Attached files
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EX-32 - EXHIBIT 32 - NATIONAL MENTOR HOLDINGS, INC. | c99643exv32.htm |
EX-4.2 - EXHIBIT 4.2 - NATIONAL MENTOR HOLDINGS, INC. | c99643exv4w2.htm |
EX-31.1 - EXHIBIT 31.1 - NATIONAL MENTOR HOLDINGS, INC. | c99643exv31w1.htm |
EX-31.3 - EXHIBIT 31.3 - NATIONAL MENTOR HOLDINGS, INC. | c99643exv31w3.htm |
EX-31.2 - EXHIBIT 31.2 - NATIONAL MENTOR HOLDINGS, INC. | c99643exv31w2.htm |
EX-4.1 - EXHIBIT 4.1 - NATIONAL MENTOR HOLDINGS, INC. | c99643exv4w1.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 March 31, 2010
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 o 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 (Do not check if smaller reporting company) | Smaller reporting company o |
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 May 13, 2010, 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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29 | ||||||||
38 | ||||||||
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39 | ||||||||
39 | ||||||||
40 | ||||||||
Exhibit 4.1 | ||||||||
Exhibit 4.2 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 31.3 | ||||||||
Exhibit 32 |
2
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements. |
National Mentor Holdings, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)
March 31, | September 30, | |||||||
2010 | 2009 | |||||||
Assets |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ | 13,722 | $ | 23,650 | ||||
Restricted cash |
6,995 | 5,192 | ||||||
Accounts receivable, net |
121,708 | 118,969 | ||||||
Deferred tax assets, net |
11,385 | 13,897 | ||||||
Prepaid expenses and other current assets |
15,198 | 16,868 | ||||||
Total current assets |
169,008 | 178,576 | ||||||
Property and equipment, net |
142,380 | 145,876 | ||||||
Intangible assets, net |
440,708 | 440,202 | ||||||
Goodwill |
216,865 | 206,699 | ||||||
Other assets |
14,988 | 16,047 | ||||||
Investment in related party debt securities |
9,504 | 8,210 | ||||||
Total assets |
$ | 993,453 | $ | 995,610 | ||||
Liabilities and shareholders equity |
||||||||
Current liabilities |
||||||||
Accounts payable |
$ | 20,785 | $ | 19,819 | ||||
Accrued payroll and related costs |
59,835 | 58,388 | ||||||
Other accrued liabilities |
43,927 | 45,000 | ||||||
Obligations under capital lease, current |
88 | 118 | ||||||
Current portion of long-term debt |
3,684 | 7,415 | ||||||
Total current liabilities |
128,319 | 130,740 | ||||||
Other long-term liabilities |
14,230 | 13,462 | ||||||
Deferred tax liabilities, net |
123,656 | 125,237 | ||||||
Obligations under capital lease, less current portion |
1,643 | 1,680 | ||||||
Long-term debt, less current portion |
502,627 | 500,763 | ||||||
Total liabilities |
770,475 | 771,882 | ||||||
Shareholders equity |
||||||||
Common stock |
| | ||||||
Additional paid-in-capital |
250,286 | 250,038 | ||||||
Other comprehensive loss, net of tax |
(3,415 | ) | (7,115 | ) | ||||
Accumulated deficit |
(23,893 | ) | (19,195 | ) | ||||
Total shareholders equity |
222,978 | 223,728 | ||||||
Total liabilities and shareholders equity |
$ | 993,453 | $ | 995,610 | ||||
See accompanying notes.
3
Table of Contents
National Mentor Holdings, Inc.
Condensed Consolidated Statements of Operations
(In thousands)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net revenue |
$ | 252,502 | $ | 240,737 | $ | 504,330 | $ | 481,970 | ||||||||
Cost of revenue |
193,659 | 184,386 | 385,502 | 367,474 | ||||||||||||
Gross profit |
58,843 | 56,351 | 118,828 | 114,496 | ||||||||||||
Operating expenses: |
||||||||||||||||
General and administrative |
34,197 | 32,724 | 68,861 | 67,326 | ||||||||||||
Depreciation and amortization |
14,444 | 13,287 | 28,866 | 26,341 | ||||||||||||
Total operating expenses |
48,641 | 46,011 | 97,727 | 93,667 | ||||||||||||
Income from operations |
10,202 | 10,340 | 21,101 | 20,829 | ||||||||||||
Other income (expense): |
||||||||||||||||
Management fee of related party |
(287 | ) | (259 | ) | (563 | ) | (482 | ) | ||||||||
Other expense, net |
(185 | ) | (440 | ) | (128 | ) | (801 | ) | ||||||||
Interest income |
18 | 28 | 31 | 144 | ||||||||||||
Interest income from related party |
469 | 117 | 945 | 117 | ||||||||||||
Interest expense |
(11,520 | ) | (11,742 | ) | (23,401 | ) | (24,181 | ) | ||||||||
Loss from continuing operations before income taxes |
(1,303 | ) | (1,956 | ) | (2,015 | ) | (4,374 | ) | ||||||||
Benefit for income taxes |
(736 | ) | (700 | ) | (1,369 | ) | (736 | ) | ||||||||
Loss from continuing operations |
(567 | ) | (1,256 | ) | (646 | ) | (3,638 | ) | ||||||||
(Loss) income from discontinued operations, net of tax |
(4,089 | ) | 74 | (4,052 | ) | 116 | ||||||||||
Net loss |
$ | (4,656 | ) | $ | (1,182 | ) | $ | (4,698 | ) | $ | (3,522 | ) | ||||
See accompanying notes.
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Table of Contents
National Mentor Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Six Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Operating activities |
||||||||
Net loss |
$ | (4,698 | ) | $ | (3,522 | ) | ||
Adjustments to reconcile net loss to cash provided by operating activities: |
||||||||
Accounts receivable allowances |
5,537 | 4,709 | ||||||
Depreciation and amortization of property and equipment |
11,651 | 10,095 | ||||||
Amortization of other intangible assets |
17,214 | 16,361 | ||||||
Amortization of deferred financing costs |
1,598 | 1,640 | ||||||
Accretion of investment in related party debt securities |
(481 | ) | | |||||
Stock-based compensation |
248 | 835 | ||||||
Loss on disposal of property and equipment |
389 | 267 | ||||||
Gain on disposal of assets |
(43 | ) | (38 | ) | ||||
Non-cash impairment charge and other charges from discontinued operations |
6,604 | 300 | ||||||
Non-cash interest income from related party |
(464 | ) | (117 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(5,314 | ) | (12,951 | ) | ||||
Other assets |
1,244 | 8,730 | ||||||
Accounts payable |
761 | (2,468 | ) | |||||
Accrued payroll and related costs |
411 | (1,721 | ) | |||||
Other accrued liabilities |
2,912 | 2,791 | ||||||
Deferred taxes |
(6,560 | ) | (3,071 | ) | ||||
Other long-term liabilities |
768 | 456 | ||||||
Net cash provided by operating activities |
31,777 | 22,296 | ||||||
Investing activities |
||||||||
Cash paid for acquisitions, net |
(29,199 | ) | (13,113 | ) | ||||
Purchases of property and equipment |
(9,061 | ) | (17,263 | ) | ||||
Purchase of related party debt securities |
| (6,555 | ) | |||||
Changes in
restricted cash |
(1,800 | ) | | |||||
Cash proceeds from sale of assets |
43 | 76 | ||||||
Cash proceeds from sale of discontinued operations |
72 | 116 | ||||||
Cash proceeds from sale of property and equipment |
174 | 520 | ||||||
Net cash used in investing activities |
(39,771 | ) | (36,219 | ) | ||||
Financing activities |
||||||||
Repayments of long-term debt |
(1,867 | ) | (1,868 | ) | ||||
Repayments of capital lease obligations |
(67 | ) | (110 | ) | ||||
Dividend to parent |
| (7,306 | ) | |||||
Parent capital contribution |
| 201 | ||||||
Payments of deferred financing costs |
| (33 | ) | |||||
Net cash used in financing activities |
(1,934 | ) | (9,116 | ) | ||||
Net decrease in cash and cash equivalents |
(9,928 | ) | (23,039 | ) | ||||
Cash and cash equivalents at beginning of period |
23,650 | 38,908 | ||||||
Cash and cash equivalents at end of period |
$ | 13,722 | $ | 15,869 | ||||
See accompanying notes.
5
Table of Contents
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
March 31, 2010
(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 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 medically complex challenges.
Since the Companys founding in 1980, the Company has grown to provide services to approximately
24,000 clients in 36 states. The Company designs customized service plans to meet the unique
needs of its clients in home- and community-based settings. Most of the Companys services involve
residential support, typically in small group home or host home settings, designed to improve the
clients quality of life and to promote client independence and participation in community life.
Other services that the Company provides include day programs, vocational services, case
management, early intervention, family-based services, post-acute treatment and neurorehabilitation
services, among others. The Companys customized services offer its clients, as well as the payors
of these services, an attractive, cost-effective alternative to human services provided in large,
institutional settings.
The accompanying unaudited condensed consolidated financial statements have been prepared by
the Company in accordance with U.S. 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, 2009, 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. All significant intercompany balances and transactions between the Company and its
subsidiaries have been eliminated in consolidation. Operating results for the three and
six months ended March 31, 2010 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 the appropriate
application of certain accounting policies, many of which require the Company 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 the Companys estimates. These differences could be
material to the financial statements.
2. Recently Adopted Accounting Pronouncements
Authoritative guidance has recently
been updated governing principles
and requirements for the recognition and measurement of identifiable assets acquired, the
liabilities assumed, contractual contingencies, and contingent consideration at their fair value on
the acquisition date. Some of the changes, such as the accounting for contingent consideration and
expensing transaction costs for business combinations may introduce more volatility into earnings.
The Company is required to record the present value of contingent consideration for all future
years at the time of acquisition. The Company is required to review its estimates on a quarterly
basis and subsequent changes to estimates are recorded in the
statements of operations in the period
of change. The Company adopted this guidance on October 1, 2009 and the statement applies
prospectively for business combinations incurred on or after that date.
