|Edgar Online, Inc.|
This Management's Discussion and Analysis (MD&A) section is intended to help the reader understand ResCare's financial performance and condition. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes. All references in this MD&A to "ResCare", "Company", "our company", "we", "us", or "our" mean
Res-Care, Inc.and, unless the context otherwise requires, its consolidated subsidiaries. The individual sections of MD&A are:
† Onex Transaction - a description of the purchase of ResCare common stock by Onex.
† † Our Business-a general description of our business and revenue sources. †
† Application of Critical Accounting Policies- a discussion of accounting policies that require critical judgments and estimates.
† Results of Operations-an analysis of our consolidated results of operations for the periods presented including analysis of our operating segments.
† Financial Condition, Liquidity and Capital Resources- an analysis of cash flows, sources and uses of cash and financial position.
† Contractual Obligations and Commitments - a tabular presentation of our contractual obligations and commitments for future periods.
As more fully described in Note 2 of the Notes to Consolidated Financial Statements, on
This change of control resulted in a new basis of accounting under the
Financial Accounting Standards Board(FASB) Accounting Standards Codification (ASC) 805, Business Combinations (previously Statement of Financial Accounting Standards No. 141R). This change creates many differences between reporting for ResCare post-acquisition, as successor, and ResCare pre-acquisition, as predecessor. The accompanying Consolidated Financial Statements and the Notes to Consolidated Financial Statements reflect periods ended December 31, 2011and December 31, 2010as successor and November 15, 2010and December 31, 2009as predecessor. As a result of the following transactions on December 22, 2010, ResCare became a wholly owned subsidiary of Onex Rescare Holdings Corp.(" ResCare Holdings"), which in turn, is owned by the Onex Investors, certain co-investors and members of our management team: † † ResCare entered into new senior secured credit facilities, comprised of a new $170 millionterm loan facility and an amended and restated $275 millionrevolving credit facility; †
† ResCare issued
† ResCare repurchased
$120 million(approximately 80%) aggregate principal amount of its 7.75% Senior Notes due 2013 in a tender offer, and the $30 millionaggregate principal amount of 7.75% Senior Notes not tendered was satisfied and discharged by delivering to the trustee amounts sufficient to pay the applicable redemption price, plus accrued and unpaid interest up to the January 21, 2011redemption date; † † Purchaser completed the acquisition of all of the publicly held common shares of ResCare through a second-step share exchange transaction, whereby each outstanding share of ResCare common stock not currently held by Onex Investorsor by members of management was exchanged for the right to receive $13.25in cash (a total of $56.9 million); 34 --------------------------------------------------------------------------------
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† Purchaser redeemed preferred membership interests held by certain of the
Onex Investorsfor an amount equal to the contributions ( $158.8 million) made by them in respect of the purchase of such interests plus the accrued preferred return ( $0.8 million) on such interests through the redemption date; and
† The holders of equity interests in Purchaser and of ResCare stock contributed those holdings to
Our Business We receive revenues primarily from the delivery of residential, training, educational and support services to various populations with special needs. Our programs include an array of services provided in both residential and non-residential settings for adults and youths with intellectual, cognitive or other developmental disabilities, and youths who have special educational or support needs, are from disadvantaged backgrounds, or have severe emotional disorders, including some who have entered the juvenile justice system. We also offer, through drop-in or live-in services, personal care, meal preparation, housekeeping, transportation and some skilled nursing care to the elderly in their own homes. Additionally, we provide services to transition welfare recipients, young people and people who have been laid off or have special barriers to employment into the workforce and become productive employees. Effective
January 1, 2011, we changed our reportable operating segments to: (i) Residential Services, (ii) ResCare HomeCare, (iii) Youth Services and (iv) Workforce Services. Residential Services primarily includes services for individuals with intellectual, cognitive or other developmental disabilities in our community home settings. ResCare HomeCare primarily includes periodic in-home care services to the elderly, as well as persons with disabilities. Youth Services consists of our Job Corpscenters, a variety of youth programs including foster care, alternative education programs and charter schools. Workforce Services is comprised of job training and placement programs that assist welfare recipients and disadvantaged job seekers in finding employment and improving their career prospects. We believe the changes in our segments will allow us to serve our customers more efficiently and allow future growth and long-term sustainability. Further information regarding our segments is included in Note 10 of the Notes to Consolidated Financial Statements. Revenues for our Residential Services operations are derived primarily from state Medicaidprograms, other government agencies, commercial insurance companies and from management contracts with private operators, generally not-for-profit providers, who contract with state government agencies and are also reimbursed under the Medicaidprogram. Our services include social, functional and vocational skills training, supported employment and emotional and psychological counseling for individuals with intellectual or other disabilities. We also provide respite, therapeutic and other services to individuals with special needs and to older people in their homes. These services are provided on an as-needed basis or hourly basis through our periodic in-home services programs that are reimbursed on a unit-of-service basis. Reimbursement varies by state and service type, and may be based on a variety of methods including flat-rate, cost-based reimbursement, per person per diem, or unit-of-service basis. Rates are periodically adjusted based upon state budgets or economic conditions and their impact on state budgets. At programs where we are the provider of record, we are directly reimbursed under state Medicaidprograms for services we provide and such revenues are affected by occupancy levels. At most programs that we operate pursuant to management contracts, the management fee is negotiated with the provider of record. Through ResCare HomeCare, we also provide in-home services to seniors on a private pay basis. We are concentrating growth efforts in the home care private pay business to further diversify our revenue streams. We operate vocational training centers under the federal Job Corpsprogram administered by the Department of Labor(DOL) through our Youth Services operations. Under Job Corpscontracts, we are reimbursed for direct costs of services related to Job Corpscenter operations, allowable indirect costs for general and administrative costs, plus a predetermined management fee. The management fee takes the form of a fixed contractual amount plus a computed amount based on certain performance criteria. All of such amounts are reflected as revenue, and all such direct costs are reflected as cost of services. Final determination of amounts due under Job Corpscontracts is subject to audit and review by the DOL, and renewals and extension of Job Corpscontracts are based in part on performance reviews. We operate job training and placement programs that assist disadvantaged job seekers in finding employment and improving their career prospects through our Workforce Services operations. These programs are administered under contracts with local and state governments. We are typically reimbursed for direct costs of services related to the job training centers, allowable indirect costs plus a fee for profit. The fee can take the form of a fixed contractual amount (rate or price) or be 35
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computed based on certain performance criteria. The contracts are funded by federal agencies, including the
Application of Critical Accounting Policies
Our discussion and analysis of the financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts and related disclosures of commitments and contingencies. We rely on historical experience and on various other assumptions that we believe to be reasonable under the circumstances to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe the following critical accounting policies involve the more significant judgments and estimates used in the preparation of our Consolidated Financial Statements. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee.
