Form 10-Q Civitas Solutions, Inc. For: Jun 30

August 12, 2015 4:23 PM


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 001-36623
 CIVITAS SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
65-1309110
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
313 Congress Street, 6th Floor
Boston, Massachusetts 02210
 
(617) 790-4800
(Address of principal executive offices, including zip code)
 
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
 
o
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
x  (Do not check if smaller reporting company)
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of August 11, 2015, there were 36,969,486 shares outstanding of the registrant’s common stock, $0.01 par value.




Index
Civitas Solutions, Inc.
 
 
Page
PART I. FINANCIAL INFORMATION
3

Item 1.     Financial Statements (unaudited)
3

                 Condensed Consolidated Balance Sheets as of June 30, 2015 and September 30, 2014
3

                 Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2015 and 2014
4

                 Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended June 30, 2015 and 2014
5

                 Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2015 and 2014
6

                 Notes to Condensed Consolidated Financial Statements
7

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
18

Item 3.    Quantitative and Qualitative Disclosures about Market Risk
31

Item 4.    Controls and Procedures
31

 
 
PART II. OTHER INFORMATION
32

Item 1.     Legal Proceedings
32

Item 1A.  Risk Factors
32

Item 2.     Unregistered Sales of Equity Securities
32

Item 3.     Defaults Upon Senior Securities
33

Item 4.     Mine Safety Disclosures
33

Item 5.     Other Information
33

Item 6.     Exhibits
33

Signatures
34



2



PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements.
Civitas Solutions, Inc.
Condensed Consolidated Balance Sheets
(Amounts in thousands, except share and per share amounts)
(Unaudited)
 
 
June 30,
2015
 
September 30,
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
16,665

 
$
196,147

Restricted cash
1,498

 
1,944

Accounts receivable, net of allowances of $11,392 and $11,491 at June 30, 2015 and September 30, 2014
150,186

 
141,378

Deferred tax assets, net
17,238

 
18,176

Prepaid expenses and other current assets
24,619

 
16,207

Total current assets
210,206

 
373,852

Property and equipment, net
164,164

 
159,486

Intangible assets, net
315,401

 
327,726

Goodwill
274,520

 
257,632

Restricted cash
50,000

 
50,000

Other assets
42,969

 
39,258

Total assets
$
1,057,260

 
$
1,207,954

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
22,475

 
$
22,350

Accrued payroll and related costs
82,779

 
84,176

Other accrued liabilities
43,158

 
49,320

Obligations under capital lease, current
485

 
451

Current portion of long-term debt
6,554

 
168,000

Total current liabilities
155,451

 
324,297

Other long-term liabilities
76,923

 
69,314

Deferred tax liabilities, net
59,990

 
57,552

Obligations under capital lease, less current portion
5,690

 
6,058

Long-term debt, less current portion
639,142

 
635,195

Commitments and Contingencies (Note 15)

 

Stockholders’ Equity
 
 
 
Common stock, $.01 par value; 350,000,000 shares authorized; and 36,950,000 shares issued and outstanding at June 30, 2015 and September 30, 2014 respectively
370

 
370

Additional paid-in capital
277,280

 
272,943

Accumulated gain on derivatives
1,381

 

Accumulated deficit
(158,967
)
 
(157,775
)
Total stockholders’ equity
120,064

 
115,538

Total liabilities and stockholders’ equity
$
1,057,260

 
$
1,207,954

See accompanying notes to these condensed consolidated financial statements.

3



Civitas Solutions, Inc.
Condensed Consolidated Statements of Operations
(Amounts in thousands, except share and per share amounts)
(Unaudited)
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
Net revenue
$
345,994

 
$
318,189

 
$
1,015,764

 
$
928,547

Cost of revenue (exclusive of depreciation expense shown below)
268,393

 
247,579

 
786,024

 
725,754

Operating expenses:
 
 
 
 
 
 
 
General and administrative
39,671

 
36,448

 
119,452

 
108,104

Depreciation and amortization
26,415

 
18,190

 
64,278

 
50,594

Total operating expenses
66,086

 
54,638

 
183,730

 
158,698

Income from operations
11,515

 
15,972

 
46,010

 
44,095

Other income (expense):
 
 
 
 
 
 
 
Management fee of related party

 
(342
)
 
(162
)
 
(1,041
)
Other income (expense), net
(386
)
 
148

 
(333
)
 
664

Extinguishment of debt

 

 
(17,058
)
 
(14,699
)
Interest expense
(8,547
)
 
(16,252
)
 
(28,868
)
 
(53,204
)
Income (loss) from continuing operations before income taxes
2,582

 
(474
)
 
(411
)
 
(24,185
)
Expense (benefit) for income taxes
1,191

 
(450
)
 
(185
)
 
(7,243
)
Income (loss) from continuing operations
1,391

 
(24
)
 
(226
)
 
(16,942
)
(Loss) gain from discontinued operations, net of tax
(841
)
 
29

 
(966
)
 
67

Net income (loss)
$
550

 
$
5

 
$
(1,192
)
 
$
(16,875
)
Income (loss) per common share, basic and diluted
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
0.04

 
$

 
$
(0.01
)
 
$
(0.67
)
Income (loss) from discontinued operations
(0.03
)
 

 
(0.02
)
 

Net income (loss)
$
0.01

 
$

 
$
(0.03
)
 
$
(0.67
)
Weighted average number of common shares outstanding, basic
36,950,000

 
25,250,000

 
36,950,000

 
25,250,000

Weighted average number of common shares outstanding, diluted
37,122,904

 
25,250,000

 
36,950,000

 
25,250,000

See accompanying notes to these condensed consolidated financial statements.


4



Civitas Solutions, Inc.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(Amounts in thousands)
(Unaudited)
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss)
$
550

 
$
5

 
$
(1,192
)
 
$
(16,875
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Gain on derivative instrument classified as cash flow hedge, including a tax effect for the three and nine months ended June 30, 2015 of $770 and $939, respectively, and $310 for the nine months ended June 30, 2014
1,132

 

 
1,381

 
466

Reclassification adjustments for gains on derivative instruments included in net income, net of tax for the three and nine months ended June 30, 2014 of $353 and $589, respectively

 
531

 

 
884

Comprehensive income (loss)
$
1,682

 
$
536

 
$
189

 
$
(15,525
)
See accompanying notes to these condensed consolidated financial statements.


5



Civitas Solutions, Inc.
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited) 
 
Nine Months Ended
June 30,
 
2015
 
2014
Operating activities:
 
 
 
Net loss
$
(1,192
)
 
$
(16,875
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Accounts receivable allowances
11,573

 
12,487

Depreciation of property and equipment
24,597

 
20,931

Amortization of intangible assets
29,184

 
28,745

Amortization and write-off of original issue discount and initial purchasers discount
4,829

 
6,659

Amortization and write-off of financing costs
2,749

 
9,707

Stock-based compensation
3,761

 
103

Deferred income taxes
2,437

 
(4,382
)
Loss on disposal of assets
422

 
463

Gain on derivatives

 
(884
)
Non-cash impairment charge
10,611

 
1,310

Net change in fair value of contingent liabilities
317

 

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
(20,381
)
 
(10,645
)
Other assets
(12,489
)
 
6,057

Accounts payable
87

 
(1,069
)
Accrued payroll and related costs
(1,397
)
 
15,562

Other accrued liabilities
(7,967
)
 
8,814

Other long-term liabilities
3,573

 
(10,316
)
Net cash provided by operating activities
50,714

 
66,667

Investing activities:
 
 
 
Acquisition of businesses, net of cash acquired
(38,738
)
 
(15,178
)
Purchases of property and equipment
(30,310
)
 
(24,271
)
Changes in restricted cash
446

 
(1,156
)
Proceeds from sale of assets
1,068

 
894

Net cash used in investing activities
(67,534
)
 
(39,711
)
Financing activities:
 
 
 
Issuance of long-term debt, net of original issue discount
54,450

 
598,500

Repayments of long-term debt
(216,778
)
 
(586,026
)
Proceeds from borrowings under senior revolver
206,700

 
9,300

Repayments of borrowings under senior revolver
(206,700
)
 
(9,300
)
Repayments of capital lease obligations
(334
)
 
(311
)
Dividend to NMH Investment

 
(110
)
Payments of financing costs

 
(10,923
)
Net cash (used in) provided by financing activities
(162,662
)
 
1,130

Net (decrease) increase in cash and cash equivalents
(179,482
)
 
28,086

Cash and cash equivalents at beginning of period
196,147

 
19,440

Cash and cash equivalents at end of period
$
16,665

 
$
47,526

Supplemental disclosure of cash flow information
 
 
 
Cash paid for interest
$
29,508

 
$
42,666

Cash paid for call premium on redemption of senior notes
$
11,688

 
$
2,375

Cash paid for income taxes
$
1,498

 
$
393

Supplemental disclosure of non-cash investing activities:
 
 
 
Accrual for acquisition paid in July 2014
$

 
$
1,500

Accrued property and equipment
$
996

 
$
646

Fair value of contingent consideration related to acquisitions
$
6,100

 
$

See accompanying notes to these condensed consolidated financial statements.

