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EXCEL - IDEA: XBRL DOCUMENT - NATIONAL MENTOR HOLDINGS, INC. | Financial_Report.xls |
EX-32 - EXHIBIT 32 - NATIONAL MENTOR HOLDINGS, INC. | c17644exv32.htm |
EX-31.1 - EXHIBIT 31.1 - NATIONAL MENTOR HOLDINGS, INC. | c17644exv31w1.htm |
EX-31.2 - EXHIBIT 31.2 - NATIONAL MENTOR HOLDINGS, INC. | c17644exv31w2.htm |
EX-31.3 - EXHIBIT 31.3 - NATIONAL MENTOR HOLDINGS, INC. | c17644exv31w3.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 333-129179
NATIONAL MENTOR HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 31-1757086 | |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) |
313 Congress Street, 6th Floor | ||
Boston, Massachusetts 02210 | (617) 790-4800 | |
(Address of principal executive offices, | (Registrants telephone number, | |
including zip code) | including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes o No þ
The Company is a voluntary filer of reports required of companies with public securities under
Sections 13 or 15(d) of the Securities Exchange Act of 1934 and has filed all reports which would
have been required of the Company during the past 12 months had it been subject to such provisions.
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ | Smaller reporting company o | |||
(Do not check if smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
As of August 15, 2011, there were 100 shares outstanding of the registrants common stock,
$.01 par value.
Index
National Mentor Holdings, Inc.
National Mentor Holdings, Inc.
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44 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 31.3 | ||||||||
Exhibit 32 | ||||||||
EX-101 INSTANCE DOCUMENT | ||||||||
EX-101 SCHEMA DOCUMENT | ||||||||
EX-101 CALCULATION LINKBASE DOCUMENT | ||||||||
EX-101 LABELS LINKBASE DOCUMENT | ||||||||
EX-101 PRESENTATION LINKBASE DOCUMENT |
2
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements. |
National Mentor Holdings, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited) | ||||||||
June 30, | September 30, | |||||||
2011 | 2010 | |||||||
Assets |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ | 20,577 | $ | 26,448 | ||||
Restricted cash |
962 | 1,046 | ||||||
Accounts receivable, net |
124,314 | 125,979 | ||||||
Deferred tax assets, net |
15,530 | 13,571 | ||||||
Prepaid expenses and other current assets |
10,729 | 14,701 | ||||||
Total current assets |
172,112 | 181,745 | ||||||
Property and equipment, net |
144,456 | 142,112 | ||||||
Intangible assets, net |
410,306 | 437,757 | ||||||
Goodwill |
240,526 | 229,757 | ||||||
Restricted cash |
50,000 | | ||||||
Other assets |
20,377 | 13,915 | ||||||
Investment in related party debt securities |
| 10,599 | ||||||
Total assets |
$ | 1,037,777 | $ | 1,015,885 | ||||
Liabilities and shareholders equity |
||||||||
Current liabilities |
||||||||
Accounts payable |
$ | 25,614 | $ | 26,503 | ||||
Accrued payroll and related costs |
75,367 | 68,272 | ||||||
Other accrued liabilities |
50,694 | 48,307 | ||||||
Obligations under capital lease, current |
307 | 92 | ||||||
Current portion of long-term debt |
5,300 | 3,667 | ||||||
Total current liabilities |
157,282 | 146,841 | ||||||
Other long-term liabilities |
16,158 | 15,166 | ||||||
Deferred tax liabilities, net |
117,395 | 126,322 | ||||||
Obligations under capital lease, less current portion |
6,542 | 1,624 | ||||||
Long-term debt, less current portion |
755,326 | 500,799 | ||||||
Total liabilities |
1,052,703 | 790,752 | ||||||
Shareholders equity |
||||||||
Common stock |
| | ||||||
Additional paid-in-capital |
32,933 | 250,620 | ||||||
Accumulated other comprehensive (loss) income |
(2,175 | ) | 575 | |||||
Accumulated deficit |
(45,684 | ) | (26,062 | ) | ||||
Total shareholders equity |
(14,926 | ) | 225,133 | |||||
Total liabilities and shareholders equity |
$ | 1,037,777 | $ | 1,015,885 | ||||
See accompanying notes.
3
Table of Contents
National Mentor Holdings, Inc.
Condensed Consolidated Statements of Operations
(In thousands)
(Unaudited) | ||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net revenue |
$ | 271,196 | $ | 258,785 | $ | 803,583 | $ | 758,266 | ||||||||
Cost of revenue (exclusive of depreciation expense shown below) |
209,492 | 199,170 | 621,086 | 582,196 | ||||||||||||
Operating expenses: |
||||||||||||||||
General and administrative |
36,586 | 32,719 | 106,006 | 98,819 | ||||||||||||
Depreciation and amortization |
16,800 | 14,627 | 46,795 | 42,990 | ||||||||||||
Total operating expenses |
53,386 | 47,346 | 152,801 | 141,809 | ||||||||||||
Income from operations |
8,318 | 12,269 | 29,696 | 34,261 | ||||||||||||
Other income (expense): |
||||||||||||||||
Management fee of related party |
(297 | ) | (279 | ) | (952 | ) | (842 | ) | ||||||||
Other income (expense), net |
48 | (223 | ) | 522 | (349 | ) | ||||||||||
Extinguishment of debt |
| | (19,278 | ) | | |||||||||||
Gain from available for sale investment security |
| | 3,018 | | ||||||||||||
Interest income |
11 | 4 | 22 | 35 | ||||||||||||
Interest income from related party |
| 480 | 684 | 1,425 | ||||||||||||
Interest expense |
(19,660 | ) | (11,595 | ) | (41,950 | ) | (34,996 | ) | ||||||||
(Loss) income from continuing operations before income taxes |
(11,580 | ) | 656 | (28,238 | ) | (466 | ) | |||||||||
(Benefit) provision for income taxes |
(3,187 | ) | 1,115 | (8,763 | ) | 146 | ||||||||||
Loss from continuing operations |
(8,393 | ) | (459 | ) | (19,475 | ) | (612 | ) | ||||||||
Income (loss) from discontinued operations, net of tax |
64 | (242 | ) | (147 | ) | (4,784 | ) | |||||||||
Net loss |
$ | (8,329 | ) | $ | (701 | ) | $ | (19,622 | ) | $ | (5,396 | ) | ||||
See accompanying notes.
4
Table of Contents
National Mentor Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited) | ||||||||
Nine Months Ended | ||||||||
June 30, | ||||||||
2011 | 2010 | |||||||
Operating activities |
||||||||
Net loss |
$ | (19,622 | ) | $ | (5,396 | ) | ||
Adjustments to reconcile net loss to cash provided by operating activities: |
||||||||
Accounts receivable allowances |
8,352 | 8,949 | ||||||
Depreciation and amortization of property and equipment |
17,546 | 17,479 | ||||||
Amortization of other intangible assets |
29,286 | 26,036 | ||||||
Amortization of original issue discount and initial purchasers discount |
1,183 | | ||||||
Amortization and write-off of financing costs |
9,927 | 2,401 | ||||||
Accretion of investment in related party debt securities |
(325 | ) | (721 | ) | ||||
Stock-based compensation |
3,509 | 638 | ||||||
Deferred income taxes |
(9,410 | ) | (8,734 | ) | ||||
Gain from available for sale investment security |
(3,018 | ) | | |||||
(Gain) loss on disposal of assets |
(148 | ) | 399 | |||||
Change in fair value of contingent consideration |
(1,745 | ) | 1,072 | |||||
Non-cash impairment charge |
20 | 6,556 | ||||||
Non-cash interest income from related party |
(359 | ) | (704 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(6,349 | ) | (11,407 | ) | ||||
Other assets |
2,416 | (26 | ) | |||||
Accounts payable |
(1,262 | ) | (410 | ) | ||||
Accrued payroll and related costs |
6,979 | 3,414 | ||||||
Other accrued liabilities |
4,840 | 8,082 | ||||||
Other long-term liabilities |
992 | 1,007 | ||||||
Net cash provided by operating activities |
42,812 | 48,635 | ||||||
Investing activities |
||||||||
Cash paid for acquisitions, net of cash received |
(12,678 | ) | (32,776 | ) | ||||
Purchases of property and equipment |
(14,633 | ) | (14,465 | ) | ||||
Changes in restricted cash |
(49,916 | ) | (1,247 | ) | ||||
Proceeds from sale of assets |
753 | 1,069 | ||||||
Net cash used in investing activities |
(76,474 | ) | (47,419 | ) | ||||
Financing activities |
||||||||
Repayments of long-term debt |
(506,689 | ) | (2,795 | ) | ||||
Issuance of long term debt, net of original issue discount |
761,667 | | ||||||
Repayments of capital lease obligations |
(169 | ) | (96 | ) | ||||
Cash paid for contingent consideration |
(4,930 | ) | | |||||
Dividend to Parent |
(207,855 | ) | (95 | ) | ||||
Payments of financing costs |
(14,233 | ) | | |||||
Net cash provided by (used in) financing activities |
27,791 | (2,986 | ) | |||||
Net decrease in cash and cash equivalents |
(5,871 | ) | (1,770 | ) | ||||
Cash and cash equivalents at beginning of period |
26,448 | 23,650 | ||||||
Cash and cash equivalents at end of period |
$ | 20,577 | $ | 21,880 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid for interest |
$ | 31,291 | $ | 27,506 | ||||
Cash paid for income taxes |
$ | 865 | $ | 1,075 | ||||
Supplemental disclosure of non-cash investing activities: |
||||||||
Accrued contingent consideration |
$ | 800 | $ | 1,617 | ||||
Accrued property, plant and equipment |
$ | 614 | $ | 153 | ||||
Supplemental disclosure of non-cash financing activities: |
||||||||
Capital lease obligation incurred to acquire assets |
$ | 5,302 | $ | |
See accompanying notes.
5
Table of Contents
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
June 30, 2011
(Unaudited)
1. Basis of Presentation
National Mentor Holdings, Inc., through its wholly owned subsidiaries (collectively, the
Company), is a leading provider of home and community-based health and human services to adults
and children with intellectual and/or developmental disabilities, acquired brain injury and other
catastrophic injuries and illnesses; and to youth with emotional, behavioral and/or medically
complex challenges. Since the Companys founding in 1980, the Company has grown to provide services
to approximately 23,300 clients in 35 states.
The Company designs customized service plans to meet the unique needs of its clients, which it
delivers in home- and community-based settings. Most of the Companys service plans involve
residential support, typically in small group homes, host home settings, or specialized community
facilities, designed to improve the clients quality of life and to promote their independence and
participation in community life. Other services offered include supported living, day and
transitional programs, vocational services, case management, family-based services, post-acute
treatment and neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and
speech therapies, among others. The Companys customized service plans offer its clients as well as
the payors of these services, an attractive, cost-effective alternative to health and human
services provided in large, institutional settings.
The accompanying unaudited condensed consolidated financial statements have been prepared by
the Company in accordance with generally accepted accounting principles (GAAP) for interim
financial information and pursuant to the applicable rules and regulations of the Securities and
Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes
required by GAAP for complete financial statements. The unaudited condensed consolidated financial
statements herein should be read in conjunction with the Companys audited consolidated financial
statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal
year ended September 30, 2010, which is on file with the SEC. In the opinion of management, the
accompanying unaudited condensed consolidated financial statements contain all adjustments,
consisting of normal and recurring accruals, necessary to present fairly the financial statements
in accordance with GAAP. Intercompany balances and transactions between the Company and its
subsidiaries have been eliminated in consolidation. Operating results for the three and nine months
ended June 30, 2011 may not necessarily be indicative of results to be expected for any other
interim period or for the full year.
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results could differ from those
estimates.
2. Recent Accounting Pronouncements
Presentation of Insurance Claims and Related Insurance Recoveries In August 2010, the
Financial Accounting Standards Board (FASB) issued Accounting Standards Update No 2010-24, Health
Care Entities (Topic 954), Presentation of Insurance Claims and Related Insurance Recoveries (ASU
2010-24), which clarifies that companies should not net insurance recoveries against a related
claim liability. Additionally, the amount of the claim liability should be determined without
consideration of insurance recoveries. The adoption of ASU 2010-24 is effective for the Company
beginning the first quarter of the fiscal year ending September 30, 2012 (fiscal 2012). With its
adoption, the Companys accounting for insurance recoveries and related claim liability will change
on a prospective basis on the date of adoption. The Company is evaluating the impact of this
guidance on its financial statements.
Disclosure of Supplementary Pro Forma Information for Business Combinations In December
2010, the FASB issued Accounting Standards Update 2010-29, Business Combinations (Topic 805),
Disclosure of Supplementary Pro Forma Information for Business Combinations (ASU 2010-29). ASU
2010-29 requires a public entity to disclose pro forma revenue and earnings of the combined entity
for the current reporting period as though the acquisition date for all business combinations that
occurred during the fiscal year had been as of the beginning of the annual reporting period or the
beginning of the comparable prior annual reporting period if showing comparative financial
statements. ASU 2010-29 is effective prospectively for the Company for business combinations for
which the acquisition date is on or after October 1, 2011.
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Table of Contents
Presentation of Comprehensive Income In June 2011, the FASB issued Accounting Standards
Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU
2011-05). ASU 2011-05 eliminates the current option to report other comprehensive income and its
components in the statement of changes in equity. The final standard requires entities to present
net income and other comprehensive income in either a single continuous statement or in two
separate, but consecutive, statements of net income and other comprehensive income. ASU 2011-05 is
effective for the Company beginning in the first quarter of fiscal 2012. The Company is evaluating
the impact of this guidance on its financial statements.
Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP
and IFRS In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Fair Value
Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and IFRS (ASU 2011-04). Under ASU 2011-04, the valuation premise of
highest and best use is only relevant when measuring the fair value of nonfinancial assets.
Additionally, ASU 2011-04 includes enhanced disclosure requirements for fair value measurements.
ASU 2011-04 is effective for the Company beginning in the first quarter of fiscal 2012. The
Company is evaluating the impact of this guidance on its financial statements.
3. Comprehensive (Loss) Income
The components of comprehensive (loss) income and related tax effects are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(in thousands) | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Net loss |
$ | (8,329 | ) | $ | (701 | ) | $ | (19,622 | ) | $ | (5,396 | ) | ||||
Changes in unrealized
(loss) gain on derivatives
net of taxes of $(1,476)
and $1,391 for the three
months ended June 30, 2011
and 2010, respectively and
$(1,476) and $3,761 for
the nine months ended June
30, 2011 and 2010,
respectively |
(2,175 | ) | 2,049 | (2,175 | ) | 5,539 | ||||||||||
Changes in unrealized gain
(loss) on
available-for-sale debt
securities net of taxes of
$22 for the three months
ended June 30, 2010 and
$(390) and $165 for the
nine months ended June 30,
2011 and 2010,
respectively |
| 32 | (575 | ) | 244 | |||||||||||
Comprehensive (loss) income |
$ | (10,504 | ) | $ | 1,380 | $ | (22,372 | ) | $ | 387 | ||||||
4. Long-Term Debt
The Companys long-term debt consists of the following:
June 30, | September 30, | |||||||
(in thousands) | 2011 | 2010 | ||||||
Term loan, principal and interest due in quarterly installments through February 9, 2017 |
$ | 528,675 | $ | | ||||
Original
issue discount on term loan, net of accumulated amortization |
(7,419 | ) | | |||||
Senior notes, due February 15, 2018; semi-annual cash interest payments due each February 1st and
August 1st (interest rate of 12.50%) |
250,000 | | ||||||
Original issue discount and initial purchase discount on senior notes, net of accumulated amortization |
(10,630 | ) | | |||||
Old senior term B loan, principal and interest were due in quarterly installments through June 29,
2013 |
| 320,763 | ||||||
Senior revolver, due February 9, 2016; quarterly cash interest payments at a variable interest rate |
| | ||||||
Old senior revolver, due June 29, 2012; quarterly cash interest payments at a variable interest rate |
| | ||||||
Senior subordinated notes, due July 1, 2014; semi-annual cash interest payments were due each
January 1st and July 1st (interest rate of 11.25%) |
| 180,000 | ||||||
Term loan mortgage, principal and interest due in monthly installments through June 29, 2012;
variable interest rate (4.75% at September 30, 2010) |
| 3,703 | ||||||
760,626 | 504,466 | |||||||
Less current portion |
5,300 | 3,667 | ||||||
Long-term debt |
$ | 755,326 | $ | 500,799 | ||||
At September 30, 2010, the Company had $504.5 million of indebtedness, consisting of $320.8
million of indebtedness under the old senior secured term B loan facility, $180.0 million principal
amount of the 11.25% Senior Subordinated Notes due 2014 (the senior subordinated notes) and $3.7
million outstanding under the mortgage facility. As of September 30, 2010, the Company did not have
any borrowings under the old senior revolving credit facility (the old senior revolver).
7
Table of Contents
On February 9, 2011, the Company completed refinancing transactions, which included entering
into senior secured credit facilities and issuing $250.0 million in aggregate principal amount of
12.50% senior notes due 2018 (the senior notes).
Also, in connection with the refinancing transactions, the old senior secured credit
facilities and the mortgage facility were repaid. Approximately $171.9 million of the senior
subordinated notes were purchased on February 9, 2011 pursuant to a tender offer and consent
solicitation for the senior subordinated notes and the remaining senior subordinated notes were
redeemed prior to March 31, 2011.
