general economic and market conditions;

the effect of the recent change in the United Kingdom (“U.K.”) government and the impact of proposed changes in recent policy making related to health and social care that may reduce revenue and profitability;

the impact of the recent HM Treasury Comprehensive Spending Review setting out the U.K. government’s plans to reduce spending;

the introduction of the individualized budgets and direct payment for service users (the “personalization agenda”), which could lead to Allied Healthcare International Inc.’s (the “Company”) hospital, healthcare facility and other customers to bypass the Company’s services and which might decrease its revenues and margins;

the Company’s ability to continue to recruit and retain flexible healthcare staff;

the Company’s ability to enter into contracts with local governmental social service departments, National Health Service Trusts, hospitals, other healthcare facility clients and private clients on terms attractive to the Company;

the general level of demand for healthcare and social care;

dependence on the proper functioning of the Company’s information systems;

the effect of existing or future government regulation of the healthcare and social care industry, and the Company’s ability to comply with these regulations;

the impact of medical malpractice and other claims asserted against the Company;

the effect of regulatory change that may apply to the Company and that may increase costs and reduce revenue and profitability;

the effect of existing or future governmental regulation in relation to employment and agency workers’ rights and benefits, including changes to National Insurance rates and pension provisions;

the ability to use net operating loss carry forwards to offset net income;

the effect that fluctuations in foreign currency exchange rates may have on the Company’s dollar-denominated results of operations; and

the impairment of goodwill, of which the Company has a substantial amount on the balance sheet, may have the effect of decreasing earnings or increasing losses.

 

Current assets:

Cash and cash equivalents

Accounts receivable, less allowance for doubtful accounts of $880 and $732, respectively

Unbilled accounts receivable

Deferred income taxes

Prepaid expenses and other assets

 

 

Total current assets

 

Property and equipment, net

Goodwill

Other intangible assets, net

 

 

Total assets

 

 

 

Current liabilities:

Accounts payable

Current maturities of debt and capital leases

Accrued expenses, inclusive of payroll and related expenses

Taxes payable

 

 

Total current liabilities

 

Long-term debt and capital leases, net of current maturities

Deferred income taxes

Other long-term liabilities

 

 

Total liabilities

 

 

Commitments and contingencies (Note 10)

 

Noncontrolling interest (Note 5)

 

 

Shareholders’ equity:

Preferred stock, $.01 par value; authorized 10,000 shares, issued and outstanding — none

Common stock, $.01 par value; authorized 80,000 shares, issued 45,721 and 45,721 shares, respectively

Additional paid-in capital

Accumulated other comprehensive loss

Accumulated deficit

 

 

Less cost of treasury stock (2,150 shares)

 

 

Total shareholders’ equity

 

Total liabilities and shareholders’ equity

 

Revenues:

Net patient services

 

 

Cost of revenues:

Patient services

 

 

Gross profit

 

Selling, general and administrative expenses

 

 

Operating income

 

Interest income

Interest expense

Foreign exchange loss

 

 

Income before income taxes

 

Provision for income taxes

 

 

Net income

 

Less: Net income attributable to noncontrolling interest

 

 

Net income attributable to Allied Healthcare International Inc.

 

 

Basic net income per share attributable to Allied Healthcare International Inc. common shareholders

 

 

Diluted net income per share attributable to Allied Healthcare International Inc. common shareholders

 

 

Weighted average number of common shares outstanding:

Basic

 

Diluted

 

Cash flows from operating activities:

Net income

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

Amortization of intangible assets

Foreign exchange loss

Increase (decrease) in provision for allowance for doubtful accounts

Loss on sale of fixed assets

Stock based compensation

Deferred income taxes

Changes in operating assets and liabilities, excluding the effect of businesses acquired and sold:

Decrease in accounts receivable

Decrease in prepaid expenses and other assets

(Decrease) increase in accounts payable and other liabilities

 

 

Net cash provided by operating activities

 

 

Cash flows from investing activities:

Capital expenditures

Payments for acquisitions — net of cash acquired

Proceeds from sale of property and equipment

 

 

Net cash used in investing activities

 

 

Cash flows from financing activities:

Repayments of debt and capital lease obligations

Borrowings under invoice discounting facility, net

Stock options exercised

 

 

Net cash (used in) provided by financing activities

 

 

Effect of exchange rate on cash

 

 

Increase in cash

 

Cash and cash equivalents, beginning of year

 

 

Cash and cash equivalents, end of year

 

 

Supplemental cash flow information:

Cash paid for interest

 

 

Cash paid for income taxes, net

 

 

Supplemental disclosure of non-cash investing and financing activities:

Capital expenditures included in accrued expenses

 

 

Details of business acquired in purchase transactions:

Fair value of assets acquired

 

 

Liabilities assumed or incurred

 

 

Cash paid for acquisitions

Cash acquired

 

Net cash paid for acquisitions

 

 

Deferred acquisition payment

 

The Company is a homecare provider of health and social care (often referred to as domiciliary care) in the United Kingdom (“U.K.”) and Ireland. The Company was incorporated in New York in 1981. The Company provides personal or basic care and nursing services in the customers’ own homes, public or private hospitals and nursing and care homes. The Company’s healthcare staff consists principally of homecare aides (known as carers in the U.K.), nurses and nurses aides.

The services provided by the Company are provided by its integrated network of approximately 120 branches, which have similar economic characteristics and are located mainly throughout most of the U.K. The operations of the Company’s Ireland operations are effectively reviewed as one branch as they provide comparable services and are operated on a similar basis as the Company’s U.K. operations. The Company’s management evaluates operating results on a branch basis. For financial reporting purposes, all its branches are aggregated into one reportable segment.