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Table of Contents
3. Comprehensive (Loss) Income
The components of comprehensive (loss) income and related tax effects are as follows:
Three Months Ended | Six Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
(in thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Net loss |
$ | (4,656 | ) | $ | (1,182 | ) | $ | (4,698 | ) | $ | (3,522 | ) | ||||
Changes in unrealized gain (losses) on derivatives |
2,984 | 3,485 | 5,860 | (6,091 | ) | |||||||||||
Changes in unrealized (losses) gain on available-for-sale debt securities |
(265 | ) | | 352 | | |||||||||||
Income tax effect |
(1,100 | ) | (1,409 | ) | (2,512 | ) | 2,463 | |||||||||
Comprehensive (loss) income |
$ | (3,037 | ) | $ | 894 | $ | (998 | ) | $ | (7,150 | ) | |||||
4. Long-Term Debt
The Companys long-term debt consists of the following:
March 31, | September 30, | |||||||
(in thousands) | 2010 | 2009 | ||||||
Senior term B loan, principal and interest due in quarterly installments through June 29, 2013 |
$ | 322,438 | $ | 324,113 | ||||
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 due each January
1st and July 1st (interest rate of 11.25%) |
180,000 | 180,000 | ||||||
Term loan mortgage, principal and interest due in monthly installments through June 29, 2012;
variable interest rate (4.75% at March 31, 2010 and September 30, 2009) |
3,873 | 4,065 | ||||||
506,311 | 508,178 | |||||||
Less current portion |
3,684 | 7,415 | ||||||
Long-term debt |
$ | 502,627 | $ | 500,763 | ||||
Senior secured credit facilities
The Companys senior credit facility consists of a $335.0 million seven-year senior secured
term B loan facility (the term B loan), a $125.0 million six-year senior secured revolving credit
facility (the senior revolver) and a $20.0 million six-year senior secured synthetic letter of
credit facility (together, the senior secured credit facilities).
The senior secured credit facilities and the term loan mortgage have priority in right of
payment over all of the Companys other long-term debt. The senior credit facilities are guaranteed
by the Companys subsidiaries, except for the captive insurance subsidiary, and are secured by
substantially all of the assets of the Company.
Total cash paid for interest on the Companys debt amounted to $15.8 million and $16.1 million
for the three months ended March 31, 2010 and 2009, respectively, and $21.8 million and $22.7
million for the six months ended March 31, 2010 and 2009, respectively.
Term B loan
The $335.0 million term B loan amortizes one percent per year, paid quarterly, for the first
six years, with the remaining balance due in the seventh year. The senior credit agreement also
includes a provision for the prepayment of a portion of the outstanding term loan amounts at any
year-end 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 B loan is equal to LIBOR plus 2.00% or Prime plus 1.00%, at the Companys option.
7
Table of Contents
To reduce the interest rate exposure on the term B loan, the Company is a party to interest
rate swap agreements with respect to $292.2 million of the $322.4 million outstanding as of March 31,
2010. Effective August 31, 2006, the Company fixed a portion of the term B loan at 5.32% plus
2.00%, of which $85.7 million was outstanding at March 31, 2010. These swap agreements mature on
June 30, 2010. Effective August 31, 2007, the Company fixed an additional portion of the term B
loan debt at 4.89% plus 2.00%, of which $206.5 million was outstanding at March 31, 2010. This
swap agreement matures on September 30, 2010. The Company is considering its options for
addressing interest rate exposure after the termination of these swap agreements.
The swap is a derivative and the fair value of the swap agreements, representing the price
that would be paid to transfer the liability in an orderly transaction between market participants,
was $6.6 million or $3.9 million after taxes at March 31, 2010 and $12.4 million or $7.4 million
after taxes at September 30, 2009. 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
Company accounts for these interest rate swaps as cash flow hedges. The
effectiveness of the hedge relationships is assessed on a quarterly basis during the term of the
hedge by comparing whether the critical terms of the hedge continue to match the terms of the debt.
Under this approach, the Company exactly matches the terms of the interest rate swap to the terms
of the underlying debt and, therefore, assumes 100% hedge effectiveness. 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.
Senior revolver and synthetic letter of credit facility
The Company had no borrowings and $115.7 million of availability under the $125.0 million
senior revolver as of March 31, 2010. The Company had $29.3 million in standby letters of credit
outstanding as of March 31, 2010 related to the Companys workers compensation insurance coverage.
Of these letters of credit, $20.0 million were issued under the Companys synthetic letter of
credit facility, and $9.3 million were issued under the Companys $125.0 million senior revolver.
Letters of credit in excess of the $20.0 million synthetic letter of credit facility reduce
availability under the Companys senior revolver. The interest rates for any senior revolver
borrowings are equal to either LIBOR plus 2.00% or Prime plus 1.00%, at the Companys option, and
subject to reduction depending on the Companys leverage ratio.
Senior subordinated notes
The Company issued $180.0 million of 11.25% senior subordinated notes due 2014 (the senior
subordinated notes) in connection with the merger of NMH MergerSub, Inc., a wholly-owned
subsidiary of NMH Investment, LLC (NMH Investment), with and into the Company, with the Company
as the surviving corporation, on June 29, 2006 (the Merger). The senior subordinated notes are
guaranteed by the Companys subsidiaries, except for the captive insurance subsidiary.
Term loan mortgage
In January 2010, the Company entered into an agreement to extend the term of its mortgage
facility through June 29, 2012, the maturity date of the senior credit agreement. As a result of
this extension, the majority of the term loan mortgage balance has been classified as long-term
debt. The term loan mortgage is secured by certain buildings and land of the Company.
8
Table of Contents
Covenants
The senior credit agreement and the indenture governing the senior subordinated notes contain
both affirmative and negative financial and non-financial covenants, including limitations on the
Companys ability to incur additional debt, sell material assets, retire, redeem or otherwise
reacquire capital stock, acquire the capital stock or assets of another business and pay dividends.
5. Acquisitions
Springbrook
On January 15, 2010, the Company acquired the assets of Springbrook, Inc. and an affiliate
(together, Springbrook) for $6.3 million, subject to increase based on earnout provisions.
Springbrook operates in Arizona and Oregon and provides residential and mental health services to
individuals with developmental disabilities and behavioral issues.
Pursuant to the acquisition agreement, the Company agreed to pay up to an additional
$3.5 million in cash based upon achieving certain earnings targets (the earnout). The fair value
of the cash earnout on the date of acquisition was $1.6 million
that has been accrued for as contingent
consideration. The Company is required to remeasure the fair value of the earnout at each
reporting date until the contingency is resolved. 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
March 31, 2010.
As a result of the Springbrook acquisition, the Company recorded $1.5 million of goodwill in
the Human Services segment, which is expected to be deductible for tax purposes. The acquired
intangible assets also included $5.2 million of agency contracts with
a weighted average useful life of eleven
years, $0.7 million of licenses and permits with a weighted
average useful life of ten years and $0.1
million of non-compete/non-solicit with a weighted average useful life of five years.
NeuroRestorative
On February 22, 2010, in a purchase of stock and assets, the Company acquired a provider
of neurobehavioral and supported living programs (NeuroRestorative) for $17.0 million.
NeuroRestorative has operations in Arkansas, Louisiana, Oklahoma and Texas and serves individuals
who have sustained a traumatic brain injury.
As
a result of the NeuroRestorative acquisition, the Company recorded $5.9 million of goodwill
in the Post Acute Specialty Rehabilitation Services segment, none of which is expected to be
deductible for tax purposes. The acquired intangible assets included $11.7 million of agency
contracts with a weighted average useful life of eleven years, $1.4 million of licenses and permits
with a weighed average useful life of ten years, $0.4 million of trade name with a weighed average
useful life of eleven years and $0.3 million of
non-compete/non-solicit arrangements with a weighed average
useful life of five years.
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Table of Contents
Villages
In addition to Springbrook and NeuroRestorative, the Company acquired two California
facilities (together, Villages), one on January 29, 2010 and one on February 11, 2010, engaged in neurorehabilitation services for total consideration of $6.0 million. As a
result of these acquisitions, the Company recorded $2.7 million of goodwill in the Post Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes. The acquired intangible assets included $3.0 million of agency contracts with a weighted average
useful life of eleven years and $0.3 million of licenses and permits with a weighted average useful life of ten years.
The purchase prices for these acquisitions have been initially allocated as follows:
(in thousands) | Springbrook | NeuroRestorative | Villages | |||||||||
Accounts receivable, net |
$ | 240 | $ | 2,711 | $ | | ||||||
Other assets, current and long-term |
32 | 781 | | |||||||||
Property and equipment |
171 | 293 | 20 | |||||||||
Identifiable intangible assets |
5,974 | 13,763 | 3,280 | |||||||||
Goodwill |
1,467 | 5,903 | 2,742 | |||||||||
Contingent consideration |
(1,617 | ) | | | ||||||||
Accounts payable and accrued expenses |
(7 | ) | (6,451 | ) | | |||||||
$ | 6,260 | $ | 17,000 | $ | 6,042 | |||||||
The operating results of the acquired entities 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 market value of net tangible assets was allocated to
specifically identified intangible assets, with the residual being allocated to goodwill.
The unaudited pro forma results of operations provided below for the six months ended March
31, 2010 and 2009 is presented as though the acquisitions noted above had occurred at the beginning
of the earliest period presented. The pro forma information presented below does not intend to
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 does it intend to be a projection of
the impact on future results or trends.
Six months ended | ||||||||
March 31, | March 31, | |||||||
2010 | 2009 | |||||||
Net revenue |
$ | 519,174 | $ | 496,265 | ||||
Income from operations |
23,694 | 22,556 |
6. Discontinued Operations and Assets Held for Sale
REM Colorado
During the second quarter of fiscal 2010, the Company closed its business operations in the
state of Colorado (REM Colorado) and recognized a pre-tax impairment charge of $2.5 million.