The Company incurred $19.3 million of expenses related to the refinancing transactions
including (i) $10.8 million related to the tender premium and consent fees paid in connection with
the repurchase of the senior subordinated notes, (ii) $7.9 million related to the acceleration of
financing costs related to the prior indebtedness and (iii) $0.6 million related to
transaction costs. These expenses are recorded on the Companys consolidated statements of
operations as Extinguishment of debt.
Senior Secured Credit Facilities
On February 9, 2011, the Company entered into new senior secured credit facilities, consisting
of a (i) six-year $530.0 million term loan facility (the term loan), of which $50.0 million was
deposited in a cash collateral account in support of issuance of letters of credit under an
institutional letter of credit facility (the institutional letter of credit facility) and a (ii)
$75.0 million five-year senior secured revolving credit facility (the senior revolver). The
Company refers to these facilities as the senior secured credit facilities.
Term loan
The $530.0 million term loan was issued at a price equal to 98.5% of its face value and
amortizes one percent per year, paid quarterly, with the remaining balance payable at maturity. The
senior credit agreement also includes a provision for the prepayment of a portion of the
outstanding term loan amounts beginning in fiscal 2011 equal to an amount ranging from 0-50% of a
calculated amount, depending on the Companys leverage ratio, if the Company generates certain
levels of cash flow. The variable interest rate on the term loan is equal to (i) a rate equal to
the greater of (a) the prime rate, (b) the federal funds rate plus 1/2 of 1% and (c) the Eurodollar
rate for an interest period of one-month beginning on such day plus 100 basis points, plus 4.25%;
or (ii) the Eurodollar rate (provided that the rate shall not be less than 1.75% per annum), plus
5.25%, at the Companys option. At June 30, 2011, the variable interest rate on the term loan was
7.0%.
Senior revolver
At June 30, 2011, the Company had $75.0 million of availability under the senior revolver and
$35.9 million of standby letters of credit issued under the institutional letter of credit facility
primarily related to the Companys workers compensation insurance coverage. Letters of credit can
be issued under the Companys institutional letter of credit facility up to the $50.0 million limit
and letters of credit in excess of that amount reduce availability under the Companys senior
revolver. The interest rates for any borrowings under the senior revolver are the same as the term
loan.
Senior Notes
On February 9, 2011, the Company issued $250.0 million of the senior notes at a price equal to
97.737% of their face value, for net proceeds of $244.3 million. The net proceeds were reduced by
an initial purchasers discount of $5.6 million. The senior notes are the Companys unsecured
obligations and are guaranteed by certain of the Companys existing subsidiaries.
Covenants
The senior credit agreement and the indenture governing the senior notes contain negative
financial and non-financial covenants, including, among other things, limitations on the Companys
ability to incur additional debt, transfer or sell assets, pay dividends, redeem stock or make
other distributions or investments, and engage in certain transactions with affiliates. In
addition, the senior credit agreement governing the Companys senior secured credit facilities contains
financial covenants that require the Company to maintain a specified consolidated leverage ratio
and consolidated interest coverage ratio commencing with the quarter ending September 30, 2011.
The Company is restricted from paying dividends to NMH Holdings, LLC (Parent) in excess of
$15.0 million, except for dividends used for the repurchase of equity from former officers and
employees and for the payment of management fees, taxes, and
certain other expenses.
8
Table of Contents
Derivatives
The Company entered into an interest rate swap in a notional amount of $400.0 million
effective March 31, 2011 and ending September 30, 2014. The Company entered into this interest rate
swap to hedge the risk of changes in the floating rate of interest on borrowings under the term
loan. Under the terms of the swap, the Company receives from the counterparty a quarterly payment
based on a rate equal to the greater of 3-month LIBOR and 1.75% per annum, and the Company makes
payments to the counterparty based on a fixed rate of 2.54650% per annum, in each case on the
notional amount of $400.0 million, settled on a net payment basis. Based on the applicable margin
of 5.25% under the Companys term loan, this swap effectively fixes the Companys cost of borrowing
for $400.0 million of the term loan at 7.7965% per annum for the term of the swap.
The Company accounts for the interest rate swap as a cash flow hedge and the effectiveness of
the hedge relationship is assessed on a quarterly basis. The fair value of the swap agreement,
representing the price that would be paid to transfer the liability in an orderly transaction
between market participants, was $3.7 million or $2.2 million after taxes at June 30, 2011. The
fair value was recorded in current liabilities (under Other accrued liabilities) and was determined
based on pricing models and independent formulas using current assumptions. The entire change in
fair market value is recorded in shareholders equity, net of tax, on the condensed consolidated
balance sheets as other comprehensive loss.
5. Shareholders Equity
Common Stock
The holders of the Companys common stock are entitled to receive dividends when and as
declared by the Companys Board of Directors. In addition, the holders of common stock are entitled
to one vote per share. All of the outstanding shares of common stock are held by Parent.
Dividend to Parent
On February 9, 2011, as part of the refinancing transactions described in Note 4, the Company
declared a dividend of $219.7 million to Parent, which in turn made a distribution of $219.7 million to
its direct parent, NMH Holdings, Inc. (NMH Holdings). NMH Holdings used the proceeds of the
distribution to (i) repurchase $210.9 million aggregate principal amount of the Senior Floating
Rate Toggle Notes due 2014 (the NMH Holdings notes) at a
premium including $13.5 million principal amount of NMH Holdings
notes the Company held as on investment and (ii) pay related fees and
expenses.
6. Business Combinations
The operating results of the businesses acquired during the nine months ended June 30, 2011
were included in the consolidated statements of operations from the date of acquisition. The
Company accounted for the acquisitions under the purchase method of accounting and, as a result,
the purchase price was allocated to the assets acquired and liabilities assumed based upon their
respective fair values. The excess of the purchase price over the estimated fair value of net
tangible assets was allocated to specifically identified intangible assets, with the residual being
allocated to goodwill, except where otherwise noted.
During the three months ended June 30, 2011, the Company acquired two companies complementary
to its business engaged in behavioral health and human services for total fair value consideration
of $10.1 million, including $0.8 million of accrued
contingent consideration.
Inclusive Solutions. On June 1, 2011, the Company acquired the assets of MEIS, LLC and New
Life Enterprises N.W. Ohio, Inc., d/b/a Inclusive Solutions (Inclusive Solutions) for total cash
of $2.0 million. Inclusive Solutions operates in Ohio and provides community based services to
individuals with developmental disabilities. The Company has to date allocated a portion of the
purchase price for this acquisition to tangible assets, with the remaining allocated to goodwill in
the Human Services segment. Goodwill is expected to be deductible for tax purposes. The Company
is in the process of determining the appropriate amount to be allocated to specifically identified
intangible assets.
Communicare. On June 23, 2011, the Company acquired the assets of Communicare, LLC
(Communicare) for total fair value consideration of $8.1 million, including $0.8 million of
accrued contingent consideration. Communicare provides health, rehabilitation and residential services in the state
of Florida to individuals with brain injuries, neuromuscular disorders, spinal cord injuries,
pulmonary disorders, congenital anomalies, developmental disabilities and similar conditions.
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The contingent consideration is for a period of one year and provides for an additional $0.9 million in cash
to be paid based upon the purchased entitys achieving certain earnings targets. The fair value
of the contingent consideration on the date of acquisition was $0.8 million. The Company is required to re-measure the fair value of the
contingent consideration at each reporting date until the contingency is resolved on June 30, 2012 and changes to the
fair value are recognized in earnings in the period of the change. There was no change in fair
value for the quarter ended June 30, 2011.
The Company has to date allocated a portion of the purchase price for this acquisition to
tangible assets, with the remaining allocated to goodwill in the Post-Acute Specialty
Rehabilitation Services Segment. Goodwill is expected to be deductible for tax purposes. The
Company is in the process of determining the appropriate amount to be allocated to specifically
identified intangible assets.
In addition to Inclusive Solutions and Communicare, during the nine months ended June 30,
2011, the Company acquired five companies complementary to its business engaged in behavioral
health and human services for total cash of $3.3 million.
As a result of the acquisitions, during the nine months ended June 30, 2011, the Company
recorded $2.7 million of goodwill and $1.4 million of intangible assets in the Human Services
segment and $8.3 million of goodwill and $0.4 million of intangible assets in the Post-Acute
Specialty Rehabilitation Services segment. The remaining purchase price was allocated to tangible
assets.
The following table summarizes the amounts of identifiable assets acquired and liabilities
assumed at the date of the acquisition:
New Start | SunnySide | Inclusive | ||||||||||||||||||||||||||||||
(in thousands) | Homes | ViaQuest | Phoenix | Homes | TheraCare | Solutions | Communicare | TOTAL | ||||||||||||||||||||||||
Accounts receivable |
$ | | $ | 191 | $ | | $ | | $ | | $ | | $ | | $ | 191 | ||||||||||||||||
Identifiable intangible assets |
410 | 600 | 587 | 156 | 82 | | | 1,835 | ||||||||||||||||||||||||
Property and equipment |
3 | | | | | 413 | 91 | 507 | ||||||||||||||||||||||||
Accounts payable and accrued expenses |
| (116 | ) | | | | | (800 | ) | (916 | ) | |||||||||||||||||||||
Total identifiable net assets |
$ | 413 | $ | 675 | $ | 587 | $ | 156 | $ | 82 | $ | 413 | $ | (709 | ) | $ | 1,617 | |||||||||||||||
Goodwill |
$ | 237 | $ | 428 | $ | 488 | $ | 129 | $ | 68 | $ | 1,587 | $ | 8,033 | $ | 10,970 |
Pro forma
The unaudited pro forma results of operations provided below for the nine months ended June
30, 2011 are presented as though the acquisitions had occurred at the beginning of the
period presented. The pro forma information presented below does not indicate what the Companys
results of operations would have been if the acquisitions had in fact occurred at the beginning of
the earliest period presented nor is it a projection of the impact on
future results or trends. Net revenue from the acquisitions noted
above was $6.0 million from the date of acquisition. The
Company has determined that the presentation of the remaining results of operations for each of these
acquisitions, from the date of acquisition, is impracticable because the operations were integrated
with the Companys existing operations upon acquisition.
Nine Months Ended | ||||
(in thousands) | June 31, 2011 | |||
Net revenue |
$ | 815,425 | ||
Income from operations |
$ | 32,005 |
Contingent consideration
Springbrook. On January 15, 2010, the Company acquired the assets of Springbrook, Inc. and an
affiliate (together, Springbrook) for total fair value consideration of $9.3 million, subject to
increase of up to $3.5 million to be paid based upon the purchased entitys achieving certain earnings targets. The fair value of the
contingent consideration on the date of acquisition was $1.6 million. For the nine months ended June 30, 2011, the
fair value of the contingent consideration increased $0.3 million which was recognized as a charge to earnings and is included in
general and administrative expenses in the consolidated statements of operations. Since the
initial estimate, the fair value of the contingent consideration increased to $3.4 million based on actual
financial performance of Springbook and was paid by the Company in its entirety during the three
months ended June 30, 2011.
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IFCS. On June 1, 2009, the Company acquired the stock of Institute for Family Centered
Services, Inc. (IFCS) for total cash of $11.5 million. This acquisition took place prior to the
October 1, 2009 change in authoritative guidance and as a
result, any adjustments to the contingent consideration
are recorded to goodwill. During fiscal 2010, the Company accrued an additional $3.3 million of
expected contingent consideration which was paid during the three months ended December 31, 2010.
7. Goodwill and Intangible Assets
Goodwill
The changes in goodwill for the nine months ended June 30, 2011 are as follows:
Post Acute | ||||||||||||
Specialty | ||||||||||||
Human | Rehabilitation | |||||||||||
(in thousands) | Services | Services | Total | |||||||||
Balance as of September 30, 2010 |
$ | 169,885 | $ | 59,872 | $ | 229,757 | ||||||
Goodwill acquired through acquisitions |
2,700 | 8,270 | 10,970 | |||||||||
Adjustments to goodwill, net |
66 | (267 | ) | (201 | ) | |||||||
Balance as of June 30, 2011 |
$ | 172,651 | $ | 67,875 | $ | 240,526 | ||||||
The adjustments to goodwill relate to the finalization of the purchase price for acquisitions
during the measurement period.
Intangible Assets
Intangible assets consist of the following as of June 30, 2011:
Gross | ||||||||||||
Carrying | Accumulated | Intangible | ||||||||||
Description | Value | Amortization | Assets, Net | |||||||||
(in thousands) | ||||||||||||
Agency contracts |
$ | 465,648 | $ | 135,795 | $ | 329,853 | ||||||
Non-compete/non-solicit |
1,044 | 560 | 484 | |||||||||
Relationship with contracted caregivers |
12,804 | 7,103 | 5,701 | |||||||||
Trade names |
3,989 | 1,750 | 2,239 | |||||||||
Trade names (indefinite life) |
47,700 | | 47,700 | |||||||||
Licenses and permits |
42,473 | 18,779 | 23,694 | |||||||||
Intellectual property |
904 | 269 | 635 | |||||||||
$ | 574,562 | $ | 164,256 | $ | 410,306 | |||||||
Intangible assets consist of the following as of September 30, 2010:
Gross | ||||||||||||
Carrying | Accumulated | Intangible | ||||||||||
Description | Value | Amortization | Assets, Net | |||||||||
(in thousands) | ||||||||||||
Agency contracts |
$ | 465,679 | $ | 113,418 | $ | 352,261 | ||||||
Non-compete/non-solicit |
1,044 | 403 | 641 | |||||||||
Relationship with contracted caregivers |
12,804 | 5,977 | 6,827 | |||||||||
Trade names |
4,039 | 1,463 | 2,576 | |||||||||
Trade names (indefinite life) |
47,700 | | 47,700 | |||||||||
Licenses and permits |
42,713 | 15,693 | 27,020 | |||||||||
Intellectual property |
904 | 172 | 732 | |||||||||
$ | 574,883 | $ | 137,126 | $ | 437,757 | |||||||
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Amortization expense was $10.9 million and $8.8 million for the three months ended June 30,
2011 and 2010, respectively and $29.3 million and 25.8 million for the nine months ended June 30,
2011 and 2010, respectively.
During the assessment of long-lived assets that was performed during the three months ended
June 30, 2011, the Company determined that the value of certain of its agency contracts, licenses
and permits in the Human Services segment was impaired. As a result, the Company recorded a
non-cash impairment charge which reduced the carrying amount of these long-lived assets to their
fair value of zero as of June 30, 2011. The total impairment charge was $1.7 million and included
a $1.6 million write off of agency contracts and $0.1 million write off of licenses and permits,
all related to underperforming programs which were closed as of June 30, 2011. The fair market
value of these assets was determined using managements
estimates about future cash flows, which is a Level 3 financial
measurement. These
impairment charges are included in Depreciation and amortization expense in the accompanying
condensed consolidated statements of operations.
8. Related Party Transactions
Management Agreement
On June 29, 2006, the Company entered into a management agreement with Vestar Capital Partners
V, L.P. (Vestar) relating to certain advisory and consulting services for an annual management
fee equal to the greater of (i) $850 thousand or (ii) an amount equal to 1.0% of the Companys
consolidated earnings before interest, taxes, depreciation, amortization and management fee for
each fiscal year determined as set forth in the Companys senior credit agreement.
As part of the management agreement, the Company agreed to indemnify Vestar and its affiliates
from and against all losses, claims, damages and liabilities arising out of the performance by
Vestar of its services pursuant to the management agreement. The management agreement will
terminate upon such time that Vestar and its partners and their respective affiliates hold,
directly or indirectly in the aggregate, less than 20% of the voting power of the outstanding
voting stock of the Company.
This agreement was amended and restated effective February 9, 2011 to provide for the payment
of reasonable and customary fees to Vestar for services in connection with a sale of the Company,
an initial public offering by or involving NMH Investment, LLC (NMH Investment) or any of its
subsidiaries or any extraordinary acquisition by or involving NMH Investment or any of its
subsidiaries; provided, that such fees shall only be paid with the consent of the directors of the
Company who are not affiliated with or employed by Vestar. The Company expensed $0.3 million of
management fees and expenses for the three months ended June 30, 2011 and 2010 and $1.0 million and
$0.8 million for the nine months ended June 30, 2011 and 2010, respectively.
Consulting Agreements
During fiscal 2010, the Company engaged Alvarez & Marsal Healthcare Industry Group (Alvarez &
Marsal) to provide certain transaction advisory and other services. A Company director, Guy
Sansone, is a Managing Director at Alvarez & Marsal and the head of its Healthcare Industry Group.
The engagement resulted in aggregate fees of $0.6 million for the nine months ended June 30, 2011,
and was approved by the Companys Audit Committee. Mr. Sansone is not a member of the Companys
Audit Committee and was not personally involved in the engagement.
The Company engaged Duff & Phelps, LLC as a financial advisor in connection with the
refinancing transactions described in Note 4, including the repurchase of the NMH Holdings notes,
and related matters. According to public filings, Vestar owns 12.4% of the Class A common stock of
Duff & Phelps Corporation, the parent company of Duff & Phelps, LLC, and one of Vestars principals
serves on the Board of Directors of Duff & Phelps Corporation but was not personally involved in
this engagement. This engagement resulted in fees of approximately $0.2 million during the nine
months ended June 30, 2011 and was approved by the Companys Board of Directors, with the Vestar
members abstaining from voting.