Valuation of Accounts Receivable
Accounts receivable consist primarily of amounts due from
Medicaidprograms, other government agencies and commercial insurance companies. An estimated allowance for doubtful accounts receivable is recorded to the extent it is probable that a portion or all of a particular account will not be collected. In evaluating the collectibility of accounts receivable, we consider a number of factors, including historical loss rates, age of the accounts, changes in collection patterns, the status of ongoing disputes with third-party payors, general economic conditions and the status of state budgets. Complex rules and regulations regarding billing and timely filing requirements in various states are also a factor in our assessment of the collectibility of accounts receivable. Actual collections of accounts receivable in subsequent periods may require changes in the estimated allowance for doubtful accounts. Changes in these estimates are charged or credited to the results of operations in the period of the change of estimate. Insurance Losses We self-insure a substantial portion of our professional, general and automobile liability, workers' compensation and health benefit risks. These liabilities are necessarily based on estimates and, while we believe that the provision for loss is adequate, the ultimate liability may be more or less than the amounts recorded. Provisions for losses for workers' compensation risks are based upon actuarially determined estimates and include an amount determined from reported claims and an amount based on past experiences for losses incurred but not reported. Estimates of workers' compensation claims reserves have been discounted using a discount rate of 3% at December 31, 2012and 2011, respectively. The liabilities are reviewed quarterly and any adjustments are reflected in earnings in the period known. Legal Contingencies We are party to numerous claims and lawsuits with respect to various matters. The material legal proceedings in which ResCare is currently involved are described in Item 3 of this report and Note 16 to the Consolidated Financial Statements. We provide for costs related to contingencies when a loss is probable and the amount is reasonably determinable. We confer with outside counsel in estimating our potential liability for certain legal contingencies. While we believe our provision for legal contingencies is adequate, the outcome of legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that exceed our estimates.
Valuation of Long-Lived Assets
We regularly review the carrying value of long-lived assets with respect to any events or circumstances that indicate a possible inability to recover their carrying amount. Indicators of impairment include, but are not limited to, loss of contracts, significant census declines, reductions in reimbursement levels, significant litigation and impact of economic conditions on service demands and levels. Our evaluation is based on cash flow, profitability and projections that incorporate current or projected operating results, as well as significant events or changes in the reimbursement and regulatory environment. If circumstances suggest the recorded amounts cannot be recovered, the carrying values of such assets are reduced to fair value based upon various techniques to estimate fair value. 36
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Goodwill and Other Indefinite-Lived Intangible Assets
With respect to businesses we have acquired, we evaluate the costs of purchased businesses in excess of net assets acquired (goodwill) for impairment at least annually, unless significant changes in circumstances indicate a potential impairment may have occurred sooner. Our annual impairment test date is
October 1. We are required to test goodwill on a reporting unit basis. We use a fair value approach to test goodwill for impairment and recognize an impairment charge for the amount, if any, by which the carrying amount of reporting unit goodwill exceeds its implied fair value. Fair values for goodwill are typically determined using an income approach (using discounted cash flow analysis method) or a market approach (using the guideline company method or the guideline transactions method), or it can be based on a weighted average of all or a combination of these methods. Due to limited comparability to our reporting units of the comparable guideline companies and limited financial information available surrounding the transactions for companies sold, we utilized the discounted cash flow analysis to establish fair values in our 2012 annual impairment test. The goodwill impairment test is a two-part test. Step One of the impairment test compares the fair values of each of our reporting units to their carrying value. If the fair value is less than the carrying value for any of our reporting units, Step Two must be completed. Fair values for indefinite-lived intangible assets are measured using the cost approach. Discounted cash flow computations depend on a number of key assumptions including estimates of future market growth and trends, forecasted revenue and costs, expected periods the assets will be utilized, appropriate discount rates and other variables. We base our fair value estimates on assumptions we believe to be reasonable, including recent historical performance and sales growth and margin improvement that we believe a buyer would assume when determining a purchase price for the reporting units. but which are unpredictable and inherently uncertain. Actual future results may differ from those estimates. In addition, we make certain judgments about the selection of comparable companies used in determining market multiples in valuing our reporting units (not used in 2012 valuation due to limited comparability of companies to our reporting units), as well as certain assumptions to allocate shared assets and liabilities to calculate values for each of our reporting units. At December 31, 2012, we had approximately $287.2 millionof goodwill and $226.7 millionof other indefinite-lived intangible assets. Goodwill at December 31, 2012, reflects the excess purchase price from the acquisition as described in Note 2 of the Consolidated Financial Statements plus goodwill recorded from acquisitions completed after the predecessor period ended November 15, 2010. Other indefinite-lived intangible assets include licenses that are essential for ResCare to operate its businesses in various states and other jurisdictions. Goodwill and other indefinite-lived intangible assets