6



Civitas Solutions, Inc.
Notes to Condensed Consolidated Financial Statements
June 30, 2015
(Unaudited)
1. Business Overview
Civitas Solutions, Inc. (“Civitas”), through its wholly-owned subsidiaries (collectively, the “Company”), is the leading provider of home- and community-based health and human services to individuals with intellectual and/or developmental disabilities, acquired brain injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and/or medically complex challenges. Since the Company’s founding in 1980, the Company’s operations have grown to 35 states. The Company provides residential services to approximately 12,400 clients and more than 17,800 clients receive periodic services from the Company in non-residential settings.
The Company designs customized service plans to meet the unique needs of its clients, which it delivers in home- and community-based settings. Most of the Company’s service plans involve residential support, typically in small group homes, host home settings, or specialized community facilities, designed to improve the clients’ quality of life and to promote their independence and participation in community life. Other services offered include supported living, day and transitional programs, vocational services, case management, family-based and outpatient therapeutic services, post-acute treatment and neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and speech therapies, among others. The Company’s customized service plans offer its clients as well as the payors of these services, an attractive, cost-effective alternative to health and human services provided in large, institutional settings.
Civitas Solutions, Inc. is a subsidiary of NMH Investment, LLC (“NMH Investment”), which was formed in connection with the acquisition of our business by affiliates of Vestar Capital Partners (“Vestar’’) in 2006. The equity interests of NMH Investment are owned by Vestar and certain of our executive officers and directors and other members of management. NMH Holdings, LLC is a wholly owned subsidiary of Civitas and National Mentor Holdings, Inc. (“NMHI”) is a wholly-owned subsidiary of NMH Holdings, LLC ("NMHH").

2. Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The unaudited condensed consolidated financial statements herein should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2014, which is on file with the SEC. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal and recurring accruals, necessary to present fairly the financial statements in accordance with GAAP. Intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. Operating results for the three and nine months ended June 30, 2015 may not necessarily be indicative of results to be expected for any other interim period or for the full year.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Our financial results are affected by the selection and application of accounting policies and methods. There were no material changes in the nine months ended June 30, 2015 to the application of significant accounting policies as described in our audited financial statements for the year ended September 30, 2014.

7



Statement of Cash Flow Correction
In the Company's Quarterly Report on Form 10-Q for the three and six months ended March 31, 2015, the Company incorrectly included the fair value of contingent consideration related to acquisitions of businesses, net of cash acquired, and the corresponding changes to other accrued and long term liabilities, in its cash flow statement for the six months ended March 31, 2015. This resulted in an overstatement of net cash provided by operating activities and an overstatement of net cash used in investing activities of $6.1 million for the six months ended March 31, 2015. For the six months ended March 31, 2015, the Company’s net cash provided by operating activities was $15.4 million, and the Company’s net cash used in investing activities was $50.6 million. This has been corrected in the reported amounts for the nine months ended June 30, 2015.
    

3. Recent Accounting Pronouncements
Reporting Discontinued Operations—In April 2014, the FASB issued Accounting Standards Update No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). ASU 2014-08 changes the definition of a discontinued operation to include only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, and changes the criteria and enhances disclosures for reporting discontinued operations. The pronouncement is applied prospectively, and the Company adopted it for the first quarter of our fiscal year ending September 30, 2015 and applied the new accounting guidance to the divestiture of our at-risk youth services in the states of Florida, Louisiana, Indiana, North Carolina and Texas as further explained in Note 12 of the Condensed Consolidated Financial Statements.
Revenue from Contracts with Customers— In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The new standard will be effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method.
Imputation of Interest— In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest - Imputation of Interest. ASU 2015-03 simplifies the presentation of debt issuance costs related to a recognized debt liability by requiring the costs to be presented in the balance sheet as a deduction from the carrying amount of that debt liability as opposed to being recognized as a deferred charge. The pronouncement is to be applied retrospectively, and is effective for the fiscal years beginning after December 15, 2015, and interim periods therein. As of June 30, 2015 and September 30, 2014, the Company had deferred financing costs of $7.8 million and $10.0 million, respectively, of which $6.3 million and $6.8 million, respectively, are classified as long-term in Other assets and $1.5 million and $3.2 million, respectively, are classified as short-term in Prepaid expenses and other current assets.

4. Long-Term Debt
As of June 30, 2015 and September 30, 2014, the Company’s long-term debt consisted of the following:
(in thousands)
June 30,
2015
 
September 30,
2014
Term loan principal and interest due in quarterly installments through January 31, 2021
$
647,223

 
$
597,000

Original issue discount on term loan, net of accumulated amortization
(1,527
)
 
(1,235
)
Senior Notes

 
212,000

Original issue discount and initial purchaser discount on senior notes, net of accumulated amortization

 
(4,570
)
 
645,696

 
803,195

Less current portion
6,554

 
168,000

Long-term debt
$
639,142

 
$
635,195

    

8



Senior Secured Credit Facilities
On January 31, 2014, NMHI and NMHH 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”), 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 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, pursuant to the terms of the senior credit agreement that permit up to $125.0 million of incremental borrowings plus any additional amounts so long as NMHI’s consolidated first lien leverage ratio, as defined in the senior credit agreement, does not exceed 4.50 to 1.00 on a pro forma basis, subject to the conditions set forth in the senior credit agreement. In addition, the Incremental Amendment amended the senior credit agreement to provide that, subject to certain exceptions, if, on or prior to August 27, 2015, NMHI reprices any portion of the term loan and that repricing results in a lower interest rate applicable to the term loan, NMHI will be required to pay a prepayment premium of 1% of the loans being repriced. All of the other terms of the additional $55.0 million term loan are identical to the term loan.
Term loan
As of June 30, 2015 and September 30, 2014, NMHI had $647.2 million and $597.0 million, respectively, of borrowings under the term loan. At June 30, 2015 and September 30, 2014, the variable interest rate on the term loan was 4.25% and 4.75%, respectively.
Senior revolver
The senior revolver includes borrowing capacity available for borrowings on same-day notice, referred to as the “swingline loans.” Any swingline loans or other borrowings under the senior revolver would have maturities less than one year, and would be reflected under current portion of long-term debt on the Company’s consolidated balance sheets.
During the nine months ended June 30, 2015, NMHI had borrowings and repayments of $206.7 million on the senior revolver. At June 30, 2015 and September 30, 2014, NMHI had no outstanding borrowings under the senior revolver. The interest rate for borrowings under the senior revolver was 5.5% and 6.0% as of June 30, 2015 and September 30, 2014, respectively. At September 30, 2014, NMHI had $100.0 million of available credit under 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. At June 30, 2015, NMHI had $119.1 million of available credit under the senior revolver.
NMHI’s institutional letter of credit facility provided for the issuance of letters of credit up to the $50.0 million limit, subject to certain maintenance and issuance limitations, and letters of credit in excess of that amount reduced availability under the NMHI’s senior revolver. NMHI had $48.4 million and $44.3 million of standby letters of credit issued under the institutional letter of credit facility primarily related to the Company’s workers’ compensation insurance coverage at June 30, 2015 and September 30, 2014, respectively. NMHI also issued $0.9 million of standby letters of credit under the senior revolver at June 30, 2015.
Senior Notes
In February 2011, NMHI issued $250.0 million of 12.5% senior notes due 2018 (the “senior notes”). As of September 30, 2014, NMHI had $212.0 million of aggregate principal amount of senior notes outstanding.
On October 17, 2014, NMHI paid $175.6 million to redeem $162.0 million in aggregate principal of senior notes plus accrued interest of $3.5 million using the net proceeds from the Company's initial public offering. In accordance with the provisions of the indenture governing the senior notes, the amount paid included an associated call premium of $10.1 million. 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.

9



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.
Covenants
The senior credit agreement contains a springing financial covenant. If, at the end of any fiscal quarter, the Company’s outstanding borrowings of the senior revolver exceeds 30% of the commitments thereunder, it 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 NMHI’s outstanding borrowings of the senior revolver did not exceed the threshold for that quarter.
The senior credit agreement also contains a number of covenants that, among other things, restrict, subject to certain exceptions, NMHI’s ability and that 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 its junior indebtedness; (xii) change its lines of business; (xiii) make certain acquisitions; and (xiv) limitations on the letter of credit cash collateral account. If NMHI withdraws any of the $50.0 million from the cash collateral account supporting the issuance of letters of credit, it 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.
Derivatives

On January 20, 2015, NMHI entered into two new 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. The Company entered into these interest rate swaps to hedge the risk of changes in the floating rate of interest on borrowings under the term loan. Under the terms of the swaps, the Company will 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 the Company will 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.

