10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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Form 10-K
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x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended September 30, 2015
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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: 001-36623
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CIVITAS SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
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Delaware | 65-1309110
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(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
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313 Congress Street, 6th Floor Boston, Massachusetts 02210 | (617) 790-4800 |
(Address of principal executive offices, including zip code) | (Registrant’s telephone number, including area code) |
Securities Registered Pursuant to Section 12(b) of the Act |
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Title of each Class
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Common Stock, $0.01 par value per share
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Securities Registered Pursuant to Section 12(g) of the Act:
None.
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
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. (Check one):
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Large accelerated filer | | ¨ | Accelerated filer | | x |
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Non-accelerated filer | | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of March 31, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $245,000,000.
As of November 30, 2015, there were 37,095,034 shares of the registrant’s common stock, $0.01 par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the registrant’s proxy statement for use in connection with its 2016 Annual Meeting of Stockholders, to be filed no later than 120 days after September 30, 2015 are incorporated by reference to Part III of this report.
TABLE OF CONTENTS
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FORWARD-LOOKING STATEMENTS
Some of the matters discussed in this report may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
These statements relate to future events or our future financial performance, and include statements about our expectations for future periods with respect to demand for our services, the political climate and budgetary environment, our expansion efforts and the impact of our recent acquisitions, our plans for investments to further grow and develop our business, our margins and our liquidity. Terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” or similar expressions are intended to identify these forward looking statements. 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 not possible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to, those factors or conditions described under “Part I. Item 1A. Risk Factors” in this Annual Report on Form 10-K as well as the following:
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• | reductions or changes in Medicaid or other funding or changes in budgetary priorities by federal, state and local governments; |
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• | substantial claims, litigation and governmental proceedings; |
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• | reductions in reimbursement rates, policies or payment practices by our payors; |
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• | an increase in labor costs or labor-related liability; |
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• | matters involving employees that expose us to potential liability; |
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• | our substantial amount of debt, our ability to meet our debt service obligations and our ability to incur additional debt; |
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• | our ability to maintain effective internal controls; |
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• | our ability to comply with complicated billing and collection rules and regulations; |
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• | failure to comply with reimbursement procedures and collect accounts receivable; |
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• | changes in economic conditions; |
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• | an increase in our self-insured retentions and changes in the insurance market for professional and general liability, workers’ compensation and automobile liability and our claims history and our ability to obtain coverage at reasonable rates; |
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• | an increase in workers’ compensation related liability; |
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• | our ability to control labor costs, including healthcare costs imposed by the Patient Protection and Affordable Care Act; |
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• | our ability to attract and retain experienced personnel; |
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• | our ability to establish and maintain relationships with government agencies and advocacy groups; |
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• | negative publicity or changes in public perception of our services; |
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• | our ability to maintain our status as a licensed service provider in certain jurisdictions; |
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• | our ability to maintain, expand and renew existing services contracts and to obtain additional contracts or acquire new licenses; |
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• | our ability to successfully integrate acquired businesses; |
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• | our inability to successfully expand into adjacent markets; |
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• | government regulations, changes in government regulations and our ability to comply with such regulations; |
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• | decrease in popularity of home- and community-based human services among our targeted client populations and/or state and local governments; |
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• | our susceptibility to any reduction in budget appropriations for our services in Minnesota or any other adverse developments in that state; |
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• | our ability to operate our business due to constraints imposed by covenants in our senior credit agreement; |
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• | our ability to retain the continued services of certain members of our management team; |
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• | our ability to manage and integrate key administrative functions; |
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• | failure of our information systems or failure to upgrade our information systems when required; |
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• | information technology failure, inadequacy, interruption or security failure; |
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• | write-offs of goodwill or other intangible assets; and |
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• | natural disasters or public health catastrophes. |
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.
PART I
Company Overview
In this section “Civitas”, “we”, “us”, the “Company” and “our” refer to Civitas Solutions, Inc. (formerly known as NMH Holdings, Inc.) and its consolidated subsidiaries. Throughout this Annual Report on Form 10-K we use the term “must serve” to describe the people we serve. We consider “must-serve individuals” to be those that public policy has recognized a responsibility to care for because they are highly vulnerable by virtue of a condition acquired at birth or after birth, or their status as a minor, or as elders, and have special needs and/or disabilities such that they need to be supported or cared for in the daily activities of living.
We are the leading national provider of home- and community-based health and human services to must-serve individuals with intellectual, developmental, physical or behavioral disabilities and other special needs. These populations are large, growing and increasingly being served in home- and community-based settings such as those we provide. Our clinicians and caregivers develop customized service plans, delivered in non-institutional settings, designed to address a broad range of often life-long conditions and to enable those we serve to thrive in less restrictive settings. We believe we offer a powerful value proposition to government and non-public payors, referral sources and individuals and families by providing innovative, high-quality and cost-effective services that enable greater client independence, skill building and community involvement.
Since our founding in 1980, we have been a pioneer in the movement to provide home- and community-based
services for people who would otherwise be institutionalized. During our 35-year history, we have evolved from a single residential program serving at-risk youth to a diversified national network providing an array of high-quality services and care in large, growing and highly-fragmented markets. While we have the capabilities to serve individuals with a wide variety of special needs and disabilities, we currently provide our services to individuals with intellectual and/or developmental disabilities (“I/DD”), individuals with catastrophic injuries and illnesses, particularly acquired brain injury (“ABI”), youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (“ARY”) and elders in need of day health services to support their independence, or adult day health (“ADH”). As of September 30, 2015, we operated in 35 states, serving approximately 12,400 clients in residential settings and more than 17,000 clients in non-residential settings. We have a diverse group of hundreds of public payors that fund our services with a combination of federal, state and local funding, as well as an increasing number of non-public payors for our services for acquired brain injury and other catastrophic injuries and illnesses.
Our core strength is providing a continuum of residential, day and vocational programs, and periodic services to support diverse populations with disabilities and special needs. We currently offer our services through a variety of models, including (i) neighborhood group homes, most of which are residences for six or fewer individuals, (ii) host homes, or the “Mentor” model, in which a client lives in the private home of a licensed caregiver, (iii) in-home settings, within which we support clients’ independent living or provide therapeutic services, (iv) specialized community facilities to support individuals with more complex medical, physical and behavioral challenges, and (v) non-residential care, consisting primarily of day and vocational programs and periodic services that are provided outside the client’s home. As of September 30, 2015, our services were provided by approximately 22,300 full-time equivalent employees, as well as more than 4,800 independently-contracted host home caregivers.
Although we have announced the closure of the ARY businesses in certain states, the numbers above include the clients, employees and host home caregivers because the divestitures had not yet been completed as of September 30, 2015.
The Company
Civitas Solutions, Inc. is the parent and public reporting entity of a consolidated group of subsidiaries that market their services under The MENTOR Network tradename. Prior to October 1, 2015, Civitas Solutions, Inc. was a subsidiary of NMH Investment, LLC (“NMH Investment”), which was formed in connection with the acquisition of our business by affiliates of Vestar Capital Partners (“Vestar”) in 2006. See “Our Sponsor” below. Approximately 53% of the Common Stock of Civitas Solutions, Inc. is owned by Vestar. Our common stock is listed on the New York Stock Exchange under the ticker symbol CIVI .
Description of Services by Segment
We have two reportable segments, Human Services and Post-Acute Specialty Rehabilitation Services (“SRS”).
We do not derive any revenues from countries outside the United States.
Human Services
Our Human Services segment provides home- and community-based human services to individuals with intellectual and/or developmental disabilities, youth with emotional, behavioral and/or medically complex challenges, or at-risk youth, and elders. Our Human Services segment represented approximately 80.7% of our net revenue in fiscal 2015.
Delivery of services to individuals with I/DD is the largest portion of our Human Services segment. Our I/DD programs include residential support, day habilitation, vocational services, case management, crisis intervention and hourly support care. We provide services to these clients through small group homes, Intermediate Care Facilities for Individuals with Intellectual and/or Developmental Disabilities (“ICFs-I/DD”), host homes, in-home settings and non-residential settings. We operate approximately 1,300 group homes and 150 ICFs-I/DD. As of September 30, 2015, we provided I/DD services to approximately 16,900 clients in 22 states. In fiscal 2015, our I/DD services generated net revenue of $891.9 million, representing 65.2% of our net revenue. We receive substantially all our revenue for I/DD services from a diverse group of state and local governmental payors.
Our Human Services segment also includes the delivery of ARY services. Our ARY programs include therapeutic foster care, family preservation, adoption services, early intervention, school-based services and juvenile offender programs. Our individualized approach allows us to work with an ever-changing client population that is diverse demographically as well as in type and severity of condition. We provide services to these clients through host homes, group homes, educational settings, in their family homes and in other non-residential settings. As of September 30, 2015, we provided ARY services to more than 9,400 children, adolescents and their families in 13 states. In fiscal 2015, our ARY services generated net revenue of $191.5 million, representing 14.0% of our net revenue. As previously disclosed, we have decided to discontinue ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas. The net revenue generated and clients served during fiscal 2015 of $48.2 million and approximately 3,900 individuals, respectively, are included in our ARY results for fiscal 2015. We receive substantially all our revenue for ARY services from a diverse group of state and local governmental payors.
Our newest service line, ADH, delivers elder services including case management, nursing oversight, medication management, nutrition, daily living assistance, transportation, and therapeutic services. Our adult day health facilities provide outpatient, center-based services to approximately 1,400 adults in a group environment. In fiscal 2015, our ADH services generated net revenue of $19.7 million, representing 1.4% of our net revenue. We receive substantially all our revenue for ADH services from a diverse group of state and local governmental payors.
Post-Acute Specialty Rehabilitation Services
Our SRS segment delivers health care and community-based health and human services to individuals who have suffered acquired brain injury, spinal injuries and other catastrophic injuries and illnesses. Our SRS segment represented approximately 19.3% of our net revenue in fiscal 2015.
Within our SRS segment, our NeuroRestorative business unit is focused on rehabilitation and transitional living services and our CareMeridian business unit is focused on the more medically-intensive post-acute care services. Our SRS services range from sub-acute healthcare for individuals with intensive medical needs to day treatment programs, and include: neurorehabilitation; neurobehavioral rehabilitation; specialized nursing; physical, occupational and speech therapies; supported living; outpatient treatment; and pre-vocational services. Our goal is to provide a continuum of care that allows our clients to achieve the highest level of function possible while enhancing their quality of life. We provide services to these clients primarily through specialized community facilities, small group homes, in-home and non-residential settings. As of September 30, 2015, our SRS operations provided services in 26 states and served approximately 1,700 clients nationally. In fiscal 2015, we received 55% of our SRS revenue from non-public payors, such as commercial insurers, workers’ compensation funds, managed care and other private payors and 45% from state, local and federal governmental payors.
For additional information on the Company’s segments, please see note 20 to the consolidated financial statements.
Industry Overview
We provide home- and community-based services to large populations of individuals with intellectual, developmental, physical or behavioral disabilities and other special needs. These populations are must serve due to the nature of their disabilities, which in many cases are life-long and irreversible, or their status as children, adolescents, or elders. Within the broader health and human services market, we currently serve four primary populations:
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• | I/DD. Based on reports prepared by Dr. David Braddock, public spending on I/DD services was estimated to be $61.5 billion in 2013, of which approximately 81% was spent to provide services in community settings of six or fewer beds, |
our target market, and for other non-institutional services, including supported living, supported employment and family assistance. In 2013, there were approximately 5.0 million individuals with an intellectual or developmental disability across the nation. Over the past two decades, the delivery of services to the I/DD population in supervised residential settings has grown significantly and, at the same time, there has been a shift from institutional settings to home- and community-based settings. Dr. Braddock is Associate Vice President of the University of Colorado (CU) System and Executive Director of the Coleman Institute for Cognitive Disabilities.
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• | ABI. The market for post-acute care and rehabilitation for individuals with ABI, the largest of these populations, is approximately $10.0 billion annually, according to the Centers for Disease Control and Prevention (the “CDC”). According to the Brain Injury Association of America (“BIAA”), more than 3.5 million children and adults sustain a brain injury each year, many of which result in complex, life-long medical and/or behavioral issues that require specialized care. Approximately 5.3 million individuals in the United States are living with permanent disability as a result of an ABI. Many of these individuals are currently served in costly and often medically inappropriate care settings such as long-term acute care facilities and nursing homes. We expect that there will be a continuing shift in care delivery to more appropriate community-based settings such as those that we offer. |
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• | ARY. According to reports published by the organization Child Trends, an estimated $28.2 billion was spent in fiscal year 2012 on child welfare, including spending for residential and non-residential family support services such as those that we offer. Approximately 3.4 million referrals for abuse or neglect, which involved an estimated 6.3 million children, were investigated or assessed in the United States in federal fiscal year 2012. An estimated 653,000 children and adolescents were served by the foster care system in 2014. According to the Federal Department of Health and Human Services AFCARS data, there were more than 415,000 children and adolescents in foster care as of September 30, 2014. Of those individuals, approximately 200,000 are living in non-relative foster family homes, which includes the therapeutic foster care market, the primary market for our residential ARY services. |
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• | ADH. The ADH portion of the elder services market is an estimated $6.2 billion based on IBISWorld estimates for spending in 2010. IBISWorld forecasts growth to be at an annualized rate for ADH of 7% with revenue for this industry projected to reach $8.7 billion in 2018. We believe that there will be a growing demand for ADH services for several reasons, including that the population of adults 65 years of age and older is a growing demographic. According to the United States Census Bureau (“Census Bureau”), the population of individuals age 65 and older will reach 83.7 million by 2050, almost double the estimated population of 43.1 million in 2012. Moreover, states are increasingly looking for alternatives to more expensive models of home-based, residential and institutional care. The ADH market, like other markets in which we operate, is highly fragmented with opportunities for consolidation. |
Our Business Strategy
We believe the market opportunity for home- and community-based health and human services that increase client independence and participation in community life while reducing costs will continue to grow. We intend to continue leveraging our strengths to capitalize on this trend, both in existing markets and in new markets where we believe significant opportunities exist. The primary aspects of our strategy include the following:
Leverage our Core Competencies to Drive Organic Growth.
We expect to capture the embedded growth opportunities resulting from organic growth initiatives and leverage our core competencies to further expand our presence in markets we currently serve and to further expand our geographic footprint in our existing service lines. During our 35-year history, we have developed and refined a core set of competencies through our experience developing customized service plans for complex cases and supporting our operations with expertise in areas such as risk management, compliance and quality assurance.
Pursue Opportunistic Acquisitions.
As a leading provider in our markets with national scale and a proven track record of quality care, we are well positioned as an acquiror of choice for small operators in a highly-fragmented industry. This dynamic leads to a number of attractive tuck-in acquisition opportunities that can drive returns. We continue to maintain a robust acquisition pipeline and deploy capital in a disciplined and opportunistic manner to pursue acquisitions.
We intend to continue to pursue acquisitions that are consistent with our mission and complement our existing operations. We have invested in a team dedicated to mergers and acquisitions, as well as the infrastructure and formalized processes to enable us to pursue acquisition opportunities and to integrate them into our business. We monitor the market nationally for businesses that we can acquire at attractive prices and efficiently integrate with our existing operations. From the
beginning of fiscal 2009 through September 30, 2015, we have successfully acquired 50 companies, at an aggregate purchase price of approximately $211.2 million.
Continue to Invest in our New Start Programs.
A key driver of growth has been our new start programs that have historically generated attractive returns on our investments. Our demonstrated ability to quickly launch new start programs positions us well to meet new sources of market demand. New starts, which typically turn profitable within 18-24 months, require modest investments, consisting of operating losses and capital expenditures. Our investment of approximately $8.1 million in new starts between fiscal 2007 and fiscal 2010 generated net revenues and operating income of approximately $72.0 million and $17.9 million, respectively, in fiscal 2015. We have made a number of recent investments that we believe will continue to drive near term growth as they reach maturity. In 2011, we increased our level of new start investment, expanding it from an average of $3.1 million in fiscal 2009 and fiscal 2010 to an average of more than $7.0 million in fiscal 2012 through 2015. Our investment of $16.3 million in new starts between fiscal 2012 and 2013 generated net revenues and operating income of approximately $74.6 million and $11.0 million, respectively, in fiscal 2015. We intend to continue to aggressively pursue new start opportunities with attractive rates of return.
Expand our SRS Platform.
We intend to leverage our scale and leadership position to continue to expand our SRS platform through continued organic growth in new and existing markets, as well as through opportunistic acquisitions. We are the only provider with a national platform dedicated to providing post-acute care for individuals with brain injuries or other catastrophic injuries and illnesses, and thus we believe we are the leader serving this market. We have more than doubled the size and contribution of our SRS segment since fiscal 2010, achieving a 14.0% compound annual growth rate in net revenue over that period. Furthermore, our SRS business is funded by a highly attractive payor mix, with 55% of net revenues in fiscal 2015 derived from commercial insurers and other private entities.
Pursue Opportunities in Adjacent Markets and Complementary Service Lines that Diversify our Service Offerings.
We have a proven track record of developing new service areas, as evidenced by the growth of our SRS segment, and we intend to leverage our core competencies and relationships with state agencies to pursue opportunities in adjacent markets, particularly the $6.2 billion market for ADH, which we entered in 2014 with the acquisition of the Mass Adult Day Health Alliance. Since completing this acquisition, we have opened two additional ADH centers in Massachusetts and are evaluating opportunities to expand this service both organically and through potential acquisitions in Massachusetts and several other states. In the future, we may explore additional opportunities to leverage our periodic, day and residential service models to support individuals in the broader elder care market as well as other adjacent markets, such as those serving youth with autism and individuals with mental health issues.
Customers and Contracts
Our customers that pay us to provide services to our clients, are governmental agencies, non-public payors and not-for-profit organizations. Our I/DD and ARY services, as well as a significant portion of our SRS services, are delivered pursuant to contracts with various governmental agencies, such as state departments of developmental disabilities, juvenile justice, child welfare and the Federal Veterans Health Administration. Such contracts may be issued at the county or state level, depending upon the structure of the service system of the state in question. In addition, a majority of our SRS revenue is derived from contracts with commercial insurers, workers’ compensation carriers and other non-public payors.
In all of our service lines, the clients and/or the payors/referral sources (e.g., state agencies) select us as a provider and, although clients funded by Medicaid have the right to choose an alternative provider at any time, it has been our experience that our clients change providers infrequently. We believe that many of our clients develop close relationships with their direct care workers and our organization. Although a client may develop a close relationship with his or her direct care worker, it is our experience that if such direct care worker leaves our employment, clients rarely elect to switch providers based on such direct care worker’s departure. The length of stay of our clients varies widely based on their individual needs. For instance, in our SRS segment, a client’s care may be focused on rehabilitation, in which case we will provide services for several months, or, if a client suffered a catastrophic illness or accident, that client could remain in our care for the duration of that individual’s life, which could span years or decades. In our I/DD business, the length of stay is generally years, with many of our clients having used our services for decades. For our ARY clients, the length of treatment can vary widely but most often is for several months.
Contracts may cover a range of individuals such as all children referred for host home services in a county or a particular set of individuals who will share group living arrangements. Contracts are sometimes issued for specific individuals, where rates are individually determined based on need. Although our contracts generally have a stated term of one year and generally may be terminated without cause on 60 days’ notice, the contracts are typically renewed annually if we have complied with licensing, certification, program standards and other regulatory requirements. As a provider of record, we contractually obligate ourselves to adhere to the applicable federal and state regulations regarding the provision of services, the maintenance of records and submission of claims for reimbursement under Medicaid and other government programs. In addition, while we are not obligated to serve each individual that is referred to us, we make every effort to review referrals made and accept individuals who need our services.
During both fiscal 2015 and 2014, revenue from our contracts with state and local governmental payors in the states of Minnesota, California, West Virginia, Florida and New Jersey, our five largest revenue-generating states, comprised 39% and 40% of our net revenue, respectively. Revenue from our contracts with state and local governmental payors in the State of Minnesota, our largest state, accounted for 15% and 14% of our net revenue in each of fiscal 2015 and 2014, respectively.
Training and Supporting our Direct Service Professionals
We provide pre-service and in-service education to all of our direct service professionals and clinical and administrative staff, and we encourage staff to avail themselves of outside training opportunities whenever possible. Employees participate in orientation programs designed to increase their understanding of our mission, philosophy of service, and our Code of Conduct and compliance program. Our employees benefit from our library of training materials and an intranet site that facilitates the identification and exchange of expertise across all of our operations. We work to increase individual job satisfaction and retention of motivated and qualified employees.
We use equally rigorous methods to identify and contract with independent contractor providers (host home providers), whether in an adult host home or foster care environment. In addition to pre-service and in-service orientation to familiarize the host home providers to the specifics of our model and expectations, the contracted host home providers in our ARY business receive a detailed briefing tailored to the individualized needs of the individual or child placed in their home. Prior to any placements being made, we conduct a home study to evaluate the appropriateness of any placement and conduct interviews and criminal background checks on adult members residing in the host home provider household. The services provided by host home providers are evaluated for contractual compliance by our case manager or coordinator according to standards set by licensing and regulatory agencies as well as our own quality standards. While host home providers can provide services independently, they have access to emergency telephone triage and on-site crisis intervention, if necessary. Host home providers also avail themselves of support groups, whether independent or offered at the program office.
Employees and Independent Contractors
As of September 30, 2015, we had approximately 22,300 full-time equivalent employees and more than 4,800 independent contractors. Although our employees are generally not unionized, we have one business in New Jersey with 35 employees who are represented by a labor union. We consider our employee relations to be good.
Sales/Business Development and Marketing
We market our services nationally as The MENTOR Network, a national network of local service providers. We operate under several brands across the country, predominantly under the REM and MENTOR brands in our Human Services segment and the NeuroRestorative and CareMeridian brands in our SRS segment.