This charge was reported separately as discontinued operations for the three and six months ended
March 31, 2010. REM Colorados results of operations were immaterial to the consolidated financial
statements and have not been reported separately as discontinued operations.
REM Maryland
Also during the second quarter of fiscal 2010, the Company adopted a plan to sell certain
business operations in the state of Maryland (REM Maryland). For the three and six months ended
March 31, 2010, the Company recorded a pre-tax impairment charge of $4.2 million related to the
write-down of the REM Maryland assets to fair value and recorded the impairment charge separately
as discontinued operations. At March 31, 2010, there was $1.8 million of property and equipment
being held for sale.
10
Table of Contents
REM Marylands net revenue and loss from operations for the three and six months ended March
31, 2010 and 2009 are summarized as follows:
Three Months Ended | Six Months Ended | |||||||||||||||
March 31 | March 31 | |||||||||||||||
(in thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Net revenue |
$ | 1,337 | $ | 1,564 | $ | 2,887 | $ | 3,258 | ||||||||
Loss from operations |
$ | (328 | ) | $ | (162 | ) | $ | (379 | ) | $ | (181 | ) |
REM Marylands assets and results of operations are immaterial to the Company and, as a
result, are not reported separately as assets held for sale or discontinued operations in the
Companys financial statements.
Both REM Colorado and REM Maryland were reported under the Human Services segment.
7. Related Party Transactions
Investment in Related Party Debt Securities
During fiscal 2009, the Company purchased $11.5 million in aggregate principal amount of
senior floating rate toggle notes due 2014 (the NMH Holdings notes) issued by the Companys
indirect parent company, NMH Holdings, Inc. (NMH Holdings), for $6.6 million. The security was
classified as an available-for-sale debt security and was recorded on the Companys condensed
consolidated balance sheets as Investment in related party debt securities. Cash interest on the
NMH Holdings notes accrues at a rate per annum, reset quarterly, equal to LIBOR plus 6.375%, and
PIK Interest (defined below) accrues at the cash interest rate plus 0.75%. NMH Holdings may elect
to pay interest on the NMH Holdings notes (a) entirely in cash, (b) entirely by increasing the
principal amount of the NMH Holdings notes or issuing new notes (PIK Interest) or (c) 50% in cash
and 50% in PIK Interest.
NMH Holdings is a holding company with no direct operations. Its principal assets are the
direct and indirect equity interests it holds in its subsidiaries, including the Company, and all
of its operations are conducted through the Company and the Companys subsidiaries. As a result,
NMH Holdings will be dependent upon dividends and other payments from the Company to generate the
funds necessary to meet its outstanding debt service and other obligations, including its
obligations on the notes held by the Company.
NMH Holdings has paid all of the interest payments to date on the NMH Holdings notes entirely
in PIK Interest which increased the principal amount by $50.9 million. The Company recorded $0.5
million and $0.9 million of interest income related to the NMH Holdings notes for the three and six
months ended March 31, 2010, respectively, which is recorded under Interest income from related
party on the condensed consolidated statements of operations. Interest income from related party
includes PIK Interest as well as the accretion of the purchase discount on the securities.
As of March 31, 2010, the Companys investment in related-party debt securities had a carrying
value of $8.7 million, and an approximate fair value of $9.5 million which is reflected on the
Companys condensed consolidated balance sheets as Investment in related party debt securities. As
a result, the Company has recorded $0.8 million of unrealized holding gain in other comprehensive
loss, $0.4 million of which was recorded during the six months ended March 31, 2010. The debt
security is scheduled to mature on June 15, 2014, but actual maturities may differ from the
contractual or expected maturities since borrowers have the right to prepay obligations with or
without prepayment penalties.
The Company evaluates available-for-sale securities for other-than-temporary impairment at
least quarterly. If the fair value of a security is less than its cost, an other-than-temporary
impairment is required to be recognized if either of the following criteria is met: (1) if the
Company intends to sell the security; or (2) if it is more likely than not that the Company will be
required to sell the security before recovery of its amortized cost basis less any current period
credit loss. There were no securities impaired on an other than temporary basis for the three and
six months ended March 31, 2010.
Lease Agreements
The Company leases several offices, homes and other facilities from its employees, or from
relatives of employees, primarily in the states of Minnesota, California and Nevada, which have
various expiration dates extending out as far as May 2016. 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. Related party lease expense
was $0.9 million and $0.8 million for the three months ended March 31, 2010 and 2009,
respectively and $1.8 million and $1.7 million for the six months ended March 31, 2010 and 2009,
respectively.
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8. Fair Value Measurements
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 on a Recurring Basis
Quoted | Significant Other | Significant | ||||||||||||||
Market Prices | Observable Inputs | Unobservable Inputs | ||||||||||||||
(in thousands): | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Cash equivalents |
$ | 7,400 | $ | 7,400 | $ | | $ | | ||||||||
Interest rate swap agreements |
$ | (6,579 | ) | $ | | $ | (6,579 | ) | $ | | ||||||
Investment in related party debt securities |
$ | 9,504 | $ | | $ | 9,504 | $ | | ||||||||
Contingent consideration |
$ | (1,617 | ) | $ | | $ | | $ | (1,617 | ) |
Cash equivalents. Cash equivalents consist primarily of money market funds and the carrying
value of cash equivalents approximates fair value.
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.
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 earnout was accrued for and
classified as contingent consideration. The fair value was determined based on unobservable inputs,
namely managements estimate of expected performance based on current information.
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At March 31, 2010, the carrying values of cash and cash equivalents, accounts receivable and
accounts payable approximated fair value. The carrying value and fair value of the Companys debt
instruments are set forth below:
March 31, 2010 | September 30, 2009 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
(in thousands): | Amount | Value | Amount | Value | ||||||||||||
Senior subordinated notes |
$ | 180,000 | $ | 180,000 | $ | 180,000 | $ | 175,500 |
The Company estimated the fair value of the debt instruments using market quotes and
calculations based on current market rates available.
9. Income Taxes
The Company files a federal consolidated return and files various state income tax returns
and, generally, the Company is no longer subject to income tax examinations by the taxing
authorities for years prior to September 30, 2003. 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 March 31, 2010, the Companys effective income tax
rate was 56.5% compared to an effective tax rate of 35.8% for the three months ended March 31,
2009. For the six months ended March 31, 2010, the Companys effective income tax rate was 67.9%
compared to an effective tax rate of 16.8% for the six months ended March 31, 2009. 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.
The Companys reserve for uncertain income tax positions at March 31, 2010 is $5.0 million.
There has been no change in unrecognized tax benefits in the three or
six months ended March 31, 2010 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 income tax.
10. Segment Information
The Company has two reportable segments, Human Services and Post Acute Specialty
Rehabilitation Services (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 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 provides a mix of health care and community-based human services to
individuals with acquired brain 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 | ||||||||||||||||
(in thousands) | Human | Rehabilitation | ||||||||||||||
For the three months ended March 31, | Services | Services | Corporate | Consolidated | ||||||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 222,296 | $ | 30,206 | $ | | $ | 252,502 | ||||||||
Income (loss) from operations |
19,278 | 3,012 | (12,088 | ) | 10,202 | |||||||||||
Total assets |
834,975 | 110,860 | 47,618 | 993,453 | ||||||||||||
Depreciation and amortization |
11,089 | 2,182 | 1,173 | 14,444 | ||||||||||||
Purchases of property and equipment |
2,435 | 1,931 | 765 | 5,131 | ||||||||||||
2009 |
||||||||||||||||
Net revenue |
$ | 218,707 | $ | 22,030 | $ | | $ | 240,737 | ||||||||
Income (loss) from operations |
17,798 | 3,200 | (10,658 | ) | 10,340 | |||||||||||
Depreciation and amortization |
10,731 | 1,563 | 993 | 13,287 | ||||||||||||
Purchases of property and equipment |
3,548 | 1,081 | 1,588 | 6,217 |
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Post Acute | ||||||||||||||||
Specialty | ||||||||||||||||
(in thousands) | Human | Rehabilitation | ||||||||||||||
For the six months ended March 31, | Services | Services | Corporate | Consolidated | ||||||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 447,228 | $ | 57,102 | $ | | $ | 504,330 | ||||||||
Income (loss) from operations |
39,667 | 5,497 | (24,063 | ) | 21,101 | |||||||||||
Total assets |
834,975 | 110,860 | 47,618 | 993,453 | ||||||||||||
Depreciation and amortization |
22,398 | 4,130 | 2,338 | 28,866 | ||||||||||||
Purchases of property and equipment |
5,274 | 2,305 | 1,482 | 9,061 | ||||||||||||
2009 |
||||||||||||||||
Net revenue |
$ | 438,940 | $ | 43,030 | $ | | $ | 481,970 | ||||||||
Income (loss) from operations |
37,317 | 5,965 | (22,453 | ) | 20,829 | |||||||||||
Depreciation and amortization |
21,325 | 3,061 | 1,955 | 26,341 | ||||||||||||
Purchases of property and equipment |
7,692 | 6,444 | 3,127 | 17,263 |
11. Accruals for Self-Insurance and Other Commitments and Contingencies
The
Company maintains insurance for employment practices liability, 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 and professional and general liability has a self-insured
retention of $1.0 million per claim and $2.0 million in the aggregate, with additional insurance
coverage above the retention. In connection with the Merger on June 29, 2006, subject to the same
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 Companys wholly-owned subsidiary captive insurance company provides coverage for the
Companys self-insured portion of professional and general liability claims and its employment
practices liability. The accounts of the captive insurance company are fully consolidated with
those of the other operations of the Company in the accompanying condensed consolidated financial
statements.