The fair value of the swap agreement, representing the price that would be received to transfer the asset in an orderly transaction between market participants, was $2.3 million or $1.4 million after taxes, at June 30, 2015. The fair value was recorded in current assets and was determined based on pricing models and independent formulas using current assumptions. The change in fair market value during the three months ended June 30, 2015 of $1.9 million, net of tax effect of $0.8 million, is included in the consolidated statements of comprehensive income (loss) for the three and nine months ended June 30, 2015. Hedge ineffectiveness, if any, associated with the swap will be reported by the Company in interest expense. There was no ineffectiveness associated with the swap during the quarter ended June 30, 2015, nor was any amount excluded from ineffectiveness testing for the period.

5. Stockholders’ Equity
The holders of the Company’s common stock are entitled to receive dividends when and as declared by the Company’s Board of Directors. In addition, the holders of common stock are entitled to one vote per share.
During fiscal 2015, the Company revised its estimate for offering costs incurred in connection with the Company's initial public offering in September 2014. This resulted in a decrease to Other accrued liabilities and a corresponding increase to Additional paid-in capital of approximately $0.6 million.


10



6. Business Combinations
The operating results of the businesses acquired are included in the consolidated statements of operations from the date of acquisition. The Company accounted for the acquisitions under the acquisition method and, as a result, the purchase price was allocated to the assets acquired and liabilities assumed based upon their respective fair values. The excess of the purchase price over the estimated fair value of net tangible assets was allocated to specifically identified intangible assets, with the residual being allocated to goodwill.
Fiscal 2015 Acquisitions
During the nine months ended June 30, 2015, the Company acquired certain assets of ten companies complementary to its business for a total fair value consideration of $44.8 million, including $6.1 million of contingent consideration.
Capstone Services, LLC (“Capstone”). On October 31, 2014, the Company acquired the assets of Capstone for $4.5 million. Capstone is located in Minnesota and provides residential and home-based supportive living services to individuals with developmental disabilities.The Company acquired $3.5 million of intangible assets which included $2.6 million of agency contracts with a weighted average useful life of 12 years, $0.8 million of licenses and permits with a weighted average useful life of 10 years, and $0.1 million for a non-compete/non-solicit agreement with a useful life of 5 years. In addition, the Company acquired total tangible assets of $0.2 million. As a result of this acquisition, the Company recorded $0.8 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes.
Lakeview Systems (“Lakeview”). On December 29, 2014, the Company acquired certain assets of Lakeview’s New Hampshire programs for $8.0 million. Lakeview provides community-based residential services for individuals with brain injuries. The Company acquired $6.7 million of intangible assets which included $6.0 million of agency contracts with a weighted average useful life of 12 years, $0.7 million of licenses and permits with a weighted average useful life of 10 years, and $31 thousand for a non-compete/non-solicit agreement with a useful life of 5 years. In addition, the Company acquired total tangible assets of $48 thousand. As a result of this acquisition, the Company recorded $1.3 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes.
Cassell & Associates LLC ("Cassell"). On January 13, 2015, the Company acquired the assets of Cassell's Michigan programs for $24.3 million, including $6.1 million of contingent consideration. The terms of the acquisition agreement require the Company to pay an earn-out upon successfully meeting certain revenue and EBITDA targets through February 2017. There is no dollar cap on the earn-out. Cassell provides non-residential therapeutic vocational services to individuals recovering from brain injuries in the state of Michigan. The Company acquired $11.6 million of intangible assets which included $10.3 million of agency contracts with a weighted average useful life of 12 years, $0.2 million of non-compete/non-solicit agreement with a useful life of 5 years, and $1.1 million of trade names with a useful life of 5 years. In addition, the Company acquired total tangible assets of $37 thousand. The estimated fair values of the intangible assets acquired at the date of acquisition are determined based on a valuation that has yet to be finalized. The Company’s valuations are subject to adjustment as additional information is obtained; however these adjustments are not expected to be material. Based on the preliminary fair value estimate of the net assets acquired at the date of acquisition, the Company recorded $12.6 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes.
Comprehensive Professional Services ("CPS"). On March 23, 2015, the Company acquired the assets of CPS's Michigan programs for $1.3 million. CPS provides community-based, residential services for individuals with brain injuries. The Company acquired $0.9 million of intangible assets which included $0.7 million of agency contracts with a weighted average useful life of 12 years, $0.2 million of licenses and permits with a weighted average useful life of 10 years, $5 thousand for a non-compete/non-solicit agreement with a useful life of 5 years. In addition, the Company acquired total tangible assets of $19 thousand. As a result of this acquisition, the Company recorded $0.4 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes.
Snug Harbor Home Health, Inc. ("Snug Harbor"). On April 1, 2015, the Company acquired the assets of Snug Harbor for $1.0 million. Snug Harbor provides home and community-based services to individuals with intellectual and/or developmental disabilities. The Company acquired $0.9 million of agency contracts with a weighted average useful life of 12 years. In addition, the Company acquired total tangible assets of $28 thousand. The estimated fair values of the intangible assets acquired at the date of acquisition are determined based on a valuation that has yet to be finalized. The Company’s valuations are subject to adjustment as additional information is obtained; however these adjustments are not expected to be material. Based on the preliminary fair value estimate of the net assets acquired at the date of acquisition, the Company recorded $34 thousand of goodwill in the Human Services segment, which is expected to be deductible for tax purposes.

11



Heritage Residential Services, Inc. ("Heritage"). On April 30, 2015, the Company acquired the assets of Heritage for $2.2 million. Heritage provides residential and related services to individuals with intellectual and/or developmental disabilities. The Company acquired $1.3 million of intangible assets which included $1.1 million of agency contracts with a weighted average useful life of 12 years, $0.2 million of licenses and permits with a weighted average useful life of 10 years, and $22 thousand of trade names with a useful life of 1 year. The estimated fair values of the intangible assets acquired at the date of acquisition are determined based on a valuation that has yet to be finalized. The Company’s valuations are subject to adjustment as additional information is obtained; however these adjustments are not expected to be material. Based on the preliminary fair value estimate of the net assets acquired at the date of acquisition, the Company recorded $0.9 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes.
Visions of N.E.W., LLC ("Visions of N.E.W."). On April 30, 2015, the Company acquired the assets of Visions of N.E.W. for $3.0 million. Visions of N.E.W. provides residential, transportation, job coaching, supportive care and similar services to individuals with developmental disabilities. The Company acquired $2.2 million of intangible assets which included $1.8 million of agency contracts with a weighted average useful life of 12 years, and $0.4 million of licenses and permits with a weighted average useful life of 10 years. In addition, the Company acquired total tangible assets of $0.1 million. The estimated fair values of the intangible assets acquired at the date of acquisition are determined based on a valuation that has yet to be finalized. The Company’s valuations are subject to adjustment as additional information is obtained; however these adjustments are not expected to be material. Based on the preliminary fair value estimate of the net assets acquired at the date of acquisition, the Company recorded $0.7 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes.
Other Acquisitions. During fiscal 2015, the Company acquired the assets of Kessel Group Home, Inc ("Kessel"), Individual Expressions, Inc ("Individual Expressions"), and Georgia Rehabilitation Institute, Inc at Harison Heights ("Harison Heights"). Kessel and Individual Expressions are in the business of providing group home and related services to individuals with developmental disabilities and are included in our Human Services segment. Harison Heights is engaged in the business of providing assisted living, supported living or transitional living services to individuals with brain injuries, neuromuscular disorders, spinal cord injuries and similar conditions and is included in our SRS segment. Total cash consideration for these companies was $0.6 million of which $0.4 million was recorded for identifiable intangible assets, $0.2 million was recorded for goodwill and $48 thousand was recorded for tangible assets.
The following table summarizes the recognized amounts of identifiable assets acquired at the date of each acquisition:
(in thousands)
Identifiable
intangible
assets
 
Property and
equipment
 
Total identifiable
net assets
 
Goodwill
Capstone
$
3,539

 
$
178

 
$
3,717

 
$
758

Lakeview
6,664

 
48

 
6,712

 
1,272

Cassell
11,600

 
37

 
11,637

 
12,633

CPS
876

 
19

 
895

 
355

Snug Harbor
938

 
28

 
966

 
34

Heritage
1,252

 

 
1,252

 
945

Visions of N.E.W.
2,240

 
122

 
2,362

 
663

Other acquisitions
361

 
48

 
409

 
228

Total
$
27,470

 
$
480

 
$
27,950

 
$
16,888

Fiscal 2014 Acquisitions
During the nine months ended June 30, 2014, the Company acquired seven companies complementary to its business for a total cash consideration of $16.6 million, of which $1.5 million was paid in July 2014.
Show-Me Health Care, Inc. (“Show-Me Health Care”). On November 29, 2013, the Company acquired the assets of Show-Me Health Care for $1.2 million. Show-Me Health Care is located in Missouri and provides community-based supportive living services to individuals with developmental disabilities. As a result of this acquisition, the Company recorded $0.3 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.9 million of intangible assets which included $0.7 million of agency contracts with a weighted average useful life of 12 years, $0.2 million of licenses and permits with a weighted average useful life of 10 years, and $14 thousand of non-compete/non-solicit agreement with a useful life of 5 years.