are not amortized. For our October 1, 2012annual impairment test, we used a 2% long-term terminal growth rate for all reporting units tested. We also used 13%, 14%, 17%, 16% and 13% for our Residential Services, ResCare HomeCare, Workforce Services, Youth Services-Job Corpsand Youth Services-Residential Youth reporting units, respectively, for discount rates. All reporting units passed Step One. The Youth Services-Residential Youth reporting unit only passed Step One with a fair value that exceeded its carrying value by a 15 percent margin. The Youth Services-Residential Youth reporting unit had a goodwill balance of $10.3 millionas of October 1, 2012. A 100 basis point increase in the discount rate for this reporting unit would decrease the fair value in excess of carrying value to a 5 percent margin. A 100 basis point decrease in the long-term growth rate would decrease the fair value in excess of carrying value to a 9 percent margin for this reporting unit. In February 2012, we were informed by the New York Human Resources Administrationthat our Workforce Services' Wellness, Comprehensive Assessment, Rehabilitation and Employment ("WeCARE") contract had been awarded to another operator through the competitive bid process. Annual revenues for this contract were approximately $28 million. Our formal protest was denied. During the three months ended March 31, 2012, we considered the loss of the WeCARE contract to be an indicator of potential impairment and performed an interim analysis on the Workforce Services reporting unit and concluded that its goodwill was not impaired at March 31, 2012. However, the interim analysis did indicate that Workforce Services' excess of fair value over its carrying value had decreased to approximately a three percent margin. During the three months ended June 30, 2012and September 30, 2012, we continued to monitor this reporting unit. While operating results were still below original projected levels, margins had improved since March 31, 2012due to measures that had been implemented within this reporting unit. Based on our review, we concluded there were no impairment indicators present and therefore, no impairment analysis was performed for the quarters ended June 30, 2012and September 30, 2012. During the third quarter of 2010 (predecessor period), we updated our current and future year forecasts. The updated revenues and profits in the forecasts were significantly impacted by various contract losses, rate and service cuts by 37
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numerous states and other factors attributed to the general economic environment. We concluded that these factors, when viewed together, were indicators of possible impairment of goodwill, requiring an interim impairment test during the quarter. We performed the interim test on all five reporting units. As such, the Company recorded an estimated impairment charge during the third quarter of 2010 of
$65.6 million. Accordingly, the net carrying values of goodwill in the Residential Services, ResCare HomeCare, Youth Services-Residential Youth, Youth Services-Education and Workforce Services-Internationalreporting units were reduced $33.2 million, $11.4 million, $2.3 million, $4.9 millionand $13.8 million, respectively. Step Two of the goodwill impairment test was completed for these five reporting units in the fourth quarter of 2010. Step Two required that we determine the implied fair value of the reporting units' goodwill by allocating the reporting units' fair value determined in Step One to the fair value of the reporting units' net assets, including unrecognized intangible assets. The goodwill calculated in Step Two is then compared to the recorded goodwill, with an impairment charge recorded in the amount that the book value of goodwill exceeds the implied fair value of goodwill calculated in this step. As such, we recorded an additional impairment charge of $197.6 millionrelated to goodwill in the period October 1, 2010to November 15, 2010, including $140.9 millionin the Residential Services, $48.4 millionin the ResCare HomeCare and $9.7 millionin the Youth Services-Residential Youth reporting units, $0.6 millionreduction to the third quarter charge recorded in the Youth Services-Education reporting unit and $0.8 millionreduction to the third quarter charge recorded in the Workforce Services-Internationalreporting unit. The increase over the third quarter estimate was due primarily to unrecognized intangibles that are utilized in the Step Two computation. Revenue Recognition Overview: We recognize revenues as they are realizable and earned in accordance with SECStaff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104). SAB 104 requires that revenue can only be recognized when persuasive evidence of an arrangement exists, services have been rendered, the price is fixed or determinable and collectibility is reasonably assured. Residential Services. Revenues are derived primarily from state Medicaidprograms, other government agencies, commercial insurance companies and from management contracts with private operators, generally not-for-profit providers, who contract with state agencies and are also reimbursed under the Medicaidprograms. Revenues are recorded at rates established at or before the time services are rendered. Revenue is recognized in the period services are rendered. ResCare HomeCare. Revenues are derived from state Medicaidprograms, other government agencies, commercial insurance companies, long-term care insurance policies, as well as private pay customers. Revenues are recorded at rates established at or before the time services are rendered. Revenue is recognized in the period services are rendered. Youth Services. Revenues include amounts reimbursable under cost reimbursement contracts with the DOL for operating Job Corpscenters for education and training programs. The contracts provide reimbursement for direct facility and program costs related to operations, allowable indirect costs for general and administrative costs, plus a predetermined management fee, normally a combination of fixed and performance-based. Final determination of amounts due under the contracts is subject to audit and review by the applicable government agencies. Additional revenues are reimbursed from various state government agencies including Medicaidprograms as we operate our foster care programs, residential youth programs and school programs in multiple states. Revenue is recognized in the period associated costs are incurred and services are rendered.