The Condensed Consolidated Financial Statements presented herein are unaudited and include all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations of the interim periods pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America (“U.S.”) have been condensed or omitted pursuant to the SEC rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. The balance sheet at September 30, 2010 has been derived from the audited consolidated balance sheet at that date, but does not include all information and footnotes required by U.S. GAAP for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Form 10-K for the year ended September 30, 2010. Although the Company’s operations are not highly seasonal, the results of operations for the three and six months ended March 31, 2011 are not necessarily indicative of operating results for the full year.

For each of the three and six months ended March 31, 2011 and 2010, stock-based compensation cost recognized in selling, general and administrative expenses amounted to $0.1 million and $0.2 million, respectively. As of March 31, 2011, there was $0.6 million of total unrecognized compensation cost related to share-based compensation awards, net of estimated forfeitures, which the Company expects to recognize over a weighted average period of approximately 1.8 years. The compensation cost as generated by the Black-Scholes option-pricing model may not be indicative of the future benefit, if any, that may be received by the option holder. Shares available for future grant under the 2002 Stock Option Plan were 3.0 million shares at March 31, 2011.

Following is a summary of stock option activity during the three and six months ended March 31, 2011 (in thousands, except per share data):

Outstanding at January 1, 2011

Forfeited

 

Outstanding at March 31, 2011

 

Outstanding at October 1, 2010

Forfeited

 

Outstanding at March 31, 2011

 

Exercisable at March 31, 2011

 

Vested and expected to vest at March 31, 2011

 

The total intrinsic value of options exercised during the six months ended March 31, 2010 was $0.2 million. For options exercised during the six months ended March 31, 2010, $0.3 million was received in cash to cover the exercise price of the options exercised. There were no options exercised during the six months ended March 31, 2011.

Following is a summary of the status of the Company’s nonvested stock options as of March 31, 2011 and the activity for the three and six months ended March 31, 2011 (in thousands, except per share data):

Nonvested at January 1, 2011

Forfeited

 

Nonvested at March 31, 2011

 

Nonvested at October 1, 2010

Vested

Forfeited

 

Nonvested at March 31, 2011

 

The total grant date fair value of stock options vested during the six months ended March 31, 2011 and 2010 was $0.1 million in each period. There were no stock options that vested during the three months ended March 31, 2011 or 2010.

The Company has granted certain options that, in addition to the time vesting requirement, have performance conditions based on one or more of the Company’s growth in sales, earnings per share, earnings before interest and taxes, earnings before interest, taxes and amortization or earnings before interest, taxes, depreciation and amortization. Of the 3.1 million options outstanding at March 31, 2011, 1.0 million options have both time and performance conditions. The following is a summary of the status of the Company’s options that have both the time vesting requirement and performance conditions (in thousands, except per share data):

Outstanding at January 1, 2011

Forfeited

 

Outstanding at March 31, 2011

 

Outstanding at October 1, 2010

Forfeited

 

Outstanding at March 31, 2011

 

Exercisable at March 31, 2011

 

Vested and expected to vest at March 31, 2011

 

Nonvested at January 1, 2011

Forfeited

 

Nonvested at March 31, 2011

 

Nonvested at October 1, 2010

Forfeited

 

Nonvested at March 31, 2011

 

The total grant date fair value of time and performance based stock options that vested during the six months ended March 31, 2010 was $0.1 million. There were no time and performance based stock options that vested in the six months ended March 31, 2011.

In fiscal 2009, the Company’s Board of Directors, upon the recommendation of its Compensation Committee, made a grant of 0.6 million stock appreciation rights (the “SARs”) to Alexander (Sandy) Young, its Chief Executive Officer (the “CEO”). The SARs represent the right to receive a payment, in shares of the Company’s common stock, equal to the product of (a) the number of SARs granted that vest and (b) the excess of (i) the closing sale price of a share of the Company’s common stock on the date that the SARs are settled over (ii) the base price of $1.51 (the closing price of a share of the Company’s common stock on Nasdaq on April 21, 2009, the date that the SARs were granted to Mr. Young). The SARs are subject to both time vesting and performance vesting.

The SARs agreement with Mr. Young provides that the potential maximum value of the SARs (when aggregated with the value of the vested portion of the option to purchase 0.2 million shares of the Company’s common stock held by Mr. Young) is £3.0 million (approximately $4.8 million at the exchange rate at March 31, 2011). If the total value of the SARs and the value of the vested portion of Mr. Young’s options exceeds £3.0 million, then the base price of $1.51 for the SARs will be increased so that the total value is equal to £3.0 million.

At March 31, 2011, the Company estimated that none of the performance measures will be achieved which resulted in zero stock-based compensation cost related to SARs to be recognized as of March 31, 2011. At March 31, 2011, the Company had $0.3 million of total unrecognized compensation cost related to SARs compensation awards. A change in the estimate of the SARs performance measures vesting could result in the Company incurring such cost over a period through September 30, 2011. The compensation cost as generated by the Monte-Carlo pricing model may not be indicative of the future benefit, if any, that may be received by the SARs holder.

Property and equipment is carried at cost, net of accumulated depreciation and amortization. Leasehold improvements are amortized over the related lease terms or estimated useful lives, whichever is shorter. Furniture, fixtures and equipment are amortized on a straight-line method over the estimated useful lives ranging from three to eight years. Computer software is amortized on a straight-line method over the estimated useful lives ranging from three to seven years.

Major classes of property and equipment, net, consist of the following at March 31, 2011 and September 30, 2010 (in thousands):

Furniture, fixtures and equipment (including software)

Leasehold improvements

Vehicles

 

 

Less, accumulated depreciation and amortization

 

 

 

Depreciation and amortization of property and equipment for the three and six months ended March 31, 2011 were $1.0 million and $1.9 million, respectively. Depreciation and amortization of property and equipment for the three and six months ended March 31, 2010 were $0.7 million and $1.5 million, respectively.

The following table presents the changes in the carrying amount of goodwill for the six months ended March 31, 2011 (in thousands):

Balance at October 1, 2010

Goodwill acquired during the year

Foreign exchange effect

 

Balance at March 31, 2011

 

Of the $108.0 million goodwill amount, approximately $4.3 million is deductible for U.K. income tax purposes.