12



Occazio, Inc. (“Occazio”). On January 2, 2014, the Company acquired the assets of Occazio for $5.5 million. Occazio is located in Indiana and provides residential, home care and home health care services to consumers with intellectual and/or developmental disabilities. As a result of this acquisition, the Company recorded $1.4 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $3.9 million of intangible assets which included $2.9 million of agency contracts with a weighted average useful life of 12 years, $0.7 million of licenses and permits with a weighted average useful life of 10 years, $0.2 million trade name with a useful life of 5 years, and $24 thousand of non-compete/non-solicit agreement with a useful life of 5 years. In addition, the Company acquired total tangible assets of $0.2 million.
Momentum Rehabilitation Services, Inc., D/B/A Ann Arbor Rehabilitation Centers (“Ann Arbor”). On February 7, 2014, the Company acquired the assets of Ann Arbor for $4.8 million. Ann Arbor is located in Michigan and provides comprehensive on and off-campus residential housing and personalized daily services to adults with traumatic brain injury. As a result of this acquisition, the Company recorded $1.0 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes. The Company acquired $3.8 million of intangible assets which included $3.7 million of agency contracts with a weighted average useful life of 12 years, $0.1 million trade name with a useful life of 5 years, and $33 thousand of non-compete/non-solicit agreement with a useful life of 5 years.
Tender Loving Care Metro, LLC (“Tender Loving Care”). On April 7, 2014, the Company acquired the assets of Tender Loving Care for $3.0 million. Tender Loving Care is located in Minnesota and provides residential and related services to adults with intellectual and/or developmental disabilities. As a result of this acquisition, the Company recorded $0.5 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $2.4 million of intangible assets which included $2.0 million of agency contracts with a weighted average useful life of 12 years, $0.3 million of licenses and permits with a weighted average useful life of 10 years, and $0.1 million of non-compete/non-solicit agreement with a useful life of 5 years.
G&D Alternative Living, Inc. (“G&D”). On June 30, 2014, the Company acquired the assets of G&D for $1.5 million. G&D is located in Ohio and provides group home services, day program services and related services to individuals with developmental disabilities. As a result of this acquisition, the Company recorded $0.3 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $1.1 million of intangible assets which included $0.9 million of agency contracts with a weighted average useful life of 12 years, $0.2 million of licenses and permits with a weighted average useful life of 10 years, and $6 thousand of non-compete/non-solicit agreement with a useful life of 5 years.
AmeriServe International of Arizona, Inc.(“AmeriServe”). On June 30, 2014, the Company acquired the assets of AmeriServe for $0.4 million. AmeriServe is located in Arizona and provides group home services, day program services and related services to individuals with developmental disabilities. As a result of this acquisition, the Company recorded $0.1 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.3 million of intangible assets which included $0.2 million of agency contracts with a weighted average useful life of 12 years, $39 thousand of licenses and permits with a weighted average useful life of 10 years, and $12 thousand of non-compete/non-solicit agreement with a useful life of 5 years.
Other Acquisitions. The Company acquired the assets of Rose View Group Home, LLC. This acquisition is in the business of providing group home and related services to individuals with developmental disabilities and is included in our Human Services segment. Total cash consideration for this company was $0.2 million.
The following table summarizes the recognized amounts of identifiable assets acquired assumed at the date of the acquisition:
(in thousands)
Identifiable
intangible
assets
 
Property and
equipment
 
Total identifiable
net assets
 
Goodwill
Show-Me Health Care
$
895

 
$
9

 
$
904

 
$
336

Occazio
3,863

 
216

 
4,079

 
1,421

Ann Arbor
3,801

 
50

 
3,851

 
972

Tender Loving Care
2,396

 
16

 
2,412

 
538

G&D
1,086

 
102

 
1,188

 
312

AmeriServe
288

 
43

 
331

 
69

Other acquisitions
143

 
1

 
144

 
57

Total
$
12,472

 
$
437

 
$
12,909

 
$
3,705





13



Pro forma Results of Operations
The following table presents the unaudited pro forma financial results as if the fiscal 2015 and fiscal 2014 acquisitions had occurred on the first day of the period presented. The pro forma information presented below does not intend to indicate what the Company’s results of operations would have been if the acquisitions had in fact occurred at the beginning of the earliest period presented nor does it intend to be a projection of the impact on future results or trends. The Company has determined that the presentation of the results of operations for each of these acquisitions, from the date of acquisition, is impracticable due to the integration of the operations upon acquisition.
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
(in thousands)
2015
 
2014
 
2015
 
2014
Pro forma net revenues
$
346,997

 
$
328,800

 
$
1,029,420

 
$
967,578

Net income (loss)
652

 
2,316

 
1,501

 
(8,607
)

7. Goodwill and Intangible Assets
Goodwill
The changes in goodwill for the nine months ended June 30, 2015 are as follows (in thousands):
 
Human
Services
 
Post -Acute
Specialty
Rehabilitation
Services
 
Total
Balance as of September 30, 2014
$
190,658

 
$
66,974

 
$
257,632

Goodwill acquired through acquisitions
2,628

 
14,260

 
16,888

Balance as of June 30, 2015
$
193,286

 
$
81,234

 
$
274,520

Intangible Assets
Intangible assets consist of the following as of June 30, 2015 (in thousands):
Description
Weighted
Average
Amortization Period
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Intangible
Assets,
Net
Agency contracts
8 years

 
$
468,549

 
$
217,707

 
$
250,842

Non-compete/non-solicit
2 years

 
6,097

 
3,223

 
2,874

Relationship with contracted caregivers
1 year

 
7,520

 
6,727

 
793

Trade names
2 years

 
4,968

 
3,232

 
1,736

Trade names (indefinite life)

 
45,800

 

 
45,800

Licenses and permits
3 years

 
48,395

 
35,098

 
13,297

Intellectual property
1 year

 
452

 
393

 
59

 
 
 
$
581,781

 
$
266,380

 
$
315,401


14



Intangible assets consist of the following as of September 30, 2014 (in thousands):
Description
Weighted
Average
Amortization Period
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Intangible
Assets,
Net
Agency contracts
8 years

 
$
484,994

 
$
224,566

 
$
260,428

Non-compete/non-solicit
3 years

 
5,716

 
2,448

 
3,268

Relationship with contracted caregivers
2 years

 
10,963

 
9,013

 
1,950

Trade names
4 years

 
7,467

 
2,907

 
4,560

Trade names (indefinite life)

 
42,400

 

 
42,400

Licenses and permits
3 years

 
47,629

 
32,724

 
14,905

Intellectual property
2 years

 
904

 
689

 
215

 
 
 
$
600,073

 
$
272,347

 
$
327,726

Amortization expense for continuing operations was $9.9 million and $29.2 million for the three and nine months ended June 30, 2015, as compared to $9.7 million and $28.6 million for for the three and nine months ended June 30, 2014, respectively. There was no amortization expense for discontinued operations for the three and nine months ended June 30, 2015, as compared to $0.1 million and $0.2 million for the three and nine months ended June 30, 2014.
During the quarter ended June 30, 2015, the Company completed a review of its service line supporting at-risk youth that will result in the Company discontinuing ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas. These operations are included in the Human Services Segment. As a result, the Company recorded impairment charges of $0.2 million for relationships with contracted caregivers, $7.9 million for agency contracts, and $0.1 million of miscellaneous other intangibles. The total impairment charge of $8.2 million is included in depreciation and amortization expense for the three and nine months ended June 30, 2015. See Note 12 for further information about the decision to discontinue at-risk youth services in these states.
The estimated remaining amortization expense related to intangible assets with finite lives for the three months remaining in fiscal 2015 and each of the four succeeding years and thereafter is as follows:
(in thousands)
 
2015
$
9,524

2016
36,447

2017
32,755

2018
31,898

2019
31,593

Thereafter
127,384

Total
$
269,601


8. Related Party Transactions
Management Agreement
On February 9, 2011, the Company entered into an amended and restated management agreement with Vestar Capital Partners V, L.P. (“Vestar”) relating to certain advisory and consulting services for an annual management fee equal to the greater of (i) $850 thousand or (ii) an amount equal to 1.0% of the Company’s consolidated earnings before interest, taxes, depreciation, amortization and management fee for each fiscal year determined as set forth in the Company’s senior credit agreement. This agreement was terminated on September 22, 2014 in connection with the Company's initial public offering.
The Company recorded no management fees and expenses for the three months ended June 30, 2015 and $0.2 million of management fees and expenses for the nine months ended June 30, 2015, as compared to $0.3 million and $1.0 million for the three and nine months ended June 30, 2014. The $0.2 million of expense during the nine months ended June 30, 2015 relates to reimbursable expenses that were incurred prior to the termination of the management agreement. The accrued liability relating to such fees and expenses was $0.6 million at September 30, 2014 and $0.2 million at June 30, 2015.