Workforce Services. Revenues are derived primarily through contracts with local and state governments funded by federal agencies. Revenue is generated from contracts which contain various pricing arrangements, including: (1) cost reimbursable, (2) performance-based, (3) hybrid and (4) fixed price.
With cost reimbursable contracts, revenue consists of the direct costs associated with functions that are specific to the contract, plus an indirect cost percentage that is applied to the direct costs, plus a profit. Revenue is recognized in the period the associated costs are incurred and services are rendered. Under a performance-based contract, revenue is generally recognized as earned based upon the attainment of a unit performance measure times the fixed unit price for that specific performance measure. Typically, there are many different performance measures that are stipulated in the contract that must be tracked to support the billing and revenue recognition. Revenue may be recognized prior to achieving a benchmark as long as reliable measurements of progress-to-date activity can be obtained, indicating that it is probable that the benchmark will be achieved. This requires judgment in determining what is considered to be a reliable measurement. 38
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Revenues for hybrid contracts are generally recognized based on the specific contract language. The most common type of hybrid contract is "cost-plus," which provide for the reimbursement of direct and indirect costs with profit tied to meeting certain performance measures. Revenues for cost-plus contracts are generally recognized in the period the associated costs are incurred with an estimate made for the performance-based portion, as long as reliable measurements of progress-to-date activity can be obtained, indicating that it is probable that the benchmark will be achieved. This requires judgment in determining what is considered to be a reliable measurement.
Revenues for fixed price contracts are generally recognized in the period services are rendered. Certain of our long-term fixed price contracts may contain performance-based measures that can increase or decrease our revenue. Revenue is deferred in cases where the fixed price is not determinable as a result of these provisions.
Laws and regulations governing the government programs and contracts are complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates could change by a material amount in the near term. For each operating segment, expenses are subject to examination by agencies administering the contracts and services. We believe that adequate provisions have been made for potential adjustments arising from such examinations. There were no material changes in the application of our revenue recognition policies during the year. Results of Operations SUCCESSOR PREDECESSOR COMBINED Year Ended Year Ended Nov-16, 2010 Jan-1, 2010 Year Ended Dec-31, Dec-31, thru thru Dec-31, 2012 2011 Dec-31, 2010 Nov-15, 2010 2010 (4) (Dollars In thousands) Revenues: Residential Services $ 885,633 $ 853,474 $ 104,302 $ 724,536 $ 828,838 ResCare HomeCare 336,968 321,832 39,522 266,544 306,066 Youth Services 180,552 185,143 22,541 158,688 181,229 Workforce Services (1) 195,956 218,886 28,711 217,833 246,544 Consolidated $ 1,599,109 $ 1,579,335 $ 195,076
Operating income(loss): Residential Services (2) $ 122,062 $ 103,749 $ 14,662 $ (93,623 ) $ (78,961 ) ResCare HomeCare(2) 22,799 22,915 2,893 (47,391 ) (44,498 ) Youth Services (2) 13,696 14,899 2,303 (1,835 ) 468 Workforce Services (1) 12,117 18,352 2,917 13,160 16,077 Corporate (3) (61,515 ) (56,015 ) (6,721 ) (64,870 ) (71,591 ) Consolidated (2) (3) $ 109,159 $ 103,900 $ 16,054 $ (194,559 ) $ (178,505 ) Operating margin: Residential Services (2) 13.8 % 12.2 % 14.1 % (12.9 )% (9.5 )% ResCare HomeCare(2) 6.8 % 7.1 % 7.3 % (17.8 )% (14.5 )% Youth Services (2) 7.6 % 8.0 % 10.2 % (1.2 )% 0.3 % Workforce Services (1) 6.2 % 8.4 % 10.2 % 6.0 % 6.5 % Corporate (3) (3.8 )% (3.5 )% (3.4 )% (4.7 )% (4.6 )% Consolidated (2) (3) 6.8 % 6.6 % 8.2 % (14.2 )% (11.4 )%
(1) Excludes results for international operations, which were reclassified to discontinued operations for all periods presented.