The Company is in the human services business and, therefore, has been and reasonably expects
it will continue to be subject to claims alleging that the Company, its Mentors, or its employees
failed to provide proper care for a client, as well as claims by the Companys clients, Mentors,
employees or community members against the Company for negligence, intentional misconduct or
violation of applicable law. 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 accrues for costs related to contingencies when a loss is probable and the amount
is reasonably estimable. While the Company believes the provision for contingencies is adequate,
the outcome of the legal and other such proceedings is difficult to predict and the Company may
settle 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 the historical consolidated financial statements and the related notes included
elsewhere in this report. 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
Founded in 1980, we are a leading provider of home and community-based human services to
adults and children with intellectual and/or developmental disabilities (I/DD), acquired brain
injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and
medically complex challenges, or at risk youth (ARY). As of March 31, 2010, we provided our
services to approximately 24,000 clients in 36 states through approximately 16,400 full-time
equivalent employees. Most of our services involve residential support, typically in small group
homes, Intermediate Care Facilities for the Mentally Retarded (ICFs-MR) or host home settings,
designed to improve our clients quality of life and to promote client independence and
participation in community life. Our non-residential services consist primarily of day programs and
periodic services in various settings. We derive most of our revenue from state and county
governmental payors, as well as smaller amounts from non-public payors, mostly for services
provided to persons with acquired brain injury and other catastrophic injuries and illnesses.
The largest part of our business is the delivery of services to adults and children with
intellectual and/or developmental disabilities. Our I/DD programs include residential support, day
habilitation, vocational services, case management, home health care and personal care. We also
provide a variety of services to youth with emotional, behavioral and medically complex challenges.
Our ARY services include therapeutic foster care, independent living, family reunification, family
preservation, alternative schools and adoption services. We also provide a range of post-acute
specialty rehabilitation treatment and care services to adults and children with an acquired brain
injury and other catastrophic injuries and illnesses. Our specialty rehabilitation services range
from post-acute care to assisted independent living and include neurobehavioral rehabilitation,
neurorehabilitation, adolescent integration, outpatient or day treatment and pre-vocational
services.
We operate our business in two reportable segments, Human Services and Post Acute Specialty
Rehabilitation Services (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 medically complex challenges. The SRS segment provides a mix of
health care and community-based human services to individuals with acquired brain injuries and
other catastrophic injuries and illnesses.
Factors affecting our operating results
Demand for Home and Community-Based 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.
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 specialty rehabilitation services has also grown
as faster emergency response and improved medical techniques have resulted in more people surviving
a traumatic brain injury.
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 current 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 and Minnesota where we have
significant market presence. In addition, the volume of referrals to
our programs has also been constrained in many markets as payors have
taken steps to reduce spending. We
cannot be certain whether there will be further rate reductions in the
coming months as state governments address revenue shortfalls.
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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. 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.
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 program
starts typically require us to fund operating losses for a period of approximately 18-24 months. If
a new program start does not become profitable during such period, we may terminate it. During the
12 months ended March 31, 2010, losses on new program starts for programs started within the last
18 months that generated operating losses were $3.8 million.
Acquisitions
As of March 31, 2010, we have completed 33 acquisitions since 2004, 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.
On January 15, 2010, we acquired the assets of Springbrook, Inc. and an affiliate (together,
Springbrook) for $6.3 million, subject to increase based on earnout provisions. Springbrook
operates in Arizona and Oregon and provides residential and mental health services to individuals
with developmental disabilities and behavioral issues.
On February 22, 2010, in a purchase of stock and assets, we acquired a provider of
neurobehavioral and supported living programs (NeuroRestorative) for $17.0 million.
NeuroRestorative has operations in Arkansas, Louisiana, Oklahoma and Texas and serves individuals
who have sustained a traumatic brain injury.
In
addition to Springbrook and NeuroRestorative, we acquired two
California facilities (together, Villages), one on
January 29, 2010 and one on February 11, 2010, engaged
in neurorehabilitation services for total consideration of $6.0 million.
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
by business units. Revenue is also reported net of any state provider taxes or gross receipts taxes
levied on services we provide. For the six months ended March 31, 2010, we derived approximately
90% of our net revenue from state and local government 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. 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.
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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. General and administrative
expenses primarily include salaries and benefits for administrative employees, or employees that
are not directly providing services, administrative occupancy and insurance costs, as well as
professional expenses such as consulting, legal 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
reimbursed 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 March 31, 2010,
we owned 406 facilities and one office, and we leased 923 facilities and 277 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 0.4% and 0.5% of our net revenue for the three months
ended March 31, 2010 and 2009, respectively and 0.4% of our net revenue for the six months ended
March 31, 2010 and 2009. We have incurred professional and general liability claims and insurance
expense for professional and general liability of $1.1 million and $1.3 million for the three
months ended March 31, 2010 and 2009, respectively and $2.3 million and $2.2 million for the six
months ended March 31, 2010 and 2009, respectively. We currently insure through our wholly-owned
captive insurance company professional and general liability claims for amounts of up to $1.0
million per claim and up to $2.0 million in the aggregate. Above these limits, we have limited
additional third-party coverage. We also insure through our wholly-owned captive insurance company
employment practices liability claims of up to $240 thousand per claim and up to $1.0 million in
the aggregate.
Our ability to maintain our margin in the future is dependent upon obtaining increases in
rates and/or controlling our expenses. In fiscal 2008 and 2009, we invested in our infrastructure
initiatives and business process improvements, which had a negative impact on our margin. As we
continue to invest in our infrastructure initiatives and business process improvements our margin
may continue to be negatively impacted.
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Results of Operations
Post Acute Specialty | ||||||||||||||||
Rehabilitation | ||||||||||||||||
Three Months Ended March 31, | Human Services | Services | Corporate | Consolidated | ||||||||||||
(in thousands) | ||||||||||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 222,296 | $ | 30,206 | $ | | $ | 252,502 | ||||||||
Income (loss) from operations |
19,278 | 3,012 | (12,088 | ) | 10,202 | |||||||||||
Operating margin |
8.7 | % | 10.0 | % | | 4.0 | % | |||||||||
2009 |
||||||||||||||||
Net revenue |
$ | 218,707 | $ | 22,030 | $ | | $ | 240,737 | ||||||||
Income (loss) from operations |
17,798 | 3,200 | (10,658 | ) | 10,340 | |||||||||||
Operating margin |
8.1 | % | 14.5 | % | | 4.3 | % |
Post Acute Specialty | ||||||||||||||||
Rehabilitation | ||||||||||||||||
Six Months Ended March 31, | Human Services | Services | Corporate | Consolidated | ||||||||||||
(in thousands) | ||||||||||||||||
2010 |
||||||||||||||||
Net revenue |
$ | 447,228 | $ | 57,102 | $ | | $ | 504,330 | ||||||||
Income (loss) from operations |
39,667 | 5,497 | (24,063 | ) | 21,101 | |||||||||||
Operating margin |
8.9 | % | 9.6 | % | | 4.2 | % | |||||||||
2009 |
||||||||||||||||
Net revenue |
$ | 438,940 | $ | 43,030 | $ | | $ | 481,970 | ||||||||
Income (loss) from operations |
37,317 | 5,965 | (22,453 | ) | 20,829 | |||||||||||
Operating margin |
8.5 | % | 13.9 | % | | 4.3 | % |
Three months ended March 31, 2010 compared to three months ended March 31, 2009
Consolidated
Consolidated revenue for the three months ended March 31, 2010 increased by $11.8 million, or
4.9%, compared to revenue for the three months ended March 31, 2009. Revenue increased $13.1
million related to acquisitions that closed during the period from January 1, 2009 to March 31,
2010 and $1.9 million related to organic growth, including growth related to new programs. Revenue
growth was partially offset by a reduction in revenue of $3.2 million from businesses we divested
during the same period.
Consolidated income from operations decreased from $10.3 million, or 4.3% of revenue, for the
three months ended March 31, 2009 to $10.2 million, or 4.0% of revenue, for the three months ended
March 31, 2010. Our operating margin decreased due to a $1.2 million increase in depreciation and
amortization expense, primarily from acquisitions, a $0.9 million increase in our health insurance
costs and a $0.8 million increase related to investment in growth initiatives. This decrease was
partially offset by an increase in our cost-containment efforts.
In addition, consolidated net loss increased from $1.2 million for the three months ended
March 31, 2009 to $4.7 million for the three months ended March 31, 2010. This increase was
primarily due to loss from discontinued operations of $4.1 million, net of tax, related to the
impairment charges recorded to close our business operations in the state of Colorado (REM
Colorado) and to write-down the assets of certain business operations in the state of Maryland
(REM Maryland) to fair value.
Human Services
Human Services revenue for the three months ended March 31, 2010 increased by $3.6 million, or
1.6% compared to the three months ended March 31, 2009. Revenue increased $7.4 million related to
acquisitions that closed during the period from January 1, 2009 to March 31, 2010, but was
partially offset by a reduction in revenue of $3.2 million from businesses we divested during the
same period. Revenue from existing programs decreased $0.6 million due to a reduction in revenue from programs we
closed during the period and due to rate reductions in states in which we operate.
Operating margin increased from 8.1% during the three months ended March 31, 2009 to 8.7%
during the three months ended March 31, 2010 primarily due to our ongoing cost-containment efforts.
Offsetting the cost-containment efforts was a $0.5 million increase in our health insurance costs
as well as a $0.4 million increase in depreciation and amortization expense.
Human Services net loss was negatively impacted by the loss from discontinued operations of
$4.1 million, net of tax, related to the impairment charges recorded to close REM Colorado and to
write-down the REM Maryland assets to fair value.
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Post Acute Specialty Rehabilitation Services
Post Acute Specialty Rehabilitation Services revenue for the three months ended March 31, 2010
increased by $8.2 million, or 37.1%, compared to the three months ended March 31, 2009
due to growth of $5.7 million related to acquisitions that closed during the period from January 1,
2009 to March 31, 2010 and $2.5 million related to organic growth.
Operating margin decreased from 14.5% for the three months ended March 31, 2009 to 10.0% for
the three months ended March 31, 2010 primarily due to a $0.8 million increase in growth
initiatives, namely $0.3 million related to increased infrastructure and $0.5 million related to
new or expanded facilities. Operating margin also decreased due to a $0.6 million increase in
depreciation and amortization expense and a $0.4 million increase in health insurance costs.
