Filed Pursuant to Rule 424 (b)(4)
Registration No. 333-206998
PROSPECTUS
2,000,000 Shares
Civitas Solutions, Inc.
Common Stock
The selling stockholders named in this prospectus are selling 2,000,000 shares of our common stock. We will not receive any of the proceeds from the sale of the shares of common stock being sold in this offering.
Our common stock is traded on the New York Stock Exchange under the symbol CIVI. On October 1, 2015, the last reported sale price of our common stock on the New York Stock Exchange was $22.56 per share.
Investing in our common stock involves risks. See Risk Factors beginning on page 15.
Per Share | Total | |||||||
Price to the public |
$ | 21.50000 | $ | 43,000,000 | ||||
Underwriting discounts and commissions |
$ | 1.12875 | $ | 2,257,500 | ||||
Proceeds, before expenses, to the selling stockholders (1) |
$ | 20.37125 | $ | 40,742,500 |
(1) | We refer you to Underwriting beginning on page 143 of this prospectus for additional information regarding underwriting compensation. |
The selling stockholders have granted the underwriters a 30-day option to purchase up to 300,000 additional shares from it at the public offering price, less the underwriting discount.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
The underwriters expect to deliver the shares on or about October 7, 2015.
Barclays | BofA Merrill Lynch | UBS Investment Bank |
Raymond James | SunTrust Robinson Humphrey | BMO Capital Markets | Avondale Partners |
Prospectus dated October 1, 2015
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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION |
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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
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CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS FOR NON-U.S. HOLDERS |
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We have not and the underwriters have not authorized anyone to provide you with any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where such offers and sales are permitted. The information in this prospectus or any free writing prospectus is accurate only as of its date, regardless of its time of delivery or the time of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.
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MARKET, RANKING AND OTHER INDUSTRY DATA
The data included in this prospectus regarding markets and ranking, including the size of certain markets and our position and the position of our competitors within these markets, are based on (1) published and unpublished industry sources and (2) our estimates based on our managements knowledge and experience in the markets in which we operate. Unless otherwise stated, all statistical information in this prospectus relating to I/DD has been obtained from reports prepared by Dr. David Braddock, including annual and/or biennial data collected for inclusion in The State of the States in Developmental Disabilities, a research report prepared by Dr. Braddock, and data that was publicly presented by Dr. Braddock in 2015. Dr. Braddock is Associate Vice President of the University of Colorado (CU) System and Executive Director of the Coleman Institute for Cognitive Disabilities. We have provided the most recent market data available to us, including the data that was publicly presented by Dr. Braddock in 2015. Our estimates have been based on these sources as well as information obtained from our customers, the federal government, trade and business organizations and other contacts in the markets in which we operate. We are responsible for all of the disclosure in this prospectus. References in this prospectus to federal fiscal year 2012 are to the federal fiscal year ending September 30, 2012, and references in this prospectus to state fiscal year 2012 are to the state fiscal year ending June 30, 2012.
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The following summary highlights information appearing elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully. In particular, you should read the sections entitled Risk Factors and Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and the notes relating to those statements included elsewhere in this prospectus. Some of the statements in this prospectus constitute forward-looking statements. See Forward-Looking Statements.
In this prospectus, unless the context requires otherwise, references to Civitas refer to Civitas Solutions, Inc. (formerly known as NMH Holdings, Inc.), the issuer of the common stock offered hereby, and references to the Company, we, our or us refer to Civitas and its consolidated subsidiaries. Throughout this prospectus 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 minors 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.
Company 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. 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 a continuum of high quality, cost-effective residential, day and vocational programs, and periodic services. 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 clients home.
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. As of June 30, 2015, we operated in 35 states, serving approximately 12,400 clients in residential settings and more than 17,800 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 in our newest service lines. Our services are provided by over 22,000 full-time equivalent employees, as well as approximately 4,900 independently-contracted host home caregivers.
For fiscal 2014, we generated net revenue of $1,256 million and a net loss of $22.8 million, and for the nine months ended June 30, 2015, we generated net revenue of $1,016 million and a net loss of $1.2 million. Over the last three fiscal years ended September 30, 2014, we grew our annual revenue 20%, or $207 million, approximately 65% of which was from organic growth and approximately 35% of which was attributable to businesses acquired during this period or in the preceding year. We believe that our new start investments and
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our substantial acquisition pipeline, coupled with new opportunities to expand our services in new and existing markets, position us for continued strong growth.
Our Industry
While we have the capabilities to serve individuals with a wide variety of special needs and disabilities, the current principal focus of our business is on the provision of 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).
| 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. |
| ABI. The market for post-acute care and rehabilitation for individuals with ABI, the largest of these populations, is approximately $10 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. |
| ARY. According to reports published by the organization Child Trends, an estimated $28.2 billion was spent in state 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, nearly 200,000 were living in non-relative foster family homes, which includes the therapeutic foster care market, the primary market for our residential ARY services. |
| ADH. The ADH portion of the elder services market is an estimated $6.2 billion, based on IBISWorld estimates. IBISWorld forecasts an annualized growth 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 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. |
Industry Trends
We believe we are well positioned to benefit from a number of favorable trends in our industry:
There are large and growing must-serve populations for our services
The markets we serve are growing as a result of changing demographics, shifts in public policy, consumer awareness and increased focus on cost-effectiveness.
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There is an expanding population of individuals with I/DD eligible for residential and other support services. This growth has been driven by a number of factors, including the following:
| Longer lifespan. Increasingly, individuals with I/DD are living longer lives, with life expectancy climbing from 59 years in the 1970s to 66 years in 1993, the most recent year for which data is available. As these individuals increasingly live longer lives, they require additional care and in many cases outlive the ability to live independently or with family caregivers. |
| Aging caregivers. In 2013, approximately 71% of individuals with I/DD, or 3.5 million individuals, lived with family caregivers, including more than 863,000 with family caregivers aged 60 years or older. As these family caregivers age and become less capable of providing continuous care, we expect they will increasingly seek out-of-home or supported living arrangements, such as those we provide, for their relatives with disabilities. |
| Waiting lists. There is a significant unmet need for residential services for individuals with I/DD. Many states maintain waiting lists for individuals seeking placements for these services. Nationwide, as of 2012, there were an estimated 110,000 individuals with I/DD waiting for residential services, including approximately 77,000 on formal waiting lists in 31 states. There are legislative, advocacy and litigation efforts currently under way in many states to reduce waiting lists and provide additional access to residential services, which we believe will continue to drive additional demand for services such as those we provide. |
| De-institutionalization. As of 2013, there were approximately 73,600 individuals with I/DD residing in institutions with 16 or more beds, including nearly 25,000 in public institutions. At the federal and state levels, policy changes, legal decisions and cost containment efforts are driving a continuing trend of de-institutionalization for the treatment of individuals with disabilities and special needs. Several states are currently in the process of downsizing or closing I/DD institutions, including California, Georgia, New Jersey and Ohio. |
The market for ABI services is growing due to several factors, including:
| Advances in medical care. Advances in emergency care and medical technology are increasing the survival rate and extending the life span of those who suffer a catastrophic injury. This has served to both expand the overall population of these individuals and to place increased responsibility on payors and government agencies to seek cost-effective care. |
| Increasing public awareness. Increases in public awareness of the causes and potential complications of brain injury are driving an increased focus on the diagnosis and proper treatment of these injuries. In particular, the conflicts in Afghanistan and Iraq, where traumatic brain injury has been one of the signature wounds for our military, as well as significant research and media coverage related to the incidence of brain injury in contact sports, especially professional football, have contributed to this increased awareness. As a result, emergency room visits for traumatic brain injury increased by approximately 30% from 2006 to 2010, an eight times increase compared with the growth in emergency room visits generally. |
| Increasing demand for specialized care. Patients, families and payors are increasingly seeking specialized care provided in ABI-specific community-based settings such as those that we offer. There are tens of thousands of individuals with brain injuries currently in nursing facilities. We believe many of these patients, particularly younger individuals, would be better served in community-based rehabilitative programs, as evidenced and supported by growing advocacy, changes in public policy and legal precedents supporting their transition to specialized care settings. |
| Increasing funding for community-based settings. Both the public and private sectors finance post-acute services for individuals with ABI. We believe that payors are increasingly seeking to serve patients in more cost-effective and appropriate community-based settings. For example, in recent years |
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the increase in state ABI waiver programs that provide easier access to Medicaid funds has expanded the number of individuals who can afford ABI services. According to the Centers for Medicare & Medicaid Services (CMS), the compound annual growth rate of individuals with ABI eligible to receive Medicaid funds pursuant to Section 1915(c) of the Home and Community Based Waiver program (1915(c) waivers) was 15.8% from 2006 to 2011. |
We believe the ARY population is growing, along with the demand for many of the services we offer. Specific trends impacting the ARY population include:
| Shifting demographics of children. An increasing number of children are living in poverty in the United States. According to the Childrens Defense Fund, the number of children living below the poverty line increased by approximately 3.1 million from 2000 to 2013, and 2.75 million more children were categorized as poor in 2012 than before the economic downturn began in 2007. In addition, the number of children in single-parent families increased from 22.7 million in 2008 to 24.7 million in 2012, or an increase of approximately 9%. We believe these children are more likely to require the residential and periodic services offered through our ARY segment as their caregivers face greater demands. |
| Stabilization of the foster care population. The number of children in foster care at the end of the federal fiscal year on September 30 reached a peak of approximately 567,000 in 1999 and declined to approximately 397,000 as of September 30, 2012. The decline in the population was driven by several factors causing a shift in care delivery, but more recently the population has stabilized and grown modestly, increasing to more than 415,000 on September 30, 2014. |
| Growing demand for periodic services. In an effort to prevent children and adolescents from requiring an out-of-home placement, public child welfare agencies have for several years been emphasizing periodic support services to strengthen families at-risk. |
The market for ADH services is growing based on a number of factors, including:
| Aging population. According to the Census Bureau, the population aged 65 and over is projected to reach 83.7 million by 2050, almost double the estimated population of 43.1 million in 2012. By 2030, elders will account for approximately 20% of the population, representing an increase from 2013 when elders accounted for approximately 14% of the population. The increase in the elder population is largely attributed to the aging baby boomer generation. |
| Increased life expectancy. The Census Bureau projects the average life expectancy for individuals born in 2050 will be 83.2 years, an increase of 4.7 years from individuals born in 2012. In addition, individuals 85 years of age in 2050 can expect to live for approximately another 7.7 years. |
| Growing need for services and supports. As the average life expectancy continues to rise, so does the number of individuals over 65 with two or more chronic diseases. The CDC reports that from 1999 to 2009, the percentage of adults over 64 years of age with two or more diagnoses of chronic disease increased from 37.2% to 45.3%. Chronic diseases, such as heart disease, emphysema, cancer, kidney disease and hypertension, can impair an individuals functional and cognitive abilities, thus impacting his or her ability to live independently. Non-residential Long-Term Services and Supports (LTSS), which include ADH services, are alternatives to more restrictive and more costly settings such as nursing homes, and the demand for LTSS is expected to continue growing. |
Clients, caregivers and payors are increasingly recognizing the value of home- and community-based services
We believe home- and community-based services are strongly preferred by clients and their caregivers. The less restrictive settings provide greater control over care delivery, support patient quality of life and
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independence, and facilitate stronger bonds between those we serve and their caregivers. Additionally, consumers are becoming increasingly aware of the full spectrum of services available in the market, and we believe they will continue to demand the type of tailored and cost-effective community-based care we offer.
Furthermore, we believe that in our target markets, both public and non-public payors will increasingly emphasize and fund community-based services that offer comprehensive care across the continuum at a better relative value. We believe tailored solutions and ongoing support, such as the services we provide, offer better overall outcomes for the populations we serve. For most of our patient populations, our customized service plans cost less than care plans in large-scale institutional settings. Home- and community-based services are also preferred as a clinically appropriate and less expensive step-down alternative for individuals who no longer require care in more expensive acute care settings.
Funding for home- and community-based services is expanding
We believe funding for home and community-based services is expanding for a variety of reasons, including the must-serve nature of our population, and legislation, legal precedents and advocacy efforts supporting the individuals we serve. Human services, including services for the I/DD and ARY populations, are generally funded by government programs, predominantly Medicaid, while ABI services are funded by a mix of government programs and private insurance. These programs are often administered on a state-wide level and, in selected states, decisions regarding funding for individual clients and programs occur at the county level, resulting in a large and diverse payor base. State governments are financially incentivized to continue funding services in our core markets because states receive matching federal funds for state expenditures. As a result of these factors, our rates have remained stable, with some rate contraction in 2009 through 2011 following the economic downturn and modest expansion starting in 2012 and continuing through the third quarter of fiscal 2015. We believe improving state budgets resulting from a recovering economic environment will further drive growth in funding.
The health and human services markets we serve are highly fragmented, and we expect continued consolidation of the numerous local and regional providers who lack our scale and resources
The markets we serve are highly fragmented, with only a limited number of national providers of significant scale. We believe as payors and other stakeholders increasingly look to evidence-informed services and evidence-based outcomes, the demand will increase for more sophisticated reporting, quality, billing and clinical outcomes data, which require complex and robust administrative and IT systems. Small providers often lack the resources to implement and the scale to leverage these systems. We also believe that payors are increasingly seeking to contract with larger providers that can offer a more comprehensive suite of services across a continuum of care, deliver consistent quality of care and act quickly to establish new programs for populations in need of service.
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Competitive Strengths
We believe we are uniquely positioned to be the preferred provider of home- and community-based health and human services in the markets we serve. In particular, our strengths include:
The Leading Provider of Home- and Community-Based Health and Human Services in the United States. As of June 30, 2015, we provided services to approximately 12,400 clients in residential settings and more than 17,800 clients in non-residential settings across 35 states, which are home to approximately 84% of the U.S. population. Our national scale and breadth of service offerings provide us with significant competitive advantages:
| Responsiveness: Our scale enables us to deliver a broad range of highly customized services across a continuum of care with a greater level of responsiveness than many of our regional or local service competitors. We have the knowledge, financial resources and relationships to anticipate and rapidly respond to customer needs and market opportunities, positioning us well to capture new business. |
| Clinical Expertise: Given our extensive national network of clinicians and the wide variety of service models we use, we have developed a broad range of clinical expertise to address a range of disabilities and special needs. We leverage clinical best practices from across our network to expand into new markets and initiate new service lines and programs to address the needs of our payors, our clients and their caregivers. For example, to promote excellence in our ARY service line, we recently created a Children and Family Services Center of Excellence composed of child welfare experts who are focused on enhancing training programs, supporting adherence to clinical models and measuring outcomes for all ARY programs. We believe our ability to serve individuals with the most complex physical and behavioral challenges distinguishes us from many of our competitors. |
| Infrastructure: Unlike smaller competitors that lack our scale and resources, we have developed a robust infrastructure, including functions such as quality assurance, compliance, risk management, information technology, human resources, billing and financial management, that we leverage across our care-delivery network. This infrastructure enables our operations to focus on efficiently delivering consistent, high-quality care and enables us to respond to the increasing compliance, regulatory and fiscal requirements of payors. |
Powerful Value Proposition. We believe we offer a powerful value proposition to our payors, our clients and their caregivers through our ability to design customized service plans to meet the unique needs of our clients in cost-effective settings. We specialize in adapting our service offerings to a wide range of intensities of care and other client requirements.
Proven Ability to Make Acquisitions at Attractive Valuations. We believe our scale, in-depth industry knowledge, payor relationships, reputation for quality and operational expertise strategically position us as a preferred acquirer, with an ability to efficiently and opportunistically deploy capital. We are the only company with a national platform dedicated to serving each of the I/DD, ABI, ARY and ADH populations. This positions us as a prime exit option for small providers in these highly-fragmented markets. We have completed 50 acquisitions at an aggregate purchase price of approximately $211.2 million from the beginning of fiscal 2009 through June 30, 2015.
Unique First Mover Advantage in SRS. Through our history of acquisitions and new starts, we now serve over 1,600 individuals in 26 states in our SRS segment. 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. Through our NeuroRestorative and CareMeridian business units, we offer solutions to SRS clients across the continuum of care, from post-acute care and neurorehabilitation to day treatment and supportive living services, that help individuals in their recovery and, in many cases, to regain independence. Our experience in SRS enables us to deliver high-quality specialized
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care and offer significant cost savings for payors, leading to an expanding pipeline of referrals. Our quality of care and outcomes, along with limited competition of scale in the underserved SRS market, position us to capitalize on this opportunity and benefit from its rapid growth.
Stable Cash Flows Fund Growth Opportunities. Our highly-diverse group of payors and the must-serve populations we support have insulated our revenue streams from significant and widespread rate reductions. This, coupled with our modest capital expenditures and working capital needs, has helped us deliver stable cash flows through periods of economic recession and prosperity. We have utilized our stable cash flows to invest in new growth opportunities and fuel the expansion of our services.
Proven Management Team with a Track Record of Performance. Our management team, having served previously as policy makers, fiscal managers and service providers, has extensive public and private sector experience in health and human services. Our executive officers have been with us for an average of 15 years and average approximately 24 years in the human services industry. Our management team has demonstrated the ability and experience to ensure the delivery of high quality services to clients, pursue and integrate numerous acquisitions, manage critical human resources, develop and maintain robust IT and financial systems, mitigate risk in the business and oversee our significant growth and expansion.
Our Business Strategy
We intend to continue leveraging our strengths to capitalize on the market opportunity for home-and community-based health and human services. The primary aspects of our strategy include:
Leverage our Core Competencies to Drive Organic Growth. We expect to capture the embedded growth opportunities resulting from recent 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. 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 June 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 investment of approximately $8.1 million in new starts between fiscal 2007 and fiscal 2010 generated net revenues and operating income of approximately $70.7 million and $16.5 million, respectively, in fiscal 2014. We intend to continue to aggressively pursue new start opportunities with attractive rates of return.
Expand our SRS Platform. We intend to leverage our unique 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 2009, achieving a 19% compound annual growth rate in net revenue over that period. Furthermore, our SRS business is funded by a highly attractive payor mix, with 53% of net revenues in fiscal 2014 derived from commercial insurers and other private entities.
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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.
Recent Developments
We have not yet closed our books for, and our independent registered public accounting firm has not completed its review of, our results for the fiscal year ended September 30, 2015. Set forth below are preliminary estimates that we expect for fiscal 2015.
We estimate our fiscal 2015 net revenue to be in the range of $1.355 billion to $1.375 billion and our fiscal 2015 Adjusted EBITDA to be in the range of $152 million to $154 million.
The preliminary estimates set forth above for fiscal 2015 are unaudited and subject to completion. They reflect managements estimates based solely upon information available as of the date of this prospectus and are not a comprehensive statement of our financial results for fiscal 2015. Our actual results for fiscal 2015 are subject to our completion of year-end financial and accounting closing procedures (which have yet to be performed), and the making of any final adjustments to our results of operations and other developments that may arise between now and the time the financial results for fiscal 2015 are finalized. There is a possibility that actual results for fiscal 2015 will vary materially from the preliminary estimates. Accordingly, you should not place undue reliance upon these preliminary estimates. Please see Forward-Looking Statements. The preliminary estimates have been prepared by, and are the responsibility of, management, and Deloitte & Touche LLP has not audited, reviewed, compiled or performed any procedures with respect to such preliminary estimates, nor have they expressed any opinion or any other form of assurance with respect thereto.
Adjusted EBITDA is a non-GAAP financial measure. We have not provided a quantitative reconciliation of our Adjusted EBITDA estimate for fiscal 2015 to estimated net income, the most comparable financial measure calculated and presented in accordance with GAAP, due to the difficulty in forecasting and quantifying the exact amount of the items excluded from Adjusted EBITDA that will be included in net income, such that it is not practicable to prepare such reconciliations without unreasonable effort.
Risk Factors
An investment in our common stock involves a high degree of risk. Any of the factors set forth under Risk Factors may limit our ability to successfully execute our business strategy. You should carefully consider all of the information set forth in this prospectus and, in particular, should evaluate the specific factors set forth under Risk Factors in deciding whether to invest in our common stock. Among these important risks are the following:
| we rely on Medicaid funding as we derive approximately 89% of our revenue from contracts with state and local governments and a substantial portion of this revenue is state funded with federal matching Medicaid dollars; accordingly, 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; |
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| the nature of our operations subjects us to substantial claims, litigation and governmental proceedings; |
| an increase in labor costs or labor-related liability; |
| 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 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; and |
| due in large part to our high level of indebtedness, we have a history of losses and we could report losses in the future. |
Our Corporate Information
Civitas Solutions, Inc. (formerly known as NMH Holdings, Inc.) is a Delaware corporation incorporated on June 15, 2007. Our business was originally formed in 1980. We were acquired in 2006 pursuant to a merger and contribution (the Merger) by affiliates of Vestar Capital Partners (Vestar). Our principal executive office is located at 313 Congress Street, Boston, Massachusetts 02210, and our telephone number is (617) 790-4800. The address of our main website is www.civitas-solutions.com. You should not consider any information on, or that can be accessed through, our website as part of this prospectus.
Civitas largest stockholder immediately prior to this offering, NMH Investment, LLC (the LLC), is controlled by investment funds managed by Vestar. The equity interests of the LLC are owned by Vestar and certain of our executive officers and directors and other members of management.
The Distribution
On October 1, 2015, in connection with this offering, the LLC 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 LLCs limited liability company agreement and the management unitholders agreements (the Distribution). It is currently contemplated that the LLC will be dissolved following the completion of this offering and the winding up of the LLCs affairs.
The Distribution will not affect our operations, which we will continue to conduct through our operating subsidiaries. The primary purpose of the Distribution was to give increased liquidity to those who previously held equity interests in us indirectly through their ownership of units of the LLC.