Intangible assets subject to amortization are being amortized on the straight-line method and consist of the following (in thousands):

Customer relationships

Trade names

Non-compete agreements

Favorable leasehold interests

 

Total

 

Customer relationships

Trade names

Non-compete agreements

Favorable leasehold interests

 

Total

 

Amortization expense for other intangible assets subject to amortization was $0.3 million and $0.6 million for each of the three and six months ended March 31, 2011 and 2010, respectively. At March 31, 2011, estimated future amortization expense of other intangible assets still subject to amortization for the six months ending September 30, 2011 and the succeeding fiscal years is as follows:

Remainder of 2011

2012

2013

2014

2015

Thereafter

 

 

 

The change in the net carrying amount at March 31, 2011 is due to amortization expense and the foreign exchange effect.

In May 2010 the Company acquired a shareholding in a group of businesses commonly known as Homecare Independent Living Group (the “HILG”). The Company acquired a 50.1% shareholding in L&B (No. 182) Limited, the holding company of the five entities that make up the HILG business, for a consideration of £3.9 million ($5.7 million, at the acquisition date exchange rate). Such consideration may be adjusted based on the final value of the net assets. The purchase price was funded through the Company’s cash on hand. In addition, the Company has also entered into call option agreements giving the Company the right to buy the remaining shares between March 2013 and March 2020. The sellers have also entered into put option agreements giving them the right to require the Company to buy the remaining shares between March 2011 and March 2020. The minimum amount payable by the Company for 100% of the HILG business will be £7.7 million ($12.3 million at the exchange rate at March 31, 2011). The maximum amount payable by the Company for 100% of the HILG business will be £11.2 million ($18.0 million at the exchange rate at March 31, 2011) and is subject to HILG achieving certain annual earnings before interest, taxes, depreciation and amortization targets.

HILG is a leading provider of homecare to the elderly, physically disabled and mentally disabled with four operating divisions in Northern Ireland and an increasing presence in the Republic of Ireland. This acquisition gives the Company a market-leading position in Northern Ireland as well as a strategic footprint in the Republic of Ireland market. Both are new territories for the Company for which management believes will provide opportunities for future growth, especially in the Republic of Ireland. The two sellers of HILG remain in their existing roles as directors of HILG and have been joined by additional directors appointed by the Company to this business.

The goodwill of $7.4 million arising from the acquisition consists largely of the benefits expected from this transaction. None of the goodwill recognized is deductible for income tax purposes.

The following tables summarize the consideration paid for HILG and the estimates of the fair value of the assets acquired and liabilities assumed, the resulting goodwill recognized at the acquisition date, as well as the fair value at the acquisition date of the noncontrolling interest in HILG. The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in adjustments to the preliminary values presented below. The Company expects to finalize these amounts in its next fiscal period ended June 30, 2011.

Cash

 

Fair value of total consideration transferred

 

Property and equipment

Current assets^(a)

Current liabilities^(b)

Debt and capital lease obligations

Deferred tax liability

 

Total identifiable net liabilities

Goodwill

Other intangible assets^(c)

Noncontrolling interest in HILG

 

Total purchase price

 

In the third quarter of fiscal 2010, acquisition-related costs of $0.5 million related to the acquisition of HILG were included in selling, general, and administrative expenses in the Company’s condensed consolidated statement of operations.

The fair value of the noncontrolling interest in HILG, a private company, was estimated by using the observed transaction relating to a controlling interest which occurred as of the measurement date. The fair value measurement is based on significant inputs that are not observable in the market and thus represents a Level 3 measurement. Key assumptions include (i) an estimated discount to account for the lack of control feature of the noncontrolling interest derived using implied discounts as observed through control premiums of private transactions in the company’s sector, and (ii) an estimated discount to account for the lack of marketability of the noncontrolling interest derived using an option-based model which estimates the cost of holding a security for period time needed before achieving a transaction. Significant inputs into the option-based model include (i) a estimated holding period of 3 years until a transaction is consummated, (ii) an equity volatility estimate of 42% based on comparable companies, and (iii) a risk free rate of 1.34% based on the holding period selected.

Due to the put option agreements, the Company has classified the noncontrolling interest as mezzanine equity on its condensed consolidated balance sheets. The following table presents a reconciliation of the carrying amount of the noncontrolling interest at September 30, 2010 and March 31, 2011 (in thousands):

Fair value of noncontrolling interest at acquisition

Net income attributable to noncontrolling interest

Change in cumulative translation adjustment

 

Noncontrolling interest at September 30, 2010

Net income attributable to noncontrolling interest

Change in cumulative translation adjustment

 

Noncontrolling interest at March 31, 2011

 

In March 2011 the Company acquired the entire share capital of Health and Lifecare Options Limited, which trades under the ScotHomecare name, for an initial consideration of £0.7 million ($1.2 million, at the acquisition date exchange rate) and £0.2 million ($0.4 million, at the acquisition date exchange rate) additional consideration which was deferred for three months pending the finalization of the completion accounts. Such consideration may be adjusted based on the final value of the net assets. In addition, the Company repaid £1.5 million ($2.4 million, at the acquisition date exchange rate) of liabilities assumed on acquisition. The purchase price and liabilities repaid were funded through the Company’s cash on hand.

ScotHomecare is a flexible domiciliary homecare business with nine branches in Scotland and one branch in Leicester, England. ScotHomecare’s services include adult health care, child nursing care, palliative care nursing and elderly care services.

The goodwill of $3.7 million arising from the acquisition consists largely of the benefits expected from this transaction. The acquisition expands the Company’s operations, making it one of the largest provider of domiciliary care in Scotland. Management believes that the transaction will allow the Company to introduce new higher margin services, including learning disabilities and continuing care, in these new locations. None of the goodwill recognized is deductible for income tax purposes.