Lease Agreements
The Company leases several offices, homes and other facilities from its employees, or from
relatives of employees, primarily in the states of California, Nevada and Arkansas, which have
various expiration dates extending out as far as February 2020. In connection with the acquisition
of NeuroRestorative in the second quarter of fiscal 2010, the Company entered into a lease of a
treatment facility in Arkansas with a former shareholder and executive who is providing consulting
services. The lease is an operating
lease with an initial ten-year term, and the total expected minimum lease commitment is $7.0
million.
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Table of Contents
Related party lease expense was $1.2 million for both the three months ended June 30, 2011 and
2010 and $3.7 million and $3.2 million for the nine months ended June 30, 2011 and 2010,
respectively
Investment in Related Party Debt Securities
During fiscal 2009, the Company purchased $11.5 million in aggregate principal amount of the
NMH Holdings notes for $6.6 million. The security was classified as an available-for-sale debt
security and recorded on the Companys consolidated balance sheets as Investment in related party
debt securities. Cash interest on the NMH Holdings notes accrued at a rate per annum, reset
quarterly, equal to LIBOR plus 6.375%, and PIK Interest (defined below) accrued at the cash
interest rate plus 0.75%. NMH Holdings paid all of the interest on the NMH Holdings notes entirely
by increasing the principal amount of the NMH Holdings notes or issuing new notes (PIK Interest).
The carrying value of the asset increased after it was purchased as a result of the Company
recording (i) PIK Interest income and (ii) accretion of the purchase discount on the security. The
Companys investment in related-party debt securities was reflected on the Companys consolidated
balance sheets at fair value with the unrealized holding gain recorded in accumulated other
comprehensive (loss) income.
In connection with the refinancing transactions on February 9, 2011, NMH Holdings repurchased
the NMH Holdings notes (which the Company purchased at a discount) from the Company at a premium.
As a result, the Company recorded a gain of $3.0 million which was recorded on the statements of operations as Gain
from available for sale investment security.
9. Fair Value Measurements
The Company measures and reports its financial assets and liabilities on the basis of fair
value. Fair value is defined as the price that would be received to sell an asset or paid to
transfer a liability (an exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants on the measurement date.
A three-level hierarchy for disclosure has been established to show the extent and level of
judgment used to estimate fair value measurements, as follows:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Significant other observable inputs (quoted prices in active markets for similar
assets or liabilities, quoted prices for identical or similar assets or liabilities in markets
that are not active, or inputs other than quoted prices that are observable for the asset or
liability).
Level 3: Significant unobservable inputs for the asset or liability. These values are
generally determined using pricing models which utilize management estimates of market
participant assumptions.
Valuation techniques for assets and liabilities measured using Level 3 inputs may include
methodologies such as the market approach, the income approach or the cost approach, and may use
unobservable inputs such as projections, estimates and managements interpretation of current
market data. These unobservable inputs are only utilized to the extent that observable inputs are
not available or cost-effective to obtain.
A description of the valuation methodologies used for instruments measured at fair value as
well as the general classification of such instruments pursuant to the valuation hierarchy, is set
forth below.
Assets and liabilities recorded at fair value at June 30, 2011 consist of:
Quoted | Significant Other | Significant | ||||||||||||||
Market Prices | Observable Inputs | Unobservable Inputs | ||||||||||||||
(in thousands) | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Contingent consideration |
$ | (800 | ) | $ | | $ | | $ | (800 | ) | ||||||
Interest rate swap agreements |
$ | (3,651 | ) | $ | | $ | (3,651 | ) | $ | |
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Assets and liabilities recorded at fair value at September 30, 2010 consist of:
Quoted | Significant Other | Significant | ||||||||||||||
Market Prices | Observable Inputs | Unobservable Inputs | ||||||||||||||
(in thousands) | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Cash equivalents |
$ | 15,500 | $ | 15,500 | $ | | $ | | ||||||||
Investment in related party debt securities |
$ | 10,599 | $ | | $ | 10,599 | $ | | ||||||||
Contingent consideration |
$ | (3,041 | ) | $ | | $ | | $ | (3,041 | ) |
Cash equivalents. Cash equivalents consist primarily of money market funds and the carrying
value of cash equivalents approximates fair value.
Investment in related party debt securities. The fair value of the investment in related party
debt securities was recorded in long-term assets (under Investment in related party debt
securities). The fair value measurements consider observable market data that may include, among
other data, credit ratings, credit spreads, future interest rates and risk free rates of return.
Contingent consideration. The fair value of the contingent consideration associated with the fiscal 2011 and
2010 acquisitions was
determined based on unobservable inputs, namely managements estimate of expected performance based
on current information.
Interest rate swap agreements. The fair value of the swap agreements was recorded in current
liabilities (under Other accrued liabilities). The fair value of these agreements was determined
based on pricing models and independent formulas using current assumptions that included swap
terms, interest rates and forward LIBOR curves.
The following table provides a reconciliation of the beginning and ending balances for the
liability measured at fair value using significant unobservable inputs (Level 3).
Due to Seller | ||||
Balance at September 30, 2010 |
$ | (3,041 | ) | |
Change in fair value of contingent consideration |
(321 | ) | ||
Balance at March 31, 2011 |
(3,362 | ) | ||
Increase related to new acquisitions |
(800 | ) | ||
Payment of contingent consideration |
3,362 | |||
Balance at June 30, 2011 |
$ | (800 | ) | |
At June 30, 2011, the carrying values of cash, accounts receivable and accounts payable
approximated fair value. The carrying value and fair value of the Companys debt instruments are
set forth below:
June 30, 2011 | September 30, 2010 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
(in thousands) | Amount | Value | Amount | Value | ||||||||||||
Senior subordinated notes (retired February 9, 2011) |
$ | | $ | | $ | 180,000 | $ | 184,050 | ||||||||
Senior notes (issued February 9, 2011) |
$ | 239,370 | $ | 255,000 | | |
The Company estimated the fair value of the debt instruments using market quotes and
calculations based on current market rates available.
10. Income Taxes
The Companys effective income tax rate for the interim periods was based on managements
estimate of the Companys annual effective tax rate for the applicable year. For the three months
ended June 30, 2011, the Companys effective income tax rate was 27.5% compared to an effective tax
rate of 170.0% for the three months ended June 30, 2010. For the nine months ended June 30, 2011,
the Companys effective income tax rate was 31.0% compared to an effective tax rate of (31.3)% for
the nine months ended June 30, 2010. These rates differ from the federal statutory income tax rate
primarily due to nondeductible permanent differences such as meals and nondeductible compensation,
net operating losses not benefited and changes in the applicability of certain employment
tax credits.
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NMH Holdings files a federal consolidated return and files various state income tax returns.
The Company files various state income tax returns and, generally, is no longer subject to income
tax examinations by the taxing authorities for years prior to September 30, 2003. The Companys
reserve for uncertain income tax positions at June 30, 2011 is $4.9 million. There has been no
change in unrecognized tax benefits in the nine months ended June 30, 2011 and the Company does not
expect any significant changes to unrecognized tax benefits within the next twelve months. The
Companys policy is to recognize interest and penalties related to unrecognized tax benefits as
charges to income tax expense.
11. Segment Information
The Company has two reportable segments, Human Services and Post-Acute Specialty
Rehabilitation Services (SRS).
The Human Services segment delivers home and community-based human services to adults and
children with intellectual and/or developmental disabilities and to youth with emotional,
behavioral and/or medically complex challenges. Human Services is organized in a reporting
structure composed of two operating segments which are aggregated into one reportable segment based
on similarity of the economic characteristics and services provided.
The SRS segment delivers health care and community-based health and human services to
individuals who have suffered acquired brain, spinal injuries and other catastrophic injuries and
illnesses. This segment is organized in a reporting structure composed of two operating segments
which are aggregated based on similarity of economic characteristics and services provided.
Activities classified as Corporate in the table below relate primarily to unallocated home
office items.
The Company generally evaluates the performance of its operating segments based on income from
operations. The following is a financial summary by reportable operating segment for the periods
indicated.
Post-Acute | ||||||||||||||||
Specialty | ||||||||||||||||
Human | Rehabilitation | |||||||||||||||
For the three months ended June 30, | Services | Services | Corporate | Consolidated | ||||||||||||
(in thousands) | ||||||||||||||||
2011 |
||||||||||||||||
Net revenue |
$ | 227,414 | $ | 43,782 | $ | | $ | 271,196 | ||||||||
Income (loss) from operations |
19,540 | 4,878 | (16,100 | ) | 8,318 | |||||||||||
Total assets |
560,615 | 162,489 | 314,673 | 1,037,777 | ||||||||||||
Depreciation and amortization |
12,724 | 3,134 | 942 | 16,800 | ||||||||||||
Income
(loss) from continuing operations before income taxes |
2,627 | 1,742 | (15,949 | ) | (11,580 | ) | ||||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 222,279 | $ | 36,506 | $ | | $ | 258,785 | ||||||||
Income (loss) from operations |
21,110 | 3,686 | (12,527 | ) | 12,269 | |||||||||||
Depreciation and amortization |
10,825 | 2,593 | 1,209 | 14,627 | ||||||||||||
Income
(loss) from continuing operations before income taxes |
10,663 | 2,027 | (12,034 | ) | 656 |
Post-Acute | ||||||||||||||||
Specialty | ||||||||||||||||
Human | Rehabilitation | |||||||||||||||
For the nine months ended June 30, | Services | Services | Corporate | Consolidated | ||||||||||||
(in thousands) | ||||||||||||||||
2011 |
||||||||||||||||
Net revenue |
$ | 673,233 | $ | 130,350 | $ | | $ | 803,583 | ||||||||
Income (loss) from operations |
60,658 | 14,123 | (45,085 | ) | 29,696 | |||||||||||
Total assets |
560,615 | 162,489 | 314,673 | 1,037,777 | ||||||||||||
Depreciation and amortization |
34,367 | 9,215 | 3,213 | 46,795 | ||||||||||||
Income
(loss) from continuing operations before income taxes |
17,959 | 5,843 | (52,040 | ) | (28,238 | ) | ||||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 661,272 | $ | 96,994 | $ | | $ | 758,266 | ||||||||
Income (loss) from operations |
60,611 | 10,232 | (36,582 | ) | 34,261 | |||||||||||
Depreciation and amortization |
32,715 | 6,728 | 3,547 | 42,990 | ||||||||||||
Income
(loss) from continuing operations before income taxes |
28,717 | 5,941 | (35,124 | ) | (466 | ) |
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12. Stock-Based Compensation
Under its equity-based compensation plan adopted in 2006, NMH Investment previously issued
units of limited liability company interests consisting of Class B Units, Class C Units, Class D
Units and Class E Units to the Companys employees and members of the Board of Directors as
incentive compensation. As of June 30, 2011, there were 192,500 Class B Units, 202,000 Class C
Units, 388,881 Class D Units and 6,375 Class E Units authorized for issuance under the plan. These
units derive their value from the value of the Company.
On June 15, 2011, NMH Investment issued the Class F Units, a new class of non-voting common
equity units of NMH Investment, as incentive compensation. Up to 5,396,388 Class F Common Units
may be issued under the 2006 Unit Plan to management of the Company as equity-based compensation.
In addition, the terms of the Class B, C and D Common Units were amended to accelerate the vesting
of any outstanding unvested Class B, C and D Common Units so
that they became 100% vested.
For participants who have been continuously employed by the Company since December 31, 2008,
75% of the Class F Common Units vested upon grant and 25% of the Class F Common Units will vest on
the date that is 18 months following the date of grant if the participant continues to be employed
by the Company on that date. For participants who have not been continuously employed by the
Company since December 31, 2008, 50% of the Class F Common Units vested upon grant, 25% of the
Class F Common Units vest on the date that is 18 months following the date of grant and 25% of the
Class F Common Units vest on the date that is 36 months following the date of grant, in each case,
if the participant continues to be employed by the Company on that date. Class F Common Units that
are awarded after the initial issuances approved on May 10, 2011 will vest in three equal tranches
on each of the first three anniversaries of the date on which such Class F Common Units are
awarded.
For purposes of determining the compensation expense associated with these grants, management
valued the business enterprise using a variety of widely accepted valuation techniques which
considered a number of factors such as the financial performance of the Company, the values of
comparable companies and the lack of marketability of the Companys equity. The Company then used
the option pricing method to determine the fair value of the units granted.
The fair value of the units issued during the three months ended June 30, 2011 was calculated
using the following assumptions:
Risk-free interest rate |
0.68 | % | ||
Expected term |
3 years | |||
Expected volatility |
50 | % |
The estimated fair value of the units, less an assumed forfeiture rate of 9.7%, was recognized
as expense in the Companys consolidated financial statements on a straight-line basis over the
requisite service periods of the awards. The assumed forfeiture rate is based on an average of the
Companys historical forfeiture rates, which the Company estimates is indicative of future
forfeitures.
The Company recorded $3.3 million and $0.4 million of stock-based compensation expense for the
three months ended June 30, 2011 and 2010, respectively, and $3.5 million and $0.6 million for the
nine months ended June 30, 2011 and 2010, respectively. Stock-based compensation expense is
included in general and administrative expense in the accompanying consolidated statements of
operations. The summary of activity under the plan is presented below:
Weighted Average | ||||||||
Units | Grant-Date | |||||||
Outstanding | Fair Value | |||||||
Nonvested balance at September 30, 2010 |
103,065 | $ | 3.87 | |||||
Granted |
4,302,473 | 1.01 | ||||||
Forfeited |
(14,983 | ) | 7.50 | |||||
Vested |
(3,307,952 | ) | 1.09 | |||||
Nonvested balance at June 30 , 2011 |
1,082,603 | $ | 1.01 | |||||
As of June 30 2011, there was $1.0 million of total unrecognized compensation expense related
to the units. These costs are expected to be recognized over a weighted average period of 1.6
years.
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13. Accruals for Self-Insurance and Other Commitments and Contingencies
The Company maintains insurance for professional and general liability, workers compensation
liability, automobile liability and health insurance liabilities that include self-insured
retentions. The Company intends to maintain such coverage in the future and is of the opinion that
its insurance coverage is adequate to cover potential losses on asserted claims. Employment
practices liability is fully self-insured.
Until September 30, 2010, the Company insured professional and general liability through its
captive insurance subsidiary amounts of up to $1.0 million per claim and up to $2.0 million in the
aggregate. Commencing October 1, 2010, the Company is self-insured for $2.0 million per claim and
$8.0 million in the aggregate, and for $500 thousand per claim in excess of the aggregate. In
connection with the Merger on June 29, 2006, subject to the $1.0 million per claim and up to $2.0
million in the aggregate retentions, the Company purchased additional insurance for certain claims
relating to pre-Merger periods. For workers compensation, the Company has a $350 thousand per
claim retention with statutory limits. Automobile liability has a $100 thousand per claim
retention, with additional insurance coverage above the retention. The Company purchases specific
stop loss insurance as protection against extraordinary claims liability for health insurance
claims. Stop loss insurance covers claims that exceed $300 thousand on a per member basis.
The Company is in the health and human services business and, therefore, has been and
continues to be subject to substantial claims alleging that the Company, its employees or its
independently contracted host-home caregivers (Mentors) failed to provide proper care for a
client. The Company is also subject to claims by its clients, its employees, its Mentors or
community members against the Company for negligence, intentional misconduct or violation of
applicable laws. Included in the Companys recent claims are claims alleging personal injury,
assault, battery, abuse, wrongful death and other charges. Regulatory agencies may initiate
administrative proceedings alleging that the Companys programs, employees or agents violate
statutes and regulations and seek to impose monetary penalties on the Company. The Company could be
required to incur significant costs to respond to regulatory investigations or defend against civil
lawsuits and, if the Company does not prevail, the Company could be required to pay substantial
amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.
The Company reserves for costs related to contingencies when a loss is probable and the amount
is reasonably estimable. While the Company believes the provision for legal contingencies is
adequate, the outcome of the legal proceedings is difficult to predict and the Company may settle
legal claims or be subject to judgments for amounts that differ from the Companys estimates.
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of
Operations. |
The following discussion of our financial condition and results of operations should be read
in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2010, as
well as our reports on Forms 10-Q and 8-K and other publicly available information. This discussion
may contain forward-looking statements about our markets, the demand for our services and our
future results. We based these statements on assumptions that we consider reasonable. Actual
results may differ materially from those suggested by our forward-looking statements for various
reasons, including those discussed in the Risk factors and Forward-looking statements sections
of this report.
Overview
We are a leading provider of home and community-based health and human services to adults and
children with intellectual and/or developmental disabilities (I/DD), acquired brain injury
(ABI) and other catastrophic injuries and illnesses, and to youth with emotional, behavioral
and/or medically complex challenges, or at-risk youth (ARY). Since our founding in 1980, we have
grown to provide services to approximately 23,300 clients in 35 states.
We design customized service plans to meet the unique needs of our clients, which we deliver
in home and community-based settings. Most of our service plans involve residential support,
typically in small group homes, host home settings or specialized community facilities, designed to
improve our clients quality of life and to promote client independence and participation in
community life. Other services offered include supported living, day and transitional programs,
vocational services, case management, family-based services, post-acute treatment and
neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and speech
therapies, among others. Our customized service plans offer our clients, as well as the payors for
these services, an attractive, cost-effective alternative to health and human services provided in
large, institutional settings.