Corporate
Corporate represents corporate general and administrative expenses. Total corporate expense
increased by $1.4 million from the three months ended March 31, 2009 to $12.1 million for the three
months ended March 31, 2010. In connection with our consolidation of invoice processing from
disparate field locations to a centralized shared services center, corporate expense increased $0.5
million. Expensed transaction costs related to acquisitions also contributed $0.2 million to
expense during the three months ended March 31, 2010.
Six months ended March 31, 2010 compared to six months ended March 31, 2009
Consolidated
Consolidated revenue for the six months ended March 31, 2010 increased by $22.4 million, or
4.6%, compared to revenue for the six months ended March 31, 2009. Revenue increased $22.5 million
related to acquisitions that closed during fiscal 2009 and 2010 and $6.2 million related to organic
growth, including growth related to new programs. Revenue growth was partially offset by a
reduction in revenue of $6.3 million from businesses we divested during the same period.
Consolidated income from operations increased from $20.8 million for the six months ended
March 31, 2009 to $21.1 million for the six months ended March 31, 2010 while operating margins
decreased from 4.3% to 4.2%. Our operating margin decreased due to a $2.5 million increase in
depreciation and amortization expense, primarily from acquisitions, a
$2.4 million increase in our
health insurance costs, a $1.8 million increase in growth initiatives and a $1.1 million increase
in our workers compensation costs. This decrease was partially offset by an increase in our
cost-containment efforts.
In addition, consolidated net loss increased from $3.5 million for the six months ended March
31, 2009 to $4.7 million for the six months ended March 31, 2010. This increase was primarily due
to the loss from discontinued operations of $4.1 million, net of tax, related to the impairment
charges recorded to close our business operations in REM Colorado and to write-down the REM
Maryland assets to fair value.
Human Services
Human Services revenue for the six months ended March 31, 2010 increased by $8.3 million, or
1.9% compared to the six months ended March 31, 2009. Revenue increased $13.7 million related to
acquisitions that closed during fiscal 2009 and 2010 and $0.9 million related to organic growth,
including growth related to new programs. Human Services revenue growth was offset by a reduction
in revenue of $6.3 million from businesses we divested during the same period.
Operating margin increased from 8.5% during the six months ended March 31, 2009 to 8.9% during
the six months ended March 31, 2010 primarily due to our ongoing cost-containment efforts.
Offsetting our cost-containment efforts were a $1.7 million increase in our health insurance costs,
a $1.1 million increase in depreciation and amortization expense
and a $0.8 million increase in our
workers compensation costs.
Human Services net loss was negatively impacted by the loss from discontinued operations of
$4.1 million, net of tax, related to the impairment charges recorded to close REM Colorado and to
write-down the REM Maryland assets to fair value.
Post Acute Specialty Rehabilitation Services
Post Acute Specialty Rehabilitation Services revenue for the six months ended March 31, 2010
increased by $14.1 million, or 32.7%, compared to the six months ended March 31, 2009. This
increase was due to growth of $8.8 million related to acquisitions that closed during
fiscal 2009 and 2010 and $5.3 million related to organic growth.
Operating margin decreased from 13.9% for the six months ended March 31, 2009 to 9.6% for the
six months ended March 31, 2010 primarily due to a $1.8 million increase in growth initiatives,
namely $0.9 million related to increased infrastructure and $0.9 million related to new or expanded
facilities. Operating margin also decreased due to a $1.1 million increase in depreciation and
amortization expense, a $0.7 million increase in our health insurance costs and a $0.3 million
increase in our workers compensation costs.
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Corporate
Corporate represents corporate general and administrative expenses. Total corporate expense
increased by $1.6 million from the six months ended March 31, 2009 to $24.1 million for the six
months ended March 31, 2010. In connection with our consolidation of invoice processing from
disparate field locations to a centralized shared services center, corporate expense increased $0.8
million. Expensed transaction costs related to acquisitions also contributed $0.7 million to
expense during the six months ended March 31, 2010.
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 credit facilities.
Operating activities
Cash
flows provided by operating activities for the six months ended
March 31, 2010 were $31.8
million compared to $22.3 million for the six months ended March 31, 2009. Our days sales
outstanding decreased one day from 46 days at
September 30, 2009 to 45 days at March 31, 2010.
Investing activities
Net cash used in investing activities, primarily consisting of purchases of property and
equipment and cash paid for acquisitions, was $39.8 million for the six months ended March 31, 2010
compared to $36.2 million for the six months ended March 31, 2009.
Cash
paid for acquisitions for the six months ended March 31, 2010 was $29.2 million,
primarily reflecting the acquisitions of NeuroRestorative for $17.0 million and Springbrook for
$6.3 million, which is subject to increase based on earnout
provisions. The fair value of the cash earnout was $1.6 million for
the quarter ended March 31, 2010. In addition to
NeuroRestorative and Springbrook, we acquired Villages for total consideration of $6.0 million. Cash paid for acquisitions
for the six months ended March 31, 2009 was $13.1 million, primarily reflecting the earnout payment
of $12.0 million associated with the CareMeridian acquisition and the acquisition of RIA, Inc. for
$0.9 million.
Cash paid for property and equipment for the six months ended March 31, 2010 was $9.1 million,
or 1.8% of net revenue, and included $0.9 million related to the purchase of real estate and $0.2
million related to the implementation of a new billing system. Cash paid for property and equipment
was $17.3 million, or 3.6% of net revenue, for the six months ended March 31, 2009 and included
$4.4 million related to the purchase of real estate and $1.4 million related to the implementation
of a new billing system.
Investing activities for the six months ended March 31, 2009 also included the purchase of
$11.5 million of senior floating rate toggle notes due 2014 (the NMH Holdings notes) from our
indirect parent company, NMH Holdings, Inc. (NMH Holdings) for $6.6 million.
Financing activities
Net cash used in financing activities was $1.9 million for the six months ended March 31, 2010
compared to $9.1 million for the six months ended March 31, 2009. Our financing activities for the
six months ended March 31, 2010 and 2009, included the repayment of long term debt of $1.9 million.
During the six months ended March 31, 2009, we paid a dividend of $7.0 million to our direct
parent company, which used the proceeds to make a distribution to NMH Holdings and NMH Holdings
used the proceeds of the distribution to repurchase an aggregate principal amount of $13.9 million
of the NMH Holdings notes.
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We may seek to purchase a portion of our outstanding debt or the debt of NMH Holdings from
time to time. The amount of debt
that may be purchased, if any, would be decided at the discretion of our Board of Directors
and management and will depend on market conditions, prices, contractual restrictions, our
liquidity and other factors.
As mentioned above, our principal sources of funds are cash flows from operating activities
and available borrowings under the $125.0 million senior revolver. As of March 31, 2010, we did not
have any borrowings under our senior revolver. The availability on the senior revolver was reduced
by $9.3 million to $115.7 million as letters of credit in excess of $20.0 million under our
synthetic letters of credit facility were outstanding. For a description of the senior credit
facilities, see note 4 to the condensed consolidated financial statements. We believe that these
funds will provide sufficient liquidity and capital resources to meet our near term and future
financial obligations, including scheduled principal and interest payments, as well as to provide
funds for working capital, capital expenditures and other needs for
the foreseeable future.
However, as of March 31, 2010, our indirect parent company, NMH Holdings had $212.0 million
aggregate principal amount of the NMH Holdings notes outstanding (including the $12.7 million of
which was held by us). NMH Holdings is a holding company with no direct operations. Its principal
assets are the direct and indirect equity interests it holds in its subsidiaries, including us, and
all of its operations are conducted through us and our subsidiaries.
As a result, absent other sources of liquidity, NMH Holdings will
be dependent upon dividends and other payments from us to generate the funds necessary to meet its
outstanding debt service and other obligations, including its obligations on the notes held by us.
NMH Holdings has paid all of the interest payments to date on the notes entirely in PIK Interest
(defined below) which increased the principal amount by $50.9 million, including the PIK Interest
issued to us. NMH Holdings currently expects to elect to make interest payments entirely by
increasing the NMH Holdings notes or issuing new notes (PIK Interest) through June 15, 2012.
Beginning September 15, 2012, interest payments must be made in cash, including the accrued PIK
Interest. We expect the September 2012 payment to be in the range of $95.0 million to $100.0
million depending on interest rates.
Our senior credit agreement and the indenture governing our
senior subordinated notes limit our ability to pay dividends to our parent companies. We do not
currently expect to have the ability under our debt agreements to make a dividend payment in an
amount sufficient to satisfy the payment due in September 2012. In order to fund this payment,
NMH Holdings may pursue various financing alternatives, including modifying the terms of our existing
indebtedness or the indebtedness of NMH Holdings, raising new capital through debt or equity financing, retiring or purchasing our
outstanding debt or the debt of NMH Holdings through exchanges for newly issued debt or equity
securities or a combination of these alternatives. Any financings, repurchases or exchanges would
be approved by the Board of Directors and will depend on market conditions, prices, contractual
restrictions, our liquidity and other factors. Such financings, repurchases or exchanges could
have a material impact on our liquidity and could also require amendments to the agreements
governing our outstanding debt obligations or those of NMH Holdings. Additional financing may not
be available or, if available, may not be made on terms favorable to us.
Covenants
The senior credit agreement and the indenture governing the senior subordinated notes contain
both affirmative and negative financial and non-financial covenants, including limitations on our
ability to incur additional debt, sell material assets, retire, redeem or otherwise reacquire
capital stock, acquire the capital stock or assets of another business and pay dividends. In
addition, in the case of the senior credit agreement, we are required to maintain a consolidated
leverage ratio of no more than 5.00 to 1.00 as of March 31, 2010 and a consolidated interest
coverage ratio of no less than 2.00 to 1.00 for the four consecutive fiscal quarters ended March
31, 2010. The 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. 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. Beginning with the quarter ending
December 31, 2010, we will be required to maintain a consolidated leverage ratio of no more than
4.50 to 1.00 and a consolidated interest coverage ratio of no less than 2.25 to 1.00 for the four
consecutive fiscal quarters ending December 31, 2010.