The following tables summarize the consideration paid for ScotHomecare and the estimates of the fair value of the assets acquired and liabilities assumed and the resulting goodwill recognized at the acquisition date. The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in adjustments to the preliminary values presented below. The Company expects to finalize these amounts by the end of its fiscal year ended September 30, 2011.

Cash

Deferred cash payment^(a)

 

Fair value of total consideration

 

Property and equipment

Current assets^(a)

Current liabilities^(b)

Debt

 

Total identifiable net liabilities

Goodwill

 

Total purchase price

 

In the second quarter of fiscal 2011, acquisition-related costs of $0.1 million related to the acquisition of ScotHomecare were included in selling, general, and administrative expenses in the Company’s condensed consolidated statement of operations.

The pro forma results of operations and related per share information for these acquisitions have not been presented as the acquisitions are not considered material.

Accrued expenses consist of the following at March 31, 2011 and September 30, 2010 (in thousands):

Payroll and related expenses

Professional fees

Refunds payable

Other

 

 

 

The Company recorded a provision for income taxes amounting to $1.0 million or 31.7% of income before income taxes for the three months ended March 31, 2011, compared to a provision of $0.9 million or 24.4% of income before income taxes for the three months ended March 31, 2010. The Company recorded a provision for income taxes amounting to $2.1 million or 33.9% of income before income taxes for the six months ended March 31, 2011, compared to a provision of $1.9 million or 25.5% of income before income taxes for the six months ended March 31, 2010. The difference in the effective tax rate between the three and six months ended March 31, 2011 and March 31, 2010 is mainly due to the U.K. tax deduction on intra-group interest expense no longer being an allowable deduction effective October 1, 2010.

As of March 31, 2011, the Company has recorded a full valuation allowance against its U.S. deferred tax assets as management believes it is not more likely than not that these deferred tax assets will be utilized prior to their expiration. Subsequent recognition of these deferred tax assets would result in an income tax benefit in the year of such recognition. The Company’s public offering in July 2004 of its common shares caused an ownership change under Section 382 of the Internal Revenue Code of 1986, as amended, (the “Code”). Accordingly, Section 382 imposes an annual limit on the Company’s ability to utilize it net operating loss carryforward. The Company has discovered that, upon the ownership change triggered by the 2004 public offering, an election required under Section 382 of the Code to include the value of its foreign subsidiaries for purposes of determining the annual net operating loss utilization limitation had not been filed. Absent this election, the annual net operating utilization limitation would be negligible. The Company has requested a private letter ruling from the Internal Revenue Service seeking relief which would allow for a retroactive election and believes it is more likely than not that such relief will be obtained. An inability to use a significant portion of the Company’s federal net operating loss carryforward could have a material adverse effect on its consolidated financial position and results of operations.

As of March 31, 2011, the Company has not recorded any unrecognized tax benefits, which remains unchanged from September 30, 2010.

Basic earnings per share (“EPS”) is computed using the weighted average number of common shares outstanding. Diluted EPS adjusts basic EPS for the effects of stock options and warrants only when such effect is dilutive. The Company uses the treasury stock method to calculate the effect of potential common shares, which require it to compute total assumed proceeds as the sum of (a) the amount the employee must pay upon exercise of the award, (b) the amount of unrecognized share-based compensation costs attributed to future services and (c) the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the award. Share-based compensation awards for which total assumed proceeds exceed the average market price over the applicable period have an antidilutive effect on EPS and are excluded from the calculation of diluted EPS. At March 31, 2011 and 2010, the Company had outstanding stock options (including performance-based stock options) to purchase 1.8 million and 0.9 million shares, respectively, of common stock ranging in price from $2.11 to $6.20 and $2.11 to $6.20 per share, respectively, that were not included in the computation of diluted EPS either because the exercise price was greater than the average market price of the common shares or the conditions of the performance-based stock options have yet to be satisfied or such effect would have been anti-dilutive. Further, 0.6 million of contingently issuable shares related to the SARs issued to the CEO, as further described in Note 2, have not been included in the computation of diluted EPS at March 31, 2011 and 2010.

The weighted average number of shares used in the basic and diluted earnings per share computations for the three and six months ended March 31, 2011 and 2010 are as follows (in thousands):

Weighted average number of common shares outstanding as used in computation of basic EPS of common stock

Effect of dilutive securities — stock options

 

Shares used in computation of diluted EPS of common stock

 

Components of comprehensive income (loss) include net income and all other non-owner changes in equity, such as the change in the cumulative translation adjustment, which is the only item of other comprehensive income (loss) impacting the Company. The translation of the financial statement of the Company’s U.K. operations is impacted by fluctuations in foreign currency exchange rates. The following table displays comprehensive income (loss) for the three and six months ended March 31, 2011 and 2010 (in thousands):

Net income

Change in cumulative translation adjustment, net of income taxes

 

Comprehensive income (loss), net of income taxes

Comprehensive income attributable to the noncontrolling interest

 

Comprehensive income (loss) attributable to the Company

 

The Company has employment agreements with its two executive officers that provide for minimum aggregate annual base compensation of approximately $0.6 million (at the exchange rate at March 31, 2011) in fiscal 2011.

The Company has entered into various operating lease agreements for office space and equipment, as well as housing accommodations used by HILG in providing social care. Certain of these leases provide for renewal options. Of the $5.3 million operating lease obligations at March 31, 2011, $0.3 million relates to properties that are owned by the noncontrolling interest holders.

In connection with the Company’s acquisition of HILG, the Company assumed various capital lease agreements mainly related to leased vehicles and furniture, fixtures and equipment, which had gross carrying values of $0.7 million and $0.1 million, respectively, at March 31, 2011 and $0.7 million and $0.1 million, respectively, at September 30, 2010 and are included within property and equipment in the Company’s Condensed Consolidated Balance Sheet. Accumulated amortization related to these capital leases totaled $0.3 million and $0.1 million at March 31, 2011 and September 30, 2010, respectively. Depreciation of assets under capital leases is included in depreciation expense. The present value of the net minimum capital lease payments estimated using a discounted cash flow analysis was $0.5 million at March 31, 2011.