We offer our services through a variety of models, including (i) small group homes, most of
which are residences for six people or fewer, (ii) host homes, or the Mentor model, in which a
client lives in the home of a trained Mentor, (iii) in-home settings, in which we support clients
independence with 24-hour services in their own homes, (iv) small, specialized community facilities
which provide post-acute, specialized rehabilitation and comprehensive care for individuals who
have suffered ABI, spinal injuries and other catastrophic injuries and illnesses and (v)
non-residential settings, consisting primarily of day programs and periodic services in various
settings.
Delivery of services to adults and children with I/DD is the largest portion of our Human
Services segment. Our I/DD programs include residential support, day habilitation, vocational
services, case management and personal care. Our Human Services segment also includes the delivery
of ARY services. Our ARY programs include therapeutic foster care, family reunification, family
preservation, early intervention and adoption services. Our Post-Acute Specialty Rehabilitation
Services (SRS) segment delivers healthcare and community-based human services to individuals who
have suffered ABI, spinal injuries and other catastrophic injuries and illnesses. Our services
range from sub-acute healthcare for individuals with intensive medical needs to day treatment
programs, and include skilled nursing, neurorehabilitation, neurobehavioral rehabilitation,
physical, occupational, and speech therapy, supported living, outpatient treatment, and
pre-vocational services.
We have two reportable segments, Human Services and SRS. The Human Services segment provides
home and community-based human services to adults and children with intellectual and/or
developmental disabilities and to youth with emotional, behavioral and/or medically complex
challenges. The SRS segment provides a mix of health care and community-based health and human
services to individuals who have suffered ABI, spinal injuries and other catastrophic injuries and
illnesses.
Factors Affecting our Operating Results
Demand for Home and Community-Based Health and Human Services
Our growth in revenue has historically been related to increases in the rates we receive for
our services as well as increases in the number of individuals served. This growth has depended
largely upon development-driven activities, including the maintenance and expansion of existing
contracts and the award of new contracts, and upon acquisitions. We also attribute the continued
growth in our client base to certain trends that are increasing demand in our industry, including
demographic, medical and political developments.
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Demographic trends have a particular impact on our I/DD business. Increases in the life
expectancy of individuals with I/DD, we believe, have resulted in steady increases in the demand
for I/DD services. In addition, caregivers currently caring for their relatives at home are aging
and may soon be unable to continue with these responsibilities. Each of these factors affects the
size of the I/DD population in need of services. Similarly, growth for our ARY services has been
driven by favorable demographics. Demand for our SRS services has also grown as faster emergency
response and improved medical techniques have resulted in more people surviving a catastrophic
injury. SRS services are increasingly
sought out as a clinically-appropriate and less-expensive alternative to institutional care and
step-down for individuals who no longer require care in acute settings.
Political and economic trends can also affect our operations. In particular, state budgetary
pressures, especially within Medicaid programs, may influence the overall level of payments for our
services, the number of clients and the preferred settings for many of the services we provide.
Since the beginning of the recent economic downturn, our government payors in several states have
responded to deteriorating revenue collections by implementing provider rate reductions, including
in the states of Arizona, California, Indiana and Minnesota. In total, rate reductions implemented
since October 1, 2008 have reduced revenue by approximately $20 million or about 1.9% of annualized
revenue. In addition, the volume of referrals to our programs has also been constrained in many
markets as payors have taken steps to reduce spending. The termination of the enhanced federal
Medicaid funding after June 30, 2011 contributed to significant budgetary challenges that
confronted state governments for fiscal 2012, which began July 1, 2011 in most states. The result
is that some of our public payors have implemented, or will implement in the coming months,
additional rate reductions, particularly for our I/DD services,
including the state of Minnesota which recently announced rate
reductions of approximately 1.5% for Medicaid Waiver and ICF Services
effective September 1, 2011.
Historically, pressure from client advocacy groups for the populations we serve has generally
helped our business, as these groups generally seek to pressure governments to fund residential
services that use our small group home or host home models, rather than large, institutional
models. In addition, our ARY services have historically been positively affected by the trend
toward privatization of these services. Furthermore, we believe that successful lobbying by these
groups has preserved I/DD and ARY services and, therefore, our revenue base, from significant
cutbacks as compared with certain other human services, although we suffered rate reductions during
and since the recent recessionary environment. In addition, a number of states have developed
community-based waiver programs to support long-term care services for survivors of a traumatic
brain injury. The majority of our specialty rehabilitation services revenue is derived from
non-public payors, such as commercial insurers, managed care and other private payors.
Expansion
We have grown our business through expansion of existing markets and programs as well as
through acquisitions.
Organic Growth
We believe that our future growth will depend heavily on our ability to expand existing
service contracts and to win new contracts. Our organic expansion activities consist of both new
program starts in existing markets and geographical expansion in new markets. Our new programs in
new and existing geographic markets (which we refer to as new starts) typically require us to
fund operating losses for a period of approximately 18 to 24 months. If a new start does not become
profitable during such period, we may terminate it. During the twelve months ended June 30, 2011,
operating losses on new starts for programs started within the previous 18 months were $2.0
million.
Acquisitions
As of June 30, 2011, we have completed 33 acquisitions since 2005, including several
acquisitions of rights to government contracts or fixed assets from small providers, which we
integrate with our existing operations. We have pursued larger strategic acquisitions in markets
with significant opportunities. Acquisitions could have a material impact on our consolidated
financial statements.
During the three months ended June 30, 2011, we acquired two companies complementary to our
business, one in the Human Services segment and one in the SRS segment, for total fair value
consideration of $10.1 million, including $0.8 million of accrued contingent consideration.
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Divestitures
We regularly review and consider the divestiture of underperforming or non-strategic
businesses to improve our operating results and better utilize our capital. We have made
divestitures from time to time and expect that we may make additional divestitures in the future.
Divestitures could have a material impact on our consolidated financial statements.
Net revenue
Revenue is reported net of allowances for unauthorized sales and estimated sales adjustments.
Revenue is also reported net of any state provider taxes or gross receipts taxes levied on services
we provide. For the three months ended June 30, 2011, we derived approximately 90% of our net
revenue from state and local government payors and approximately 10% of our net revenue from
non-public payors. Substantially all of our non-public revenue is generated by our SRS business
through contracts with commercial insurers, workers compensation carriers and other private
payors. The payment terms and rates of these contracts vary widely by jurisdiction and service
type, and may be based on per person per diems, rates established by the jurisdiction, cost-based
reimbursement, hourly rates and/or units of service. We bill most of our residential services on a
per diem basis, and we bill most of our non-residential services on an hourly basis. Some of our
revenue is billed pursuant to cost-based reimbursement contracts, under which the billed rate is
tied to the underlying costs. Lower than expected cost levels may require us to return previously
received payments after cost reports are filed. Reserves are provided when estimable and probable.
In addition, our revenue may be affected by adjustments to our billed rates as well as adjustments
to previously billed amounts. Revenue in the future may be affected by changes in rate-setting
structures, methodologies or interpretations that may be proposed in states where we operate or by
the federal government which provides matching funds. We cannot determine the impact of such
changes or the effect of any possible governmental actions.
Occasionally, timing of payment streams may be affected by delays by the state related to bill
processing systems, staffing or other factors. While these delays have historically impacted our
cash position in particular periods, they have not resulted in long-term collections problems.
Expenses
Expenses directly related to providing services are classified as cost of revenue. Direct
costs and expenses principally include salaries and benefits for service provider employees, per
diem payments to our Mentors, residential occupancy expenses, which are primarily comprised of rent
and utilities related to facilities providing direct care, certain client expenses such as food,
medicine and transportation costs for clients requiring services and insurance costs. General and
administrative expenses primarily include salaries and benefits for administrative employees, or
employees that are not directly providing services, administrative occupancy costs as well as
professional expenses such as consulting and accounting services. Depreciation and amortization
includes depreciation for fixed assets utilized in both facilities providing direct care and
administrative offices, and amortization related to intangible assets.
Wages and benefits to our employees and per diem payments to our Mentors constitute the most
significant operating cost in each of our operations. Most of our employee caregivers are paid on
an hourly basis, with hours of work generally tied to client need. Our Mentors are paid on a per
diem basis, but only if the Mentor is currently caring for a client. Our labor costs are generally
influenced by levels of service and these costs can vary in material respects across regions.
Occupancy costs represent a significant portion of our operating costs. As of June 30, 2011,
we owned 398 facilities and one office, and we leased 950 facilities and 266 offices. We incur no
facility costs for services provided in the home of a Mentor.
Expenses incurred in connection with liability insurance and third-party claims for
professional and general liability totaled 0.9% and 0.3% of our net revenue for the three months
ended June 30, 2011 and 2010, respectively and 1.0% and 0.4% of our net revenue for the nine months
ended June 30, 2011 and 2010, respectively. We have incurred professional and general liability
claims and insurance expense for professional and general liability of $2.5 million and $0.8
million for the three months ended June 30, 2011 and 2010, respectively, and $7.7 million and $2.9
million for the nine months ended June 30, 2011 and 2010, respectively. Claims paid by us and our
insurers for professional and general liability have increased sharply in recent years. We have
historically self-insured amounts of up to $1.0 million per claim and up to $2.0 million in the
aggregate. Commencing October 1, 2010, we pay substantially higher premiums for our professional
and general liability policies, and our self-insured retentions substantially exceed the amounts we
previously had. Since October 1, 2010, we have had self-insured retentions for $2.0 million per
claim and $8.0 million in the aggregate, and for $500 thousand per claim in excess of the
aggregate.
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Our ability to maintain our margin in the future is dependent upon obtaining increases in
rates and/or controlling our expenses. In fiscal 2008, 2009 and 2010, we invested in infrastructure
initiatives and business process improvements, which had a net negative impact on our margin.
Results of Operations
The following table sets forth income (loss) from operations as a percentage of net revenue
for the periods indicated:
Post Acute Specialty | ||||||||||||||||
For the three months ended June 30, | Human Services | Rehabilitation Services | Corporate | Consolidated | ||||||||||||
(in thousands) | ||||||||||||||||
2011 |
||||||||||||||||
Net revenue |
$ | 227,414 | $ | 43,782 | $ | | $ | 271,196 | ||||||||
Income (loss) from operations |
19,540 | 4,878 | (16,100 | ) | 8,318 | |||||||||||
Operating margin |
8.6 | % | 11.1 | % | | 3.1 | % | |||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 222,279 | $ | 36,506 | $ | | $ | 258,785 | ||||||||
Income (loss) from operations |
21,110 | 3,686 | (12,527 | ) | 12,269 | |||||||||||
Operating margin |
9.5 | % | 10.1 | % | | 4.7 | % |
Post-Acute Specialty | ||||||||||||||||
For the nine months ended June 30, | Human Services | Rehabilitation Services | Corporate | Consolidated | ||||||||||||
(in thousands) | ||||||||||||||||
2011 |
||||||||||||||||
Net revenue |
$ | 673,233 | $ | 130,350 | $ | | $ | 803,583 | ||||||||
Income (loss) from operations |
60,658 | 14,123 | (45,085 | ) | 29,696 | |||||||||||
Operating margin |
9.0 | % | 10.8 | % | | 3.7 | % | |||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 661,272 | $ | 96,994 | $ | | $ | 758,266 | ||||||||
Income (loss) from operations |
60,611 | 10,232 | (36,582 | ) | 34,261 | |||||||||||
Operating margin |
9.2 | % | 10.5 | % | | 4.5 | % |
Three months ended June 30, 2011 compared to three months ended June 30, 2010
Consolidated
Consolidated revenue for the three months ended June 30, 2011 increased by $12.4 million, or
4.8%, compared to revenue for the three months ended June 30, 2010. Revenue increased $7.7 million
related to acquisitions that closed during and after the three months ended June 30, 2010 and $4.7
million related to organic growth, including growth related to new programs. Modest organic growth
was achieved despite the negative impact of rate reductions in several states, including Indiana
(5%), Oregon (multiple cuts to I/DD day and residential services) and Wisconsin (individual,
client-specific adjustments).
Consolidated income from operations decreased from $12.3 million or 4.7% of revenue, for the
three months ended June 30, 2010 to $8.3 million or 3.1% of revenue, for the three months ended
June 30, 2011.
Our operating margin was negatively impacted by
an additional $2.9 million of stock based
compensation expense recorded during the three
months ended June 30, 2011 compared to the three months ended
June 30, 2010. During
the three months ended June 30, 2011, we issued additional equity units of NMH Investment to
members of management and accelerated the vesting of previously outstanding units.
Depreciation and amortization expense increased $2.2 million during the three months ended
June 30, 2011 primarily due to the write-off of under performing assets. During the
assessment of long-lived assets that was performed during the three months ended June 30, 2011, we
determined that certain of our agency contracts and licenses and permits in the Human Services
segment were impaired. As a result, we recorded a non-cash impairment charge of $1.7 million which reduced the
carrying amount of these long-lived assets to their fair value of zero as of June 30, 2011.
In addition, our margin was negatively impacted by an increased expense relating to
professional and general liability. During the three months ended June 30, 2011, we increased our
reserves against higher self-insured retentions and paid higher premiums for professional and
general liability policies, which resulted in an additional $1.7 million of expense.
Also
during the three months ended June 30, 2011, our operating
margin was negatively impacted by rate reductions in several states,
including Indiana, Oregon and Wisconsin, and a $1.1 million increase in
occupancy expense, which included $0.7 million of expense related to a lease termination fee associated with
the closing of an underperforming program in the Human Services segment. In addition, during the
three months ended June 30, 2011, we recorded an additional $0.9 million of expense related to a
restructuring of certain corporate and field functions.
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The decrease in income from operations was partially offset by expense reduction from our
on-going cost containment efforts.
Interest expense increased by $8.1 million primarily due to an increase in the average debt
balance as well as an increase in the weighted average interest rate from 8.2% during the three
months ended June 30, 2010 to 9.2% during the three months ended June 30, 2011.
Human Services
Human Services revenue for the three months ended June 30, 2011 increased by $5.1 million, or
2.3%, compared to the three months ended June 30, 2010. Revenue increased $2.6 million related to
organic growth, including growth related to new programs, which increased despite the negative
impact of rate reductions in several states, including Indiana (5%), Oregon (multiple cuts to I/DD
day and residential services) and Wisconsin (individual, client-specific adjustments). Revenue also
increased $2.5 million related to acquisitions that closed during and after the three months ended
June 30, 2010.
Income from operations decreased from $21.1 million or 9.5% of revenue, during the three
months ended June 30, 2010 to $19.5 million or 8.6% of revenue during the three months ended June
30, 2011. Income from operations was negatively impacted by a non-cash impairment charge of $1.7
million related to the write-off of under performing assets and rate reductions in
several states, including Indiana, Oregon and Wisconsin. Also, our
operating margin was negatively impacted by a $1.3 million increase in our professional and
general liability expense and an increase in occupancy expense
which included $0.7 million related to a lease termination fee associated with the closing of an
underperforming program.
Partially offsetting the decrease in income from operations, income from operations was
positively impacted by increased revenue and expense reduction from our ongoing cost containment
efforts.
Post-Acute Specialty Rehabilitation Services
Post-Acute Specialty Rehabilitation Services revenue for the three months ended June 30, 2011
increased by $7.3 million, or 20.0%, compared to the three months ended June 30, 2010. This
increase was due to growth of $5.2 million related to acquisitions that closed during and after the
three months ended June 30, 2010 and $2.1 million related to organic growth, including growth
related to new programs.
Income from operations increased from $3.7 million, or 10.1% of revenue for the three months
ended June 30, 2010 to $4.9 million, or 11.1% of revenue for the three months ended June 30, 2011
primarily due to the increase in revenue noted above. Our margin was negatively impacted by a $0.8
million increase in occupancy expense as a result of acquisitions.
Corporate
Total corporate expenses increased by $3.6 million from the three months ended June 30, 2010
to $16.1 million for the three months ended June 30, 2011. During the three months ended June 30,
2011, we recorded an additional $2.9 million of stock based
compensation expense compared to the three months ended June 30, 2010. In addition, we recorded an additional
$0.8 million related to restructuring of certain corporate and
field functions compared to the three months ended June 30, 2010.
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Nine months ended June 30, 2011 compared to nine months ended June 30, 2010
Consolidated
Consolidated revenue for the nine months ended June 30, 2011 increased by $45.3 million, or
6.0%, compared to revenue for the
nine months ended June 30, 2010. Revenue increased $34.7 million related to acquisitions that
closed during and after fiscal 2010 and $10.6 million related to organic growth, including growth
related to new programs. Modest organic growth was achieved despite the negative impact of rate
reductions in several states, including Indiana (5%), Oregon (multiple rate cuts to I/DD day and
residential services) and Wisconsin (individual, client-specific adjustments).
Consolidated income from operations decreased from $34.3 million or 4.5% of revenue, for the
nine months ended June 30, 2010 to $29.7 million or 3.7% of revenue, for the nine months ended June
30, 2011.
Our operating margin was negatively impacted by
an increased expense relating to professional and general liability. During the nine months ended June 30, 2011, we incurred higher
reserves against higher self-insured retentions and paid higher premiums for professional and
general liability policies, which resulted in an additional $4.8 million of expense compared to the
nine months ended June 30, 2010.
