agreement requiring a minimum ratio of consolidated EBITDA to consolidated interest expense. The amendment revises each of the financial covenants contained in the credit agreement and includes changes in the interest rates charged on any borrowings. Interest rates under the amended agreement are based on margins over LIBOR and vary based on our ratio of total net funded debt to consolidated EBITDA. The borrowing margin will increase by 25 basis points as a result of this amendment. Additionally, the amendment allows for certain acquisitions and dispositions. There are outstanding letters-of-credit of approximately $43.6 million issued under the credit facility. There are no borrowings against the credit facility at September 30, 2002.

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     During July 2002, we renewed our insurance coverages related to workers’ compensation, general and professional liability, auto and property. Significant changes in our coverages include 1) an increase in our deductible for workers’ compensation from $500,000 per occurrence to $1 million, with no change in loss limits and 2) a change in our property coverage from a $403 million aggregate limit per year to a $50 million per occurrence limit, with no change in the per occurrence deductible. We believe these changes were appropriate after evaluating our loss experience in both the workers’ compensation and property programs and do not believe that such changes significantly increase our exposure to unfavorable outcomes. All other insurance programs were renewed with no changes in deductibles or loss limits. Additionally, in connection with the renewal, we were required to provide additional collateral of approximately $15.5 million (comprised of letters-of-credit of $10.5 million and a callable cash deposit of $5.0 million) for the projected claims payments by us under the terms of the policies plus a market adjustment for prior years.

     During the third quarter of 2002, we completed transactions to redeem approximately $4.6 million of our 6% convertible subordinated notes, resulting in a pretax gain of approximately $1.0 million. During the nine months ended September 30, 2002, we redeemed $6.0 million of our 6% convertible notes for a gain of approximately $1.3 million. The gains are included in other income in the accompanying condensed consolidated statement of income.

     During the third quarter of 2002, our mental health services subsidiary incurred operating losses of approximately $1.0 million. The subsidiary is a non-core operation that provides skills training to persons with severe mental illness in five Texas counties. The operating losses are due primarily to reductions in reimbursement rates that took effect at the beginning of 2002, costs associated with a regulatory investigation begun in June 2002, and subsequent census reductions. See “Legal Proceedings.” We expect to incur continued operating losses and legal costs during the fourth quarter of 2002; however, we are evaluating various options, including the possible sale or closure of this non-core operation.

     In October 2002, we signed a definitive agreement with Media, Pennsylvania-based ARBOR, Inc., a job training and placement company with operations in New York, New Jersey, Pennsylvania, Georgia and California, to purchase the assets of ARBOR’s Employment & Training Division (ARBOR E&T). The transaction is expected to close in the first quarter of 2003, subject to licensing and other approvals. Upon completion of the transaction, ARBOR E&T will become part of our Division for Training Services and is expected to generate approximately $20 million in annual revenue.

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Results of Operations

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     Consolidated revenues for the third quarter of 2002 were $236.6 million, or 5.3% over the same period in 2001. For the nine months ended September 30, 2002, revenues were $696.7 million, a 4.7% increase over the same period for 2001. These increases are due primarily to growth in census, increased services in our periodic in-home services business unit, prior year rate increases in various states effective mid-2001 and the addition of 108 new homes during the first nine months of 2002. Revenues for the first nine months of 2001 include approximately $2.2 million related to certain operations in Tennessee which we exited in March 2001.

     Our consolidated operating income for the third quarter of 2002 as compared to the same period of 2001 was negatively impacted by the operating losses incurred by the non-core business in Texas described above. This business represents less than 1% of the total revenues of the Disabilities Services division and incurred a loss of approximately $1.0 million, including legal expenses, for the quarter. The third quarter of 2002 was also negatively impacted by increased insurance costs of approximately $1.1 million compared to the same period in 2001. Consolidated labor costs for the third quarter are up from the year-earlier period due principally to increased costs for higher census in our Training Services division, as well as growth in our periodic in-home services in our Disabilities Services division which carries a higher labor cost as a percent of revenue. However, our initiative to deploy the time and attendance system is showing preliminary positive results. Consolidated operating income for the third quarter of 2002 was positively impacted by a pretax gain of approximately $1.0 million realized on the extinguishment of debt. The consolidated results for the third quarter of 2001 were favorably impacted by the recognition of a bequest of $0.8 million to one of our operations from the estate of a local resident. Both of these items are included in other income in the accompanying condensed consolidated statement of income.

