UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended December 31, 2008 |
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OR |
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o |
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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: 333-138362
NATIONAL MENTOR HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 31-1757086 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
313 Congress Street, 6th Floor Boston, Massachusetts 02210 |
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(617) 790-4800 |
(Address of principal executive offices,
including zip code) |
(Registrant's telephone number,
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 ý
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 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
ý
(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 ý
As of February 17, 2009, there were 100 shares outstanding of the registrant's common stock, $.01 par value.
Index
National Mentor Holdings, Inc.
2
Item 1. Financial Statements
National Mentor Holdings, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)
|
December 31,
2008 |
September 30,
2008 |
||||||
---|---|---|---|---|---|---|---|---|
Assets |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ | 28,295 | $ | 38,908 | ||||
Restricted cash |
5,661 | 5,773 | ||||||
Accounts receivable, net |
111,632 | 113,933 | ||||||
Deferred tax assets, net |
14,428 | 10,355 | ||||||
Prepaid expenses and other current assets |
16,576 | 23,268 | ||||||
Total current assets |
176,592 | 192,237 | ||||||
Property and equipment, net |
150,090 | 144,233 | ||||||
Intangible assets, net |
454,433 | 462,987 | ||||||
Goodwill |
200,475 | 199,392 | ||||||
Other assets |
16,725 | 17,584 | ||||||
Total assets |
$ | 998,315 | $ | 1,016,433 | ||||
Liabilities and shareholders' equity |
||||||||
Current liabilities |
||||||||
Accounts payable |
$ | 18,136 | $ | 20,840 | ||||
Accrued payroll and related costs |
51,422 | 59,146 | ||||||
Other accrued liabilities |
54,044 | 52,437 | ||||||
Obligations under capital lease, current |
177 | 201 | ||||||
Current portion of long-term debt |
3,735 | 3,735 | ||||||
Total current liabilities |
127,514 | 136,359 | ||||||
Other long-term liabilities |
11,072 | 10,859 | ||||||
Deferred tax liabilities, net |
121,190 | 122,103 | ||||||
Obligations under capital lease, less current portion |
1,762 | 1,806 | ||||||
Long-term debt, less current portion |
507,244 | 508,178 | ||||||
Total liabilities |
768,782 | 779,305 | ||||||
Shareholders' equity |
||||||||
Common stock |
| | ||||||
Additional paid-in-capital |
257,098 | 256,648 | ||||||
Other comprehensive loss, net of tax |
(11,485 | ) | (5,781 | ) | ||||
Accumulated deficit |
(16,080 | ) | (13,739 | ) | ||||
Total shareholders' equity |
229,533 | 237,128 | ||||||
Total liabilities and shareholders' equity |
$ | 998,315 | $ | 1,016,433 | ||||
See accompanying notes.
3
National Mentor Holdings, Inc.
Condensed Consolidated Statements of Operations
(In thousands)
(Unaudited)
|
Three Months Ended | |||||||
---|---|---|---|---|---|---|---|---|
|
December 31,
2008 |
December 31,
2007 |
||||||
Net revenues | $ | 241,233 | $ | 232,105 | ||||
Cost of revenues | 183,089 | 176,437 | ||||||
Gross profit | 58,144 | 55,668 | ||||||
Operating expenses: | ||||||||
General and administrative | 34,602 | 31,082 | ||||||
Depreciation and amortization | 13,054 | 12,623 | ||||||
Total operating expenses | 47,656 | 43,705 | ||||||
Income from operations | 10,488 | 11,963 | ||||||
Other income (expense): | ||||||||
Management fee of related party | (223 | ) | (451 | ) | ||||
Other (expense) income, net | (361 | ) | 33 | |||||
Interest income | 116 | 289 | ||||||
Interest expense | (12,439 | ) | (12,183 | ) | ||||
Loss from continuing operations before income taxes | (2,419 | ) | (349 | ) | ||||
(Benefit) provision for income taxes | (36 | ) | 86 | |||||
Loss from continuing operations | (2,383 | ) | (435 | ) | ||||
Income from discontinued operations, net of tax | 42 | 116 | ||||||
Net loss | $ | (2,341 | ) | $ | (319 | ) | ||
See accompanying notes.
4
National Mentor Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(In
thousands)
(Unaudited)
|
Three Months Ended | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
December 31, 2008 | December 31, 2007 | |||||||
Operating activities | |||||||||
Net loss | $ | (2,341 | ) | $ | (319 | ) | |||
Adjustments to reconcile net loss to cash provided by operating activities: | |||||||||
Accounts receivable allowances | 2,196 | 2,117 | |||||||
Depreciation and amortization of property and equipment | 4,937 | 4,634 | |||||||
Amortization of other intangible assets | 8,211 | 8,084 | |||||||
Amortization of deferred financing costs | 825 | 799 | |||||||
Stock based compensation | 498 | 302 | |||||||
Loss on disposal of property and equipment | 59 | 290 | |||||||
Gain on disposal of business units | (38 | ) | (30 | ) | |||||
Gain from sale of discontinued operations | (99 | ) | | ||||||
Asset impairment charge | 344 | | |||||||
Changes in operating assets and liabilities: | |||||||||
Accounts receivable | 103 | (2,864 | ) | ||||||
Other assets | 6,785 | 2,666 | |||||||
Accounts payable | (2,763 | ) | 1,206 | ||||||
Accrued payroll and related costs | (7,724 | ) | (6,160 | ) | |||||
Other accrued liabilities | 4,030 | 10,165 | |||||||
Deferred taxes | (1,114 | ) | (6,539 | ) | |||||
Restricted cash | 112 | 108 | |||||||
Other long-term liabilities | 213 | 1,045 | |||||||
Net cash provided by operating activities | 14,234 | 15,504 | |||||||
Investing activities |
|
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|
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|
|
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Cash paid for acquisitions, net of cash received | (13,106 | ) | (5,693 | ) | |||||
Purchases of property and equipment | (11,046 | ) | (3,585 | ) | |||||
Cash proceeds from sale of business units | 76 | 90 | |||||||
Cash proceeds from sale of discontinued operations | 83 | | |||||||
Cash proceeds from sale of property and equipment | 220 | 199 | |||||||
Net cash used in investing activities | (23,773 | ) | (8,989 | ) | |||||
Financing activities |
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|
|
|
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|
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Repayments of long-term debt | (934 | ) | (904 | ) | |||||
Repayments of capital lease obligations | (62 | ) | (84 | ) | |||||
Distribution to parent | (48 | ) | (5 | ) | |||||
Payments of deferred financing costs | (30 | ) | (1 | ) | |||||
Net cash used in financing activities | (1,074 | ) | (994 | ) | |||||
Net (decrease) increase in cash and cash equivalents | (10,613 | ) | 5,521 | ||||||
Cash and cash equivalents at beginning of period | 38,908 | 29,373 | |||||||
Cash and cash equivalents at end of period | $ | 28,295 | $ | 34,894 | |||||
See accompanying notes.
5
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
December 31, 2008
(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 Company's founding in 1980, the Company has grown to provide services to approximately 23,000 clients in 35 states and the District of Columbia. The Company designs customized service plans to meet the unique needs of its clients in home- and community-based settings. Most of the Company's 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 Company's customized services offer its clients, as well as the payers of these services, an attractive, cost-effective alternative to human services provided in large, institutional settings.
On June 29, 2006, NMH MergerSub, Inc., a wholly owned subsidiary of NMH Investment, LLC ("NMH Investment"), merged with and into the Company, and the Company was the surviving corporation (the "Merger"). Vestar Capital Partners V, L.P. ("Vestar"), certain affiliates of Vestar and members of management and certain of the Company's directors own NMH Investment and, therefore, own the Company.
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. 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. The unaudited condensed consolidated financial statements herein should be read in conjunction with the Company's audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2008, which is on file with the SEC. Operating results for the three months ended December 31, 2008 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 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 the Company's estimates. These differences could be material to the financial statements.
6
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
2. Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R), replacing SFAS 141, Business Combinations (SFAS 141). SFAS 141R retains the fundamental requirements of purchase method accounting for acquisitions as set forth previously in SFAS 141. However, this statement defines the acquirer as the entity that obtains control of a business in the business combination, thus broadening the scope of SFAS 141 which applied only to business combinations in which control was obtained through transfer of consideration. SFAS 141R also establishes 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 exclusion of transaction costs from acquisition accounting may introduce more volatility into earnings. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. With the adoption of SFAS 141R, the Company's accounting for business combinations will change on a prospective basis beginning in the first quarter of fiscal 2010.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (SFAS 161), which expands the disclosure requirements in SFAS 133 about an entity's derivative instruments and hedging activities. SFAS 161 is effective for fiscal years beginning after November 15, 2008. The Company is currently evaluating the effect that the adoption of SFAS 161 will have on its consolidated financial position, results of operations and cash flows beginning in the first quarter of fiscal 2010.