(2) Operating income and margin were negatively impacted in the predecessor period for 2010 due to a goodwill impairment charge of
$250.2 million, of which $174.1 millionrelated to our Residential Services segment, $59.8 millionrelated to our ResCare HomeCare segment and $16.3 millionrelated to our Youth Services segment. (3) Represents corporate general and administrative expenses, as well as other operating (income) and expenses related to the corporate office. Expenses related to the Onex transaction were $12.2 millionin the 2010 predecessor period, $0.2 millionin the 2010 successor period and $1.7 millionin the 2011 period. (4) The combined year ended December 31, 2010sets forth the combined successor and predecessor revenues, operating income (loss), operating expenses and operating margins for comparison purposes. Our comments in the discussion below will be referring to the 2010 combined period. 39 --------------------------------------------------------------------------------
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Consolidated revenues increased
Consolidated operating income increased
$5.3 million, or 5.1%, to $109.2 millionin 2012 compared to $103.9 millionin 2011. Operating margin increased to 6.8% in 2012 compared to 6.6% in 2011. Consolidated operating income increased $282.4 millionto $103.9 millionin 2011 compared to an operating loss of $178.5 millionin 2010. Operating margin increased from (11.4%) in 2010 to 6.6% in 2011. The 2010 operating loss and negative margin primarily resulted from a $250.2 milliongoodwill impairment charge and costs of $12.4 millionassociated with the Onex transaction, partially offset by 2010 acquisitions in the Residential Services and ResCare HomeCare segments. Net interest expense decreased $6.8 millionin 2012, compared to 2011 due primarily to lower interest rates as a result of the new senior secured credit facility which closed in April 2012, which was partially offset by $1.0 millionof additional interest expense related to our vehicle capital leases, as disclosed in Note 13. Net interest expense increased $22.8 millionin 2011, compared to 2010, due primarily to higher average debt balances and an increase in interest rates arising from the refinancing of debt in December 2010in which the annual interest rate payable on our outstanding unsecured senior notes increased from 7.75% to 10.75%. Our effective income tax rates were 38.6%, 32.4% and 23.1% in 2012, 2011 and 2010, respectively. The 2011 to 2012 change in our effective rate was negatively impacted by the expiration of jobs tax credits after 2011, an increase in our reserve for uncertain tax positions and an adjustment associated with the going private transaction costs (2011). The 2010 to 2011 change in our effective rate was positively (increased benefit) impacted by adjustments associated with the going private transaction costs and nondeductible goodwill impairments (2010). Residential Services Residential Services revenues in 2012 of $885.6 millionincreased $32.2 million, or 3.8%, over the 2011 revenues of $853.5 milliondue primarily to acquisition growth of $25.3 millionand organic growth of $6.9 million. Operating margin increased to 13.8% in 2012 from 12.2% in 2011 due primarily to growth and effective management of labor and controllable costs. Residential Services revenues increased 3.0% in 2011 over 2010 due primarily to a $14.5 millionincrease in our pharmacy business revenue, as well as $13.5 millionin acquisition growth. Operating margin increased to 12.2% in 2011 from (9.5%) in 2010 due primarily to a $174.1 milliongoodwill impairment charge in 2010 and approximately $0.7 millionof higher share-based compensation expense in 2010, as well as savings and efficiencies in 2011 from our reorganization efforts. ResCare HomeCare ResCare HomeCare revenues in 2012 of $337.0 millionincreased $15.1 million, or 4.7%, over 2011 revenues of $321.8 million. This increase was due primarily to $23.8 millionfrom acquisition related growth which was partially offset by rate and service cuts of $3.5 millionand a $5.1 millionreduction in organic business across several states. Operating margin decreased from 7.1% in 2011 to 6.8% in 2012 due primarily to rate and service cuts of $1.1 million, $1.6 millionreduction in organic business across several states and $0.8 millionincrease in bad debt expense, which were partially offset by $2.9 millionimpact from acquisitions and $0.4 millionin lower marketing costs.. ResCare HomeCare revenues increased 5.3% in 2011 over 2010 due primarily to $31.3 millionfrom acquisition related growth which was partially offset by reductions from rate, service hour levels and reimbursement system changes of $15 million. Operating margin increased to 7.3% in 2011 from (14.0%) in 2010 due primarily to a $59.8 milliongoodwill impairment charge in 2010, as well as $3.7 millionand $1.3 millionof higher bad debt and amortization expenses, respectively, in 2010. Youth Services Youth Services revenues decreased $4.6 million, or 2.5%, from 2011 to 2012 due primarily to Job Corpscontract loss and contract spending reductions of $1.3 millionand $1.2 million, respectively, as well as a $2.0 millionreduction due to lower 40
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census in our Residential Youth reporting unit. Operating margin decreased from 8.0% in 2011 to 7.6% in 2012 due primarily to lower margins in our Residential Youth reporting unit due to the lower census. Youth Services revenues increased 2.5% in 2011 over 2010 due primarily to increases in the