     Consolidated operating income for the nine months ended September 30, 2002 was positively impacted by a pretax gain of approximately $1.3 million realized on the extinguishment of debt, an arbitration award of approximately $285,000 and a favorable adjustment of $338,000 resulting from changing our estimated useful lives of our billing and time and attendance systems. The consolidated results for the first nine months of 2001 were negatively impacted by a special charge of $1.6 million related to the write-off of assets and costs associated with the cessation of certain operations in Tennessee, and the write-off of $134,000 in deferred debt issuance costs resulting from a previous credit agreement.

     As a percentage of total revenues, corporate general and administrative expenses for the third quarter and nine months ended September 30, 2002, were 3.9% and 3.8%, respectively. For the same periods in 2001, these expenses were 3.6%. The relative increase in the first nine months of 2002 over the same period in 2001 was due primarily to expanding the management infrastructure at the end of the first quarter of 2001 and costs related to our strategic projects initiated during 2001. Additionally, we have incurred higher legal expenses during 2002. These were partly offset by the arbitration settlement of approximately $285,000 discussed above.

     Effective January 1, 2002, we adopted Statement of Financial Accounting Standards (Statement) No. 142 and are no longer amortizing goodwill. Net income for the third quarter and nine months ended September 30, 2001 includes goodwill amortization of $2.0 million, ($1.6 million net of tax, or $0.07 per share) and $6.0 million, ($4.5 million, net of tax, or $0.18 per share), respectively.

     Net interest expense was $6.1 million in the third quarter of 2002 compared to $4.4 million for the same period in 2001. For the nine months ended September 30, 2002, net interest expense was $18.3 million and $14.2 million for 2002 and 2001, respectively. This increase resulted primarily from the issuance of the $150 million senior notes in November 2001, which was used in part to reduce borrowings under our previous credit facility, combined with a higher average interest rate in 2002 (9.1%) compared with 2001 (7.7%).

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     Our effective income tax rates were 33.4% and 43.5% for the third quarter of 2002 and 2001, respectively. The lower estimated annual rate of 36.0% in 2002 is primarily a result of the elimination of nondeductible goodwill amortization and of changes in estimates of profitability in 2002.

     Disabilities Services

     Results for the Disabilities Services segment for the third quarter and the nine months ended September 30, 2002 as compared to the same periods in 2001 were impacted by the growth in periodic in-home services, offset by the losses encountered by the non-core business in Texas described above. Revenues increased by 6% to $185.9 million for the third quarter of 2002 and by 5% to $547.3 million for the nine months ended September 30, 2002 compared to the same periods in 2001. The increases are due primarily to growth in census, increased services in our periodic in-home services business unit, prior year rate increases effective mid-year 2001 in various states, and the new homes discussed above, offset by the loss of revenue resulting from our exit from Tennessee in March 2001. Segment profit, EBITDA and EBITDAR for the quarter were negatively impacted by the losses in the non-core business described above, as well as increased insurance costs.

     Effective January 1, 2002, we completed a transaction to acquire operations we had previously operated under a management contract. Consideration for the acquisition totaled approximately $10 million, including $9.9 million of debt forgiven and $100,000 in cash. As a result of the transaction, we recorded trade accounts receivable with a fair value of approximately $4.7 million and goodwill of approximately $4.6 million, as well as other assets and liabilities.

     Training Services

     Training Services revenues increased by 7% to $36.6 million for the third quarter of 2002 and by 5% to $107.2 million for the first nine months of 2002, compared to the same periods in 2001, primarily from improved census at many of our Job Corps centers. This also resulted in increases in segment profit, EBITDA and EBITDAR for the third quarter and first nine months of 2002 compared to 2001.

     Youth Services

     Youth Services revenues decreased 3% to $14.1 million for the third quarter of 2002 and 4% to $42.2 million in the first nine months of 2002 compared to the same periods in 2001. The decrease in revenues was due primarily from reduced census at certain operations where states have referred fewer juveniles in response to budgetary pressures and the closure of an operation in Puerto Rico effective January 1, 2002, offset to some degree by the addition of a new contract.

     We believe the operating results for the Youth Services segment for the third quarter of 2002 reflect a temporary decline in the market for these services. We will continue to monitor the operating performance of this segment of our business and determine the impact, if any, on the recoverability of our assets. As of September 30, 2002, Youth Services had total assets of approximately $35 million, which includes goodwill of approximately $9 million and fixed assets of approximately $9 million.

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Financial Condition

     Total assets increased approximately 3% from the prior year end. The increase is due primarily to the acquisition described above and revenue growth. The acquisition contributed to an increase in accounts receivable of approximately $4.7 million and goodwill of approximately $4.6 million, offset by a decrease in other assets due to the forgiveness of debt. Revenue growth contributed to an increase in accounts receivable.