3. Comprehensive Loss
SFAS No. 130, Reporting Comprehensive Income (SFAS 130), requires classifying items of other comprehensive income (loss) by their nature in a financial statement and displaying the accumulated balance of other comprehensive income (loss) separately from retained earnings and additional paid in capital in the equity section of the balance sheet. The Company's other comprehensive loss includes the unrealized losses on derivatives designated as cash flow hedges.
|
Three Months Ended | ||||||
---|---|---|---|---|---|---|---|
(in thousands)
|
December 31,
2008 |
December 31,
2007 |
|||||
Net loss |
$ | (2,341 | ) | $ | (319 | ) | |
Changes in unrealized losses on derivatives |
(9,576 | ) | (6,036 | ) | |||
Income tax effect |
3,872 | 2,440 | |||||
Comprehensive loss |
$ | (8,045 | ) | $ | (3,915 | ) | |
7
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
4. Long-Term Debt
The Company's long-term debt consists of the following:
(in thousands)
|
December 31, 2008 | September 30, 2008 | |||||||
---|---|---|---|---|---|---|---|---|---|
Senior term B loan, principal and interest due in quarterly installments through June 29, 2013 |
|||||||||
fixed interest rate of 7.32% |
$ | 135,577 | $ | 137,844 | |||||
fixed interest rate of 6.89% |
177,362 | 183,930 | |||||||
variable interest rate of 3.46% and 5.71% at December 31, 2008 and September 30, 2008, respectively |
13,686 | 5,689 | |||||||
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 1 st and July 1 st (interest rate of 11.25%) |
180,000 | 180,000 | |||||||
Term loan mortgage, principal and interest due in monthly installments through May 20, 2010; variable interest rate (4.75% and 6.50% at December 31, 2008 and September 30, 2008, respectively) |
4,354 | 4,450 | |||||||
|
510,979 | 511,913 | |||||||
Less current portion |
3,735 | 3,735 | |||||||
Long-term debt |
$ | 507,244 | $ | 508,178 | |||||
The Company's 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 senior secured revolving credit facility (the "senior revolver") and a $20.0 million senior secured synthetic letter of credit facility (together, the "senior secured credit facilities"). Any amounts outstanding under the senior revolver are due June 29, 2012. The $335.0 million term B loan has a term of seven years and 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 Company's 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 Company's option. The interest rate on the term B loan outstanding at December 31, 2008 was equal to LIBOR plus 2.00%. The interest rates for any senior revolving credit facility borrowings are equal to either LIBOR plus 2.25% or Prime plus 1.25%, at the Company's option, and subject to reduction depending on the Company's leverage ratio. Cash paid for interest amounted to approximately $6.5 million and $6.3 million for the three months ended December 31, 2008 and 2007, respectively. In connection with the Merger and the related transactions on June 29, 2006 (the
8
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
4. Long-Term Debt (Continued)
"Transactions"), the Company issued $180.0 million of 11.25% senior subordinated notes due 2014 (the "senior subordinated notes").
The Company is exposed to changes in interest rates as a result of its outstanding variable rate debt. To reduce the interest rate exposure, the Company entered into interest rate swap agreements whereby the Company fixed the interest rate on approximately $221.2 million of its $335.0 million term B loan, effective as of August 31, 2006 and maturing on June 30, 2010 and fixed the interest rate on approximately $113.3 million of its remaining $335.0 million term B loan, effective as of August 31, 2007 and maturing on September 30, 2010. In total, as of December 31, 2008, the Company fixed the interest rate on approximately $312.9 million of its $326.6 million term B loan.
The table below provides information about the Company's interest rate swap agreements and remaining variable rate debt related to the term B loan.
The swap is a derivative and is accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The fair value of the swap agreements, representing the estimated amount that the Company would pay to a third party assuming the Company's obligations under the interest rate swap agreements terminated at December 31, 2008, was approximately $19.3 million, or approximately $11.5 million after taxes. The fair value of these agreements was determined based on pricing models and independent formulas using current assumptions.
Since the Company has the ability to elect different interest rates on the debt at each reset date, the hedging relationship does not qualify for use of the shortcut method under SFAS 133. Therefore, 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 consolidated balance sheets as other comprehensive loss.
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 Company's ability to incur additional debt, sell material assets, retire, redeem or otherwise reacquire capital stock, acquire the capital stock or assets of another business, pay dividends, and, in the case of the senior credit agreement, require the Company to meet or exceed certain financial ratios. At
9
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
4. Long-Term Debt (Continued)
December 31, 2008, management of the Company believes that the Company is in compliance with all covenants.
The priority with regard to the right of payment on the Company's debt is such that the senior credit facilities and the term loan mortgage have priority over all of the Company's long-term debt. The senior credit facilities are guaranteed by the Company's subsidiaries, except for the captive insurance subsidiary, and are secured by substantially all of the assets of the Company. The term loan mortgage facility is secured by certain buildings and land of the Company. The senior subordinated notes are guaranteed by the Company's subsidiaries, except for the captive insurance subsidiary. The results and operations of the captive insurance subsidiary are not material to the Company's consolidated results.
The consolidated balance sheets as of both December 31, 2008 and September 30, 2008 include deferred financing costs of approximately $22.8 million related to the 2006 refinancing: $3.2 million in current assets (under Prepaid expenses and other current assets) and $19.6 million at December 31, 2008 and $19.5 million at September 30, 2008 in other long-term assets (under Other assets). The Company incurred amortization expense of $0.8 million for both the three months ended December 31, 2008 and 2007, respectively. Amortization of these deferred financing costs is included in interest expense in the consolidated statements of operations.
5. Fair Value Measurements
SFAS No. 157, Fair Value Measurements (SFAS 157) defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. SFAS 157 applies to accounting pronouncements that require or permit assets or liabilities to be measured at fair value and does not expand the use of fair value in any new circumstances. In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-2, which delayed until the first quarter of 2010 the effective date of SFAS No. 157 for nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis.
The Company adopted SFAS 157 as of October 1, 2008 for financial assets and financial liabilities. There was no material impact on the Company's consolidated financial position and results of operations for the three months ended December 31, 2008. The Company is currently assessing the impact of SFAS 157 for nonfinancial assets and nonfinancial liabilities on the Company's consolidated financial position and results of operations.
10
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
5. Fair Value Measurements (Continued)
SFAS 157 establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values. The statement requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1: | Unadjusted quoted market prices in active markets for identical assets or liabilities. | |
Level 2: |
|
Unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted 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: |
|
Unobservable inputs for the asset or liability. |
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 management's 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.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The table below presents the liabilities measured at fair value on a recurring basis at December 31, 2008 categorized by the level of inputs used in the valuation of each liability.
(in thousands):
|
Total | Unadjusted Quoted Market Prices (Level 1) | Significant Other Observable Inputs (Level 2) | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Interest rate swap agreementsliability | $ | 19,282 | $ | | $ | 19,282 |
The Company's interest rate swap agreements qualify for hedge accounting treatment under SFAS 133 and have been designated as cash flow hedges. Hedge effectiveness testing indicates that the swaps are fully effective hedges and as such, the derivative mark-to-market adjustment is recorded to other comprehensive loss rather than recorded to the statements of operations. The full balance of accumulated other comprehensive loss is due to accounting for our interest rate swaps. The fair value of the swap agreements, representing the estimated amount that the Company would pay to a third party assuming the Company's obligations under the interest rate swap agreements terminated at December 31, 2008, was approximately $19.3 million, or approximately $11.5 million after taxes. The fair value of these agreements was determined based on pricing models and independent formulas using current assumptions.
The Company also adopted the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement No. 115 (SFAS 159) as of October 1, 2008. SFAS 159 allows the Company to choose to measure eligible assets and liabilities at fair value with changes in value recognized in earnings. Fair value treatment may be elected either
11
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
5. Fair Value Measurements (Continued)
upon initial recognition of an eligible asset or liability or, for an existing asset or liability, if an event triggers a new basis of accounting. The Company did not elect to re-measure any of its existing financial assets or liabilities under the provisions of SFAS 159.
6. Stock-Based Compensation
In connection with the Transactions, NMH Investment adopted a new equity-based plan and issued units of limited liability company interests consisting of Class B Units, Class C Units, Class D Units and Class E Units. The units are limited liability company interests and are available for issuance to the Company's employees and members of the Board of Directors for incentive purposes. As of December 31, 2008, there were 192,500 Class B Units, 202,000 Class C Units, 388,881 Class D Units and 6,375 Class E Units authorized for issuance under the plan.