Job Corpsbusiness, which was partially offset by a reduction in our Residential Youth reporting unit revenues driven by lower census. Operating margin increased to 7.6% in 2011 from (0.7%) in 2010 due primarily to goodwill impairment charges in 2010 of $12.0 millionand $4.3 millionin our Residential Youth and Education reporting units, respectively. Exclusive of the 2010 impairment charge, the operating income and margins for 2011 decreased from 2010 levels due primarily to lower margins in our Residential Youth reporting unit. Workforce Services Workforce Services revenues decreased $22.9 million, or 10.5% from 2011 to 2012 due primarily to net contract losses of $14.1 million, contract amendments of $2.4 millionand contract performance issues of $6.0 million. Operating margins decreased to 6.2% in 2012 from 8.4% in 2011 due primarily to net contract losses of $3.0 million, contract performance issues of $5.2 million, which were partially offset by overhead cost reductions of $0.8 million. In February 2012, we were informed by the New York City Human Resources Administrationthat our WeCARE contract had been awarded to another operator through the competitive bid process. Our performance continued under a contract extension until December 2012. Annual revenues for this contract are $28 million. Workforce Services revenues decreased 11.7% from 2010 to 2011 due primarily to the loss of contracts in Texasand the absence of the American Recovery and Investment Act (ARRA) funding in 2011. Operating margins increased to 8.5% in 2011 from 6.7% in 2010 due primarily to the absence of lower margin services funded under ARRA. Corporate Total Corporate operating expenses represent corporate general and administrative expenses, as well as other operating income and expenses. Total corporate operating expenses increased $5.5 million, or 9.8%, from 2011 to 2012 due primarily to increases in insurance costs of $2.6 million, share-based compensation of $1.5 millionand depreciation expense of $2.9 million, which were partially offset by lower Onex transaction costs of $1.7 million. Total corporate operating expenses decreased $15.6 million, or 21.8%, from 2010 to 2011 due primarily to decreases in depreciation of $3.2 million, insurance costs of $1.9 millionand Onex transaction costs of $10.7 million. The decrease in depreciation is due to the valuation of fixed assets as required through purchase price accounting for the Onex transaction described in Note 2 to the Notes to Consolidated Financial Statements. Discontinued Operations The discontinued operations relate to the international Workforce Services segment's closure of the operations in Germanyand the Netherlandsin the first quarter of 2011 and the sale of the United Kingdomoperations on July 1, 2011. Total exit costs of $0.8 millionwere recorded in the first quarter of 2011. For the sale of the operations in the United Kingdom, we recorded a charge in other expenses of $2.2 millionin the second quarter of 2011 to adjust assets and liabilities to their net realizable value. We had no net income or loss from discontinued operations in 2012. Net income from discontinued operations was $11.2 millionfor 2011 compared to net losses of $18.1 millionin 2010. The 2011 net income includes tax benefits of $19.8 million, while the 2010 net loss includes a $13 milliongoodwill impairment charge. During the third quarter of 2011, a U.S. tax election was made which changed the tax status and triggered the recognition of tax basis associated with international operations.
Financial Condition, Liquidity and Capital Resources
Total assets increased
$59.7 million, or 6.0%, in 2012 over 2011. This increase was primarily related to $32.5 millionof additional goodwill and intangible assets from 2012 acquisitions, $16.5 millionof revisions for vehicle capital leases described in Note 13 and $24.5 millionof additional cash and cash equivalents, which were partially offset by an $11.4 millionreduction in refundable income taxes. 41
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Cash and cash equivalents were
$50.1 millionat December 31, 2012, compared to $25.7 millionat December 31, 2011. Cash provided by operating activities for 2012 was $80.3 millioncompared to $72.6 millionfor 2011 and $85.3 millionfor 2010. The increase from 2011 to 2012 was primarily due to $6.1 millionof higher depreciation due to the revision for vehicle capital leases described in Note 13. The decrease from 2010 to 2011 was primarily due to the change in trade accounts payable. Days revenue in net accounts receivable were 49 days at December 31, 2012, December 31, 2011and December 31, 2010. Net accounts receivable at December 31, 2012increased to $228.4 million, compared to $221.1 millionat December 31, 2011and $215.9 millionat December 31, 2010. The increase in net accounts receivable from 2011 to 2012 and from 2010 to 2011 is primarily due to acquisition growth. Our capital requirements relate primarily to our plans to expand through selective acquisitions and the development of new and expansion of existing facilities and programs, and our need for sufficient working capital for general corporate purposes. Since budgetary pressures and other forces are expected to limit increases in reimbursement rates and service levels, our ability to continue to grow at the current rate depends in large part on our acquisition activity and our success in building additional home care brands, billing excess capacity in our Residential and Youth Services lines and making appropriate investments in complementary lines of business. We have historically satisfied our working capital requirements, capital expenditures and scheduled debt payments from our operating cash flow and borrowing under our revolving credit facility. Capital expenditures were $15.5 millionfor the year ended December 31, 2012, compared to $13.5 millionfor the year ended December 31, 2011. We invested $33.1 million( $30.7 millionin cash and $2.4 millionin seller notes) on acquisitions in 2012. For 2011, we invested $27.9 million( $23.1 millionin cash and $2.1 millionin seller notes and $2.7 millionin forgiven seller obligations to company) on acquisitions. We invested $32.5 million( $28.4 millionin cash and $4.1 millionin seller notes) on acquisitions in 2010. Our financing activities for 2012 included proceeds of $175 millionrelated to the new term loan (the "Term Loan A") and the payoff of $172.1 millionrelated to the old term loan (the "Term Loan B"), both of which are discussed below. During 2012, we have paid $4.0 millionin debt issuance costs resulting from the new senior secured credit facility (the "Credit Agreement") we entered into on April 5, 2012. We also had $6.0 millionof payments on capital leases obligations, which were primarily related to the vehicle capital leases disclosed in Note 13.