Also during the nine months ended June 30, 2011, we recorded an additional $4.5 million in
occupancy expense primarily related to (i) acquisitions in our Post-Acute Specialty Rehabilitation
Services segment and (ii) $0.7 million of expense related to a lease termination fee associated with
closing an underperforming program in the Human Services segment.
Depreciation and amortization expense increased $3.8 million during the nine months ended
June 30, 2011 primarily due to the write-off of under performing assets, which resulted in a
non-cash impairment charge of $1.7 million.
During the nine months ended June 30, 2011, we recorded an additional $2.9 million of stock
based compensation expense compared to the nine months ended June 30, 2010 as we issued additional
equity units of NMH Investment to members of management and accelerated the vesting of previously
outstanding units.
During the nine months ended June 30, 2011, we recorded $2.4 million for the payment of
one-time discretionary bonuses in recognition of individuals contributions to enabling the
successful closing of the refinancing transactions described in Note 4 (the transaction
recognition bonuses). The transaction recognition bonuses are included in general and
administrative expense in the accompanying consolidated statement of operations. In addition, we
recorded an additional $2.4 million during the nine months ended June 30, 2011 related to restructuring of certain corporate and field
functions.
Our
operating margin was also negatively impacted by rate reductions in
several states, including Indiana, Oregon and Wisconsin, as well as a
$1.4 million increase in reserves for employment practices liability
claims.
The decrease in income from operations was partially offset by expense reduction from our
on-going cost containment efforts.
During the nine months ended June 30, 2011, we recorded an additional $19.3 million of
debt extinguishment expenses related to the refinancing transactions including (i) $10.8 million related to the tender
premium and consent fees paid in connection with the repurchase of the senior subordinated notes,
(ii) $7.9 million related to the acceleration of financing costs related to the prior
indebtedness and (iii) $0.6 million related to transaction costs. These expenses are recorded on
our consolidated statements of operations as Extinguishment of debt.
During the nine months ended June 30, 2011, we recorded a $3.0 million gain as NMH Holdings
repurchased the NMH Holdings notes (which we purchased at a discount) from us at a premium. The
gain was recorded on our statements of operations as Gain from available for sale investment
security.
Interest expense increased by $7.0 million from the nine months ended June 30, 2010 primarily
due to an increase in the average debt balance partially offset by a decrease in the weighted
average interest rate from 8.3% during the nine months ended June 30, 2010 to 7.8% during the nine
months ended June 30, 2011. We paid a lower variable rate interest during the nine months ended
June 30, 2011 compared to the nine months ended June 30, 2010 due to the expiration of swap
contracts at a higher fixed rate of interest during the three months ended September 30, 2010.
Discontinued operations for all periods presented include the operations of REM Health, REM
Maryland, REM Colorado, New Hampshire MENTOR and Nebraska MENTOR, all of which are included in the
Human Services segment. Loss from discontinued operations for the nine months ended June 30, 2010
included additional impairment charges recorded to close our business operations
in REM Colorado and to write-down the REM Maryland assets to fair value.
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Human Services
Human Services revenue for the nine months ended June 30, 2011 increased by $12.0 million, or
1.8%, compared to the nine months ended June 30, 2010. Revenue increased $7.7 million related to
acquisitions that closed during and after fiscal 2010 and $4.3 million related to organic growth,
including growth related to new programs. Modest organic growth was achieved despite the negative
impact of rate reductions in several states, including Indiana (5%), Oregon (multiple rate cuts to
I/DD day and residential services) and Wisconsin (individual, client-specific adjustments).
Income from operations remained essentially constant from $60.6 million during the nine months
ended June 30, 2010 to $60.7 million during the nine months ended June 30, 2011 while operating
margin decreased slightly from 9.2% of revenue to 9.0% of revenue for the same periods. Operating
margin was negatively impacted by an increase in expense related to our higher self-insured
retentions and premiums for professional and general liability policies. During the nine months
ended June 30, 2011, we recorded an additional $3.7 million related to professional and general
liability expense. Operating margin was also negatively impacted by rate reductions in several states, including
Indiana, Oregon and Wisconsin, as well as a $1.7 million increase in depreciation and
amortization expense related to the write-off of under performing
assets. During the nine months ended June 30, 2011, we recorded an additional $1.3 million related
to employment practices liability due to the development of claims. Also, our occupancy expense for the same period included $0.7 million
related to a lease termination fee associated with the closing of an underperforming program.
Income from operations was positively impacted by increased revenue and expense reduction from
our ongoing cost-containment efforts.
Post-Acute Specialty Rehabilitation Services
Post-Acute Specialty Rehabilitation Services revenue for the nine months ended June 30, 2011
increased by $33.3 million, or 34.4%, compared to the nine months ended June 30, 2010. This
increase was due to growth of $27.0 million related to acquisitions that closed during and after
fiscal 2010 and $6.3 million related to organic growth, including growth related to new programs.
Income from operations increased from $10.2 million, or 10.5% of revenue for the nine months
ended June 30, 2010 to $14.1 million, or 10.8% of revenue for the nine months ended June 30, 2011
primarily due to the increase in revenue noted above. Our margin was negatively impacted by a $3.9
million increase in occupancy expense as a result of acquisitions.
Corporate
Total corporate expenses increased by $8.5 million from the nine months ended June 30, 2010 to
$45.1 million for the nine months ended June 30, 2011. During the nine months ended June 30, 2011,
we recorded an additional (i) $2.9 million of stock based compensation expense, (ii) $2.4 million
related to restructuring of certain corporate and field functions and (iii) $2.4 million related to the payment of
transaction recognition bonuses.
Liquidity and Capital Resources
Our principal uses of cash are to meet working capital requirements, fund debt obligations and
finance capital expenditures and acquisitions. Cash flows from operations have historically been
sufficient to meet these cash requirements. Our principal sources of funds are cash flows from
operating activities and available borrowings under our senior revolver (as defined below).
Operating activities
Cash flows provided by operating activities for the nine months ended June 30, 2011 were $42.8
million compared to $48.6 million for the nine months ended June 30, 2010. The decrease was
primarily due to a decrease in operating income primarily as a result of the refinancing
transactions including $10.8 million related to the tender premium and consent fees paid in
connection with the repurchase of the senior subordinated notes. However, our working capital
decreased as our days sales outstanding decreased three days from 47 days at September 30, 2010 to
44 days at June 30, 2011.
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Investing activities
Net cash used in investing activities was $76.5 million for the nine months ended June 30,
2011 compared to $47.4 million for the nine months ended June 30, 2010.
Cash paid for acquisitions was $12.7 million for the nine months ended June 30, 2011 and
included cash paid for seven acquisitions, namely Communicare, Inclusive Solutions, New Start
Homes, ViaQuest, Phoenix Homes, SunnySide Homes and TheraCare. Cash paid for acquisitions for the
nine months ended June 30, 2010 was $32.8 million, primarily reflecting the acquisitions of
NeuroRestorative for $17.0 million, Springbrook for $6.3 million, Villages for $6.0 million and
Anchor Inne for $3.4 million. Cash paid for property and equipment for the nine months ended June
30, 2011 was $14.6 million, or 1.8% of revenue and cash paid for property and equipment for the
nine months ended June 30, 2010 was $14.5 million, or 1.9% of revenue.
In addition, during the nine months ended June 30, 2011, our restricted cash balance increased
by $49.9 million primarily due to $50.0 million which was deposited in a cash collateral account in
support of issuance of letters of credit under the institutional letter of credit facility.
Financing activities
Net cash provided by financing activities was $27.8 million for the nine months ended June 30,
2011 compared to $3.0 million used in financing activities for the nine months ended June 30, 2010.
Net cash provided by financing activities for the nine months ended June 30, 2011 include the
following items related to the refinancing transaction:
(In millions) | ||||
Repayment of long-term debt |
$ | (504.4 | ) | |
Proceeds from the issuance of long-term debt |
761.7 | |||
Dividend to Parent |
(206.4 | ) | ||
Payments of financing costs |
(14.2 | ) |
See -Debt and Refinancing Arrangements for a description of the refinancing transactions.
In addition to the refinancing related items, net cash used in financing activities for the
nine months ended June 30, 2011 included contingent consideration payments of $4.9 million. We paid $3.3 million
for the IFCS acquisition, which we acquired in fiscal 2009 and we paid $3.4 million for the
Springbrook acquisition which we acquired in fiscal 2010. The IFCS payment is reflected
in the statements of cash flow as $3.3 million cash used in financing activities. The Springbrook
payment is reflected in the statements of cash flow as (i) $1.6 million cash used in
financing activities related to the liability recognized at fair value as of the acquisition date
and (ii) $1.7 million cash used operating activities related to the fair value adjustments
previously recognized in earnings.
Also during the nine months ended June 30, 2011, we paid a dividend of $1.5 million to NMH
Holdings, LLC (Parent), which used the proceeds of the dividend to make a distribution to NMH
Holdings, Inc. (NMH Holdings), which in turn used the proceeds of the distribution to pay a
dividend of $1.5 million to NMH Investment, LLC (NMH Investment). NMH Investment used the
proceeds of the dividend to repurchase its preferred and common equity units from certain employees
upon or after their departures.
Our principal sources of funds are cash flows from operating activities and available
borrowings under our senior revolver. We believe that these funds will provide sufficient liquidity
and capital resources to meet our financial obligations for the next twelve months, including
scheduled principal and interest payments, as well as to provide funds for working capital,
acquisitions, capital expenditures and other needs. No assurance can be given, however, that this
will be the case.
Debt and Financing Arrangements
On February 9, 2011, we completed refinancing transactions, which included entering into a
senior credit agreement (the senior credit agreement) for senior secured credit facilities (the
senior secured credit facilities) and issuing $250.0 million in aggregate principal amount of
12.50% senior notes due 2018 (the senior notes). We used the net proceeds from the senior secured
credit facilities ($520.9 million) and the senior notes ($238.7 million), together with cash on
hand, to: (i) repay all amounts owing under our old senior secured credit facilities and our
mortgage facility; (ii) purchase $171.9 million of our senior subordinated notes; (iii) pay
$9.6 million to NMH Holdings related to a tax sharing arrangement; (iv) declare a $219.7
million dividend to Parent, which in turn made a distribution to NMH Holdings, which used $206.4
million cash proceeds of the distribution to repurchase $210.9 million principal amount of the NMH
Holdings notes at a premium, including $13.5 million principal amount of NMH Holdings notes we held
as an investment; and (v) pay related fees and expenses.
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Senior Secured Credit Facilities
We entered into senior secured credit facilities, consisting of a (i) six-year $530.0 million
term loan facility (the term loan), of which $50.0 million was deposited in a cash collateral
account in support of issuance of letters of credit under an institutional letter of credit
facility (the institutional letter of credit facility) and a (ii) $75.0 million five-year senior
secured revolving credit facility (the senior revolver). All of our obligations under the senior
secured credit facilities are guaranteed by Parent and certain of our existing subsidiaries. The
obligations under the senior secured credit facilities are secured by a pledge of 100% of our
capital stock and the capital stock of domestic subsidiaries owned by us and any other domestic
subsidiary guarantor and 65% of the capital stock of any first tier foreign subsidiaries, and a
security interest in substantially all of our tangible and intangible assets and the tangible and
intangible assets of Parent and each guarantor.
At our option, we may add one or more new term loan facilities or increase the commitments
under the senior revolver (collectively, the incremental borrowings) in an aggregate amount of up
to $125.0 million so long as certain conditions, including a consolidated leverage ratio (as
defined in the senior credit agreement) of not more than 6.00 to 1.00 on a pro forma basis, are
satisfied. The covenants in the indenture governing the senior notes effectively limit the amount
of incremental borrowings that we may incur to not more than $75.0 million.
The senior credit agreement contains a number of covenants that, among other things, restrict,
subject to certain exceptions, our ability to: (i) incur additional indebtedness; (ii) create liens
on assets; (iii) engage in mergers or consolidations; (iv) sell assets; (v) pay dividends and
distributions or repurchase our capital stock; (vi) make capital expenditures; (vii) make
investments, loans or advances; (viii) repay certain indebtedness; (ix) engage in certain
transactions with affiliates; (x) enter into sale and leaseback transactions; (xi) amend material
agreements governing certain of our indebtedness; (xii) change our lines of business; (xiii) make
certain acquisitions; (xiv) change the status of NMH Holdings as a passive holding company; and
(xv) use the cash in the letter of credit cash collateral account. If we withdraw any of the $50.0
million from the cash collateral account supporting the issuance of letters of credit, we must use
the cash to either prepay the term loan facility or to secure any other obligations under the
senior secured credit facilities in a manner reasonably satisfactory to the administrative agent.
The senior credit agreement contains customary affirmative covenants and events of default. The
senior credit agreement also requires us to maintain certain financial covenants, as described
under Covenants below.
Term loan
The $530.0 million term loan was issued at a price equal to 98.5% of its face value and
amortizes one percent per year, paid quarterly, with the remaining balance payable at maturity. The
senior credit agreement also includes a provision for the prepayment of a portion of the
outstanding term loan amounts beginning in fiscal 2011 equal to an amount ranging from 0 to 50% of
a calculated amount, depending on our leverage ratio, if we generate certain levels of cash flow,
sell certain assets or incur other indebtedness, subject to certain exceptions. We are required to
repay the term loan portion of the senior credit facilities in quarterly principal installments of
0.25% of the principal amount, with the balance payable at maturity. The variable interest rate on
the term loan bears interest at (i) a rate equal to the greater of (a) the prime rate (b) the
federal funds rate plus 1/2 of 1% and (c) the Eurodollar rate for an interest period of one-month
beginning on such day plus 100 basis points, plus 4.25%; or (ii) the Eurodollar rate (provided that
the rate shall not be less than 1.75% per annum), plus 5.25%, at our option. At June 30, 2011, the
variable interest rate on the term loan was 7.0%.
Senior revolver
We had $75.0 million of availability under the senior revolver at June 30, 2011 and had $35.9
million of standby letters of credit issued under the institutional letter of credit facility
primarily related to our workers compensation insurance coverage. Letters of credit can be issued
under our institutional letter of credit facility up to the $50.0 million credit collateral
account. Letters of credit in excess of that amount reduce availability under our senior revolver.
The interest rates for any borrowings under the senior revolver are the same as outlined for the
term loan.
The senior revolver includes borrowing capacity available for letters of credit and for
borrowings on same-day notice, referred to
as the swingline loans. Any issuance of letters of credit or making of a swingline loan will
reduce the amount available under the senior revolver.
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Senior Notes
On February 9, 2011, we issued $250.0 million in aggregate principal amount of the senior
notes at a price equal to 97.737% of their face value. The senior notes mature on February 15, 2018
and bear interest at a rate of 12.50% per annum, payable semi-annually on February 15 and August 15
of each year, beginning on August 15, 2011. The senior notes are our unsecured obligations and are
fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by certain
of our existing subsidiaries.
We may redeem the senior notes at our option, in whole or part, at any time prior to February
15, 2014, at a price equal to 100% of the principal amount of the senior notes redeemed plus
accrued and unpaid interest to the redemption date and plus an applicable premium. We may redeem
the senior notes, in whole or in part, on or after February 15, 2014, at the redemption prices set
forth in the indenture plus accrued and unpaid interest to the redemption date. At any time on or
before February 15, 2014, we may choose to redeem up to 35% of the aggregate principal amount of
the senior notes at a redemption price equal to 112.5% of the principal amount thereof, plus
accrued and unpaid interest to the redemption date, with the net proceeds of one or more equity
offerings, so long as at least 65% of the original aggregate principal amount of the senior notes
remain outstanding after each such redemption.
Covenants
The senior credit agreement and the indenture governing the senior notes contain negative
financial and non-financial covenants, including, among other things, limitations on our ability to
incur additional debt, transfer or sell assets, pay dividends, redeem stock or make other
distributions or investments, and engage in certain transactions with affiliates. We were in
compliance with these covenants as of June 30, 2011. In addition, in the case of the senior credit
agreement, we are required to maintain at the end of each fiscal quarter, commencing with the
quarter ending September 30, 2011, a consolidated leverage ratio of not more than 7.25 to 1.00.
This consolidated leverage ratio will step down over time, starting with the quarter ending
December 31, 2012. The consolidated leverage ratio is defined as the ratio of total debt, net of
cash and cash equivalents, to consolidated adjusted EBITDA, as defined in the senior credit
agreement, for the most recently completed four fiscal quarters. We are also required to maintain
at the end of each fiscal quarter, commencing with the quarter ending September 30, 2011, a
consolidated interest coverage ratio of at least 1.30 to 1.00. This interest coverage ratio will
step up over time, starting with the quarter ending March 31, 2012. The consolidated interest
coverage ratio is defined as the ratio of consolidated adjusted EBITDA to consolidated interest
expense, both as defined under the senior credit agreement, for the most recently completed four
fiscal quarters.
As of June 30, 2011, our consolidated leverage ratio was 5.82 to 1.00, as calculated in
accordance with the senior credit agreement and our consolidated interest coverage ratio was 1.68
to 1.00, as calculated in accordance with the senior credit agreement. As of June 30, 2011, total
debt, net of cash and cash equivalents, was $714.9 million. Under the senior credit agreement,
consolidated adjusted EBITDA is defined as net income before interest expense and interest income,
income taxes, depreciation and amortization, further adjusted to add back certain non-cash charges,
fees under the management agreement with our equity sponsor, proceeds of business insurance,
certain expenses incurred under indemnification or refunding provisions for acquisitions, certain
start-up losses, non-cash compensation expense, transaction bonuses, unusual or non-recurring
losses, charges, severance costs and relocation costs and deductions attributable to minority
interests, business optimization expenses and further adjusted to subtract unusual or non-recurring
income or gains, income tax credits to the extent not netted, non-cash income and interest income
and gains on interest rate hedges, and further adjusted for certain other items including EBITDA
and pro forma adjustments from acquired businesses and exclusion of discontinued operations.