The majority of our human services clients come to us through third-party referrals, and frequently our I/DD referrals come through recommendations to family members from state or local agencies. Since our operations depend heavily on these referrals, we seek to ensure that we provide high-quality services in all states in which we operate, allowing us to enhance our name recognition and maintain a positive reputation with state and local agencies.
Relationships with referral sources are cultivated and maintained at the local level by key operations managers and supported by an array of corporate supports including marketing communications, government relations and business development services to promote both new and existing product lines.
Our SRS sales activities are independently organized from those of our Human Services businesses. We have dedicated, geographically assigned clinical marketing and sales staff cultivating relationships with public and private payors,
referral sources and directly with potential participants and their families. These regional teams are also supported by corporate resources as outlined above.
To further distinguish ourselves in both segments, we have established a comprehensive presence at both the national and local level through a robust online presence, including social media. Additionally, through our government relations and business development activities, we believe we have successfully positioned ourselves to anticipate and meet the needs of our public partners.
Competition
I/DD
The I/DD market is highly fragmented, with both not-for-profit and for-profit providers ranging in size from small, local agencies to large, national organizations. We and the other leading national provider account for less than 5% of services by revenue in the I/DD market. Although state and local governments continue to supply a small percentage of services, the majority of services are provided by the private sector. Not-for-profit organizations are also active in all states and range from small agencies serving a limited area with specific programs to multi-state organizations. Many of the not-for-profit companies are affiliated with advocacy groups such as community mental health and religious organizations.
SRS
We compete with local providers, both large and small, including hospitals, post-acute rehabilitation facilities, residential community-based facilities, day treatment centers and outpatient centers specializing in long-term catastrophic care and short-term rehabilitation. This market also includes several large national providers of general inpatient and outpatient rehabilitation services.
ARY
The at-risk youth market is extremely fragmented, with several thousand providers in the United States. Competitors include both not-for-profit and for profit local providers serving one particular geographic area to a single state, and, to a limited extent, multi-state providers.
ADH
The ADH market in the United States is highly fragmented, with approximately 3,700 providers operating 4,800 centers according to IBISWorld and the National Center on Health Statistics. The majority of providers are relatively small companies, and only 33% of these providers have two or more locations according to a 2010 MetLife study. In 2014, the National Center on Health Statistics reported that in 2012, for-profit providers served nearly one-half, or 47%, of the nearly 275,000 individuals who received this service.
Regulatory Framework
We must comply with comprehensive government regulation of our business, including federal, state and local statutes, regulations and policies governing the licensing of services, the quality of service, the revenues received for services, and reimbursement for the cost of services. State and federal regulatory agencies have broad discretionary powers over the administration and enforcement of laws and regulations that govern our operations.
The following regulatory considerations are critical to our operations:
New federal regulation regarding “waivered” services. Individuals with disabilities or chronic illnesses who need certain levels of care may qualify for home- and community-based “waivered” services (“HCBS Waiver”). The waiver program allows the states to furnish an array of home- and community-based services and avoid institutional care. On March 17, 2014, a newly promulgated federal regulation governing HCBS Waiver programs became effective. The rule establishes eligibility requirements for payment for Medicaid home and community-based services provided under the “waiver” program. Under the new rule, home- and community-based settings must be integrated in and support full access to the greater community, be selected by the individual from different setting options, ensure individual rights of privacy, and optimize autonomy and independence in making life choices. The rule includes additional requirements for provider-owned or controlled home and community-based residential settings, including that the individual has a lease or other legally enforceable agreement, and standards related to the individual’s privacy, control over schedule and visitors, and physical accessibility of the setting. At this
juncture it is unclear how individual states will seek to implement this newly adopted regulation. The rule may present some implementation costs and challenges. Some of the broad requirements may conflict with individual recipient needs and/or precautions that we must undertake to assure individual
services and safety. It is unclear how each state will seek to address this potential conflict. The impact and costs of implementation and compliance with this regulation are currently unknown. States have the option to request a variation or delay of compliance with the federal standards for as long as five (5) years from the effective date.
Funding. Federal and state funding for our services is subject to frequent statutory and regulatory changes, contracting and managed care initiatives, level of care assessments, court orders, rate setting and state budgetary considerations, all of which may materially increase or decrease reimbursement for our services. We actively participate in local and national legislative initiatives that seek to impact funding and regulation of our services. We derive revenues for our I/DD and ARY services and a significant portion of our SRS services from Medicaid programs.
Licensure and qualification to deliver service. We are required to comply with extensive licensing and regulatory requirements applicable to the services we deliver. These include requirements for participation in the Medicaid program, state and local contractual obligations, and requirements relating to individual rights, the credentialing of individual employees and contract Mentors (including background and Office of Inspector General checks), the quality of care delivered, the physical plant and facilitation of community participation. Compliance with state licensing requirements is a prerequisite for participation in government-sponsored public health care assistance programs, such as Medicaid. To qualify for reimbursement under Medicaid, facilities and programs are subject to various requirements imposed by federal and state authorities. We maintain a licensing database that tracks activity impacting licenses governing the provision of services.
In addition to Medicaid participation requirements, our facilities and services are subject to annual or semi-annual licensing and other regulatory requirements of state and local authorities. These requirements relate to the condition of the facilities, the quality and adequacy of personnel staff and service ratios and the quality of services provided. State licensing and other regulatory requirements vary by jurisdiction and are subject to change and local interpretation.
From time to time we receive notices from regulatory inspectors that, in their opinion, there are deficiencies resulting from a failure to comply with various regulatory requirements. We review such notices and take corrective action as appropriate. In most cases we and the reviewing agency agree upon the steps to be taken to address the deficiency and, from time to time, we or one or more of our subsidiaries may enter into agreements with regulatory agencies requiring us to take certain corrective action in order to maintain our licenses or certification. Serious or repeat deficiencies, or failure to comply with any regulatory agreements, may result in the assessment of fines or penalties, referral holds, payment suspensions and/or decertification or de-licensure actions by various federal or state regulatory agencies.
We deliver services and support under a number of different funding and program provisions. Our most significant sources of funding for our I/DD services are HCBS Waiver programs, Medicaid programs for which eligibility is based on a set of criteria (typically disability or age) established by the state and approved by the federal government. There is no uniformity among states and/or regulations governing our delivery of waivered services to individuals. Each state where we deliver services operates under a plan submitted by the state to Centers for Medicare and Medicaid Services (“CMS”) which authorizes the state to use Medicaid funds in non-institutional settings using federal financial participation (“FPP”). Typically the state writes state specific regulations governing providers and services provided under the state waiver program. Consequently, there is no uniform method of describing or predicting the content or impact of regulations across states where we deliver HCBS Waiver services. In addition, our ICFs-I/DD are governed by federal regulations, and may also be subject to individual state rules that vary widely in application and content. Federal regulations require that in order to maintain Medicaid certification as an ICF-I/DD, the facility is subject to annual on-site survey (a federal rule and process implemented by state agencies), the results of which provide or deny the certification necessary to bill Medicaid for services in the facility. Failure to successfully pass this inspection and remedy all defects or conditions cited may result in a finding of immediate jeopardy or other serious sanction and, ultimately, may cause a loss of both certification and funding for that particular facility.
Similarly, child foster care and other children’s services are largely governed by individual state regulations which vary both in terms and regulatory content. Failure to comply with any state’s regulations requires remedial action on our part and a failure to adequately remedy the problem may result in provider or contract termination.
All states in which we operate have adopted laws or regulations which generally require that a state agency approve us as a provider, and many require a determination that a need exists prior to the admission of covered individuals or services.
Provider licenses are not transferable. Consequently, should we intend to acquire, develop, expand or divest services in any state or to enter a new state, we may be required to undergo a rigorous licensing, transfer and approval process prior to conducting business or completing any transaction.
Similarly, some states have a formal Certificate of Need (“CON”) process, whereby the state health care authority must first determine that a service proposed is needed under the state health plan, prior to any service being licensed or applied for. The CON process varies by state and may be formal in design, encompassing any transfer, organizational change, capital improvements, divestitures or acquisitions. Formal processes may include public notice, opportunity for affected parties to request a hearing prior to the health care authority approving the project, as well as an opportunity for the state authority to deny the project. Other states have a less formal process for CON application and approval and may be limited to new or institutional projects. Very few states require CON approval for waivered services. Failure to comply with a state CON process may result in a prohibition on Medicaid billing and may subject the provider to fines, penalties, other civil sanctions or criminal penalties for the operators or owners of an unapproved health service.
Other regulatory matters. The Health Insurance Portability and Accountability Act of 1996, or “HIPAA,” as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”), set national standards for the protection of health information created, maintained or transmitted by health providers. Under the law and regulations known collectively as the privacy and security rules, covered entities must implement standards to protect and guard against the misuse of individually identifiable health information, report breaches and undertake notification and remedial steps consistent with regulation.
Federal regulations issued pursuant to HIPAA and the HITECH ACT contain, among other measures, provisions that require organizations to implement significant and expensive computer systems, employee training programs and business procedures. Rules have been established to protect the integrity, security and distribution of electronic health and related financial information. Many states have also implemented extensive data privacy and security laws and regulations. Failure to timely implement or comply with HIPAA or other data privacy and security regulations may, under certain circumstances, trigger the imposition of civil or criminal penalties.
The federal False Claims Act imposes civil liability on individuals and entities that submit or cause to be submitted false or fraudulent claims for payment to the government. Violations of the False Claims Act may include treble damages and penalties of up to $11,000 per false or fraudulent claim. Similarly, retention of any overpayments may be regarded by the government as a false claim.
In addition to actions being brought by government officials under the False Claims Act, this statute and analogous state laws also allow a private individual with direct knowledge of fraud to bring a “whistleblower” claim on behalf of the government for violations. The whistleblower receives a statutory amount of up to 30% of the recovered amount from the government’s litigation proceeds if the litigation is successful or if the case is successfully settled. Recently, the number of whistleblower suits brought against healthcare providers has increased dramatically, and has included suits based (among other things) upon alleged violations of the Federal Anti-Kickback Law.
The Anti-Kickback Law prohibits kickbacks, rebates and any other forms of remuneration in return for referrals. Any remuneration, direct or indirect, offered, paid, solicited or received, in return for referrals of patients or business for which payment may be made in whole or in part under Medicaid, could be considered a violation of law. The language of the Anti-Kickback law also prohibits payments made to anyone to induce them to recommend purchasing, leasing, or ordering any goods, facility, service or item for which payment may be made in whole or in part by Medicaid. Criminal penalties under the Anti-Kickback Law include fines up to $25,000, imprisonment for up to 5 years, or both. In addition, acts constituting a violation of the Anti-Kickback Law may also lead to civil penalties, such as fines, assessments and exclusion from participation in the Medicaid program.
Additionally we must comply with local zoning and licensing ordinances and requirements. The Federal Fair Housing Amendments Act of 1988 protects the interests of the individuals we serve, prohibits local discriminatory ordinance practices and provides additional opportunities and accommodations for people with disabilities to live in their community of choice.
Federal regulations promulgated by the Occupational Safety and Health Administration (“OSHA”) require us to have safety plans for blood borne pathogens and other work place risks. At any point in time OSHA investigators may receive a complaint which requires on-site inspection and/or audit, the outcome of which may adversely affect our operations.
Periodically, new statutes and regulations are written and adopted that directly affect our business. It is often difficult to predict the impact a new regulation will have on our operations until we have taken steps to implement its requirements. For
example, the Patient Protection and Affordable Care Act of 2010 provided a mandate for more vigorous and widespread enforcement and directed state Medicaid agencies to establish Recovery Audit Contractor (“RAC”) programs. RACs are private entities which will perform audits on a contingency fee basis, giving them an incentive to identify discrepancies in payments, from which they may be permitted to extrapolate disproportionately large penalties and fines. States were required to be in compliance by January 1, 2012 unless granted an extension. We have experienced only modest RAC auditing activity to date; however this remains a fairly new federal initiative and the ultimate impact remains unclear. Only the passage of time and our experience with enforcement and compliance will permit our assessment of the exact impact the new statute and regulations have on our business.
Similarly the HIPAA and HITECH Regulations increased both the scope of liability and obligations of business associates with whom such covered entities contract for services, as well as increase disclosure obligations of providers in the event of a breach. The Federal enforcement agency has expressed an intent to increase investigations and potential penalties for noncompliance in part due to these new standards.
Managed care initiatives undertaken in a given state may impact our business by modifying the types of services eligible for payment, the qualifications required for payment and the rates that are paid for those services. Similarly, some states are pursuing waivers for dual-eligible populations (that is, persons eligible for both Medicare and Medicaid), and our ability to participate in such waivered services may depend on our ability to become a Medicare provider.
We participate in Medicare in a very select number of areas of the country, as well as in managed care projects that allocate funds for recipients who are dually eligible for Medicare and Medicaid. Medicare has a unique and different set of regulations, funding mechanisms and audit and compliance risks compared to Medicaid. In recent years, states have begun working toward maximizing Medicare funding for services for dual eligible populations due to the fiscal incentive to lower state contributions and shift the cost of service to Medicare. In some state markets “equalization” of rates is required, thereby mandating that the rates we charge to private payors may not exceed rates established and paid by Medicaid and/or Medicare. Public policy initiatives and cost-containment initiatives in the Medicare program may continue and may affect our operating margins where we participate in Medicare.
Conviction of abusive or fraudulent behavior with respect to one facility or program may subject other facilities and programs under common control or ownership to disqualification from participation in the Medicaid program. Executive Order 12549 prohibits any corporation or facility from participating in federal contracts if it or its principals (included but not limited to officers, directors, owners and key employees) have been debarred, suspended or declared ineligible or have been voluntarily excluded from participating in federal contracts. In addition, some state regulators provide that all facilities licensed with a state under common ownership or control are subject to delicensure if any one or more of such facilities are delicensed.
We must also comply with the standards set forth by the Office of Inspector General (“OIG”) governing internal compliance and external reporting requirements. We regularly review and monitor OIG advisory opinions, although they are limited in their application to community-based Medicaid providers. Significant legislative, media and public attention has recently focused on health care. Because the law in this area is complex and continuously evolving, ongoing or future governmental investigations or litigation may result in interpretations that are inconsistent with our current practices. It is possible that outside entities could initiate investigations or future litigation impacting our services and that such matters could result in penalties and adverse publicity. It is also possible that our executive and other management personnel could be included in these investigations and litigation or be named defendants.
The Patient Protection and Affordable Care Act and Health Care and Education Reconciliation Act of 2010, and the rules and regulations thereunder (together, the “Affordable Care Act”) were signed into law in March 2010 and represent significant changes to the U.S. healthcare system. The legislation is far-reaching and it is intended to expand access to health insurance coverage over time. The legislation includes requirements that most individuals obtain health insurance coverage beginning in 2014 and that most employers offer coverage meeting certain requirements to their employees or they will be required to pay a financial penalty beginning in 2015. We do not expect this potential penalty to have a significant impact on our fiscal 2016 financial results.
The legislation also imposes new requirements and restrictions, including, but not limited to, guaranteed coverage requirements, prohibitions on some annual and all lifetime limits on amounts paid on behalf of or to our employees, increased restrictions on rescinding coverage, establishment of minimum medical loss ratio requirements, the establishment of state insurance exchanges and essential benefit packages, and greater limitations on product pricing.
The Affordable Care Act has already had a significant impact on the structure of the health plans we offer our employees. We have redesigned our health benefits to only offer employees health coverage that meets the requirements of the Affordable Care Act.
Finally, we are also subject to a large number of employment related laws and regulations, including laws regarding discrimination, wrongful discharge, retaliation, and federal and state wage and hours laws.
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. Failure to comply with laws and regulations could have a material adverse effect on our business.
A Compliance Officer (vice president level position) oversees our compliance program and reports to our Chief Legal Officer, a management compliance committee, the board’s quality and risk management committee and the board’s audit committee, as applicable. The program activities are reported regularly to the management compliance committee which includes the CEO, CFO, as well as HR, legal and quality assurance leaders. In addition, the program activities are periodically reported at the board level.
Seasonality
In general, our financial performance is not significantly impacted by fluctuations from seasonality.
Our Sponsor
Vestar, our principal stockholder, is a leading U.S. middle market private equity firm specializing in management buyouts and growth capital investments. Vestar’s investment in the Company was funded by Vestar Capital Partners V, L.P., a $3.7 billion fund which closed in 2005, and affiliates.
Since the firm’s founding in 1988, Vestar funds have completed more than 70 investments in companies with a total value of more than $40.0 billion. These companies have varied in size and geography and span a broad range of industries including healthcare, an area in which Vestar’s principals have had meaningful experience. Vestar currently manages funds with approximately $5.0 billion of assets and has offices in New York, Denver and Boston.
Our business faces a number of risks. The risks described below are items of most concern to us, however these are not all of the risks we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impact our business operations.
Reductions or changes in Medicaid funding or changes in budgetary priorities by the federal, state and local governments that pay for our services could have a material adverse effect on our revenue and profitability.
We currently derive approximately 89% of our revenue from contracts with state and local governments. These governmental payors fund a significant portion of their payments to us through Medicaid, a joint federal and state health insurance program through which state expenditures are matched by federal funds typically ranging from 50% to approximately 75% of total costs, a number based largely on a state’s per capita income. Our revenue, therefore, is largely determined by the level of federal, state and local governmental spending for the services we provide.
Efforts at the federal level to reduce the federal budget deficit pose risk for reductions in federal Medicaid matching funds to state governments. Previously, the Joint Select Committee on Deficit Reduction’s failure to meet the deadline imposed by the Budget Control Act of 2011 triggered automatic across-the-board cuts to discretionary funding, including a 2% reduction to Medicare, which went into effect April 1, 2013, but specifically exempted Medicaid payments to states. While this development did not reduce federal Medicaid funding, reductions in other federal payments to states will put additional stress on state budgets, with the potential to negatively impact the ability of states to provide the state Medicaid matching funds necessary to maintain or increase the federal financial contribution to the program. Negotiations in recent years regarding deficit reduction efforts have been contentious and resulted in a 16-day government shutdown in October 2013. While Medicaid payments were not affected during this period, the potential of longer shutdowns in the future if new negotiations regarding the federal budget and/or the federal debt ceiling fail to produce a resolution could cause disruptions in Medicaid support and payments to states. In addition, the federal government may choose to adopt alternative proposals to reduce the federal budget deficit. These alternative reductions could have a negative impact on state Medicaid budgets, including
proposals to provide states with more flexibility to determine Medicaid benefits, eligibility or provider payments through the use of block grants or streamlined waiver approvals, as well as those that would reduce the amount of federal Medicaid matching funding available to states by curtailing the use of provider taxes or by adjusting the Federal Medical Assistance Percentage (FMAP). Furthermore, any new Medicaid-funded benefits and requirements established by Congress, particularly those included in the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, and the rules and regulations thereunder (together, the “Patient Protection and Affordable Care Act”), that mandate certain uses for Medicaid funds could have the effect of diverting those funds from the services we provide.
Budgetary pressures facing state governments, as well as other economic, industry, and political factors, could cause state governments to limit spending, which could significantly reduce our revenue, referrals, margins and profitability, and adversely affect our growth strategy. Governmental agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If a government agency does not receive an appropriation sufficient to cover its contractual obligations with us, it may terminate a contract or defer or reduce our reimbursement. In addition, there is risk that previously appropriated funds could be reduced through subsequent legislation. Many states in which we operate experienced unprecedented budgetary deficits during and in the wake of the recession that began in 2008, and, as a result, implemented service reductions, rate freezes and/or rate reductions, including states such as Minnesota, California, Florida, Indiana and Arizona. Similarly, programmatic changes such as conversions to managed care with related contract demands regarding billing and services, unbundling of services, governmental efforts to increase consumer autonomy and reduce provider oversight, coverage and other changes under state Medicaid plans, may cause unanticipated costs and risks to our service delivery. The loss or reduction of or changes to reimbursement under our contracts could have a material adverse effect on our business, financial condition and operating results.
The nature of our operations subjects us to substantial claims, litigation and governmental proceedings.
We are in the health and human services business and, therefore, we have been and continue to be subject to substantial claims alleging that we, our employees or our Mentors failed to provide proper care for a client. We are also subject to claims by our clients, our employees, our Mentors or community members against us for negligence and intentional misconduct, or violation of applicable laws. Included in our recent claims are claims alleging personal injury, assault, abuse, wrongful death and other charges. Several years ago, we experienced a spike in claims filed against the Company, and we could face an increase in claims in the future. As a result of the prior increase in claims, we received less favorable insurance terms and have expensed greater amounts to fund potential claims. For more information, see “Item 3, Legal Proceedings”.
Professional and general liability expense totaled 0.8%, 0.8% and 1.0% of our gross revenue for the fiscal years ended September 30, 2015, 2014 and 2013, respectively. We incurred professional and general liability expenses of $10.5 million, $10.9 million, and $12.1 million for the fiscal years ended September 30, 2015, 2014 and 2013, respectively. These expenses are incurred in connection with our claims reserve and insurance premiums. For more information, see “—Our financial results could be adversely affected if claims against us are successful, to the extent we must make payments under our self-insured retentions, or if such claims are not covered by our applicable insurance or if the costs of our insurance coverage increase.” Increased costs of insurance and claims have negatively impacted our results of operations and have resulted in a renewed emphasis on reducing the occurrence of claims. Although insurance premiums did not increase in fiscal 2014 and 2015, they have increased in prior years and may increase in the future.
We are subject to employee-related claims under state and federal law, including claims for discrimination, wrongful discharge or retaliation, as well as claims for violations under the Fair Labor Standards Act or state wage and hour laws.