As of March 31, 2010, our consolidated leverage ratio was 4.20 to 1.00, as calculated in
accordance with the senior credit agreement and our consolidated interest coverage ratio was 2.68
to 1.00, as calculated in accordance with the senior credit agreement. As of March 31, 2010, total
debt, net of cash and cash equivalents, was $495.9 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, among other items,
permitted start up losses, annualized EBITDA from acquisitions and certain unusual and non-
recurring expenses.
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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 March 31, 2010:
(in thousands) | ||||
Net loss |
$ | (6,631 | ) | |
Loss from discontinued operations, net of tax |
5,347 | |||
Benefit for income taxes |
(2,686 | ) | ||
Interest income |
(80 | ) | ||
Interest income from related party |
(2,030 | ) | ||
Interest expense |
47,474 | |||
Depreciation and amortization |
60,296 | |||
Management fee of related party |
1,227 | |||
Loss on disposal of property and equipment |
1,029 | |||
Loss on disposal of assets |
376 | |||
Stock based compensation |
719 | |||
Predecessor company claims |
1,008 | |||
Acquisition costs |
708 | |||
Annualized EBITDA from acquisitions |
6,982 | |||
Permitted start up losses |
3,764 | |||
Non-recurring fees and expenses |
465 | |||
Other |
154 | |||
Consolidated adjusted EBITDA per the senior credit agreement |
$ | 118,122 | ||
Set
forth below is a calculation of interest expense, as calculated under the credit
agreement, for the most recently completed four
fiscal quarters ended March 31, 2010:
(in thousands) | ||||
Interest rate swap agreements |
$ | 13,776 | ||
Unused line of credit |
609 | |||
Senior term B loan |
8,546 | |||
Letters of credit |
589 | |||
Senior subordinated notes |
20,250 | |||
Term loan mortgage |
194 | |||
Capital leases |
175 | |||
Interest income |
(80 | ) | ||
Interest expense per the senior credit agreement |
$ | 44,059 | ||
The consolidated leverage ratio and the consolidated interest coverage ratios are 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 March 31,
2010:
Less than | More than | |||||||||||||||||||
(in thousands) | Total | 1 year | 1-3 years | 3-5 years | 5 years | |||||||||||||||
Long-term debt obligations(1) |
$ | 506,311 | $ | 3,684 | $ | 10,245 | $ | 492,382 | $ | | ||||||||||
Operating lease obligations(2) |
149,897 | 36,795 | 52,374 | 30,751 | 29,977 | |||||||||||||||
Capital lease obligations |
1,731 | 88 | 125 | 147 | 1,371 | |||||||||||||||
Standby letters of credit |
29,278 | 29,278 | | | | |||||||||||||||
Total obligations and commitments |
$ | 687,217 | $ | 69,845 | $ | 62,744 | $ | 523,280 | $ | 31,348 | ||||||||||
(1) | Does not include interest on long-term debt or the $210.7 million of senior floating rate
toggle notes due 2014, net of discount,
issued by NMH Holdings. We hold $12.7 million of the outstanding senior floating rate toggle
notes. |
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(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. |
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 U.S. 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.
The following critical accounting policies affect our more significant judgments and estimates
used in the preparation of our financial statements.
Revenue Recognition
Revenue is reported net of any state provider taxes or gross receipts taxes levied on services
we provide. Revenue is also reported net of allowances for unauthorized sales and estimated sales
adjustments by business units. Sales adjustments are estimated based on an analysis of historical
sales adjustments and recent developments in the payment trends in each business unit. Revenue is
recognized when evidence of an arrangement exists, the service has been provided, the price is
fixed or determinable and collectibility is reasonably assured.
We recognize revenue for services performed pursuant to contracts with various state and local
government agencies and private health care agencies as follows: cost-reimbursement contract
revenue is recognized at the time the service costs are incurred and units-of-service contract
revenue is recognized at the time the service is provided. For our cost-reimbursement contracts,
the rate provided by the payor is based on a certain level of service and types of costs incurred
in delivering the service. From time to time, we receive payments under cost-reimbursement
contracts in excess of the allowable costs required to support those payments. In such instances,
we estimate and record a liability for such excess payments. At the end of the contract period, any
balance of excess payments is maintained as a liability until it is reimbursed to the payor.
Revenue in the future may be affected by changes in rate-setting structures, methodologies or
interpretations that may be enacted in states where we operate or by the federal government.
Accounts Receivable
Accounts receivable primarily consist of amounts due from government agencies, not-for-profit
providers and commercial insurance companies. An estimated allowance for doubtful accounts is
recorded to the extent it is probable that a portion or all of a particular account will not be
collected. In evaluating the collectibility of accounts receivable, we consider a number of
factors, including payment trends in individual states, age of the accounts and the status of
ongoing disputes with third party payors. Complex rules and regulations regarding billing and
timely filing requirements in various states are also a factor in our assessment of the
collectibility of accounts receivable. Actual collections of accounts receivable in subsequent
periods may require changes in the estimated allowance for doubtful accounts. Changes in these
estimates are charged or credited to revenue in the statements of operations in the period of the
change in estimate.
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Accruals for Self-Insurance
We maintain employment practices liability, professional and general liability, workers
compensation, automobile liability and health insurance with policies that include self-insured
retentions. We record expenses related to claims on an incurred basis, which
includes estimates of fully developed losses for both reported and unreported claims. The
accruals for the health and workers compensation, automobile and professional and general
liability programs are based on analyses performed internally by management and may take into
account reports by independent third parties. Accruals relating to prior periods are periodically
reevaluated and increased or decreased based on new information. Changes in estimates are charged
or credited to the statements of operations in a period subsequent to the change in estimate.
Goodwill and Indefinite-lived Intangible Assets
We review costs of purchased businesses in excess of net assets acquired (goodwill), and
indefinite-life intangible assets for impairment at least annually, unless significant changes in
circumstances indicate a potential impairment may have occurred sooner.
We are required to test goodwill on a reporting unit basis, which is the same level as our
operating segments. We use a fair value approach to test goodwill for impairment and potential
impairment is noted for a reporting unit if its carrying value exceeds the fair value of the
reporting unit. For those reporting units that have potential goodwill impairment, we determine the
implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value,
an impairment loss is recorded.
The impairment test for indefinite-life intangible assets requires the determination of the
fair value of the intangible asset. If the fair value of the indefinite-life intangible asset is
less than its carrying value, an impairment loss is recognized in an amount equal to the
difference. Fair values are established using discounted cash flow and comparative market multiple
methods. We conduct our annual impairment test on July 1 of each year.
Discounted cash flows are based on managements estimates of our future performance. As such,
actual results may differ from these estimates and lead to a revaluation of our goodwill and
indefinite-life intangible assets. If updated calculations indicate that the fair value of goodwill
or any indefinite-life intangibles is less than the carrying value of the asset, an impairment
charge is recorded in the statements of operations in the period of the change in estimate.
Impairment of Long-Lived Assets
We review long-lived assets for impairment when circumstances indicate the carrying amount of
an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the
carrying amount of the asset is determined not to be recoverable, a write-down to fair value is
recorded based upon various techniques to estimate fair value.
Income Taxes
We account for income taxes using the asset and liability method. Under this method, deferred
tax assets and liabilities are determined by multiplying the differences between the financial
reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to
be in effect when such differences are recovered or settled. These deferred tax assets and
liabilities are separated into current and long-term amounts based on the classification of the
related assets and liabilities for financial reporting purposes. Valuation allowances on deferred
tax assets are estimated based on our assessment of the realizability of such amounts.
We also recognize the benefits of tax positions when certain criteria are satisfied. We follow
the more likely than not recognition threshold for financial statement recognition and measurement
of a tax position taken or expected to be taken in an income tax return.
Stock-Based Compensation
NMH Investment, LLC adopted an equity-based compensation plan, and issued units of limited
liability company interests pursuant to such plan. The units are limited liability company
interests and are available for issuance to our employees and members of the Board of Directors for
incentive purposes. For purposes of determining the compensation expense associated with these
grants, management values the business enterprise using a variety of widely accepted valuation
techniques which considered a number of factors such as our financial performance, the values of
comparable companies and the lack of marketability of our equity. We then used the option pricing
method to determine the fair value of these units at the time of grant using valuation assumptions
consisting of the expected term in which the units will be realized; a risk-free interest rate
equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend
yield, for which there is none; and expected volatility based on the historical data of equity
instruments of comparable companies. The Class B and Class E units vest over a five-year service
period. The Class C and Class D units vest over a three-year period based on service and on certain
performance and/or investment return conditions being met or achieved. The estimated fair value of
the units, less an assumed forfeiture rate, is recognized in expense on a straight-line basis over
the requisite service/performance periods of the awards.
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Derivative Financial Instruments
We report derivative financial instruments on the balance sheet at fair value and establish
criteria for designation and effectiveness of hedging relationships. Changes in the fair value of
derivatives are recorded each period in current operations or in shareholders equity as other
comprehensive income (loss) depending upon whether the derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction.
We, from time to time, enter into interest rate swap agreements to hedge against variability
in cash flows resulting from fluctuations in the benchmark interest rate, which is LIBOR, on our
debt. These agreements involve the exchange of variable interest rates for fixed interest rates
over the life of the swap agreement without an exchange of the notional amount upon which the
payments are based. On a quarterly basis, the differential to be received or paid as interest rates
change is accrued and recognized as an adjustment to interest expense in the accompanying condensed
consolidated statement of operations. In addition, on a quarterly basis the mark to market
valuation is recorded as an adjustment to other comprehensive income (loss) as a change to
shareholders equity, net of tax. The related amount receivable from or payable to counterparties
is included as an asset or liability in our consolidated balance sheets.
Available-for-Sale Securities
Our investments in related party marketable debt securities have been classified as
available-for-sale securities and, accordingly, are valued at fair value at the end of each
reporting period. Unrealized gains and losses arising from such valuation are reported, net of
applicable income taxes, in other comprehensive income (loss).