Set forth below is a reconciliation of consolidated adjusted EBITDA, as calculated under the
credit agreement, to net loss for the most recently completed four fiscal quarters ended June 30,
2011:
(In thousands) | ||||
Net loss |
$ | (21,093 | ) | |
Loss from discontinued operations, net of tax |
193 | |||
Benefit for income taxes |
(9,491 | ) | ||
Gain from available for sale investment security |
(3,018 | ) | ||
Interest income |
(29 | ) | ||
Interest income from related party |
(1,180 | ) | ||
Interest expense |
53,647 | |||
Depreciation and amortization |
61,348 |
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(In thousands) | ||||
Management fee of related party |
1,318 | |||
Extinguishment of debt |
19,278 | |||
Loss on disposal of assets |
13 | |||
Stock based compensation |
3,548 | |||
Acquisition costs |
662 | |||
Change in fair value of contingent consideration |
673 | |||
Claims made insurance liability |
1,778 | |||
Predecessor company claims |
766 | |||
Transaction recognition bonuses |
2,362 | |||
Restructuring expense |
2,665 | |||
Terminated transaction costs |
1,977 | |||
Lease termination fee |
713 | |||
Franchise taxes, transaction fees, costs, and expenses |
160 | |||
Acquired EBITDA |
4,374 | |||
Disposed EBITDA |
139 | |||
Operating losses from new starts |
1,967 | |||
Consolidated adjusted EBITDA per the senior credit agreement |
$ | 122,770 | ||
Set forth below is an annualized calculation of consolidated interest expense as of June 30,
2011, as calculated under the credit agreement:
(In thousands) | ||||
Interest rate swap agreements |
$ | 3,230 | ||
Unused line of credit |
428 | |||
Senior term B loan |
37,562 | |||
Standby letters of credit |
92 | |||
Senior subordinated notes |
31,515 | |||
Capital leases |
169 | |||
Interest income |
(29 | ) | ||
Consolidated interest expense per the senior credit agreement |
$ | 72,967 | ||
Beginning September 30, 2011, the consolidated leverage ratio and the consolidated interest
coverage ratios will be material components of the senior credit agreement and non-compliance with
these ratios could prevent us from borrowing under the senior revolver and would result in a
default under the senior credit agreement.
Contractual Commitments Summary
The following table summarizes our contractual obligations and commitments as of June 30,
2011:
Less Than | More Than | |||||||||||||||||||
(in thousands) | Total | 1 Year | 1-3 Years | 3-5 Years | 5 Years | |||||||||||||||
Long-term debt obligations (1) |
$ | 778,675 | $ | 5,300 | $ | 10,600 | $ | 10,600 | $ | 752,175 | ||||||||||
Operating lease obligations (2) |
131,949 | 38,274 | 50,591 | 27,149 | 15,935 | |||||||||||||||
Capital lease obligations |
6,849 | 307 | 672 | 760 | 5,110 | |||||||||||||||
Contingent consideration |
800 | 800 | | | | |||||||||||||||
Standby letters of credit |
35,924 | 35,924 | | | | |||||||||||||||
Total obligations and commitments (3) |
$ | 954,197 | $ | 80,605 | $ | 61,863 | $ | 38,509 | $ | 773,220 | ||||||||||
(1) | Does not include interest on long term debt. |
|
(2) | Includes the fixed rent payable under the leases and does not include additional amounts,
such as taxes, that may be payable under the leases |
|
(3) | The table above does not include $4.9 million of unrecognized tax benefits for uncertain tax
positions and $1.9 million of associated accrued interest and penalties. Due to the high
degree of uncertainty regarding the timing of potential future cash flows, we are unable to
reasonably estimate the amount and period in which these liabilities might be paid. |
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet transactions or interests.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with generally
accepted accounting principles (GAAP). The preparation of financial statements in conformity with
GAAP requires the appropriate application of certain accounting policies, many of which require us
to make estimates and assumptions about future events and their impact on amounts reported in the
financial statements and related notes. Since future events and the impact of those events cannot
be determined with certainty, the actual results may differ from our estimates. These differences
could be material to the financial statements.
We believe our application of accounting policies, and the estimates inherently required
therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and
adjustments are made when facts and circumstances dictate a change.
As of June 30, 2011, there has been no material change in our accounting policies or the
underlying assumptions or methodology used to fairly present our financial position, results of
operations and cash flows for the periods covered by this report. In addition, no triggering events
have come to our attention pursuant to our review of goodwill that would
indicate impairment as of June 30, 2011.
For further discussion of our critical accounting policies see managements discussion and
analysis of financial condition and results of operations contained in our Form 10-K for the year
ended September 30, 2010.
Forward-Looking Statements
Some of the matters discussed in this report may constitute forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the Exchange Act).
These statements relate to future events or our future financial performance, and include
statements about our expectations for future periods with respect to demand for our services, the
political climate and budgetary environment, our expansion efforts and the impact of our recent
acquisitions, our plans for divestitures and investments in our infrastructure and business process
improvements, our margins and our liquidity. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expect, plan, anticipate,
believe, estimate, predict, potential or continue, the negative of such terms or other
comparable terminology. These statements are only predictions. Actual events or results may differ
materially.
The information in this report is not a complete description of our business or the risks
associated with our business. There can be no assurance that other factors will not affect the
accuracy of these forward-looking statements or that our actual results will not differ materially
from the results anticipated in such forward-looking statements. While it is impossible to identify
all such factors, factors that could cause actual results to differ materially from those estimated
by us include, but are not limited to, those factors or conditions described under Part II. Item
1A. Risk Factors in this report as well as the following:
| changes in Medicaid funding or changes in budgetary priorities by state and local
governments; |
| changes in reimbursement rates, policies or payment practices by our payors; |
| our significant amount of debt, our ability to meet our debt service obligations and our
ability to incur additional debt; |
| current credit and financial market conditions; |
| changes in interest rates; |
| an increase in the number and nature of pending legal proceedings and the outcomes of
those proceedings; |
| an increase in our self-insured retentions and changes in the insurance market for
professional and general liability, workers compensation and automobile liability and our
claims history that affect our ability to obtain coverage at reasonable rates;
|
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| our ability to control operating costs and collect accounts receivable; |
| our ability to maintain, expand and renew existing services contracts and to obtain
additional contracts; |
| our ability to attract and retain experienced personnel, including members of our senior
management team; |
| our ability to acquire new licenses or to maintain our status as a licensed service
provider in certain jurisdictions; |
| government regulations, changes in government regulations and our ability to comply with
such regulations; |
| our ability to establish and maintain relationships with government agencies and advocacy
groups; |
| increased or more effective competition; |
| successful integration of acquired businesses; and |
| the potential for conflict between the interests of our majority equity holder and those
of our debt holders. |
Although we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance or achievements.
Moreover, we do not assume responsibility for the accuracy and completeness of the forward-looking
statements. All written and oral forward-looking statements attributable to us or persons acting on
our behalf are expressly qualified in their entirety by the Risk Factors and other cautionary
statements included herein. We are under no duty to update any of the forward-looking statements
after the date of this report to conform such statements to actual results or to changes in our
expectations.
Item 3. | Quantitative and Qualitative Disclosures about Market Risk. |
We are exposed to changes in interest rates as a result of our outstanding variable rate debt.
To reduce the interest rate exposure related to the variable debt, we entered into an interest rate
swap in a notional amount of $400.0 million effective March 31, 2011 and ending September 30, 2014.
Under the terms of the swap, we receive from the counterparty a quarterly payment based on a rate
equal to the greater of 3-month LIBOR and 1.75% per annum, and we make payments to the counterparty
based on a fixed rate of 2.54650% per annum, in each case on the notional amount of $400.0 million,
settled on a net payment basis. Based on the applicable margin of 5.25% under our term loan
facility, this swap effectively fixes our cost of borrowing for $400.0 million of our term loan
debt at 7.7965% per annum for the term of the swap.
As a result of the interest rate swap, the variable rate debt outstanding was effectively
reduced from $528.7 million outstanding to $128.7 million outstanding as of June 30, 2011. The
variable rate debt outstanding relates to the term loan and the senior revolver, which bear
interest at (i) a rate equal to the greater of (a) the prime rate (b) the federal funds rate plus
1/2 of 1% and (c) the Eurodollar rate for an interest period of one-month beginning on such day
plus 100 basis points, plus 4.25%; or (ii) the Eurodollar rate (provided that the rate shall not be
less than 1.75% per annum), plus 5.25%, at our option. A 1% increase in the interest rate on our
floating rate debt would increase cash interest expense on the floating rate debt by approximately
$1.3 million per annum.
Item 4. | Controls and Procedures. |
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures to ensure that information required to be
disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized
and reported, within the time periods specified in the rules and forms of the SEC, and is
accumulated and communicated to management, including the Chief Executive Officer and the President
(principal executive officers) and the Chief Financial Officer (principal financial officer), to
allow for timely decisions regarding required disclosure. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including the possibility of
human error and the circumvention or overriding of the controls and procedures. As of June 30,
2011, the end of the period covered by this Quarterly Report on Form 10-Q, our management, with the
participation of our principal executive officers and principal financial officer, has evaluated
the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and
15d-15(e) of the Exchange Act. Based on that evaluation, our principal executive officers and
principal financial officer concluded that our disclosure controls and procedures were effective as
of June 30, 2011.
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(b) | Changes in Internal Control over Financial Reporting |
During the quarter ended March 31, 2011, we began to transition certain field billing and
accounts receivable functions into a centralized shared services center. This centralization is
expected to continue in a phased approach over the next several years. As part of this
centralization, as well as the continued implementation of our new billing and accounts receivable
system for additional business units, we continue to refine and optimize our new billing and
accounts receivable process and related system in a majority of our operations. This has affected,
and will continue to affect, the processes that impact our internal control over financial
reporting. We will continue to review the related controls and may take additional steps to ensure
that they remain effective.
Except for the continuing centralization and optimization of our billing and accounts
receivable process and related system, during the most recent fiscal quarter, there were no
significant changes in our internal control over financial reporting that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. | Legal Proceedings. |
We are in the health and human services business and, therefore, we have been and continue to
be subject to substantial claims alleging that we, our employees or our Mentors failed to provide
proper care for a client. We are also subject to claims by our clients, our employees, our Mentors
or community members against us for negligence, intentional misconduct or violation of applicable
laws. Included in our recent claims are claims alleging personal injury, assault, battery, abuse,
wrongful death and other charges. Regulatory agencies may initiate administrative proceedings
alleging that our programs, employees or agents violate statutes and regulations and seek to impose
monetary penalties on us. We could be required to incur significant costs to respond to regulatory
investigations or defend against civil lawsuits and, if we do not prevail, we could be required to
pay substantial amounts of money in damages, settlement amounts or penalties arising from these
legal proceedings.
We reserve for costs related to contingencies when a loss is probable and the amount is
reasonably estimable. While we believe our provision for legal contingencies is adequate, the
outcome of the legal proceedings is difficult to predict and we may settle legal claims or be
subject to judgments for amounts that differ from our estimates.
See Part I. Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations and Part II. Item 1A. Risk Factors for additional information.
Item 1A. | Risk Factors. |
Reductions or changes in Medicaid funding or changes in budgetary priorities by the state and local
governments that pay for our services could have a material adverse effect on our revenue and
profitability.
We derive the vast majority of our revenue from contracts with state and local governments.
These governmental payors fund a significant portion of their payments to us through Medicaid, a
joint federal and state health insurance program through which state expenditures are matched by
federal funds typically ranging from 50% to approximately 76% of total costs, a number based
largely on a states per capita income. Our revenue, therefore, is determined by the level of
federal, state and local governmental spending for the services we provide. Budgetary pressures,
particularly during the recent recessionary period as well as other economic, industry, political
and other factors, could cause the federal and state governments to limit spending, which could
significantly reduce our revenue, referrals, margins and profitability and adversely affect our
growth strategy. Governmental agencies generally condition their contracts with us upon a
sufficient budgetary appropriation. If a government agency does not receive an appropriation
sufficient to cover its contractual obligations with us, it may terminate a contract or defer or
reduce our reimbursement. In addition, there is risk that previously appropriated funds could be
reduced through subsequent legislation. The Patient Protection and Affordable Care Act of 2010
mandates certain uses for Medicaid funds, which could have the effect of diverting those funds from
the services we provide. Many states in which we operate have been experiencing unprecedented
budgetary deficits and constraints and have implemented or are considering initiating service
reductions, rate freezes and/or rate reductions, including states such as Minnesota, California,
Indiana and Arizona. Similarly, programmatic changes such as conversions to managed care with
related contract demands regarding billing and services, unbundling of services, governmental
efforts to increase consumer autonomy and reduce provider oversight, coverage and other changes
under state Medicaid plans, may cause unanticipated costs and risks to our service delivery. The
loss or reduction of or changes to reimbursement under our contracts could have a material adverse
effect on our business, financial condition and operating results.
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Reductions in reimbursement rates or failure to obtain increases in reimbursement rates could
adversely affect our revenue, cash flows and profitability.
Our revenue and operating profitability depend on our ability to maintain our existing
reimbursement levels and to obtain periodic increases in reimbursement rates to meet higher costs
and demand for more services. Ten percent of our revenue is derived from contracts based on a cost
reimbursement model where we are reimbursed for our services based on our costs plus an agreed-upon
margin. If we are not entitled to, do not receive or cannot negotiate increases in reimbursement
rates, or are forced to accept a reduction in our reimbursement rates at approximately the same
time as our costs of providing services increase, including labor costs and rent, our margins and
profitability could be adversely affected. Changes in how federal and state government agencies
operate reimbursement programs can also affect our operating results and financial condition. Some
states have, from time to time, revised their rate-setting methodologies in a manner that has
resulted in rate decreases. In some instances, changes in rate-setting methodologies have resulted
in third-party payors disallowing, in whole or in part, our requests for reimbursement.
The termination of the enhanced federal Medicaid funding after June 30, 2011 contributed to significant
budgetary challenges that confronted state governments for fiscal 2012, which began July 1, 2011
in most states. The result is that some of our public payors have implemented, or are likely to
implement in the coming months, additional rate reductions, particularly for our I/DD services.
Any reduction in or the failure to maintain or increase our reimbursement rates could have a material
adverse effect on our business, financial condition and results of operations. Changes in the
manner in which state agencies interpret program policies and procedures or review and audit
billings and costs could also adversely affect our business, financial condition and operating
results and our ability to meet obligations under our indebtedness.
Our level of indebtedness could adversely affect our liquidity and ability to raise additional
capital to fund our operations, and it could limit our ability to react to changes in the economy
or our industry.
We have a significant amount of indebtedness and substantial leverage. As of June 30, 2011, we
had total indebtedness of $785.5 million, no borrowings under our senior revolver and $75.0 million
of availability under our senior revolver. Interest on our indebtedness is payable entirely in
cash, whereas as of September 30, 2010, our total indebtedness was lower and our indirect parent,
NMH Holdings, paid interest on the NMH Holdings notes as PIK Interest. Our annualized interest
expense as of June 30, 2011, as calculated under the credit agreement is $73.0 million as compared
to $43.2 million at September 30, 2010. As of June 30, 2011, our consolidated leverage ratio was
5.82 to 1.00, as calculated in accordance with the senior credit agreement.
Our substantial degree of leverage could have important consequences, including the following:
| it may significantly curtail our acquisitions program and may limit our ability to obtain
additional debt or equity financing for working capital, capital expenditures, debt service
requirements, and general corporate or other purposes; |
| a substantial portion of our cash flows from operations will be dedicated to the payment
of principal and interest on our indebtedness and will not be available for other purposes,
including our operations, future business opportunities and acquisitions and capital
expenditures; |
| the debt service requirements of our indebtedness could make it more difficult for us to
satisfy our indebtedness and contractual and commercial commitments; |
| interest rates on the portion of our variable interest rate borrowings under the senior
secured credit facilities that have not been hedged may increase; |
| it may limit our ability to adjust to changing market conditions and place us at a
competitive disadvantage compared to our competitors that have less debt and a lower degree
of leverage; |
| we may be vulnerable if the current downturn in general economic conditions continues or
if there is a downturn in our business, or we may be unable to carry out activities that are
important to our growth; and |
| it may prevent us from raising the funds necessary to repurchase senior subordinated
notes tendered to us if there is a change of control, which would constitute a default under
the senior credit agreement governing our senior secured credit facilities. |
Subject to restrictions in the indenture governing our senior notes and the senior credit
agreement, we may be able to incur more debt in the future, which may intensify the risks described
in this risk factor. All of the borrowings under the senior secured credit facilities are secured
by substantially all of the assets of the Company and its subsidiaries.
In addition to our high level of indebtedness, we have significant rental obligations under
our operating leases for our group homes, other service facilities and administrative offices. For
the three and nine months ended June 30, 2011, our aggregate rental payments for these leases,
including taxes and operating expenses, were $12.6 million and $36.2 million, respectively. These
obligations could further increase the risks described above.