Equity Sponsor
Founded in 1988, Vestar Capital Partners is a leading U.S. middle market private equity firm specializing in management buyouts and growth capital investments. Vestar invests and collaborates with incumbent management teams and private owners in a creative, flexible and entrepreneurial way to build long-term enterprise value. Since Vestars founding, Vestar funds have completed more than 70 investments in companies with a total value of more than $40 billion.
Vestar has extensive experience investing across a wide variety of industries, including healthcare, financial services, information services, consumer, digital media and diversified industries. Vestar Capital Partners has been making successful investments in the healthcare sector since the late 1990s, when the firm helped the physician managers of Sheridan Healthcare take the company private and build it from a local operation into a nationwide provider of outsourced medical services.
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Since then, Vestars healthcare investments have spanned the healthcare spectrum, including, in addition to the Company, Essent Healthcare, a hospital management company, and more recently, healthcare information and measurement technologies investments, which include HealthGrades, Press Ganey and MediMedia.
Vestar currently manages funds with approximately $5 billion of assets and has offices in New York, Denver and Boston. Vestars investment in the LLC was funded by Vestar Capital Partners V, L.P., a $3.7 billion fund which closed in 2005, and affiliates.
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The Offering
Issuer |
Civitas Solutions, Inc. |
Common stock offered by the selling stockholders |
2,000,000 shares |
Underwriters option to purchase additional shares |
The selling stockholders have granted the underwriters a 30-day option to purchase up to an additional 300,000 shares at the public offering price less the underwriting discount. |
Common stock to be outstanding immediately before and after completion of the Distribution and this offering |
37,079,707 shares |
Use of proceeds |
We will not receive any of the proceeds from the sale of any shares of our common stock by the selling stockholders. See Use of Proceeds. |
New York Stock Exchange symbol |
CIVI |
Director purchases |
Gregory S. Roth, one of our directors, will be given the opportunity to purchase up to $300,000 of our common stock in this offering at the public offering price. |
Risk factors |
For a discussion of risks relating to us, our business and an investment in our common stock, see Risk Factors and all other information set forth in this prospectus before investing in our common stock. |
Unless otherwise indicated, all information in this prospectus relating to the number of shares of common stock to be outstanding immediately after this offering:
| is based on the number of shares of common stock outstanding as of September 25, 2015; |
| excludes 571,495 shares of our common stock underlying stock options issued under our 2014 Incentive Plan (as defined herein), 387,556 shares of our common stock issuable upon the vesting of outstanding restricted stock unit awards under our 2014 Incentive Plan and 2,164,132 shares of our common stock reserved for issuance under our 2014 Incentive Plan; and |
| assumes no exercise by the underwriters of their option to purchase up to 300,000 additional shares from the selling stockholders. |
11
Summary Consolidated Financial and Other Data
The following tables set forth our summary consolidated financial and other data as of and for the dates indicated. The consolidated financial and other data as of September 30, 2013 and 2014 and for the years ended September 30, 2012, 2013 and 2014 are derived from our audited consolidated financial statements, included elsewhere in this prospectus. The consolidated financial balance sheet data as of September 30, 2012 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated financial and other data presented below as of and for the nine months ended June 30, 2014 and 2015 have been derived from our unaudited condensed consolidated financial statements, which are included elsewhere in this prospectus. Operating results for the nine months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the entire fiscal year ending September 30, 2015.
Our results included below and elsewhere in this prospectus are not necessarily indicative of our future performance. The following summary consolidated financial and other data are qualified in their entirety by reference to, and should be read in conjunction with, our audited consolidated financial statements and the accompanying notes, included elsewhere in this prospectus, and the information under Selected Historical Consolidated Financial Data, Managements Discussion and Analysis of Financial Condition and Results of Operations, our financial statements and notes thereto and other financial information included in this prospectus.
Fiscal Year Ended September 30, | Nine Months Ended June 30, | |||||||||||||||||||
2012 | 2013 | 2014 | 2014 | 2015 | ||||||||||||||||
(dollars in thousands, except per share data) | ||||||||||||||||||||
Statements of Operations Data: |
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Net revenue |
$ | 1,107,351 | $ | 1,182,509 | $ | 1,255,838 | $ | 928,547 | $ | 1,015,764 | ||||||||||
Cost of revenue (exclusive of depreciation expense shown separately below) |
861,691 | 921,618 | 983,043 | 725,754 | 786,024 | |||||||||||||||
General and administrative expenses |
139,630 | 145,184 | 145,041 | 108,104 | 119,452 | |||||||||||||||
Depreciation and amortization |
59,987 | 63,573 | 67,488 | 50,594 | 64,278 | |||||||||||||||
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Income from operations |
46,043 | 52,134 | 60,266 | 44,095 | 46,010 | |||||||||||||||
Management fee of related party |
(1,325 | ) | (1,359 | ) | (9,488 | ) | (1,041 | ) | (162 | ) | ||||||||||
Other income (expense), net |
330 | 1,046 | 374 | 664 | (333 | ) | ||||||||||||||
Extinguishment of debt |
| | (14,699 | ) | (14,699 | ) | (17,058 | ) | ||||||||||||
Interest expense |
(79,445 | ) | (78,075 | ) | (69,349 | ) | (53,204 | ) | (28,868 | ) | ||||||||||
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Loss from continuing operations before income taxes |
(34,397 | ) | (26,254 | ) | (32,896 | ) | (24,185 | ) | (411 | ) | ||||||||||
Benefit for income taxes |
(19,883 | ) | (9,942 | ) | (11,463 | ) | (7,243 | ) | (185 | ) | ||||||||||
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Loss from continuing operations |
(14,514 | ) | (16,312 | ) | (21,433 | ) | (16,942 | ) | (226 | ) | ||||||||||
Gain (loss) from discontinued operations, net of tax (1) |
245 | (1,984 | ) | (1,382 | ) | 67 | (966 | ) | ||||||||||||
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Net loss |
$ | (14,269 | ) | $ | (18,296 | ) | $ | (22,815 | ) | $ | (16,875 | ) | $ | (1,192 | ) | |||||
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Per Share Data: |
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Net loss per common share, basic and diluted: |
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Loss from continuing operations |
$ | (0.57 | ) | $ | (0.65 | ) | $ | (0.84 | ) | $ | (0.67 | ) | $ | (0.01 | ) | |||||
Gain (loss) from discontinued operations |
| $ | (0.07 | ) | $ | (0.05 | ) | | $ | (0.02 | ) | |||||||||
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Net loss per common share, basic and diluted |
$ | (0.57 | ) | $ | (0.72 | ) | $ | (0.89 | ) | $ | (0.67 | ) | $ | (0.03 | ) | |||||
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Weighted-average common shares outstanding, basic and diluted: |
25,250,000 | 25,250,000 | 25,538,493 | 25,250,000 | 36,950,000 | |||||||||||||||
Balance Sheet Data (at end of period): |
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Cash and cash equivalents |
$ | 125 | $ | 19,440 | $ | 196,147 | $ | 47,526 | $ | 16,665 | ||||||||||
Working capital (2) |
26,192 | 59,262 | 49,555 | 66,085 | 54,755 | |||||||||||||||
Total assets |
1,045,880 | 1,021,269 | 1,027,954 | 1,031,494 | 1,057,260 | |||||||||||||||
Total debt (3) |
799,895 | 803,464 | 815,509 | 817,128 | 653,397 | |||||||||||||||
Stockholders equity (deficit) |
(29,391 | ) | (46,515 | ) | 115,538 | (62,047 | ) | 120,064 | ||||||||||||
Other Financial Data: |
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Cash flows provided by (used in): |
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Operating activities |
$ | 29,251 | $ | 55,738 | $ | 83,916 | $ | 66,667 | $ | 50,714 | ||||||||||
Investing activities |
(42,662 | ) | (39,377 | ) | (88,924 | ) | (39,711 | ) | (67,534 | ) | ||||||||||
Financing activities |
13,148 | 2,954 | 181,715 | 1,130 | (162,662 | ) | ||||||||||||||
Capital expenditures |
29,995 | 31,901 | 35,295 | 24,271 | 30,310 | |||||||||||||||
Program rent expense (4) |
32,411 | 38,603 | 42,165 | 31,156 | 36,882 | |||||||||||||||
EBITDA (5) |
104,707 | 115,259 | 103,758 | 79,450 | 92,985 | |||||||||||||||
Adjusted EBITDA (5) |
106,704 | 116,107 | 128,840 | 95,293 | 116,637 |
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(1) | During fiscal 2013, 2014 and 2015, we closed certain Human Services operations in the states of Virginia and Connecticut, sold our Rhode Island ARY business and closed our Rhode Island I/DD business. All fiscal years presented reflect the classification of these businesses as discontinued operations. In April 2014, the FASB issued Accounting Standards Update No. 2014-08 which was adopted by the Company on October 1, 2014. Under the new standard, which is applied prospectively, similar closures will no longer be classified as discontinued operations. In June 2015, we decided to discontinue ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas. These businesses have not been classified as discontinued operations. |
(2) | Calculated as current assets minus current liabilities. |
(3) | Includes obligations under capital leases. |
(4) | Program rent expense is defined as lease expenses related to buildings directly utilized in providing services to clients. |
(5) | We define EBITDA as income before interest expense and interest income, taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA further adjusted to add back certain charges, fees and expenses. EBITDA and Adjusted EBITDA are presented because they are important measures used by management to assess financial performance, and management believes they provide a more transparent view of our operating performance and operating trends without the effect of non-cash charges and other items that vary from period to period without any correlation to our operating performance. We also believe these non-GAAP measures are useful to investors in assessing financial performance because these measures are similar to the metrics used by investors and other interested parties when comparing companies in our industry that have different capital structures, debt levels and/or tax rates. |
EBITDA and Adjusted EBITDA are not determined in accordance with GAAP and should not be considered in isolation or as an alternative to net income, income from operations, net cash provided by operating, investing or financing activities or other financial statement data presented as indicators of financial performance or liquidity, each as presented in accordance with GAAP. Neither EBITDA nor Adjusted EBITDA should be considered as a measure of discretionary cash available to us to invest in the growth of our business. While EBITDA and Adjusted EBITDA are frequently used as measures of operating performance and the ability to meet debt service requirements, they are not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation.
Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual items.
The following table provides a reconciliation from net loss to EBITDA and Adjusted EBITDA:
Fiscal Year Ended September 30, | Nine Months Ended June 30, | |||||||||||||||||||
2012 | 2013 | 2014 | 2014 | 2015 | ||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Net loss |
$ | (14,269 | ) | $ | (18,296 | ) | $ | (22,815 | ) | $ | (16,875 | ) | $ | (1,192 | ) | |||||
Loss (gain) from discontinued operations, net of tax |
(245 | ) | 1,984 | 1,382 | (67 | ) | 966 | |||||||||||||
Benefit for income taxes |
(19,883 | ) | (9,942 | ) | (11,463 | ) | (7,243 | ) | (185 | ) | ||||||||||
Interest expense, net |
79,117 | 77,940 | 69,166 | 53,041 | 29,118 | |||||||||||||||
Depreciation and amortization |
59,987 | 63,573 | 67,488 | 50,594 | 64,278 | |||||||||||||||
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EBITDA |
$ | 104,707 | $ | 115,259 | $ | 103,758 | $ | 79,450 | $ | 92,985 | ||||||||||
Adjustments: |
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Management fee of related party (a) |
1,325 | 1,359 | 9,488 | 1,041 | 162 | |||||||||||||||
Stock based compensation (b) |
672 | 273 | 895 | 103 | 3,761 | |||||||||||||||
Predecessor provider tax reserve adjustments (c) |
| (2,118 | ) | | | | ||||||||||||||
Extinguishment of debt (d) |
| | 14,699 | 14,699 | 17,259 | |||||||||||||||
Long-term compensation plan payment (e) |
| | | | 2,470 | |||||||||||||||
Non-cash impairment charges (f) |
| 1,334 | | | | |||||||||||||||
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Adjusted EBITDA |
$ | 106,704 | $ | 116,107 | $ | 128,840 | $ | 95,293 | $ | 116,637 | ||||||||||
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Supplemental Information: |
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Operating losses for new starts (g) |
$ | 7,460 | $ | 8,802 | $ | 6,148 | $ | 4,491 | $ | 3,898 | ||||||||||
Pro forma effect of acquired EBITDA (h) |
3,450 | 2,229 | 6,582 | 1,748 | 2,693 |
(a) | Represents management fees and reimbursable expenses incurred under our management agreement with our private equity sponsor that terminated during the year ended September 30, 2014. |
13
(b) | Represents non-cash stock-based compensation. |
(c) | Represents an adjustment to a reserve for a provider tax. |
(d) | Represents the write-off of the remaining deferred financings costs on debt that we refinanced during the year ended September 30, 2014, and the costs associated with the redemption of $212 million of senior notes during the nine months ended June 30, 2015, including the write-off of the associated deferred financing costs and original issue discount and costs associated with the $55 million term loan that closed in February 2015. |
(e) | Represents payments associated with the termination of an equity-like plan for employees of the CareMeridian business unit made in connection with our initial public offering. |
(f) | Represents impairment charges associated with indefinite lived intangible assets and goodwill related to the closing of underperforming programs. |
(g) | Operating losses from new starts represent losses from any new start programs initiated within 18 months of the end of the period that had operating losses during the period. Net operating loss from a new start is defined as its revenue for the period less direct expenses but not including allocated overhead costs. |
(h) | Represents the estimated additional EBITDA from acquisitions made during the periods presented assuming the acquisitions had occurred on the first day of each respective period. |
14
Investing in our common stock involves a number of risks. Before you purchase our common stock, you should carefully consider the risks described below and the other information contained in this prospectus, including our consolidated financial statements and accompanying notes. If any of the following risks actually occurs, our business, financial condition, results of operation or cash flows could be materially adversely affected. In any such case, the trading price of our common stock could decline, and you could lose all or part of your investment.
Risks Related to Our Business
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 states 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 Reductions 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. Current projections estimate that the federal government will reach the debt ceiling during the fall of 2015, which could result in negotiations over the debt ceiling occurring at the same time as the federal budget debate. 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
15
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 BusinessLegal Proceedings.
Professional and general liability expense totaled 0.8%, 0.8%, 0.9%, 1.0% and 1.0% of our net revenue for the nine months ended June 30, 2015 and 2014 and the fiscal years ended September 30, 2014, 2013 and 2012, respectively. We incurred professional and general liability expenses of $7.7 million, $7.9 million, $10.9 million, $12.1 million and $10.7 million for the nine months ended June 30, 2015 and 2014 and the fiscal years ended September 30, 2014, 2013 and 2012, 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 2013 and 2014, 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 states 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. On August 10, 2015, a staff member of the SFC requested additional information. We have been working diligently to respond to the SFCs request for information in a timely manner. It is both costly and time consuming for us to comply with these inquiries. We currently provide privatized foster care in 13 states. We anticipate that upon completion of our previously announced strategic review and divestiture of our ARY service line in five states, we will provide
16
foster care in eight states. At this juncture, we cannot predict the scope, duration or outcome of the SFCs 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 11.7% 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.
17
Although our employees are generally not unionized, we acquired one business in New Jersey in 2010 that currently has approximately 24 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 Companys 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 are due by 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 June 30, 2015, we had total indebtedness, excluding capital lease obligations, of $645.7 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. A portion of our indebtedness, including borrowings under the senior secured credit facilities, bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same. 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.
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Our substantial degree of leverage could have important consequences, including the following:
| it may curtail our acquisitions program and may limit our ability to invest in our infrastructure and in growth opportunities; |
| 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; |
| the debt service requirements of our indebtedness could make it more difficult for us to satisfy our indebtedness and contractual and commercial commitments; |
| 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; |
| interest rates on any portion of our variable interest rate borrowings under the senior secured credit facilities that we have not hedged may increase; |
| it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt and a lower degree of leverage; and |
| 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 nine months ended June 30, 2015, our aggregate rental expense for these leases was $48.3 million. We expect this number will increase during the remainder of fiscal 2015 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, 2013 and 2012 and the nine months ended June 30, 2015, we generated net losses of $22.8 million, $18.3 million, $14.3 million, and $1.2 million respectively. Although we 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 Risk FactorsRisks Related to Our Business.
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Failure to comply with requirements to design, implement and maintain effective internal controls could have a material adverse effect on our business.
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. For the first time, after the conclusion of this fiscal year ending September 30, 2015, we will be required, pursuant to Section 404, to furnish an attestation report of our independent registered public accounting firm on the effectiveness of our internal control over financial reporting. We have identified significant deficiencies in our internal control over financial reporting related to information technology, revenue processes and financial reporting and disclosure. We have taken measures to remediate these deficiencies, but we have not yet completed the testing to determine if these deficiencies have been remediated. If we are unable to remedy past deficiencies, or if we identify additional deficiencies in the future, we may be unable to conclude that our internal control over financial reporting is effective or obtain an unqualified opinion from our independent registered public accounting firm.
No evaluation can provide complete assurance that our internal controls will operate as intended. Managements report is required to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. Testing and maintaining internal controls may divert our managements attention from other matters that are important to our business. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 or our independent registered public accounting firm may not issue an unqualified opinion when they are required to do so. 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.
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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, goes into effect on October 1, 2015, at which time all providers must use the updated codes for billing. Failure to adequately prepare for ICD-10 would 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:
| require us to refund amounts we have previously been paid; |
| terminate or modify our existing contracts; |
| suspend or prevent us from receiving new contracts or extending existing contracts; |
| impose referral holds on us; |
| impose fines, penalties or other sanctions on us; and |
| reduce the amount we are paid under our existing contracts. |
As a result of past reviews and audits of our operations, we have been and are subject to some of these actions from time to time. While we do not currently believe that our existing 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.
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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 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 & Poors downgraded the Federal governments credit rating and additional downgrades are possible in the future. In October 2013, Fitch Ratings placed the Federal governments 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.
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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 isnt 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, based on wages, benefits and other working conditions. 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 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.
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Negative publicity or changes in public perception of our services may adversely affect our ability to obtain new contracts and renew existing ones 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 failure by our direct care staff or host-home providers to properly care for clients; |
| the failure to submit proper documentation to the applicable government agency, including documentation supporting reimbursements for costs; |
| the failure by our programs to abide by the applicable laws and regulations relating to the provision of health and human services; and |
| the failure of our facilities to comply with the applicable building, health and safety codes and ordinances. |
From time to time, some of our licenses or certifications, or those of our employees, are temporarily placed on probationary status or suspended. If we lost our status as a licensed provider of 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 providers 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.
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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:
| the business we acquire may not continue to generate income at the same historical levels on which we based our acquisition decision; |
| we may be unable to maintain and renew the contracts of the acquired business; |
| unforeseen difficulties may arise in integrating the acquired operations, including employment practices, information systems and accounting controls; |
| we may not achieve operating efficiencies, synergies, economies of scale and cost reductions as expected; |
| we may be required to pay higher purchase prices for acquisitions than we have paid historically; |
| management may be distracted from overseeing existing operations by the need to integrate the acquired business; |
| we may acquire or assume unexpected liabilities or there may be other unanticipated costs; |
| we may encounter unanticipated regulatory risk; |
| we may experience problems entering new markets or service lines in which we have limited or no experience; |
| we may fail to retain and assimilate key employees of the acquired business; |
| we may finance the acquisition by incurring additional debt and further increase our leverage ratios; and |
| the culture of the acquired business may not match well with our culture. |
As a result of these risks, there can be no assurance that any future acquisition will be successful or that it will not have a material adverse effect on our financial condition and results of operations.
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
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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.
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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 newly promulgated 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 individuals 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
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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 the fiscal year ended September 30, 2014 and the nine months ended June 30, 2015, 14% and 15% of our net revenue, respectively, was derived from contracts with government agencies in the State of Minnesota. Accordingly, any reduction in Minnesotas budgetary appropriations for our services, whether as a result of fiscal constraints due to recession, changes in policy or otherwise, could result in a reduction in our 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:
| the failure to maintain and renew our licenses; |
| the failure to maintain important relationships with officials of government agencies; and |
| any negative publicity regarding our operations. |
Any of these adverse developments occurring in Minnesota could result in a reduction in revenue or a loss of contracts, which could have a material adverse effect on our results of operations, financial position and cash flows.
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:
| incur additional debt or issue certain preferred shares; |
| pay dividends on or make distributions in respect of capital stock or make other restricted payments; |
| make certain investments; |
| sell certain assets; |
| create liens on certain assets to secure debt; |
| enter into agreements that restrict dividends from subsidiaries; |
| consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and |
| enter into certain transactions with our affiliates. |
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.
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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:
| accounting and financial reporting; |
| billing and collecting accounts; |
| coding and compliance; |
| clinical systems, including census and incident reporting; |
| records and document storage; and |
| monitoring quality of care and collecting data on quality and compliance measures. |
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
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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 55.8% and 48.5% of the total assets on our consolidated balance sheets as of June 30, 2015 and September 30, 2014, respectively. In connection with the decision to discontinue ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas, we incurred an impairment charge of $8.2 million for intangible assets owned by 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.
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Our divestiture of ARY programs in five states may expose us to liability.
A planned and comprehensive analysis of the ARY market resulted in the review and planned divestitures of operations in five states serving ARY contracts. As part of acquiring or divesting certain business lines, the regulators may require that the acquiring entity or provider enter into a temporary management agreement whereby the acquiring entity operates under the existing license and provider number until such time as a new license and/or provider certification is issued to the acquiring entity. While we do not enter into such agreements frequently, we have identified that as part of our divestiture of the ARY business in five states, certain states will require a management agreement to accomplish the transaction. A management agreement carries with it certain risks in that acquiring entity will operate under our license and provider certification for some time period. While the acquiring entity operates under our license, the acquiring entitys activities, over which we have no control, would be attributable to us, and could result in suspensions or revocations of our license if our license was deemed to be violated by the acquiring entity. While we endeavor to keep the duration of this arrangement as short term as possible, the time required to issue the new license and/or certification to the new provider is most often beyond our control and rests almost exclusively with the issuing state authority.