Our financing activities for 2011 included payments of
As described further below, our financing activities for 2010 included a refinancing in which our revolving credit facility was amended, adding a secured term loan. We also redeemed substantially all of the existing senior notes and issued new senior notes. In addition, the preferred shares were redeemed in connection with the Onex transaction. On
December 22, 2010, we issued $200 millionof 10.75% senior notes due January 15, 2019in a private placement to qualified institutional buyers under the Securities Act of 1933. The 10.75% senior notes, which had an issue price of 100% of the principal amount, are unsecured obligations ranking equal to existing and future debt and are subordinate to existing and future secured debt. Proceeds were used to fund $120 millionof our tendered 7.75% senior notes due October 2013. The remaining $30 millionof these senior notes that were not repurchased were satisfied and discharged by delivering to the trustee amounts sufficient to pay the applicable redemption price in January 2011. The 7.75% senior notes were originally issued on October 3, 2005for $150 millionunder a private placement arrangement at an issue price of 99.261%. These securities were unsecured obligations. In addition, proceeds from the $200 millionissuance of 10.75% senior notes were used to purchase outstanding shares of common stock tendered by our shareholders and for general corporate purposes. The 10.75% senior notes are jointly, severally, fully and unconditionally guaranteed by our domestic subsidiaries. On December 22, 2010, we amended our existing senior secured revolving credit facility that originally had been scheduled to mature on July 28, 2013. The aggregate amount available under that revolving credit facility was $275 millionuntil July 28, 2013, after which the revolving credit facility was to be extended until December 22, 2015for the extending revolving credit lenders. The aggregate amount available under the extended revolving credit facility was $240 million. In addition, $175 millionof additional borrowing capacity was available for use to increase the revolving credit facility, or to increase other certain senior secured indebtedness, subject to certain limitations and conditions in our other debt agreements. The 42 --------------------------------------------------------------------------------
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facility was to be used primarily for working capital purposes, letters of credit required under our insurance programs and for acquisitions. The amended and restated senior credit facility contains various financial covenants relating to capital expenditures and rentals, and requires us to maintain specified ratios with respect to interest coverage and leverage. The amendment provided for the exclusion of charges incurred in connection with the resolution of the matter described in Note 16 of the Notes to Consolidated Financial Statements, as well as any non-cash impairment charges, in the calculation of certain financial covenants. The amended and restated senior credit facility was secured by a lien on all of our assets and, through secured guarantees, on our domestic subsidiaries' assets. On
December 22, 2010, we issued a $170 millionsenior secured term loan (the Term Loan B) due December 22, 2016, at a discounted price of 98% with realized net proceeds of $166.6 million. Additional capacity of $175 millionwas available for use to increase the Term Loan B, or to increase the revolving credit facility, subject to certain limitations and conditions in our other debt agreements. The Term Loan B was used primarily to repay the $159.6 millionof preferred equity plus accrued dividends from Purchaser, to various Onex affiliates related to its acquisition and funding of tendered Company shares on November 16, 2010. The Term Loan B contains various financial covenants similar with respect to the amended and restated revolving credit facility. The Term Loan B was an amortizing obligation, with principal payments of 1% of the outstanding Term Loan B balance due annually. Pricing for the Term Loan B was variable, at the London Interbank Offer Rate (LIBOR) plus 550 basis points. LIBOR is defined as having a minimum rate of 1.75%. The Term Loan B was secured by a lien on all of our assets and, through secured guarantees, on our domestic subsidiaries' assets. On April 5, 2012, we entered into a new senior secured credit facility (the "Credit Agreement") in an aggregate principal amount of $375 million, which replaced our 2010 senior secured revolving credit facility and the senior secured term loan (the "Term Loan B"). The new Credit Agreement consists of a new term loan (the "Term Loan A") in an aggregate principal amount of $175 millionand a new revolving credit facility (the "Revolving Facility") in an aggregate principal amount of $200 million. The Term Loan A and the Revolving Facility each mature on April 5, 2017. The Term Loan A will amortize in an aggregate annual amount equal to a percentage of the original principal amount of the Term Loan A as follows: (i) 5% during each of the first two years after funding, (ii) 10% during the third year after funding and (iii) 15% during each of the final two years of the term. The balance of the Term Loan A is payable at maturity. Pricing for the Term Loan A will be variable, at the London Interbank Offer Rate (LIBOR) plus a spread, which is currently 275 basis points. LIBOR is defined as having no minimum rate. The spread varies between 225 and 300 basis points depending on our total leverage ratio. The proceeds of the Term Loan A were used to repay the Company's prior Term Loan B and pay certain related fees and expenses. The proceeds of the Revolving Facility may be used for working capital and for other general corporate purposes permitted under the Credit Agreement, including certain acquisitions and investments. The Credit Agreement also provides that, upon satisfaction of certain conditions, the Company may increase the aggregate principal amount of loans outstanding thereunder by up to $175 million, subject to receipt of additional lending commitments for such loans. The loans and other obligations under the Credit Agreement are (i) guaranteed by Onex Rescare Holdings Corp.