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 or ask for recoupment of amounts paid. We could be required to incur significant costs to respond to regulatory investigations or defend against 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.
On April 24, 2015, the United States Senate Finance Committee (the “SFC”) sent a letter to the governor of every state requesting information regarding the state’s administration of its foster care system and, in particular, the role of privatized foster care involving both not-for-profit and for-profit agencies. On June 17, 2015, the SFC sent a letter to us requesting extensive information regarding our foster care services. Following the June 17, 2015 letter we have received additional requests for further information regarding our foster care services from the SFC. We have been working diligently to respond to the SFC’s requests for information in a timely manner. It is both costly and time consuming for us to comply with these inquiries. On December 1, 2015, we completed the sale of our foster care services in North Carolina and expect that by December 31, 2015 we will have substantially completed the transition of all foster care services provided under our at-risk
youth service line in Florida, Indiana, Louisiana, and Texas. We anticipate that upon completion of our previously announced divestiture of our ARY service line in these states, we will provide foster care in eight states. At this juncture, we cannot predict the scope, duration or outcome of the SFC’s review. It is possible that the inquiries could result in negative publicly or other negative action that could harm our reputation.
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, lawsuits or regulatory proceedings could also irreparably damage our reputation.
Reductions in reimbursement rates, a failure to obtain increases in reimbursement rates or subsequent negative audit adjustments could adversely affect our revenue, cash flows and profitability.
Our revenue and operating profitability depend on our ability to maintain our existing reimbursement levels and to obtain periodic increases in reimbursement rates to meet higher costs and demand for more services. Approximately 11.4% of our revenue is derived from contracts based on a retrospective cost reimbursement model, whereby we are required to maintain a certain cost structure in order to realize the specified rate. For such programs, if our costs are less than the required amount, we are required to return a portion of the revenue to the payor. Some of our programs are also subject to prospective rate adjustments based on current spending levels. For such programs, we could experience reduced rates in the future if our current spending is not sufficient. If we are not entitled to, do not receive or cannot negotiate increases in reimbursement rates, or are forced to accept a reduction in our reimbursement rates at approximately the same time as our costs of providing services increase, including labor costs and rent, our margins and profitability could be adversely affected.
Changes in how federal and state government agencies operate reimbursement programs can also affect our operating results and financial condition. Some states have, from time to time, revised their rate-setting methodologies in a manner that has resulted in rate decreases. In some instances, changes in rate-setting methodologies have resulted in third-party payors disallowing, in whole or in part, our requests for reimbursement. 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.
As a result of cost reporting, we have from time to time experienced negative audit adjustments which are based on subjective judgments of reasonableness, necessity or allocation of costs in our services provided to clients. These adjustments are generally required to be negotiated as part of the overall audit resolution and may result in paybacks to payors and adjustments of our rates. We cannot assure you that our rates will be maintained or that we will be able to keep all payments made to us, until an audit of the relevant period is complete.
Our variable cost structure is directly related to our labor costs, which may be adversely affected by labor shortages, a deterioration in labor relations or increased unionization activities.
Our variable cost structure and operating profitability are directly related to our labor costs. Labor costs may be adversely affected by a variety of factors, including a limited supply of qualified personnel in any geographic area, local competitive forces, ineffective utilization of our labor force, increases in minimum wages or the need to increase wages to remain competitive, health care costs and other personnel costs, and adverse changes in client service models. We typically cannot recover our increased labor costs from payors and must absorb them ourselves. We have incurred higher labor costs in certain markets from time to time because of difficulty in hiring qualified direct care 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 staff, 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.
Although our employees are generally not unionized, we acquired one business in New Jersey in 2010 that currently has approximately 35 employees who are represented by a labor union. From time to time, we experience attempts to unionize certain of our non-union employees. Recently, the National Labor Relations Board (“NLRB”) issued a final rule that took effect April 14, 2015, that significantly reduces the maximum number of days to hold a union election. This reduction in the open election period may limit the Company’s ability to adequately inform employees regarding the risks associated with unionization. Future unionization activities could result in an increase of our labor and other costs. If any employees covered by a collective bargaining
agreement were to engage in a strike, work stoppage or other slowdown, we could experience a disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.
Matters involving employees may expose us to potential liability.
We are subject to United States federal, state and local employment laws that expose us to potential liability if we are determined to have violated such employment laws. Failure to comply with federal and state labor laws pertaining to minimum
wage, overtime pay, meal and rest breaks, unemployment tax rates, workers’ compensation rates, citizenship or residency requirements, and other employment-related matters may have a material adverse effect on our business or operations. In addition, employee claims based on, among other things, discrimination, harassment or wrongful termination may divert financial and management resources and adversely affect operations. We are further subject to the Fair Labor Standards Act (which governs such matters as minimum wages, overtime and other working conditions) as well as state and local wage and hour laws.
We expect increases in payroll expenses as a result of recent state and federal policy initiatives to increase the minimum wage. Although such increases are not expected to be material, we cannot assure you that there will not be material increases in the future.
On July 6, 2015, the Department of Labor announced a proposed rule that significantly raised the minimum salary required to classify an employee as exempt. The proposed rule would raise the current base salary minimum to be exempt from overtime pay for all hours worked over 40 hours in a designated workweek from $23,660 ($455 per week) to $50,440 ($970 per week) in 2016, with yearly adjustments tied to a designated index thereafter. Comments to the proposed rule were due on September 4, 2015. If the final rule adopts the minimum salary level for administrative, professional, and executive exempt employees, we are likely to incur additional labor costs in the form of increased salaries, overtime pay for previously exempt employees and additional hires to minimize overtime exposure.
The potential losses that may be incurred as a result of any violation of or change in employment laws are difficult to quantify, but they could be material.
Our level of indebtedness could adversely affect our liquidity and ability to raise additional capital to fund our operations, and it could limit our ability to invest in our growth initiatives or react to changes in the economy or our industry.
We have a significant amount of indebtedness and substantial leverage. As of September 30, 2015, we had total indebtedness, excluding capital lease obligations, of $644.1 million (after giving effect to $1.5 million of original
issue discount on the term loan) and an ability to borrow up to an additional $119.1 million under our revolving credit facility. Borrowings under the senior secured credit facilities bear interest at rates that fluctuate with changes in certain short-term prevailing interest rates. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same. We expect to continue to make new investments in our growth that may reduce liquidity, and we may need to increase our indebtedness in the future.
Our substantial degree of leverage could have important consequences, including the following:
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• | it may curtail our acquisitions program and may limit our ability to invest in our infrastructure and in growth opportunities; |
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• | it may diminish our ability to obtain additional debt or equity financing for working capital, capital expenditures, debt service requirements and general corporate or other purposes; |
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• | the debt service requirements of our indebtedness could make it more difficult for us to satisfy our indebtedness and contractual and commercial commitments; |
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• | a significant portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness and will not be available for other purposes, including our operations, future business opportunities and acquisitions and capital expenditures; |
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• | interest rates on any portion of our variable interest rate borrowings under the senior secured credit facilities that we have not hedged may increase; |
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• | it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt and a lower degree of leverage; and |
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• | we may be vulnerable if the country falls into another recession, or if there is a downturn in our business, or we may be unable to carry out activities that are important to our growth. |
Subject to restrictions in the senior credit agreement, we may be able to incur more debt in the future, which may intensify the risks described in this risk factor. All of the borrowings under our senior secured credit facilities are secured by substantially all of the assets of the National Mentor Holdings, Inc. (“NMHI”) and its subsidiaries.
In addition to our significant amount of indebtedness, we have significant rental obligations under our operating leases for our group homes, other service facilities and administrative offices. For the fiscal year ended September 30, 2015 our aggregate rental expense for these leases was $65.1 million. We expect this number will increase during fiscal 2016 as a result of new leases entered into pursuant to acquisitions and new program starts. Our ongoing rental obligations could exacerbate the risks described above.
Our ability to generate sufficient cash flow to fund our debt service, rental payments and other obligations depends on many factors beyond our control. See “—Economic conditions could have a material adverse effect on our cash flows, liquidity and financial condition.” In addition, possible acquisitions or investments in organic growth and other strategic initiatives could require additional debt financing. If our future cash flows do not meet our expectations and we are unable to service our debt, or if we are unable to obtain additional debt financing, we may be forced to take actions such as revising or delaying our strategic plans, reducing or delaying acquisitions, selling assets, restructuring or refinancing our debt, or seeking additional equity capital. We may be unable to effect any of these transactions on satisfactory terms, or at all. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to obtain additional financing on satisfactory terms, or at all, could have a material adverse effect on our business, financial condition and operating results.
We have a history of losses, and we might not be profitable in the future.
Due in large part to our high levels of indebtedness, we have had a history of losses. For the years ended September 30, 2014 and 2013, we generated net losses of $22.8 million and $18.3 million, respectively. Although we generated net income of $3.1 million for the year ended September 30, 2015 and have decreased our interest payments by repaying all of our senior notes and refinancing our senior secured credit facilities, we could report losses in the future. Other factors may cause us to report losses in the future, including reductions in funding for our services, reductions in reimbursement rates, increases in our costs, increased competition and other factors described elsewhere under this “Item 1A, Risk Factors”.
We have identified a material weakness in our internal control over financial reporting, and if we are unable to maintain effective internal control over financial reporting, investors could lose confidence in our financial statements, which could have a material adverse effect on our business and our stock price.
We are required, pursuant to Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm must report on its evaluation of our internal controls over financial reporting. As disclosed in Item 9A of this report, we have identified a material weakness as of September 30, 2015 in our internal control over financial reporting because we did not maintain effective controls over information technology. Our management team has taken action to begin remediating this material weakness, but we cannot be certain when the remediation will be completed. If we fail to fully remediate the material weakness or fail to maintain effective internal controls, it could result in a material misstatement of our financial statements, which could cause investors to lose confidence in our financial statements or cause our stock price to decline. In future periods, we may identify additional deficiencies in our system of internal controls over financial reporting that may require remediation. The generally decentralized nature of our operations and manual nature of many of our controls increases our risk of control deficiencies. In addition, future acquisitions may present challenges in implementing appropriate internal controls. Any future material weaknesses in internal control over financial reporting could result in material misstatements in our financial statements. Moreover, any future disclosures of additional material weaknesses, or errors as a result of those weaknesses, could result in a negative reaction in the financial markets if there is a loss of confidence in the reliability of our financial reporting.
State and local government payors with which we have contracts have complicated billing and collection rules and regulations, and if we fail to meet such requirements, our business could be materially impacted.
We derive approximately 89% of our revenue from contracts with state and local government agencies, and a substantial portion of this revenue is state-funded with federal Medicaid matching dollars. In billing for our services to third-party payors, we must follow complex documentation, coding and billing rules and there can be delays before we receive payment. These rules are based on federal and state laws, rules and regulations, various government pronouncements, and on industry practice. If we fail to
comply with federal and state documentation, coding and billing rules, we could be subject to criminal and/or civil penalties, loss of licenses and exclusion from the Medicaid programs, which could materially harm us. Specifically, failure to follow these rules could result in potential criminal or civil liability under the False Claims Act and various federal and state criminal healthcare fraud statutes, under which extensive financial penalties and exclusion from participation in federal healthcare programs can be imposed.
Federal false claims laws prohibit any person from knowingly presenting or causing to be presented a false claim for payment to the federal government, or knowingly making or causing to be made a false statement to get a false claim paid. Penalties for a False Claims Act violation include three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim, the potential for exclusion from participation in federal healthcare programs and criminal liability. The majority of states also have statutes or regulations similar to the federal false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. See “—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 annually submit a large volume of claims for Medicaid and other payments, and there can be no assurance that there have not been errors. The rules are frequently vague and confusing, and we cannot assure that governmental investigators, private insurers, private whistleblowers or Medicaid auditors will not challenge our practices. Such a challenge could result in a material adverse effect on our business.
The International Statistical Classification of Diseases and Related Health Problems is a medical classification list created by the World Health Organization (WHO). It contains codes for diagnoses, which are used to bill Medicaid and Medicare for services. The tenth revision of the list, ICD-10, went into effect on October 1, 2015, and, as a result, all providers must use the updated codes for billing. At this juncture we do not have sufficient experience to determine if we are adequately prepared for ICD-10. If we have not adequately prepared for ICD-10, it could result in the potential for rejected billing. In addition, payor readiness presents a risk, as payments could be delayed if payors’ systems are not updated and billing is rejected.
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, at their discretion:
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• | require us to refund amounts we have previously been paid; |
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• | terminate or modify our existing contracts; |
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• | suspend or prevent us from receiving new contracts or extending existing contracts; |
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• | impose referral holds on us; |
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• | impose fines, penalties or other sanctions on us; and |
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• | reduce the amount we are paid under our existing contracts. |
As a result of past reviews and audits of our operations, we have been and are subject to some of these actions from time to time. While we do not currently believe that our existing governmental reviews and audit proceedings will have a material adverse effect on our financial condition or significantly harm our reputation, we cannot assure you that such actions or 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. Moreover, if we are required to restructure our billing and collection methods, these changes could be disruptive to our operations and costly to implement.
Complicated billing and collection procedures can result in delays in collecting payment for our services, which may adversely affect our liquidity, cash flows and operating results.
The reimbursement process is time consuming and complex, and there can be delays before we receive payment. Government reimbursement, facility credentialing, 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. Similar issues arise in seeking payment from some of our private payors. These reimbursement and procedural issues occasionally cause us to have to resubmit claims several times and manage other administrative requests before payment is remitted. Missed filing deadlines can cause rejections of claims. 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.
Economic conditions could have a material adverse effect on our cash flows, liquidity and financial condition.
Our government payors rely on tax revenue to pay for our services. In the wake of the last economic recession that began in 2008, most states faced unprecedented declines in tax revenues and, as a result, record budget gaps. Furthermore, even after six years of economic improvement, state tax revenue is only 5% above prerecession levels, after adjusting for inflation. If the economy were to contract into a recession again, our government payors or other counterparties that owe us money could be delayed in obtaining, or may not be able to obtain, necessary funding and/or financing to meet their cash flow needs. In 2011, Standard & Poor’s downgraded the Federal government’s credit rating and additional downgrades are possible in the future. In October 2013, Fitch Ratings placed the Federal government’s credit rating on negative watch. If the credit rating of the federal government is downgraded again, it is possible there will be related downgrades of state credit ratings as well. If this or unrelated state downgrades occur, this could make it more expensive for states to finance their cash flow needs and put additional pressure on state budgets. Delays in payment could have a material adverse effect on our cash flows, liquidity and financial condition. In the event that our payors or other counterparties are financially unstable or delay payments to us, our financial condition could be further impaired if we are unable to borrow additional funds under our senior credit agreement to finance our operations.
Our financial results could be adversely affected if claims against us are successful, to the extent we must make payments under our self-insured retentions, or if such claims are not covered by our applicable insurance or if the costs of our insurance coverage increase.
We have been and continue to be subject to substantial claims against our professional and general liability and automobile liability insurance. Professional and general liability claims, if successful, could result in substantial damage awards which might require us to make significant payments under our self-insured retentions and increase future insurance costs. For claims made from October 1, 2011 to September 30, 2013, we were self-insured for the first $4.0 million of each and every claim with no aggregate limit. As of October 1, 2013, we are self-insured for $4.0 million per claim and $28.0 million in the aggregate. We may be subject to increased self-insurance retention limits in the future which could have a negative impact on our results. An award may exceed the limits of any applicable insurance coverage, and awards for punitive damages may be excluded from our insurance policies either contractually or by operation of state law. In addition, our insurance does not cover all potential liabilities including, for example, those arising from employment practice claims, wage and hour violations, and governmental fines and penalties. As a result, we may become responsible for substantial damage awards that are uninsured.
Insurance against professional and general liability and automobile liability can be expensive and our insurance premiums may increase in the future. Insurance rates vary from state to state, by type and by other factors. Rising costs of insurance premiums, as well as successful claims against us, could have a material adverse effect on our financial position and results of operations.
It is also possible that our liability and other insurance coverage will not continue to be available at acceptable costs or on favorable terms.
If payments for claims exceed actuarially determined estimates, if claims are not covered by insurance, or if our insurers fail to meet their obligations, our results of operations and financial position could be adversely affected.
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 we have so many employees, and because of the inherent physical risk associated with the interaction of employees with our clients, many of whom have intensive care needs, the potential for incidents giving rise to workers’ compensation liability is 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. In prior years, our results of operations have been adversely impacted by higher than anticipated claims, and they may be adversely impacted in the future if actual occurrences and claims exceed our assumptions and historical trends.
The Patient Protection and Affordable Care Act may materially increase our costs and/or make it harder for us to compete as an employer.
The Patient Protection and Affordable Care Act imposed new mandates on employers and individuals. The mandate requiring all individuals to enroll in a health insurance plan deemed credible became effective on January 1, 2014, but the implementation of the requirement that all employers with 50 or more full-time employees provide to employees health insurance deemed credible or pay a penalty became effective on January 1, 2015. Despite the delayed implementation of the employer mandate, we redesigned our health benefits for calendar year 2014 to offer employees health coverage that meets the requirements of the Patient Protection and Affordable Care Act. We are now in just our second year of experience with our new plans. Depending upon claims experience or enrollment changes in our new plans, our cost for employee health insurance could materially increase. Moreover, if the coverage we are offering isn’t competitive with the health insurance benefits our employees could receive at other employers, we may become less attractive as an employer and it may become more difficult for us to compete for qualified employees.
We face substantial competition in attracting and retaining experienced personnel, and we may be unable to maintain or grow our business if we cannot attract and retain qualified employees.
Our success depends to a significant degree on our ability to attract and retain qualified and experienced human service and other professionals, who possess the skills and experience necessary to deliver quality services to our clients and manage our operations. We face competition for certain categories of our employees, particularly direct service professionals and managers. Contractual requirements and client needs determine the number, as well as the education and experience levels, of health and human service professionals we hire. We face substantial turnover among our direct service professionals. Also, due to the nature of the services we provide, our working conditions require additional sensitivities and skills relative to traditional medical care environments. 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, working conditions and professional growth opportunities. The inability to attract and retain experienced personnel could have a material adverse effect on our business.
If we fail to establish and maintain relationships with government agencies, we may not be able to successfully procure or retain government-sponsored contracts, which could negatively impact our revenue.
To facilitate our ability to procure or retain government-sponsored contracts, we rely in part on establishing and maintaining relationships with officials of various government agencies, primarily at the state and local level but also including federal 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 may not be subject to non-compete or non-solicitation covenants. Any failure to establish, maintain or manage relationships with government and agency personnel may hinder our ability to procure or retain government-sponsored contracts, and could negatively impact our revenue.
Negative publicity or changes in public perception of our services may adversely affect our ability to obtain new contracts and renew existing ones or obtain third-party referrals.
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, our clients and the public. Negative publicity, changes in public perception, quality lapses, legal proceedings and government investigations with respect to our operations could damage our reputation and hinder our ability to retain contracts and obtain new contracts, and could reduce referrals, increase government scrutiny and compliance or litigation costs, or generally discourage clients from using our services. Any of these events could have a material adverse effect on our business, financial condition and operating results.
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 maintain or grow our client base.
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. Additionally, each of our service lines can be regulated differently within a particular jurisdiction. As a result, maintaining the necessary licenses and certifications to conduct our operations is cumbersome. Our licenses and certifications could be suspended, revoked or terminated for a number of reasons, including the:
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• | failure by our direct care staff or host-home providers to properly care for clients; |
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• | failure to submit proper documentation to the applicable government agency, including documentation supporting reimbursements for costs; |
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• | failure by our programs to abide by the applicable laws and regulations relating to the provision of health and human services; and the |
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• | failure of our facilities to comply with the applicable building, health and safety codes and ordinances. |
From time to time, some of our licenses or certifications, or those of our employees, are temporarily placed on probationary status or suspended. If we lost our status as a licensed provider of health and 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. In providing services in certain jurisdictions, we subcontract to another provider. In those situations, the other provider may hold the license or certification. However, if the other provider’s license or certification were revoked or suspended, we may no longer be permitted to provide services in that jurisdiction. Loss of a license as a direct provider or subcontractor of another provider of health and human services 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 financial performance and operations.
We have increased and will continue to make substantial expenditures to expand existing services, win new business and grow revenue, but we may not realize the anticipated benefits of such increased expenditures.
In order to grow our business, we must capitalize on opportunities to expand existing services and win new business, some of which require spending in advance of revenue. For example, states such as California and New Jersey are in the process of closing state institutions and transitioning individuals with intellectual and developmental disabilities into community-based settings such as ours. Responding to opportunities such as these typically requires significant investment of our resources in advance of revenue.
We spend a significant amount on growth initiatives, especially new starts. These investments have had a negative effect on our operating margin, and we may not realize the anticipated benefits of the spending as soon as we expect to or at any point in the future. If we target the wrong areas, or fail to identify the evolving needs of our payors by responding with service offerings that meet their fiscal and programmatic requirements, we may not realize the anticipated benefits of our investments and the results of our operations may suffer.
We may not realize the anticipated benefits of any future acquisitions, and we may experience difficulties in integrating these acquisitions.
As part of our growth strategy, we intend to make acquisitions. Growing our business through acquisitions involves risks because with any acquisition there is the possibility that:
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• | the business we acquire may not continue to generate income at the same historical levels on which we based our acquisition decision; |
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• | we may be unable to maintain and renew the contracts of the acquired business; |
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• | unforeseen difficulties may arise in integrating the acquired operations, including employment practices, information systems and accounting controls; |
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• | we may not achieve operating efficiencies, synergies, economies of scale and cost reductions as expected; |
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• | we may be required to pay higher purchase prices for acquisitions than we have paid historically; |
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• | management may be distracted from overseeing existing operations by the need to integrate the acquired business; |
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• | we may acquire or assume unexpected liabilities or there may be other unanticipated costs; |
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• | we may encounter unanticipated regulatory risk; |
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• | we may experience problems entering new markets or service lines in which we have limited or no experience; |
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• | we may fail to retain and assimilate key employees of the acquired business; |
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• | we may finance the acquisition by incurring additional debt and further increase our leverage ratios; and |
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• | the culture of the acquired business may not match well with our culture. |
As a result of these risks, there can be no assurance that any future acquisition will be successful or that it will not have a material adverse effect on our financial condition and results of operations.