Risks Related to this Offering and Ownership of Our Common Stock
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, and following this offering we will continue to be, 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 requirement that a majority of the Board of Directors consists of independent directors; |
| the requirement that nominating and corporate governance matters be decided solely by independent directors; and |
| the requirement that employee and officer compensation matters be decided solely by independent directors. |
We currently rely on each of these 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 the public offering 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 those described under Risks Related to Our Business and the following:
| 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; |
| downgrades by any securities analysts who follow our common stock; |
| future sales of our common stock by our officers, directors and significant stockholders; |
| 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; |
| announcements by us of significant contracts, acquisitions, joint ventures or capital commitments; and |
| 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 will have the ability to control significant corporate activities after the completion of this offering and our majority stockholders interests may not coincide with yours.
After the consummation of the Distribution and this offering, Vestar will own approximately 53.3% of our common stock, assuming the underwriters do not exercise their option to purchase additional shares. If the underwriters exercise in full their option to purchase additional shares, Vestar will own approximately 52.9% of our common stock. So long as Vestar holds a majority of our outstanding shares, Vestar will have the ability to control the outcome of matters submitted to a vote of stockholders and, through our Board of Directors, the ability to control decision-making with respect to our business direction and policies. In addition, under the director nominating agreement that we entered into with the LLC 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 will, directly or indirectly, exercise control following this offering include:
| the election of our Board of Directors and the appointment and removal of our officers; |
| mergers and other business combination transactions, including proposed transactions that would result in our stockholders receiving a premium price for their shares; |
| other material acquisitions or dispositions of businesses or assets; |
| incurrence of indebtedness and the issuance of equity securities; |
| repurchase of stock and payment of dividends; and |
| the issuance of shares to management under our equity incentive plans. |
Even if Vestars 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. See Description of Capital StockCorporate 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 after this offering, 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. We had 37,079,707 shares of common stock outstanding as of September 25, 2015. The 11,700,000 shares of common stock sold in our initial public offering and the 2,000,000 shares of common stock offered in this offering will be 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.
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In addition, the 23,250,000 shares of our common stock distributed to the members of the LLC in the Distribution and not sold in this offering will be 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. See Shares Eligible for Future Sale.
We, each of our executive officers and directors, the selling stockholders and all of the other members of the LLC who received shares of our common stock in the Distribution have agreed, subject to certain exceptions, with the underwriters not to dispose of or hedge any of the shares of common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date that is 90 days after the date of this prospectus (subject to extension in certain circumstances). Barclays Capital Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and UBS Securities LLC may, in their discretion, release any of these shares from these restrictions at any time without notice. See Underwriting.
All of the members of the LLC who received shares of common stock in the Distribution, who will hold 23,250,000 shares, or approximately 63% of our common stock, assuming the underwriters do not exercise their option to purchase additional shares, upon completion of the Distribution and this offering, will have the right to require us to register such shares pursuant to the terms of a registration rights agreement between us and the former members of the LLC. See Shares Eligible for Future SaleRegistration Rights for a more detailed description of these rights.
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.
Anti-takeover provisions in our charter documents and Delaware law might discourage or delay acquisition attempts for us that you might consider favorable.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the acquisition of the Company more difficult without the approval of our Board of Directors. These provisions:
| authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend or other rights or preferences superior to the rights of the holders of common stock; |
| prohibit stockholder action by written consent, requiring all stockholder actions be taken at a meeting of our stockholders, if Vestar ceases to own more than 40% of our common stock; |
| provide that the Board of Directors is expressly authorized to make, alter or repeal our amended and restated bylaws; |
| establish advance notice requirements for nominations for elections to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; |
| establish a classified Board of Directors, as a result of which our Board of Directors will be divided into three classes, with each class serving for staggered three-year terms, which prevents stockholders from electing an entirely new Board of Directors at an annual meeting; |
| limit the ability of stockholders to remove directors if Vestar ceases to own more than 40% of our common stock; |
33
| prohibit stockholders, other than Vestar for so long as it beneficially owns at least 40% of our common stock, from calling special meetings of stockholders; and |
| require the approval of holders of at least 75% of the outstanding shares of our voting common stock to amend our amended and restated certificate of incorporation and for stockholders to amend our amended and restated bylaws, in each case if Vestar ceases to own more than 40% of our common stock. |
These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of the Company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire. For a further discussion of these and other such anti-takeover provisions, see Description of Capital StockAnti-takeover Effects of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws.
Our amended and restated certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our amended and restated certificate of incorporation provides that, subject to limited exceptions, the Court of Chancery of the State of Delaware is the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii) any action asserting a claim against us arising pursuant to any provision of the General Corporation Law of the State of Delaware (the DGCL), our certificate of incorporation or our by-laws or (iv) any other action asserting a claim against us that is governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to the provisions of our certificate of incorporation described above. This choice of forum provision may limit a stockholders ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and employees. Alternatively, if a court were to find these provisions of our amended and restated certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business and financial condition.
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
34
credit facilities and the indenture governing our senior notes, 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 in this offering, 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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Some of the matters discussed in this prospectus 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. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict, potential or continue, the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.
The information in this prospectus is not a complete description of our business or the risks associated with our business. There can be no assurance that other factors will not affect the accuracy of these forward-looking statements or that our actual results will not differ materially from the results anticipated in such forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to, those factors or conditions described under Risk Factors in this prospectus as well as the following:
| reductions or changes in Medicaid or other funding or changes in budgetary priorities by federal, state and local governments; |
| substantial claims, litigation and governmental proceedings; |
| reductions in reimbursement rates, policies or payment practices by our payors; |
| an increase in labor costs or labor-related liability; |
| matters involving employees that expose us to potential liability; |
| our substantial amount of debt, our ability to meet our debt service obligations and our ability to incur additional debt; |
| our history of losses; |
| our ability to comply with requirements to maintain effective internal controls; |
| our ability to comply with complicated billing and collection rules and regulations; |
| failure to comply with reimbursement procedures and collect accounts receivable; |
| changes in economic conditions; |
| 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; |
| an increase in workers compensation related liability; |
| our ability to control labor costs, including healthcare costs imposed by the Patient Protection and Affordable Care Act; |
| our ability to attract and retain experienced personnel; |
| our ability to establish and maintain relationships with government agencies and advocacy groups; |
| negative publicity or changes in public perception of our services; |
| our ability to maintain our status as a licensed service provider in certain jurisdictions; |
| our ability to maintain, expand and renew existing services contracts and to obtain additional contracts or acquire new licenses; |
36
| our ability to successfully integrate acquired businesses; |
| our inability to successfully expand into adjacent markets; |
| government regulations, changes in government regulations and our ability to comply with such regulations; |
| increased competition; |
| decrease in popularity of home- and community-based human services among our targeted client populations and/or state and local governments; |
| our susceptibility to any reduction in budget appropriations for our services in Minnesota or any other adverse developments in that state; |
| our ability to operate our business due to constraints imposed by covenants in NMHIs senior credit agreement; |
| our ability to retain the continued services of certain members of our management team; |
| our ability to manage and integrate key administrative functions; |
| failure of our information systems or failure to upgrade our information systems when required; |
| write-offs of goodwill or other intangible assets; |
| natural disasters or public health catastrophes; and |
| potential exposure to liability in connection with our divestiture of ARY programs in five states. |
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 prospectus to conform such statements to actual results or to changes in our expectations.
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We will not receive any proceeds from the sale of our common stock by the selling stockholders.
MARKET PRICE OF OUR COMMON STOCK
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 since September 17, 2014:
High Sale Price |
Low Sale Price |
|||||||
Fiscal 2016 |
||||||||
First Quarter (through October 1, 2015) |
$ | 22.99 | $ | 22.24 | ||||
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 |
On September 25, 2015, there were 37,079,707 shares of our common stock outstanding, held by three stockholders of record, one of which was Cede & Co., which is the nominee of shares held through The Depository Trust Company. On October 1, 2015, the closing price of our common stock was $22.56.
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Prior to our initial public offering, during fiscal 2013 and 2014, we paid dividends of $39,000 and $110,000, respectively, to the LLC, to fund repurchases of equity units from employees upon or after their departures. We have paid no dividends on our common stock since the time of our initial public offering.
We currently intend to retain all available funds and any future earnings to fund the development and growth of our business, and therefore we do not anticipate paying any cash dividends in the foreseeable future. Additionally, our ability to pay dividends on our common stock will be limited by restrictions on the ability of our subsidiaries and us to pay dividends or make distributions under the terms of NMHIs 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 NMHIs 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.
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The following table sets forth our cash and cash equivalents and restricted cash and our capitalization as of June 30, 2015.
You should read the following table in conjunction with the sections entitled Use of Proceeds, Selected Historical Consolidated Financial Data, Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes included elsewhere in this prospectus.
June 30, 2015 | ||||
(in thousands) | ||||
Cash and cash equivalents: |
||||
Cash and cash equivalents |
$ | 16,665 | ||
Restricted cash: |
||||
Restricted cash (1) |
50,000 | |||
Debt: |
||||
Revolving Credit Facility |
| |||
Term Loan Facility (2) |
647,223 | |||
|
|
|||
Total long-term debt (3) |
647,223 | |||
|
|
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Stockholders Equity: |
||||
Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares outstanding |
| |||
Common stock, $0.01 par value, 350,000,000 shares authorized; 36,950,000 shares outstanding |
370 | |||
Additional paid-in-capital |
277,280 | |||
Accumulated gain on derivatives |
1,381 | |||
Accumulated deficit |
(158,967 | ) | ||
|
|
|||
Total stockholders equity |
120,064 | |||
|
|
|||
Total capitalization |
$ | 767,287 | ||
|
|
(1) | Represents cash deposited in a cash collateral account in support of the issuance of undrawn letters of credit. |
(2) | Excluding original issue discount, net of accumulated amortization of $1.5 million. |
(3) | Includes current portion but excludes obligations under capital leases of $6.2 million. |
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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
On June 24, 2015, we announced our decision to discontinue ARY services in the states of Florida, Indiana, Louisiana, North Carolina and Texas. On August 26, 2015, we entered into an asset purchase agreement to sell our ARY operations in the five states in exchange for a promissory note in the principal amount of $2.5 million that is due and payable on the first anniversary of the closing date. The pro forma effect of the divestiture of the ARY operations in the five states is reflected in the Unaudited Pro Forma Condensed Consolidated Financial Information. We assessed the disposal group under the guidance of ASU 2014-08, Discontinued Operations and Disclosures of Disposals of Components of an Entity and concluded that the planned divestiture does not represent a strategic shift, and therefore will not be classified as discontinued operations.
The following Unaudited Pro Forma Condensed Consolidated Financial Information were prepared in accordance with GAAP and pursuant to U.S. Securities and Exchange Commission Regulation S-X Article 11, and present the pro forma results of operations of the Company, based upon the historical information, after giving effect to the divestiture and related adjustments described in the Notes to the Unaudited Pro Forma Condensed Consolidated Financial Information. The Unaudited Pro Forma Condensed Consolidated Statements of Operations for the year ended September 30, 2014 and the nine months ended June 30, 2015 are presented as if the divestiture had occurred on October 1, 2013. The pro forma effect of the planned divestiture on the Condensed Consolidated Balance Sheet as of June 30, 2015 is immaterial; therefore, it has not been included in the following Unaudited Pro Forma Condensed Consolidated Financial Information.
The following Unaudited Pro Forma Condensed Consolidated Financial Information is presented for illustrative and informational purposes only and is not intended to represent or be indicative of the results of operations that would actually have been recorded if the divestiture of the ARY operations in Florida, Indiana, Louisiana, North Carolina and Texas had occurred during the periods presented. In addition, the Unaudited Pro Forma Condensed Consolidated Financial Information is not intended to represent our results of operations for any future date or period.
The unaudited pro forma financial information includes the adjustments deemed appropriate by the Companys management for the fair presentation of the divestiture. An explanation of the adjustments is set forth under the Notes to Unaudited Pro Forma Condensed Consolidated Financial Information.
The unaudited pro forma financial information should be read in conjunction with the Companys historical audited Consolidated Financial Statements for the years ended September 30, 2014, 2013 and 2012 and the unaudited Condensed Consolidated Financial Statements for the nine months ended June 30, 2015 and 2014 included elsewhere in this prospectus.
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Civitas Solutions, Inc
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Nine Months Ended June 30, 2015
($ in thousands except share and per share amounts)
Reported Nine Months Ended June 30, 2015 |
(a) Pro Forma Adjustments |
Pro Forma Nine Months Ended June 30, 2015 |
||||||||||
Net revenue |
$ | 1,015,764 | $ | 37,672 | $ | 978,092 | ||||||
Cost of revenue (exclusive of depreciation expense shown below) |
786,024 | 30,095 | 755,929 | |||||||||
Operating expenses: |
||||||||||||
General and administrative |
119,452 | 4,920 | 114,532 | |||||||||
Depreciation and amortization |
64,278 | 9,311 | (b) | 54,967 | ||||||||
|
|
|
|
|
|
|||||||
Total operating expenses |
183,730 | 14,231 | 169,499 | |||||||||
|
|
|
|
|
|
|||||||
Income (loss) from operations |
46,010 | (6,654 | ) | 52,664 | ||||||||
Other income (expense): |
||||||||||||
Management fee of related party |
(162 | ) | | (162 | ) | |||||||
Other income (expense), net |
(333 | ) | | (333 | ) | |||||||
Extinguishment of debt |
(17,058 | ) | | (17,058 | ) | |||||||
Interest expense |
(28,868 | ) | | (28,868 | ) | |||||||
|
|
|
|
|
|
|||||||
(Loss) income from continuing operations before income taxes |
(411 | ) | (6,654 | ) | 6,243 | |||||||
(Benefit) expense for income taxes |
(185 | ) | (2,995 | )(d) | 2,810 | |||||||
|
|
|
|
|
|
|||||||
(Loss) income from continuing operations |
$ | (226 | ) | (3,659 | ) | $ | 3,433 | |||||
|
|
|
|
|
|
|||||||
(Loss) income per common share, basic and diluted: |
||||||||||||
(Loss) income from continuing operations |
$ | (0.01 | ) | $ | 0.09 | |||||||
|
|
|
|
|||||||||
Weighted average number of common shares outstanding, basic and diluted |
36,950,000 | 37,046,897 |
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Civitas Solutions, Inc
Unaudited Pro Forma Condensed Consolidated Statement of Operations
Fiscal Year Ended September 30, 2014
($ in thousands except share and per share amounts)
Reported Fiscal Year Ended September 30, 2014 |
(c) Pro Forma Adjustments |
Pro Forma Fiscal Year Ended September 30, 2014 |
||||||||||
Net revenue |
$ | 1,255,838 | $ | 56,894 | $ | 1,198,944 | ||||||
Cost of revenue (exclusive of depreciation expense shown below) |
983,043 | 46,902 | 936,141 | |||||||||
Operating expenses: |
||||||||||||
General and administrative |
145,041 | 7,931 | 137,110 | |||||||||
Depreciation and amortization |
67,488 | 1,915 | 65,573 | |||||||||
|
|
|
|
|
|
|||||||
Total operating expenses |
212,529 | 9,846 | 202,683 | |||||||||
|
|
|
|
|
|
|||||||
Income from operations |
60,266 | 146 | 60,120 | |||||||||
Other income (expense): |
||||||||||||
Management fee of related party |
(9,488 | ) | | (9,488 | ) | |||||||
Other income (expense), net |
374 | | 374 | |||||||||
Extinguishment of debt |
(14,699 | ) | | (14,699 | ) | |||||||
Interest expense |
(69,349 | ) | | (69,349 | ) | |||||||
|
|
|
|
|
|
|||||||
(Loss) income from continuing operations before income taxes |
(32,896 | ) | 146 | (33,042 | ) | |||||||
(Benefit) expense for income taxes |
(11,463 | ) | 51 | (d) | (11,514 | ) | ||||||
|
|
|
|
|
|
|||||||
(Loss) income from continuing operations |
$ | (21,433 | ) | 95 | $ | (21,528 | ) | |||||
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|
|
|
|
|
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Loss per common share, basic and diluted: |
||||||||||||
Loss from continuing operations |
$ | (0.84 | ) | $ | (0.84 | ) | ||||||
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|
|
|
|||||||||
Weighted average number of common shares outstanding, basic and diluted |
25,538,493 | 25,538,493 |
43
Note to Unaudited Pro Forma Condensed Consolidated Financial Information
Pro Forma Adjustments
The following is a summary of the pro forma adjustments reflected in the Unaudited Pro Forma Condensed Consolidated Financial Information based on preliminary estimates, which may change as additional information is obtained:
(a) | Represents the elimination of the historical financial results of ARY operations in Florida, Indiana, Louisiana, North Carolina and Texas for the nine months ended June 30, 2015. |
(b) | Pro forma adjustment includes the intangible asset impairment charge of $8.2 million related to the planned divestiture of the ARY operations in Florida, Indiana, Louisiana, North Carolina and Texas that was recorded in the nine months ended June 30, 2015. |
(c) | Represents the elimination of historical financial results of ARY operations in Florida, Indiana, Louisiana, North Carolina and Texas for the fiscal year ended September 30, 2014. |
(d) | The tax effect of the pro forma adjustments was determined based on the Companys effective tax rate for each respective period presented. |
44
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following table sets forth our selected historical consolidated financial data as of September 30, 2013 and 2014 and for the years ended September 30, 2012, 2013 and 2014 and are derived from the audited historical consolidated financial statements of the Company and the related notes included elsewhere in this prospectus. The selected consolidated financial data as of September 30, 2010, 2011 and 2012 and for the years ended September 30, 2010 and 2011 are derived from the Companys audited consolidated financial statements not included in this prospectus, as adjusted for discontinued operations. All adjustments necessary for a fair presentation have been included. All such adjustments are considered to be of a normal recurring nature.
The statement of operations for each of the nine-month periods ended June 30, 2014 and June 30, 2015 and the balance sheet as of June 30, 2014 and June 30, 2015 set forth below are derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus and contain all adjustments, consisting of normal recurring adjustments, that management considers necessary for a fair presentation of our financial position and results of operations for the periods presented. Operating results for the nine-month periods are not necessarily indicative of results for a full financial year, or any other periods.
You should read the following data in conjunction with Capitalization, Unaudited Pro Forma Consolidated Financial Information, Managements Discussion and Analysis of Financial Condition and Results of Operations and our audited historical consolidated financial statements and the accompanying notes, included elsewhere in this prospectus, and other financial information included in this prospectus.
Fiscal Year Ended September 30, |
Nine Months Ended June 30, |
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2010 | 2011 | 2012 | 2013 | 2014 | 2014 | 2015 | ||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||
Statements of Operations Data: |
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Net revenue |
$ | 991,877 | $ | 1,048,949 | $ | 1,107,351 | $ | 1,182,509 | $ | 1,255,838 | $ | 928,547 | $ | 1,015,764 | ||||||||||||||
Cost of revenue (exclusive of depreciation expense shown separately below) |
761,112 | 811,765 | 861,691 | 921,618 | 983,043 | 725,754 | 786,024 | |||||||||||||||||||||
General and administrative expenses |
132,467 | 143,516 | 139,630 | 145,184 | 145,041 | 108,104 | 119,452 | |||||||||||||||||||||
Depreciation and amortization |
55,496 | 60,804 | 59,987 | 63,573 | 67,488 | 50,594 | 64,278 | |||||||||||||||||||||
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Income from operations |
42,802 | 32,864 | 46,043 | 52,134 | 60,266 | 44,095 | 46,010 | |||||||||||||||||||||
Management fee of related party |
(1,208 | ) | (1,271 | ) | (1,325 | ) | (1,359 | ) | (9,488 | ) | (1,041 | ) | (162 | ) | ||||||||||||||
Other income (expense), net |
(290 | ) | (97 | ) | 330 | 1,046 | 374 | 664 | (333 | ) | ||||||||||||||||||
Extinguishment of debt |
| (23,684 | ) | | | (14,699 | ) | (14,699 | ) | (17,058 | ) | |||||||||||||||||
Interest expense |
(62,233 | ) | (67,511 | ) | (79,445 | ) | (78,075 | ) | (69,349 | ) | (53,204 | ) | (28,868 | ) | ||||||||||||||
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|
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Loss from continuing operations before income taxes |
(20,929 | ) | (59,699 | ) | (34,397 | ) | (26,254 | ) | (32,896 | ) | (24,185 | ) | (411 | ) | ||||||||||||||
Benefit for income taxes |
(8,016 | ) | (19,884 | ) | (19,883 | ) | (9,942 | ) | (11,463 | ) | (7,243 | ) | (185 | ) | ||||||||||||||
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|
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Loss from continuing operations |
(12,913 | ) | (39,815 | ) | (14,514 | ) | (16,312 | ) | (21,433 | ) | (16,942 | ) | (226 | ) | ||||||||||||||
(Loss) gain from discontinued operations, net of tax (1) |
(4,362 | ) | (3,686 | ) | 245 | (1,984 | ) | (1,382 | ) | 67 | (966 | ) | ||||||||||||||||
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Net loss |
$ | (17,275 | ) | $ | (43,501 | ) | $ | (14,269 | ) | $ | (18,296 | ) | $ | (22,815 | ) | $ | (16,875 | ) | $ | (1,192 | ) | |||||||
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Net loss per common share, basic and diluted: |
||||||||||||||||||||||||||||
Loss from continuing operations |
$ | (0.51 | ) | $ | (1.58 | ) | $ | (0.57 | ) | $ | (0.65 | ) | $ | (0.84 | ) | $ | (0.67 | ) | $ | (0.01 | ) | |||||||
(Loss) gain from discontinued operations |
(0.17 | ) | (0.15 | ) | | (0.07 | ) | (0.05 | ) | | $ | (0.02 | ) | |||||||||||||||
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Net loss |
$ | (0.68 | ) | $ | (1.73 | ) | $ | (0.57 | ) | $ | (0.72 | ) | $ | (0.89 | ) | $ | (0.67 | ) | $ | (0.03 | ) | |||||||
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Weighted-average common shares outstanding, basic and diluted: |
25,250,000 | 25,250,000 | 25,250,000 | 25,250,000 | 25,538,493 | 25,250,000 | 36,950,000 | |||||||||||||||||||||
Balance Sheet Data (at end of period): |
||||||||||||||||||||||||||||
Cash and cash equivalents |
$ | 26,635 | $ | 387 | $ | 125 | $ | 19,440 | $ | 196,147 | $ | 47,526 | $ | 16,665 | ||||||||||||||
Working capital (2) |
44,848 | 12,634 | 26,192 | 59,262 | 49,555 | 66,085 | 54,755 | |||||||||||||||||||||
Total assets |
1,006,998 | 1,011,360 | 1,045,880 | 1,021,269 | 1,027,954 | 1,031,494 | 1,057,260 | |||||||||||||||||||||
Total debt (3) |
713,242 | 784,124 | 799,895 | 803,464 | 815,509 | 817,128 | 653,397 | |||||||||||||||||||||
Stockholders equity (deficit) |
28,377 | (16,917 | ) | (29,391 | ) | (46,515 | ) | 115,538 | (62,047 | ) | 120,064 |
45
(1) | During fiscal 2010, 2011, 2013, and 2014 we sold our home health business, closed certain Human Services operations in the states of Maryland, Colorado, Nebraska, New Hampshire, New York, Virginia and Connecticut, sold our Rhode Island ARY business and closed our Rhode Island I/DD business. All fiscal years presented reflect the classification of these businesses as discontinued operations. In April 2014, the FASB issued Accounting Standards Update No. 2014-08 which was adopted by the Company on October 1, 2014. Under the new standard, which is applied prospectively, similar closures will no longer be classified as discontinued operations. In June 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. |
(2) | Calculated as current assets minus current liabilities. |
(3) | Includes obligations under capital leases. |
46
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the historical consolidated financial statements and the related notes included elsewhere in this prospectus. 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 prospectus.