The Class B Units vest over 61 months. Assuming continued employment of the employee with the Company, 40 percent vest at the end of 37 months from the grant date, and the remaining 60 percent vest monthly over the remainder of the term. Assuming continued employment, the Class C Units and Class D Units vest after three years, subject to certain performance conditions and/or investment return conditions being met or achieved in each of the first three years. The performance conditions relate to the Company achieving certain financial targets for the fiscal years ending September 30, 2007, 2008 and 2009, and the investment return conditions relate to Vestar receiving a specified multiple on its investment upon a liquidation event.
If an employee holder's employment is terminated, NMH Investment may repurchase the holder's units. If the termination occurs within 12 months after the relevant measurement date, all of the B units will be repurchased at the initial purchase price, or cost. If the termination occurs during the following four-year period, the proportion of the B units that may be purchased at fair market value will be determined depending on the circumstances of the holder's departure and the date of termination. From month 13 to month 60, if the holder is terminated without cause, or resigns for good reason, he or she is entitled to receive a higher proportion of the purchase price at fair market value than if he or she resigns voluntarily. This proportion increases ratably each month. For the C and D units, the holder is entitled to receive fair market value if he or she is terminated without cause or resigns for good reason or, after the third anniversary of the relevant measurement date, upon termination for any reason except for cause. Before the third anniversary, all the C and D units are callable at cost if the holder resigns without good reason. In the event of a termination for cause at any time, all of the units would be callable at cost. The Class E Units vest over time given continued service of the director as a member of the Board of Directors of the Company.
For purposes of determining the compensation expense associated with these grants, management valued the business enterprise using a variety of widely accepted valuation techniques which considered a number of factors such as the financial performance of the Company, the values of comparable companies and the lack of marketability of the Company's equity. The Company then used the option pricing method to determine the fair value of the units granted in fiscal 2007 and fiscal 2008.
The fair value of the units granted during fiscal 2007 was calculated using the following assumptions: a term of five years, which is based on the expected term in which the units will be
12
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
6. Stock-Based Compensation (Continued)
realized; a risk-free interest rate of 4.61%, which is the five-year U.S. federal treasury bond rate consistent with the term assumption; and expected volatility of 40%, which is based on the historical data of equity instruments of comparable companies.
The fair value of the units granted during fiscal 2008 was calculated using the following assumptions: a term of 3.5 years, which is based on the expected term in which the units will be realized; a risk-free interest rate of 2.81%, which is the 3.5 year U.S. federal treasury bond rate consistent with the term assumption; and expected volatility of 37%, which is based on the historical data of equity instruments of comparable companies.
The estimated fair value of the units, less an assumed forfeiture rate of 7.5%, will be recognized in expense in the Company's financial statements on a straight-line basis over the requisite service periods of the awards. For Class B and E Units, the requisite service period is five years, and for Class C and D Units, the requisite service period is three years. The assumed forfeiture rate is based on an average of the Company's historical forfeiture rates. The historical trend of forfeitures is deemed reasonable to use in determining expected forfeitures.
In accordance with SFAS 123(R), the Company recorded $0.5 million and $0.3 million of stock-based compensation expense for the three months ended December 31, 2008 and 2007, respectively. Stock-based compensation expense is included in general and administrative expense in the accompanying consolidated statements of operations. The summary of activity under the plan is presented below:
(in thousands)
|
Units
Outstanding |
Weighted Average
Grant-Date Fair Value |
|||||
---|---|---|---|---|---|---|---|
Nonvested balance at September 30, 2008 | 757,971 | $ | 6.94 | ||||
Granted | | | |||||
Forfeited | (7,606 | ) | 7.78 | ||||
Vested | | | |||||
Nonvested balance at December 31, 2008 | 750,365 | $ | 7.01 | ||||
As of December 31, 2008, there was $1.5 million of total unrecognized compensation expense related to the units. These costs are expected to be recognized over a weighted average period of 3.5 years. For purposes of this table above, no units were vested as of December 31, 2008 such that value was realized, as NMH Investment could repurchase at cost the units of any employee who terminated his or her employment voluntarily up to that date. However, in most cases, if an employee is terminated without cause or resigns for good reason, he or she is entitled to receive fair market value for a portion of his or her units, calculated in accordance with the applicable Management Unit Subscription Agreement.
7. Income Taxes
The Company's effective income tax rate for the interim periods was based on management's estimate of the Company's effective tax rate for the applicable year and differs from the federal
13
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
7. Income Taxes (Continued)
statutory income tax rate primarily due to nondeductible permanent differences such as meals and nondeductible compensation. For the three months ended December 31, 2008, the Company's effective income tax rate was 1.5% compared to an effective tax rate of (24.6)% for the three months ended December 31, 2007. The change in the effective tax rate was primarily due to the benefit on the increased loss from continuing operations before 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 Company's policy is to recognize interest and penalties related to unrecognized tax benefits as income tax.
8. Discontinued Operations and Assets Held for Sale
The Company has adopted a plan to sell REM Health, Inc., REM Health of Wisconsin, Inc., and REM Health of Iowa, Inc. (together, "REM Health") in fiscal 2009. Assets held for sale are recorded at the lower of their carrying amount or their fair value less cost to sell. In the first quarter of fiscal 2009, the Company recorded a pre-tax impairment charge of $0.3 million, related to the write-down of the REM Health assets to their fair value less cost to sell.
The REM Health assets classified as held for sale at December 31, 2008 are summarized as follows:
(in thousands)
|
|
|||
---|---|---|---|---|
Assets |
||||
Goodwill and other intangibles |
$ | 4,838 | ||
Property and equipment |
178 | |||
Other assets |
24 | |||
Total assets held for sale |
$ | 5,040 | ||
REM Health's assets to be sold are immaterial to the Company and, as a result, are not reported separately as assets held for sale on the consolidated balance sheets.
The operations of REM Health have been presented as discontinued operations on the consolidated statements of operations and the prior periods have been reclassified. Income from discontinued operations, net of tax, for the three months ended December 31, 2008 includes the $0.3 million impairment charge. The components of the REM Health discontinued operations for the three month periods ended December 31, 2008 and 2007 are summarized as follows:
(in thousands)
|
2008 | 2007 | |||||
---|---|---|---|---|---|---|---|
Net revenues |
$ | 5,790 | $ | 5,294 | |||
(Loss) income before income tax |
(32 | ) | 185 |
14
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
9. Segment Information
In accordance with the criteria of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS 131), the Company's Human Services segment is the only reportable segment. The Human Services segment provides home and community-based human services to adults and children with intellectual and/or developmental disabilities, to youth with emotional, behavioral and medically complex challenges, and to individuals in specific markets with acquired brain injuries. Human Services is organized in a reporting structure composed of two operating groups. The two operating groups are aggregated into one reportable segment under SFAS 131 based on similarity of the economic characteristics of the groups.
The column entitled "Other" in the table below is composed of a mix of health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. The operations included in the "Other" column do not qualify as reportable segments under SFAS 131. Activities classified as "Corporate" in the table below relate primarily to unallocated home office items.
The Company generally evaluates the performance of its operating groups based on income from operations. Segment disclosures for the three months ended December 31, 2007 have been restated to reflect the change in the composition of the Company's reportable operating segment effective October 1, 2008. The following is a financial summary by reportable segment for the periods indicated.
Three Months Ended December 31,
|
Human Services | Other | Corporate | Consolidated | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(in thousands)
|
|
|
|
|
|||||||||
2008 |
|||||||||||||
Net revenue |
$ | 220,234 | $ | 20,999 | $ | | $ | 241,233 | |||||
Income from operations |
19,447 | 2,920 | (11,879 | ) | 10,488 | ||||||||
Total assets |
855,640 |
92,960 |
49,715 |
998,315 |
|||||||||
2007 |
|||||||||||||
Net revenue |
$ | 212,644 | $ | 19,461 | $ | | $ | 232,105 | |||||
Income from operations |
19,450 | 2,692 | (10,179 | ) | 11,963 | ||||||||
Total assets |
868,172 |
90,088 |
51,079 |
1,009,339 |
10. Accruals for Self-Insurance and Other Commitments and Contingencies
The Company maintains employment practices liability, professional and general liability, workers' compensation, automobile liability and health insurance policies 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, 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
15
National Mentor Holdings, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
December 31, 2008
(Unaudited)
10. Accruals for Self-Insurance and Other Commitments and Contingencies (Continued)
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.