15



Lease Agreements
The Company leases several offices, homes and other facilities from its employees, or from relatives of employees, primarily in the states of Minnesota, California and Wisconsin. These leases have various expiration dates extending out as far as December 2019. Related party lease expense was $0.2 million and $0.6 million for the three and nine months ended June 30, 2015, as compared to $0.3 million and $0.8 million for the three and nine months ended June 30, 2014.

9. Fair Value Measurements
The Company measures and reports its financial assets and liabilities on the basis of fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
A three-level hierarchy for disclosure has been established to show the extent and level of judgment used to estimate fair value measurements, as follows:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Significant other observable inputs (quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability).
Level 3: Significant unobservable inputs for the asset or liability. These values are generally determined using pricing models which utilize management estimates of market participant assumptions.
Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach, and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data. These unobservable inputs are only utilized to the extent that observable inputs are not available or cost-effective to obtain.
A description of the valuation methodologies used for instruments measured at fair value as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
The following table sets forth the Company’s assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2015.
(in thousands)
Total
 
Quoted
Market Prices
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Interest rate swap agreements

$
2,319

 
$

 
$
2,319

 
$

Liabilities
 
 
 
 
 
 
 
Contingent consideration
$
(8,817
)
 
$

 
$

 
$
(8,817
)
The following table sets forth the Company’s assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2014.
(in thousands)
Total
 
Quoted
Market Prices
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Money Market Funds
$
130,000

 
$
130,000

 
$

 
$

Liabilities
 
 
 
 
 
 
 
Contingent consideration
$
(2,400
)
 
$

 
$

 
$
(2,400
)

16



Money Market Funds. The Company’s money market funds are classified within Level 1 of the fair value hierarchy because they are valued using quoted prices in active markets for identical instruments.

Interest rate-swap agreements. The Company’s interest rate-swap agreements are classified within Level 2 of the fair value hierarchy. The fair value of the swap agreements was recorded in current assets (under prepaid expenses and other current assets) in the Company’s consolidated balance sheets. The fair value of these agreements was determined based on pricing models and independent formulas using current assumptions that included swap terms, interest rates and forward LIBOR curves and the Company’s credit risk.
Contingent Consideration. In connection with the acquisition of Mass Adult Day Health (“Adult Day Health”) in August 2014 and Cassell in January 2015, the Company recorded contingent consideration pertaining to the amounts potentially payable to the former owners of Adult Day Health and Cassell. The fair values of the Company's contingent consideration obligations are based on a probability-weighted approach derived from the overall likelihood of achieving certain performance targets. The resultant probability-weighted earn-out payments are discounted using a discount rate based upon the weighted-average cost of capital. The fair value measurement is based on significant inputs not observable in the market, which represent Level 3 inputs within the fair value hierarchy. The valuation of contingent consideration uses assumptions the Company believes would be made by a market participant. The Company assesses these estimates on an ongoing basis as additional data impacting the assumptions is obtained. Increases or decreases in the fair values of the contingent consideration obligations may result from changes in discount periods and rates, changes in the timing and amount of earn-out criteria and changes in probability assumptions with respect to the likelihood of achieving the various earn-out criteria. Changes in the fair value of contingent consideration related to updated assumptions and estimates are recognized in Other income (expense) within the consolidated statements of operations.
The following table presents a summary of changes in fair value of the Company’s Level 3 liabilities measured on a recurring basis for the nine months ended June 30, 2015.
 
Nine Months Ended
June 30, 2015
Balance at September 30, 2014
$
(2,400
)
Acquisition date fair value of contingent consideration obligations recorded
(6,100
)
Present value accretion
(317
)
Balance at June 30, 2015
$
(8,817
)

Items Measured at Fair Value on a Nonrecurring Basis. The Company’s intangible assets are measured at fair value on a nonrecurring basis using Level 3 inputs. During the three months ended June 30, 2015, certain intangible assets associated with the at-risk youth business with a carrying value of $8.2 million were written off because the Company determined the assets had no net realizable value. See Note 12 for further information about the decision to discontinue at-risk youth services in Florida, Louisiana, Indiana, North Carolina and Texas. The asset impairment charge of $8.2 million was recorded in amortization in the accompanying consolidated statement of operations. These adjustments were determined by comparing the projected future discounted cash flows to be provided from the intangible assets to the assets' carrying value.
At June 30, 2015 and September 30, 2014, the carrying values of cash, accounts receivable, accounts payable and variable rate debt approximated fair value.

10. Income Taxes
The Company’s effective income tax rate for the interim periods was based on management’s estimate of the Company’s annual effective tax rate for the applicable year. For the three and nine months ended June 30, 2015, the Company’s effective income tax rate was 46.1% and 45.0%, as compared to an effective tax rate of 94.9% and 29.9% for the three and nine months ended June 30, 2014, respectively. These rates differ from the federal statutory income tax rate primarily due to state income taxes, nondeductible permanent differences such as meals and nondeductible compensation, and net operating losses not benefited.

17



The Company files a federal consolidated return and files various state income tax returns and, generally, is no longer subject to income tax examinations by the taxing authorities for years prior to September 30, 2012. The Company did not have a reserve for uncertain income tax positions at June 30, 2015 and September 30, 2014. The Company does not expect any significant changes to unrecognized tax benefits within the next twelve months. The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits as charges to income tax expense.
11. Segment Information
The Company conducts its business through two reportable business segments: the Human Services Segment and the Post-Acute Specialty Rehabilitation Services (“SRS”) Segment.
Through the Human Services Segment, the Company primarily provides home and community-based human services to adults and children with intellectual and developmental disabilities (“I/DD”), and to youth with emotional, behavioral and/or medically complex challenges (“ARY”) 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 ASC Topic 280, Segment Reporting. Through the SRS Segment, the Company delivers 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. The NeuroRestorative operating group provides behavioral therapies to brain injured clients in post-acute community settings and the CareMeridian operating group provides a higher level of medical support to traumatically injured clients. These business units, which comprise two operating segments, have been aggregated based on the criteria set forth in ASC Topic 280, Segment Reporting. Each operating segment is aligned with the Company’s reporting structure and has a segment manager that is directly accountable for its operations and regularly reports results to the chief operating decision maker for the purpose of evaluating these results and making decisions regarding resource allocations.
The Company evaluates performance based on income from operations. Income from operations is revenue less operating expenses and is not affected by other income (expense) or by income taxes.
Activities classified as “Corporate” in the table below relate primarily to unallocated home office expenses.
The following table is a financial summary by reportable segments for the periods indicated (in thousands):
For the three months ended June 30,
Human Services
 
Post-Acute
Specialty
Rehabilitation
 Services
 
Corporate
 
Consolidated
2015
 
 
 
 
 
 
 
Net revenue
$
278,398

 
$
67,596

 
$

 
$
345,994

Income (loss) from operations
21,083

 
6,781

 
(16,349
)
 
11,515

Total assets
616,217

 
257,702

 
183,341

 
1,057,260

Depreciation and amortization
19,790

 
5,995

 
630

 
26,415

Purchases of property and equipment
5,800

 
4,200

 
599

 
10,599

Income (loss) from continuing operations before income taxes
14,126

 
5,022

 
(16,566
)
 
2,582

2014
 
 
 
 
 
 
 
Net revenue
$
259,194

 
$
58,995

 
$

 
$
318,189

Income (loss) from operations
25,269

 
4,512

 
(13,809
)
 
15,972

Depreciation and amortization
12,566

 
4,998

 
626

 
18,190

Purchases of property and equipment
4,715

 
4,206

 
992

 
9,913

Income (loss) from continuing operations before income taxes
11,669

 
1,317

 
(13,460
)
 
(474
)


18



For the nine months ended June 30,
Human Services
 
Post-Acute
Specialty
Rehabilitation
 Services
 
Corporate
 
Consolidated
2015
 
 
 
 
 
 
 
Net revenue
$
820,112

 
$
195,652

 
$

 
$
1,015,764

Income (loss) from operations
77,812

 
19,229

 
(51,031
)
 
46,010

Total assets
616,217

 
257,702

 
183,341

 
1,057,260

Depreciation and amortization
45,303

 
17,137

 
1,838

 
64,278

Purchases of property and equipment
15,803

 
12,162

 
2,345

 
30,310

Income (loss) from continuing operations before income taxes
40,183

 
10,665

 
(51,259
)
 
(411
)
2014
 
 
 
 
 
 
 
Net revenue
$
758,872

 
$
169,675

 
$

 
$
928,547

Income (loss) from operations
71,894

 
12,414

 
(40,213
)
 
44,095

Depreciation and amortization
34,689

 
14,021

 
1,884

 
50,594

Purchases of property and equipment
11,110

 
10,661

 
2,500

 
24,271

Income (loss) from continuing operations before income taxes
17,351

 
587

 
(42,123
)
 
(24,185
)
Revenue derived from contracts with state and local governmental payors in the state of Minnesota, the Company’s largest state, which is included in the Human Services segment, accounted for approximately 15% and 14% of the Company’s net revenue for the three months ended June 30, 2015 and 2014, respectively, and 15% and 14% for the nine months ended June 30, 2015 and 2014, respectively.