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 June 30, 2015, we operated in 35 states, serving approximately 12,400 clients in residential settings and more than 17,800 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 Companys 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
47
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.
The Distribution
On October 1, 2015, in connection with this offering, NMH Investment, LLC (the LLC) distributed all of its 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 LLCs limited liability company agreement and the management unitholders agreements. It is currently contemplated that the LLC will be dissolved following the completion of this offering and the winding up of the LLCs affairs.
Each holder of vested units of the LLC received shares of our common stock in the Distribution. The unvested Class F Units and the unvested Class H Units vested in connection with the Distribution and this offering which will result in the recognition of $0.2 million of expense and $10.3 million of expense, respectively. 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 as it only reflects a reallocation of economic value among Vestar and the management investors in the LLC.
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 more recently this population has stabilized and grown modestly. The decline 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 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. The decision will not affect other services provided by us in those states.
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
48
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 and 2014, pricing increases contributed to revenue growth. This positive trend has continued in fiscal year 2015.
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 continued 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 the new start operating income for such period. During the nine months ended June 30, 2015 and 2014, new starts generated operating losses of $3.9 million and $4.5 million, respectively, and operating income of $2.0 million and $1.5 million, respectively.
Acquisitions
From the beginning of fiscal 2009 through June 30, 2015, we have completed 50 acquisitions, including several acquisitions of rights to government contracts or 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 nine months ended June 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.
49
During the nine months ended June 30, 2014, we acquired six companies complementary to our business in the Human Services segment and one company in the SRS segment for total cash consideration of $16.6 million of which $1.5 million was paid in July 2014.
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 consolidated financial statements.
During the second quarter of fiscal 2015 we announced our decision 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 nine months ended June 30, 2015. We also recorded an impairment charge of $2.2 million for intangible assets owned by the business unit during the quarter ended March 31, 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. During the quarter ended June 30, 2015, we recorded an impairment charge of $8.2 million for intangible assets owned by the business units. On August 26, 2015, we entered into an asset purchase agreement to sell our ARY operations in Florida, Louisiana, Indiana, North Carolina and Texas in exchange for a promissory note in the principal amount of $2.5 million that is due and payable on the first anniversary of the closing date. This transaction, which is subject to regulatory approvals, is expected to be completed during the first quarter of fiscal 2016. Upon the completion of the sale, we expect to record a loss of approximately $2.7 million. There can be no assurance that we will complete this transaction. If we do not complete this transaction, we estimate that we could incur closure costs of up to $6.7 million, consisting of up to $1.9 million of severance costs and up to $4.8 million of lease termination costs.
In addition to the five states noted above where we plan to discontinue ARY services, we currently provide ARY services in eight states. We do not expect that services in these eight states will be impacted by the planned closures. For the nine months ended June 30, 2015, ARY gross revenues in these eight states increased by 4.6% over the comparable period in the prior year.
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 years ended September 30, 2014 and 2013, we derived 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 nine months ended June 30, 2015, we derived 89% of our net
50
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 nine months ended June 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. 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. |
51
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):
Nine Months Ended June 30, | Year Ended September 30, | |||||||||||||||||||
2015 (1) | 2014 (1) | 2014 (1) | 2013 (1) | 2012 (1) | ||||||||||||||||
I/DD Services |
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Gross Revenues |
$ | 668,883 | $ | 619,087 | $ | 839,127 | $ | 768,362 | $ | 719,180 | ||||||||||
Average Residential Census |
7,818 | 7,369 | 7,435 | 6,931 | 6,521 | |||||||||||||||
Average Daily Rate |
$ | 233.64 | $ | 228.16 | $ | 229.02 | $ | 222.53 | $ | 217.18 | ||||||||||
Non-Residential Billable Units |
9,342,956 | 8,543,140 | 11,608,274 | 11,131,686 | 8,810,339 | |||||||||||||||
Average Non-Residential Billable Unit Rate |
$ | 18.22 | $ | 18.74 | $ | 18.75 | $ | 18.46 | $ | 22.80 | ||||||||||
Gross Revenue Growth % |
8.0 | % | 9.2 | % | 6.8 | % | ||||||||||||||
Gross Revenue growth due to: |
||||||||||||||||||||
Volume Growth |
6.9 | % | 6.5 | % | 11.9 | % | ||||||||||||||
Average Rate Growth |
1.1 | % | 2.7 | % | (5.0 | )% | ||||||||||||||
At-Risk Youth Services |
||||||||||||||||||||
Gross Revenues |
$ | 147,772 | $ | 153,181 | $ | 203,353 | $ | 223,037 | $ | 214,405 | ||||||||||
Average Residential Census |
3,594 | 3,858 | 3,840 | 4,094 | 3,856 | |||||||||||||||
Average Daily Rate |
$ | 106.81 | $ | 100.47 | $ | 101.11 | $ | 96.78 | $ | 97.96 | ||||||||||
Non-residential Billable Units |
506,970 | 549,223 | 712,497 | 931,646 | 947,318 | |||||||||||||||
Average Non-Residential Billable Unit Rate |
$ | 84.78 | $ | 86.24 | $ | 86.51 | $ | 84.19 | $ | 80.39 | ||||||||||
Gross Revenue Growth % |
(3.5 | %) | (8.8 | )% | 4.0 | % | ||||||||||||||
Gross Revenue growth due to: |
||||||||||||||||||||
Volume Growth |
(7.1 | %) | (12.3 | )% | 3.4 | % | ||||||||||||||
Average Rate Growth |
3.6 | % | 3.5 | % | 0.6 | % | ||||||||||||||
Specialty Rehabilitation Services |
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Gross Revenues |
$ | 197,845 | $ | 172,256 | $ | 234,435 | $ | 213,465 | $ | 189,561 | ||||||||||
Average Residential Census |
1,166 | 1,053 | 1,065 | 996 | 916 | |||||||||||||||
Average Daily Rate |
$ | 608.74 | $ | 599.24 | $ | 603.22 | $ | 587.14 | $ | 565.50 | ||||||||||
Non-Residential Billable Units |
66,779 | | | | | |||||||||||||||
Average Non-Residential Billable Unit Rate |
$ | 62.17 | | | | | ||||||||||||||
Gross Revenue Growth % |
14.9 | % | 9.8 | % | 12.6 | % | ||||||||||||||
Gross Revenue growth due to: |
||||||||||||||||||||
Volume Growth |
13.1 | % | 6.9 | % | 8.7 | % | ||||||||||||||
Average Rate Growth |
1.8 | % | 2.9 | % | 3.9 | % |
(1) | During fiscal 2014 and 2015, the Company closed all Human Services operations in the State of Connecticut. All fiscal periods presented reflect the classification of these business as discontinued operations. |
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.
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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. Depreciation and amortization includes depreciation for fixed assets utilized in both facilities providing direct care and administrative offices, and amortization related to intangible assets.
Wages and benefits to our employees and per diem payments to our Mentors constitute the most significant operating cost in each of our operations. Most of our employee caregivers are paid on an hourly basis, with hours of work generally tied to client need. Our Mentors are paid on a per diem basis, but only if the Mentor is currently caring for a client. Our labor costs are generally influenced by levels of service, and these costs can vary in material respects across regions.
Occupancy costs represent a significant portion of our operating costs. As of June 30, 2015, we owned 373 facilities and three offices and we leased 1,526 facilities and 249 offices. We expect occupancy costs to increase during fiscal 2015 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%, 0.8%, 0.9%, 1.0% and 1.0% of our net revenue for the nine months ended June 30, 2015 and 2014 and the fiscal years ended September 30, 2014, 2013 and 2012, respectively. We incurred professional and general liability expenses of $7.7 million, $7.9 million, $10.9 million, $12.1 million and $10.7 million for the nine months ended June 30, 2015 and 2014 and the fiscal years ended September 30, 2014, 2013 and 2012, respectively.
Results of Operations
During the second quarter of fiscal 2015, we revised the presentation of our expenses and operating margin as a percentage of revenue. Accordingly, the calculations of our costs categories and operating margin as a percentage of revenue for the nine months ended June 30, 2015 and 2014 shown below are based on gross revenue rather than net, as disclosed prior to the second quarter of fiscal 2015. There has been no change to the expenses categories compared to prior periods.
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The following table sets forth our consolidated results of operations as a percentage of total gross revenues for the nine months ended June 30, 2015 and 2014 and as a percentage of net revenue for the fiscal year ended September 30, 2014, 2013 and 2012.
Nine Months Ended June 30, | Year Ended September 30, | |||||||||||||||||||
2015 | 2014 | 2014 | 2013 | 2012 | ||||||||||||||||
Gross revenue |
100.00 | % | 100.00 | % | ||||||||||||||||
Sales adjustments |
(1.2 | )% | (1.7 | )% | ||||||||||||||||
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Net revenues |
98.8 | % | 98.3 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
Cost of revenue (exclusive of depreciation and amortization expense shown below) |
76.4 | % | 76.8 | % | 78.3 | % | 77.9 | % | 77.8 | % | ||||||||||
Operating expenses: |
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General and administrative |
11.6 | % | 11.4 | % | 11.5 | % | 12.3 | % | 12.6 | % | ||||||||||
Depreciation and amortization |
6.2 | % | 5.4 | % | 5.4 | % | 5.4 | % | 5.4 | % | ||||||||||
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Total operating expense |
17.8 | % | 16.8 | % | 16.9 | % | 17.7 | % | 18.0 | % | ||||||||||
Income from operations |
4.6 | % | 4.7 | % | 4.8 | % | 4.4 | % | 4.2 | % | ||||||||||
Other income (expense): |
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Management fee of related party |
0.0 | % | (0.1 | )% | (0.8 | )% | (0.1 | )% | (0.1 | )% | ||||||||||
Other income (expense), net |
0.0 | % | 0.1 | % | 0.0 | % | 0.1 | % | 0.0 | % | ||||||||||
Extinguishment of debt |
(1.7 | )% | (1.6 | )% | (1.2 | )% | 0.0 | % | 0.0 | % | ||||||||||
Interest expense |
(2.9 | )% | (5.6 | )% | (5.5 | )% | (6.6 | )% | (7.2 | )% | ||||||||||
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Loss from continuing operations before income taxes |
0.0 | % | (2.5 | )% | (2.6 | )% | (2.2 | )% | (3.1 | )% | ||||||||||
Benefit for income taxes |
0.0 | % | (0.8 | )% | (0.9 | )% | (0.8 | )% | (1.8 | )% | ||||||||||
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Loss from continuing operations |
0.0 | % | (1.7 | )% | (1.7 | )% | (1.4 | )% | (1.3 | )% | ||||||||||
(Loss) gain from discounted operations, net of tax |
(0.1 | )% | 0.0 | % | (0.1 | )% | (0.2 | )% | 0.0 | % | ||||||||||
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Net loss |
(0.1 | )% | (1.7 | )% | (1.8 | %) | (1.5 | %) | (1.3 | %) | ||||||||||
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Nine Months Ended June 30, 2015 compared to Nine Months Ended June, 2014
The calculations of our cost categories and operating margin as a percentage of revenue for the nine months ended June 30, 2015 compared to the nine months ended June 30, 2014 are based on gross revenue.
Consolidated Overview
Nine Months Ended June 30, | Increase (Decrease) |
|||||||||||
2015 | 2014 | |||||||||||
Gross revenue |
$ | 1,028,498 | $ | 944,524 | $ | 83,974 | ||||||
Sales adjustments |
(12,734 | ) | (15,977 | ) | 3,243 | |||||||
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Net revenue |
1,015,764 | 928,547 | 87,217 | |||||||||
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Income from operations |
$ | 46,010 | $ | 44,095 | $ | 1,915 | ||||||
Operating margin |
4.5 | % | 4.7 | % | (0.2 | )% |
Consolidated gross revenue for the nine months ended June 30, 2015 increased by $84.0 million, or 8.9%, compared to gross revenue for the nine months ended June 30, 2014. Gross revenue increased $40.6 million from organic growth, including growth related to new programs, and $43.4 million from acquisitions that closed during and after the nine months ended June 30, 2014. Our Human Services segment contributed 59.0% of the organic revenue growth with the remaining 41.0% contributed by our SRS segment. Sales adjustments as a
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percentage of gross revenue decreased by 0.5% from 1.7% during the nine months ended June 30, 2014 to 1.2% during the nine months ended June 30, 2015. The decrease was the result of improvements in authorization management, claims processing, and collections.
Consolidated operating margin decreased from 4.7% of gross revenue, or $44.1 million, for the nine months ended June 30, 2014 to 4.5% of gross revenue, or $46.0 million, for the nine months ended June 30, 2015. The decrease in our operating margin was primarily due to intangible assets impairment charges of $10.4 million related to completed and planned divestitures of our ARY services in six states, a $3.7 million increase in stock-based compensation and increases in client occupancy costs due to increases in rent and higher levels of excess capacity within our Human Services segment. 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 revenue for the Human Services segment for the periods indicated (in thousands):
Nine Months Ended June 30, | Increase (Decrease) |
Percentage Increase (Decrease) |
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2015 | 2014 | |||||||||||||||
I/DD gross revenue |
$ | 668,883 | $ | 619,087 | $ | 49,796 | 8.0 | % | ||||||||
ARY gross revenue |
147,772 | 153,181 | (5,409 | ) | (3.5 | )% | ||||||||||
ADH gross revenue |
13,998 | | 13,998 | NM | ||||||||||||
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Total Human Services gross revenue |
830,653 | 772,268 | 58,385 | 7.6 | % | |||||||||||
Sales adjustments |
(10,541 | ) | (13,396 | ) | ||||||||||||
Sales adjustments as a percentage of gross revenue |
(1.3 | )% | (1.7 | )% | ||||||||||||
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Total Human Services net revenue |
$ | 820,112 | $ | 758,872 | $ | 61,240 | 8.1 | % | ||||||||
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Human Services gross revenue for the nine months ended June 30, 2015 increased by $58.4 million, or 7.6%, compared to the nine months ended June 30, 2014. The increase in gross revenue was driven by a $49.8 million increase in I/DD gross revenue while ARY gross revenue decreased by $5.4 million compared to the nine months ended June 30, 2014. Gross revenue for ADH, which was acquired in fiscal 2014, was $14.0 million.
The increase in I/DD gross revenue included $29.3 million from organic growth and $20.4 million from acquisitions that closed during and after the nine months ended June 30, 2014. The organic growth was the result of a 3.8% increase in volume coupled with a 1.0% increase in average billing rates for the nine months ended June 30, 2015 compared to the nine months ended June 30, 2014.
The $5.4 million decrease in ARY gross revenue was due to a 7.1% decrease in volume partially offset by a 3.6% increase in the average billing rate during the nine months ended June 30, 2015 compared to the nine months ended June 30, 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 $6.6 million in gross revenue partially offset by volume and average billing rate activity in other states.
Sales adjustments for the nine months ended June 30, 2015 decreased by $2.9 million compared to the nine months ended June 30, 2014. The decrease was the result of improvements in authorization management, claims processing, and collections.
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The following table sets forth revenue for the SRS segment for the periods indicated (in thousands):
Nine Months Ended June 30, | Increase (Decrease) |
Percentage Increase (Decrease) |
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2015 | 2014 | |||||||||||||||
SRS gross revenue |
$ | 197,845 | $ | 172,256 | $ | 25,589 | 14.9 | % | ||||||||
Sales adjustments |
(2,193 | ) | (2,581 | ) | ||||||||||||
Sales adjustments as a percentage of gross revenue |
(1.1 | )% | (1.5 | )% | ||||||||||||
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SRS net revenue |
$ | 195,652 | $ | 169,675 | $ | 25,977 | 15.3 | % | ||||||||
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The SRS segments gross revenue for the nine months ended June 30, 2015 increased by $25.6 million, or 14.9%, compared to the nine months ended June 30, 2014. The increase included $16.6 million from organic growth and $9.0 million from acquisitions that closed during and after the nine months ended June 30, 2014. The organic growth was driven by an increase in volume of 6.6% and an increase in the average billing rate of 3.2%. The increase in volume was primarily due to lower levels of excess capacity resulting from the maturation of programs started in recent years.
Cost of revenues by segment
The following table sets forth cost of revenues for the Human Services segment for the periods indicated (in thousands):
Nine Months Ended June 30, | ||||||||||||||||||||||||
2015 | 2014 | Change in % of gross revenue |
||||||||||||||||||||||
Amount | % of gross revenue |
Amount | % of gross revenue |
Increase (Decrease) |
||||||||||||||||||||
Direct labor costs |
$ | 525,706 | 63.3 | % | $ | 491,780 | 63.7 | % | $ | 33,926 | (0.4 | )% | ||||||||||||
Client program costs |
31,480 | 3.8 | % | 30,537 | 4.0 | % | 943 | (0.2 | )% | |||||||||||||||
Client occupancy costs |
47,497 | 5.7 | % | 40,591 | 5.3 | % | 6,906 | 0.4 | % | |||||||||||||||
Travel & transportation costs |
21,760 | 2.6 | % | 20,402 | 2.6 | % | 1,358 | | % | |||||||||||||||
Other direct costs |
17,786 | 2.1 | % | 16,499 | 2.1 | % | 1,287 | | % | |||||||||||||||
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Total cost of revenues |
$ | 644,229 | 77.5 | % | $ | 599,809 | 77.7 | % | $ | 44,420 | (0.2 | )% | ||||||||||||
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Human Services cost of revenues for the nine months ended June 30, 2015 decreased as a percentage of gross revenue by 0.2%, as compared to the nine months ended June 30, 2014. This was primarily due to a decrease in direct labor costs of 0.4% and client program costs of 0.2%, partially offset by an increase in client occupancy costs of 0.4%. The decrease in direct labor costs and client program 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.
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The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):
Nine Months Ended June 30, | ||||||||||||||||||||||||
2015 | 2014 | Change in % of gross revenue |
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Amount | % of gross revenue |
Amount | % of gross revenue |
Increase (Decrease) |
||||||||||||||||||||
Direct labor costs |
$ | 99,336 | 50.2 | % | $ | 88,754 | 51.5 | % | $ | 10,582 | (1.3 | )% | ||||||||||||
Client program costs |
13,886 | 7.0 | % | 12,575 | 7.3 | % | 1,311 | (0.3 | )% | |||||||||||||||
Client occupancy costs |
22,207 | 11.2 | % | 19,151 | 11.1 | % | 3,056 | 0.1 | % | |||||||||||||||
Travel and transportation costs |
2,494 | 1.3 | % | 2,271 | 1.3 | % | 223 | | % | |||||||||||||||
Other direct costs |
3,429 | 1.7 | % | 3,065 | 1.8 | % | 364 | (0.1 | )% | |||||||||||||||
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Total cost of revenues |
$ | 141,352 | 71.4 | % | $ | 125,816 | 73.0 | % | $ | 15,536 | (1.6 | )% | ||||||||||||
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SRS segments cost of revenues for the nine months ended June 30, 2015 decreased as a percentage of gross revenue by 1.6% as compared to the nine months ended June 30, 2014. This was primarily due to a decrease in direct labor costs of 1.3% and client program costs of 0.3%. The decrease in direct labor costs and client program 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):
Nine Months Ended June 30, | ||||||||||||||||||||||||
2015 | 2014 | Change in % of gross revenue |
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Amount | % of gross revenue |
Amount | % of gross revenue |
Increase (Decrease) |
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General and administrative |
$ | 119,452 | 11.6 | % | $ | 108,104 | 11.4 | % | $ | 11,348 | 0.2 | % | ||||||||||||
Depreciation and amortization |
64,278 | 6.2 | % | 50,594 | 5.4 | % | 13,684 | 0.8 | % | |||||||||||||||
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Total operating expense |
$ | 183,730 | 17.8 | % | $ | 158,698 | 16.8 | % | $ | 25,032 | 1.0 | % | ||||||||||||
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General and administrative expenses for the nine months ended June 30, 2015 increased by $11.3 million, or 10.5%, as compared to the nine months ended June 30, 2014. As a percentage of gross revenue, general and administrative expenses increased by 0.2% as compared to the nine months ended June 30, 2014. The increase as a percentage of gross revenue was primarily due to an increase of $3.7 million in stock based compensation expense and $2.5 million of expense associated with the payment of a long-term compensation plan, partially offset by the impact of leveraging certain general and administrative expenses.