In connection with the Company’s acquisition of HILG, the Company assumed debt related to two invoice discounting facilities and a bank loan for the funding of capital expenditures. The invoice discounting facilities provide for available funds of up to $1.5 million (at the exchange rate at March 31, 2011) that mature in April and June of 2011. The loans bear interest at rates equal to LIBOR plus 2.0% with a minimum of 4.0% per annum. At March 31, 2011 and September 30, 2010, the Company had outstanding borrowings of $0.4 million and $0.3 million, respectively, under the invoice discounting facilities and a bank loan that bore interest at rates ranging from 4.0% to 4.7%.

Other obligations represent our contractual commitment for a new branch operating system and purchase commitment for new office equipment and software.

The following table summarizes the Company’s future minimum rental commitments required under both operating and capital lease agreements, debt and other obligations as of March 31, 2011 (in thousands):

2011

2012

2013

2014

2015

Thereafter

 

Total

 

Less: Amounts representing interest

 

Net present value of capital lease obligations

Less current portion

 

Long-term capital lease obligations

 

The Company believes that it has been in compliance, in all material respects, with the applicable provisions of the federal statutes, regulations and laws and applicable state laws, together with the applicable laws and regulations of other countries in which the Company operates. There can be no assurance that an enforcement action will not be brought against the Company for violations of applicable law or that the Company will not be found to be in violation of one or more of these provisions. If the Company is found to have violated laws or regulations that are applicable to it, the Company could incur civil and/or criminal penalties as well as adverse publicity. In addition, in such circumstances, the parties to certain of the Company’s existing contracts could exercise their right to terminate their contracts with the Company and/or the Company might find itself disadvantaged when bidding on new contracts. At present, the Company cannot anticipate what impact, if any, administrative or judicial interpretation of the applicable federal and state laws and those of other countries may have on the Company’s consolidated financial position, cash flows or results of operations.

The Company is involved in various legal proceedings and claims incidental to its normal business activities. The Company is vigorously defending its position in all such proceedings. Management believes these matters should not have a material adverse impact on the consolidated financial position, cash flows or results of operations of the Company.

Liabilities for loss contingencies, arising from claims, assessments, litigation and other sources are recorded when it is probable that a liability has been incurred and the amount of liability can be reasonably estimated. Based on management’s best estimate of probable liability, the Company has accrued $0.1 million for such costs at March 31, 2011 and at September 30, 2010.

The Company has a defined contribution plan, pursuant to Section 401(k) of the Internal Revenue Code, covering all U.S. employees who meet certain requirements. In addition to the U.S. plan, the Company’s U.K. subsidiaries also sponsor personal pension plans that operate as salary reduction plans. Further, as part of certain employees’ compensation, the Company has agreed to make payments towards their U.K.- based private pension fund. The Company expects to contribute $0.2 million to such plans in fiscal 2011.

Transfers of Financial Assets. In June 2009, the FASB issued a standard which provides guidance to improve transparency about transfers of financial assets and a transferor’s continuing involvement, if any, with transferred financial assets. This standard amends various provisions of the previously issued standard relating to transfers and servicing of financial assets and extinguishments of liabilities to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. Effective October 1, 2010, the Company adopted this standard, which did not have any impact on the Company’s consolidated financial position or results of operations.

Consolidation of Variable Interest Entities. In June 2009, the FASB issued a standard, which changes the criteria to determine whether to consolidate a variable interest entity, to provide more relevant and reliable information to users of financial statements. Effective October 1, 2010, the Company adopted this standard, which did not have any impact on the Company’s consolidated financial position and results of operations as the Company does not have variable interest entities.

Fair Value Measurements and Disclosures. In August 2009, the FASB issued a standard to further update the fair value measurement guidance to clarify how an entity should measure liabilities at fair value. This standard update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. When quoted prices are not available, the quoted price of the identical liability traded as an asset, quoted prices for similar liabilities or similar liabilities traded as an asset, or another valuation approach should be used. This standard update also clarifies that restrictions preventing the transfer of a liability should not be considered as a separate input or adjustment in the measurement of fair value. Effective October 1, 2010, the Company adopted this standard, which did not have any impact on the Company’s consolidated financial position or results of operations.

Stock Compensation. In April 2010, the FASB issued an update to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, the entity would not classify such an award as a liability if it otherwise qualifies as equity. This update is effective for the Company in its fiscal year beginning October 1, 2011 and is not expected to have an impact on the Company’s consolidated financial position or results of operations as the Company’s current practice is consistent with the update.

The Company’s short term financial instruments include cash, accounts receivable, unbilled accounts receivable, accounts payable, current maturities of debt and capital leases, accrued expenses and taxes payable. The carrying value of the short term financial instruments approximates the fair value due to their short term nature. These financial instruments have no stated maturities or the financial instruments have short term maturities that approximate market value.

The fair value of the Company’s long-term debt and capital lease obligations was approximately $0.2 million and $0.4 million at March 31, 2011 and September 30, 2010, respectively. The fair values were estimated using a discounted cash flow analysis.

On May 6, 2011, the Company acquired the entire issued share capital of BiJu Limited for maximum total consideration of £1.6 million ($2.6 million, at the acquisition date exchange rate). Initial consideration of £1.3 million ($2.1 million, at the acquisition date exchange rate) was paid on completion of the transaction and was funded through the Company’s cash on hand. Additional consideration of £0.3 million ($0.5 million, at the acquisition date exchange rate) could become payable after 12 months depending on the level of gross profit generated in the business during the next twelve-month period equating to a pro forma earnings before interest, tax, depreciation and amortization of £0.4 million ($0.6 million, at acquisition date exchange rate).