Beginning November 1, 2005, the Company's self-insured portion of professional and general liability claims was transferred into the Company's wholly-owned subsidiary captive insurance company. The captive insurance company also provides coverage for the Company's employment practices liability beginning October 1, 2007. The accounts of the captive insurance company are fully consolidated with those of the other operations of the Company in the accompanying consolidated financial statements.
The Company issued approximately $23.5 million in standby letters of credit as of December 31, 2008 related to the Company's workers' compensation insurance coverage. These letters of credit are secured by the $20.0 million synthetic letter of credit facility. The availability under our senior secured revolving credit facility was reduced by $3.5 million as letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding.
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 independently contracted host-home caregivers (called "Mentors"), or its employees failed to provide proper care for a client, as well as claims by the Company's clients, Mentors, employees or community members against the Company for negligence, intentional misconduct or violation of applicable law. Included in the Company's recent claims are claims alleging personal injury, assault, battery, abuse, wrongful death and other charges. Regulatory agencies may initiate administrative proceedings alleging that the Company's 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 Company's estimates.
11. Subsequent Events
During the second quarter of fiscal 2009, the Company paid a dividend to NMH Holdings, Inc. ("NMH Holdings"), and NMH Holdings used the proceeds of the dividend to repurchase an aggregate principal amount of $13.9 million of its senior floating rate toggle notes due 2014 (the "NMH Holdings notes"). In addition, during the second quarter, the Company also agreed to purchase an aggregate principal amount of $11.5 million of the NMH Holdings notes, which it plans to hold.
16
Item 2. Management's 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 condensed 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 ("ABI"); and to youth with emotional, behavioral and medically complex challenges ("ARY"). As of December 31, 2008, we provided our services to approximately 23,000 clients in 35 states and the District of Columbia through approximately 16,800 full-time equivalent employees. Most of our services involve residential support, typically in small group homes, 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 revenues from state and county governmental payors, as well as smaller amounts from private sector payors, mostly in our ABI services.
The largest part of our business is the delivery of services to adults and children with 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 treatment and care services to adults and children with an acquired brain injury and other catastrophic injuries and illnesses. Our ABI 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.
Prior to this quarter, we operated our business in two operating groups and aggregated those two groups as one reportable segment, described as Human Services. Effective October 1, 2008, we began managing the majority of our services to individuals with acquired brain injuries and other catastrophic injuries and illnesses separately from the other services provided by the two operating groups which include services to adults and children with intellectual and/or developmental disabilities, youth with emotional, behavioral and medically complex challenges, and to individuals in specific markets with acquired brain injuries. As a result, we changed the composition of our reportable segment in accordance with SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information (SFAS 131) to reflect our one reportable segment, Human Services, and an Other category. Human Services continues to consist of two operating groups which are aggregated under SFAS 131 based on the similarity of the economic characteristics of the groups. The Other category consists of a mix of health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. The operations included in the Other category do not qualify as reportable segments under SFAS 131. Operating segment performance is evaluated primarily based on income from operations.
As detailed in note 1 in the consolidated financial statements included elsewhere in this report, on June 29, 2006, we were merged with a wholly owned subsidiary of NMH Investment. The Merger was accounted for under the purchase method of accounting in accordance with Financial Accounting Standard No. 141, Business Combinations (SFAS 141). Under purchase accounting, fixed assets and
17
identifiable intangible assets acquired and liabilities assumed are recorded at their respective fair values. We have accounted for the Merger in accordance with Staff Accounting Bulletin No. 54, Push Down Accounting (SAB 54), whereby NMH Holdings, LLC has "pushed down" the purchase price in revaluing our assets and liabilities.
Factors affecting our operating results
Demand for Home and Community-Based Human Services
Our growth in revenues has been directly 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 I/DD individuals, 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 and, therefore, the amount of residential and non-residential I/DD programs offered by governments in our markets. Similarly, our ARY service line has been driven by favorable demographics. In addition, demand for our ABI services has been increased by increased life expectancy resulting from faster emergency response and improved medical techniques that have resulted in more people surviving an ABI.
Political trends can also affect our operations. In particular, budgetary changes can influence the overall level of payments for our services, the number of clients and the preferred settings for many of the services we provide. 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 service line has been positively affected by the trend toward privatization of 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 ABI.
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 can 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 December 31, 2008, losses on new program starts for programs started within the last 18 months that generated operating losses were $4.6 million.
18
Acquisitions
As of December 31, 2008, we have completed more than 25 acquisitions since 2003, including several acquisitions of rights to government contracts or fixed assets from small providers, which we refer to as "tuck-in" acquisitions. We have pursued larger strategic acquisitions in markets with significant opportunities.
We also "cross-sell" new services in existing markets. Depending on the nature of the program and the state or local government involved, we will seek new programs through either unsolicited proposals to government agencies or by responding to a request, generally known as a request for proposal, from a public sector agency.
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 revenues
Revenues are reported net of allowances for unauthorized sales, expected sales adjustments by business units and changes in the allowance for doubtful accounts. Revenues are also reported net of any state provider taxes or gross receipts taxes levied on services we provide. For the three months ended December 31, 2008, we derived more than 90% of our net revenues from states, counties or regional entities (e.g., Departments of Mental Retardation). 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 revenues are 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 revenues may be affected by adjustments to our billed rates as well as write-offs of previously billed amounts. Revenues in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be proposed in states where we operate or by the federal government which provides matching funds. We cannot determine the impact of such changes or the effect of any possible governmental actions.
Occasionally, timing of payment streams may be affected by delays by the state related to bill processing systems, staffing or other factors. While these delays have historically impacted our cash position in particular periods, they have not resulted in long-term collections problems.
Expenses
Expenses directly related to providing services are classified as cost of revenues. 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 and 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.
19
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 December 31, 2008, we owned 413 facilities and two offices, and we leased 867 facilities and 273 offices. Many of our leased facilities, which are comprised primarily of group homes, are operated under leases with terms of less than two years. 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 approximately 0.4% and 0.3% of our net revenues for the three months ended December 31, 2008 and 2007, respectively. We have incurred professional and general liability claims and insurance expense for professional and general liability of $0.9 million and $0.8 million for the three months ended December 31, 2008 and 2007, respectively. We currently insure through our captive subsidiary 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 captive subsidiary employment practices liability claims of up to $240,000 per claim and up to $1.0 million in the aggregate.
Our cost of net revenues as a percentage of revenues for our different services may vary, with our ABI services, generally, having the highest margin (or lowest costs as a percentage of revenues). 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 the first quarter of fiscal 2009, we invested in our infrastructure initiatives and business process improvements, which had a negative impact on our margin. If we choose to continue to invest in our infrastructure initiatives and business process improvements our margin will continue to be negatively impacted.
Highlights from the Quarter
Results of Operations
|
Three Months Ended
December 31, |
|||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
Revenue: |
||||||||
Human Services |
$ | 220,234 | $ | 212,644 | ||||
Other |
20,999 | 19,461 | ||||||
Corporate |
| | ||||||
Consolidated |
$ | 241,233 | $ | 232,105 | ||||
Income (loss) from operations: |
||||||||
Human Services |
$ | 19,447 | $ | 19,450 | ||||
Other |
2,920 | 2,692 | ||||||
Corporate |
(11,879 | ) | (10,179 | ) | ||||
Consolidated |
$ | 10,488 | $ | 11,963 | ||||
20
Consolidated
Consolidated revenue for the three months ended December 31, 2008 increased 3.9% compared to consolidated revenue for the three months ended December 31, 2007. The increase in revenue was primarily related to organic growth of $8.1 million, including growth related to new programs that began operations during fiscal 2008 and the first quarter of fiscal 2009, in our Human Services segment and the Other category. In addition, our Human Services segment experienced growth in revenue of $3.1 million relating to Transitional Services, Inc. ("TSI"), which we acquired during the fourth quarter of fiscal 2008.
Consolidated income from operations for the three months ended December 31, 2008 was $10.5 million, compared to $12.0 million for the three months ended December 31, 2007. Consolidated operating margins were 4.3% and 5.2% for the three months ended December 31, 2008 and 2007, respectively. The decreases in income from operations and in operating margins were primarily due to increased investment in growth initiatives in our Human Services segment as well as increased investment in business process improvements and growth initiatives in Corporate.