Depreciation and amortization expense increased by $13.7 million, or 27.0%, during the nine months ended June 30, 2015. As a percentage of gross revenue, depreciation and amortization expense increased by 0.8% as compared to the nine months ended June 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 $0.9 million during the nine months ended June 30, 2015 as compared to the nine months ended June 30, 2014. The decrease is due to the termination of our management agreement with Vestar in connection with our initial public offering.
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Other income (expense), net: Other income (expense), 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 $0.7 million in the nine months ended June 30, 2014 to expense of $0.3 million in the nine months ended June 30, 2015.
Loss on extinguishment of debt: Extinguishment of debt was $17.1 million in the nine months ended June 30, 2015. On October 17, 2014 and March 4, 2015, the Company redeemed $162.0 million and $50.0 million in aggregate principal amount 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 related to the the senior notes of $11.7 million.
Interest expense: Interest expense decreased by $24.3 million during the nine months ended June 30, 2015 as compared to the nine months ended June 30, 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 the nine months ended June 30, 2015, our effective income tax rate was 45.0% compared to an effective tax rate of 29.9% for the nine months ended June 30, 2014. During the nine months ended June 30, 2015, our effective tax rate was higher than the federal statutory tax rate of 35.0% due to the impact of state income taxes and other non-deductible expenses.
Fiscal Year Ended September 30, 2014 compared to Fiscal Year Ended September 30, 2013
The calculations of our cost categories and operating margin as a percentage of revenue for the fiscal year ended September 30, 2014 compared to the fiscal year ended September 30, 2013 are based on net revenue.
Consolidated overview
Year ended September 30, | Increase (Decrease) |
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2014 | 2013 | |||||||||||
Gross revenue |
$ | 1,277,957 | $ | 1,204,864 | $ | 73,093 | ||||||
Sales adjustments |
(22,119 | ) | (22,355 | ) | $ | 236 | ||||||
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Net revenue |
$ | 1,255,838 | $ | 1,182,509 | $ | 73,329 | ||||||
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Income from operations |
$ | 60,266 | $ | 52,134 | $ | 8,132 | ||||||
Operating margin |
4.8 | % | 4.4 | % |
Consolidated gross revenue for the fiscal year ended September 30, 2014 (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 4.4% of net revenue, in fiscal 2013 to $60.3 million, or 4.8% of net revenue, in fiscal 2014. The increase in our operating margin was primarily due to the increase in revenue, as well as, expense leveraging and cost containment efforts in our direct labor costs and general administrative expenses. The improvement in operating margin was partially offset by the increase in
58
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 net revenue for the Human Services segment for the periods indicated (in thousands):
Year ended September 30, | Increase (Decrease) |
Percentage Increase (Decrease) |
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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 | )% | ||||||||||
ADH gross revenue |
1,042 | | 1,042 | NM | ||||||||||||
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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 | )% | ||||||||||||
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Total Human Services net revenue |
$ | 1,025,672 | $ | 974,088 | $ | 51,584 | 5.3 | % | ||||||||
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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 during fiscal 2014 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. The impact of this reduction accounted for approximately $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 net revenue for the SRS segment for the periods indicated (in thousands):
Year ended September 30, | Increase (Decrease) |
Percentage Increase (Decrease) |
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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 | )% | ||||||||||||
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SRS net revenue |
$ | 230,166 | $ | 208,421 | $ | 21,745 | 10.4 | % | ||||||||
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The SRS segments 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%.
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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 | Change in % of net revenue |
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Amount | % of net revenue |
Amount | % of net revenue |
Increase (Decrease) |
||||||||||||||||||||
Direct labor costs |
$ | 664,032 | 64.7 | % | $ | 632,456 | 64.9 | % | $ | 31,576 | (0.2 | )% | ||||||||||||
Client program costs |
42,133 | 4.1 | % | 39,722 | 4.1 | % | 2,411 | 0.0 | % | |||||||||||||||
Client occupancy costs |
55,025 | 5.4 | % | 50,411 | 5.2 | % | 4,614 | 0.2 | % | |||||||||||||||
Travel & transportation costs |
27,935 | 2.7 | % | 26,288 | 2.7 | % | 1,647 | 0.0 | % | |||||||||||||||
Other direct costs |
23,375 | 2.3 | % | 18,353 | 1.9 | % | 5,022 | 0.4 | % | |||||||||||||||
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Total cost of revenue |
$ | 812,500 | 79.2 | % | $ | 767,230 | 78.8 | % | $ | 45,270 | 0.4 | % | ||||||||||||
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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 net revenue was primarily due to expense leveraging. The increase in client occupancy costs as a percentage of net 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 of revenue as a percentage of net revenue was primarily due to an increase in workers compensation claims 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 | Change in % of net revenue |
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Amount | % of net revenue |
Amount | % of net revenue |
Increase (Decrease) |
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Direct labor costs |
$ | 119,397 | 51.9 | % | $ | 110,508 | 53.0 | % | $ | 8,889 | (1.1 | )% | ||||||||||||
Client program costs |
17,483 | 7.6 | % | 14,486 | 7.0 | % | 2,997 | 0.6 | % | |||||||||||||||
Client occupancy costs |
25,987 | 11.3 | % | 22,662 | 10.9 | % | 3,325 | 0.4 | % | |||||||||||||||
Travel & transportation costs |
3,134 | 1.4 | % | 2,635 | 1.3 | % | 499 | 0.1 | % | |||||||||||||||
Other direct costs |
4,480 | 1.9 | % | 3,144 | 1.5 | % | 1,336 | 0.4 | % | |||||||||||||||
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Total cost of revenue |
$ | 170,481 | 74.1 | % | $ | 153,435 | 73.7 | % | $ | 17,046 | 0.4 | % | ||||||||||||
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The SRS segments 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 net revenue was primarily due to expense leveraging. The increase in client program costs as a percentage of net revenue during fiscal 2014 was due to an increase in
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medical supply and pharmacy costs relating to the SRS segments client mix. The increase in client occupancy costs as a percentage of net 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, | Change in % of net revenue |
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2014 | 2013 | |||||||||||||||||||||||
Amount | % of net revenue |
Amount | % of net revenue |
Increase (Decrease) |
||||||||||||||||||||
General and administrative |
$ | 145,041 | 11.5 | % | $ | 145,184 | 12.3 | % | $ | (143 | ) | (0.8 | )% | |||||||||||
Depreciation and amortization |
67,488 | 5.4 | % | 63,573 | 5.4 | % | 3,915 | 0.0 | % | |||||||||||||||
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Total operating expense |
$ | 212,529 | 16.9 | % | $ | 208,757 | 17.7 | % | $ | 3,772 | (0.8 | )% | ||||||||||||
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General and administrative expenses for fiscal 2014 decreased by $0.1 million, or 0.1%, as compared to fiscal 2013. As a percentage of net revenue, general and administrative expenses decreased by 0.8% 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 net 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 Companys IPO, 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.
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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.
Fiscal Year Ended September 30, 2013 compared to Fiscal Year Ended September 30, 2012
The calculations of our cost categories and operating margin as a percentage of revenue for the fiscal year ended September 30, 2013 compared to the fiscal year ended September 30, 2012 are based on net revenue.
Consolidated overview
Year ended September 30, | Increase (Decrease) |
|||||||||||
2013 | 2012 | |||||||||||
Gross revenue |
$ | 1,204,864 | $ | 1,123,146 | $ | 81,718 | ||||||
Sales adjustments |
(22,355 | ) | (15,795 | ) | $ | (6,560 | ) | |||||
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Net revenue |
$ | 1,182,509 | $ | 1,107,351 | $ | 75,158 | ||||||
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Income from operations |
$ | 52,134 | $ | 46,043 | $ | 6,091 | ||||||
Operating margin |
4.4 | % | 4.2 | % |
Consolidated gross revenue for the fiscal year ended September 30, 2013 increased by $81.7 million, or 7.3%, compared to gross revenue for the fiscal year ended September 30, 2012. Sales adjustments as a percentage of gross revenue increased by 0.5% from 1.4% during fiscal 2012 to 1.9% during fiscal 2013. The increase in sales adjustments was primarily in our Human Services segment. Gross revenue increased $57.2 million from organic growth, including growth related to new programs, and $24.5 million from acquisitions that closed during and after fiscal 2012. The organic growth was partially offset by a reduction in revenue of $3.6 million from businesses we divested during fiscal 2013.
Consolidated income from operations increased from $46.0 million, or 4.2% of net revenue, in fiscal 2012 to $52.1 million, or 4.4% of net revenue, in fiscal 2013. The increase in our operating margin was primarily due to expense leveraging and cost containment efforts in our direct labor costs and general and administrative expenses. The improvement in operating margin was partially offset by an increase in other costs of revenues. Client occupancy expense increased by $10.4 million due to new programs and acquisitions that closed during and after fiscal 2012. Additionally, our health insurance expense and professional and general liability expense increased in fiscal 2013 as compared to fiscal 2012. Our health insurance expense increased approximately $3.0 million in fiscal 2013 compared to fiscal 2012, $2.4 million of which was included in cost of revenue. Professional and general liability expense increased by approximately $1.4 million in fiscal 2013 compared to fiscal 2012 due to an increase in our tail reserve for professional and general liability claims.
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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) |
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2013 | 2012 | |||||||||||||||
I/DD gross revenue |
$ | 768,362 | $ | 719,180 | $ | 49,182 | 6.8 | % | ||||||||
ARY gross revenue |
223,037 | 214,405 | 8,632 | 4.0 | % | |||||||||||
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Total Human Services gross revenue |
991,399 | 933,585 | 57,814 | 6.2 | % | |||||||||||
Sales adjustments |
(17,311 | ) | (11,700 | ) | ||||||||||||
Sales adjustments as a percentage of gross revenue |
(1.7 | )% | (1.3 | )% | ||||||||||||
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Total Human Services net revenue |
$ | 974,088 | $ | 921,885 | $ | 52,203 | 5.7 | % | ||||||||
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Human Services gross revenue for fiscal 2013 increased by $57.8 million, or 6.2%, compared to fiscal 2012. The increase was driven by a 6.8% increase in I/DD gross revenue and 4.0% increase in ARY gross revenue. The increase in I/DD gross revenue included $37.3 million from organic growth and $11.9 million from acquisitions that closed during and after fiscal 2012. The increase from organic growth was driven by an increase in volume of 10.7% offset by a decrease in average billing rate of 5.5% during fiscal 2013 compared to fiscal 2012. The organic growth was partially offset by a reduction in revenue of $3.6 million from businesses we divested during fiscal 2013. The increase of $8.6 million in ARY gross revenue was derived from organic growth which was driven by a 4.0% increase in volume during fiscal 2013 compared to fiscal 2012.
Sales adjustments increased by $5.6 million in fiscal 2013 compared to fiscal 2012. Sales adjustments as a percentage of gross revenue increased by 0.4% to 1.7% during fiscal 2013. The increase was primarily due to increases in sales adjustment allowances in our Florida, North Carolina and Pennsylvania business units for the potential write-off of outstanding aged receivables that are in dispute with certain payors.
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) |
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2013 | 2012 | |||||||||||||||
SRS gross revenue |
$ | 213,465 | $ | 189,561 | $ | 23,904 | 12.6 | % | ||||||||
Sales adjustments |
(5,044 | ) | (4,095 | ) | ||||||||||||
Sales adjustments as a percentage of gross revenue |
(2.4 | )% | (2.2 | )% | ||||||||||||
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SRS net revenue |
$ | 208,421 | $ | 185,466 | $ | 22,955 | 12.4 | % | ||||||||
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The SRS segments gross revenue for fiscal 2013 increased by $23.9 million, or 12.6%, compared to fiscal 2012. The increase in gross revenue included $11.0 million from organic growth and $12.9 million from acquisitions that closed during and after fiscal 2012. The organic growth was driven by an increase in volume of 2.1% and an increase in average billing rate of 3.7% during fiscal 2013 compared to fiscal 2012.
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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, | ||||||||||||||||||||||||
2013 | 2012 | Change in % of net revenue |
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Amount | % of net revenue |
Amount | % of net revenue |
Increase (Decrease) |
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Direct labor costs |
$ | 632,456 | 64.9 | % | $ | 601,867 | 65.3 | % | $ | 30,589 | (0.4 | )% | ||||||||||||
Client program costs |
39,722 | 4.1 | % | 38,658 | 4.2 | % | 1,064 | (0.1 | )% | |||||||||||||||
Client occupancy costs |
50,411 | 5.2 | % | 44,365 | 4.8 | % | 6,046 | 0.4 | % | |||||||||||||||
Travel & transportation costs |
26,288 | 2.7 | % | 25,841 | 2.8 | % | 447 | (0.1 | )% | |||||||||||||||
Other direct costs |
18,353 | 1.9 | % | 20,390 | 2.2 | % | (2,037 | ) | (0.3 | )% | ||||||||||||||
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Total cost of revenue |
$ | 767,230 | 78.8 | % | $ | 731,121 | 79.3 | % | $ | 36,109 | (0.5 | )% | ||||||||||||
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Human Services cost of revenue for fiscal 2013 increased by $36.1 million, or 4.9%, compared to fiscal 2012. This increase was driven by $30.6 million increase in direct labor costs and a $6.0 million increase in client occupancy costs and was offset by a $2.0 million decrease in other direct costs.
The increase in direct labor costs was primarily due to increased staffing in connection with new programs and acquisitions that closed during and after fiscal 2012. The decrease in direct labor costs as a percentage of net revenue during fiscal 2013 compared to fiscal 2012 was due to expense leveraging. The increases in client occupancy costs and in client occupancy costs as a percentage of net revenue were attributable to acquisitions and new programs with higher levels of open occupancy and increases in rent, utilities and repairs and maintenance expense related to our businesses. The decrease in other direct costs was primarily due to a reduction of $1.5 million in the cash bonus provided to our direct care workers in fiscal 2013 compared to fiscal 2012.
The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):
Year ended September 30, | Increase (Decrease) |
Change in % of net revenue |
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2013 | 2012 | |||||||||||||||||||||||
Amount | % of net revenue |
Amount | % of net revenue |
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Direct labor costs |
$ | 110,508 | 53.0 | % | $ | 93,412 | 50.4 | % | $ | 17,096 | 2.6 | % | ||||||||||||
Client program costs |
14,486 | 7.0 | % | 13,634 | 7.4 | % | 852 | (0.4 | )% | |||||||||||||||
Client occupancy costs |
22,662 | 10.9 | % | 18,291 | 9.9 | % | 4,371 | 1.0 | % | |||||||||||||||
Travel & transportation costs |
2,635 | 1.3 | % | 2,383 | 1.3 | % | 252 | 0.0 | % | |||||||||||||||
Other direct costs |
3,144 | 1.5 | % | 2,935 | 1.6 | % | 209 | (0.1 | )% | |||||||||||||||
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Total cost of revenue |
$ | 153,435 | 73.7 | % | $ | 130,655 | 70.6 | % | $ | 22,780 | 3.1 | % | ||||||||||||
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The SRS segments cost of revenue for fiscal 2013 increased by $22.8 million, or 17.4%, compared to fiscal 2012. This increase was driven by $17.1 million increase in direct labor costs, and a $4.4 million increase in client occupancy costs.
The increase in direct labor costs period to period and as a percentage of net revenue was primarily due to increased staffing in connection with new programs and acquisitions and due to additional staff to facilitate higher quality and service. The increase in client occupancy expense was primarily attributable to acquisitions that have closed during and after fiscal 2012, and new starts. Client occupancy costs have also been affected by increases in rent, utilities and repairs and maintenance expense related to our existing businesses.
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Consolidated operating expenses
General and administrative and depreciation and amortization expense were as follows (in thousands):
Year ended September 30, | Increase (Decrease) |
Change in % of net revenue |
||||||||||||||||||||||
2013 | 2012 | |||||||||||||||||||||||
Amount | % of net revenue |
Amount | % of net revenue |
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General and administrative |
$ | 145,184 | 12.3 | % | $ | 139,630 | 12.6 | % | $ | 5,554 | (0.3 | )% | ||||||||||||
Depreciation and amortization |
63,573 | 5.4 | % | 59,987 | 5.4 | % | 3,586 | 0.0 | % | |||||||||||||||
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Total operating expense |
$ | 208,757 | 17.7 | % | $ | 199,617 | 18.0 | % | $ | 9,140 | (0.3 | )% | ||||||||||||
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General and administrative expenses for fiscal 2013 increased by $5.6 million, or 4.0%, as compared to fiscal 2012 due to increases in professional service fees and administrative staffing costs. Additionally, we wrote off goodwill related underperforming programs within the Human Services segment which were closed in fiscal 2013. The total impairment charge for goodwill that was included in general and administrative expense was $1.3 million.
Depreciation and amortization expense for fiscal 2013 increased $3.6 million, or 6.0%, as compared to fiscal 2012 but remained consistent as a percent of net revenue at 5.4%. The increase in depreciation and amortization expense was primarily due to an increase in leasehold improvements to our properties and the acquisition of amortizable assets. Partially offsetting this increase was a decrease in depreciation and amortization expense as certain assets became fully depreciated. Additionally, we wrote off $1.0 million of intangible assets related to underperforming programs within the Human Services segment which were closed during fiscal 2013.
Non-operating (income) expense
Management fee of related party: Management fee has remained consistent during fiscal 2013 compared to fiscal 2012.
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, increased from $0.3 million in fiscal 2012 to $1.0 million in fiscal 2013.
Interest expense: Interest expense for fiscal 2013 decreased $1.4 million to $78.1 million as compared to fiscal 2012. The decrease is due to the lower interest rate we pay on our borrowings under the prior senior secured credit facilities as a result of the amendment to our prior senior credit agreement during fiscal 2013.
Benefit for income taxes
For fiscal 2013, our effective income tax rate was 37.9% compared to an effective tax rate of 57.8% for fiscal 2012. 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. In addition, our effective tax rate for fiscal 2012 was impacted by a $5.6 million reduction in our reserve for uncertain income tax positions, including interest and penalties, as a result of favorable settlement of an audit.
Loss from discontinued operations
Loss from discontinued operations net of taxes for fiscal 2013 was $2.0 million as compared to a gain of $0.2 million for fiscal 2012. During the second quarter of fiscal 2013, we adopted a plan to sell certain Human Services operations in the State of Rhode Island and completed the sale in the third quarter of fiscal 2013.
65
Additionally, we closed certain Human Services operations in the Commonwealth of Virginia during the second quarter of fiscal 2013. We recorded a total impairment charge of $4.1 million to write off the related intangible assets. 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.
Operating activities
Net cash provided by operating activities was $50.7 million for the nine months ended June 30, 2015, compared to $66.7 million for the nine months ended June 30, 2014. The decrease in cash provided by operating activities was primarily attributable to the net effect of changes in operating assets and liabilities including a reduction in Other accrued liabilities primarily resulting from a decrease in accrued compensation and an increase in Accounts receivable resulting from revenue growth and the effect of a more consistent average days sales outstanding compared to the nine months ended June 30, 2014.
Cash flows provided by operating activities were $83.9 million, $55.7 million and $29.3 million for fiscal 2014, 2013 and 2012, respectively. The increase in cash provided by operating activities in 2014 is primarily attributable to the management of working capital items. The increase in cash provided by operating activities in 2013 and 2014 is also attributable to the decrease in our days sales outstanding. Our days sales outstanding decreased from 47 days to 43 days at September 30, 2014 as compared to September 30, 2013 and from 52 days to 47 days at September 30, 2013 as compared to September 30, 2012. This is 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 $67.5 million and $39.7 million for the nine months ended June 30, 2015 and 2014, respectively. Cash paid for property and equipment for the nine months ended June 30, 2015 was $30.3 million, or 3.0% of net revenue, compared to $24.3 million, or 2.6% of net revenue, for the nine months ended June 30, 2014. During the nine months ended June 30, 2015 we paid $38.7 million for ten acquisitions. During the nine months ended June 30, 2014, we paid $15.2 million for seven acquisitions.
Net cash used in investing activities was $88.9 million, $39.4 million and $42.7 million for fiscal 2014, 2013 and 2012, respectively. Cash paid for acquisitions was $53.7 million, $9.3 million and $16.5 million for fiscal 2014, 2013 and 2012, respectively. We acquired eleven, three and seven companies in each of fiscal 2014, 2013 and 2012, respectively. Cash paid for property and equipment for fiscal 2014 was $35.3 million, or 2.8% of net revenue, compared to $31.9 million, or 2.7% of net revenue for fiscal 2013, and $30.0 million or 2.7% of net revenue for fiscal 2012. During fiscal 2012, we sold certain real estate assets for total cash proceeds of $2.8 million, which we subsequently leased back.