12. Disposition of Business

On June 23, 2015, following a six-month review of its service line supporting at-risk youth, the Company announced its decision to discontinue ARY services in the states of Florida, Louisiana, Indiana, North Carolina and Texas. These operations are included in the Human Services Segment. At the time of the decision, Management set a target date of September 30, 2015 to transition each child or adolescent served in the five states into the program of another provider, but is committed to work with its public partners to ensure that each transition is completed safely and with minimal disruption. In connection with the decision to discontinue these services the Company recorded an impairment charge of approximately $8.2 million for intangible assets associated with these businesses and expects to incur additional closures 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. The actual exit costs could ultimately be less, depending on whether another provider or providers purchase all or some of the programs, the new providers’ demand for employees and office space, and other factors.

The Company 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 closure of the disposal group does not represent a "strategic shift" and therefore has not been classified as discontinued operations for any of the periods presented. However, the Company has concluded that the disposal group was an individually significant disposal group. Pretax losses for this disposal group were $8.8 million and $11.1 million for the three and nine months ended June 30, 2015, respectively. The pretax loss included an intangible asset impairment charge of $8.2 million that was recorded in the current quarter.

13. Net Income (Loss) Per Share
Basic net income per common share is computed by dividing net income by the basic weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the diluted weighted average number of common shares and common equivalent shares outstanding during the period. The weighted average number of common equivalent shares outstanding has been determined in accordance with the treasury-stock method. Common equivalent shares consist of common stock issuable on the exercise of outstanding options and vesting of restricted stock units when dilutive.

19



The following table sets forth the computation of basic and diluted earnings per share (“EPS”):
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Numerator
 
 
 
 
 
 
 
Net income (loss)
$
550

 
$
5

 
$
(1,192
)
 
$
(16,875
)
Denominator
 
 
 
 
 
 
 
Weighted average shares outstanding, basic
36,950,000

 
25,250,000

 
36,950,000

 
25,250,000

Weighted average common equivalent shares
172,904

 

 

 

Weighted average shares outstanding, diluted
37,122,904

 
25,250,000

 
36,950,000

 
25,250,000

Net income (loss) per share, basic and diluted
$
0.01

 
$

 
$
(0.03
)
 
$
(0.67
)
Equity instruments excluded from diluted net income (loss) per share calculation as the effect would have been anti-dilutive:
 
 
 
 
 
 
 
Stock options
571,491

 

 
567,664

 

Restricted stock units

 

 
570,601

 


For each of the periods presented above for which the Company incurred a net loss the outstanding stock options and restricted stock units have an anti-dilutive effect and therefore all awards have been excluded from the diluted weighted average shares outstanding. Accordingly, basic and diluted weighted average shares for those periods are equal. During the three and nine months ended June 30, 2014, there were no common share equivalents outstanding.

14. Accruals for Self-Insurance
The Company maintains insurance for professional and general liability, workers’ compensation liability, automobile liability and health insurance liabilities that includes self-insured retentions. The Company intends to maintain such coverage in the future and is of the opinion that its insurance coverage is adequate to cover potential losses on asserted claims. Employment practices liability is fully self-insured.
The Company records 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, and professional and general liability programs are based on analyses performed by management and take into account reports by independent third parties. Accruals are periodically reevaluated and increased or decreased based on new information.
For professional and general liability, from October 1, 2011 to September 30, 2013, the Company was self-insured for the first $4.0 million of each and every claim with no aggregate limit. Commencing October 1, 2013, the Company has been self-insured for $4.0 million per claim and $28.0 million in the aggregate.
For workers’ compensation, the Company has a $350 thousand per claim retention with statutory limits. Automobile liability has a $100 thousand per claim retention, with additional insurance coverage above the retention. The Company purchases specific stop loss insurance as protection against extraordinary claims liability for health insurance claims. Stop loss insurance covers claims that exceed $300 thousand on a per member basis per year.
The Company reports its self-insurance liabilities on a gross basis without giving effect to insurance recoveries. Anticipated insurance recoveries are presented in Prepaid expenses and other current assets and Other assets on the Company’s consolidated balance sheets. Self-insured liabilities are presented in accrued payroll and related costs, other accrued liabilities and other long-term liabilities on its consolidated balance sheets.

20



15. Other Commitments and Contingencies
The Company is in the health and human services business and, therefore, has been and continues to be subject to numerous claims alleging that the Company, its employees or its independently contracted host-home caregivers (“Mentors”) failed to provide proper care for a client. The Company is also subject to claims by its clients, its employees, its Mentors or community members against the Company for negligence, intentional misconduct or violation of applicable laws. Included in the Company’s recent claims are claims alleging personal injury, assault, abuse, wrongful death and other charges. Regulatory agencies may initiate administrative proceedings alleging that the Company’s programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on the Company. The Company could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if the Company does not prevail, the Company could be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.
The Company is also 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 the Company is found to have violated the False Claims Act, it 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.
The Company is also subject to employee-related claims under state and federal law, including claims for discrimination, wrongful discharge or retaliation; claims for wage and hour violations under the Fair Labor Standards Act or state wage and hour laws.

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2014, as well as our reports on Form 8-K and other publicly available information. This discussion may contain forward-looking statements about our markets, the demand for our services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons, including those discussed in the “Risk Factors” and “Forward-Looking Statements” sections of this report.
Overview
We are 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 nearly 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 (“Adult Day Services”). 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

21



operating segments, have been aggregated based on the criteria set forth in the accounting standards. Each operating segment is aligned with the Company’s reporting structure and has a segment manager that is directly accountable for its operations and regularly reports results to the chief operating decision maker for the purpose of evaluating these results and making decisions regarding resource allocations.
Delivery of services to individuals with I/DD is the largest portion of our Human Services segment. Our I/DD programs include residential support, day habilitation, vocational services, case management, crisis intervention and hourly support care. Our Human Services segment also includes the delivery of ARY services. Our ARY programs include therapeutic foster care, family preservation, adoption services, early intervention, school-based services and juvenile offender programs. Within our SRS segment, our NeuroRestorative business unit is focused on rehabilitation and transitional living services and our CareMeridian business unit is focused on the more medically-intensive post-acute care services. Our SRS services range from sub-acute healthcare for individuals with intensive medical needs to day treatment programs, and include: neurorehabilitation; neurobehavioral rehabilitation; specialized nursing; physical, occupational and speech therapies; supported living; outpatient treatment; and pre-vocational services.

Factors Affecting our Operating Results

Demand for Home and Community-Based Health and Human Services
Our growth in revenue has historically been related to increases in the number of individuals served as well as increases in the rates we receive for our services. This growth has depended largely upon development-driven activities, including the maintenance and expansion of existing contracts and the award of new contracts, our new start program and acquisitions. We also attribute the long-term growth in our client base to certain trends that are increasing demand in our industry, including demographic, health-care and political developments.