Interest expense increased $0.3 million for the three months ended December 31, 2008 compared to the three months ended December 31, 2007. The increase in interest expense was primarily the result of approximately $0.4 million of interest expense related to borrowings under our senior secured revolving credit facility, partially offset by a decrease in our outstanding debt and our weighted average interest rates. During the three months ended December 31, 2008, we borrowed $40.0 million from our senior secured revolving credit facility and repaid the amount in full prior to the quarter end. The operations of REM Health have been presented as discontinued operations on the consolidated statements of operations and the prior periods have been reclassified. Income from discontinued operations for the three months ended December 31, 2008 included a $0.3 million impairment charge. Our effective income tax rate for the three months ended December 31, 2008 was 1.5% as compared to (24.6)% for the three months ended December 31, 2007. The change in the effective tax rate was due to the benefit on our loss before income taxes.
Human Services
Human Services revenue for the three months ended December 31, 2008 increased by 3.6% compared to the three months ended December 31, 2007. The increase was due mostly to organic growth of $6.6 million, which included growth related to new programs that began operations during fiscal 2008 and the first quarter of fiscal 2009. In addition, the acquisition of TSI contributed additional revenue growth of $3.1 million. Human Services revenue growth was partially offset by a reduction in revenue of approximately $2.1 million from businesses we divested in fiscal 2008. Operating margin decreased from 9.1% during the three months ended December 31, 2007 to 8.8% during the three months ended December 31, 2008. The decrease in operating margin was primarily due to an increase in growth initiatives in the current quarter.
Other
Included in the Other category are our health care and community-based human services to individuals with acquired brain injuries and other catastrophic injuries and illnesses. Revenue for the Other category during the three months ended December 31, 2008 increased by 7.9% compared to the three months ended December 31, 2007. This increase was due primarily to organic growth of $1.5 million, which included growth related to new programs that began operations during fiscal 2008 and the first quarter of fiscal 2009. Operating margin remained relatively consistent at 13.8% for the three months ended December 31, 2007 as compared to 13.9% for the three months ended December 31, 2008.
21
Corporate
Corporate represents corporate general and administrative expenses. Total corporate expense increased by approximately $1.7 million, or 16.7% from the three months ended December 31, 2007 to $11.9 million for the three months ended December 31, 2008. The increase was primarily due to increased investment in business process improvements and growth initiatives, as well as, additional stock based compensation expense.
Liquidity and Capital Resources
Our principal uses of cash are to meet working capital requirements, to fund debt obligations and to finance capital expenditures and acquisitions. Cash flows from operations have historically been sufficient to meet these cash requirements.
Cash flows provided by operating activities for the three months ended December 31, 2008 were $14.2 million compared to $15.5 million for the three months ended December 31, 2007. The decrease from the three months ended December 31, 2007 to the three months ended December 31, 2008 was primarily due to a decrease in operating income. Our days sales outstanding decreased approximately two days from 45.8 days at September 30, 2008 to 44.1 days at December 31, 2008.
Net cash used in investing activities, primarily consisting of cash paid for acquisitions and purchases of property and equipment, was $23.8 million for the three months ended December 31, 2008 compared to $9.0 million for the three months ended December 31, 2007.
Cash paid for acquisitions for the three months ended December 31, 2008 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 approximately $0.9 million. Cash paid for acquisitions for the three months ended December 31, 2007 was $5.7 million, primarily reflecting the earnout payment of $5.5 million associated with the CareMeridian acquisition.
Investing activities also included the purchase of property and equipment. Cash paid for property and equipment was $11.0 million, or 4.6% of net revenues, for the three months ended December 31, 2008, compared to $3.6 million, or 1.5% of net revenues, for the three months ended December 31, 2007. Approximately $4.3 million of cash paid for property and equipment for the three months ended December 31, 2008 was related to the purchase of real estate and approximately $0.8 million was related to the implementation of a new billing system.
Net cash used in financing activities was $1.1 million for the three months ended December 31, 2008 compared to $1.0 million for the three months ended December 31, 2007. Our financing activities primarily included the repayment of long term debt of $0.9 million for the three months ended December 31, 2008 and 2007.
On October 14, 2008, we borrowed $40.0 million of funds from the senior secured revolving credit facility and we repaid the entire amount on December 31, 2008. At December 31, 2008, we have an available capacity of approximately $121.5 million remaining under the revolving credit facility.
During the second quarter of fiscal 2009, we paid a dividend to NMH Holdings, Inc. ("NMH Holdings"), and NMH Holdings used the proceeds of the dividend to repurchase an aggregate principal amount of $13.9 million of its senior floating rate toggle notes due 2014 (the "NMH Holdings notes"). We also agreed to purchase an aggregate principal amount of $11.5 million of the NMH Holdings notes. As a result, as of February 17, 2009, the aggregate principal amount of the NMH Holdings notes outstanding is $191.8 million, $11.5 million of which will be held by us. 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 sole discretion of our Board of Directors and management and will depend on market conditions, prices, contractual restrictions, our liquidity and other factors.
22
Contractual Commitments Summary
The following table summarizes our contractual obligations and commitments as of December 31, 2008:
(in thousands)
|
Total |
Less than
1 year |
1-3 years | 3-5 years |
More than
5 years |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Long-term debt obligations(1) | $ | 510,979 | $ | 3,735 | $ | 10,669 | $ | 316,575 | $ | 180,000 | ||||||
Operating lease obligations(2) | 122,069 | 32,362 | 46,583 | 25,272 | 17,852 | |||||||||||
Capital lease obligations | 1,939 | 177 | 164 | 131 | 1,467 | |||||||||||
Standby letters of credit | 23,518 | 23,518 | | | | |||||||||||
Total obligations and commitments(3) | $ | 658,505 | $ | 59,792 | $ | 57,416 | $ | 341,978 | $ | 199,319 | ||||||
Off-balance sheet arrangements
We have no significant 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 accounting principles generally accepted in the United States ("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
Revenues are reported net of any state provider taxes or gross receipts taxes levied on services we provide. Revenues are 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. We follow Staff
23
Accounting Bulletin 104, Revenue Recognition (SAB 104), which requires that revenue can only be recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectibility is probable.
We recognize revenues for services performed pursuant to contracts with various state and local government agencies and private health care agencies as follows: cost-reimbursement contract revenues are recognized at the time the service costs are incurred and units-of-service contract revenues are 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. Revenues 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 statement of operations in the period of the change in estimate.
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 actuarially determined estimates. Accruals relating to prior periods are periodically reevaluated and increased or decreased based on new information. As such, these changes in estimates are recorded as charges or credits to the statement of operations in a period subsequent to the change in estimate.
Goodwill and Intangible Assets
Pursuant to SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142), 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. We use a fair value approach to test goodwill for impairment and recognize an impairment charge for the amount, if any, by which the carrying amount of goodwill exceeds fair value. 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 intangible asset were less than its carrying value, an impairment loss would be recognized in an amount equal to the difference. Fair values are established using discounted cash flow and comparative market multiple
24
methods. We conduct our annual impairment test on July 1 of each year, and as of the date of the last test, there was no impairment and there have been no indicators of impairment since the date of the test.
Discounted cash flows are based on management's estimates of our future performance. As such, actual results may differ from these estimates and lead to a revaluation of our goodwill and 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 would be recorded in the statement of operations in the period of the change in estimate.
Pursuant to SFAS No. 141, Business Combinations (SFAS 141), assets acquired and liabilities assumed are recorded at their respective fair values.
Impairment of Long-Lived Assets
Pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), 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 in accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109). Under SFAS 109, the asset and liability method is used in accounting for income taxes. 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.
On October 1, 2007, the Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN 48), which clarifies the criteria that a tax position must satisfy for some or all of the benefits of that position to be recognized in an enterprise's financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold of more-likely-than-not and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
Stock-Based Compensation
The Company adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payments (SFAS 123(R)), to account for share-based payments to employees. NMH Investment adopted an equity-based 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 valued 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;
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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 based 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 being recognized in expense on a straight-line basis over the requisite service/performance periods of the awards.
Derivative Financial Instruments
We account for derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), which requires that all derivative instruments be reported on the balance sheet at fair value and establishes 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 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 sheet.
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.
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
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limited to, those factors or conditions described under "Item 1A. Risk Factors" in this report as well as the following:
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, we do not assume responsibility for the accuracy and completeness of the forward-looking statements. All written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the "Risk Factors" and other cautionary statements included herein. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to changes in interest rates as a result of our outstanding variable rate debt. To reduce our interest rate exposure, we entered into interest rate swap agreements whereby we fixed the interest rate on approximately $221.2 million of our $335.0 million term B loan, effective as of August 31, 2006 and maturing on June 30, 2010 and fixed the interest rate on approximately $113.3 million of our remaining $335.0 million term B loan, effective as of August 31, 2007 and maturing on September 30, 2010. In total, as of December 31, 2008, we fixed the interest rate on approximately $312.9 million of our $326.6 term B loan.