Financing activities
Net cash used in financing activities was $162.7 million for the nine months ended June 30, 2015 as compared to net cash provided by financing activities of $1.1 million for the nine months ended June 30, 2014. The increase in cash used by financing activities is due to the redemption of $212.0 million in aggregate principal amount of our senior notes during fiscal 2015, partially offset by the net proceeds received from the incremental term loan of $55.0 million.
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Net cash provided by financing activities was $181.7 million, $3.0 million and $13.1 million for fiscal years 2014, 2013 and 2012, respectively. The increase in cash provided by financing activities in fiscal 2014 is primarily due to the $182.2 million in proceeds as a result of the September 2014 IPO. On October 17, 2014, $172.1 million of these proceeds was used to repay principal and the associated call premium on the senior notes.
During the nine months ended June 30, 2015 and 2014, we borrowed an aggregate of $206.7 million and $9.3 million, respectively, under our senior revolver and repaid $206.7 million and $9.3 million, respectively, during the same periods. During fiscal 2014, we borrowed an aggregate of $9.3 million under our senior revolver and repaid $9.3 million during the same period. During fiscal 2013, we borrowed an aggregate of $469.4 million under our senior revolver and repaid $488.4 million during the same period. At June 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 June 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. If these refinancing transactions had occurred at the beginning of fiscal 2013, they would have reduced our interest expense by approximately $11.6 million, based on (i) a reduction in the applicable margin and LIBOR floor used to calculate interest rates under the senior secured credit facilities, partially offset by the increase in the principal amount outstanding under the term loan, and (ii) the elimination of interest expense on the $38.0 million principal amount of our senior notes that were redeemed. Assuming an effective tax rate of 40%, this reduction in interest expense would have reduced our fiscal 2013 net loss by approximately $7.0 million. See Note 9 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 to of $8.0 million and to redeem $162.0 million in aggregate principle 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, wholly-owned subsidiaries of Civitas, 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.
During fiscal 2014, 2013 and 2012, the LLC repurchased equity units from employees upon or after their departures from the Company for $110 thousand, $39 thousand and $75 thousand, respectively.
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.
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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 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, NMHI increased the revolving commitment under the senior revolver by $20.0 million, on terms identical to those applicable to the existing senior revolver. The aggregate amount of the revolving commitment under the senior revolver is now $120.0 million. 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 lenders 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 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 NMHIs 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. All of the other terms of the additional $55.0 million term loan are identical to the term loan facility.
As of June 30, 2015, NMHI had $647.2 million of borrowings outstanding under the term loan facility. The aggregate amount of the revolving commitment under the senior revolver as of June 30, 2015 was $120.0 million. At June 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 June 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 NMHIs 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 NMHIs 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 same-day 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.
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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. NMHI is 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, with the balance payable at maturity. The senior credit agreement permits NMHI 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.
Senior Notes
On October 17, 2014, NMHI redeemed $162.0 million in aggregate principal amount of the outstanding senior notes using proceeds of the Companys initial public offering at a redemption price of 106.25% plus accrued and unpaid interest thereon to, but not including, the date of redemption. As a result of this redemption, the Company expensed deferred financing fees of $0.8 million, original issue discount of $3.4 million, and the call premium of $10.1 million resulting in $14.3 million of expense reflected in extinguishment of debt in the statement of operations for the nine months ended June 30, 2015.
On March 4, 2015, NMHI paid $51.9 million to redeem the remaining $50.0 million in aggregate principal of senior notes plus accrued interest of $0.3 million using the net proceeds from the Incremental Amendment. In accordance with the provisions of the indenture governing the senior notes, the amount paid included an associated call premium of $1.6 million. As a result of this redemption, the Company expensed deferred financing fees of $0.2 million, original issue discount of $0.9 million, and the call premium of $1.6 million resulting in $2.7 million of expense reflected in extinguishment of debt in the statement of operations for the nine months ended June 30, 2015. As of June 30, 2015, NMHI had no senior notes outstanding.
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Covenants
The senior credit agreement contains negative financial and non-financial covenants, including, among other things, limitations on the ability of NMHI and its restricted subsidiaries 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. NMHI was in compliance with these covenants as of June 30, 2015.
The senior credit agreement contains a springing financial covenant. If, at the end of any fiscal quarter, NMHIs usage of the senior revolver exceeds 30% of the commitments thereunder, NMHI is 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 June 30, 2015 or September 30, 2014 as NMHIs usage of the senior revolver did not exceed the threshold for those quarters.
The senior credit agreement also contains a number of customary covenants that, among other things, restrict, subject to certain exceptions, NMHIs 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 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. NMHI was in compliance with these covenants as of June 30, 2015 and September 30, 2014. If NMHI withdraws any of the $50.0 million from the cash collateral account supporting the issuance of letters of credit, NMHI 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, 2014:
Total | Less Than 1 Year |
1-3 Years | 3-5 Years | More Than 5 Years |
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(In thousands) | ||||||||||||||||||||
Long-term debt obligations (1) |
$ | 1,011,136 | $ | 206,380 | $ | 80,997 | $ | 120,388 | $ | 603,371 | ||||||||||
Operating lease obligations (2) |
208,411 | 52,748 | 78,397 | 43,757 | 33,509 | |||||||||||||||
Capital lease obligations |
6,509 | 451 | 1,046 | 1,282 | 3,730 | |||||||||||||||
Purchase obligations (3) |
11,230 | 4,699 | 6,100 | 431 | | |||||||||||||||
Standby letters of credit |
44,287 | 44,287 | | | | |||||||||||||||
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Total obligations and commitments |
$ | 1,281,573 | $ | 308,565 | $ | 166,540 | $ | 165,858 | $ | 640,610 | ||||||||||
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(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, 2014. The maturity of the term loan principal and interest, which is due in quarterly installments through January 31, 2021, is subject to acceleration to November 15, 2017. The interest payments do not reflect the projected impact of interest rate swap agreements. See Note 9 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. |
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The following table summarizes our contractual obligations and commitments as of June 30, 2015:
Total | Less Than 1 Year |
1-3 Years | 3-5 Years | More Than 5 Years |
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(In thousands) | ||||||||||||||||||||
Long-term debt obligations (1) |
$ | 799,031 | $ | 34,414 | $ | 67,828 | $ | 66,771 | $ | 630,018 | ||||||||||
Operating lease obligations (2) |
245,906 | 57,786 | 89,306 | 49,763 | 49,051 | |||||||||||||||
Capital lease obligations |
6,175 | 485 | 1,127 | 1,388 | 3,175 | |||||||||||||||
Purchase obligations (3) |
8,179 | 4,733 | 3,338 | 108 | | |||||||||||||||
Standby letters of credit |
49,354 | 49,354 | | | | |||||||||||||||
Contingent consideration obligations (4) |
8,817 | 3,439 | 5,378 | | | |||||||||||||||
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Total obligations and commitments |
$ | 1,117,462 | $ | 150,211 | $ | 166,977 | $ | 118,030 | $ | 682,244 | ||||||||||
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(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 June 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 4 to our unaudited condensed 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 9 to our unaudited condensed 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.
During the nine months ended June 30, 2015, there has been no material change in our accounting policies or the underlying assumptions or methodology used to fairly present our financial position, results of operations and cash flows for the periods covered by this prospectus. In addition, no triggering events have come to our attention pursuant to our review of goodwill that would indicate impairment as of June 30, 2015.
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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:
| 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 2012, 2013 and 2014 and the nine months ended June 30, 2015, 40.8%, 40.4%, 32.7% and 30.5%, respectively, of our revenues were earned from contracts that fall into this category. |
| 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 2012, 2013 and 2014 and the nine months ended June 30, 2015, 39.6%, 40.1%, 46.5% and 49.5%, respectively, of our revenues were earned from contracts that fall into this category. |
| 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 2012, 2013 and 2014 and the nine months ended June 30, 2015, 10.1%, 10.7%, 11.7% and 11.5%, respectively, of our revenues were earned from contracts that fall into this category. |
| 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 2012, 2013 and 2014 and the nine months ended June 30, 2015, 9.5%, 8.8%, 9.1% and 8.5%, respectively, of our revenues were earned from contracts that fall into this category. |
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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 2012, 2013 and 2014 and the nine months ended June 30, 2015, liabilities to payors for cost based contracts were $5.4 million, $3.6 million, $3.7 million and $10.6 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, 2012, 2013 and 2014 and June 30, 2015, our sales adjustment allowance was $9.3 million, $12.5 million, $11.5 million and $11.4 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, 2012, 2013 and 2014 and June 30, 2015, our non-authorized sales allowance was $1.7 million, $1.8 million, $2.3 million and $3.2 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 aftertax 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
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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 units 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 2014, 2013 and 2012 and determined in each of those periods that the carrying value of goodwill and indefinite-lived assets was not impaired. In fiscal 2014, the fair value of each of our reporting units was in excess of its carrying value and passed with a substantial margin, except for one reporting unit, whose fair value exceeded the carrying value by approximately $13.2 million. For this reporting unit, we performed a sensitivity analysis on our significant assumptions and determined that none of (i) a 10% reduction in projected free cash flows, (ii) a 50 basis point increase in the weighted average cost of capital or (iii) a 50 basis point reduction in terminal growth rate, individually, which we determined to be reasonable, would impact our conclusions.
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
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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
The LLC 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 are limited liability company interests and are available for issuance to our employees and members of the Board of Directors for incentive purposes. Compensation expense is recorded for these awards based on the estimated fair value on the grant date. Compensation expense reflects 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, is recognized in expense on a straight-line basis over the requisite service periods of the awards. We use 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 will then be 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, the company recognized $0.6 million of expense in fiscal 2014. As of June 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.
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Each holder of vested units of the LLC received shares of our common stock in the Distribution. The unvested Class F Units and the unvested Class H Units vested in connection with the Distribution and this offering which will result in the recognition of $0.2 million of expense and $10.3 million of expense, respectively. 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 as it only reflects a reallocation of economic value among Vestar and the management investors in the LLC.
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 Companys 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.
On January 20, 2015, NMHI entered into two interest rate swap agreements in an aggregate notional amount of $375.0 million in order to reduce the variability of cash flows of our variable rate debt. We entered into these interest rate swaps to hedge the risk of changes in the floating rate of interest on borrowings under the term loan.
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Under the terms of the swaps, 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. The swap agreements expire on March 31, 2020.
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 BusinessLegal Proceedings for additional information.
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 June 30, 2015 would have increased cash interest expense on the floating rate debt by approximately $6.6 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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Company 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. 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, the current principal focus of our business is on the provision of services to individuals with intellectual and/or developmental disabilities, individuals with catastrophic injuries and illnesses, particularly acquired brain injury, youth with emotional, behavioral and/or medically complex challenges, or at-risk youth and elders. As of June 30, 2015, we operated in 35 states, serving approximately 12,400 clients in residential settings and more than 17,800 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.
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 clients home. As of June 30, 2015, our services were provided by over 22,000 full-time equivalent employees, as well as approximately 4,900 independently-contracted host home caregivers.
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The following table presents an overview of our two reportable segments:
Segment: |
Human Services |
Post-Acute Specialty Rehabilitation Services | ||||||
Populations Served: | I/DD: Individuals with intellectual and/or developmental disabilities | ARY: Youth with emotional, behavioral and/or medically complex challenges |
ADH: Elders in need of day health services to support their independence | ABI: Individuals who have sustained brain, spinal cord and other catastrophic injuries and illnesses | ||||
Core Services: | Residential support Day habilitation Vocational services Case management Crisis intervention Hourly support |
Therapeutic foster care Family preservation Adoption services Early intervention School-based services Juvenile offender programs |
Case management Nursing oversight Medication management Nutrition Daily living assistance Transportation Therapeutic services |
Neurorehabilitation Neurobehavioral rehabilitation Specialized nursing Physical, occupational and speech therapies Supported living Outpatient treatment Pre-vocational services | ||||
Payors / Referral Sources |
State governments County governments Managed care organizations |
State governments Managed care organizations |
Commercial insurers Workers compensation companies Veterans Health Administration Managed care organizations State governments County governments | |||||
Number of Individuals Served |
~17,000 | ~10,300(1) | ~1,400 | ~1,700 | ||||
Number of States | 22 | 13(1) | 1 | 26 | ||||
Market Size | $61.5 billion in 2013(2) | $28.2 billion in state fiscal year 2012(3) | $6.2 billion in 2010(4) | $10 billion spent annually(5) | ||||
Net Revenue (Fiscal 2014) |
$826.8 million (66% of total) |
$197.8 million (16% of total) |
$1.0 million (less than 1% of total)(6) | $230.2 million (18% of total) |
(1) | In June 2015, we decided to discontinue ARY services in the states of Florida, Indiana, Louisiana, North Carolina and Texas. The number of states presented in this table includes these five states. The number of individuals served presented in this table includes approximately 4,800 individuals in these five states to whom we currently provide ARY services and whom we plan to transition to the program of another provider. We expect the divestiture of ARY services in these five states to be complete during the first quarter of fiscal 2016. |
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(2) | Based on data from the Braddock Report. |
(3) | Based on data from Child Trends. |
(4) | Based on data from IBISWorld estimated for spending on ADH in 2010. |
(5) | Based on data from the CDC. |
(6) | Represents net revenue from September 8, 2014, the date we acquired Mass Adult Day Health Alliance, to September 30, 2014, our fiscal year end. |
For fiscal 2014 and the nine months ended June 30, 2015, we generated net revenue of $1,256 million and $1,016 million, respectively. Over the last three fiscal years ended September 30, 2014, we grew our annual revenue 20%, or $207 million, 65% of which was from organic growth and 35% of which was through acquisitions. In each of these years our revenue growth has accelerated, driven in large part by a rapid expansion in organic growth resulting from our investment in our de novo, or new start, programs. We believe that our new start investments, coupled with new opportunities to expand our services in existing and new markets, as well as our substantial acquisition pipeline, have positioned us for continued strong growth.
Our Industry
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:
| 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. |
| ABI. The market for post-acute care and rehabilitation for individuals with ABI, the largest of these populations, is approximately $10 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. |
| ARY. According to reports published by the organization Child Trends, an estimated $28.2 billion was spent in state 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. Furthermore, over the last decade state and local agencies have increasingly favored innovative solutions that provide at-risk youth and families with periodic support services to promote and preserve successful family environments. |
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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. |
Industry Trends
We believe we are well positioned to benefit from a number of favorable trends in our industry:
There are large and growing must-serve populations for our services
The markets we serve are growing as a result of changing demographics, shifts in public policy, consumer awareness and increased focus on cost-effectiveness.
There is an expanding population of individuals with I/DD eligible for residential and other support services. This growth has been driven by a number of factors, including the following:
| Longer lifespan. Increasingly, individuals with I/DD are living longer lives, with life expectancy climbing from 59 years in the 1970s to 66 years in 1993, the most recent year for which data is available. As these individuals increasingly live longer lives, they require additional care and in many cases outlive the ability to live independently or with family caregivers. |
| Aging caregivers. In 2013, approximately 71% of individuals with I/DD, or 3.5 million individuals, lived with family caregivers, including more than 863,000 with family caregivers aged 60 years or older. As these family caregivers age and become less capable of providing continuous care, we expect they will increasingly seek out-of-home or supported living arrangements, such as those we provide, for their relatives with disabilities. |
| Waiting lists. There is a significant unmet need for residential services for individuals with I/DD. Many states maintain waiting lists for individuals seeking placements for these services. Nationwide, as of 2012, there were an estimated 110,000 individuals with I/DD waiting for residential services, including approximately 77,000 on formal waiting lists in 31 states. There are legislative, advocacy and litigation efforts currently under way in many states to reduce waiting lists and provide additional access to residential services, which we believe will continue to drive additional demand for services such as those we provide. |
| De-institutionalization. As of 2013, there were approximately 73,600 individuals with I/DD residing in institutions with 16 or more beds, including nearly 25,000 in public institutions. At the federal and state levels, policy changes, legal decisions and cost containment efforts are driving a continuing trend of de-institutionalization for the treatment of individuals with disabilities and special needs. Several states are currently in the process of downsizing or closing I/DD institutions, including California, Georgia, New Jersey and Ohio. |
The market for ABI services is growing due to several factors, including:
| Advances in medical care. Advances in emergency care and medical technology are increasing the survival rate and extending the life span of those who suffer a catastrophic injury. This has served to both expand the overall population of these individuals and to place increased responsibility on payors and government agencies to seek cost-effective care. |
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| Increasing public awareness. Increases in public awareness of the causes and potential complications of brain injury are driving an increased focus on the diagnosis and proper treatment of these injuries. In particular, the conflicts in Afghanistan and Iraq, where traumatic brain injury has been one of the signature wounds for our military, as well as significant research and media coverage related to the incidence of brain injury in contact sports, especially professional football, have contributed to this increased awareness. As a result, emergency room visits for traumatic brain injury increased by approximately 30% from 2006 to 2010, an eight times increase compared with the growth in emergency room visits generally. |
| Increasing demand for specialized care. Patients, families and payors are increasingly seeking specialized care provided in ABI-specific community-based settings such as those that we offer. There are tens of thousands of individuals with brain injuries currently in nursing facilities. We believe many of these patients, particularly younger individuals, would be better served in community-based rehabilitative programs, as evidenced and supported by growing advocacy, changes in public policy and legal precedents supporting their transition to specialized care settings. |
| Increasing funding for community-based settings. Both the public and private sectors finance post-acute services for individuals with ABI. We believe that payors are increasingly seeking to serve patients in more cost-effective and appropriate community-based settings. For example, in recent years the increase in state ABI waiver programs that provide easier access to Medicaid funds has expanded the number of individuals who can afford ABI services. According to CMS, the compound annual growth rate of individuals with ABI eligible to receive Medicaid funds pursuant to 1915(c) waivers was 15.8% from 2006 to 2011. |
We believe the ARY population is growing, along with the demand for many of the services we offer. Specific trends impacting the ARY population include:
| Shifting demographics of children. An increasing number of children are living in poverty in the United States. According to the Childrens Defense Fund, the number of children living below the poverty line increased by approximately 3.1 million from 2000 to 2013, and 2.75 million more children were categorized as poor in 2012 than before the economic downturn began in 2007. In addition, the number of children in single-parent families increased from 22.7 million in 2008 to 24.7 million in 2012, or an increase of approximately 9%. We believe these children are more likely to require the residential and periodic services offered through our ARY segment as their caregivers face greater demands. |
| Stabilization of the foster care population. The number of children in foster care at the end of the federal fiscal year on September 30 reached a peak of approximately 567,000 in 1999 and declined to approximately 397,000 as of September 30, 2012. The decline in the population was driven by several factors causing a shift in care delivery, but more recently the population has stabilized and grown modestly, increasing to more than 415,000 on September 30, 2014. |
| Growing demand for periodic services. In an effort to prevent children and adolescents from requiring an out-of-home placement, public child welfare agencies have for several years been emphasizing periodic support services to strengthen families at-risk. |
The market for ADH services, which is a portion of the $75 billion elder services market, is growing based on a number of factors, including:
| Aging population. According to the Census Bureau, the population aged 65 and over is projected to reach 83.7 million by 2050, almost double the estimated population of 43.1 million in 2012. By 2030, elders will account for approximately 20% of the population, representing an increase from 2013 when elders accounted for 14% of the population. The increase in the elder population is largely attributed to the aging baby boomer generation. |
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| Increased life expectancy. The Census Bureau projects the average life expectancy for individuals born in 2050 will be 83.2 years, an increase of 4.7 years from individuals born in 2012. In addition, individuals 85 years of age in 2050 can expect to live for approximately another 7.7 years. |
| Growing need for services and supports. As the average life expectancy continues to rise, so does the number of individuals over 65 with two or more chronic diseases. The CDC reports that from 1999 to 2009, the percentage of adults over 64 years of age with two or more diagnoses of chronic disease increased from 37.2% to 45.3%. Chronic diseases, such as heart disease, emphysema, cancer, kidney disease and hypertension, can impair an individuals functional and cognitive abilities, thus impacting his or her ability to live independently. Non-residential Long-Term Services and Supports (LTSS), which include ADH services, serve as alternatives to restrictive and more costly settings such as nursing homes, and the demand for LTSS is expected to continue growing. |
Clients, caregivers and payors are increasingly recognizing the value of home- and community-based services
We believe home- and community-based services are strongly preferred by clients and their caregivers. The less restrictive settings provide greater control over care delivery, support patient quality of life and independence, and facilitate stronger bonds between those we serve and their caregivers. Additionally, consumers are becoming increasingly aware of the full spectrum of services available in the market, and we believe they will continue to demand the type of tailored and cost-effective community-based care we offer.
Furthermore, we believe that in our target markets, both public and non-public payors will increasingly emphasize and fund community-based services that offer comprehensive care across the continuum at a better relative value. We believe tailored solutions and ongoing support, such as the services we provide, offer better overall outcomes for the populations we serve. For most of our patient populations, our customized service plans cost less than care plans in large-scale institutional settings. Home- and community-based services are also preferred as a clinically appropriate and less expensive step-down alternative for individuals who no longer require care in more expensive acute care settings.
Funding for home- and community-based services is expanding
We believe funding for home- and community-based services is expanding for a variety of reasons, including the must-serve nature of our population, and legislation, legal precedents and advocacy efforts supporting the individuals we serve.
Human services, including services for the I/DD and ARY populations, are generally funded by government programs, predominantly Medicaid, while ABI services are funded by a mix of government programs and private insurance. These programs are often administered on a state-wide level and, in selected states, decisions regarding funding for individual clients and programs occur at the county level, resulting in a large and diverse payor base. State governments are financially incentivized to continue funding services in our core markets because states receive matching federal funds for state expenditures. As a result of these factors, our rates have remained stable, with some rate contraction in 2009 through 2011 following the economic downturn and modest expansion starting in 2012 and continuing through the third quarter of fiscal 2015. We believe improving state budgets resulting from a recovering economic environment will further drive growth in funding.