If we are not successful in expanding into adjacent markets, our growth strategy could suffer.
Our growth strategy depends on pursuing opportunities in adjacent markets, and we may not be successful in adapting our service models to markets or service lines in which we have little or no prior experience. We recently expanded into the ADH services market. In the future, we may explore other adjacent markets, such as services to youth with autism and individuals with mental health issues, which would expose us to additional operational, regulatory and legal risks. Serving other populations may require compliance with additional federal and state laws and regulations which may differ from the laws and regulations that apply to the populations we currently serve. Compliance with new laws and regulations may result in unanticipated expenses or liabilities. Programs we open in adjacent markets may also take longer to reach expected revenue and profit levels on a consistent basis and may have higher occupancy or operating costs than programs in our existing markets, which may affect our overall profitability. Adjacent markets may have different payors, referral sources, staffing requirements, client preferences and competitive conditions. We may find it more difficult to hire, motivate and keep qualified direct care workers and other employees in these adjacent markets. We may need to augment our staffing to meet regulatory requirements, and the overall cost of labor may be higher. As a result, we may not be successful in diversifying the populations we serve, and we may fail to capture market share in adjacent markets. If any steps taken to expand our existing business into adjacent markets are unsuccessful, we may not be able to achieve our growth strategy and our business, financial condition or results of operations could be adversely affected.
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 are required to comply with comprehensive government regulation of our business, including statutes, regulations and policies governing the licensing of our facilities, the maintenance and management of our work place for our employees, the quality of our service, the revenue we receive for our services and reimbursement for the cost of our services. Compliance with these laws, regulations and policies is expensive, and if we fail to comply with these laws, regulations and policies, we could lose contracts and the related revenue, thereby harming our financial results. State and federal regulatory agencies have broad discretionary powers over the administration and enforcement of laws and regulations that govern our operations. A material violation of a law or regulation could subject us to fines and penalties and in some circumstances could disqualify some or all of the facilities and programs under our control from future participation in Medicaid or other government programs.
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”) and other federal and state data privacy and security laws govern the collection, dissemination, security, use and confidentiality of patient-identifiable health information. HIPAA and the HITECH Act require us to comply with standards for the use and disclosure of health information within our company and with third parties, including, among other things, the adoption of administrative, physical and technical safeguards to protect such information. Additionally, certain states have adopted comparable privacy and security laws and regulations, some of which may be more stringent than HIPAA. While we have taken steps to comply with applicable health information privacy and security requirements to which we are aware that we are subject to, if we do not comply with existing or new federal or state laws and regulations related to patient health information, we could be subject to criminal or civil sanctions and any resulting liability could adversely affect our operations. The costs of complying with privacy and security related legal and regulatory requirements are burdensome and could have a material adverse effect on our operations.
Expenses incurred under governmental agency contracts for any of our services, as well as management contracts with providers of record for such agencies, are subject to review by agencies administering the contracts and services.
Representatives of those agencies visit our group homes to verify compliance with state and local regulations governing our home operations. A negative outcome from any of these examinations could increase government scrutiny, increase compliance costs or hinder our ability to obtain or retain contracts. Any of these events could have a material adverse effect on our business, financial condition and operating results.
The federal Anti-Kickback Law and similar state statutes, prohibit the provision of kickbacks, rebates and any other form of remuneration in return for referrals. Any remuneration, direct or indirect, offered, paid, solicited or received, in return for referrals of patients or business for which payment may be made in whole or in part under Medicaid could be considered a violation of law. The Anti-Kickback Law also prohibits payments made to anyone to induce them to recommend purchasing, leasing or ordering any goods, facility, service or item for which payment may be made in whole or in part by Medicaid. Criminal penalties under the Anti-Kickback Law include fines up to $25,000, imprisonment for up to five years, or both. In addition, acts constituting a violation of the Anti-Kickback Law may also lead to civil penalties, such as fines, assessments, exclusion from participation in the Medicaid programs and liability under the False Claims Act.
We are subject to many different and varied audit mechanisms for post-payment review of claims submitted under the Medicaid program. These include Recovery Audit Contractor (“RAC”) auditors, State Medicaid auditors, surveillance integrity review audits and Payment Error Rate Measurement (“PERM”) audits, among others. Any one of these audit activities may identify claims that the auditors deem problematic and, following such determination, auditors may require recoupment of claims by Medicaid to us.
On March 17, 2014, a federal regulation governing home- and community-based services became effective. The rule establishes eligibility requirements for Medicaid home and community-based services provided under the “waiver” program. The waiver program allows the states to furnish an array of home- and community-based services and avoid institutional care. Under the new rule, home- and community-based settings must be integrated in and support full access to the greater community, be selected by the individual from different setting options, ensure individual rights of privacy, and optimize autonomy and independence in making life choices. The rule includes additional requirements for provider-owned or controlled home and community-based residential settings, including that the individual has a lease or other legally enforceable agreement, and standards related to the individual’s privacy, control over schedule and visitors, and physical accessibility of the setting. At this juncture it is unclear how individual states will seek to implement this newly adopted regulation. The rule presents some implementation challenges, as some of the broad requirements may conflict with the needs and/or precautions that we must take for some of the individuals that we serve. It is unclear how each state will seek to address this potential conflict, and the impact and costs of implementation and compliance with this regulation are currently unknown. States have the option to request a variation or delay of compliance with the federal standards for as long as five years from the effective date. Moreover, each state Medicaid agency may interpret and submit different requests and extension timelines.
Any change in interpretations or enforcement of existing or new laws and regulations could subject our current business practices to allegations of impropriety or illegality, or could require us to make changes in our homes, equipment, personnel, services, pricing or capital expenditure programs, which could increase our operating expenses and have a material adverse effect on our operations or reduce the demand for or profitability of our services.
Should we be found out of compliance with these statutes, regulations and policies, depending on the nature of the findings, our business, our financial position and our results of operations could be materially adversely impacted.
The high level of competition in our industry could adversely affect our contract and revenue base.
We compete in a highly fragmented industry 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.
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. For example,
during the course of much of the last decade, state governments increasingly adopted policies that emphasized greater family preservation and family reunification for at-risk youth, which reduced the demand for foster care services and required that we adapt our service offerings. The ARY market in several states has continued to be volatile and challenging, which has resulted in a strategic review by us and completed and planned divestitures of operations in six states serving ARY contracts. Shifts in public policy
and, therefore, our future success, are subject to a variety of political, economic, social and legal pressures, all of which are beyond our control. A reversal in the downsizing and privatization trends could reduce the demand for our services, which could adversely affect our revenue and profitability.
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 each of the fiscal years ended September 30, 2015, 2014, and 2013 15%, 14%, and 14% of our net revenue, respectively, was derived 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 revenues and possibly the loss of contracts. For example, our I/DD services in Minnesota were negatively impacted in 2009 and 2011 by rate cuts of 2.6% and 1.5%, respectively. We cannot assure you that we will not receive additional rate reductions this year or in the future. The concentration of our operations in Minnesota also makes us particularly susceptible to many of the other risks described above occurring in this state, including:
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• | the failure to maintain and renew our licenses; |
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• | the failure to maintain important relationships with officials of government agencies; and |
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• | any negative publicity regarding our operations. |
Any of these adverse developments occurring in Minnesota could result in a reduction in revenue or a loss of contracts, which could have a material adverse effect on our results of operations, financial position and cash flows.
Covenants in our senior credit agreement impose several restrictions on our business.
The senior credit agreement contains various covenants that limit our ability to, among other things:
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• | incur additional debt or issue certain preferred shares; |
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• | pay dividends on or make distributions in respect of capital stock or make other restricted payments; |
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• | make certain investments; |
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• | create liens on certain assets to secure debt; |
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• | enter into agreements that restrict dividends from subsidiaries; |
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• | consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and |
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• | enter into certain transactions with our affiliates. |
The senior credit agreement governing the senior secured credit facilities also requires us to maintain a specified financial ratio, which began in the quarter ended June 30, 2014, in the event that we draw greater than 30% of the revolving commitment under our senior revolver. Our ability to meet this financial ratio could be affected by events beyond our control. The breach of any of these covenants or financial ratio could result in a default under the senior secured credit facilities and our 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.
We depend upon the continued services of certain members of our senior management team, without whom our business operations could be significantly disrupted.
Our success depends, in part, on the continued contributions of our senior officers and other key employees. Our management team has significant industry experience and a long history with us, and would be difficult to replace. If we lose or suffer an extended interruption in the service of one or more of our key employees, our financial condition and operating results could be adversely affected. The market for qualified individuals is highly competitive and we may not be able to attract and
retain qualified personnel to replace or succeed members of our senior management or other key employees, should the need arise.
Our success depends on our ability to manage and integrate key administrative functions.
Our operations and administrative functions are largely decentralized and subject to disparate accounting and billing requirements established and often modified by our local payors and referral sources. Although in recent years we have undertaken an effort to consolidate accounting, billing, cash collections and other financial and administrative functions which may have mitigated this risk to some degree, there remains a substantial portion of the business that has not yet been centralized and some risk in the centralization process itself. If we encounter difficulties in integrating our operations further or fail to effectively manage these functions to ensure compliance with disparate and evolving requirements imposed by our payors and referral sources, it could have a material adverse effect on our results of operations, financial position and cash flows.
Our information systems are critical to our business and a failure of those systems, or a failure to upgrade them when required, could materially harm us.
We depend on our ability to store, retrieve, process and manage a significant amount of information, and to provide our operations with efficient and effective accounting, census, incident reporting and other quality assurance systems. Our information systems require maintenance and upgrading to meet our needs, which could significantly increase our administrative expenses.
Any system failure that causes an interruption in service or availability of our critical systems could adversely affect operations or delay the collection of revenues. Even though we have implemented network security measures, our servers are vulnerable to computer viruses, hacking and similar disruptions from unauthorized tampering. The occurrence of any of these events could result in interruptions, delays, the loss or corruption of data, or cessations in the availability of systems, all of which could have a material adverse effect on our financial position and results of operations and harm our business reputation. Furthermore, a loss of health care information could result in potential penalties in certain of our businesses if we fail to comply with privacy and security standards in violation of HIPAA, as amended by the HITECH Act.
The performance of our information technology and systems is critical to our business operations. Our information systems are essential to a number of critical areas of our operations, including:
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• | accounting and financial reporting; |
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• | billing and collecting accounts; |
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• | clinical systems, including census and incident reporting; |
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• | records and document storage; and |
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• | monitoring quality of care and collecting data on quality and compliance measures. |
In addition, as we continue to upgrade our systems, we run the risk of ongoing disruptions while we transition from legacy, and often paper-based, systems. Disruptions in our systems could result in delays and difficulties in billing, which could negatively affect our results from operations and cash flows. We may choose systems that ultimately fail to meet our needs, or that cost more to implement and maintain than we had anticipated. Such systems may become obsolete sooner than expected, our payors may require us to invest in other systems, and state and/or federal regulations may impose electronic records standards that we cannot easily address from our existing platform. If we fail to upgrade successfully and cost-effectively, or if we are forced to invest in new or incompatible technology, our financial condition, cash flows and results of operations may suffer.
We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business.
We rely on information technology networks and systems to process, transmit and store electronic information in order to manage or support a variety of our business processes, including consumer records, financial transactions and maintenance of
records. These processes may include sensitive financial information, personally identifiable information of clients and employees, and personal health information protected by HIPPA. Our business and operations may be harmed if we do not securely maintain our business processes and information systems or maintain the integrity of our confidential information. Although we have developed systems and processes that are designed to protect information against security breaches, it is impossible to prevent all
security breaches. Failure to protect such information or mitigate any such breaches may adversely affect our operating results. Security breaches, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns and unauthorized disclosure of confidential information. Any failure to maintain proper function, security and availability of our information systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties, increase administrative expenses or lead to other adverse consequences.
Our financial results may suffer if we have to write off goodwill or other intangible assets.
A large portion of our total assets consists of goodwill and other intangible assets. Goodwill and other intangible assets, net of accumulated amortization, accounted for 54.6% and 48.5% of the total assets on our consolidated balance sheets as of September 30, 2015 and 2014, respectively. In connection with the decision to discontinue ARY services in the states of Florida, Louisiana, Illinois, Indiana, North Carolina and Texas, we incurred an impairment charge of $10.4 million in the year ended September 30, 2015 for intangible assets attributable to the business. We may not realize the value of our goodwill or other intangible assets and we expect to engage in additional transactions that will result in our recognition of additional goodwill or other intangible assets.
We evaluate on a regular basis whether events and circumstances have occurred that indicate that all or a portion of the carrying amount of goodwill or other intangible assets may no longer be recoverable, and is therefore impaired. Under current accounting rules, any determination that impairment has occurred would require us to write-off the impaired portion of our goodwill or the unamortized portion of our intangible assets, resulting in a charge to our earnings.
We may be more susceptible to the effects of a natural disaster or public health catastrophe, compared with other businesses due to the vulnerable nature of our client population.
Our primary clients are individuals with developmental disabilities, brain injuries, or emotionally, behaviorally and/or medically complex challenges, many of whom would be more vulnerable than the general public in a natural disaster or public health catastrophe. In a natural disaster, we could be forced to relocate some of our clients on short notice under dangerous conditions and our new program starts and acquisitions could experience delays. Accordingly, natural disasters and certain public health catastrophes could have a material adverse effect on our financial condition and results of operations.
We are classified as a “controlled company” and, as a result, we qualify for, and rely on, certain exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.
We are a “controlled company” within the meaning of the New York Stock Exchange corporate governance standards. Under the rules of the New York Stock Exchange, a company of which more than 50% of the outstanding voting power is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain stock
exchange corporate governance requirements, including the requirements that:
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• | a majority of the Board of Directors consists of independent directors; |
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• | nominating and corporate governance matters be decided solely by independent directors; and |
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• | employee and officer compensation matters be decided solely by independent directors. |
We do currently rely on each of the above exemptions. Accordingly, you may not have the same protections afforded to stockholders of companies that are subject to all of the stock exchange corporate governance requirements.
Our stock price may be volatile or may decline regardless of our operating performance, and you may not be able to resell your shares at or above your purchase price.
The market price for our common stock may be volatile. You may not be able to resell your shares at or above the public offering price, due to fluctuations in the market price of our common stock, which may be caused by a number of factors, many of which we cannot control including the following:
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• | changes in financial estimates by any securities analysts who follow our common stock, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our common stock; |
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• | downgrades by any securities analysts who follow our common stock; |
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• | future sales of our common stock by our officers, directors and significant stockholders; |
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• | market conditions or trends in our industry or the economy as a whole and, in particular, in the healthcare environment; |
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• | investors’ perceptions of our prospects; |
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• | announcements by us of significant contracts, acquisitions, joint ventures or capital commitments; and |
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• | changes in key personnel. |
In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies, including companies in the healthcare industry. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were involved in securities litigation, we could incur substantial costs, and our resources and the attention of management could be diverted from our business.
Our equity sponsor has the ability to control significant corporate activities and our majority stockholder’s interests may not coincide with yours.
Vestar owns approximately 53% of our common stock. As a result, Vestar has the ability to control the outcome of matters submitted to a vote of stockholders. In addition, under the director nominating agreement that we entered into in connection with our IPO (the “Nominating Agreement”), affiliates of Vestar will have the right to nominate directors for election to our Board of Directors, and we will agree to support those nominees. Under certain circumstances, those nominees could constitute a majority of our Board of Directors even though affiliates of Vestar at the time owns less than a majority of our common stock, giving Vestar decision-making control over us. Matters over which Vestar may, directly or indirectly, exercise control include:
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• | the election of our Board of Directors and the appointment and removal of our officers; |
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• | mergers and other business combination transactions, including proposed transactions that would result in our stockholders receiving a premium price for their shares; |
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• | other material acquisitions or dispositions of businesses or assets; |
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• | incurrence of indebtedness and the issuance of equity securities; |
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• | repurchase of stock and payment of dividends; and |
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• | the issuance of shares to management under our equity incentive plans. |
Even if Vestar’s ownership of our shares falls below a majority, Vestar may continue to be able to influence or effectively control our decisions. Under our amended and restated certificate of incorporation, Vestar and its affiliates will not have any obligation to present to us, and Vestar may separately pursue, corporate opportunities of which they become aware, even if those opportunities are ones that we would have pursued if granted the opportunity.
Future sales of our common stock, or the perception in the public markets that these sales may occur, may depress our stock price.
Sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur, could adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional shares. As of September 30, 2015, we had 37,093,237 shares of common stock outstanding. The shares of common stock sold in our initial public offering and secondary offering in 2015 are freely tradable without restriction under the Securities Act, except for any shares of our common stock that may be held or acquired by our directors, executive officers and other affiliates, as that term is defined in the Securities Act, which will be subject to the volume limits and other restrictions of Rule 144.
In addition, the 22,950,000 shares of our common stock distributed to the members of NMH Investment in the distribution of all of the shares of our common stock held by it to its existing members in accordance with their respective
membership interests, as described in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Subsequent Events” ("the Distribution") and not sold in the secondary offering were immediately saleable under Rule 144 under the Securities Act, except for any shares distributed in the Distribution to our directors, executive officers and other affiliates, which must be sold in accordance with the requirements of Rule 144 applicable to affiliates, including aggregation of sales by such persons in calculating the volume limits of Rule 144 for a period of six months following the Distribution.
As of November 30, 2015, all of the members of NMH Investment who received shares of common stock in the Distribution, who hold 22,950,000 shares, or approximately 62% of our common stock, have the right to require us to register such shares pursuant to the terms of a registration rights agreement between us and the holders of those shares.
In the future, we may also issue our securities in connection with acquisitions or investments. The amount of shares of our common stock issued in connection with an acquisition or investment could constitute a material portion of our then-outstanding shares of our common stock.
If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our stock price and trading volume to decline.
Because we do not intend to pay cash dividends in the foreseeable future, you may not receive any return on investment unless you are able to sell your common stock for a price greater than your purchase price.
The continued operation and expansion of our business will require substantial funding. Accordingly, we
do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon results of operations, financial condition, contractual restrictions, including those under our senior secured credit facilities, any potential indebtedness we may incur, restrictions imposed by applicable law and other factors our Board of Directors deems relevant. Accordingly, if you purchase shares, realization of a gain on your investment will depend on the appreciation of the price of our common stock, which may never occur. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.
We are a holding company and rely on dividends, distributions and other payments, advances and transfers of funds from our subsidiaries to meet our obligations.
We are a holding company that does not conduct any business operations of our own. As a result, we are largely dependent upon cash dividends and distributions and other transfers from our subsidiaries to meet our obligations. The deterioration of income from, or other available assets of, our subsidiaries for any reason could limit or impair their ability to pay dividends or other distributions to us.
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Item 1B. | Unresolved Staff Comments |
We have not received written comments from the Securities and Exchange Commission that remain unresolved.
Our principal executive office is located at 313 Congress Street, Boston, Massachusetts 02210. We operate a number of facilities and administrative offices throughout the United States. As of September 30, 2015, we provided services in 370 owned facilities and 1,556 leased facilities, as well as in homes owned by our Mentors. We also own three offices and lease 244 offices. We believe that our properties are adequate for our business as presently conducted and we believe we can meet requirements for additional space by exercising options on leases or by finding alternative space.
We are in the health and human services business and, therefore, we have been and continue to be subject to substantial claims alleging that we, our employees or our Mentors failed to provide proper care for a client. We are also subject to claims by our clients, our employees, our Mentors or community members against us for negligence, intentional misconduct or violation of applicable laws. Included in our recent claims are claims alleging personal injury, assault, 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 also are subject to potential lawsuits under the False Claims Act and other federal and state whistleblower statutes designed to combat fraud and abuse in the health care industry. These lawsuits can involve significant monetary awards that may incentivize private plaintiffs to bring these suits. If we are found to have violated the False Claims Act, we could be excluded from participation in Medicaid and other federal healthcare programs. The Patient Protection and Affordable Care Act provides a mandate for more vigorous and widespread enforcement activity to combat fraud and abuse in the health care industry.
Finally, we are also subject to employee-related claims under state and federal law, including claims for discrimination, wrongful discharge or retaliation and claims for wage and hour violations under the Fair Labor Standards Act or state wage and hour laws.
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 I. Item 1A. Risk Factors” and “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and "Notes to Consolidated Financial Statements. Note 18. Other Commitments and Contingencies" for additional information.
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Item 4. | Mine Safety Disclosures |
Not applicable.
PART II
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Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Our common stock began trading on the NYSE under the symbol “CIVI” on September 17, 2014. Prior to that, there was no public market for our common stock. The following table sets forth the high and low sales prices per share of our common stock as reported by the NYSE for each quarter in the year ended September 30, 2015 and the period from September 17, 2014 to September 30, 2014:
|
| | | | | | | |
| High Sale Price | | Low Sale Price |
Fiscal 2015 | | | |
Fourth Quarter | $ | 27.85 |
| | $ | 20.60 |
|
Third Quarter | $ | 22.52 |
| | $ | 17.78 |
|
Second Quarter | $ | 21.12 |
| | $ | 16.69 |
|
First Quarter | $ | 17.50 |
| | $ | 11.88 |
|
| | | |
Fiscal 2014 | | | |
Fourth Quarter (beginning September 17, 2014)
| $ | 17.19 |
| | $ | 15.11 |
|
Stockholders
On November 30, 2015, there were 37,095,034 shares of our common stock outstanding, held by 78 stockholders of record, one of which was Cede & Co., which is the nominee of shares held through The Depository Trust Company. The number of beneficial owners is substantially greater than the number of owners of record because a significant portion of our common stock is held through brokerage firms.