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Current credit and economic conditions could have a material adverse effect on our cash flows,
liquidity and financial condition.
Tax revenue continues to be down in many jurisdictions due to the economic recession and high
rates of unemployment and government payors may not be able to pay us for our services until they
collect sufficient tax revenue. Due to the general tightening of the credit markets over the last
several years, our government payors or other counterparties that owe us money, such as
counterparties to swap contracts, could be delayed in obtaining, or may not be able to obtain,
necessary funding and/or financing to meet their cash-flow needs.
In the aftermath of the downgrading of the Federal governments
credit rating by Standard & Poors, it is possible there will be downgrades of state credit ratings and
if they occur, this could make it more expensive for states to finance their cash-flow needs and
put additional pressure on state budgets.
Delays in payment could have a
material adverse effect on our cash flows, liquidity and financial condition. In the
event that our payors or other counterparties are financially unstable or delay payments to us, our
financial condition could be further impaired if we are unable to borrow additional funds under our
senior credit agreement to finance our operations.
Our variable cost structure is directly related to our labor costs, which may be adversely
affected by labor shortages, a deterioration in labor relations or increased unionization
activities.
Our variable cost structure and operating profitability are directly related to our labor
costs. Labor costs may be adversely affected by a variety of factors, including a limited supply of
qualified personnel in any geographic area, local competitive forces, the ineffective utilization
of our labor force, increases in minimum wages, health care costs and other personnel costs, and
adverse changes in client service models. We typically cannot recover our increased labor costs
from payors and must absorb them ourselves. We have incurred higher labor costs in certain markets
from time to time because of difficulty in hiring qualified direct service staff. These higher
labor costs have resulted from increased wages and overtime and the costs associated with
recruitment and retention, training programs and use of temporary staffing personnel. In part to
help with the challenge of recruiting and retaining direct care employees, we offer these employees
a benefits package that includes paid time off, health insurance, dental insurance, vision
coverage, life insurance and a 401(k) plan, and these costs can be significant. In addition, The
Patient Protection and Affordable Care Act signed into law on March 23, 2010 imposed new mandates
on employers beginning in January 2011 and will continue to impose new mandates through 2014. Given
the composition of our workforce, these mandates could be material to our costs, and we are
studying the potential impact of these mandates.
Although our employees are generally not unionized, we have one business in New Jersey with
fifty employees who are represented by a labor union. Future unionization activities could result
in an increase of our labor and other costs. The President and the National Labor Relations Board
may take regulatory and other action that could result in increased unionization activities and
make it easier for employees to join unions. We may not be able to negotiate labor agreements on
satisfactory terms with any future labor unions. If employees covered by a collective bargaining
agreement were to engage in a strike, work stoppage or other slowdown, we could experience a
disruption of our operations and/or higher ongoing labor costs, which could adversely affect our
business, financial condition and results of operations.
Covenants in our debt agreements restrict our business in many ways.
The senior credit agreement governing the senior secured credit facilities and the indenture
governing the senior notes contain various covenants that limit our ability and/or our
subsidiaries ability to, among other things:
| incur additional debt or issue certain preferred shares; |
| pay dividends on or make distributions in respect of capital stock or make other
restricted payments; |
| make certain investments; |
| sell certain assets; |
| create liens on certain assets to secure debt; |
| enter into agreements that restrict dividends from subsidiaries; |
| consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
and |
| enter into certain transactions with our affiliates. |
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The senior credit agreement governing the senior secured credit facilities also contains
restrictive covenants and requires the Company and its subsidiaries to maintain specified financial
ratios and satisfy other financial condition tests. Our ability to meet those financial ratios and
tests may be affected by events beyond our control, and we cannot assure you that we will meet
those tests. The breach of any of these covenants or financial ratios could result in a default
under the senior secured credit facilities and the lenders could elect to declare all amounts
borrowed there under, together with accrued interest, to be due and payable and could proceed
against the collateral securing that indebtedness.
The nature of our operations could subject us to substantial claims, litigation and governmental
investigations.
We are in the health and human services business and, therefore, we have been and continue to
be subject to substantial claims alleging that we, our employees or our Mentors failed to provide
proper care for a client. We are also subject to claims by our clients, our employees, our Mentors
or community members against us for negligence, intentional misconduct or violation of applicable
laws. Included in our recent claims are claims alleging personal injury, assault, battery, abuse,
wrongful death and other charges, and our claims for professional and general liability have
increased sharply in recent years. Regulatory agencies may initiate administrative proceedings
alleging that our programs, employees or agents violate statutes and regulations and seek to impose
monetary penalties on us. We could be required to incur significant costs to respond to regulatory
investigations or defend against civil lawsuits and, if we do not prevail, we could be required to
pay substantial amounts of money in damages, settlement amounts or penalties arising from these
legal proceedings.
A litigation award excluded by, or in excess of, our third-party insurance limits and
self-insurance reserves could have a material adverse impact on our operations and cash flow and
could adversely impact our ability to continue to purchase appropriate liability insurance. Even if
we are successful in our defense, civil lawsuits or regulatory proceedings could also irreparably
damage our reputation.
We also are subject to potential lawsuits under the False Claims Act and other federal and
state whistleblower statutes designed to combat fraud and abuse in the health care industry. These
lawsuits can involve significant monetary awards and bounties to private plaintiffs who
successfully bring these suits. If we are found to have violated the False Claims Act, we could be
excluded from participation in Medicaid and other federal healthcare programs. The Patient
Protection and Affordable Care Act provides a mandate for more vigorous and widespread enforcement
activity.
Finally, we are also subject to employee-related claims under state and federal law, including
claims for discrimination, wrongful discharge or retaliation; claims for wage and hour violations
under the Fair Labor Standards Act or state wage and hour laws; and novel intentional tort claims.
Our financial results could be adversely affected if claims against us are successful, to the
extent we must make payments under our self-insured retentions, or if such claims are not covered
by our applicable insurance or if the costs of our insurance coverage increase.
We have been and continue to be subject to substantial claims against our professional and
general liability and automobile liability insurance. Any claims, if successful, could result in
substantial damage awards which might require us to make payments under our self-insured
retentions. We had historically self-insured amounts of up to $1.0 million per claim and up to $2.0
million in the aggregate, but as of October 1, 2010, we are self-insured for $2.0 million per claim
and $8.0 million in the aggregate, and for $500,000 per claim in excess of the aggregate. An award
may exceed the limits of any applicable insurance coverage, and awards for punitive damages may be
excluded from our insurance policies either contractually or by operation of state law. In
addition, our insurance does not cover all potential liabilities including, for example, those
arising from employment practice claims, governmental fines and penalties. As a result, we may
become responsible for substantial damage awards that are uninsured.
Insurance against professional and general liability and automobile liability can be
expensive. Our insurance premiums have increased and may increase in the near future. Insurance
rates vary from state to state, by type and by other factors. The rising costs of insurance
premiums, as well as successful claims against us, could have a material adverse effect on our
financial position and results of operations.
It is also possible that our liability and other insurance coverage will not continue to be
available at acceptable costs or on favorable terms.
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If payments for claims exceed actuarially determined estimates, are not covered by insurance,
or our insurers fail to meet their obligations, our results of operations and financial position
could be adversely affected.
Because a substantial portion of our indebtedness bears interest at rates that fluctuate with
changes in certain prevailing short-term interest rates, we are vulnerable to interest rate
increases.
A portion of our indebtedness, including borrowings under the senior revolver and borrowings
under the term loan facility for which we have not hedged our interest rate exposure under an
interest rate swap agreement, bears interest at rates that fluctuate with changes in certain
short-term prevailing interest rates. If interest rates increase, our debt service obligations on
the variable rate indebtedness would increase even though the amount borrowed remained the same.
As of June 30, 2011, we had $528.7 million of floating rate debt outstanding before giving
effect to the swap agreement. As a result of the interest rate swap agreement, the floating rate
debt has been effectively reduced to $128.7 million. A 1% increase in the interest rate on our
floating rate debt would increase cash interest expense of the floating rate debt by approximately
$1.3 million per annum. If interest rates increase dramatically, the Company and its subsidiaries
could be unable to service their debt.
The nature of services that we provide could subject us to significant workers compensation
related liability, some of which may not be fully reserved for.
We use a combination of insurance and self-insurance plans to provide for potential liability
for workers compensation claims. Because of our high ratio of employees per client, and because of
the inherent physical risk associated with the interaction of employees with our clients, many of
whom have intensive care needs, the potential for incidents giving rise to workers compensation
liability is relatively high.
We estimate liabilities associated with workers compensation risk and establish reserves each
quarter based on internal valuations, third-party actuarial advice, historical loss development
factors and other assumptions believed to be reasonable under the circumstances. Our results of
operations have been adversely impacted and may be adversely impacted in the future if actual
occurrences and claims exceed our assumptions and historical trends.
If any of the state and local government agencies with which we have contracts determines that we
have not complied with our contracts or have violated any applicable laws or regulations, our
revenue may decrease, we may be subject to fines or penalties and we may be required to
restructure our billing and collection methods.
We derive the vast majority of our revenue from state and local government agencies, and a
substantial portion of this revenue is state-funded with federal Medicaid matching dollars. If we
fail to comply with federal and state documentation, coding and billing rules, we could be subject
to criminal and/or civil penalties, loss of licenses and exclusion from the Medicaid programs,
which could harm us. In billing for our services to third-party payors, we must follow complex
documentation, coding and billing rules. These rules are based on federal and state laws, rules and
regulations, various government pronouncements, and on industry practice. Failure to follow these
rules could result in potential criminal or civil liability under the False Claims Act, under which
extensive financial penalties can be imposed. It could further result in criminal liability under
various federal and state criminal statutes. We annually submit a large volume of claims for
Medicaid and other payments and there can be no assurance that there have not been errors. The
rules are frequently vague and confusing and we cannot assure that governmental investigators,
private insurers or private whistleblowers will not challenge our practices. Such a challenge could
result in a material adverse effect on our business.
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If any of the state and local government payors determine that we have not complied with our
contracts or have violated any applicable laws or regulations, our revenue may decrease, we may be
subject to fines or penalties and we may be required to restructure our billing and collection
methods. We are routinely subject to governmental reviews, audits and investigations to verify our
compliance with applicable laws and regulations. As a result of these reviews, audits and
investigations, these governmental payors may be entitled to, in their discretion:
| require us to refund amounts we have previously been paid; |
| terminate or modify our existing contracts; |
| suspend or prevent us from receiving new contracts or extending existing contracts; |
| impose referral holds on us; |
| impose fines, penalties or other sanctions on us; and |
| reduce the amount we are paid under our existing contracts. |
As a result of past reviews and audits of our operations, we have been and are subject to some
of these actions from time to time. While we do not currently believe that our existing audit
proceedings will have a material adverse effect on our financial condition or significantly harm
our reputation, we cannot assure you that similar actions in the future will not do so. In
addition, such proceedings could have a material adverse impact on our results of operations in a
future reporting period.
In some states, we operate on a cost reimbursement model in which revenue is recognized at the
time costs are incurred. In these states, payors audit our historical costs on a regular basis, and
if it is determined that our historical costs are insufficient to justify our rates, our rates may
be reduced, or we may be required to return fees paid to us in prior periods. In some cases we have
experienced negative audit adjustments which are based on subjective judgments of reasonableness,
necessity or allocation of costs in our services provided to clients. These adjustments are
generally required to be negotiated as part of the overall audit resolution and may result in
paybacks to payors and adjustments of our rates. We cannot assure you that our rates will be
maintained, or that we will be able to keep all payments made to us, until an audit of the relevant
period is complete. Moreover, if we are required to restructure our billing and collection methods,
these changes could be disruptive to our operations and costly to implement. Failure to comply with
laws and regulations could have a material adverse effect on our business.
If we fail to establish and maintain relationships with state and local government agencies, we
may not be able to successfully procure or retain government-sponsored contracts, which could
negatively impact our revenue.
To facilitate our ability to procure or retain government-sponsored contracts, we rely in part
on establishing and maintaining relationships with officials of various government agencies. These
relationships enable us to maintain and renew existing contracts and obtain new contracts and
referrals. The effectiveness of our relationships may be reduced or eliminated with changes in the
personnel holding various government offices or staff positions. We also may lose key personnel who
have these relationships and such personnel are generally not subject to non-compete or
non-solicitation covenants. Any failure to establish, maintain or manage relationships with
government and agency personnel may hinder our ability to procure or retain government-sponsored
contracts, and could negatively impact our revenue.
Negative publicity or changes in public perception of our services may adversely affect our
ability to obtain new contracts and renew existing ones.
Our success in obtaining new contracts and renewals of our existing contracts depend upon
maintaining our reputation as a quality service provider among governmental authorities, advocacy
groups, families of our clients and the public. Negative publicity, changes in public perception,
legal proceedings and government investigations with respect to our operations could damage our
reputation and hinder our ability to retain contracts and obtain new contracts, and could reduce
referrals, increase government scrutiny and compliance or litigation costs, or generally discourage
clients from using our services. Any of these events could have a material adverse effect on our
business, financial condition and operating results.
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We face substantial competition in attracting and retaining experienced personnel, and we may be
unable to maintain or grow our business if we cannot attract and retain qualified employees.
Our success depends to a significant degree on our ability to attract and retain qualified and
experienced human service and other professionals who possess the skills and experience necessary
to deliver quality services to our clients and manage our operations. We face competition for
certain categories of our employees, particularly service provider employees, based on the wages,
benefits and other working conditions we offer. Contractual requirements and client needs determine
the number, education and experience levels of human service professionals we hire. Our ability to
attract and retain employees with the requisite credentials, experience and skills depends on
several factors, including, but not limited to, our ability to offer competitive wages, benefits
and professional growth opportunities. The inability to attract and retain experienced personnel
could have a material adverse effect on our business.
We may not realize the anticipated benefits of any future acquisitions and we may experience
difficulties in integrating these acquisitions.
As part of our growth strategy, we intend to make acquisitions. Growing our business through
acquisitions involves risks because with any acquisition there is the possibility that:
| we may be unable to maintain and renew the contracts of the acquired business; |
| unforeseen difficulties may arise in integrating the acquired operations, including
information systems and accounting controls; |
| we may not achieve operating efficiencies, synergies, economies of scale and cost
reductions as expected; |
| the business we acquire may not continue to generate income at the same historical levels
on which we based our acquisition decision; |
| management may be distracted from overseeing existing operations by the need to integrate
the acquired business; |
| we may acquire or assume unexpected liabilities or there may be other unanticipated
costs; |
| we may encounter unanticipated regulatory risk; |
| we may experience problems entering new markets or service lines in which we have limited
or no experience; |
| we may fail to retain and assimilate key employees of the acquired business; |
| we may finance the acquisition by incurring additional debt and further increase our
leverage ratios; and |
| the culture of the acquired business may not match well with our culture. |
As a result of these risks, there can be no assurance that any future acquisition will be
successful or that it will not have a material adverse effect on our financial condition and
results of operations.
A loss of our status as a licensed service provider in any jurisdiction could result in the
termination of existing services and our inability to market our services in that jurisdiction.
We operate in numerous jurisdictions and are required to maintain licenses and certifications
in order to conduct our operations in each of them. Each state and local government has its own
regulations, which can be complicated, and each of our service lines can be regulated differently
within a particular jurisdiction. As a result, maintaining the necessary licenses and
certifications to conduct our operations can be cumbersome. Our licenses and certifications could
be suspended, revoked or terminated for a number of reasons, including:
| the failure by our employees or Mentors to properly care for clients; |
| the failure to submit proper documentation to the applicable government agency, including
documentation supporting reimbursements for costs;
|
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| the failure by our programs to abide by the applicable regulations relating to the
provision of human services; or |
| the failure of our facilities to comply with the applicable building, health and safety
codes and ordinances. |
From time to time, some of our licenses or certifications, or those of our employees, are
temporarily placed on probationary status or suspended. If we lost our status as a licensed
provider of human services in any jurisdiction or any other required certification, we would be
unable to market our services in that jurisdiction, and the contracts under which we provide
services in that jurisdiction would be subject to termination. Moreover, such an event could
constitute a violation of provisions of contracts in other jurisdictions, resulting in other
contract, license or certification terminations. Any of these events could have a material adverse
effect on our operations.
We are subject to extensive governmental regulations, which require significant compliance
expenditures, and a failure to comply with these regulations could adversely affect our business.
We must comply with comprehensive government regulation of our business, including statutes,
regulations and policies governing the licensing of our facilities, the maintenance and management
of our work place for our employees, the quality of our service, the revenue we receive for our
services, and reimbursement for the cost of our services. Compliance with these laws, regulations
and policies is expensive, and if we fail to comply with these laws, regulations and policies, we
could lose contracts and the related revenue, thereby harming our financial results. State and
federal regulatory agencies have broad discretionary powers over the administration and enforcement
of laws and regulations that govern our operations. A material violation of a law or regulation
could subject us to fines and penalties and in some circumstances could disqualify some or all of
the facilities and programs under our control from future participation in Medicaid or other
government programs. The Health Insurance Portability and Accountability Act of 1996 (as amended,
HIPAA) and other federal and state data privacy and security laws, which require the
establishment of privacy standards for health care information storage, retrieval and dissemination
as well as electronic transmission and security standards, could result in potential penalties in
certain of our businesses if we fail to comply with these privacy and security standards.