The individuals we serve are faced with significant challenges in everyday life, and require outside care and support to reach independence and successfully integrate within their communities. Funding for this support is established by legislation and legal precedents, and driven by strong advocacy groups. For example, funding for services in our I/DD segment is supported by the Olmstead decision by the U.S. Supreme Court in 1999, which held that, under the Americans with Disabilities Act of 1990 (ADA), state governments are required to support
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persons with I/DD in the least restrictive setting that is medically appropriate. The U.S. Department of Justice (DOJ) has significantly intensified Olmstead enforcement actions in recent years, most notably in a 2010 settlement with the state of Georgia under which the state agreed to a five-year plan to fund residential waiver services for 1,150 people with I/DD living in state institutions or waiting for residential services. For example, in 2011, the DOJ issued findings against Virginia for non-compliance with the ADA due to the number of people still living in the Central Virginia Training Center and other institutions. As a result, the state agreed to create developmental disabilities waivers for approximately 4,200 people who were on waitlists and people transitioning to the community over a ten year period. Prompted by the Olmstead decision, policy makers, civil rights lawyers, social workers and advocacy groups are driving states to offer individuals with I/DD and other disabilities the option to live and receive services in home- and community-based settings.
The health and human services markets we serve are highly fragmented, and we expect continued consolidation of the numerous local and regional providers who lack our scale and resources
The markets we serve are highly fragmented, with only a limited number of national providers of significant scale. For example, within the I/DD market the two leading national providers only account for less than 5% of services by revenue, with the remaining services provided primarily by smaller, local providers. We believe as payors and other stakeholders increasingly look to evidence-informed services and evidence-based outcomes, the demand will increase for more sophisticated reporting, quality, billing and clinical outcomes data, which require complex and robust administrative and IT systems. Small providers often lack the resources to implement and the scale to leverage these systems. We also believe that payors are increasingly seeking to contract with larger providers that can offer a more comprehensive suite of services across a continuum of care, deliver consistent quality of care and act quickly to establish new programs for populations in need of service. As a result of these trends, we believe our industry will continue to consolidate and larger, well-capitalized providers will be well positioned to benefit from this consolidation.
Competitive Strengths
We believe our scale, broad range of services, high-quality reputation and longstanding relationships with a diverse group of referral services and payors have made us the leading provider of home- and community-based health and human services in the markets we serve. The current healthcare environment that demands better access to high-quality care at a lower cost, improved patient experience and continuous clinical improvement and administrative efficiency aligns well with our competitive strengths.
The Leading Provider of Home- and Community-Based Health and Human Services in the United States
Since our founding in 1980, our company has evolved to become the largest provider of home- and community-based health and human services in the markets we serve. As of June 30, 2015, we provided services to approximately 12,400 clients in residential settings and more than 17,800 clients in non-residential settings across 35 states, which are home to approximately 84% of the U.S. population. Our national scale and breadth of service offerings provide us with significant competitive advantages:
| Responsiveness: Our scale enables us to deliver a broad range of highly customized services across a continuum of care with a greater level of responsiveness than many of our regional or local service competitors. We have the knowledge, financial resources and relationships to anticipate and rapidly respond to customer needs and market opportunities, positioning us well to capture new business. |
| Clinical Expertise: Given our extensive national network of clinicians and the wide variety of service models we use, we have developed a broad range of clinical expertise to address a range of disabilities and special needs. We leverage clinical best practices from across our network to expand into new markets and initiate new service lines and programs to address the needs of our payors, our clients and their caregivers. For example, to promote excellence in our ARY service line, we recently created a |
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Children and Family Services Center of Excellence composed of child welfare experts who are focused on enhancing training programs, supporting adherence to clinical models and measuring outcomes for all ARY programs. We believe our ability to serve individuals with the most complex physical and behavioral challenges distinguishes us from many of our competitors. |
| Infrastructure: Unlike smaller competitors that lack our scale and resources, we have developed a robust infrastructure, including functions such as quality assurance, compliance, risk management, information technology, human resources, billing and financial management, that we leverage across our care-delivery network. This infrastructure enables our operations to focus on efficiently delivering consistent, high-quality care and enables us to respond to the increasing compliance, regulatory and fiscal requirements of payors. |
Powerful Value Proposition
We believe we offer a powerful value proposition to our payors, our clients and their caregivers through our ability to design customized service plans to meet the unique needs of our clients in cost-effective settings. We specialize in adapting our service offerings to a wide range of intensities of care and other client requirements. Through our customized service plans we believe we are able to deliver better outcomes, more community integration and a better quality of life for the individuals we serve. We deliver our services in appropriate non-institutional settings, enabling us to provide significant cost savings for our payors while maintaining high quality standards.
Our recent strategic focus in California highlights the powerful value proposition we offer. Through the recent economic downturn, the state of California faced unprecedented fiscal distress, with a budget deficit at one point of approximately $42 billion. As a result, state and local payors were receptive to innovative care models to achieve cost savings. Over a four-year period from fiscal year 2010 to fiscal year 2014, we worked with state and local regulators to create innovative solutions, and despite the economic downturn, we were able to grow our net revenue in California at a compound annual growth rate of 8.5% during that period. Our strategic response was to:
| Aggressively market our Family Home Agency (FHA) host home model, which was underutilized in California. Payors have embraced this model, which allows individuals with I/DD to live with host home families at a significantly lower cost to payors. This effort increased FHA census by approximately 64% to 742 in the last five years. |
| Deploy a new model for adult residential care to accommodate the transition of individuals with I/DD and intensive medical needs from public institutions to community-based settings, resulting in substantial cost savings for our payors. |
| Significantly expand day and vocational programming. For example, we launched a new College to Career program aimed at helping young adults with developmental disabilities succeed in college and reducing their dependency on government services. |
Proven Ability to Make Acquisitions at Attractive Valuations
We believe our scale, in-depth industry knowledge, payor relationships, reputation for quality and operational expertise strategically position us as a preferred acquirer, with an ability to efficiently and opportunistically deploy capital. We are the only company with a national platform dedicated to serving each of the I/DD, ABI, ARY and ADH populations. This positions us as a prime exit option for small providers in these highly-fragmented markets. We believe we appeal to small providers looking to ensure their clients and businesses are well cared for following a sale.
We have completed 50 acquisitions at an aggregate purchase price of approximately $211.2 million from the beginning of fiscal 2009 through June 30, 2015. During the nine months ended June 30, 2015, we completed ten
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acquisitions with combined annual revenue of $38.5 million, based on revenues for the fiscal year immediately preceding the acquisition for nine of the acquisitions and an estimate of annualized revenues for one of the acquisitions. The majority of the acquisitions we make are small and of a tuck-in nature, although we have completed more transformative acquisitions, including REM, Inc. in 2003, CareMeridian, LLC in 2006 and Mass Adult Day Health Alliance in 2014. We have a demonstrated history of both in-market acquisitions and acquisitions that expand market segments.
Unique First Mover Advantage in SRS
Through our history of acquisitions and new starts, we now serve over 1,600 individuals in 26 states in our SRS segment. 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. Through our NeuroRestorative and CareMeridian business units, we offer solutions to SRS clients across the continuum of care, from post-acute care and neurorehabilitation to day treatment and supportive living services, that help individuals in their recovery and, in many cases, to regain independence. On this continuum of care, our CareMeridian business unit is focused on the more medically-intensive post-acute care services, including specialty rehabilitation and specialized nursing services, and our NeuroRestorative business unit is focused on rehabilitation and transitional living services, including neurorehabilitation, neurobehavioral, transitional living, supported living and outpatient services. Our experience in SRS enables us to deliver high-quality specialized care and offer significant cost savings for payors, leading to an expanding pipeline of referrals. Our quality of care and outcomes, along with limited competition of scale in the underserved SRS market, position us to capitalize on this opportunity and benefit from its rapid growth.
Stable Cash Flows Fund Growth Opportunities
Our highly-diverse group of payors and the must-serve populations we support have insulated our revenue streams from significant and widespread rate reductions. This, coupled with our modest capital expenditures and working capital needs, has helped us deliver stable cash flows through periods of economic recession and prosperity. We have utilized our stable cash flows to invest in new growth opportunities and fuel the expansion of our services.
Proven Management Team with a Track Record of Performance
Our management team, having served previously as policy makers, fiscal managers and service providers, has extensive public and private sector experience in health and human services. Our management team has a history of identifying market opportunities and providing creative solutions to states and payors, as demonstrated by the continued growth of I/DD services and identification of the growth opportunity in our ABI services. Our executive officers have been with us for an average of 15 years and average approximately 24 years in the human services industry. Our management team has demonstrated the ability and experience to ensure the delivery of high quality services to clients, pursue and integrate numerous acquisitions, manage critical human resources, develop and maintain robust IT and financial systems, mitigate risk in the business and oversee our significant growth and expansion.
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 recent organic growth initiatives and leverage our core competencies to further expand our presence in markets we currently serve and to further
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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 and create stockholder value. 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 June 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 $70.7 million and $16.5 million, respectively, in fiscal 2014. 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 dramatically 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 $7.5 million in fiscal 2013 and fiscal 2014. We intend to continue to aggressively pursue new start opportunities with attractive rates of return.
Expand our SRS Platform
We intend to leverage our unique 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 2009, achieving a 19% compound annual growth rate in net revenue over that period. Furthermore, our SRS business is funded by a highly attractive payor mix, with 53% of net revenues in fiscal 2014 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. We believe our reputation and credibility in existing markets and service lines will facilitate our entry into adjacent markets, particularly the $6.2 billion market for ADH services, 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. We may also explore strategic
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acquisitions to enhance our ability to pursue adjacent markets. We intend to leverage our core competencies and relationships with state agencies to pursue opportunities in adjacent markets, including potentially those serving youth with autism and individuals with mental health issues, and the market we recently entered serving elders. In the future, we may explore additional opportunities to leverage our periodic, day and residential services 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 workers departure. The length of stay of our clients varies widely based on their individual needs. For instance, in our SRS segment, a clients 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 individuals 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 fiscal 2014 and 2013, 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 45% and 46% of our revenue, respectively. Revenue from our contracts with state and local governmental payors in the State of Minnesota, our largest state, accounted for 14% of our revenue in each of fiscal 2014 and 2013.
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,
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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 strict quality standards. While all host home providers can provide services independently and with minimal oversight, they have access to emergency telephone triage and on-site crisis intervention, when necessary. Host home providers also avail themselves of support groups, whether independent or offered at the program office.
Employees and Independent Contractors
As of June 30, 2015, we had approximately 22,000 full-time equivalent employees and approximately 4,900 independent contractors. Although our employees are generally not unionized, we have one business in New Jersey with approximately 24 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 have successfully positioned ourselves to anticipate and meet the needs of our public partners.
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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 only 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.
Properties
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 June 30, 2015, we owned 373 facilities and leased 1,526 facilities. We also provided services in homes owned by our Mentors. We also own three offices and lease 249 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.
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
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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 individuals 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
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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 (FFP). 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-IDD 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-IDD, 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 childrens services are largely governed by individual state regulations which vary both in terms and regulatory content. Failure to comply with any states 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.
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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 governments 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
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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 expect to pay a modest penalty and additional fees in the 2016 calendar year and have included the estimated amount of such penalty and fees in our budget.
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.
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A Compliance Officer (vice president level position) oversees our compliance program and reports to our Chief Legal Officer, a management compliance committee, the boards quality and risk management committee and the boards 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.
Legal Proceedings
We are in the health and human services business and, therefore, we have been and continue to be subject to substantial claims alleging that we, our employees or our Mentors failed to provide proper care for a client. We are also subject to claims by our clients, our employees, our Mentors or community members against us for negligence, intentional misconduct or violation of applicable laws. Included in our recent claims are claims alleging personal injury, assault, 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.
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The following table sets forth the name, age and position of each of our directors and executive officers as of October 1, 2015:
Name |
Age | Position | ||||
Edward M. Murphy (1) |
68 | Executive Chair and Director | ||||
Bruce F. Nardella |
58 | President, Chief Executive Officer and Director | ||||
Denis M. Holler |
61 | Chief Financial Officer | ||||
Neil D. Brendmoen |
58 | Hastings Operating Group President | ||||
Jeffrey M. Cohen |
47 | Chief Information Officer | ||||
Linda De Renzo |
55 | Chief Legal Officer, General Counsel and Secretary | ||||
Kathleen P. Federico |
56 | Chief Human Resources Officer | ||||
Gerald J. Morrissey, Jr. |
62 | Chief Quality Officer | ||||
Robert M. Melia |
59 | Chief Business Development Officer | ||||
David M. Petersen |
67 | Redwood Operating Group President | ||||
Dwight D. Robson |
44 | Chief Public Strategy and Marketing Officer | ||||
Chris A. Durbin |
50 | Director | ||||
James L. Elrod, Jr. |
60 | Director | ||||
Patrick M. Gray |
66 | Director | ||||
Pamela F. Lenehan |
63 | Director | ||||
Kevin A. Mundt |
61 | Director | ||||
Gregory S. Roth |
58 | Director | ||||
Guy Sansone |
50 | Director | ||||
Mary Ann Tocio |
67 | Director |
(1) | Mr. Murphy has informed our Board of Directors that he intends to retire from employment with us on December 31, 2015 and that he will not stand for re-election as a director at our 2016 annual meeting of stockholders. |
Directors are elected at the annual meeting of our sole stockholder and hold office until the next annual meeting or a special meeting in lieu thereof, and until their successors are elected and qualified, or upon their earlier resignation or removal. There are no family relationships between any of the directors and executive officers listed in the table. There are no arrangements or understandings between any executive officer and any other person pursuant to which he or she was selected as an officer.
Edward M. Murphy has served as Executive Chair of the Board of Directors since January 2014 and as Director since September 2004. Mr. Murphy served as Chief Executive Officer from January 2005 until December 2013. He also served as our President from September 2004 until December 2009. Mr. Murphy founded Alliance Health and Human Services, Inc. (Alliance) in 1999 and served as the organizations President and CEO until September 2004. Prior to founding Alliance, he was a Senior Vice President at Tucker Anthony and President and Chief Operating Officer of Olympus Healthcare Group. Mr. Murphy is a former Commissioner of the Massachusetts Department of Youth Services and the Massachusetts Department of Mental Health, and the former Executive Director of the Massachusetts Health and Educational Facilities Authority. Mr. Murphy earned an A.B. from Boston College, and an M.A. and Ph.D in Communications from the University of Massachusetts at Amherst. On August 14, 2015, Mr. Murphy informed our Board of Directors that he intends to retire from employment with us on December 31, 2015 and that he will not stand for re-election as a director at our 2016 annual meeting of stockholders.
Bruce F. Nardella has served as Chief Executive Officer and Director since January 2014 and has served as President since December 2009. Mr. Nardella was our President and Chief Operating Officer from December 2009 to December 2013, as well as our Executive Vice President and Chief Operating Officer from May 2007 to December 2009. Mr. Nardella joined the Company in 1996 as a state director and in May 2003 he was named
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President of our Eastern Division. Prior to that, he was a deputy commissioner for the Massachusetts Department of Youth Services. Mr. Nardella earned an A.B. from Colgate University, an M.A. in Education from Boston University and an M.P.A. from the Kennedy School of Government at Harvard University.
Denis M. Holler was appointed Chief Financial Officer in May 2007 and served as Treasurer from May 2007 through February 2015. Mr. Holler joined the Company in 2000 and was named Senior Vice President of Finance in January 2002. He has led the Companys finance function since our acquisition by Vestar in 2006. In addition to overseeing all financial operations, he manages external relationships with our equity sponsor, investment banking and banking partners, high-yield investors and, most recently, in September 2014, our initial public offering. Prior to joining the Company in October 2000 as Vice President of Financial Operations, Mr. Holler was Chief Financial Officer of the Fortress Corporation. Mr. Holler earned a B.A. from Fordham University, an M.S. in Accounting and an M.B.A. from Northeastern University.
Neil D. Brendmoen was named Hastings Operating Group President in July 2014, where he oversees all human services operations in Alabama, Delaware, Florida, Georgia, Louisiana, Maryland, Massachusetts, Mississippi, Missouri, New Jersey, North Carolina, South Carolina and Texas and services for at-risk youth in Indiana, Illinois, Ohio and Pennsylvania. Mr. Brendmoen began his human services career in 1979 as a direct care worker in a state institution for individuals with developmental disabilities. Mr. Brendmoen joined REM Minnesota in 1980 as a Program Director before being appointed as Executive Director and Vice President of Operations for the Redwood Operating Groups eastern region. Mr. Brendmoen earned a B.A. from Southwest State University.
Jeffrey M. Cohen joined the Company as its Chief Information Officer in November 2011. From 2008 until joining the Company, Mr. Cohen served as Vice President of Information Technology for Magellan Biosciences, a private equity backed medical device company, where he oversaw the strategic transformation of its worldwide IT and communications systems. Prior to that, Mr. Cohen was Director of Information Technology at Biogen Idec, where he was responsible for its ERP, SOX program and ancillary systems for finance, human resources, legal and business development. He started his career at Cambridge Technology Partners, in various consulting roles culminating as a Vice President for its eBusiness practice. Mr. Cohen earned a B.S. from Cornell University and an M.B.A. from the Wharton School at the University of Pennsylvania.
Linda De Renzo was named our Chief Legal Officer in March 2011, and has served as our General Counsel and Secretary since March 2006. Ms. De Renzo oversees the corporate, litigation and risk management, regulatory, compliance and labor and employment legal functions. Prior to joining the Company, Ms. De Renzo was a partner at Testa, Hurwitz & Thibeault, LLP in Boston from 1992 to 2004 and was an associate with the firm from 1986 to 1992. Ms. De Renzo represented high-growth companies and their financiers in a variety of industries including information technology, life sciences and health services. She also represented both issuers and underwriters in public offerings. She has an advanced professional director certification from the American College of Corporate Directors, a national public company director education organization. Ms. De Renzo earned an A.B. from Dartmouth College and a J.D. from Harvard Law School.
Kathleen P. Federico joined the Company in December 2008 as our Senior Vice President, Human Resources, and was named our Chief Human Resources Officer in March 2011. From 2005 until joining the Company, Ms. Federico served as Senior Vice President, Sales and Human Resources, for World Travel Holdings in Woburn, Massachusetts, and was its Senior Vice President, Human Resources, from 2002 to 2005. Prior to that, she served as Vice President of Human Resources for KaBloom LLC, NE Restaurant Company and Sodexho Marriott Services. Ms. Federico was also Chief Operating Officer for Sheehan Associates, an employee benefits brokerage firm. Ms. Federico earned a B.A. from Merrimack College.
Gerald J. Morrissey, Jr. was named Chief Quality Officer in July 2014. Mr. Morrissey joined the Company in 2007 as Director, Operations and became Senior Director, Program Services later that year. In 2008, Mr. Morrissey became Vice President of Quality Assurance and Service Development. Prior to joining the
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Company, Mr. Morrissey devoted more than thirty years of his career to the Commonwealth of Massachusetts, having served for four years as Assistant Secretary for Disabilities and Community Services and more than a decade as the Commissioner of the Department of Developmental Services. Mr. Morrissey formerly served as President and Board Member of the National Association of State Directors of Developmental Disabilities Services. Mr. Morrissey earned a B.A. from the University of Massachusetts at Amherst, an M.Ed. from Antioch University, and an M.P.A. from the Kennedy School of Government at Harvard University.
Robert M. Melia was named Chief Business Development Officer in July 2014. Mr. Melia joined the Company in 2007, serving first as the head of the affiliated employment services business and then as Senior Vice President, Mergers & Acquisitions, before assuming the role of Cambridge Operating Group President in 2011, which included oversight of human services operations in seventeen states. Prior to joining the Company, Mr. Melia served as President of the Workforce Services Division at MAXIMUS and spent 12 years in a variety of positions at Massachusetts state agencies. Mr. Melia earned a B.A. from the University of Massachusetts and an M.A. in Management of Human Services from the Florence Heller School at Brandeis University.
David M. Petersen served as our Redwood Operating Group President since June 2007. He had been serving as Senior Vice President and President of our Central Division since May 2003. Prior to joining the Company, Mr. Petersen worked for REM beginning in 1972, managing various operations in Minnesota, Montana, North Dakota and Wisconsin. Mr. Petersen earned a B.S. and M.A. in Fine Arts from St. Cloud State University.
Dwight D. Robson was named Chief Public Strategy and Marketing Officer in March 2011 after serving as Vice President of Public Strategy since joining the Company in 2003. He leads the work of the Public Strategy Group, which is responsible for developing and implementing the Companys agenda with respect to communications, investor relations, marketing and proposal development, and government and community affairs. Mr. Robsons experience prior to joining the Company includes senior policy and management positions in Massachusetts state government, most recently as Assistant State Treasurer. Mr. Robson earned a B.A. from the University of Massachusetts.
Chris A. Durbin was elected to our board of directors in December 2010. He is a Managing Director in the Vestar Resources group of Vestar Capital Partners. Before joining Vestar in 2007, Mr. Durbin was Managing Director of Strategy and Business Development in Bank of Americas Global Wealth and Investment Management business from 2001 to 2007. Prior to this, he worked at Mercer Management Consulting and Corporate Decisions, Inc., where he designed and implemented growth strategies for clients including several Vestar portfolio companies. Mr. Durbin is currently a director of and serves on the Audit Committee for Triton Container International Limited. He also serves as Director of International Asset Systems (IAS). Mr. Durbin was selected as a director for his knowledge and experience in strategy and operations. Mr. Durbin earned a B.B.A. from the University of Notre Dame and an M.B.A. from Northwestern Universitys J.L. Kellogg School of Management.