Legal Contingencies
From time to time, we are involved in litigation and regulatory proceedings in the operation
of our business. 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 our legal proceedings is difficult to predict and we may settle legal claims or be
subject to judgments for amounts that differ from our estimates. In addition, legal contingencies
could have a material adverse impact on our results of operations in any given future reporting
period. See Part II, Item 1A. Risk Factors for additional information.
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. 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; |
||
| 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; |
||
| legal proceedings; |
||
| the size of our self-insurance accruals and changes in the insurance market 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 and our ability to comply with such regulations or the
interpretations thereof; |
||
| our ability to establish and maintain relationships with government agencies and advocacy
groups; |
||
| increased or more effective competition; |
||
| changes in reimbursement rates, policies or payment practices by our payors; |
||
| changes in interest rates; |
||
| successful integration of acquired businesses; and |
||
| possible conflict between the interests of our majority equity holder and those of the
holders of our notes. |
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. |
To reduce the interest rate exposure on the term
B loan, the Company is a party to interest rate swap agreements with respect to $292.2 million of the $322.4 million outstanding as of
March 31, 2010. Effective August 31, 2006, the Company fixed a portion of the term B loan at 5.32% plus 2.00%, of which $85.7 million
was outstanding at March 31, 2010. These swap agreements mature on June 30, 2010. Effective August 31, 2007, the Company fixed an
additional portion of the term B loan debt at 4.89% plus 2.00%, of which $206.5 million was outstanding at March 31, 2010. This swap
agreement matures on September 30, 2010. The Company is considering its options for addressing interest rate exposure after the
termination of these swap agreements.
As a result of the interest rate swap agreements, the variable rate debt outstanding was
effectively reduced from $326.3 million outstanding to $34.1 million outstanding as of March 31,
2010. The variable rate debt outstanding relates to the term B loan, which has an interest rate
based on LIBOR plus 2.00% or Prime plus 1.00%, the senior revolver, which has an interest rate
based on LIBOR
plus 2.00% or Prime plus 1.00%, subject to reduction depending on our leverage ratio, and the
term loan mortgage, which has an interest rate based on Prime plus 1.50%. A 1% increase in the
interest rate on our floating rate debt would increase cash interest expense of the floating rate
debt by $0.3 million.
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Item 4. | Controls and Procedures. |
None.
Item 4T. | 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 Chief
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 March 31, 2010, 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 not effective as of March 31, 2010, because they are not yet able to conclude that
we have remediated the material weaknesses in internal control over financial reporting identified
in Item 9A(T) of our Annual Report on Form 10-K for the fiscal year ended September 30, 2009.
As reported in Item 9A(T) of our Annual Report on Form 10-K for the fiscal year ended
September 30, 2009, our management, with the participation of the principal executive officers and
principal financial officer, evaluated the effectiveness of our internal control over financial
reporting as of September 30, 2009 (managements most recent assessment of internal control over
financial reporting). In making this assessment, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). In connection with this
assessment, management identified material weaknesses in our internal control over financial
reporting as of September 30, 2009.
A material weakness is a deficiency, or combination of deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a material misstatement of
our financial statements will not be prevented or detected on a timely basis. Our material
weaknesses relate to our revenue and accounts receivable balances, as detailed below:
Revenue
As reported in Item 9A(T) of our Annual Report on Form 10-K for the fiscal year ended
September 30, 2009, as of fiscal year-end, we had ineffective controls over the accuracy of revenue
and accounts receivable balances. As of March 31, 2010, we continued to have the following material
weaknesses.
| We have insufficient segregation of duties within our new billing and accounts receivable
system and insufficient controls to ensure appropriate access to our new billing and
accounts receivable system and data. This material weakness increases the risk that
erroneous or unauthorized revenue transactions could occur and the risk that they would not
be detected on a timely basis if they do occur. Management is currently designing processes
and controls to limit system access to appropriate personnel and segregate incompatible
duties. |
| We have insufficient controls over the accuracy and validity of the billing rates used to
calculate revenue recorded in our consolidated financial statements. We previously addressed
this material weakness within our legacy accounts receivable system. However, our new
billing and accounts receivable system is not yet able to generate timely reports to
identify changes to billing rates for periodic review. Therefore, as of March 31, 2010, we
have insufficient controls to verify that changes to billing rates entered into the new
system were valid and accurate. This control deficiency increases the risk of errors in the
invoicing and recording of billings to payors. |
| During the fourth quarter of fiscal 2009, we completed implementation of our new billing
and accounts receivable system, operating in a majority of our operations, with the
introduction of the system and related controls in multiple locations
representing a substantial portion of our revenue. As of March 31, 2010, these controls had
not yet been determined to be operating effectively. Because we have not yet conducted our
review and testing of revenue controls for the revenue associated with these new locations, we
are unable to conclude that these controls are operating effectively, and there can be no
assurance that there are not additional material weaknesses relating to revenue. |
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The following item was first disclosed in our Form 10-Q for the quarterly period ended
December 31, 2007. It has not been fully remediated and continues to exist.
| We have insufficient controls over revenue recognition and revenue reserves for
unauthorized sales. We maintain a revenue recognition policy in accordance with U.S.
generally accepted accounting principles. However, we lacked controls to ensure definitive,
consistent and documented application of the revenue recognition criteria regarding varying
local payor contract requirements, specifically with respect to payor service authorization
requirements. During the quarter ended September 30, 2009, management undertook a process to
remediate the control design by documenting, reviewing and approving local application of
revenue recognition requirements and developing a process to assess contract terms in each
state to ensure that revenue recognition criteria are being consistently and appropriately
interpreted and applied. However, we continue to have insufficient controls to ensure that
all unauthorized sales are identified and reserved appropriately in the consolidated
financial statements. Generally, if we provide services without a current, valid
authorization from the payor agency to provide those services, revenue associated with the
unauthorized services may need to be either reserved until such authorization is received,
or ultimately written off if authorization is not granted. Management expects our new
billing and accounts receivable system, when remediated, to capture more complete and
accurate data related to authorizations, which will improve our controls over identifying
and reserving for unauthorized sales. |
(b) Changes in Internal Control over Financial Reporting
As discussed above, during the quarter ended September 30, 2009, we completed implementation
of our new billing and accounts receivable system in a majority of our operations. This billing and
accounts receivable system has affected, and will continue to affect, the processes that impact our
internal control over financial reporting. As we optimize and remediate the system, we will review
the related controls and may take further steps to ensure that they are effective and integrated
appropriately.
In addition, during the quarter ended March 31, 2010, we continued to consolidate the
processing of vendor invoices from disparate field locations to one centralized location. In
connection with this effort, we have redesigned our processes and our controls over the payment of
invoices.
Except for the continuing optimization and remediation of our billing and accounts receivable
system and consolidation of invoice processing, 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 human services business and, therefore, we have been and continue to be subject
to 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.
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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/state health insurance program through which state expenditures are matched by
federal funds ranging from, for federal fiscal year 2010, 65% to more than 82% 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 recessionary periods, 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. Many states in which we operate have been experiencing
unprecedented budgetary pressures and have implemented or are considering initiating service
reductions, rate freezes and/or rate reductions, including states where we derive significant
revenue, such as Minnesota, California 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.
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. Twelve 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 or
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. 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 ability to raise additional capital to fund
our operations, and limit our ability to react to changes in the economy or our industry.
We have a significant amount of indebtedness. As of March 31, 2010, we had total indebtedness
of $508.0 million, no borrowings under our senior revolver and $115.7 million of availability under
our senior revolver. The senior secured credit facilities also include a $20.0 million synthetic
letter of credit facility, all of which has been fully utilized. The availability under our senior
revolver was reduced from $125.0 million as $9.3 million of letters of credit in excess of $20.0
million under our synthetic letters of credit facility were outstanding under the senior credit
agreement.
Our substantial degree of leverage could have important consequences, including the following:
| it may limit our ability to obtain additional debt or equity financing for working
capital, capital expenditures, debt service requirements, acquisitions, 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 capital expenditures; |
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| the debt service requirements of our indebtedness could make it more difficult for us to
satisfy our financial obligations; |
||
| a portion of our variable interest rate borrowings under the senior secured credit
facilities has not been hedged, exposing us to the risk of increased interest rates; |
| 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; and |
| 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. |
In addition to our indebtedness noted above, our indirect parent company, NMH Holdings had
$212.0 million aggregate principal amount of the NMH Holdings notes outstanding as of March 31, 2010 (including the $12.7 million of which was held by
us). NMH Holdings is a holding company with no direct operations. Its principal assets are the
direct and indirect equity interests it holds in its subsidiaries, including us, and all of its
operations are conducted through us and our subsidiaries. As a result, absent other sources of liquidity, NMH Holdings will be
dependent upon dividends and other payments from us to generate the funds necessary to meet its
outstanding debt service and other obligations, including its obligations on the notes held by us.
NMH Holdings has paid all of the interest payments to date on the notes entirely in PIK Interest
(defined below) which increased the principal amount by $50.9 million, including the PIK Interest
issued to us. NMH Holdings currently expects to elect to make interest payments entirely by
increasing the principal amount of the NMH Holdings notes or issuing new NMH Holdings notes (PIK
Interest) through June 15, 2012. Beginning September 15, 2012, interest payments must be made in
cash, including the accrued PIK Interest. We expect the September 2012 payment to be in the range
of $95.0 million to $100.0 million depending on interest
rates. Our senior credit
agreement and the indenture governing our senior subordinated notes limit our ability to pay
dividends to our parent companies. We do not currently expect to have the ability under our debt
agreements to make a dividend payment in an amount sufficient to satisfy the payment due in
September 2012. NMH Holdings may pursue various financing alternatives to fund this payment, any of which
could have a material impact on our liquidity and could also require amendments to the agreements
governing our outstanding debt obligations or those of NMH Holdings. Additional financing may not
be available or, if available, may not be made on terms favorable to us.
Subject to restrictions in the indentures governing our senior subordinated notes and the NMH
Holdings notes and the credit agreement governing our senior secured credit facilities, 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. The NMH Holdings notes are structurally
subordinated to the senior subordinated notes and the senior secured credit facilities.