22



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. Our residential ARY services were negatively impacted by a substantial decline in the number of children and adolescents in foster care placements during the last decade, although the population has stabilized in recent years.  This decline has contributed to increased demand for periodic, non-residential services to support at-risk youth and their families. However, notwithstanding the increased demand for periodic services, during the past two fiscal years payor demand in the state of North Carolina for periodic ARY services has significantly contracted as a result of a statewide redesign of these programs and, as a result, negatively impacted our business in that state. 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.
Political and economic trends can also affect our operations. Budgetary pressures facing state governments, especially within Medicaid programs, as well as other economic, industry and political factors could cause state governments to limit spending, which could significantly reduce our revenue, referrals, margins and profitability, and adversely affect our growth strategy. Government agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If the government agency does not receive an appropriation sufficient to cover its obligations with us, it may terminate a contract or defer or reduce our reimbursements. For example, during the economic downturn that began in 2008, our government payors in several states responded to deteriorating revenue collections by implementing service reductions, rate freezes and/or rate reductions. Beginning in fiscal 2012, the rate environment improved and, as a result, for fiscal years 2012, 2013 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 three months ended June 30, 2015 and 2014, new starts generated operating losses of $1.4 million and $1.8 million, respectively, and operating income of $0.7 million and $0.5 million, respectively. 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 2010 through June 30, 2015, we have completed 46 acquisitions, including several acquisitions of rights to government contracts or fixed assets from small providers, which we have integrated with our existing

23



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 certain assets of ten companies complementary to our business for total fair value consideration of $44.8 million, including $6.1 million of contingent consideration.
During the nine months ended June 30, 2014, we acquired certain assets of seven companies complementary to our business for total cash consideration of $16.6 million of which $1.5 million was paid in July 2014 .
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 DCFS 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 three 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. Management has a target date of September 30, 2015 to transition each child or adolescent served in the five states into the program of another provider, but is committed to work with its public partners to ensure that each transition is completed safely and with minimal disruption. During the quarter ended June 30, 2015, we recorded an impairment charge of $8.2 million for intangible assets owned by the business units. We expect to incur additional exit costs associated with these planned closures of up to $1.9 million for termination benefits and up to $4.8 million for lease termination costs. The actual exit costs could ultimately be less, depending on whether another provider or providers purchase all or some of the programs, the new providers’ demand for employees and office space, and other factors.
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 three and nine months ended June 30, 2015, we derived 89% of our net revenue from contracts with state, local and other government payors and 11% of our net revenue from non-public payors, as compared to 90% of our net revenue from contracts with state, local and other government payors and 10% of our net revenue from non-public payors during the three and 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.

24



Average Daily Rate: A mathematical calculation derived by dividing the gross residential revenue by the residential census and the resulting quotient by the number of days during the respective period.
Non-Residential Billable Units: The hourly equivalent of non-residential services provided.
Average Billable Unit Rate: Gross non-residential revenue divided by the billable units provided during the period.

A comparative summary of gross revenues by service line and our key metrics is as follows (dollars in thousands, except for daily and billable unit rates):
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
2015
 
2014
 
2015
 
2014
I/DD Services
 
 
 
 
 
 
 
Gross Revenues
$
227,942

 
$
212,034

 
$
668,883

 
$
619,087

Average Residential Census
7,926

 
7,495

 
7,818

 
7,369

Average Daily Rate
$
234.96

 
$
229.93

 
$
233.64

 
$
228.16

Non-Residential Billable Units
3,210,055

 
2,954,615

 
9,342,956

 
8,543,140

Average Non-Residential Billable Unit Rate
$
18.22

 
$
18.69

 
$
18.22

 
$
18.74

Gross Revenue Growth %
7.5
 %
 
 
 
8.0
 %
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
6.5
 %
 
 
 
6.9
 %
 
 
Average Rate Growth
1.0
 %
 
 
 
1.1
 %
 
 
At-Risk Youth Services
 
 
 
 
 
 
 
Gross Revenues
$
49,381

 
$
51,724

 
$
147,772

 
$
153,181

Average Residential Census
3,434

 
3,841

 
3,594

 
3,858

Average Daily Rate
$
111.33

 
$
102.43

 
$
106.81

 
$
100.47

Non-residential Billable Units
171,810

 
185,494

 
506,970

 
549,223

Average Non-Residential Billable Unit Rate
$
84.92

 
$
85.85

 
$
84.78

 
$
86.24

Gross Revenue Growth %
(4.5
)%
 
 
 
(3.5
)%
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
(9.6
)%
 
 
 
(7.1
)%
 
 
Average Rate Growth
5.1
 %
 
 
 
3.6
 %
 
 
Specialty Rehabilitation Services
 
 
 
 
 
 
 
Gross Revenues
$
68,663

 
$
59,938

 
$
197,845

 
$
172,256

Average Residential Census
1,193

 
1,076

 
1,166

 
1,053

Average Daily Rate
$
611.78

 
$
612.20

 
$
608.74

 
$
599.24

Non-residential Billable Units
35,734

 

 
66,779

 

Average Non-Residential Billable Unit Rate
$
63.52

 
 
 
$
62.17

 
 
Gross Revenue Growth %
14.6
 %
 
 
 
14.9
 %
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
14.7
 %
 
 
 
13.1
 %
 
 
Average Rate Growth
(0.1
)%
 
 
 
1.8
 %
 
 
Expenses
During the second quarter of fiscal 2015, we revised the presentation of our expenses and operating margin as percentage of revenue. The calculations of our costs categories and operating margin as a percentage of revenue 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.
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.

25



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% and 0.7% of gross revenue for the three and nine months ended June 30, 2015, respectively, as compared to 0.8% and 0.8% for the three and nine months ended June 30, 2014, respectively. We incurred professional and general liability expenses of $2.8 million and $7.7 million for the three and nine months ended June 30, 2015, as compared to $2.6 million and $7.9 million for the three and nine months ended June 30, 2014. These expenses are incurred in connection with our claims reserve and insurance premiums. In the past, increased costs of insurance and claims have negatively impacted our results of operations which resulted in a renewed emphasis on reducing the occurrence of claims. Although insurance premiums did not increase in fiscal 2014 and 2015, they have increased in prior years and may increase in the future.
Results of Operations

The following table sets forth our consolidated results of operations as a percentage of total gross revenues for the periods indicated.
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
2015

2014
 
2015
 
2014
Gross revenue
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Sales adjustments
(1.4
)%
 
(1.7
)%
 
(1.2
)%
 
(1.7
)%
Net revenue
98.6
 %

98.3
 %
 
98.8
 %
 
98.3
 %
Cost of revenue (exclusive of depreciation expense shown below)

76.5
 %

76.5
 %
 
76.4
 %
 
76.8
 %
Operating expenses:
 
 
 
 
 
 
 
General and administrative
11.3
 %

11.3
 %
 
11.6
 %
 
11.4
 %
Depreciation and amortization
7.5
 %

5.6
 %
 
6.2
 %
 
5.4
 %
Total operating expense
18.8
 %

16.9
 %
 
17.8
 %
 
16.8
 %
Income from operations
3.3
 %

4.9
 %
 
4.6
 %
 
4.7
 %
Other income (expense):
 
 
 
 
 
 
 
Management fee of related party
 %

(0.1
)%
 
 %
 
(0.1
)%
Other income (expense), net
(0.1
)%

 %
 
 %
 
0.1
 %
Extinguishment of debt
 %

 %
 
(1.7
)%
 
(1.6
)%
Interest expense
(2.4
)%

(5.0
)%
 
(2.9
)%
 
(5.6
)%
Income (loss) from continuing operations before income taxes
0.8
 %

(0.2
)%
 
 %
 
(2.5
)%
Expense (benefit) for income taxes
0.3
 %

(0.1
)%
 
 %
 
(0.8
)%
Income (loss) from continuing operations
0.5
 %

(0.1
)%
 
 %
 
(1.7
)%
(Loss) gain from discontinued operations, net of tax
(0.2
)%

 %
 
(0.1
)%
 
 %
Net income (loss)
0.3
 %

(0.1
)%
 
(0.1
)%
 
(1.7
)%





26



Three Months Ended June 30, 2015 and 2014
Consolidated Overview
 
Three Months Ended June 30,


Increase
(Decrease)
 
2015

2014

Gross revenue
$
351,062


$
323,696


$
27,366

Sales adjustments
(5,068
)

(5,507
)

439

Net revenue
345,994


318,189


27,805

Income from operations
$
11,515


$
15,972


$
(4,457
)
Operating margin
3.3
%

4.9
%

(1.6
)%
Consolidated gross revenue for the three months ended June 30, 2015 increased by $27.4 million, or 8.5%, compared to gross revenue for the three months ended June 30, 2014. Sales adjustments as a percentage of gross revenue decreased by 0.3% from 1.7% during three months ended June 30, 2014 to 1.4% during three months ended June 30, 2015. The decrease was the result of improvements in authorization management, claims processing, and collections. Gross revenue increased $11.5 million from organic growth, including growth related to new programs, and $15.9 million from acquisitions that closed during and after the three months ended June 30, 2014. Our Human Services segment contributed 59.5% of the organic revenue growth with the remaining 40.5% contributed by our SRS segment.
Consolidated income from operations was $11.5 million for three months ended June 30, 2015 compared to $16.0 million for the three months ended June 30, 2014. Income from operations decreased from 4.9% of gross revenue for the three months ended June 30, 2014 to 3.3% of gross revenue for the three months ended June 30, 2015. The decrease in our operating margin as a percentage of gross revenue was primarily due to an intangible asset impairment charge of $8.2 million related to the planned closures of our at-risk youth operations in five states and an increase of $1.3 million in stock-based compensation expense. Management has set a target date of September 30, 2015 to transition each child or adolescent served in the five states into the program of another provider, but is committed to work with its public partners to ensure that each transition is completed safely and with minimal disruption. The decrease was partially offset by lower expense in the self insured portion of our employee health and other insurance plans compared to the same period of the prior year.
Revenues by segment