James L. Elrod, Jr. joined our board of directors in June 2006. Mr. Elrod is a Managing Director of Vestar Capital Partners, having joined Vestar in 1998. Previously, he was Executive Vice President, Finance and Operations, for Physicians Health Service, a public managed care company. Prior to that, he was a Managing Director and Partner of Dillon, Read & Co. Inc. Mr. Elrod is currently a director of 21st Century Oncology (formerly known as Radiation Therapy Services, Inc.). Mr. Elrod was selected as a director for his knowledge and experience in finance and the health care industry. Mr. Elrod earned an A.B. from Colgate University and an M.B.A. from Harvard Business School.
Patrick M. Gray was named a director upon the completion of the Companys initial public offering in September 2014. Mr. Gray brings extensive experience in accounting and financial reporting to our board of directors, having spent over 37 years with PricewaterhouseCoopers LLP (PwC) until his retirement in 2009. He is a Certified Public Accountant who spent 25 years as an Audit Partner serving clients ranging from Fortune 500
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companies and multi-national companies to rapid-growth companies pursuing an initial public offering. At the time of his retirement, he served as the lead partner for the PwC U.S. firm Corporate Governance Group. Mr. Gray is currently a member of the board of Sancilio & Company, a privately-held, research-based biopharmaceutical company, where he has served in such capacity since 2012. Mr. Gray also serves on the Board of Datto, Inc., a private company which provides backup, disaster recovery and business continuity services. Mr. Gray was selected as a director for his knowledge and experience in accounting and finance. Mr. Gray is a certified public accountant and holds an Executive Masters Professional Director Certificate from the American College of Corporate Directors. He earned a B.S. from the Wharton School at the University of Pennsylvania.
Pamela F. Lenehan was elected to our board of directors in December 2008. Ms. Lenehan has served as President of Ridge Hill Consulting, a strategy consulting firm, since 2002. Prior to this, Ms. Lenehan was self-employed as a private investor. From 2000 to 2001, she was vice president and chief financial officer of Convergent Networks. From 1995 to 2000, she was senior vice president of corporate development and treasurer of Oak Industries Inc., which was acquired by Corning Inc. in 2000. Prior to that, Ms. Lenehan was a Managing Director in Credit Suisse First Bostons Investment Banking division and a vice president of Corporate Banking at Chase Manhattan Bank. Ms. Lenehan is currently a member of the boards of directors of Monotype Imaging Holdings Inc., where she is a member of the Audit Committee and chair of the Management Development and Compensation Committee, and American Superconductor Corporation where she chairs the Audit Committee. From 2004 to 2013, she was a member of the board of directors of Spartech Corporation until it was acquired by PolyOne and from 2001 to 2007 she was a member of the board of directors of Avid Technology. Ms. Lenehan was selected as a director for her knowledge and experience in finance and strategy and holds an Executive Masters Professional Director Certificate from the American College of Corporate Directors. Ms. Lenehan earned a B.A. and an M.A. in Economics from Brown University.
Kevin A. Mundt joined our board of directors in March 2008. He is a Managing Director at Vestar Capital Partners, and is President of the Vestar Resources group. Before joining Vestar in 2004, Mr. Mundt spent 23 years as a strategy and operations consultant specializing in consumer products, retailing and multi-point distribution, as well as healthcare and industrial marketing. For eleven of those years, Mr. Mundt was a strategic adviser to Vestar, and served on the boards of several Vestar portfolio companies. He began his consulting career at Bain and Company, and went on from there to co-found Corporate Decisions, Inc. When that firm was acquired by Marsh and McLennan, Mr. Mundt became a Managing Director of Marsh and McLennans financial consulting arm, Mercer Oliver Wyman. Mr. Mundt is currently a Director of Hearthside Food Solutions, The Woodstream Group, The Sun Products Corp. and Roland Foods, companies in which Vestar or its affiliates have a significant equity interest. Additionally, Mr. Mundt is an Observer on the Board of Directors of The J.M. Smucker Company. Further, Mr. Mundt is a member of the Presidents Leadership Council at Brigham & Womens Hospital and a member of the Corporation of Brown University. He is also a past director of MediMedia USA, Inc., Solo Cup Company, Fiorucci Foods, Birds Eye Foods, Sunrise Medical, Duff & Phelps and Big Heart Pet Brands. Mr. Mundt was selected as a director for his knowledge and experience in strategy and operations. Mr. Mundt earned a B.A. from Brown University and an M.B.A. from Harvard Business School.
Gregory S. Roth joined our board of directors in September 2015. Mr. Roth joined TeamHealth, Inc., a supplier of outsourced healthcare professional staffing and administrative services, in November 2004. After serving as its President and Chief Operating Officer, Mr. Roth was promoted in May 2008 to Chief Executive Officer, and remained in this role until his retirement in September 2014. Prior to joining TeamHealth, Mr. Roth was employed by HCAThe Healthcare Company beginning in January 1995. Beginning in July 1998, Mr. Roth served as President of HCA, Ambulatory Surgery Division. Prior to his appointment as President, Mr. Roth served in the capacity of Senior Vice President of Operations, Western Region from May 1997 to July 1998 and the Divisions Chief Financial Officer from January 1995 to May 1997. Prior to these positions, Mr. Roth held various financial and operational positions in the healthcare industry. Mr. Roth currently serves as a Director of SpecialtyCare, a leading provider of clinical services to hospitals, Press Ganey Holdings, Inc., a strategic business partner to more than 10,000 health care organizations across the country dedicated to improving the entire patient experience, and One Call Care Management, a leading provider of specialized services to the workers
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compensation industry. He previously served as a Director of Team Health Holdings, Inc. Mr. Roth was selected as a director for his knowledge and experience in the healthcare industry and his board experience. Mr. Roth received a B.S. from The Ohio State University and a Masters in Health and Hospital Administration from Xavier University. He is a Certified Public Accountant and a Registered Respiratory Therapist.
Guy Sansone was elected to our board of directors in December 2009. Mr. Sansone is a Managing Director at Alvarez & Marsal in New York and serves as head of its Healthcare Industry Group. Over the past 20 years, he has invested in and consulted as an executive to numerous companies, focusing on developing and evaluating strategic and operating alternatives designed to enhance value. Since November 2014, Mr. Sansone has been serving as the interim Chief Executive Officer of the VNSNY, the largest post-acute home-based services provider in New York State. Also, while at Alvarez & Marsal, Mr. Sansone served as Chief Executive Officer and Chief Restructuring Officer at Saint Vincent Catholic Medical Centers in New York from October 2005 to August 2007 and as interim Chief Financial Officer of HealthSouth Corporation from March 2003 to October 2004, among other positions. He most recently served as Chief Restructuring Officer for Erickson Retirement Communities, which filed for bankruptcy protection in October 2009. Mr. Sansone served as a director of Rotech Healthcare, Inc. from March 2002 to August 2005. Mr. Sansone was selected as a director for his knowledge and experience in strategy and operations, with an emphasis on the health care industry. Mr. Sansone earned a B.S. from the State University of New York at Albany.
Mary Ann Tocio joined our board of directors in October 2015. Until her retirement in July 2015, Ms. Tocio served since 1998 as the Chief Operating Officer of Bright Horizons Family Solutions, Inc., a leading provider of high-quality child care, early education and other services designed to help employers and families better address the challenges of work and life, and served as its President since 2000. Ms. Tocio began her career with Bright Horizons in 1992 as Vice President and General Manager of Child Care Operations. Before that, she served in several positions with Wellesley Medical Management, Inc., including as its Senior Vice President of Operations, where she managed more than 100 ambulatory care centers nationwide from 1983 to 1992. Ms. Tocio has been a Director of Bright Horizons Family Solutions, Inc. since November 2001 and of Harvard Pilgrim Health Care Inc. since 2004. Since 2013, she has also served as a Director of Ella Health, Inc., a 3-D mammography and womens health services provider, CareWell, which operates urgent care centers, and Horizons for Homeless Children, a non-profit organization serving young homeless children and their families. Previously, she also served as a Director of Mac-Gray Corporation, Telecare Corporation, The George B.H. Macomber Company, and Zany Brainy, Inc. Ms. Tocio was selected as a director for her public company board experience and expertise with managing growing organizations. Ms. Tocio received an M.B.A. from Simmons College Graduate School of Management.
Controlled Company
We are a controlled company under the New York Stock Exchange corporate governance standards because the LLC holds, and following the completion of this offering, Vestar will continue to hold, a majority of the voting power of our outstanding common stock. As a controlled company, we are exempt from the rules that would otherwise require that:
| a majority of our Board of Directors consist of independent directors, as defined under the rules of the New York Stock Exchange; |
| we have a nominating and corporate governance committee that is composed entirely of independent directors; and |
| we have a compensation committee that is composed entirely of independent directors. |
In accordance with those exemptions, we do not have a majority of independent directors on our Board, and our Nominating and Corporate Governance Committee and Compensation Committee are not composed entirely of independent directors.
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Based upon the information submitted by each director, the Board of Directors has affirmatively determined that Messrs. Gray, Sansone and Roth and Mses. Lenehan and Tocio is each an independent director, as such term is defined in the New York Stock Exchange rules. The Board of Directors regularly re-evaluates the independence of each director and may in the future determine that other current directors are independent under the New York Stock Exchange rules.
Board Composition
In connection with our IPO, we entered into a director nominating agreement that provides the LLC or affiliates of Vestar the right to nominate: (i) eight of nine directors so long as the LLC and affiliates of Vestar collectively own at least 40% of the total voting power of Civitas; (ii) seven of nine directors so long as the LLC and affiliates of Vestar collectively own at least 35% of the total voting power of Civitas; (iii) six of nine directors so long as the LLC and affiliates of Vestar collectively own at least 30% of the total voting power of Civitas; (iv) five of nine directors so long as the LLC and affiliates of Vestar collectively own at least 25% of the total voting power of Civitas; (v) four of nine directors so long as the LLC and affiliates of Vestar collectively own at least 20% of the total voting power of Civitas; (vi) three of nine directors so long as the LLC and affiliates of Vestar collectively own at least 15% of the total voting power of Civitas; (vii) two of nine directors so long as the LLC and affiliates of Vestar collectively own at least 10% of the total voting power of Civitas; (viii) one of nine directors so long as the LLC and affiliates of Vestar collectively own at least 5% of the total voting power of Civitas. See Certain Relationships and Related Party TransactionsDirector Nominating Agreement. Since the IPO, Messrs. Durbin, Gray, Nardella and Roth and Ms. Tocio were designated as nominees by the LLC and Vestar.
Our Board of Directors is divided into three classes as follows:
| Class I directors, Messrs. Nardella, Durbin and Gray, whose term expires at the 2018 annual meeting of the stockholders; |
| Class II directors, Messrs. Murphy, Mundt, Roth and Sansone, whose term expires at the 2016 annual meeting of the stockholders; and |
| Class III directors, Mr. Elrod and Mses. Lenehan and Tocio, whose term expires at the 2017 annual meeting of the stockholders. |
Directors in a particular class will be elected for three-year terms at the annual meeting of stockholders in the year in which their terms expire. As a result, only one class of directors will be elected at each annual meeting of our stockholders, with the other classes continuing for the remainder of their respective three-year terms. Each directors term continues until the election and qualification of his or her successor, or his or her earlier death, resignation or removal.
Our certificate of incorporation provides that, subject to any rights applicable to any then-outstanding preferred stock, the Board shall consist of such number of directors as is determined from time to time by resolution adopted by a majority of the total number of authorized directors, whether or not there are any vacancies in previously authorized directorships. The Board currently consists of ten directors. Subject to any rights applicable to any then-outstanding preferred stock, any vacancies resulting from an increase in the size of the Board or otherwise must be filled by the directors then in office unless otherwise required by law or by a resolution passed by the Board.
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Board Committees
Our Board has four standing committees: an Audit Committee, a Compensation Committee, a Nominating and Corporate Governance Committee and a Quality and Risk Management Committee. Each of the committees reports to the Board as it deems appropriate, and as the Board may request. The composition, duties and responsibilities of these committees are set forth below. In the future, our Board may establish other committees, as it deems appropriate, to assist it with its responsibilities.
Board Member |
Audit Committee |
Compensation Committee |
Nominating and Corporate Governance Committee |
Quality and Risk Management Committee |
||||||||||||
Bruce F. Nardella |
X | |||||||||||||||
Chris A. Durbin |
ü | X | ||||||||||||||
Patrick M. Gray |
X | |||||||||||||||
Edward M. Murphy (1) |
X | |||||||||||||||
Kevin A. Mundt |
ü | |||||||||||||||
Guy Sansone |
X | |||||||||||||||
James L. Elrod, Jr. |
X | ü | ||||||||||||||
Pamela F. Lenehan(2) |
ü | X | ||||||||||||||
Gregory S. Roth(3) |
X | X | ||||||||||||||
Mary Ann Tocio |
X |
ü | Chair of the committee |
(1) | Mr. Murphy has informed our Board of Directors that he will not stand for re-election as a director at our 2016 annual meeting of stockholders. |
(2) | Ms. Lenehan is expected to be appointed to the Compensation Committee effective October 6, 2015. |
(3) | Mr. Roth is expected to be appointed to the Nominating and Corporate Governance Committee effective October 6, 2015. |
Audit Committee
The Audit Committee is responsible for, among other matters: (i) appointing, compensating, retaining, overseeing and terminating our independent registered public accounting firm; (ii) reviewing our independent registered public accounting firms independence from management; (iii) reviewing with our independent registered public accounting firm the scope of their audit; (iv) approving all audit and permissible non-audit services to be performed by our independent registered public accounting firm; (v) overseeing the financial reporting process and discussing with management and our independent registered public accounting firm the interim and annual consolidated financial statements that we file with the SEC; (vi) reviewing and monitoring our accounting principles, accounting policies, financial reporting processes and controls and compliance with applicable legal and regulatory requirements; (vii) establishing procedures for the confidential anonymous submission of concerns regarding questionable accounting, internal controls or auditing matters; (viii) reviewing and approving related party transactions; and (ix) reviewing and discussing policies and guidelines with respect to risk assessment and risk management.
The Audit Committee consists of Ms. Lenehan (Chair), Mr. Gray and Mr. Roth. Our Board has affirmatively determined that each of Ms. Lenehan and Messrs. Gray and Roth meet the definition of independent director for purposes of serving on the Audit Committee under applicable SEC and New York Stock Exchange rules. In addition, both Ms. Lenehan and Mr. Gray qualify as an audit committee financial expert, as such term is defined in Item 407 of Regulation S-K.
The written charter for the Audit Committee is available on our corporate website at www.civitas-solutions.com. Our website is not part of this prospectus.
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Compensation Committee
The Compensation Committee is responsible for, among other matters: (i) reviewing and approving executive officer compensation goals, objectives and plans; (ii) reviewing and recommending the compensation of our directors; (iii) reviewing and approving employment agreements, severance arrangements and change in control agreements/provisions between us and our executive officers; and (vi) administering our stock plans and other incentive compensation plans.
Our Compensation Committee consists of Mr. Durbin (Chair), Mr. Elrod and Mr. Sansone. Ms. Lenehan is expected to be appointed to the Compensation Committee effective October 6, 2015. The written charter for the Compensation Committee is available on our corporate website at www.civitas-solutions.com. Our website is not part of this prospectus.
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee is responsible for, among other matters: (i) identifying individuals qualified to become members of our Board, consistent with criteria approved by our Board; (ii) overseeing the organization of our Board to discharge the Boards duties and responsibilities properly and efficiently; (iii) identifying best practices and recommending corporate governance principles; and (iv) reviewing and recommending to our Board any changes to a set of corporate governance guidelines and principles applicable to us.
Our Nominating and Corporate Governance Committee consists of Mr. Mundt (Chair), Mr. Murphy and Mr. Durbin. Mr. Roth is expected to be appointed to the Nominating and Corporate Governance Committee effective October 6, 2015. The written charter for the Nominating and Corporate Governance Committee is available on our corporate website at www.civitas-solutions.com. Our website is not part of this prospectus.
Quality and Risk Management Committee
The Quality and Risk Management Committee is responsible for, among other matters: (i) oversight of our management compliance committee, which is responsible for the structure and implementation of our compliance plan and service delivery risk management plan; (ii) discussing specific material compliance and other legal issues with the Audit Committee, the Chief Legal Officer and the Compliance Officer, as appropriate; (iii) oversight of our quality assurance and quality improvement programs; and (iv) conducting such investigations into matters relating to compliance matters as the committee may deem necessary.
Our Quality and Risk Management Committee consists of Mr. Elrod (Chair), Ms. Tocio and Mr. Nardella. The written charter for the Quality and Risk Management Committee is available on our corporate website at www.civitas-solutions.com. Our website is not part of this prospectus.
Risk Oversight
Our Board has delegated to the Audit Committee oversight of our risk management process. The Audit Committee focuses on our general risk management strategy and the most significant risks facing us, and directs management to implement appropriate risk mitigation strategies. The Quality and Risk Management Committee focuses on our service delivery risk management process, and directs management to implement appropriate risk mitigation strategies with respect to service delivery. Our other Board committees also consider and address risk as they perform their respective committee responsibilities. All committees report to the full Board as appropriate, including when a matter rises to the level of a material or enterprise level risk. Our management is responsible for day-to-day risk management. This oversight includes identifying, evaluating, and addressing potential risks that may exist at the enterprise, strategic, financial, operational, compliance and reporting levels.
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Compensation Committee Interlocks and Insider Participation
Messrs. Durbin, Elrod and Sansone are the members of our Compensation Committee, and none of them is or has been our officer or employee. Messrs. Durbin and Elrod are managing directors of Vestar, which controls Civitas. For a description of the transactions between us and Vestar, see Certain Relationships and Related Party Transactions. Apart from these relationships, no member of the Compensation Committee has any relationship that would be required to be reported under Item 404 of Regulation S-K. No member of the Compensation Committee serves or served during the fiscal year as a member of the board of directors or compensation committee of a company that has one or more executive officers serving as a member of our Board of Directors or Compensation Committee.
Code of Conduct and Code of Ethics
We have adopted the MENTOR Network Code of Conduct that applies to our directors, officers and employees. We have also adopted a code of ethics for senior financial officers that applies to our chief executive officer, chief financial officer, principal accounting officer and all persons performing similar functions. The MENTOR Network Code of Conduct and the code of ethics for senior financial officers are publicly available on our website at www.civitas-solutions.com. If we make any substantive amendments to the MENTOR Network Code of Conduct, or grant any waiver from a provision of the code of ethics for senior financial officers to our chief executive officer, chief financial officer or principal accounting officer, we will disclose the nature of such amendment or waiver on our website or in a current report on Form 8-K.
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Compensation Discussion and Analysis
Introduction. This Compensation Discussion and Analysis (CDA) describes the compensation arrangements we have with our Named Executive Officers (NEOs) as required under the rules of the SEC. The SEC rules require disclosure for our principal executive officer and principal financial officer, regardless of their compensation levels, and our three most highly compensated executive officers in our last completed fiscal year, other than our principal executive officer and principal financial officer.
For the fiscal year ended September 30, 2014, our NEOs were:
Name |
Position | |
Bruce F. Nardella |
President and Chief Executive Officer, Director | |
Edward M. Murphy |
Executive Chair, Director | |
Denis M. Holler |
Chief Financial Officer | |
Neil D. Brendmoen |
Hastings Operating Group President | |
Jeffrey M. Cohen |
Chief Information Officer |
Compensation Policies and Practices. The objectives of our executive compensation program are to:
| attract and retain top executive talent; |
| drive accountability for performance by linking annual cash incentive awards to achievement of measurable performance objectives; and |
| align executive officers with our stockholders, create an ownership culture, and drive long-term business success by providing opportunity for significant equity-based rewards. |
Our executive compensation program is designed to reward our executive officers to operate the business in a manner that best serves our clients, payors and other public partners, as well as our stockholders and employees, thereby enhancing equity value. We do this by:
| awarding a significant portion of our executives overall compensation based on our financial performance, specifically, revenue and achievement of earnings before interest, taxes, depreciation and amortization, or EBITDA (with certain adjustments) and including a modifier based on the quality of services managed and work performed; |
| mitigating undue risk in compensation programs; and |
| including double-trigger change of control provisions for stock options and restricted stock units. |
Our executive compensation program provides foundational elements such as base salary and benefits, and the opportunity for significant performance-based annual cash incentives and longer-term equity-based incentives.
Elements of Compensation. Each element of our executive compensation program is designed to meet the objectives of our executive compensation program. They are as follows:
| base salary; |
| annual cash incentives; |
| long-term incentive compensation in the form of equity; |
| deferred compensation; |
| severance benefits and equity vesting upon a change in control; and |
| other benefits. |
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Base salaries for our executive officers are designed to recognize the contributions of the executive team and provide a base source of cash income in line with the market for comparable positions. Our annual incentive compensation payouts reward executive officers for achievement of business performance, primarily EBITDA (with certain adjustments) and revenue. In addition, we consider quality of services managed and work performed by the executive officers because we believe that service, quality and growth are inextricably linked with service outcomes and consumer and payor satisfaction. Our equity component of compensation which, prior to the IPO was in the form of equity units in the LLC, and post IPO is in the form of Restricted Stock Units and Non-Qualified Stock Options granted by Civitas is designed to reward equity value creation over a longer period of time.
The charts below highlight each NEOs percentage contribution of salary, non-equity incentive compensation, equity grants and other compensation that comprised their 2014 compensation. Other compensation includes all other compensation paid to the NEOs, including non-qualified deferred compensation and other perquisites.
Murphy
|