Stock Performance Graph
The graph below compares the cumulative total stockholder return on our common stock from September 17, 2014 through September 30, 2015 with the cumulative total return of the Russell 2000 Healthcare Index and the NYSE Composite. This graph assumes an investment of $100.00 in our common stock and in each of the indexes on September 17, 2014 and its relative performance is tracked through September 30, 2015. We paid no dividends on our common stock during the period covered by the graph. Measurement points are September 17, 2014 and the last trading day of each subsequent month end through September 30, 2015.
The comparisons shown in the graph below are based upon historical data. We caution that the stock price performance shown in the graph below is not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock.
This graph is not deemed to be “filed” with the SEC or subject to the liabilities of Section 18 of the Exchange Act, and the graph shall not be deemed to be incorporated by reference into any prior or subsequent filing by Civitas under the Securities Act or the Exchange Act.
Dividends
We did not pay any cash dividends during fiscal 2015. During fiscal 2014 and 2013, we paid $110 thousand and $39 thousand, respectively, to NMH Investment to fund repurchases of equity units from employees upon or after their departure. We accounted for these repurchases as dividends to our former indirect parent, NMH Investment. We have paid no dividends on our common stock since the time of our initial public offering.
We do not anticipate paying any cash dividends in the foreseeable future. Our ability to pay dividends on our common stock is limited by restrictions on the ability of our subsidiaries and us to pay dividends or make distributions under the terms of NMHI’s current and any future agreements governing our indebtedness. Any future determination to pay dividends will be at the discretion of our Board of Directors, subject to compliance with covenants in NMHI’s current and any future agreements governing our indebtedness, and will depend upon our results of operations, financial condition, capital requirements and other factors that our Board of Directors deems relevant.
In addition, since we are a holding company, substantially all of the assets shown on our consolidated balance sheet are held by our subsidiaries. Accordingly, our earnings, cash flow and ability to pay dividends are largely dependent upon the earnings and cash flows of our subsidiaries and the distribution or other payment of such earnings to us in the form of dividends.
Repurchases of Equity Securities
The following table provides information about purchases we made during the three months ended September 30, 2015 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act: |
| | | | | |
| Total Number of Shares Purchased (1) | | Average Price Paid per Share |
7/1/2015 - 7/31/2015 | 9,206 |
| | $21.40 |
8/1/2015 - 8/31/2015 | — |
| | — |
|
9/1/2015 - 9/30/2015 | 49,874 |
| | $26.41 |
(1) Our employees surrendered an aggregate of 59,080 shares to us in satisfaction of minimum tax withholding obligations associated with the vesting of restricted stock units during the three months ended September 30, 2015.
Unregistered Sales of Equity Securities
No unregistered equity securities of the Company were sold during fiscal 2015.
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Item 6. | Selected Financial Data |
We derived the selected historical consolidated financial data as of and for the years ended September 30, 2015, 2014, and 2013 from the historical consolidated financial statements of the Company and the related notes included elsewhere in this Annual Report on Form 10-K.
We have derived the selected historical consolidated financial data as of and for the years ended September 30, 2012 and 2011 from the historical consolidated financial statements of the Company and the related notes not included in this Annual Report on Form 10-K, as adjusted for discontinued operations.
The selected information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical consolidated financial statements and notes included elsewhere in this report.
|
| | | | | | | | | | | | | | | | | | | |
| Year Ended September 30, |
| 2015 | | 2014 | | 2013 | | 2012 | | 2011 |
| | | | | | | | | |
| (Amounts in thousands, except share and per share amounts)
|
Statements of Operations Data (1): | | | | | | | | | |
Net revenue | $ | 1,366,946 |
| | $ | 1,255,838 |
| | $ | 1,182,509 |
| | $ | 1,107,351 |
| | $ | 1,048,949 |
|
Cost of revenue (exclusive of depreciation and amortization expense shown separately below) | 1,059,364 |
| | 983,043 |
| | 921,618 |
| | 861,691 |
| | 811,765 |
|
Operating expenses: | | | | | | | | | |
General and administrative expenses | 162,839 |
| | 145,041 |
| | 145,184 |
| | 139,630 |
| | 143,516 |
|
Depreciation and amortization | 82,172 |
| | 67,488 |
| | 63,573 |
| | 59,987 |
| | 60,804 |
|
Total operating expense | 245,011 |
|
| 212,529 |
|
| 208,757 |
|
| 199,617 |
|
| 204,320 |
|
Income from operations | 62,571 |
| | 60,266 |
| | 52,134 |
| | 46,043 |
| | 32,864 |
|
Other income (expense): | | | | | | | | | |
Management fee of related party | 28 |
| | (9,488 | ) | | (1,359 | ) | | (1,325 | ) | | (1,271 | ) |
Other income (expense), net | (1,325 | ) | | 374 |
| | 1,046 |
| | 330 |
| | (97 | ) |
Extinguishment of debt | (17,058 | ) | | (14,699 | ) | | — |
| | — |
| | (23,684 | ) |
Interest expense | (37,455 | ) | | (69,349 | ) | | (78,075 | ) | | (79,445 | ) | | (67,511 | ) |
Income (loss) from continuing operations before income taxes | 6,761 |
| | (32,896 | ) | | (26,254 | ) | | (34,397 | ) | | (59,699 | ) |
Expense (benefit) for income taxes | 2,689 |
| | (11,463 | ) | | (9,942 | ) | | (19,883 | ) | | (19,884 | ) |
Income (loss) from continuing operations | 4,072 |
| | (21,433 | ) | | (16,312 | ) | | (14,514 | ) | | (39,815 | ) |
(Loss) gain from discontinued operations, net of tax | (1,000 | ) | | (1,382 | ) | | (1,984 | ) | | 245 |
| | (3,686 | ) |
Net income (loss) | $ | 3,072 |
| | $ | (22,815 | ) | | $ | (18,296 | ) | | $ | (14,269 | ) | | $ | (43,501 | ) |
Income (loss) per common share, basic and diluted | | | | | | | | | |
Income (loss) from continuing operations | $ | 0.11 |
| | $ | (0.84 | ) | | $ | (0.65 | ) | | $ | (0.57 | ) | | $ | (1.58 | ) |
(Loss) gain from discontinued operations | (0.03 | ) | | (0.05 | ) | | (0.07 | ) | | — |
| | (0.15 | ) |
Net income (loss) | $ | 0.08 |
| | $ | (0.89 | ) | | $ | (0.72 | ) | | $ | (0.57 | ) | | $ | (1.73 | ) |
Weighted average number of common shares outstanding, basic | 36,959,997 |
| | 25,538,493 |
| | 25,250,000 |
| | 25,250,000 |
| | 25,250,000 |
|
Weighted average number of common shares outstanding, diluted | 37,088,632 |
| | 25,538,493 |
| | 25,250,000 |
| | 25,250,000 |
| | 25,250,000 |
|
| | | | | | | | | |
Balance Sheet Data (at end of period): | | | | | | | | | |
Cash and cash equivalents (2) | $ | 41,690 |
| | $ | 196,147 |
| | $ | 19,440 |
| | $ | 125 |
| | $ | 387 |
|
Working capital(3) | 60,150 |
| | 49,555 |
| | 59,262 |
| | 26,192 |
| | 12,634 |
|
Total assets | 1,063,184 |
| | 1,027,954 |
| | 1,021,269 |
| | 1,045,880 |
| | 1,011,360 |
|
Total debt(4) | 651,643 |
| | 815,509 |
| | 803,464 |
| | 799,895 |
| | 784,124 |
|
Stockholders’ equity (deficit) | 121,275 |
| | 115,538 |
| | (46,515 | ) | | (29,391 | ) | | (16,917 | ) |
_______________________
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(1) | In April 2014, the FASB issued Accounting Standards Update No. 2014-08 which was adopted by the Company on October 1, 2014. The new standard, which was applied prospectively, is expected to significantly limit the |
classification of future disposals as discontinued operations. In fiscal 2015, we decided to discontinue ARY services in the states of Florida, Indiana, Louisiana, North Carolina and Texas. These businesses have not been classified as discontinued operations. Included in the results for fiscal 2015, 2014, and 2013 is net revenue of $48.2 million, $56.9 million, and $79.5 million, respectively, and income from operations of $5.4 million, $5.2 million, and $11.8 million, respectively, related to these businesses.
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(2) | The cash and cash equivalent balance as of September 30, 2014 includes $172.1 million of cash that was used to redeem $162.0 million of our outstanding senior notes and pay the associated call premium on October 17, 2014. |
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(3) | Calculated as current assets minus current liabilities. |
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(4) | Includes obligations under capital leases. |
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Item 7. | 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 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
We are the leading national provider of home- and community-based health and human services to must-serve individuals with intellectual, developmental, physical or behavioral disabilities and other special needs. Since our founding in 1980, we have been a pioneer in the movement to provide home- and community-based services for people who would otherwise be institutionalized. During our 35-year history, we have evolved from a single residential program serving at-risk youth to a diversified national network providing an array of high-quality services and care in large, growing and highly-fragmented markets. While we have the capabilities to serve individuals with a wide variety of special needs and disabilities, we currently provide our services to individuals with intellectual and/or developmental disabilities ("I/DD"), individuals with catastrophic injuries and illnesses, particularly acquired brain injury ("ABI"), youth with emotional, behavioral and/or medically complex challenges, or at-risk youth ("ARY") and elders in need of day health services to support their independence, or adult day health (“ADH”). As of September 30, 2015, we operated in 35 states, serving approximately 12,400 clients in residential settings and more than 17,000 clients in non-residential settings. We have a diverse group of hundreds of public payors which fund our services with a combination of federal, state and local funding, as well as an increasing number of non-public payors related to our services for ABI and other catastrophic injuries and illnesses.
We have two reportable business segments: the Human Services Segment and the Post-Acute Specialty Rehabilitation Services (“SRS”) Segment. Through the Human Services Segment, we provide home- and community-based human services to adults and children with intellectual and developmental disabilities, to youth with emotional, behavioral and/or medically complex challenges and, beginning in the quarter ended September 30, 2014, to elders. The operations of the Human Services Segment have been organized by management into three business units based upon geography and clients served. These business units, which comprise three operating segments, have been aggregated based on the criteria set forth in the accounting standards. Through the SRS Segment, we deliver services to individuals who have suffered acquired brain injury, spinal injuries and other catastrophic injuries and illnesses. The operations of the SRS Segment have been organized by management into two business units, NeuroRestorative and CareMeridian, based upon service type. These business units, which comprise two operating segments, have been aggregated based on the criteria set forth in the accounting standards. Each operating segment is aligned with the Company’s reporting structure and has a segment manager that is directly accountable for its operations and regularly reports results to the chief operating decision maker for the purpose of evaluating these results and making decisions regarding resource allocations.
Delivery of services to individuals with I/DD is the largest portion of our Human Services segment. Our I/DD programs include residential support, day habilitation, vocational services, case management, crisis intervention and hourly support care. Our Human Services segment also includes the delivery of ARY services. Our ARY programs include therapeutic foster care, family preservation, adoption services, early intervention, school-based services and juvenile offender programs. Our newest service line, ADH, delivers elder services including case management, nursing oversight, medication management, nutrition, daily living assistance, transportation, and therapeutic services. Within our SRS segment, our NeuroRestorative business unit is focused on rehabilitation and transitional living services and our CareMeridian business unit is focused on the more medically-intensive post-acute care services. Our SRS services range from sub-acute healthcare for individuals with intensive medical needs to day treatment programs, and include: neurorehabilitation; neurobehavioral rehabilitation; specialized nursing; physical, occupational and speech therapies; supported living; outpatient treatment; and pre-vocational services.
Factors Affecting our Operating Results
Demand for Home and Community-Based Health and Human Services
Our growth in revenue has historically been related to increases in the number of individuals served as well as increases in the rates we receive for our services. This growth has depended largely upon development-driven activities, including the maintenance and expansion of existing contracts and the award of new contracts, our new start program and acquisitions. We also attribute the long-term growth in our client base to certain trends that are increasing demand in our industry, including demographic, health-care and political developments.
Demographic trends have a particular impact on our I/DD business. Increases in the life expectancy of individuals with I/DD, we believe, have resulted in steady increases in the demand for I/DD services. In addition, caregivers currently caring for their relatives at home are aging and many may soon be unable to continue with these responsibilities. Many states continue to downsize or close large, publicly-run facilities for individuals with I/DD and refer those individuals to private providers of community-based services. Each of these factors affects the size of the I/DD population in need of services. Demand for our SRS services has also grown as emergency response and improved medical techniques have resulted in more people surviving a catastrophic injury. SRS services are increasingly sought out as a clinically-appropriate and less-expensive alternative to institutional care and as a “step-down” for individuals who no longer require care in acute settings.
Our residential ARY services were negatively impacted by a substantial decline in the number of children and adolescents in foster care placements during the last decade, although the population has stabilized in recent years. This decline has contributed to increased demand for periodic, non-residential services to support at-risk youth and their families. However, notwithstanding the increased demand for periodic services, during the past two fiscal years payor demand in the state of North Carolina for periodic ARY services has significantly contracted as a result of a statewide redesign of these programs and, as a result, negatively impacted our business in that state. In fiscal 2015, we decided to discontinue ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas. This decision is not expected to affect other services provided by us in those states. For more information on these divestitures refer to “Part II. Item 7. Divestitures.”
Political and economic trends can also affect our operations. Budgetary pressures facing state governments, especially within Medicaid programs, as well as other economic, industry and political factors could cause state governments to limit spending, which could significantly reduce our revenue, referrals, margins and profitability, and adversely affect our growth strategy. Government agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If the government agency does not receive an appropriation sufficient to cover its obligations with us, it may terminate a contract or defer or reduce our reimbursements. For example, during the economic downturn that began in 2008, our government payors in several states responded to deteriorating revenue collections by implementing service reductions, rate freezes and/or rate reductions. Beginning in fiscal 2012, the rate environment improved and, as a result, for fiscal years 2012, 2013, 2014 and 2015 pricing increases contributed to revenue growth.
Historically, our business has benefited from the trend toward privatization and the efforts of groups that advocate for the populations we serve. These groups lobby governments to fund residential services that use our small group home or host home models, rather than large, institutional models. Furthermore, we believe that successful lobbying by advocacy groups has preserved I/DD and ARY services and, therefore, our revenue base for these services, from significant reductions as compared with certain other human services, although we did suffer rate reductions during and after the recession that began in 2008. In addition, a number of states have developed community-based waiver programs to support long-term care services for survivors of a traumatic brain injury. However, the majority of our specialty rehabilitation services revenue is derived from non-public payors, such as commercial insurers, managed care and other private payors.
Expansion of Services
We have grown our business through expansion of existing markets and programs, entry into new geographical markets as well as through acquisitions.
Organic Growth
Various economic, fiscal, public policy and legal factors are contributing to an environment with an increased number of organic growth opportunities, particularly within the Human Services segment, and, as a result, we have a renewed emphasis on growing our business organically and making investments to support the effort. Our future growth will depend heavily on our ability to expand our current programs and identify and execute upon new opportunities. Our organic expansion activities consist of both new program starts in existing markets and expansion into new geographical markets. Our new programs in new and existing geographic markets typically require us to incur and fund operating losses for a period of approximately 18 to
24 months (we refer to these new programs as “new starts”). Net operating loss or income of a new start is defined as its revenue for the period less direct expenses but not including allocated overhead costs. The aggregation of all programs with net operating losses that are less than 18 months old comprises the new start operating loss and the aggregation of all programs with net operating income that are less than 18 months old comprises new start operating income for such period. During fiscal years 2015, 2014, and 2013 new starts generated operating losses of $5.7 million, $6.1 million, and $8.8 million and operating income of $2.3 million, $1.9 million and $3.3 million, respectively.
Acquisitions
From the beginning of fiscal 2009 through September 30, 2015, we have completed 50 acquisitions, including several acquisitions of rights to government contracts and fixed assets from small providers, which we have integrated with our existing operations. We have pursued larger strategic acquisitions in the past and may opportunistically continue to do so in the future. Acquisitions could have a material impact on our consolidated financial statements.
During the fiscal year ended September 30, 2015, we acquired six companies complementary to our business in the Human Services segment and four companies in the SRS segment for total fair value consideration of $44.8 million, including $6.1 million of contingent consideration.
During the fiscal year ended September 30, 2014, we acquired ten companies complementary to our business in the Human Services segment and one company in the SRS segment for total fair value consideration of $56.1 million, including $2.4 million of contingent consideration.
During the fiscal year ended September 30, 2013, we acquired two companies complementary to our business in the Human Services segment and one company in the SRS segment, for a total cash consideration of $9.3 million.
Divestitures
We regularly review and consider the divestiture of underperforming or non-strategic businesses to improve our operating results and better utilize our capital. We have made divestitures from time to time and expect that we may make additional divestitures in the future. Divestitures could have a material impact on our financial performance and results.
In August 2014, our Connecticut-based business notified the State of Connecticut of its intention to stop providing services under existing contracts due to rate cuts and a change in state policy. The transition was completed during the first quarter of fiscal 2015. In connection with the decision to discontinue services in Connecticut, we recorded termination benefits for impacted employees of $0.1 million and impairment charges of $1.6 million and $0.7 million for intangible assets and properties attributable to the business unit, respectively. The operating results for Connecticut are included as discontinued operations in the Consolidated Statement of Operations.
During the second quarter of fiscal 2015 we decided to discontinue ARY services in the State of Illinois. The comprehensive transition plan with Illinois Department of Children and Family Services was successfully completed during the quarter ended June 30, 2015. In connection with this closure, we recorded $0.1 million of expense for termination benefits and $0.2 million of expense for lease terminations during the year ended September 30, 2015. We also recorded an impairment charge of $2.2 million for intangible assets attributable to the business unit during the year ended September 30, 2015.
In June 2015, we completed a six-month strategic review of our ARY service line. The goal of this initiative was to identify those states and markets where we can maintain services that are both high-quality and financially sustainable. As a result of this review we have decided to discontinue ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas. This decision will not affect other services provided by us in these states. As a result of this decision, we recorded an impairment charge of $8.2 million for intangible assets attributable to those business units during fiscal 2015. On December 1, 2015, we completed the sale of our ARY operations in the state of North Carolina. As consideration the buyer assumed our lease and service delivery obligations in exchange for the assets of the business, excluding working capital items, and a cash payment of $1.3 million to the buyer. Upon the completion of the sale, we recorded a loss of $1.3 million. In the other four states, we are working with our public partners to transition each child or adolescent into other provider programs by the end of the first quarter of fiscal 2016. We estimate that we will incur one-time cash charges as a result of these closures of approximately $2.4 million, consisting of severance costs of $0.3 million and lease termination costs of $2.1 million.
Revenue
Revenue is reported net of allowances for unauthorized sales and estimated sales adjustments, and net of any state provider taxes or gross receipts taxes levied on services we provide. We derive revenue from contracts with state, local and other government payors and non-public payors. During the fiscal year ended September 30, 2015, we derived 89% of our net revenue from contracts with state, local and other government payors and 11% of our net revenue from non-public payors, as compared to 90% of our net revenue from contracts with state, local and other government payors and 10% of our net revenue from non-public payors during the year ended September 30, 2014. Substantially all of our non-public revenue is generated by our SRS business through contracts with commercial insurers, workers’ compensation carriers and other private payors. The payment terms and rates of our contracts vary widely by jurisdiction and service type. We have four types of contractual arrangements with payors which include negotiated contracts, fixed fee contracts, retrospective reimbursement contracts and prospective payments contracts. See “—Critical Accounting Policies—Revenue Recognition” for further information. Our revenue may be affected by adjustments to our billed rates as well as adjustments to previously billed amounts. Revenue in the future may be affected by changes in rates, 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. In general, we take prices set by our payors and do not compete based on pricing.