BiJu Limited is a recognized supplier of diverse homecare services, including rehabilitation, physical disabilities, sensory impairment and extra care sheltered housing projects, to clients throughout Lancashire. This acquisition expands the Company’s geographical footprint in the North West of England and provides it with additional growth opportunities across Lancashire.

The following discussion and analysis should be read in conjunction with the information contained in the Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. This discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainty. Our actual results could differ materially from the results discussed in these forward-looking statements. Factors that could cause or contribute to such differences include those discussed on page 2 in this Quarterly Report on Form 10-Q under “Forward-Looking Statements.”

We are a leading homecare provider of health and social care (often referred to as domiciliary care) in the United Kingdom and Ireland, as measured by revenues, market share and number of staff. We operate a community-based network of approximately 120 branches with the capacity to provide carers (known as home health aides in the U.S.), nurses, and specialized medical personnel to locations covering approximately 90% of the U.K. population. We provide personal or basic care and nursing services in the customers’ own homes, public or private hospitals and nursing and care homes. Homecare, which accounts for over 85% of our revenues, is provided for individuals (normally elderly individuals) who require domiciliary care, individuals with learning disabilities and individuals of all ages who require health-related services for complex care needs. The main purchaser of our services for customers’ own homes is local governmental social services departments, private individuals, the Health and Social Care Board and National Health Services (the “NHS”) Primary Care Trusts. We also supply nursing staff services to nursing homes and hospitals that account for our remaining revenues.

In March 2011, we acquired the entire share capital of Health and Lifecare Options Limited, which trades under the ScotHomecare name, for an initial consideration of £0.7 million ($1.2 million, at the acquisition date exchange rate ) and £0.2 million ($0.4 million, at the acquisition date exchange rate) additional consideration which was deferred for three months pending the finalization of the completion accounts. Such consideration may be adjusted based on the final value of the net assets. In addition, we repaid £1.5 million ($2.4 million, at the acquisition date exchange rate) of liabilities assumed on acquisition. The purchase price and liabilities repaid were funded through the company’s cash on hand.

ScotHomecare is a flexible domiciliary homecare business with nine branches in Scotland and one branch in Leicester, England. ScotHomecare’s services include adult health care, child nursing care, palliative care nursing and elderly care services.

In May 2010, we acquired a shareholding in a group of business commonly known as Homecare Independent Living Group (“HILG”), which has operations in Ireland. We acquired a 50.1% shareholding in L&B (No. 182) Limited, the holding company of the five entities that make up the HILG business, for a consideration of £3.9 million ($5.7 million, at the acquisition date exchange rate), subject to adjustment based on the final value of the net assets. This was funded through the company’s cash on hand. In addition, we also entered into call option agreements giving us the right to buy the remaining shares between March 2013 and March 2020. The sellers have also entered into put option agreements giving them the right to require us to buy the remaining shares between March 2011 and March 2020. The minimum amount payable by us for 100% of the HILG business will be £7.7 million ($12.3 million at the exchange rate at March 31, 2011). The maximum amount payable by us for 100% of the HILG business will be £11.2 million ($18.0 million at the exchange rate at March 31, 2011) and is subject to HILG achieving certain annual earnings before interest, taxes, depreciation and amortization targets.

HILG is a leading provider of homecare to the elderly, physically disabled and mentally disabled in Northern Ireland with four operating divisions and an increasing presence in the Republic of Ireland. This acquisition gives us a market-leading position in Northern Ireland as well as a strategic footprint in the Republic of Ireland market. Both are new territories for us for which we believe will provide opportunities for future growth, especially in the Republic of Ireland. The two sellers of HILG remain in their existing roles as directors of HILG and have been joined by additional directors appointed by us to this business.

Our services are provided by our integrated network of approximately 120 branches, which have similar economic characteristics and which are located throughout most of the U.K. The operations of our acquisition in Ireland are effectively reviewed as one branch as they provide comparable services and are operated on a similar basis as our U.K. operations. Our healthcare staff consists principally of homecare aides, nurses and nurses aides. Our management evaluates operating results on a branch basis. All our branches are aggregated into one reportable segment for financial reporting purposes.

Effective January 1, 2010, the standard rate of U.K. value-added tax (“VAT”) reverted to 17.5% (from the previous rate of 15%) and has further increased to 20% effective January 4, 2011, which has and will continue to increase the amount of any irrecoverable VAT cost. For the three and six months ended March 31, 2011 we incurred irrecoverable VAT of $0.7 million and $1.3 million, respectively, in selling, general and administrative expenses. Based on a similar level of future purchases, management estimates that the increase in VAT would increase expense by $0.1 million per quarter.

Effective for our fiscal year beginning October 1, 2010, legislative changes have gone into effect that have disallowed the U.K. tax deduction on intra-group interest expense. This legislative change has resulted in an increase to our tax provision amount and an increase of approximately 9% to our effective tax rate for the fiscal 2011 results.

A further legislative change that went into effect in April 2011 is the U.K. government’s introduction of a 1% increase to the national insurance employer contribution amounts, which could impact our profit margins.

In March 2011, the U.K. Finance Bill 2011-12 was published. As published the U.K. Finance Bill 2011, announced that the rate of corporation tax will be reducing to 26% from April 2011 and will be reducing to 23% by April 2014. The bill was substantively enacted into law on March 29, 2011. We are currently evaluating the likely impact of this proposed change on our consolidated financial statements and results of operations.