Expenses incurred under governmental agency contracts for any of our services, as well as
management contracts with providers of record for such agencies, are subject to review by agencies
administering the contracts and services. Representatives of those agencies visit our group homes
to verify compliance with state and local regulations governing our home operations. A negative
outcome from any of these examinations could increase government scrutiny, increase compliance
costs or hinder our ability to obtain or retain contracts. Any of these events could have a
material adverse effect on our business, financial condition and operating results.
The federal anti-kickback law and non-self referral statute, and similar state statutes,
prohibit kickbacks, rebates and any other form of remuneration in return for referrals. Any
remuneration, direct or indirect, offered, paid, solicited, or received, in return for referrals of
patients or business for which payment may be made in whole or in part under Medicaid could be
considered a violation of law. The language of the anti-kickback law also prohibits payments made
to anyone to induce them to recommend purchasing, leasing, or ordering any goods, facility,
service, or item for which payment may be made in whole or in part by Medicaid. Criminal penalties
under the anti-kickback law include fines up to $25,000, imprisonment for up to five years, or
both. In addition, acts constituting a violation of the anti-kickback law may also lead to civil
penalties, such as fines, assessments and exclusion from participation in the Medicaid programs.
CMS employs Medicaid Integrity Contractors (MICs) to perform post-payment audits of Medicaid
claims and identify overpayments. Throughout 2011, we expect MIC audits will continue to expand. In
addition to MICs, several other contractors, including the state Medicaid agencies, have increased
their review activities.
Should we be found out of compliance with any of these laws, regulations or programs,
depending on the nature of the findings, our business, our financial position and our results of
operations could be materially adversely impacted.
If a federal or state agency asserts a different position or enacts new laws or regulations
regarding illegal payments under Medicaid or other governmental programs, we may be subject to
civil and criminal penalties, experience a significant reduction in our revenue or be excluded
from participation in Medicaid or other governmental programs.
Any change in interpretations or enforcement of existing or new laws and regulations could
subject our current business practices to allegations of impropriety or illegality, or could
require us to make changes in our homes, equipment, personnel, services, pricing or capital
expenditure programs, which could increase our operating expenses and have a material adverse
effect on our operations or reduce the demand for or profitability of our services.
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We have identified material weaknesses in our internal control over financial reporting in prior
periods.
As reported in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009, we
identified material weaknesses in our internal control over financial reporting relating to our
revenue and accounts receivable balances as of September 30, 2009, and management concluded that as
of that date, our internal control over financial reporting was not effective and, as a result, our
disclosure controls and procedures were not effective. We also reported material weaknesses as of
September 30, 2008, including a material weakness in controls to verify the existence of our fixed
asset balances. As a result of this material weakness, we identified errors during the quarter
ended June 30, 2009 which resulted in an adjustment to reduce property and equipment by $1.8
million. While we have taken action to remediate our identified material weaknesses and continue to
improve our internal controls, the decentralized nature of our operations and the manual nature of
many of our controls increases our risk of control deficiencies.
We did not experience similar material weaknesses in connection with our audit of fiscal 2010.
No evaluation can provide complete assurance that our internal controls will detect or uncover all
failures of persons within our company to disclose material information otherwise required to be
reported. The effectiveness of our controls and procedures could also be limited by simple errors
or faulty judgments. We may in the future identify material weaknesses or significant deficiencies
in connection with the continuing implementation of our billing and accounts receivable system and
the consolidation of our cash disbursement and accounts receivable functions at one centralized
location. As we introduce new processes and people into our accounting systems, our risk of
controls deficiencies and weaknesses may temporarily increase. In addition, if we continue to make
acquisitions, as we expect to, the challenges involved in implementing appropriate internal
controls will increase and will require that we continue to improve our internal controls. Any
future material weaknesses in internal control over financial reporting could result in material
misstatements in our financial statements. Moreover, any future disclosures of additional material
weaknesses, or errors as a result of those weaknesses, could result in a negative reaction in the
financial markets if there is a loss of confidence in the reliability of our financial reporting.
Management continues to devote significant time and attention to improving our internal
controls, and we will continue to incur costs associated with implementing appropriate processes,
which could include fees for additional audit and consulting services, which could negatively
affect our financial condition and operating results.
The high level of competition in our industry could adversely affect our contract and revenue
base.
We compete with a wide variety of competitors, ranging from small, local agencies to a few
large, national organizations. Competitive factors may favor other providers and reduce our ability
to obtain contracts, which would hinder our growth. Not-for-profit organizations are active in all
states and range from small agencies serving a limited area with specific programs to multi-state
organizations. Smaller local organizations may have a better understanding of the local conditions
and may be better able to gain political and public acceptance. Not-for-profit providers may be
affiliated with advocacy groups, health organizations or religious organizations that have
substantial influence with legislators and government agencies. Increased competition may result in
pricing pressures, loss of or failure to gain market share or loss of clients or payors, any of
which could harm our business.
We rely on third parties to refer clients to our facilities and programs.
We receive substantially all of our clients from third-party referrals and are governed by the
federal anti-kickback/non-self referral statute. Our reputation and prior experience with agency
staff, care workers and others in positions to make referrals to us are important for building and
maintaining our operations. Any event that harms our reputation or creates negative experiences
with such third parties could impact our ability to receive referrals and grow our client base.
Home and community-based human services may become less popular among our targeted client
populations and/or state and local governments, which would adversely affect our results of
operations.
Our growth depends on the continuation of trends in our industry toward providing services to
individuals in smaller, community-based settings and increasing the percentage of individuals
served by non-governmental providers. The continuation of these trends and our future success are
subject to a variety of political, economic, social and legal pressures, all of which are beyond
our control. A reversal in the downsizing and privatization trends could reduce the demand for our
services, which could adversely affect our revenue and profitability.
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Government reimbursement procedures are time-consuming and complex, and failure to comply with
these procedures could adversely affect our liquidity, cash flows and operating results.
The government reimbursement process is time-consuming and complex, and there can be delays
before we receive payment. Government reimbursement, group home credentialing and Medicaid
recipient eligibility and service authorization procedures are often complicated and burdensome,
and delays can result from, among other things, securing documentation and coordinating necessary
eligibility paperwork between agencies. These reimbursement and procedural issues occasionally
cause us to have to resubmit claims several times before payment is remitted. If there is a billing
error, the process to resolve the error may be time-consuming and costly. To the extent that
complexity associated with billing for our services causes delays in our cash collections, we
assume the financial risk of increased carrying costs associated with the aging of our accounts
receivable as well as increased potential for write-offs. We can provide no assurance that we will
be able to collect payment for claims at our current levels in future periods. The risks associated
with third-party payors and the inability to monitor and manage accounts receivable successfully
could have a material adverse effect on our liquidity, cash flows and operating results.
We conduct a significant percentage of our operations in Minnesota and, as a result, we are
particularly susceptible to any reduction in budget appropriations for our services or any other
adverse developments in that state.
For the nine months ended June 30, 2011, 15% of our revenue was generated from contracts with
government agencies in the state of Minnesota. Accordingly, any reduction in Minnesotas budgetary
appropriations for our services, whether as a result of fiscal constraints due to recession,
changes in policy or otherwise, could result in a reduction in our fees and possibly the loss of
contracts. A rate cut of 2.6% applicable for Medicaid Waiver services took effect in Minnesota on
July 1, 2009 and, more recently, the state announced a 1.5% rate
cut for both Medicaid Waiver and ICF Services effective
September 1, 2011.
We cannot assure you that we will not receive further rate reductions this year or in the future.
The concentration of our operations in Minnesota also makes us particularly susceptible to many of
the other risks described above occurring in this state, including:
| the failure to maintain and renew our licenses; |
| the failure to maintain important relationships with officials of government agencies;
and |
| any negative publicity regarding our operations. |
Any of these adverse developments occurring in Minnesota could result in a reduction in
revenue or a loss of contracts, which could have a material adverse effect on our results of
operations, financial position and cash flows.
We depend upon the continued services of certain members of our senior management team, without
whom our business operations could be significantly disrupted.
Our success depends, in part, on the continued contributions of our senior officers and other
key employees. Our management team has significant industry experience and would be difficult to
replace. If we lose or suffer an extended interruption in the service of one or more of our key
employees, our financial condition and operating results could be adversely affected. The market
for qualified individuals is highly competitive and we may not be able to attract and retain
qualified personnel to replace or succeed members of our senior management or other key employees,
should the need arise.
Our success depends on our ability to manage growing and changing operations and successfully
optimize our cost structure.
Since 1998, our business has grown significantly in size and complexity. This growth has
placed, and is expected to continue to place, significant demands on our management, systems,
internal controls and financial and physical resources. Our operations are highly decentralized,
with many billing, accounting and collection functions being performed at the local level. This
requires us to expend significant resources implementing and monitoring compliance at the local
level. In addition, we expect that we will need to further develop our financial and managerial
controls and reporting systems to accommodate future growth. This will require us to incur expenses
for hiring additional qualified personnel, retaining professionals to assist in developing the
appropriate control systems and expanding our information technology infrastructure. The nature of
our business is such that qualified management personnel can be difficult to find. We also are
continuing to take actions to optimize our cost structure, including most recently centralizing
certain functions and implementing a review of our field administrative functions. To the extent
these optimization efforts and any related reductions in force disrupt our operations, there could
be an adverse effect on our financial results. In addition, our cost structure optimization efforts
may not achieve the cost savings we expect within the anticipated time frame, or at all. Our
inability to manage growth and implement cost structure optimization effectively could have a
material adverse effect on our results of operations, financial position and cash flows.
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Our information systems are critical to our business and a failure of those systems could
materially harm us.
We depend on our ability to store, retrieve, process and manage a significant amount of
information, and to provide our operations with efficient and effective accounting, census,
incident reporting and scheduling systems. Our information systems require maintenance and
upgrading to meet our needs, which could significantly increase our administrative expenses.
Any system failure that causes an interruption in service or availability of our
critical systems could adversely affect operations or delay the collection of revenues. Even though
we have implemented network security measures, our servers are vulnerable to computer viruses,
break-ins and similar disruptions from unauthorized tampering. The occurrence of any of these
events could result in interruptions, delays, the loss or corruption of data, or cessations in the
availability of systems, all of which could have a material adverse effect on our financial
position and results of operations and harm our business reputation.
Furthermore, a loss of health care information could result in potential penalties in certain of our
businesses if we fail to comply with privacy and security standards in violation of HIPAA.
The performance of our information technology and systems is critical to our business
operations. Our information systems are essential to a number of critical areas of our operations,
including:
| accounting and financial reporting; |
| billing and collecting accounts; |
| coding and compliance; |
| clinical systems, including census and incident reporting; |
| records and document storage; and |
| monitoring quality of care and collecting data on quality and compliance measures. |
Our financial results may suffer if we have to write-off goodwill or other intangible assets.
A portion of our total assets consists of goodwill and other intangible assets. Goodwill and
other intangible assets, net of accumulated amortization, accounted for 62.7% and 65.7% of the
total assets on our balance sheet as of June 30, 2011 and September 30, 2010, respectively. We may
not realize the value of our goodwill or other intangible assets and we expect to engage in
additional transactions that will result in our recognition of additional goodwill or other
intangible assets. We evaluate on a regular basis whether events and circumstances have occurred
that indicate that all or a portion of the carrying amount of goodwill or other intangible assets
may no longer be recoverable, and is therefore impaired. Under current accounting rules, any
determination that impairment has occurred would require us to write-off the impaired portion of
our goodwill or the unamortized portion of our intangible assets, resulting in a charge to our
earnings. In the three months ended June 30, 2011, we recorded an impairment charge of $1.7 million
for the write-off of agency contracts, licenses and permits for underperforming programs. We may
record similar impairment charges in the future and such charges could have a material adverse
effect on our financial condition and results of operations.
We may be more susceptible to the effects of a public health catastrophe than other businesses due
to the vulnerable nature of our client population.
Our primary clients are individuals with developmental disabilities, brain injuries, or
emotionally, behaviorally or medically complex challenges, many of whom may be more vulnerable than
the general public in a public health catastrophe. For example, in a flu pandemic, we could suffer
significant losses to our client population and, at a high cost, be required to pay overtime or
hire replacement staff and Mentors for workers who drop out of the workforce. Accordingly, certain
public health catastrophes such as a flu pandemic could have a material adverse effect on our
financial condition and results of operations.
We are controlled by our principal equityholder, which has the power to take unilateral action.
Vestar controls our business affairs and material policies. Circumstances may occur in which
the interests of Vestar could be in conflict with the interests of our debt holders. In addition,
Vestar may have an interest in pursuing acquisitions, divestitures or other transactions that, in
their judgment, could enhance their equity investment, even though such transactions might involve
risks to our debt holders. Vestar is in the business of making investments in companies and may
from time to time acquire and hold interests in businesses that compete directly or indirectly with
us. Vestar may also pursue acquisition opportunities that may be complementary to our business and,
as a result, those acquisition opportunities may not be available to us. So long as investment
funds associated with or designated by Vestar continue to own a significant amount of our equity
interests, even if such amount is less than 50%, Vestar will continue to be able to significantly
influence or effectively control our decisions.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
Unregistered Sales of Equity Securities
No equity securities of the Company were sold during the three months ended June 30, 2011;
however, the Companys indirect parent, NMH Investment, LLC (NMH Investment), did grant equity
securities during this period for no cost.
The following table sets forth the number of units of common equity of NMH Investment issued
during the quarter ended June 30, 2011 pursuant to the NMH Investment, LLC Amended and Restated
2006 Unit Plan, as amended. The units were issued under Rule 701 promulgated under the Securities
Act of 1933.
Date | Title of Securities | Amount | Purchasers | Consideration | ||||||||
June 15, 2011 |
Class F Common Units | 4,296,387.82 | Certain employees | $ | |
Repurchases of Equity Securities
No equity securities of the Company were repurchased during the three months ended June 30,
2011.
The following table sets forth information in connection with repurchases made by NMH
Investment of its common equity units during the three months ended June 30, 2011:
(d) Maximum | ||||||||||||||||
Number (or | ||||||||||||||||
(c) Total Number | Approximate Dollar | |||||||||||||||
of Units Purchased | Value) of Shares (or | |||||||||||||||
(a) Class and | as Part of Publicly | Units) that May Yet | ||||||||||||||
Total Number of | (b) Average Price | Announced Plans | be Purchased Under | |||||||||||||
Units Purchased | Paid per Unit | or Programs | the Plans or Programs | |||||||||||||
Month #1
(April 1, 2011
through April 30,
2011) |
41,750.00 A Units | $ | 10.00 | | N/A | |||||||||||
8,364.13 B Units | $ | 0.05 | | N/A | ||||||||||||
8,776.90 C Units | $ | 0.03 | | N/A | ||||||||||||
30,283.95 D Units | $ | 0.01 | | N/A | ||||||||||||
Month #2 (May 1,
2011 through May
31, 2011) |
26,018.42 A Units | $ | 10.00 | | N/A | |||||||||||
6,439.13 B Units | $ | 0.05 | | N/A | ||||||||||||
6,756.90 C Units | $ | 0.03 | | N/A | ||||||||||||
22,023.14 D Units | $ | 0.01 | | N/A | ||||||||||||
Month #3 (June 1, 2011 through June 30, 2011) |
296.98 B Units | $ | 0.05 | | N/A | |||||||||||
505.00 C Units | $ | 0.03 | | N/A | ||||||||||||
8,404.62 D Units | $ | 0.01 | | N/A |
The Company did not repurchase any of its common stock as part of an equity repurchase program
during the three months ended June 30, 2011. NMH Investment purchased all of the units listed in
the table from four of its employees upon or after their departures.
Item 3. | Defaults Upon Senior Securities. |
None.
Item 4. | (Removed and Reserved). |
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Item 5. | Other Information. |
None.
Item 6. | Exhibits. |
The Exhibit Index is incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NATIONAL MENTOR HOLDINGS, INC. |
||||
August 15, 2011 | By: | /s/ Denis M. Holler | ||
Denis M. Holler | ||||
Its: | Chief Financial Officer, Treasurer and duly authorized officer |
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EXHIBIT INDEX
Exhibit | ||||||
No. | Description | |||||
3.1 | Amended and Restated Certificate of
Incorporation of National Mentor Holdings,
Inc.
|
Incorporated by reference to Exhibit 3.1 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended March 31, 2007 (the March 2007 10-Q) | ||||
3.2 | By-Laws of National Mentor Holdings, Inc.
|
Incorporated by reference to Exhibit 3.2 of the March 2007 10-Q | ||||
10.1 | * | Second Amendment to NMH Investment, LLC
Amended and Restated 2006 Unit Plan.
|
Incorporated by reference to Exhibit 10.6 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended March 31, 2011 (the March 2011 10-Q) | |||
10.2 | * | Form of Management Unit Subscription
Agreement (Series 1 Class F Common Units).
|
Incorporated by reference to Exhibit 10.7 of the March 2011 10-Q | |||
31.1 | Certification of principal executive officer.
|
Filed herewith | ||||
31.2 | Certification of principal executive officer.
|
Filed herewith | ||||
31.3 | Certification of principal financial officer.
|
Filed herewith | ||||
32 | Certifications furnished pursuant to 18
U.S.C. Section 1350.
|
Filed herewith | ||||
101 | Interactive Data Files |
* | Management contract or compensatory plan or arrangement. |
45