We bill the majority of our residential services on a per person per-diem basis. We believe the key factors affecting our revenues in residential service business include average daily residential census and average daily billing rates. We bill the majority of our non-residential service on a per service unit basis. These service units, which vary in length, are converted to billable units which are the hourly equivalent for the service provided. We believe the key factors affecting our revenues in our non-residential service business include billable units and average billable unit rates. We calculate the impact of these factors on gross revenue rather than net revenue because the timing of sales adjustments, both positive and negative, is unpredictable. We define these factors and gross revenue as follows:
| |
• | Gross Revenue: Revenues before adjusting for sales adjustments and state provider and gross receipts taxes. |
| |
• | Average Residential Census: The average daily residential census over the respective period. |
| |
• | Average Daily Rate: A mathematical calculation derived by dividing the gross residential revenue by the residential census and the resulting quotient by the number of days during the respective period. |
| |
• | Non-Residential Billable Units: The hourly equivalent of non-residential services provided. |
| |
• | Average Billable Unit Rate: Gross non-residential revenue divided by the billable units provided during the period. |
A comparative summary of gross revenues by service line and our key metrics is as follows (dollars in thousands, except for daily and billable unit rates):
|
| | | | | | | | | | | |
| Year Ended September 30, |
| 2015 | | 2014 | | 2013 |
I/DD Services | | | | | |
Gross Revenues | $ | 904,083 |
| | $ | 839,127 |
| | $ | 768,362 |
|
Average Residential Census | 7,869 |
| | 7,435 |
| | 6,931 |
|
Average Daily Rate | $ | 234.92 |
| | $ | 229.02 |
| | $ | 222.53 |
|
Non-Residential Billable Units | 12,560,201 |
| | 11,608,274 |
| | 11,131,686 |
|
Average Non-Residential Billable Unit Rate | $ | 18.26 |
| | $ | 18.75 |
| | $ | 18.46 |
|
Gross Revenue Growth % | 7.7 | % | | 9.2 | % | | |
Gross Revenue growth due to: | | | | | |
Volume Growth | 6.4 | % | | 6.5 | % | | |
Average Rate Growth | 1.3 | % | | 2.7 | % | | |
At-Risk Youth Services | | | | | |
Gross Revenues (1) | $ | 193,021 |
| | $ | 203,353 |
| | $ | 223,037 |
|
Average Residential Census | 3,469 |
| | 3,840 |
| | 4,094 |
|
Average Daily Rate | $ | 108.31 |
| | $ | 101.11 |
| | $ | 96.78 |
|
Non-residential Billable Units | 661,970 |
| | 712,497 |
| | 931,646 |
|
Average Non-Residential Billable Unit Rate | $ | 84.81 |
| | $ | 86.51 |
| | $ | 84.19 |
|
Gross Revenue Growth % | (5.1 | )% | | (8.8 | )% | | |
Gross Revenue growth due to: | | | | | |
Volume Growth | (8.9 | )% | | (12.3 | )% | | |
Average Rate Growth | 3.8 | % | | 3.5 | % | | |
Specialty Rehabilitation Services | | | | | |
Gross Revenues | $ | 267,293 |
| | $ | 234,435 |
| | $ | 213,465 |
|
Average Residential Census | 1,180 |
| | 1,065 |
| | 996 |
|
Average Daily Rate | $ | 605.75 |
| | $ | 603.22 |
| | $ | 587.14 |
|
Non-residential Billable Units | 103,023 |
| | — |
| | — |
|
Average Non-Residential Billable Unit Rate | $ | 62.92 |
| | $ | — |
| | $ | — |
|
Gross Revenue Growth % | 14.0 | % | | 9.8 | % | | |
Gross Revenue growth due to: | | | | | |
Volume Growth | 13.6 | % | | 6.9 | % | | |
Average Rate Growth | 0.4 | % | | 2.9 | % | | |
| |
(1) | Includes $49.3 million, $59.8 million, and $82.4 million of revenue for fiscal 2015, 2014, and 2013, respectively, from the five states that we plan to exit by the end of the first quarter of fiscal 2016. |
Expenses
Expenses directly related to providing services are classified as cost of revenue. These expenses consist of direct labor costs which principally include salaries and benefits for service provider employees and per diem payments to our Mentors; client program costs such as food, medicine and professional and general liability and employment practices liability expenses; residential occupancy expenses which are primarily comprised of rent and utilities related to facilities providing direct care; travel and transportation costs for clients requiring services; and other ancillary direct costs associated with the provision of services to clients including workers’ compensation expense.
Wages and benefits to our employees and per diem payments to our Mentors constitute the most significant operating cost in each of our segments. Most of our employee caregivers are paid on an hourly basis, with hours of work generally tied to
client need. Our Mentors are paid on a per diem basis, but only if the Mentor is currently caring for a client. Our labor costs are generally influenced by levels of service, and these costs can vary significantly across regions.
Occupancy costs represent a significant portion of our operating costs. As of September 30, 2015, we owned 370 facilities and three offices, and we leased 1,556 facilities and 244 offices. We expect occupancy costs to increase during fiscal 2016 as a result of new leases entered into pursuant to acquisitions and new starts. We incur no facility costs for services provided in the home of a Mentor.
Professional and general liability expense totaled 0.8% of our gross revenue for the fiscal year ended September 30, 2015, as compared to 0.8% and 1.0% for the fiscal years ended September 30, 2014 and 2013, respectively. We incurred professional and general liability expenses of $10.5 million, $10.9 million and $12.1 million for the fiscal years ended September 30, 2015, 2014 and 2013, respectively. These expenses are incurred in connection with our claims reserve and insurance premiums. In the past, increased costs of insurance and claims have negatively impacted our results of operations which resulted in a renewed emphasis on reducing the occurrence of claims. Although insurance premiums did not increase in fiscal 2014 and 2015, they have increased in prior years.
General and administrative expenses primarily include salaries and benefits for administrative employees, or employees that are not directly providing services, administrative occupancy costs as well as professional expenses such as accounting, consulting and legal services, and stock-based compensation expense. Depreciation and amortization includes depreciation for fixed assets utilized in both facilities providing direct care and administrative offices, and amortization related to intangible assets.
Results of Operations
The following table sets forth our consolidated results of operations as a percentage of total gross revenues for the periods indicated.
|
| | | | | | | | |
| Year ended September 30, |
| 2015 | | 2014 | | 2013 |
Gross revenue | 100.0 | % | | 100.0 | % | | 100.0 | % |
Sales adjustments | (1.3 | )% | | (1.7 | )% | | (1.9 | )% |
Net revenue | 98.7 | % | | 98.3 | % | | 98.1 | % |
Cost of revenue (exclusive of depreciation and amortization expense shown below)
| 76.5 | % | | 77.0 | % | | 76.5 | % |
Operating expenses: | | | | | |
General and administrative | 11.8 | % | | 11.3 | % | | 12.0 | % |
Depreciation and amortization | 5.9 | % | | 5.3 | % | | 5.3 | % |
Total operating expense | 17.7 | % | | 16.6 | % | | 17.3 | % |
Income from operations | 4.5 | % | | 4.7 | % | | 4.3 | % |
Other income (expense): | | | | | |
Management fee of related party | — | % | | (0.7 | )% | | (0.1 | )% |
Other income (expense), net | (0.1 | )% | | — | % | | 0.1 | % |
Extinguishment of debt | (1.2 | )% | | (1.2 | )% | | — | % |
Interest expense | (2.7 | )% | | (5.4 | )% | | (6.5 | )% |
Income (loss) from continuing operations before income taxes | 0.5 | % | | (2.6 | )% | | (2.2 | )% |
Expense (benefit) for income taxes | 0.2 | % | | (0.9 | )% | | (0.8 | )% |
Income (loss) from continuing operations | 0.3 | % | | (1.7 | )% | | (1.4 | )% |
Loss from discounted operations, net of tax | (0.1 | )% | | (0.1 | )% | | (0.2 | )% |
Net income (loss) | 0.2 | % | | (1.8 | )% | | (1.6 | )% |
Fiscal Year Ended September 30, 2015 compared to Fiscal Year Ended September 30, 2014
Consolidated overview
|
| | | | | | | | | | | |
| Year ended September 30, | | Increase(Decrease) |
(In thousands) | 2015 | | 2014 | |
Gross revenue | $ | 1,384,332 |
| | $ | 1,277,957 |
| | $ | 106,375 |
|
Sales adjustments | (17,386 | ) | | (22,119 | ) | | 4,733 |
|
Net revenue | $ | 1,366,946 |
| | $ | 1,255,838 |
| | $ | 111,108 |
|
Income from operations | $ | 62,571 |
| | $ | 60,266 |
| | $ | 2,305 |
|
Operating margin | 4.5 | % | | 4.7 | % | | (0.2 | )% |
Consolidated gross revenue for the fiscal year ended September 30, 2015 (“fiscal 2015”) increased by $106.4 million, or 8.3%, compared to gross revenue for the fiscal year ended September 30, 2014 (“fiscal 2014”). Gross revenue increased $46.5 million from organic growth, including growth related to new programs, and $59.9 million from acquisitions that closed during and after fiscal 2014. Our Human Services segment contributed 58.5% of the organic revenue growth with the remaining 41.5% contributed by our SRS segment. Sales adjustments as a percentage of gross revenue decreased from 1.7% to 1.3% during fiscal 2015. The decrease was the result of improvements in authorization management, claims processing, and collections.
Consolidated income from operations decreased from 4.7% of gross revenue, or $60.3 million, in fiscal 2014 to 4.5% of gross revenue, or $62.6 million, in fiscal 2015. The decrease in our operating margin was primarily due to intangible assets impairment charges of $10.4 million related to completed and planned closures of our ARY services in six states, a $4.3 million increase in stock-based compensation, an increase in client occupancy costs due to increases in rent and higher levels of excess capacity primarily within our Human Services segment and an increase in direct labor costs due to higher amounts of overtime compared to the prior year. The decrease was partially offset by increases in revenue and lower expense in the self insured portion of our employee health and other insurance plans.
Revenues by segment
The following table sets forth net revenue for the Human Services segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | |
| Year ended September 30, | | Increase(Decrease) | | Percentage Increase(Decrease) |
| 2015 | | 2014 | | |
I/DD gross revenue | $ | 904,083 |
| | $ | 839,127 |
| | $ | 64,956 |
| | 7.7 | % |
ARY gross revenue | 193,021 |
| | 203,353 |
| | (10,332 | ) | | (5.1 | )% |
ADH gross revenue | 19,935 |
| | 1,042 |
| | 18,893 |
| | NM |
|
Total Human Services gross revenue | 1,117,039 |
| | 1,043,522 |
| | 73,517 |
| | 7.0 | % |
Sales adjustments | (14,013 | ) | | (17,850 | ) | | | | |
Sales adjustments as a percentage of gross revenue | (1.3 | )% | | (1.7 | )% | | | | |
Total Human Services net revenue | $ | 1,103,026 |
| | $ | 1,025,672 |
| | $ | 77,354 |
| | 7.5 | % |
Human Services gross revenue for fiscal 2015 increased by $73.5 million, or 7.0%, compared to fiscal 2014. The increase in gross revenue was driven by a $65.0 million increase in I/DD gross revenue while ARY gross revenue decreased by $10.3 million. Gross revenue for ADH which was acquired in September 2014 was $19.9 million.
The increase in I/DD gross revenue included $37.5 million from organic growth and $27.4 million from acquisitions that closed during and after fiscal 2014. The organic growth was the result of a 2.7% increase in volume coupled with a 1.8% increase in average billing rates for fiscal 2015 compared to fiscal 2014.
The $10.3 million decrease in ARY gross revenue was due to a 8.9% decrease in volume partially offset by a 3.8% increase in the average billing rate during fiscal 2015 compared to fiscal 2014. The decrease in volume was primarily due to a reduction in services in North Carolina due to a state wide redesign of these programs and the voluntary termination of our contracts to provide services with a managed care organization. This reduction resulted in a decrease of approximately $8.5 million in gross revenue. On December 1, 2015, we completed the sale of our ARY operations in the state of North Carolina.
Sales adjustments for fiscal 2015 decreased by $3.8 million compared to fiscal 2014. The decrease was primarily the result of improvements in authorization management, claims processing, and collections.
The following table sets forth net revenue for the SRS segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | |
| Year ended September 30, | | Increase(Decrease) | | Percentage Increase(Decrease) |
| 2015 | | 2014 | | |
SRS gross revenue | $ | 267,293 |
| | $ | 234,435 |
| | $ | 32,858 |
| | 14.0 | % |
Sales adjustments | (3,373 | ) | | (4,269 | ) | | | | |
Sales adjustments as a percentage of gross revenue | (1.3 | )% | | (1.8 | )% | | | | |
SRS net revenue | $ | 263,920 |
| | $ | 230,166 |
| | $ | 33,754 |
| | 14.7 | % |
The SRS segment’s gross revenue for fiscal 2015 increased by $32.9 million, or 14.0%, compared to fiscal 2014. The increase included $19.3 million from organic growth and $13.6 million from acquisitions that closed during and after fiscal 2014. The organic growth was driven by an increase in volume of 4.3% and an increase in the average billing rate of 4.0%. The increase in volume was primarily due to lower levels of excess capacity resulting from the maturation of programs started in recent years.
Sales adjustments for fiscal 2015 decreased by $0.9 million compared to fiscal 2014. The decrease was primarily the result of improvements in authorization management, claims processing, and collections.
Cost of revenues by segment
The following table sets forth cost of revenues for the Human Services segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| Year ended September 30, | | | | |
| 2015 | | 2014 | | | | |
| Amount | | % of gross revenue | | Amount | | % of gross revenue | | Increase (Decrease) | | Change in % of gross revenue |
Direct labor costs | $ | 708,259 |
| | 63.4 | % | | $ | 664,032 |
| | 63.6 | % | | $ | 44,227 |
| | (0.2 | )% |
Client program costs | 42,902 |
| | 3.8 | % | | 42,133 |
| | 4.0 | % | | 769 |
| | (0.2 | )% |
Client occupancy costs | 64,815 |
| | 5.8 | % | | 55,025 |
| | 5.3 | % | | 9,790 |
| | 0.5 | % |
Travel & transportation costs | 29,405 |
| | 2.6 | % | | 27,935 |
| | 2.7 | % | | 1,470 |
| | (0.1 | )% |
Other direct costs | 22,525 |
| | 2.0 | % | | 23,375 |
| | 2.2 | % | | (850 | ) | | (0.2 | )% |
Total cost of revenues | $ | 867,906 |
| | 77.6 | % | | $ | 812,500 |
| | 77.8 | % | | $ | 55,406 |
| | (0.2 | )% |
Human Services cost of revenue for fiscal 2015 decreased as a percentage of revenue by 0.2% as compared to fiscal 2014. This was primarily due to a decrease in direct labor costs of 0.2%, client program costs of 0.2%, and other direct costs of 0.2%, partially offset by an increase in client occupancy costs of 0.5%. The decrease in direct labor costs, client program costs and other direct costs as a percentage of gross revenue was primarily due to lower expense in the self-insured portion of our employee health and other insurance plans, including a favorable adjustment to our health insurance reserves in the first quarter of fiscal 2015 of $2.6 million resulting from lower than expected claims expense for our new consumer driven insurance plans. The increase in client occupancy costs as a percentage of gross revenue was due to increases in rent expense and programs with higher levels of excess capacity compared to the same period of the prior year.
The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| Year ended September 30, | | | | |
| 2015 | | 2014 | | | | |
| Amount | | % of gross revenue | | Amount | | % of gross revenue | | Increase (Decrease) | | Change in % of gross revenue |
Direct labor costs | $ | 134,364 |
| | 50.3 | % | | $ | 119,397 |
| | 50.9 | % | | $ | 14,967 |
| | (0.6 | )% |
Client program costs | 18,761 |
| | 7.0 | % | | 17,483 |
| | 7.5 | % | | 1,278 |
| | (0.5 | )% |
Client occupancy costs | 29,985 |
| | 11.2 | % | | 25,987 |
| | 11.1 | % | | 3,998 |
| | 0.1 | % |
Travel & transportation costs | 3,390 |
| | 1.3 | % | | 3,134 |
| | 1.3 | % | | 256 |
| | — | % |
Other direct costs | 4,316 |
| | 1.6 | % | | 4,480 |
| | 1.9 | % | | (164 | ) | | (0.3 | )% |
Total cost of revenues | $ | 190,816 |
| | 71.4 | % | | $ | 170,481 |
| | 72.7 | % | | $ | 20,335 |
| | (1.3 | )% |
The SRS segment’s cost of revenue as a percentage of gross revenue for fiscal 2015 decreased 1.3% as compared to fiscal 2014. This was primarily due to a decrease in direct labor costs of 0.6%, client program costs of 0.5% and other direct costs of 0.3%. The decrease in direct labor costs, client program costs, and other direct costs as a percentage of gross revenue was primarily due to higher revenues resulting from lower levels of excess capacity and lower expense in the self-insured portion of our employee health and other insurance plans.
Consolidated operating expenses
General and administrative and depreciation and amortization expense were as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| Year ended September 30, | | | | |
| 2015 | | 2014 | | | | |
| Amount | | % of gross revenue | | Amount | | % of gross revenue | | Increase (Decrease) | | Change in % of gross revenue |
General and administrative | $ | 162,839 |
| | 11.8 | % | | $ | 145,041 |
| | 11.3 | % | | $ | 17,798 |
| | 0.5 | % |
Depreciation and amortization | 82,172 |
| | 5.9 | % | | 67,488 |
| | 5.3 | % | | 14,684 |
| | 0.6 | % |
Total operating expense | $ | 245,011 |
| | 17.7 | % | | $ | 212,529 |
| | 16.6 | % | | $ | 32,482 |
| | 1.1 | % |
General and administrative expenses for fiscal 2015 increased by $17.8 million, or 12.3%, as compared to fiscal 2014. As a percentage of gross revenue, general and administrative expenses increased by 0.5% as compared to the year ended September 30, 2014. The increase as a percentage of gross revenue was primarily due to an increase of $4.3 million in stock based compensation expense, $2.5 million of expense associated with payment of a long term compensation plan and an increase in professional service fees of approximately $2.0 million. The increase was partially offset by the impact of leveraging certain general and administrative expenses. The remaining of the increase in general and administrative expenses is attributable to increased payroll and other administrative costs to support growth of the business.
Depreciation and amortization expense increased by $14.7 million, or 21.8%, as compared to fiscal 2014. As a percentage of gross revenue, depreciation and amortization expense increased by 0.6% as compared to the year ended September 30, 2014. The increase in depreciation and amortization expense as a percentage of gross revenue is primarily due to an intangible impairment charge of $10.4 million resulting from the completed and planned divestitures of our ARY services in six states.
Other (income) expense
Management fee of related party: Management fee decreased $9.5 million during fiscal 2015 as compared to fiscal 2014. The decrease is due to the termination of our management agreement with Vestar in connection with the initial public offering.
Other income (expense), net: Other income, net, which primarily consists of interest income, mark to market adjustments of the cash surrender value of Company owned life insurance policies and the accretion of interest on acquisition related contingent consideration liabilities, decreased from income of $0.4 million in fiscal 2014 to expense of $1.3 million in fiscal 2015.
Loss on extinguishment of debt: Extinguishment of debt was $17.1 million in the fiscal year ended September 30, 2015. On October 17, 2014 and March 4, 2015, the Company redeemed $162.0 million and $50.0 million of senior notes, respectively, resulting in expensing deferred financing fees of $1.0 million, original issue discount of $4.4 million, and the associated redemption premiums of $11.7 million.
Interest Expense: Interest expense decreased by $31.9 million during fiscal 2015 compared to fiscal 2014 due to a lower interest rate on the senior secured credit facilities as a result of the refinancing on January 31, 2014 and the redemption of $38.0 million, $162.0 million, and $50.0 million of senior notes on February 26, 2014, October 17, 2014, and March 4, 2015, respectively.
Benefit for income taxes
For fiscal 2015, our effective income tax rate was 39.8% compared to an effective tax rate of 34.8% for fiscal 2014. These rates differ from the federal statutory income tax rate primarily due to state income taxes, nondeductible permanent differences such as meals and nondeductible compensation, and net operating losses not benefited. The increase in our effective tax rate is primarily due to the impact of state income taxes on income from continuing operations before taxes in fiscal 2015 compared to a loss from continuing operations before taxes in fiscal 2014.
Loss from discontinued operations
Loss from discontinued operations net of taxes for fiscal 2015 was $1.0 million as compared to $1.4 million for fiscal 2014. During the fourth quarter of fiscal 2014, the Company decided to discontinue operations in the State of Connecticut. The loss from discontinued operations in fiscal 2014 and 2015 reflect the operating results of this business including impairment charges for intangible assets and properties and the costs associated with closing the business.
Fiscal Year Ended September 30, 2014 compared to Fiscal Year Ended September 30, 2013
Consolidated overview
|
| | | | | | | | | | | |
| Year ended September 30, | | Increase(Decrease) |
(In thousands) | 2014 | | 2013 | |
Gross revenue | $ | 1,277,957 |
| | $ | 1,204,864 |
| | $ | 73,093 |
|
Sales adjustments | (22,119 | ) | | (22,355 | ) | | 236 |
|
Net revenue | $ | 1,255,838 |
| | $ | 1,182,509 |
| | $ | 73,329 |
|
Income from operations | $ | 60,266 |
| | $ | 52,134 |
| | $ | 8,132 |
|
Operating margin | 4.7 | % | | 4.3 | % | | 0.4 | % |
Consolidated gross revenue for fiscal 2014 increased by $73.1 million, or 6.1%, compared to gross revenue for the fiscal year ended September 30, 2013 (“fiscal 2013”). Sales adjustments as a percentage of gross revenue decreased from 1.9% to 1.7% during fiscal 2014. Gross revenue increased $42.5 million from organic growth, including growth related to new programs, and $30.6 million from acquisitions that closed during and after fiscal 2013. Our Human Services segment contributed 66% of the organic revenue growth with the remaining 34% contributed by our SRS segment.
Consolidated income from operations increased from $52.1 million, or 4.3% of gross revenue, in fiscal 2013 to $60.3 million, or 4.7% of gross revenue, in fiscal 2014. The increase in our operating margin was primarily due to the increase in revenue, as well as, expense leveraging in our direct labor costs and general administrative expenses. The improvement in operating margin was partially offset by an increase in client occupancy costs due to new programs with higher levels of open occupancy and increases in rent, utilities and repair and maintenance costs related to our business.