The Pensions Act 2008 is to be introduced in phases, over a five year period beginning in 2012, and will require employers to automatically enroll all eligible jobholders, who are not already in a qualifying workplace or personal pension plan, into either a qualifying workplace or personal pension plan or a new type of savings arrangement, known as the personal accounts plan. Automatic enrollment means that if jobholders do not wish to be a member of the plan offered to them they must actively opt out of that arrangement. Initially employers will be required to contribute a minimum of 1% of the jobholder’s qualifying earnings. Upon the final phase in of the legislation, employers will be required to contribute a minimum of 3% of the jobholders qualifying earnings, which will be supplemented by contributions from the jobholder so that, in total, the pension contribution for each jobholder should equal a minimum of 8% of the jobholder’s qualifying earnings. There will be limits set on the amount that employers and jobholders can contribute in any one year. The personal accounts plan will be a new trust-based occupational plan, which is independent of the U.K. government and run by a trustee corporation. The extent to which we can recover this additional cost from our customers is uncertain and could impact our profit margins.

In order to reduce the U.K. government’s fiscal deficit HM Treasury announced in October 2010, following its Comprehensive Spending Review, its plans to achieve a significant reduction in public spending. While the U.K. government has stated that it will increase spending in the NHS over the next four years to support healthcare, we note the increase will be partially offset as the NHS has increased obligations and cost of treatments going forward due to the growing population and demand for better healthcare. However, the Comprehensive Spending Review will also allocate £2 billion (approximately $3.2 billion at the exchange rate at March 31, 2011) a year of additional funding by 2014-2015 to support social care. The Comprehensive Spending Review also announced significant cuts in funding to local authorities, who are the main providers of social care, and other public bodies, which are a key source of revenue to us. Local authorities are in the process of evaluating how to apply such budget restrictions across their different areas of spending. While we expect some negative impacts on our business as a result of the upcoming changes, we believe that new opportunities will arise from the Comprehensive Spending Review (for example, potential reallocation of money from residential to homecare) and the high quality of our services, our dedicated and caring personnel and our strong market reputation will, we also believe, continue to drive demand for our homecare services. We will continue to monitor this closely.

The U.K. government is also seeking to introduce a greater level of personalization. Personalization is a social care approach which aims for social care services users to have control over how money allocated to their care is spent to achieve their own individual needs for independence, well-being and dignity.

Another of the U.K. government’s visions is for primary and community care to provide high quality, personal care and support, treating people when they are sick and helping them stay healthy, where and when they need it most. The U.K. government wishes to ensure that there is access to a dedicated team of family doctors, community nurses, health visitors, allied health professionals, social care professionals, pharmacists, dentists and opticians, to enable most patients to enjoy good quality care, close to home. The U.K. government recognizes that the NHS needs to achieve an unprecedented transfer of care and treatment from hospital to community settings and that community services have a pivotal role to play in this. Accordingly, the U.K. government has stated that it wants to build on the services which are currently provided in the community to create one integrated sustainable structure.

In addition to the personalization agenda and the opportunity for service users and patients to effectively commission their own care, the U.K. government is also radically reforming the NHS organizations that currently commission care, with the proposed abolition of Strategic Health Authorities (the “SHAs”) and NHS Primary Care Trusts with whom we currently deal and replacing them with NHS Commissioning Boards and General Practitioner Commissioning Consortia (“GP Consortia”). The GP Consortia will be given freedom and responsibility for commissioning healthcare for their local communities. Services will be more responsive to patients and designed around their needs, and local authorities will play a new role of supporting integration across health and social care. In the meantime, SHAs and NHS Primary Care Trusts will be phased out, and management costs will be reduced to commit more resources to support frontline services. While we believe there is large support for more care at home, away from more expensive residential care, these changes and the method of procurement and the extent of some of the current initiatives like personalization and independent budgets and their effects on our business should become clearer over the next twelve months. As all these proposed changes are continually evolving and could change at any time depending on their political support, we will continue to monitor this closely.

Finally, we believe that there is potential for further outsourcing of homecare by local governments and NHS Primary Care Trusts. However, both governmental and NHS bodies are under pressure to achieve significant cost savings and efficiencies. Consequently, the benefits arising from the potential for outsourcing may be reduced by tighter local governmental and NHS Primary Care Trust budgets or by policy changes or legislation.

The preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures in a given reporting period. We believe the following accounting policies are critical areas affecting our financial condition and results of operations where estimates are required.

We estimate the collectability of our accounts receivable, which requires a considerable amount of judgment in assessing the ultimate realization of these receivables, including the current credit-worthiness of each customer. Significant changes in required reserves may occur in the future as we continue to expand our business and as conditions in the marketplace change.

Our company maintains credit controls to ensure cash collection on a timely basis. The credit terms agreed with our customers range from 7 days to a maximum of 30 days from invoice date. We maintain a credit department which consists of approximately 20 personnel who are targeted to collect outstanding receivables. We have established the following guidelines for the credit department to use as well as for us to assess the credit department’s performance:

to maintain accounts receivable levels (including unbilled accounts receivable) to below 45 days;

to limit our overdues (greater than 90 days) within agreed targets; and

to limit bad debt write off in the year within agreed targets.

We also apply a policy of withdrawing supply from customers who are significantly overdue. Many private customers are contracted on a “direct debit” basis where we can collect payment direct from customers’ bank accounts.

We have devised a provisioning methodology based on the customer profile and historical credit risk across our U.K. business. Accounts receivable are written off when the credit control department determines the amount is no longer collectible. In addition, we do not have a threshold for account balance write-offs as our policy focuses on all balances, whatever the size.

We have significant amounts of goodwill and other intangible assets. The determination of whether or not goodwill has become impaired involves a significant amount of judgment. Changes in strategy and/or market conditions could significantly impact these judgments and require adjustments to recorded amounts of goodwill. We have recorded goodwill and separately identifiable intangible assets resulting from our acquisitions through March 31, 2011. Goodwill is tested for impairment annually in the fourth quarter of each fiscal year. A more frequent evaluation will be performed if indicators of impairment are present. In each quarter of fiscal 2011, we determined that there were no such indicators. We completed the annual impairment test of goodwill during the fourth quarter of fiscal 2010 and determined that there was no impairment to our goodwill balance. The calculation of fair value used for an impairment test includes a number of estimates and assumptions, including future income and cash flow projections, the identification of appropriate market multiples and the choice of an appropriate discount rate. If we are required to record an impairment charge in the future, it could have an adverse impact on our consolidated financial position or results of operations.