The following table sets forth revenue for the Human Services segment for the periods indicated (in thousands):
 
Three Months Ended June 30,
 

Increase
(Decrease)
 
Percentage
Increase
(Decrease)
 
2015
 
2014
 
 
I/DD gross revenue
$
227,942

 
$
212,034

 
$
15,908

 
7.5
 %
ARY gross revenue
49,381

 
51,724

 
(2,343
)
 
(4.5
)%
Adult Day Services gross revenue
5,076

 

 
5,076

 
NM

Total Human Services gross revenue
282,399

 
263,758

 
18,641

 
7.1
 %
Sales adjustments
(4,001
)
 
(4,564
)
 
 
 
 
Sales adjustments as a percentage of gross revenue
(1.4
)%
 
(1.7
)%
 
 
 
 
Total Human Services net revenue
$
278,398

 
$
259,194

 
$
19,204

 
7.4
 %
Human Services gross revenue for the three months ended June 30, 2015 increased by $18.6 million, or 7.1%, compared to the three months ended June 30, 2014. The increase in gross revenue was driven by a $15.9 million increase in I/DD gross revenue while ARY gross revenue decreased by $2.3 million compared to the three months ended June 30, 2014. Gross revenue for Adult Day Services, which was acquired in the fourth quarter of fiscal 2014, was $5.1 million.
The increase in I/DD gross revenue included $9.1 million from organic growth and $6.8 million from acquisitions that closed during and after the three months ended June 30, 2014. The organic growth was the result of a 3.7% increase in volume coupled with a 0.8% increase in average billing rates for the three months ended June 30, 2015 compared to the three months ended June 30, 2014.


27



The $2.3 million decrease in ARY gross revenue was due to a 9.6% decrease in volume partially offset by a 5.1% increase in the average billing rate compared to the three 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 in Illinois due to the closure of our ARY operations during the current quarter. These reductions resulted in a decrease of $3.5 million in gross revenue.
Sales adjustments for the three months ended June 30, 2015 decreased by $0.6 million, or 0.3% of gross revenue, compared to the three months ended June 30, 2014. The decrease was the result of improvements in authorization management, claims processing, and collections.

The following table sets forth revenue for the SRS segment for the periods indicated (in thousands):
 
Three Months Ended June 30,
 

Increase
(Decrease)
 
Percentage
 Increase
(Decrease)
 
2015
 
2014
 
 
SRS gross revenue
$
68,663

 
$
59,938

 
$
8,725

 
14.6
%
Sales adjustments
(1,067
)
 
(943
)
 
 
 
 
Sales adjustments as a percentage of gross revenue
(1.6
)%
 
(1.6
)%
 
 
 
 
SRS net revenue
$
67,596

 
$
58,995

 
$
8,601

 
14.6
%
The SRS segment’s gross revenue for the three months ended June 30, 2015 increased by $8.7 million, or 14.6%, compared to the three months ended June 30, 2014. The increase included $4.6 million from organic growth and $4.1 million from acquisitions that closed during and after the three months ended June 30, 2014. The organic growth was driven by an increase in volume of 6.0% and an increase in the average billing rate of 1.9%. The increase in volume was driven by lower levels of open occupancy 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):
 
Three Months Ended June 30,
 
 
 
 
 
2015
 
2014
 
 
 
Change in %
of gross
revenue
 
Amount
 
% of gross
revenue
 
Amount
 
% of gross
revenue
 
Increase
(Decrease)
 
Direct labor costs
$
179,443

 
63.5
%
 
$
166,956

 
63.3
%
 
$
12,487

 
0.2
 %
Client program costs
11,135

 
3.9
%
 
10,387

 
3.9
%
 
748

 
 %
Client occupancy costs
16,193

 
5.7
%
 
13,586

 
5.2
%
 
2,607

 
0.5
 %
Travel & transportation costs
7,412

 
2.6
%
 
7,399

 
2.8
%
 
13

 
(0.2
)%
Other direct costs
5,421

 
1.9
%
 
5,711

 
2.2
%
 
(290
)
 
(0.3
)%
Total cost of revenues
$
219,604

 
77.6
%
 
$
204,039

 
77.4
%
 
$
15,565

 
0.2
 %
Human Services cost of revenues for the three months ended June 30, 2015 increased as a percentage of gross revenue by 0.2%, as compared to the three months ended June 30, 2014. This was primarily due to an increase in direct labor costs of 0.2% and an increase in client occupancy costs of 0.5%, partially offset by decreases in other direct costs. The increase in direct labor costs as a percentage of gross revenue was primarily due to higher amounts of overtime pay compared to the three months ended June 30, 2014, partially offset by lower expense in the self-insured portion of employee health insurance plans . The increase in client occupancy costs as a percentage of gross revenue was due to increased rent and programs with higher levels of excess capacity. The decrease in other direct costs as a percentage of gross revenue was primarily due to lower expense for workers' compensation expense during the three months ended June 30, 2015.

28




The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2015
 
2014
 
 
 
Change in %
of gross
revenue
 
Amount
 
% of gross
revenue
 
Amount
 
% of gross
revenue
 
Increase
(Decrease)
 
Direct labor costs
$
34,466

 
50.2
%
 
$
30,607

 
51.1
%
 
$
3,859

 
(0.9
)%
Client program costs
4,714

 
6.9
%
 
4,363

 
7.3
%
 
351

 
(0.4
)%
Client occupancy costs
7,463

 
10.9
%
 
6,507

 
10.9
%
 
956

 
 %
Travel & transportation costs
862

 
1.3
%
 
801

 
1.3
%
 
61

 
 %
Other direct costs
1,147

 
1.7
%
 
1,114

 
1.9
%
 
33

 
(0.2
)%
Total cost of revenues
$
48,652

 
71.0
%
 
$
43,392

 
72.5
%
 
$
5,260

 
(1.5
)%
SRS segment’s cost of revenues for the three months ended June 30, 2015 decreased as a percentage of gross revenue by 1.5% as compared to the three months ended June 30, 2014. The decrease was primarily due to a decrease in direct labor costs of 0.9% and a decrease in client program costs of 0.4%. 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 open occupancy.
Consolidated operating expenses

General and administrative and depreciation and amortization expense were as follows (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2015
 
2014
 
 
 
Change in %
of gross
revenue
 
Amount
 
% of gross
revenue
 
Amount
 
% of gross
revenue
 
Increase
(Decrease)
 
General and administrative
$
39,671

 
11.3
%
 
$
36,448

 
11.3
%
 
$
3,223

 
%
Depreciation and amortization
26,415

 
7.5
%
 
18,190

 
5.6
%
 
8,225

 
1.9
%
Total operating expense
$
66,086

 
18.8
%
 
$
54,638

 
16.9
%
 
$
11,448

 
1.9
%
General and administrative expenses for the three months ended June 30, 2015 increased by $3.2 million, or 8.8%, as compared to the three months ended June 30, 2014. As a percentage of gross revenue, general and administrative expenses were consistent during the three months ended June 30, 2015 and 2014.
Depreciation and amortization expense increased as a percentage of gross revenue by 1.9% as compared to the three months ended June 30, 2014. The increase in depreciation and amortization expense as a percentage of gross revenue is primarily due to an intangible asset impairment charge of $8.2 million related to the planned closures of our at-risk youth operations in five states. Management has set a target date of September 30, 2015 to transition each child or adolescent served in the five states into the program of another provider, but is committed to work with its public partners to ensure that each transition is completed safely and with minimal disruption.
Other (income) expense
Management fee of related party: Management fee decreased $0.3 million during the three months ended June 30, 2015 as compared to the three 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.
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 $0.1 million during the three months ended June 30, 2014 to expense of $0.4 million during the three months ended June 30, 2015.
Interest expense: Interest expense decreased by $7.7 million during the three months ended June 30, 2015 as compared to the three months ended June 30, 2014 due to a lower interest expense as a result of the redemption of $162.0 million and $50.0 million of senior notes on October 17, 2014, and March 4, 2015, respectively.

29



Benefit for income taxes
For the three months ended June 30, 2015, our effective income tax rate was 46.1% compared to an effective tax rate of 94.9% for the three months ended June 30, 2014. The Company applies a forecasted annual effective tax rate to the year-to-date income (loss) from continuing operations before income taxes to calculate its year-to-date and quarterly tax provisions. The higher effective tax rate during the three months ended June 30, 2014 was due to the catch-up of the change in our year-to-date effective tax rates and a minimal change in loss from continuing operations before income taxes.
Nine Months Ended June 30, 2015 and 2014
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

Net revenue
1,015,764

 
928,547

 
87,217

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 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 closures 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)
 
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
)%
Adult Day Services gross revenue
13,998

 

 
13,998

 
NM

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
)%