Revenues by segment
The following table sets forth revenue for the Human Services segment for the periods indicated (in thousands): |
| | | | | | | | | | | | | | |
| Year ended September 30, | | Increase(Decrease) | | Percentage Increase(Decrease) |
| 2014 | | 2013 | | |
I/DD gross revenue | $ | 839,127 |
| | $ | 768,362 |
| | $ | 70,765 |
| | 9.2 | % |
ARY gross revenue | 203,353 |
| | 223,037 |
| | (19,684 | ) | | (8.8 | )% |
Adult Day Services gross revenue | 1,042 |
| | — |
| | 1,042 |
| | NM |
|
Total Human Services gross revenue | 1,043,522 |
| | 991,399 |
| | 52,123 |
| | 5.3 | % |
Sales adjustments | (17,850 | ) | | (17,311 | ) | | | | |
Sales adjustments as a percentage of gross revenue | (1.7 | )% | | (1.7 | )% | | | | |
Total Human Services net revenue | $ | 1,025,672 |
| | $ | 974,088 |
| | $ | 51,584 |
| | 5.3 | % |
Human Services gross revenue for fiscal 2014 increased by $52.1 million, or 5.3%, compared to fiscal 2013. The $52.1 million increase in gross revenue was driven by a $70.8 million increase in I/DD gross revenue while ARY gross revenue decreased by $19.7 million. The increase in I/DD gross revenue included $47.6 million from organic growth and $23.2 million from acquisitions that closed during and after fiscal 2013. The organic growth was the result of a 4.4% increase in volume coupled with a 1.8% increase in average billing rates for fiscal 2014 compared to fiscal 2013. The $19.7 million decrease in ARY gross revenue was due to a 12.3% decrease in volume partially offset by a 3.5% increase in the average billing rate compared to fiscal 2013. The majority of the decrease in volume was caused by a reduction in services in North Carolina due to a state wide redesign of these programs and the voluntary termination of our contracts to provide services with a single managed care organization. This reduction resulted in a decrease of $17.6 million of the decrease in gross revenue.
Sales adjustments as a percentage of gross revenue were consistent at 1.7% during fiscal 2014 and fiscal 2013.
The following table sets forth revenue for the SRS segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | |
| Year ended September 30, | | Increase(Decrease) | | Percentage Increase(Decrease) |
| 2014 | | 2013 | | |
SRS gross revenue | $ | 234,435 |
| | $ | 213,465 |
| | $ | 20,970 |
| | 9.8 | % |
Sales adjustments | (4,269 | ) | | (5,044 | ) | | | | |
Sales adjustments as a percentage of gross revenue | (1.8 | )% | | (2.4 | )% | | | | |
SRS net revenue | $ | 230,166 |
| | $ | 208,421 |
| | $ | 21,745 |
| | 10.4 | % |
The SRS segment’s gross revenue for fiscal 2014 increased by $21.0 million, or 9.8%, compared to fiscal 2013. The increase included $14.6 million from organic growth and $6.3 million from acquisitions that closed during and after fiscal 2013. The organic growth was driven by an increase in the average billing rate of 4.5% and an increase in volume of 2.4%.
Cost of revenues by segment
The following table sets forth cost of revenues for the Human Services segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| Year ended September 30, | | | | |
| 2014 | | 2013 | | | | |
| Amount | | % of gross revenue | | Amount | | % of gross revenue | | Increase (Decrease) | | Change in % of gross revenue |
Direct labor costs | $ | 664,032 |
| | 63.6 | % | | $ | 632,456 |
| | 63.8 | % | | $ | 31,576 |
| | (0.2 | )% |
Client program costs | 42,133 |
| | 4.0 | % | | 39,722 |
| | 4.0 | % | | 2,411 |
| | — | % |
Client occupancy costs | 55,025 |
| | 5.3 | % | | 50,411 |
| | 5.1 | % | | 4,614 |
| | 0.2 | % |
Travel & transportation costs | 27,935 |
| | 2.7 | % | | 26,288 |
| | 2.7 | % | | 1,647 |
| | — | % |
Other direct costs | 23,375 |
| | 2.2 | % | | 18,353 |
| | 1.9 | % | | 5,022 |
| | 0.3 | % |
Total cost of revenues | $ | 812,500 |
| | 77.8 | % | | $ | 767,230 |
| | 77.5 | % | | $ | 45,270 |
| | 0.3 | % |
Human Services cost of revenue for fiscal 2014 increased by $45.3 million, or 5.9%, as compared to fiscal 2013 primarily due to an increase in direct labor costs of $31.6 million, an increase in client occupancy costs of $4.6 million, and an increase in other direct costs of $5.0 million. The increases in direct labor costs and client occupancy costs were primarily attributable to additional costs associated with new programs and acquisitions that closed during and after fiscal 2013, as well as, a new compensation program for our direct care workers. The increase in other direct costs during fiscal 2014 was primarily due to an increase in workers’ compensation claims compared to fiscal 2013.
The decrease of direct labor costs as a percentage of gross revenue was primarily due to expense leveraging. The increase in client occupancy costs as a percentage of gross revenue was the result of new programs with higher levels of open occupancy and an increase in rent, utilities and repairs and maintenance expense related to our business and the increase in other direct costs as a percentage of gross revenue was primarily due to an increase in workers’ compensation expense compared to fiscal 2013.
The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| Year ended September 30, | | | | |
| 2014 | | 2013 | | | | |
| Amount | | % of gross revenue | | Amount | | % of gross revenue | | Increase (Decrease) | | Change in % of gross revenue |
Direct labor costs | $ | 119,397 |
| | 50.9 | % | | $ | 110,508 |
| | 51.8 | % | | $ | 8,889 |
| | (0.9 | )% |
Client program costs | 17,483 |
| | 7.5 | % | | 14,486 |
| | 6.8 | % | | 2,997 |
| | 0.7 | % |
Client occupancy costs | 25,987 |
| | 11.1 | % | | 22,662 |
| | 10.6 | % | | 3,325 |
| | 0.5 | % |
Travel & transportation costs | 3,134 |
| | 1.3 | % | | 2,635 |
| | 1.2 | % | | 499 |
| | 0.1 | % |
Other direct costs | 4,480 |
| | 1.9 | % | | 3,144 |
| | 1.5 | % | | 1,336 |
| | 0.4 | % |
Total cost of revenues | $ | 170,481 |
| | 72.7 | % | | $ | 153,435 |
| | 71.9 | % | | $ | 17,046 |
| | 0.8 | % |
The SRS segment’s cost of revenue for fiscal 2014 increased by $17.0 million, or 11.1%, as compared to fiscal 2013, primarily due to an increase in direct labor costs of $8.9 million, an increase in client program costs of $3.0 million and an increase in client occupancy costs of $3.3 million. These increases were primarily attributable to additional costs associated with new programs and acquisitions that closed during and after fiscal 2013.
The decrease of direct labor costs as a percentage of revenue was primarily due to expense leveraging. The increase in client program costs as a percentage of gross revenue during fiscal 2014 was due to an increase in medical supply and pharmacy costs relating to the SRS segment’s client mix. The increase in client occupancy costs as a percentage of gross revenue during fiscal 2014 was due to new programs with higher levels of open occupancy and an increase in rent, utilities and repairs and maintenance expense related to our business.
Consolidated operating expenses
General and administrative and depreciation and amortization expense were as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | |
| Year ended September 30, | | | | |
| 2014 | | 2013 | | | | |
| Amount | | % of gross revenue | | Amount | | % of gross revenue | | Increase (Decrease) | | Change in % of gross revenue |
General and administrative | $ | 145,041 |
| | 11.3 | % | | $ | 145,184 |
| | 12.0 | % | | $ | (143 | ) | | (0.7 | )% |
Depreciation and amortization | 67,488 |
| | 5.3 | % | | 63,573 |
| | 5.3 | % | | 3,915 |
| | — | % |
Total operating expense | $ | 212,529 |
| | 16.6 | % | | $ | 208,757 |
| | 17.3 | % | | $ | 3,772 |
| | (0.7 | )% |
General and administrative expenses for fiscal 2014 decreased by $0.1 million, or 0.1%, as compared to fiscal 2013. As a percentage of gross revenue, general and administrative expenses decreased by 0.7% as compared to fiscal 2013. This decrease was attributable to cost containment efforts in administrative staffing, business and office related costs.
Depreciation and amortization expense increased $3.9 million during fiscal 2014 from the prior year period primarily due to an increase in leasehold improvements to our properties and the acquisition of amortizable assets. Depreciation and amortization expense as a percentage of gross revenue remained consistent.
Other (income) expense
Management fee of related party: Management fee increased $8.1 million during fiscal 2014 as compared to fiscal 2013. In connection with the IPO of Civitas, the Company terminated the management agreement with Vestar and paid a one-time transaction advisory fee of $8.0 million to Vestar.
Other income, net: Other income, net, which primarily consists of mark to market adjustments of the cash surrender value of Company owned life insurance policies and interest income, decreased from $1.0 million in fiscal 2013 to $0.4 million in fiscal 2014.
Loss on extinguishment of debt: Extinguishment of debt was $14.7 million in the fiscal year ended September 30, 2014. The prior senior secured credit facilities were repaid and replaced with the senior secured credit facilities on January 31, 2014, and $38.0 million of the senior notes were redeemed on February 26, 2014, resulting in the write-off of deferred financing fees, original issue discount, redemption premium and initial purchase discount related to the prior senior secured credit facilities and the partial redemption of the senior notes totaling $14.7 million.
Interest Expense: Interest expense decreased by $8.7 million during fiscal 2014 compared to fiscal 2013 due to lower interest expense on the senior secured credit facilities as a result of the refinancing on January 31, 2014 and the redemption of $38.0 million of the senior notes on February 26, 2014.
Benefit for income taxes
For fiscal 2014, our effective income tax rate was 34.8% compared to an effective tax rate of 37.9% for fiscal 2013. These rates differ from the federal statutory income tax rate primarily due to nondeductible permanent differences such as meals and nondeductible compensation, and net operating losses not benefited.
Loss from discontinued operations
Loss from discontinued operations net of taxes for fiscal 2014 was $1.4 million as compared to $2.0 million for fiscal 2013. During fiscal 2014, the Company gave notice of its intention to close all Human Services operations in the State of Connecticut. The Company recorded impairment charges of $1.6 million and $0.7 million for intangible assets and properties owned by the business unit, respectively, and $0.1 million of severance expense. The impairment charge and operations of these businesses, including the expenses to close these operations, are included in discontinued operations.
Liquidity and Capital Resources
Our principal uses of cash are to meet working capital requirements, fund debt obligations and finance capital expenditures and acquisitions. Cash flows from operations have historically been sufficient to meet these cash requirements. Our principal sources of funds are cash flows from operating activities, cash on hand and available borrowings under our senior revolver (as defined below), and proceeds from the sale of equity securities.
Operating activities
Cash flows provided by operating activities were $90.5 million, $83.9 million and $55.7 million for fiscal 2015, 2014 and 2013, respectively. The increase in cash provided by operating activities in fiscal 2015 is primarily attributable to the lower interest payments resulting from the redemption of $212.0 million of our senior notes partially offset by the impact of a more consistent days sales outstanding during compared to fiscal 2014. Our days sales outstanding decreased slightly from 43 days at September 30, 2014 to 41 days at September 30, 2015. The increase in cash provided by operating activities in 2014 is primarily attributable to the decrease in our days sales outstanding. Our days sales outstanding decreased from 47 days at September 30, 2013 to 43 days at September 30, 2014. The decrease was primarily due to efficiencies resulting from the centralization of certain billing and accounts receivable functions as well as the process improvement of our billing and collections process and review of aged receivables.
Investing activities
Net cash used in investing activities was $79.0 million, $88.9 million and $39.4 million for fiscal 2015, 2014 and 2013, respectively. Cash paid for acquisitions was $38.7 million, $53.7 million and $9.3 million for fiscal 2015, 2014 and 2013,
respectively. We acquired ten, eleven, and three companies in each of fiscal 2015, 2014 and 2013, respectively. Cash paid for property and equipment for fiscal 2015 was $42.8 million, or 3.1% of net revenue, compared to $35.3 million, or 2.8% of net revenue for fiscal 2014, and $31.9 million, or 2.7% of net revenue, for fiscal 2013.
Financing activities
Net cash used in financing activities was $165.9 million for fiscal 2015 compared to net cash provided by financing activities of $181.7 million and $3.0 million for fiscal years 2014 and 2013, respectively. The increase in cash used by financing activities is due to the redemption of $212.0 million of our senior notes during fiscal 2015, partially offset by the net proceeds received from the incremental term loan of $55.0 million. The increase in cash provided by financing activities in fiscal 2014 is due to the $182.2 million in proceeds as a result of the initial public offering in September 2014.
During fiscal 2015, 2014 and 2013, we borrowed an aggregate of $210.7 million, $9.3 million, and $469.4 million, respectively, under our senior revolver and repaid $210.7 million, $9.3 million, $488.4 million, respectively, during the same periods. At September 30, 2015, we had no outstanding borrowings and $119.1 million of availability under the senior revolver due to $0.9 million in standby letters of credit issued under the senior revolver, which reduces the availability under the senior revolver. Letters of credit can be issued under our institutional letter of credit facility up to the $50.0 million limit, subject to certain maintenance and issuance limitations, and letters of credit in excess of that amount reduce availability under our senior revolver. As of September 30, 2015, $48.4 million of letters of credit were issued under the institutional letter of credit facility and $0.9 million of letters of credit were issued under the senior revolver.
On January 31, 2014, NMHI and NMH Holdings, LLC (“NMHH”), wholly owned subsidiaries of Civitas, entered into a new senior credit agreement consisting of a term loan facility and a senior revolver. The new term loan facility has a seven-year maturity and the new senior revolver has a five-year maturity. We also redeemed $38.0 million aggregate principal amount of the senior notes on February 26, 2014. See Note 11 to our consolidated financial statements included elsewhere herein for further information about our senior secured credit facilities.
On September 22, 2014, we completed an initial public offering resulting in net proceeds of $182.2 million after deducting underwriting discounts, commissions, and offering expenses. The net proceeds received from our initial public offering were used to pay a one-time transaction advisory fee of $8.0 million in September 2014 and to redeem $162.0 million in aggregate principal amount of senior notes issued by NMHI at a redemption price of 106.25%. The redemption of the senior notes occurred on October 17, 2014, and as of that date, $50.0 million in principal amount of senior notes remained.
On February 27, 2015, NMHI and NMHH, and certain subsidiaries of NMHI, as guarantors, entered into Amendment No. 3 (the “Incremental Amendment”) to the senior credit agreement. The Incremental Amendment provided for an additional $55.0 million term loan, which was funded on February 27, 2015, under the term loan. The proceeds from the Incremental Amendment were used to redeem the remaining $50.0 million of outstanding senior notes on March 4, 2015. See “—Debt and Financing Arrangements” for further information on the Incremental Amendment.
We believe that available borrowings under our senior revolver and cash flow from operations will provide sufficient liquidity and capital resources to meet our financial obligations for the next twelve months, including scheduled principal and interest payments, as well as to provide funds for working capital, acquisitions, capital expenditures and other needs. No assurance can be given, however, that this will be the case.
Debt and Financing Arrangements
Senior Secured Credit Facilities
On January 31, 2014, NMHI and NMHH, wholly-owned subsidiaries of Civitas, entered into a new senior credit agreement (the “senior credit agreement”) with Barclays Bank PLC, as administrative agent, and the other agents and lenders named therein, for the new senior secured credit facilities (the “senior secured credit facilities”), consisting of a $600.0 million term loan facility (the “term loan facility”), of which $50.0 million was deposited in a cash collateral account in support of the issuance of letters of credit under an institutional letter of credit facility (the “institutional letter of credit facility”), and a $100.0 million senior secured revolving credit facility (the “senior revolver”). On October 21, 2014, the Company increased the revolving commitment under the senior revolver by $20.0 million to $120.0 million, on terms identical to those applicable to the existing senior revolver. The term loan facility has a seven-year maturity and the senior revolver has a five-year maturity. The senior credit agreement provides that we may make one or more offers to the lenders, and consummate transactions with individual lenders that accept the terms contained in such offers, to extend the maturity date of the lender’s term loans and/or
revolving commitments, subject to certain conditions, and any extended term loans or revolving commitments will constitute a separate class of term loans or revolving commitments.
On February 27, 2015, NMHI and NMHH, and certain subsidiaries of NMHI, as guarantors, entered into Amendment No. 3 (the “Incremental Amendment”) to the senior credit agreement. The Incremental Amendment provided for an additional $55.0 million term loan, which was funded on February 27, 2015, pursuant to the terms of the senior credit agreement that permit up to $125.0 million of incremental borrowings plus any additional amounts so long as NMHI’s consolidated first lien leverage ratio, as defined in the senior credit agreement, does not exceed 4.50 to 1.00 on a pro forma basis, subject to the conditions set forth in the senior credit agreement. In addition, the Incremental Amendment amended the senior credit agreement to provide that, subject to certain exceptions, if, on or prior to August 27, 2015, NMHI reprices any portion of the term loan and that repricing results in a lower interest rate applicable to the term loan, NMHI will be required to pay a prepayment premium of 1% of the loans being repriced. All of the other terms of the additional $55.0 million term loan are identical to the term loan.
As of September 30, 2015, NMHI had $645.6 million of borrowings outstanding under the term loan facility. The aggregate amount of the revolving commitment under the senior revolver as of September 30, 2015 was $120.0 million. At September 30, 2015, NMHI had no outstanding borrowings and $119.1 million of availability under the senior revolver due to $0.9 million in standby letters of credit issued under the senior revolver, which reduces the availability under the senior revolver. As of September 30, 2015, $48.4 million of letters of credit were issued under the institutional letter of credit facility.
All of the obligations under the senior secured credit facilities are guaranteed by NMHH and the subsidiary guarantors named therein (the “Subsidiary Guarantors”). Pursuant to the Guarantee and Security Agreement, dated as of January 31, 2014 (the “guarantee and security agreement”), among NMHH, as parent guarantor, NMHI, certain of its subsidiaries, as subsidiary guarantors, and Barclays Bank, PLC, as administrative agent, subject to certain exceptions, the obligations under the senior secured credit facilities are secured by a pledge of 100% of NMHI’s capital stock and the capital stock of domestic subsidiaries owned by NMHI and any other domestic Subsidiary Guarantor and 65% of the capital stock of any first tier foreign subsidiaries and a security interest in substantially all of NMHI’s tangible and intangible assets and the tangible and intangible assets of NMHH and each Subsidiary Guarantor.
The senior revolver includes borrowing capacity available for letters of credit and for borrowings on sameday notice, referred to as the “swingline loans.” Any issuance of letters of credit or borrowing on a swingline loan will reduce the amount available under the senior revolver.
At our option, we may add one or more new term loan facilities or increase the commitments under the senior revolver (collectively, the “incremental borrowings”) in an aggregate amount of up to $125.0 million plus any additional amounts so long as certain conditions, including a consolidated first lien leverage ratio (as defined in the senior credit agreement) of not more than 4.50 to 1.00 on a pro forma basis, are satisfied. NMHI used $55.0 million of the incremental borrowings capacity in February 2015.
Borrowings under the senior secured credit facilities bear interest, at our option, at: (i) an ABR rate equal to the greater of (a) the prime rate, (b) the federal funds rate plus 1/2 of 1.0%, and (c) the Eurodollar rate for an interest period of one-month beginning on such day plus 100 basis points, plus 2.25% (provided that the ABR rate applicable to the term loan facility will not be less than 2.00% per annum); or (ii) the Eurodollar rate (provided that the Eurodollar rate applicable to the term loan facility will not be less than 1.00% per annum), plus 3.25%. NMHI is also required to pay a commitment fee to the lenders under the senior revolver at an initial rate of 0.50% of the average daily unutilized commitments thereunder. NMHI must also pay customary letter of credit fees.
The senior credit agreement requires us to make mandatory prepayments, subject to certain exceptions, with: (i) beginning in fiscal year 2015, 50% (which percentage will be reduced upon its achievement of certain first lien leverage ratios) of our annual excess cash flow; (ii) 100% of net cash proceeds of all non-ordinary course assets sales or other dispositions of property, subject to certain exceptions and thresholds; and (iii) 100% of the net cash proceeds of any debt incurrence, other than debt permitted under the senior credit agreement. Excess cash flow is defined in our senior credit agreement as (A) the sum of (i) consolidated net income (as defined in the senior credit agreement), plus (ii) the net decrease in working capital, plus (iii) noncash charges previously deducted from consolidated net income, plus (iv) non-cash losses from assets sales, minus (B) the sum of (i) certain amortization and other mandatory prepayment of indebtedness, plus (ii) unfinanced capital expenditures plus (iii) the cash portion of permitted investments plus (iv) noncash gains previously including in consolidated net income, plus (v) the net increase in working capital, plus (vi) certain cash payments of long-term liabilities, plus (vii) cash restricted payments, plus (viii) cash
expenditures not expensed during such period, plus (ix) penalties paid in connection with the repayment of indebtedness, plus (x) certain cash distributions from the SRS business, plus (xi) aggregate unfinanced portion of contract consideration for acquisition or capital expenditures to be consummated, plus (xii) aggregate amount of cash amounts received in such period but excluded from consolidated net income, plus (xiii) certain cash payments in respect of earnout obligations, plus (xiv) certain voluntary prepayments of indebtedness, plus (xv) certain cash payments of non-cash charges added back in a prior period, plus (xvi) all charges or expenses incurred in such period but excluded from consolidated net income. There are no expected excess cash flow payments for fiscal 2015. We are required to repay the term loan facility portion of the senior secured credit facilities in quarterly principal installments of 0.25% of the principal amount commencing on June 30, 2014, with the balance payable at maturity. The senior credit agreement permits the Company to offer to its lenders newly issued notes in exchange for their term loans in one or more permitted debt exchange offers, subject to the conditions set forth in the senior credit agreement.
Covenants
The senior credit agreement contains negative financial and non-financial covenants, including, among other things, limitations on our ability to incur additional debt, create liens on assets, transfer or sell assets, pay dividends, redeem stock or make other distributions or investments, and engage in certain transactions with affiliates. We were in compliance with these covenants as of September 30, 2015.
The senior credit agreement contains a springing financial covenant. If, at the end of any fiscal quarter, our usage of the senior revolver exceeds 30% of the commitments thereunder, we are required to maintain at the end of each such fiscal quarter, a consolidated first lien leverage ratio of not more than 5.50 to 1.00. This consolidated first lien leverage ratio will step down to 5.00 to 1.00 commencing with the fiscal quarter ending March 31, 2017. The springing financial covenant was not in effect as of September 30, 2015 as our usage of the senior revolver did not exceed the threshold for that quarter.