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The table below provides information about the Company's interest rate swap agreements and remaining variable rate debt related to the term B loan.
As a result of the interest rate swap agreements, the variable rate debt outstanding was effectively reduced from $331.0 million outstanding to $18.0 million outstanding at December 31, 2008. The variable rate debt outstanding relates to the term 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 2.25% or Prime plus 1.25%, subject to reduction depending on our leverage ratio, and the term loan mortgage, which has an interest rate based on Prime plus 1.50%. An increase in the interest rate by 100 basis points on the debt balance outstanding as of December 31, 2008, would increase annual interest expense by approximately $0.2 million.
Item 4. Controls and Procedures
None.
Item 4T. 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 December 31, 2008, the end of the period covered by this Quarterly Report on Form 10-Q, our management, with the participation of our Chief Executive Officer and Chief 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 Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2008, 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, 2008.
As reported in Item 9A(T) of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, our management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of September 30, 2008 (the last management's 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,
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management identified material weaknesses in our internal control over financial reporting as of September 30, 2008.
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 recognition and our fixed asset balances, as detailed below:
Revenue
We are currently developing an approach to assess contract terms in each state to ensure that our revenue recognition policy is being consistently and appropriately interpreted and applied. We are also beginning to implement a new system and processes that are expected to ultimately improve our ability to identify and reserve for unauthorized sales. During the three months ended December 31, 2008 we continued implementation of the new system.
Fixed Assets
We are continuing to implement processes to maintain and evaluate our fixed asset balances, which as designed, should provide adequate controls.
In the three months ended September 30, 2008, we introduced a new billing and accounts receivable system in certain states. As discussed above, in the three months ended December 31, 2008, we continued to implement a new billing and accounts receivable system in several states. The implementation of this billing and accounts receivable system will affect the processes that impact our internal control over financial reporting. As we continue with the system implementation, we will review the related controls and may take further steps to ensure that they are effective and integrated appropriately.
Except for the changes related to implementation of our new billing and accounts receivable system, during the quarter ended December 31, 2008, 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.
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We are in the human services business and, therefore, we have been and continue to be subject to claims alleging that we, our Mentors or our employees failed to provide proper care for a client. We are also subject to claims by our clients, our Mentors, our employees 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 "Item 1A. Risk Factors" and "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information.
Current credit and financial markets conditions could have a material adverse effect on our cash flows, liquidity and financial condition.
Due to the widespread and ongoing tightening of the credit markets, our government payors could be delayed in obtaining, or may not be able to obtain, necessary funding and/or financing to meet their cash-flow needs, and may not be able to pay us for our services until they collect sufficient tax revenues. Delays of this nature could have a material adverse effect on our cash flows, liquidity and financial condition. In addition, in the event that our payors delay payments to us, our financial condition could be further impaired if we are unable, under our senior credit agreement, to borrow funds to finance our operations.
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 revenues and profitability.
We derive substantially all of our revenues 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 dollars ranging from 50% to more than 77% of total costs, a number based largely on a state's per capita income. Our revenues, therefore, are determined by the size 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 revenues, margins and profitability and adversely affect our growth strategy. If the current economic crisis continues, we expect budgetary pressure on federal, state and local governments to increase, and, as a result, certain appropriations could be reduced. 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
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legislation. Many states in which we operate have experienced budgetary pressures from time to time and, during these times, some of these states have initiated service reductions, rate freezes and/or rate reductions. 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.
Failure to obtain increases in reimbursement rates could adversely affect our revenues, cash flows and profitability.
Our revenues 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. Approximately 13% 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 variable cost structure is directly related to our labor costs, which may be adversely affected by labor shortages or deterioration in labor relations.
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. Some of our operating units 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.
Our employees are generally not unionized. However, as of December 31, 2008, eighteen of our employees were represented by a labor union. We may not be able to negotiate labor agreements on satisfactory terms with our existing or any future labor unions. In addition, future unionization activities may result in an increase of our labor and other costs. If any of the employees covered by collective bargaining agreements 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.
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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 December 31, 2008, we had total indebtedness of approximately $512.9 million and $121.5 million of availability under our senior secured revolving credit facility. 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 secured revolving credit facility was reduced from $125.0 million as letters of credit in excess of $20.0 million under our synthetic letters of credit facility were outstanding.
Our substantial degree of leverage could have important consequences, including the following:
In addition to our indebtedness noted above, our indirect parent company, NMH Holdings had $205.7 million aggregate principal amount of senior floating rate toggle notes due 2014 outstanding as of December 31, 2008, or $191.8 million outstanding as of February 17, 2009 ($11.5 million of which will be 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, 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 to be 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 $30.7 million. NMH Holdings currently expects to elect to pay entirely by increasing the principal amount of the NMH Holdings notes or issuing new notes ("PIK Interest") through June 15, 2012.
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 three months ended December 31, 2008, our aggregate rental payments for these leases, including taxes and
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operating expenses, was approximately $10.1 million. These obligations could further increase the risks described above.
Covenants in our debt agreements restrict our business in many ways.
The senior secured credit facilities, the indenture 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:
The senior secured credit facilities also contain restrictive covenants and require 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 Mentors or our employees failed to provide proper care for a client, as well as claims by our clients, our Mentors, our employees 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.
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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 secured revolving credit facility, a portion of our borrowings under the senior secured term loan facility, 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 December 31, 2008, we had approximately $18.0 million of floating rate debt outstanding after giving effect to interest rate swaps. As of December 31, 2008, NMH Holdings had $203.6 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 approximately $0.2 million, and a 1% increase in the interest rate on the NMH Holdings notes would have increased NMH Holdings' interest expense on those notes by approximately $2.0 million. If interest rates increase dramatically, NMH Holdings and the Company and its subsidiaries could be unable to service their debt.
The nature of services that we provide could subject us to significant workers' compensation related liability, some of which may not be fully reserved for.
We use a combination of insurance and self-insurance plans to provide for potential liability for workers' compensation claims. Because of our high ratio of employees per client, and because of the inherent physical risk associated with the interaction of employees with I/DD, ARY and ABI clients, the potential for incidents giving rise to workers' compensation liability is relatively high.
We estimate liabilities associated with workers' compensation risk and establish reserves each quarter based on internal valuations, third-party actuarial advice, historical loss development factors and other assumptions believed to be reasonable under the circumstances. Our results of operations could be adversely impacted if actual future 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 violated any applicable laws or regulations, our revenues may decrease, we may be subject to fines or penalties and we may be required to restructure our billing and collection methods.
We derive virtually all of our revenues from state and local government agencies, and a substantial portion of these revenues 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:
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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 revenues are 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 retroactively return fees paid to us. 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 the 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 revenues.
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.
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 depends 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 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.
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We face substantial competition in attracting and retaining experienced personnel, and we may be unable to maintain or grow our business if we cannot attract and retain qualified employees.
Our success depends to a significant degree on our ability to attract and retain qualified and experienced human service 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:
As a result of these risks, there can be no assurance that any future acquisition will be successful or that it will not have a material adverse effect on our financial condition and results of operations.
A loss of our status as a licensed service provider in any jurisdiction could result in the termination of existing services and our inability to market our services in that jurisdiction.
We operate in numerous jurisdictions and are required to maintain licenses and certifications in order to conduct our operations in each of them. Each state and local government has its own regulations, which can be complicated, and each of our service lines can be regulated differently within a particular jurisdiction. As a result, maintaining the necessary licenses and certifications to conduct our
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operations can be cumbersome. Our licenses and certifications could be suspended, revoked or terminated for a number of reasons, including:
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 revenues 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 revenues, 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 ("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 9AT of our Annual Report on Form 10-K for the fiscal year ended September 30, 2008, we identified material weaknesses in our internal control over financial reporting. Management concluded that as of September 30, 2008, our internal control over financial reporting was not effective and, as a result, our disclosure controls and procedures were not effective. Descriptions of
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the material weaknesses are included in Item 4T of our quarterly report on Form 10-Q. While we have taken action and continue to take actions to remediate our identified material weaknesses, our new policies and procedures, when 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. We expect that the implementation of our new billing and accounts receivable system will affect a number of processes that impact our internal control over financial reporting; however we may identify additional material weaknesses or significant deficiencies in connection with this implementation. A failure to remedy our material weaknesses in internal control over financial reporting could result in material misstatements in our financial statements. Moreover, our conclusion that our internal control over financial reporting and disclosure controls and procedures are not effective, and any future disclosures of additional material 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 revenues and profitability.