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 six months ended March 31, 2010, our aggregate rental payments for these leases, including
taxes and operating expenses, was $21.8 million. 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.
Due to the tightening of the credit markets over the last several years, our government payors
or other counterparties that owe us money could be delayed in obtaining, or may not be able to
obtain, necessary funding and/or financing to meet their cash-flow needs. Moreover, 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. Delays in payment could have a material adverse effect on our cash flows,
liquidity and financial condition. In addition, in the event that our payors or other
counterparties 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 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 will impose new
mandates on employers. We are studying the potential impact of these mandates on our costs.
Although our employees are generally not unionized, sixteen of our employees were represented
by a labor union until September 30, 2009, when our only unionized program closed. Future
unionization activities could result in an increase of our labor and other costs. The Employee Free
Choice Act (EFCA) of 2009 (H.R. 1409) seeks to amend the National Labor Relations Act to make it
easier for workers to be represented by labor unions. If the EFCA or a variation of this
legislation becomes law, it could result in increased unionization activities. 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 credit agreement governing the senior secured credit facilities and the indentures
governing the senior subordinated notes and the indenture governing the NMH Holdings 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 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 thereunder,
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, some of which may not be fully
insured against or reserved for.
We are in the human services business and, therefore, we have been and continue to be subject
to claims alleging that we, our employees or our Mentors failed to provide proper care for a
client, as well as claims by our clients, our employees, our Mentors or community members against
us for negligence, intentional misconduct or violation of applicable law. 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
currently insure through our captive subsidiary amounts of up to $1.0 million per claim and up to
$2.0 million in the aggregate. Above these limits, we have limited additional third-party coverage.
Awards for punitive damages may be excluded from our insurance policies either contractually or by
operation of state law.
We also are subject to potential lawsuits under the False Claims Act or 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. 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.
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.
Because a substantial portion of NMH Holdings and 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 substantial portion of our indebtedness, including borrowings under the senior revolver, the
portion of our borrowings under the senior secured term loan facility for which the Company has not
hedged its interest rate exposure under interest rate swap agreements, and the indebtedness of NMH
Holdings under the NMH Holdings notes, bears interest at rates that fluctuate with changes in
certain short-term prevailing interest rates. If interest rates increase, our and NMH Holdings
debt service obligations on the variable rate indebtedness would increase even though the amount
borrowed remained the same.
As of March 31, 2010, we had $34.1 million of floating rate debt outstanding after giving
effect to interest rate swaps. As of March 31, 2010, NMH Holdings had $210.7 million of floating
rate debt outstanding, net of discount, excluding the debt of its subsidiaries. A 1% increase in
the interest rate on our floating rate debt would have increased cash interest expense of the
floating rate debt by $0.3 million, and a 1% increase in the interest rate on the NMH Holdings
notes would increase NMH Holdings interest expense on those notes by $2.1 million. If interest
rates increase dramatically, NMH Holdings and the Company and its subsidiaries could be unable to
service their debt.
The counterparties to our derivative financial instruments are substantial multi-national
financial institutions. Although we consider the risk of counterparty nonperformance to be low, we
cannot assure you that our counterparties will not default. If a counterparty defaulted, the effect
on our results of operations could be material.
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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. As reported in
Part I, Item 2 of this Quarterly Report on Form 10-Q for the six months ended March 31, 2010, we
recorded an increased charge for workers compensation expense compared to the six months ended
March 31, 2009. 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. As a
result of our participation in these government-funded programs, 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 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.
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.
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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 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.
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 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 selective 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.
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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; |
| 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 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), which requires 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.
We have identified material weaknesses in our internal control over financial reporting.
In connection with our internal controls assessment required by the Sarbanes-Oxley Act of 2002
and as reported in Item 9A(T) of 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.
Management concluded that as of September 30, 2009, our internal control over financial reporting
was not effective and, as a result, our disclosure controls and procedures were not effective.
Descriptions of the material weaknesses are included in Item 4(T) of this Quarterly Report on Form
10-Q. We also reported material weaknesses in our prior year assessment, for the fiscal year ended
September 30, 2008, including a material weakness in controls to verify the existence of our fixed
asset balances. In connection with 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 and continue to take actions to remediate our identified
material weaknesses, our new policies and procedures, when
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implemented, may not be effective in
remedying all of the deficiencies in our internal control over financial reporting. The decentralized nature of our
operations and the manual nature of many of our controls make compliance with the requirements of
Section 404 and remediation of our material weaknesses especially challenging. The continuing
optimization and remediation of our new billing and accounts receivable system and the
consolidation of invoice processing at one centralized location have affected and will continue to
affect a number of processes that impact our internal control over financial reporting, and we may
identify additional material weaknesses or significant deficiencies in connection with these
changes. A failure to remedy our material weaknesses in internal control over financial reporting
could result in material misstatements in our financial statements and could impede an upgrade to
our credit rating, even if our creditworthiness otherwise improves. Moreover, any future
disclosures of additional material weaknesses, or errors as a result of those weaknesses, may
result in a negative reaction in the financial markets if there is a loss of confidence in the
reliability of our financial reporting.
We have extensive work remaining to remedy the material weaknesses in our internal control
over financial reporting, and until our remediation efforts are completed, management will continue
to devote significant time and attention to these efforts. We will continue to incur costs
associated with implementing additional processes, including fees for additional auditor services
and consulting services, and may be required to incur additional costs in improving our internal
controls and hiring additional personnel, 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.
Regulations that require ARY services to be provided through not-for-profit organizations could
harm our revenue or gross margin.
Two percent of our net revenue for the six months ended March 31, 2010 was derived from
contracts with affiliates of Alliance Health and Human Services Inc., or Alliance,, an
independent not-for-profit organization that has licenses and contracts from several state and
local agencies to provide ARY services.
Historically, some state governments interpreted federal law to preclude them from receiving
federal reimbursement under Title IV-E of the Social Security Act for ARY services provided under a
contract with a proprietary organization. However, in 2005 the Fair Access Foster Care Act of 2005
was signed into law, thereby allowing states to seek reimbursement from the federal government for
ARY services provided by proprietary organizations. In some jurisdictions that interpreted the
prior federal law to preclude them from seeking reimbursement for ARY services provided under a
contract with a proprietary provider, or in others that prefer to contract with not-for-profit
providers, we provide ARY services as a subcontractor of Alliance. We do not control Alliance, and
none of our employees or agents has a role in the management of Alliance. Although
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Edward M.
Murphy, our Chief Executive Officer, was an officer and director of Alliance immediately prior to becoming our President in September
2004, Mr. Murphy has no role in the management of Alliance. Our ARY business could be harmed if
Alliance chooses to discontinue all or a portion of its service agreements with us. Our ARY
business could also be harmed if the state or local governments that prefer that ARY services be
provided by not-for-profit organizations determine that they do not want the service performed
indirectly by for-profit companies like us on behalf of not-for-profit organizations. We cannot
assure you that our contracts with Alliance will continue, and if these contracts are terminated
without our consent, it could have an adverse effect on our business, financial condition and
operating results. Alliance and its subsidiaries are organized as non-profit corporations and are
recognized as tax-exempt under section 501(c)(3) of the Internal Revenue Code. As such, Alliance is
subject to the public charity regulations of the states in which it operates and to the federal
regulations governing tax-exempt entities. If Alliance fails to comply with the laws and
regulations of the states in which it operates or with the federal regulations, it could be subject
to penalties and sanctions, including the loss of tax-exempt status, which could preclude it from
continuing to contract with certain state and local governments. Our business could be harmed if
Alliance lost its contracts and was therefore unable to continue to contract with us.
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 six months ended March 31, 2010, 16% 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. Last year, Minnesota enacted a rate cut of 2.58%, which took retroactive effect July 1,
2009, and the governor has proposed an additional 2.50% rate cut to take effect July 1, 2010.
While the legislature has not adopted the proposal for an additional rate cut at this time, 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 senior
officers, 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.
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Our success depends on our ability to manage growing and changing operations.
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. Our inability to
manage growth effectively could have a material adverse effect on our results of operations,
financial position and cash flows.
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 hire replacement
staff and Mentors for workers who drop out of the workforce in very tight labor markets.
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 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. For example, we may pursue various financing alternatives in order to
fund required cash payments on the NMH Holdings notes, accrued interest for which will be due and
payable in cash beginning September 15, 2012. 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.
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 March 31, 2010;
however, the Companys indirect parent, NMH Investment, LLC (NMH Investment), did sell equity
securities during this period.
The following table sets forth the number of units of common equity of NMH Investment issued
during the quarter ended March 31, 2010 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.
Dates | Title of Securities | Amount | Purchasers | Consideration | ||||||||
January 12,
2010 to January 20,
2010 |
Class B Common Units | 12,031.25 | Certain employees | $ | 601.56 | |||||||
Class C Common Units | 12,625.00 | $ | 378.75 | |||||||||
Class D Common Units | 13,375.00 | $ | 133.75 |
Repurchases of Equity Securities
No equity securities of the Company were repurchased during the three months ended March 31,
2010, and no repurchases were
made by NMH Investment.
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The Company did not repurchase any of its common stock as part of an equity repurchase program
during the second quarter of fiscal 2010.
Item 3. | Defaults Upon Senior Securities. |
None.
Item 4. | (Removed and Reserved). |
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. |
||||
May 13, 2010 | By: | /s/ Denis M. Holler | ||
Denis M. Holler | ||||
Its: | Executive Vice President, 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 | ||||
4.1 | Supplemental Indenture #10, dated as of February 22, 2010,
by and among National Mentor Holdings, Inc.,
NeuroRestorative Associates, Inc. and U.S. Bank National
Association, as trustee.
|
Filed herewith | ||||
4.2 | Supplemental Indenture #11, dated as of April 14, 2010, by
and among National Mentor Holdings, Inc., Timber Ridge
Group, Inc. and U.S. Bank National Association, as trustee.
|
Filed herewith | ||||
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 |
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