("Holdings") and substantially all of its subsidiaries (subject to certain exceptions and limitations) and (ii) secured by substantially all of the assets of the Company, Holdings and substantially all of its subsidiaries (subject to certain exceptions and limitations). The Credit Agreement contains various financial covenants relating to capital expenditures and rentals, and requires us to maintain specific ratios with respect to interest coverage and leverage. The new agreement continues to provide for the exclusion of charges incurred with the resolution of certain legal proceedings provided in Note 16 to Notes to the Consolidated Financial Statements, as well as any non-cash impairment charges, in the calculation of certain financial covenants. We recorded a loss on extinguishment of debt of $7.1 millionin the three months ended June 30, 2012associated with termination of the 2010 senior secured revolving credit facility and the Term Loan B prepayment. Loss on extinguishment of debt consists principally of write-offs of unamortized deferred debt issuance costs and original issue discount. Our obligations under capital leases are $17.7 millionas of December 31, 2012, due primarily to vehicle capital leases which are disclosed further in Note 13. The current portion of these lease obligations was $6.0 million. As of December 31, 2012, we had irrevocable standby letters of credit in the principal amount of $59 millionissued primarily in connection with our insurance programs. As of December 31, 2012, we had $141 millionavailable under the amended and restated revolving credit facility, with no outstanding balance. Outstanding balances bear interest at 2.75% over the LIBOR at our option. As of December 31, 2012, the weighted average interest rate was not applicable as there were no outstanding borrowings. Letters of credit had a borrowing rate of 2.88% as of December 31, 2012. The commitment fee on the unused balance was 0.50%. The margin over LIBOR and the commitment fee is determined quarterly based on our leverage ratio, as defined by the revolving credit facility. 43 --------------------------------------------------------------------------------
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Our credit facility contains a total leverage ratio and an interest coverage ratio. As of
December 31, 2012, the maximum leverage ratio allowed under the facility was 4.50. That maximum allowable leverage steps down to 4.25 at March 31, 2014, to 4.00 at September 30, 2015and to 3.75 at March 31, 2016and the end of each fiscal quarter thereafter. As of December 31, 2012, the minimum interest coverage ratio allowed under the facility was 2.25. That minimum allowable interest coverage steps up to 2.5 at March 31, 2014, to 2.75 at September 30, 2015and to 3.00 at December 31, 2016and the end of each fiscal quarter thereafter. As of December 31, 2012, our leverage ratio was 2.2 and our interest coverage ratio was 4.7. We believe we will continue to be in compliance with our debt covenants over the next twelve months. Our ability to achieve the thresholds provided for in the financial covenants largely depends upon the maintenance of continued profitability and/or reductions of amounts borrowed under the facility, and continued cash collections. Operating funding sources for 2012 were approximately 66% through Medicaidreimbursement, 8% from the DOL and 26% from other payors. We believe our sources of funds through operations and available through our credit facility will be sufficient to meet our working capital, planned capital expenditure and scheduled debt repayment requirements for the next twelve months. As described in Item 3. Legal Proceedings on Page 31 of this report, a jury returned a verdict of approximately $53.9 millionin damages against the Company, consisting of approximately $4.7 millionin compensatory damages and $49.2 millionin punitive damages, which was entered as a judgment in December 2009. On February 19, 2010, the New Mexicotrial court judge ruled on post-trial motions reducing the jury award to $15.5 million, which consists of approximately $10.8 millionin punitive damages and $4.7 millionin compensatory damages. We believe the parent company is not liable for the actions of its subsidiary ( Res-Care New Mexico, Inc.) or its employees and that both the compensatory and punitive amounts awarded are excessive and contrary to United States Supreme Courtand New Mexico Supreme Courtprecedent which would warrant a new trial or, in the alternative, would reduce the judgment amount. We, as well as the plaintiffs, have appealed. Oral arguments before the Court of Appealswere held on November 15, 2011, and we anticipate a ruling from the Court of Appealsin the near future. We will continue to defend this matter vigorously. Although we have made provisions in our condensed consolidated financial statements for this self-insured matter, the amount of our legal reserve is less than the original amount of the damages awarded, plus accrued interest. The ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations or cash flows.
Contractual Obligations and Commitments
Information concerning our contractual obligations and commercial commitments follows (in thousands): Payments Due by Period Twelve Months Ending December 31, 2018 and Contractual Obligations Total 2013 2014-2015 2016-2017 Thereafter Long-term Debt $ 373,115 $ 14,695 $ 35,748 $ 122,672 $ 200,000 Capital Lease Obligations 17,684 6,052 5,841 5,791 † Operating Leases 197,855 59,837 85,098 38,464 14,456 Fixed interest payments on Long-term Debt and Capital Lease Obligations(1) 132,035 21,793 43,501 43,448 23,293 Total Contractual Obligations(2) $ 720,689 $ 102,377 $ 170,188 $ 210,375 $ 237,749
(1) Excludes any interest payments on our variable rate debt.
(2) This amount excludes
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Commitments Expiring per Period
Total Twelve Months Ending December 31, Amounts 2018 and Other Commercial Commitments Committed 2013
2014-2015 2016-2017 Thereafter Standby Letters-of-Credit $ 59,099 $ 59,099 † † † Surety Bonds $ 30,130 $ 30,081 $ 30 $ 19 $ -
We had no significant off-balance sheet transactions or interests in 2012.
New Accounting Pronouncements Not Yet Adopted
See Note 1 to the Notes to Consolidated Financial Statements.