38
Regulations that require ARY services to be provided through not-for-profit organizations could harm our revenues or gross margin.
Approximately 3% of our net revenues for the three months ended December 31, 2008 were 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 have 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 Edward Murphy, our President and 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.
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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 three months ended December 31, 2008, approximately 16% of our revenues were generated from contracts with government agencies in the state of Minnesota. Accordingly, any reduction in Minnesota's 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. In the past, our operations in Minnesota were subject to rate reductions, although recently we have received rate increases. 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:
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 executive 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.
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, collection and payment 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, if a flu pandemic were to occur we could suffer significant losses to our client population and, at a high cost, be required to hire replacement staff and
40
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. 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 or of NMH Investment, LLC were sold during the three months ended December 31, 2008.
Repurchases of Equity Securities
No equity securities of the Company were repurchased during the three months ended December 31, 2008.
The following table sets forth information in connection with repurchases made by NMH Investment of its common equity units during the quarterly period ended December 31, 2008:
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(a) Class and
Total Number of Units Purchased |
(b) Average Price
Paid per Unit |
(c) Total Number
of Units Purchased as Part of Publicly Announced Plans or Programs |
(d) Maximum
Number (or Approximate Dollar Value) of Shares (or Units) that May Yet be Purchased Under the Plans or Programs |
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Month #1 (October 1, 2008 through October 31, 2008) |
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Month #2 (November 1, 2008 through November 30, 2008) |
3,950.00 A Units | $ | 10.00 | | N/A | ||||||||
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2,406.25 B Units | $ | 0.05 | | N/A | ||||||||
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2,525.00 C Units | $ | 0.03 | | N/A | ||||||||
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2,675.00 D Units | $ | 0.01 | | N/A | ||||||||
Month #3 (December 1, 2008 through December 31, 2008) |
| | | |
We did not repurchase any of our common stock as part of an equity repurchase program during the first quarter of fiscal 2009. NMH Investment purchased all of the units listed in the table from certain of our employees upon their departures.
Item 3. Defaults Upon Senior Securities
None.
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Item 4. Submission of Matters to a Vote of Security Holders
On December 1, 2008, by consent in lieu of annual meeting, the Company's sole stockholder voted to fix the number of directors on the Board of Directors at six and to elect the following persons as directors: James L. Elrod, Jr., Pamela F. Lenehan, Kevin A. Mundt, Edward M. Murphy, Daniel S. O'Connell and Gregory T. Torres.
None.
The Exhibit Index is incorporated herein by reference.
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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. | ||||
February 17, 2009 |
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By: |
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/s/ EDWARD M. MURPHY Edward M. Murphy |
Its: | President and Chief Executive Officer | |||
February 17, 2009 |
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By: |
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/s/ DENIS M. HOLLER Denis M. Holler |
Its: |
Executive Vice President, Chief Financial
Officer and Treasurer |
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Exhibit No.
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Description |
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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") | |||
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3.2 |
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By-Laws of National Mentor Holdings, Inc. |
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Incorporated by reference to Exhibit 3.2 of the March 2007 10-Q |
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10.1 |
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Form of Amended and Restated Severance and Noncompetition Agreement dated December 31, 2008. |
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Filed herewith |
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10.2 |
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First Amendment to Amended and Restated Employment Agreement dated December 31, 2008 between National Mentor Holdings, Inc. and Gregory Torres. |
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Filed herewith |
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10.3 |
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Amended and Restated Employment Agreement dated December 30, 2008 between National Mentor Holdings, Inc. and Edward Murphy. |
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Filed herewith |
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31.1 |
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Certification of principal executive officer. |
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Filed herewith |
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31.2 |
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Certification of principal financial officer. |
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Filed herewith |
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32 |
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Certifications furnished pursuant to 18 U.S.C. Section 1350. |
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Filed herewith |
44
Exhibit 10.1
AMENDED AND RESTATED
SEVERANCE AND NONCOMPETITION AGREEMENT
This SEVERANCE AND NONCOMPETITION AGREEMENT ( Agreement ), originally made as of June 29, 2006 by and between National Mentor Holdings, Inc., a Delaware corporation, (the Company ), and [NAME] ( Executive ), is hereby amended and restated dated December 31, 2008 and effective January 1, 2009.
WHEREAS, an Agreement and Plan of Merger (the Merger Agreement ) was previously entered into by and among NMH Holdings, LLC, a Delaware limited liability company ( Parent ), NMH Mergersub, Inc. a Delaware corporation wholly owned by Parent, and National Mentor Holdings, Inc., a Delaware corporation, pursuant to which the Company became a wholly owned subsidiary of Parent;
WHEREAS, obtaining the Executives promise to be bound by the restrictive covenants set forth in this Agreement was a significant factor in the decision of the Parent to enter into the Merger Agreement, and in connection therewith the restrictive covenants set forth in Section 3 of this Agreement are necessary to protect the Parents and the Companys legitimate business interests;
WHEREAS, as consideration to induce the Executive to comply with the restrictive covenants set forth in this Agreement, the Company shall continue to employ Executive as an at-will employee and provide the severance payments described in this Agreement; and
WHEREAS , the parties hereto have agreed that it is mutually beneficial to amend and restate the Agreement effective January 1, 2009 to comply with the requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the Code);
NOW THEREFORE, in consideration of the foregoing, and of mutual covenants and agreements hereinafter set forth, and intending to be legally bound, the parties hereto hereby agree as follows:
2
3
4
5
6
7
8
9
All payments due to Executive hereunder shall be subject to all applicable taxes required to be withheld by the Company pursuant to federal, state or local law. Executive shall be solely responsible for income and earnings taxes imposed on Executive by reason of any cash or non-cash compensation and benefits provided hereunder. No person connected with this Agreement, including but not limited to the Company, or its officers, directors, agents or employees, makes any representation, commitment or guarantee with respect to the Federal, state or local income, estate and/or gift tax treatment of any benefit paid hereunder including, without limitation, under Section 409A of the Code.
National Mentor Holdings, Inc.
c/o Vestar Capital Partners
245 Park Avenue, 41st Floor
New York, NY 10167
Attn: General Counsel
Telecopy: (212) 808-4922
with a copy to:
National Mentor Holdings, Inc.
10
313 Congress Street
Boston, MA 02210
Attn: General Counsel
Telecopy: (617) 790-4 271
11
[Signatures on next page.]
12
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of December 31, 2008.
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NATIONAL MENTOR HOLDINGS, INC. |
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By: |
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Edward M. Murphy |
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President and Chief Executive Officer |
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Executive: |
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[NAME] |
13
Exhibit 10.2
NATIONAL MENTOR HOLDINGS, INC.
Amended and Restated Employment Agreement
with
Gregory Torres
FIRST AMENDMENT
THIS FIRST AMDENDMENT is entered into as of the 31 st day of December 2008 between National Mentor Holdings, Inc. (the Company) and Gregory Torres (the Employee).
Recitals
(i) The parties entered into an amended and restated employment agreement dated June 29, 2006 (the Agreement);
(ii) Section 12 of the Agreement reserves to the parties the right to modify or amend the Agreement by written instrument signed by both the Company and the Employee; and
(iii) The Company and the Employee desire to amend the Agreement to conform to the requirements of Internal Revenue Code § 409A.
Amendment
The Agreement is amended as follows:
1. Section 4 is amended to provide as follows:
4. Expenses . Employee is authorized to incur reasonable expenses (including, without limitation, reasonable expenditures for supplies, office and administrative expenses, travel, lodging, food and related expenses) while performing the services for which he is retained under this Agreement. The Company shall reimburse the Employee for such expenses upon presentation by the Employee from time to time of appropriately itemized and approved (consistent with the Companys policy) accounts of such expenditures. All expense reimbursements and in kind benefits provided under this Section 4 or elsewhere in this Agreement will be made or provided in accordance with the requirements of Internal Revenue Code (the Code) § 409A, including, where applicable, the requirement that:
(i) The amount of expenses eligible for reimbursement, or in kind benefits provided, during a calendar year may not affect the expenses eligible for reimbursement, or in kind benefits to be provided, in any other calendar year;
(ii) The reimbursement of an eligible expense will be made on or before the last day of the calendar year following the year in which the expense is incurred; and
(iii) The right to reimbursement or in kind benefits is not subject to liquidation or exchange for another benefit.