We account for income taxes using the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities reflect tax carryforwards and the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes, as determined under currently enacted tax rates. Deferred tax assets are recorded if future realization is more likely than not. Deferred taxes are recorded primarily for foreign, federal and state net operating loss carryforwards, depreciation and amortization of intangibles, which are reported in different periods for income tax purposes than for financial reporting purposes. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized. The determination of whether or not valuation allowances are required to be recorded involves significant estimates regarding the future profitability of our company, as well as potential tax strategies for the utilization of net operating loss carryforwards. As of March 31, 2011, we had recorded a full valuation allowance against the deferred tax asset created by the U.S. federal net operating loss carryforward as we did not believe it was more likely than not that such losses would be utilized prior to their expiration. Subsequent recognition of these deferred tax assets would result in an income tax benefit in the year of such recognition.

Our public offering in July 2004 of shares of our common stock caused an ownership change under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). Accordingly, Section 382 imposes an annual limit on our ability to utilize our net operating loss carryforward. Our company has discovered that, upon the ownership change triggered by the 2004 public offering, an election required under Section 382 of the Code to include the value of our foreign subsidiaries for purposes of determining the annual net operating loss utilization limitation had not been filed. Absent this election, the annual net operating utilization limitation would be negligible. We have requested a private letter ruling from the Internal Revenue Service seeking relief which would allow for a retroactive election. Although we believe it is more likely than not that such relief will be obtained, there is no assurance that we will be able to obtain such relief. An inability to use a significant portion of our federal net operating loss carryforward could have a material adverse effect on our financial condition or results of operations.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. As of March 31, 2011, our company has not recorded any unrecognized tax benefits, which remains unchanged from September 30, 2010.

We are involved in various legal proceedings and claims incidental to our normal business activities. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies are made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters.

Patient services are recognized when services are performed and substantiated by proper documentation. For patient services, which are billed at fixed rates, revenue is mainly recognized either upon completion of timesheets that also require the signature of the recipient of services or through electronic call monitoring.

We receive a majority of our revenue from local governmental social service or social care departments and the NHS.

Amounts paid for acquisitions are allocated to the tangible assets acquired, liabilities assumed and noncontrolling interests based on their estimated fair value at the date of acquisition. We then allocate the purchase price in excess of net tangible assets acquired to identifiable intangible assets. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. We typically obtain a third-party valuation in order to complete our purchase price allocations. Accordingly, final asset and liability fair values as well as useful lives may differ from management’s original estimates and could have a material adverse impact on our consolidated financial position or results of operations.

We are one of the leading suppliers of homecare services in the U.K. Current trends in homecare services that have contributed to the growth of this business include the increasing shift from care in residential homes to care in the home, which in most cases is a lower cost option, an increase in the aging population and additional opportunities as a result of the increase in demand for higher sophisticated homecare service lines, such as continuing care and care for individuals with learning disabilities. Over the last year we have seen a switch away from the traditional larger block/spot contract tenders to smaller framework preferred supplier contracts, often in specialist services.

In order to reduce the U.K. government’s fiscal deficit HM Treasury announced in October 2010, following its Comprehensive Spending Review, its plans to achieve a significant reduction in public spending. While the U.K. government has stated that it will increase spending in the NHS over the next four years to support healthcare, we note the increase will be partially offset as the NHS has increased obligations and cost of treatments going forward due to the growing population and demand for better healthcare. However, the Comprehensive Spending Review will also allocate £2 billion (approximately $3.2 billion at the exchange rate at March 31, 2011) a year of additional funding by 2014-2015 to support social care. The Comprehensive Spending Review also announced significant cuts in funding to local authorities and other public bodies, which are a key source of revenue to us. Local authorities are in the process of evaluating how to apply such budget restrictions across their different areas of spending. As a result of the imminent budget social care cuts that were anticipated after the recent U.K. government change we have already not seen typical increases in either service prices or the number of service hours in the three and six months ended March 31, 2011 as compared to the three and six months ended March 31, 2010.

While we expect some negative impacts on our business as a result of the upcoming changes, we believe that new opportunities will arise from the Comprehensive Spending Review (for example, potential reallocation of money from residential to homecare) and the high quality of our services, our dedicated and caring personnel and our strong market reputation will continue to drive demand for our homecare services.

Nursing homes results have been impacted by the general economic market. We have experienced a lesser demand for our services from nursing homes, which we believe is a result of the economic recession, as nursing homes are trying to reduce their costs as well as their own permanent staff working additional hours. In addition, nursing homes have been impacted by the general move of care from establishments to homecare as well as the fact that smaller suppliers, who previously serviced local government authority work and social services, are focusing more on agency business. Further, as a result of the budget restrictions arising from the Comprehensive Spending Review, local authorities will spend less money on nursing homes.

The NHS requires any healthcare staffing company that provides temporary staff to NHS Hospitals in a region to enter into a Framework Agreement setting forth, among other things, applicable quality standards and maximum payment rates. The U.K. government has stated that it will increase spending in the NHS over the next four years to support healthcare. However, we note the increase will be partially offset as the NHS has increased obligations and cost of treatments going forward due to the growing population and demand for better healthcare. As such, in the three and six months ended March 31, 2011, we have noticed a tightening in NHS spending on hospitals and temporary staff.

To provide an increased understanding of our company’s business we are providing a breakdown of our revenues, gross profits, selling, general and administrative (“SG&A”) costs and operating income at constant exchange rates using the comparable prior period weighted average exchange rate.

Homecare

Nursing Homes

Hospitals

 

Total, at constant exchange rates

Effect of foreign exchange