     Accrued expenses increased due primarily to the increases in our insurance reserves and the timing of payment of interest and wage-related costs.

Liquidity and Capital Resources

     For the first nine months of 2002, cash provided by operating activities was $15.8 million compared to $7.6 million for the same period of 2001. This increase was primarily related to higher profitability and increased insurance reserve balances in 2002 as compared to 2001. Additionally, the higher operating cash flow is a result of a reduction in the rate of increase in accounts receivable during the first nine months of 2002 compared to the same period in 2001. The cash increase was offset to some extent by a decrease in accounts payable in 2002 compared to an increase in 2001 principally due to timing of payments.

     For the first nine months of 2002, cash used in investing activities was $13.9 million compared to cash provided of $18.6 million in the same period of 2001, due principally to increased maintenance capital expenditures during 2002 and sale and leaseback transactions completed during 2001.

     For the first nine months of 2002, cash used in financing activities was $5.7 million compared to $50.5 million in the same period of 2001. The first nine months of 2001 included the use of proceeds from sale and leaseback transactions to pay down the revolving credit facility.

     Days revenue in accounts receivable were 58 days at September 30, 2002, compared to 53 days at December 31, 2001. Accounts receivable were $147.8 million and $132.2 million at September 30, 2002 and December 31, 2001, respectively. Approximately $4.7 million of the increase in the balance is attributable to the first quarter 2002 acquisition described above and the balance is due to revenue growth as described previously. We continue to expand implementation of a comprehensive accounts receivable/billing system, which is expected to facilitate improvements in collections. Approximately 99% of our Disabilities Services operations are currently utilizing the new system. For 2000 and prior dates of service, collections are below expectations. While the states generally recognize the billings as valid claims, their funding has significantly deteriorated from the first quarter of 2002 and they are reluctant to process the prior claims for payment in the current economic environment. We are vigorously pursuing alternative collection efforts, as well as continuing to evaluate the full impact of this change in circumstances.

     Our capital requirements relate primarily to the working capital needed for general corporate purposes and our plans to expand through the development of new facilities and programs. We have historically satisfied our working capital requirements, capital expenditures and scheduled debt payments from our operating cash flow and utilization of our credit facility. Cash requirements for the acquisition of new business operations have generally been funded through a combination of these sources, as well as the issuance of long-term obligations and common stock.

     On November 15, 2001, we completed the issuance of $150 million of 10.625% senior notes due November 2008. The senior notes contain covenants restricting our ability to incur additional indebtedness (including the maintenance of a specified leverage ratio), pay dividends, enter into certain mergers, enter into sale and leaseback transactions and sell or otherwise dispose of assets. Additionally, the senior note agreement places limits on the allowable amount of judgments or orders for the payment of money by a court of law or administrative agency.

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     As of September 30, 2002, we had no borrowings under our $80.0 million credit facility. There are outstanding letters-of-credit of approximately $43.6 million. Therefore, as of September 30, 2002, in addition to cash, cash equivalents and short-term investments of $58.8 million, we had approximately $36.4 million available under the credit facility. The credit facility expires in September 2004. The facility also contains various financial covenants relating to indebtedness, capital expenditures, acquisitions and dividends and requires us to maintain specified ratios with respect to fixed charge coverage, leverage, cash flow from operations and net worth. Additionally, the credit facility places limits on the allowable amount of judgments or orders for the payment of money by a court of law. Our ability to achieve the thresholds provided for in the financial covenants is largely dependent upon the maintenance of continued profitability and/or reductions of amounts borrowed under the facility.

      On November 14, 2002, our $80 million credit facility was amended. The amendment contains a waiver of a technical violation at September 30, 2002 of the financial covenant contained in the previous agreement requiring a minimum ratio of consolidated EBITDA to consolidated interest expense. The proposed amendment revises each of the financial covenants contained in the credit agreement and includes changes in the interest rates charged on any borrowings. Interest rates under the amended agreement are based on margins over LIBOR and vary based on our ratio of total net funded debt to consolidated EBITDA. The borrowing margin will increase by 25 basis points as a result of this amendment. Additionally, the amendment allows for certain acquisitions and dispositions. There are outstanding letters-of-credit of approximately $43.6 million issued under the credit facility.

     We believe cash generated from operations and amounts remaining available under our credit facility will be sufficient to meet our working capital, planned capital expenditure and scheduled debt repayment requirements for the next twelve months.

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Contractual Obligations and Commitments

     Information concerning our contractual obligations and commercial commitments as of September 30, 2002 follows (in thousands):