RES CARE INC /KY/ – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

    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.

   Onex Transaction   

As more fully described in Note 2 of the Notes to Consolidated Financial Statements, on November 16, 2010, an affiliate of Onex Partners III LP (Purchaser) purchased 21,044,765 shares of ResCare common stock in a tender offer. Upon the completion of the tender offer, affiliates of Onex Corporation (the Onex Investors) beneficially owned 87.4% of the issued and outstanding shares of ResCare's common stock on an as-converted basis.

    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, 2011 and December 31, 2010 as successor and November 15, 2010 and December 31, 2009 as predecessor.    As a result of the following transactions on December 22, 2010, ResCare became a wholly owned subsidiary of Onex Rescare Holdings Corp. (New Holdco), 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 million term loan facility and an amended and restated $275 million revolving credit facility;   

† ResCare issued $200 million of unsecured 10.75% Senior Notes due 2019 (the Notes) in a private placement under the Securities Act of 1933;

    †     ResCare repurchased $120 million (approximately 80%) aggregate principal amount of its 7.75% Senior Notes due 2013 in a tender offer, and the $30 million aggregate 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, 2011 redemption 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 Investors or by members of management was exchanged for the right to receive $13.25 in cash (a total of $56.9 million);                                           33  --------------------------------------------------------------------------------

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†

  †     Purchaser redeemed preferred membership interests held by certain of the Onex Investors for 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 New Holdco in exchange for New Holdco stock, and Purchaser was merged into ResCare, with ResCare as the surviving entity.

   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 Corps centers, 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 Medicaid programs, 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 Medicaid program. 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 Medicaid programs 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 Corps program administered by the Department of Labor (DOL) through our Youth Services operations. Under Job Corps contracts, we are reimbursed for direct costs of services related to Job Corps center 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 Corps contracts is subject to audit and review by the DOL, and renewals and extension of Job Corps contracts 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                                           34 

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computed based on certain performance criteria. The contracts are funded by federal agencies, including the DOL and Department of Health and Human Services.

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 Medicaid programs, 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, 2011 and 2010, 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.                                           35 

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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 was changed from November 30 to October 1 after the Onex transaction. 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 2011 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 2011 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, 2011, we had approximately $267.7 million of goodwill and $226.4 million of other indefinite-lived intangible assets. Goodwill at December 31, 2011, 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, 2011 annual impairment test, we used a 2% long-term terminal growth rate for all reporting units tested. We also used 13%, 14%, 17%, 16% and 12% for our Residential Services, ResCare HomeCare, Workforce Services, Youth Services-Job Corps and Youth Services-Residential Youth reporting units, respectively, for discount rates. All reporting units passed Step One. The Youth Services-Residential Youth and Workforce Services reporting units only passed Step One with a fair value that exceeded its carrying value by a 13 and 12 percent margin, respectively. The Youth Services-Residential Youth and Workforce Services reporting units had allocated goodwill balances of $9.6 million and $32.7 million, respectively, as of October 1, 2011. A 100 basis point increase in the discount rate for these two reporting units would decrease the fair value in excess of carrying value to a 5 percent margin for each reporting unit. A 100 basis point decrease in the long-term growth rate for these two reporting units would decrease the fair value in excess of carrying value to a 9 percent margin for each reporting unit.    In February 2012, we were informed by the New York City Human Resources Administration that the Wellness, Comprehensive Assessment, Rehabilitation and Employment (WeCARE) contract had been awarded to another operator through the competitive bid process. We anticipate that our performance will continue under a contract extension until December 2012. Annual revenues for this contract are $28 million. We have filed a formal protest and are exploring all available options to challenge the contract award and the bid process. We believe it is at least reasonably possible that we will be unsuccessful in our efforts to retain this contract, which would indicate the potential for an impairment of the Workforce Services goodwill exists and require us to perform an impairment assessment in the near term. We estimate that this could result in an impairment charge up to $5 million for the Workforce Services reporting unit in 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 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-International reporting units were reduced $33.2 million, $11.4 million, $2.3 million, $4.9 million and $13.8 million, respectively. Step Two of the goodwill impairment test was completed for these three 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                                           36  --------------------------------------------------------------------------------

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    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 million related to goodwill in the period October 1, 2010 to November 15, 2010, including $140.9 million in the Residential Services, $48.4 million in the ResCare HomeCare and $9.7 million in the Youth Services-Residential Youth reporting units, $0.6 million reduction to the third quarter charge recorded in the Youth Services-Education reporting unit and $0.8 million reduction to the third quarter charge recorded in the Workforce Services-International reporting 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 SEC Staff 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 Medicaid programs, 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 Medicaid programs. 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 Medicaid programs, 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 Corps centers 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 Medicaid programs 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.    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.                                           37  --------------------------------------------------------------------------------