2. The following Section 18 is added immediately following Section 17:
18. Compliance with Code § 409A .
a. This Agreement will be interpreted and administered in accordance with the applicable requirements of, and exemptions from, Code § 409A, and in a manner consistent with Treas. Reg. § 1.409A-1 et. seq. To the extent any payments or benefits are subject to Code § 409A, this Agreement shall be interpreted, construed and administered in a manner that satisfies the requirements of (i) Code § 409A(a)(2), (3) and (4), (ii) Treas. Reg. § 1.409A-1 et seq., and (iii) other applicable authority issued by the Internal Revenue Service and the U.S. Department of the Treasury.
b. When used in this Agreement, the terms termination of employment, terminate employment, and words of similar import mean and refer to separation from service within the meaning of Code § 409A(a)(2)(A)(i) and Treas. Reg. § 1.409A-1(h).
c. If any amount is to be paid to the Employee as a result of the Employees termination of employment at a time when the Employee is specified employee (within the meaning of Treas. Reg. § 1.409A-1(i)), then, only to the extent necessary to avoid the imposition of excise taxes or other penalties under Code § 409A, payments to the Employee scheduled to be paid to during the first six (6) month period following the date of a termination of employment will not be paid until the date which is the first business day after six months have elapsed following the Employees termination of employment. If the Employee dies during the delay period set forth in this Section 18.c, the Employees entire benefit will be paid to his beneficiary, in cash, in a single lump sum, within sixty (60) days of death.
3. This amendment is effective as of December 31, 2008.
[ Signature page follows ]
2
EXECUTED this 31 st day of December 2008.
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NATIONAL MENTOR HOLDINGS, |
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INC. (the Employer) |
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By: |
/s/ Edward Murphy |
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Edward Murphy, Chief |
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Executive Officer |
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GREGORY TORRES (the Employee) |
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/s/ Gregory Torres |
3
Exhibit 10.3
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
(Edward Murphy)
THIS EMPLOYMENT AGREEMENT ( Agreement ), originally made as of June 29, 2006, is hereby amended and restated dated December 30, 2008 and effective January 1, 2009 by and between Edward Murphy ( Officer ), and National Mentor Holdings, Inc., a Delaware corporation ( Employer ).
WHEREAS , an Agreement and Plan of Merger dated March 22, 2006 (the Merger Agreement ) was entered into by and among NMH Holdings, LLC, a Delaware limited liability company ( Parent ), NMH Mergersub, Inc. a Delaware Corporation wholly owned by Parent, and National Mentor Holdings Inc., a Delaware corporation, pursuant to which the Employer became a wholly owned subsidiary of Parent (the Transaction );
WHEREAS , Officer continued to be employed by the Employer following the Closing (as defined in the Merger Agreement) and Officer and Employer entered into this Agreement embodying the terms of Officers employment;
WHEREAS, the parties hereto have agreed that it is mutually beneficial to amend and restate the Agreement effective January 1, 2009 to comply with the requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the Code );
NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements contained in this Agreement, the parties agree as follows:
STATEMENT OF AGREEMENT
2
Officer may resign his employment without good reason at any time by giving thirty (30) days written notice of resignation to Employer.
3
If Officer is terminated pursuant to this Section 6(a), Employers only remaining financial obligation to Officer under this Agreement will be to pay any earned but unpaid base salary, any earned but unpaid bonus for any completed full year prior to the year of such termination and accrued but unpaid vacation and reimbursable travel and entertainment expenses through the date of Officers termination (collectively, Accrued Obligations ). Any Accrued Obligations attributable to earned but unpaid bonus shall be paid to the Officer in a single lump sum no later than the 15 th day of the third month following the end of the fiscal year in which the bonus is earned, and any other Accrued Obligations under this Section 6(a) shall be paid to the Officer no later than 90 days following his Separation from Service from the Employer.
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5
6
7
8
Officer covenants and agrees as follows:
9
(A) engage in any business that competes, wholly or in part, as of the Relevant Date (as defined below), in the provision or sale of acquired brain injury services,
10
therapeutic foster care, other foster care or other home or community-based healthcare, therapy, counseling or other educational or human services to people with special needs, or any other business that Employer is actively conducting or is actively considering conducting at the time of Officers termination of employment (so long as Officer knows or reasonably should have known about such plan(s)), in each case anywhere in the United States (a Competitive Business );
(B) enter the employ of, or render any services to, any Person (or any division or controlled or controlling affiliate of any Person) who or which is a Competitive Business as of the date Officer enters such employment or renders such services; or
(C) acquire a financial interest in, or otherwise become actively involved with, any Competitive Business which is a Competitive Business as of the date of such acquisition or involvement, directly or indirectly, as an individual, partner, shareholder, officer, director, principal, agent, trustee or officer.
(A) with whom Officer had personal contact or dealings on behalf of Employer during the one-year period immediately preceding Officers termination of employment;
(B) with whom employees of Employer reporting to Officer have had personal contact on behalf of Employer and about such contacts the Officer was aware during the one-year period immediately preceding the Officers termination of employment; or
(C) with whom Officer had direct or indirect responsibility during the one-year period immediately preceding Officers termination of employment.
For purposes of this Section 8, the term Relevant Date shall mean, during the term of Officers employment, any date falling during such time, and, for the period of time during the Restricted Period that falls after the date of any termination of Officers employment with Employer, the effective date of termination of Officers employment with Employer.
11
(A) solicit or encourage any employee of Employer to leave the employment of Employer; or
(B) hire any such employee who was employed by Employer as of the date of Officers termination of employment with Employer or who left the employment of Employer coincident with, or within one year prior to or after, the termination of Officers employment with Employer; or
(C) solicit or encourage to cease to work with Employer any Officer that Officer knows, or reasonably should have known, is then under contract with Employer.
It is expressly understood and agreed that although Officer and Employer consider the restrictions contained in this Section 8 to be reasonable, if a final judicial determination is made by a court of competent jurisdiction that the time or territory or any other restriction contained in this Agreement is an unenforceable restriction against Officer, the provisions of this Agreement shall not be rendered void but shall be deemed amended to apply as to such maximum time and territory and to such maximum extent as such court may judicially determine or indicate to be enforceable (provided that in no event shall any such amendment broaden the time period or scope of any restriction herein). Alternatively, if any court of competent jurisdiction finds that any restriction contained in this Agreement is unenforceable, and such restriction cannot be amended so as to make it enforceable, such finding shall not affect the enforceability of any of the other restrictions contained herein.
12
13
14
If to Employer:
National Mentor Holdings, Inc.
Vestar Capital Partners
245 Park Avenue, 41st Floor
New York, NY 10167
Attn: General Counsel
Telecopy: (212) 808-4922
with a copy to:
National Mentor Holdings, Inc.
313 Congress Street
Boston, MA 02210
Attn: General Counsel
Telecopy: (617) 790-4 271
If to the Officer:
To the most recent address on file with Employer for the Officer.
Each notice given in accordance with this Section will be deemed to have been given, if personally delivered, on the date personally delivered; if delivered by facsimile transmission, when sent and confirmation of receipt is received; or, if mailed, on the third day following the day on which it is deposited in the United States mail, certified or registered mail, return receipt requested, with postage prepaid, to the address last given in accordance with this Section.
15
23. Counterparts . This Agreement may be executed (including by facsimile transmission) in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.
[Signatures on next page.]
16
IN WITNESS WHEREOF, the parties hereto have executed this Agreement on this 31st day of December, 2008.
EDWARD MURPHY |
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NATIONAL MENTOR HOLDINGS, INC. |
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Officer |
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Employer |
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/s/ Edward Murphy |
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By: |
/s/ Denis M. Holler |
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Name: |
Denis M. Holler |
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Title: |
Executive Vice President, |
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Chief Financial Officer and Treasurer |
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Certification required by Rule 13a-14(a) or 15d-14(a)
under the Securities Exchange Act of 1934
I, Edward M. Murphy, certify that:
February 17, 2009 |
/s/ EDWARD M. MURPHY
Edward M. Murphy President and Chief Executive Officer |
Certification required by Rule 13a-14(a) or 15d-14(a)
under the Securities Exchange Act of 1934
I, Denis M. Holler, certify that:
February 17, 2009 |
/s/ DENIS M. HOLLER
Denis M. Holler Executive Vice President, Chief Financial Officer and Treasurer |
Certifications Pursuant to 18 U.S.C. Section 1350
In connection with the Quarterly Report of National Mentor Holdings, Inc. (the "Company") on Form 10-Q for the period ended December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned hereby certifies pursuant to 18 U.S.C. Section 1350 that, to his knowledge:
Date: February 17, 2009 | By: |
/s/ EDWARD M. MURPHY
Edward M. Murphy President and Chief Executive Officer |
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Date: February 17, 2009 |
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By: |
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/s/ DENIS M. HOLLER Denis M. Holler Executive Vice President, Chief Financial Officer and Treasurer |