The senior credit agreement also contains a number of covenants that, among other things, restrict, subject to certain exceptions, NMHI's ability and the ability of its subsidiaries to: (i) incur additional indebtedness; (ii) create liens on assets; (iii) engage in mergers or consolidations; (iv) sell assets; (v) pay dividends and distributions or repurchase our capital stock; (vi) enter into certain swap transactions; (vii) make investments, loans or advances; (viii) repay certain junior indebtedness; (ix) engage in certain transactions with affiliates; (x) enter into sale and leaseback transactions; (xi) amend material agreements governing certain of our junior indebtedness; (xii) change our lines of business; (xiii) make certain acquisitions; and (xiv) limitations on the letter of credit cash collateral account. If we withdraw any of the $50.0 million from the cash collateral account supporting the issuance of letters of credit, we must use the cash to either prepay the term loan facility or to secure any other obligations under the senior secured credit facilities in a manner reasonably satisfactory to the administrative agent. The senior credit agreement contains customary affirmative covenants and events of default.
Contractual Commitments Summary
The following table summarizes our contractual obligations and commitments as of September 30, 2015:
|
| | | | | | | | | | | | | | | | | | | |
| Total | | Less Than 1 Year | | 1-3 Years | | 3-5 Years | | More Than 5 Years |
| | | | | | | | | |
| (In thousands) |
Long-term debt obligations (1) | $ | 790,364 |
| | $ | 34,343 |
| | $ | 67,686 |
| | $ | 66,629 |
| | $ | 621,706 |
|
Operating lease obligations (2) | 269,620 |
| | 58,872 |
| | 92,427 |
| | 54,320 |
| | 64,001 |
|
Capital lease obligations | 9,376 |
| | 1,124 |
| | 2,248 |
| | 2,248 |
| | 3,756 |
|
Purchase obligations (3) | 7,004 |
| | 4,518 |
| | 2,486 |
| | — |
| | — |
|
Standby letters of credit | 49,354 |
| | 49,354 |
| | — |
| | — |
| | — |
|
Contingent consideration obligations (4) | 9,075 |
| | 3,898 |
| | 5,177 |
| | — |
| | — |
|
Total obligations and commitments | $ | 1,134,793 |
| | $ | 152,109 |
| | $ | 170,024 |
| | $ | 123,197 |
| | $ | 689,463 |
|
________________________
| |
(1) | Represents the principal amount of our long-term debt and the expected cash payments for interest on our long-term debt based on the interest rates in place and amounts outstanding at September 30, 2015. The interest payments do not reflect the projected impact of interest rate swap agreements. The principal and interest payments are due in quarterly installments through January 31, 2021. See Note 11 to our consolidated financial statements included elsewhere herein for further information about our senior secured credit facilities. |
| |
(2) | Includes the fixed rent payable under the leases and does not include additional amounts, such as taxes, that may be payable under the leases. |
| |
(3) | Represents purchase obligations related to information technology services and maintenance contracts. |
| |
(4) | In connection with certain of our acquisitions, additional contingent consideration may become payable to the sellers upon the satisfaction of certain performance milestones. Amounts represent the estimated fair value of these obligations. For further information pertaining to our contingent consideration arrangements see Note 15 to our consolidated financial statements included elsewhere herein. |
Inflation
We do not believe that general inflation in the U.S. economy has had a material impact on our financial position or results of operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet transactions or interests.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
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.
No triggering events have come to our attention pursuant to our review of goodwill that would indicate impairment as of September 30, 2015.
The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.
Revenue Recognition
Revenue is reported net of allowances (discussed below) and state provider taxes. Revenue is recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectability is reasonably assured.
Generally, we recognize revenue for services provided to our clients when earned. Our services fall into two general categories: residential and non-residential. In residential services, we are providing a living environment, usually a community residence, to a client and providing care on a 24-hour basis. Non-residential services are provided to a client on an hourly (or other unit of time) basis for therapy, community support or in our day program centers. Revenues for residential services are recognized for the number of days in the accounting period that the client is in our service. Periodic service revenue is recognized when the related services are performed.
In addition, we operate under four distinct types of contracting arrangements with our payors:
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• | Negotiated Contracts. For these contracts, services are priced pursuant to a “plan of care” for the client which encompasses habilitation and therapies. Such contracts are not subject to retroactive adjustment or cost reimbursement requirements. However, we may petition for a change in rate based upon a change in circumstances with a particular client or in situations where additional services are needed. For these contracts, we recognize revenue at the negotiated rate when earned. Subsequent adjustments to rates, if any, are recognized when approved by the payor. For fiscal years ended 2013, 2014 and 2015, 40.4%, 32.7% and 30.6%, respectively, of our revenues were earned from contracts that fall into this category. |
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• | Fixed Fee Contracts. For these contracts, payors set a standard rate or set of rates for a particular service usually dependent on the acuity of the client. These rates are the same for all agencies providing the service. For these contract types, there |
is generally no cost report required or if a cost report is required it is used for informational purposes only. For these contracts, we recognize revenue at the standard rate as earned. For fiscal years ended 2013, 2014 and 2015, 40.1%, 46.5% and 49.4%, respectively, of our revenues were earned from contracts that fall into this category.
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• | Retrospective reimbursement contracts. For these contracts, a provisional rate is set for the year pending the filing of an annual cost report that may further adjust that rate. Cost reimbursement rules differ by jurisdiction and program type but generally include direct costs, indirect costs, depreciation, interest, overhead allocations with interest, overhead and profit usually subject to limitation. Should the cost report indicate that allowable rate is lower than what has been billed, we record a liability and these funds are adjusted back or refunded to the state payor at some time in the future. For these contracts we prepare an analysis quarterly to determine if any of the revenue that has been billed and recognized should be deferred and if so record that portion as a current liability. In a subsequent quarter, allowable costs may increase which would result in a reversal of the liability but if this condition persists through the end of the statutory annual period, we would refund the unallowed portion of the revenue to the state and offset the liability. For fiscal years ended 2013, 2014 and 2015, 10.7%, 11.7% and 11.4%, respectively, of our revenues were earned from contracts that fall into this category. |
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• | Prospective payment contracts. These contracts are cost reported in the same way as retrospective contracts, except the cost report for the annual period is used to set the rates in a future period. For these contracts, changes in rates are recognized in revenue prospectively. For fiscal years ended 2013, 2014 and 2015, 8.8%, 9.1% and 8.6%, respectively, of our revenues were earned from contracts that fall into this category. |
All four types of contracting arrangements are subject to audit by the payor and may be subject to recoupments of revenue if in performing our services we have not adhered to the terms of the contract, or not documented our services as specified by the payor. For fiscal years ended 2013, 2014 and 2015 liabilities to payors for cost based contracts were $3.6 million, $3.7 million and $10.1 million, respectively.
Non Authorized Sales Allowance. Our clients are generally long-term recipients of our services and require continuous care. The majority of the services are paid for through state Medicaid programs. When we enter into an arrangement to provide services to a client, we obtain an “authorization” to provide services for a specified period of time such as a six months or one year. When an authorization expires we generally do not discontinue providing service to our clients and in some cases are prevented from doing so legally. Therefore, it is not uncommon for us to serve a client without a current authorization. In this situation we determine whether a non-authorized sales allowance is required by whether the lapse in authorization is within the documented customary business practice period that we have established for that particular payor. Once the lapse in authorization extends beyond the normal period for that payor, we adjust the non-authorized sales allowance to reserve the revenue. As of September 30, 2013, 2014 and 2015, our non-authorized sales allowance was $1.8 million, $2.3 million and $3.2 million, respectively.
Accounts Receivable and Reserves
Accounts receivable primarily consists of amounts due from state payors, not-for-profit providers and commercial insurance companies. Generally there is no bad debt risk with government payors or insurance companies. However, allowances are still required for disallowances of revenue that have not been billed timely or if authorizations to deliver services have been exceeded. In addition, there are numerous retroactive adjustments to revenue in cases where rates are adjusted by payors, often after an assessment of our client that takes effect retroactively. We record the following reserves against revenue:
Sales Adjustment Allowance. The types of sales adjustments that we record typically involves rate adjustments due to billing errors or an agreed upon settlement of rate or level of services disputes with the payors. Sales adjustments expense is recorded against revenue in accordance with industry practice. We estimate the sales adjustment allowance based on historical sales adjustments experience. In addition, we also regularly evaluate our accounts receivable, especially receivables that are past due, and reassess our sales adjustment allowance based on specific payor collection issues and may record a specific addition to our sales adjustment allowance to reduce the net recognized receivable to the amount we reasonably expect to
collect. As of September 30, 2013, 2014 and 2015, our sales adjustment allowance was $12.5 million, $11.5 million and $11.2 million, respectively.
Goodwill and Indefinite-lived Intangible Assets
We review goodwill and indefinite-lived intangible assets for impairment annually, as of July 1st, or whenever events or changes in circumstances indicate the carrying value of these assets may not be recoverable to determine whether any impairment exists, and, if so, the extent of such impairment. Our goodwill balance represents the difference between the purchase price of acquired businesses and the fair value of the identifiable tangible and intangible net assets when accounted for using the purchase method of accounting. We test goodwill at the reporting unit level, which is the same level as our operating segments. We have the option to first assess qualitative factors to determine whether further impairment testing is necessary. We have elected to bypass the qualitative assessments and proceed directly to the two-step impairment test. The first step is to compare the fair value of the reporting unit with its carrying value. We estimated the fair value of each of our reporting units using the income approach. The income approach is based on a discounted cash flow analysis and calculates the fair value of a reporting unit by estimating the after–tax cash flows attributable to a reporting unit and then discounting them to a present value using a risk-adjusted discount rate. In our discounted cash flow analysis, we forecasted cash flows by reporting unit for each of the next seven years and applied a long term growth rate to the final years of the forecasted cash flows to estimate terminal value. The cash flows were then discounted to a present value using a risk-adjusted discount rate. The discount rates, which are intended to reflect the risks inherent in future cash flow projections used in the discounted cash flow analysis are based on estimates of the weighted average costs of capital of market participants relative to each respective reporting unit. If the carrying amount of the reporting unit exceeds its estimated fair value, we are required to perform the second step, or Step 2, of the goodwill impairment test to measure the amount of impairment loss. Step 2 of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying value of that goodwill in order to determine the amount of impairment to be recognized. The implied fair value of goodwill is calculated as the difference between the fair value of the reporting unit and the estimated fair value of its assets and liabilities.
Our indefinite lived intangible assets primarily consist of trade names acquired in business combinations. For these assets, we have the option to first assess qualitative factors to determine whether further impairment testing is necessary. The Company has elected to bypass the qualitative assessments and proceed directly to the quantitative impairment test. The impairment test for indefinite-lived intangible assets requires the determination of the fair value of the intangible asset. If the fair value of the indefinite-lived intangible asset is less than its carrying value, an impairment loss is recognized in an amount equal to the difference. Fair values are established using the relief from royalty method.
The estimated fair values of our reporting units and indefinite lived intangibles are based on discounted estimated future cash flows. The discounted cash flow analysis requires significant judgment, including judgments about the appropriate discount rates and terminal values, future growth, capital expenditures and market conditions over the estimated remaining operating period. As such, actual results may differ from these estimates and lead to a revaluation of our goodwill and indefinite-lived intangible assets. If updated estimates indicate that the fair value of goodwill or any indefinite-lived intangibles is less than the carrying value of the asset, an impairment charge is recorded in the consolidated statements of operations in the period of the change in estimate.
We completed our annual impairment tests in the fourth quarter of 2015, 2014 and 2013 and determined in each of those periods that the carrying value of goodwill and indefinite-lived assets was not impaired. In fiscal 2015, the fair value of each of our reporting units was in excess of its carrying value and passed with a substantial margin, except for ADH. ADH, which is the Company's smallest reporting unit, was derived through an acquisition at the end of fiscal 2014 and has goodwill of $18.0 million. If ADH fails to achieve its revenue and operating income targets or if there is a change in discount rates, an impairment could occur. There have been no significant changes in the acquired business, therefore; fair value determined on test date approximated the acquisition price and exceeded book value by approximately $1.0 million.
Impairment of Long-Lived Assets
Intangible assets with finite lives consist of agency contracts, acquired licenses and permits and non-competition agreements and are valued according to the future cash flows they are estimated to produce. Tangible assets with finite lives consist of property and equipment, which are depreciated over their estimate useful lives. We review these long-lived assets for impairment by continually evaluating whether 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.
Income Taxes
We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. These deferred tax assets and liabilities are separated into current and long-term amounts based on the classification of the related assets and liabilities for financial reporting purposes and netted by jurisdiction. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts.
The ultimate recovery of certain of our deferred tax assets is dependent on the amount and timing of taxable income we will ultimately generate in the future, as well as other factors. A high degree of judgment is required to determine the extent a valuation allowance should be provided against deferred tax assets. On a quarterly basis, we assess the likelihood of realization of our deferred tax assets considering all available evidence, both positive and negative. Our operating performance in recent years, the scheduled reversal of temporary differences, our forecast of taxable income in future periods in each applicable tax jurisdiction, our ability to sustain a core level of earnings, and the availability of prudent tax planning strategies are important considerations in our assessment. Our forecast of future earnings includes assumptions about service volumes, payor reimbursement, labor costs, operating expenses, and interest expense. Based on the weight of available evidence, we determine if it is more likely than not our deferred tax assets will be realized in the future.
We also recognize the benefits of tax positions when certain criteria are satisfied. Companies may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We recognize interest and penalties related to uncertain tax positions as a component of income tax expense which is consistent with the recognition of these items in prior reporting periods.
Stock-Based Compensation
In connection with our acquisition by affiliates of Vestar, NMH Investment adopted an equity-based compensation plan, and issued units of limited liability company interests consisting of Class B Common Units, Class C Common Units, Class D Common Units, Class E Common Units, Class F Common Units, Class G Common Units, and Class H Common Units pursuant to such plan. The units were limited liability company interests and were issued to our employees and members of the Board of Directors for incentive purposes. Compensation expense was recorded for these awards based on the estimated fair value on the grant date. Compensation expense reflected an estimate of the number of awards expected to vest and is recognized on a straight-line basis over the requisite service period or at the time it is probable that certain performance conditions will be met.
For purposes of determining the estimated fair value of these grants, which were issued prior to the IPO, 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. Significant assumptions included the expected term in which the units will be realized; a risk-free interest rate equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend yield, for which there is none; and expected volatility based on the historical data of equity instruments of comparable companies. For Class B Common Units, Class C Common Units, Class D Common Units, Class E Common Units and Class F Common Units, the estimated fair value of the units, less an assumed forfeiture rate, was recognized in expense on a straight-line basis over the requisite service periods of the awards. We used the historical forfeiture patterns to determine the forfeiture rate. The Class G Common Units vest upon a liquidity event and/or upon the occurrence of certain investment return conditions. The Class H Common Units vest upon the earlier to occur of a sale of the Company or the achievement of a multiple of investment return threshold by Vestar and its affiliates. At the time these events are determined to be probable, compensation expense is recognized in its entirety. During fiscal 2014, the Class G Units fully vested as a result of the completion of the IPO on September 22, 2014. As a result, we recognized $0.6 million of expense in fiscal 2014. As of September 30, 2015, the achievement of the vesting conditions for the Class H Common Units was not determined to be probable; therefore, no expense was recognized during fiscal 2015.
In connection with a secondary offering, on October 1, 2015, NMH Investment distributed all of the 25,250,000 shares of our common stock it held to its existing members in accordance with their respective membership interests and pursuant to the terms of the NHM Investment's Limited Liability Company Agreement and the management unitholders agreements (the “Distribution”). The Distribution triggered the vesting condition of the Class H Common Units and the acceleration of unvested Class F
Common Units. The unrecognized compensation expense of $10.5 million associated with these units will be recorded during the first quarter of fiscal 2016. Although this non-cash expense will impact our financial results, including per share results, the vesting of these awards does not impact the number of shares outstanding.
In fiscal 2014, the Company adopted an equity-based compensation plan and issued stock-based awards including non-qualified stock options and restricted stock units. The Company recognizes the fair value of stock-based compensation expense over the requisite service period of the individual grantee, which equals the vesting period. The Company is required to estimate future forfeitures of stock-based awards for recognition of compensation expense. The Company will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior recognized expense if the actual forfeitures are higher than estimated. The actual expense recognized over the vesting period will only be for those awards that vest.
The fair value of each award granted was estimated on the grant date using the Black-Scholes valuation model. Significant assumptions include the expected term in which the awards will be realized; a risk-free interest rate equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend yield, for which there is none; and expected volatility. The Company has estimated volatility for the awards granted based on the historical volatility for a group of companies believed to be a representative peer group, selected based on industry and market capitalization, due to lack of sufficient historical publicly traded prices of our own common stock. The fair value of the stock options and restricted stock awards on the date of grant, less an assumed forfeiture rate of 9.3% for employee grants, will be recognized as expense in the Company’s consolidated financial statements on a straight-line basis over the requisite service periods of the awards. The Company does not have a history with these types of awards, and as such, the historical forfeiture rate of the Unit Plan was used as the basis for determining the assumed forfeiture rate. The Company has not applied a forfeiture rate to the restricted awards granted to the Board of Directors as the awards vest 100% on the first anniversary of the grant date.
Derivative Financial Instruments
We report derivative financial instruments on the balance sheet at fair value and establish criteria for designation and effectiveness of hedging relationships. Changes in the fair value of derivatives are recorded each period in current operations or in the consolidated statements of 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 gain (loss) on derivative within the consolidated statements of comprehensive income (loss). The related amount receivable from or payable to counterparties is included as an asset or liability, respectively, in our consolidated balance sheets.
The fair value of the swap arrangements are determined based on pricing models and independent formulas using current assumptions that include swap terms, interest rates and forward LIBOR curves and our credit risk.
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. Employment practices liability is fully self-insured. 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, workers’ compensation, automobile, employment practices liability and professional and general liability programs are based on analyses performed internally by management and for certain balances, take into account reports by independent third party actuaries.
We regularly analyze our reserves for incurred but not reported claims and for reported but not paid claims related to our self-insured retentions and fully self-insured programs. We believe our reserves are adequate. However, significant judgment is involved in assessing these reserves, such as assessing historical paid claims, average lags between the claims’ incurred date, reported dates and paid dates and the frequency and severity of claims. There may be differences between actual settlement amounts and recorded reserves and any resulting adjustments are included in expense once a probable amount is known. Any significant increase in the number of claims or costs associated with claims made under these programs above our reserves could have a material adverse effect on our financial results.
Legal Contingencies
We are regularly 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 “Risk Factors” and “Business—Legal Proceedings” for additional information.
Subsequent Events
On October 1, 2015, in connection with an underwritten secondary offering, NMH Investment distributed all of the 25,250,000 shares of our common stock it held to its existing members in accordance with their respective membership interests and pursuant to the terms of the NHM Investment's Limited Liability Company Agreement and the management unitholders agreements (the “Distribution”). The Distribution triggered the vesting condition of the Class H Common Units and the acceleration of unvested Class F Common Units. The unrecognized compensation expense of $10.5 million associated with these units will be recorded during the first quarter of fiscal 2016. The Distribution had no impact on our number of shares outstanding.
The secondary offering was completed on October 7, 2015. In the secondary offering, 2,300,0000 shares of common stock were sold by the selling stockholders to the public at a price of $20.37 per share, net of underwriting discounts and commissions. The Company did not receive any proceeds from the sale of any shares by the selling stockholders.
On November 30, 2015, the Company acquired a company complementary to its Human Services business for aggregate consideration of $3.4 million.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to changes in interest rates as a result of our outstanding variable rate debt. The variable rate debt outstanding relates to the term loan and the senior revolver, which bears interest at (i) a rate equal to the greater of (a) the prime rate, (b) the federal funds rate plus 1/2 of 1% and (c) the Eurodollar rate for an interest period of one-month beginning on such day plus 100 basis points plus 2.25%; or (ii) the Eurodollar rate (subject to a LIBOR floor of 1.00%), plus 3.25%, at our option. A 1% increase in the interest rate on our floating rate debt as of September 30, 2015 would have increased cash interest expense on the floating rate debt by approximately $6.5 million per annum, without giving effect to the interest rate swap agreement discussed below.
To reduce the interest rate exposure related to our variable debt, NMHI entered into two interest rate swaps in an aggregate notional amount of $375.0 million, effective on January 20, 2015. Under the terms of the swap, we receive from the counterparty a quarterly payment based on a rate equal to the greater of 3-month LIBOR or 1.00% per annum, and we make payments to the counterparty based on a fixed rate of 1.795% per annum, in each case on the notional amount of $375.0 million, settled on a net payment basis.
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Item 8. | Financial Statements and Supplementary Data |
Our consolidated financial statements required by this Item are on pages F-1 through F-39 of this report.
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Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
Not applicable.
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Item 9A. | Controls and Procedures |
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are intended to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
We carried out an evaluation, under the supervision, and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2015. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2015 due to the material weakness in internal control over financial reporting related to information technology general controls described below.
Management has identified a material weakness in its internal control over financial reporting related to information technology general controls in the areas of user access and program change management. For additional information regarding the nature of this material weakness, see “Management’s Report on Internal Control Over Financial Reporting” below. We have developed a remediation plan for this material weakness, which is described below under “Remediation Activities.”
Notwithstanding the identified material weakness and management’s assessment that internal control over financial reporting was ineffective as of September 30, 2015, management believes that the audited consolidated financial statements contained in this Annual Report on Form 10-K fairly present, in all material respects, our financial