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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      PREDECESSOR                                 Year Ended      Nov-16, 2010      Jan-1, 2010     Year Ended      Year Ended                                   Dec-31,           thru             thru           Dec-31,        Dec-31,                                    2011         Dec-31, 2010     Nov-15, 2010      2010 (6)          2009                                                            (Dollars In thousands) Revenues: Residential Services            $   853,474    $      104,302    $     724,536    $   828,838    $    813,353 ResCare HomeCare                    323,820            39,816          267,676        307,492         296,071 Youth Services                      185,658            22,556          158,661        181,217         216,403 Workforce Services (1)              216,383            28,402          216,728        245,130         232,732 Consolidated                    $ 1,579,335    $      195,076    $   

1,367,601 $ 1,562,677$ 1,558,559

  Operating income(loss): Residential Services (2) (4)    $   103,749    $       14,662    $     (93,623 )  $   (78,961 )  $     81,812 ResCare HomeCare (2)                 23,690             3,085          (46,199 )      (43,114 )        24,249 Youth Services (2) (3)               14,042             2,136           (3,450 )       (1,314 )         8,642 Workforce Services (1) (3)           18,434             2,892           13,583         16,475         (37,209 ) Corporate (5)                       (56,015 )          (6,721 )        

(64,870 ) (71,591 ) (59,168 ) Consolidated (2) (3) (4) (5) $ 103,900 $ 16,054 $ (194,559 ) $ (178,505 ) $ 18,326

  Operating margin: Residential Services (2) (4)           12.2 %            14.1 %          (12.9 )%        (9.5 )%         10.1 % ResCare HomeCare (2)                    7.3 %             7.7 %          (17.3 )%       (14.0 )%          8.2 % Youth Services (2) (3)                  7.6 %             9.5 %           (2.2 )%        (0.7 )%          4.0 % Workforce Services (1) (3)              8.5 %            10.2 %            6.3 %          6.7 %         (16.0 )% Corporate (5)                          (3.5 )%           (3.4 )%          (4.7 )%        (4.6 )%         (3.8 )% Consolidated (2) (3) (4) (5)            6.6 %             8.2 %          (14.2 )%       (11.4 )%          1.2 %    

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(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 million related to our Residential Services segment, $59.8 million related to our ResCare HomeCare segment and $16.3 million related to our Youth Services segment.    (3)     Operating income and margin were negatively impacted in 2009 due to a goodwill impairment charge of $63.1 million, of which $53.1 million related to our Workforce Services segment and $10.0 million related to our Youth Services segment.   

(4) Operating income and margin were negatively impacted in 2009 due to a $5.0 million charge related to an increase in the Company's legal reserve.

    (5)     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 million in the 2010 predecessor period, $0.2 million in the 2010 successor period and $1.7 million in the 2011 period.    (6)     The combined year ended December 31, 2010 sets 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.                                           38  --------------------------------------------------------------------------------

   Table of Contents    Consolidated   

Consolidated revenues increased $16.7 million, or 1.1% from 2010 to 2011, while 2010 increased $4.1 million, or 0.3%, over 2009. Revenues are more fully described in the segment discussions below.

    Consolidated operating income increased $282.4 million to $103.9 million in 2011 compared to an operating loss of $178.5 million in 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 million goodwill impairment charge and costs of $12.4 million associated with the Onex transaction, partially offset by 2010 acquisitions in the Residential Services and ResCare HomeCare segments. Consolidated operating income decreased $196.8 million to an operating loss of $178.5 million in 2010 from operating income of $18.3 million in 2009. Operating margin decreased from 1.2% in 2009 to (11.4%) in 2010, due primarily to the goodwill impairment charge and Onex transaction costs discussed above which were incurred in 2010. The 2009 operating income and margin were negatively impacted by $63.1 million of goodwill impairment charges and $5.0 million to increase the Company's legal reserve.    Net interest expense increased $22.8 million in 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 2010 in which the annual interest rate payable on our outstanding unsecured senior notes increased from 7.75% to 10.75%. Net interest expense increased $3.1 million in 2010, compared to 2009, due primarily to higher interest rates and higher average debt balances.    Our effective income tax rates were 32.4%, 23.1% and (82.7%) in 2011, 2010 and 2009, respectively. Our 2011 effective income tax rate was favorably impacted by jobs tax credits and an adjustment associated with nondeductible transaction costs. Our 2010 and 2009 effective income tax rates were negatively impacted by the impact of nondeductible impairment charges.    Residential Services    Residential Services revenues increased 3.0% in 2011 over 2010 due primarily to a $14.5 million increase in our pharmacy business revenue, as well as $13.5 million in acquisition growth. Operating margin increased to 12.2% in 2011 from (9.5%) in 2010 due primarily to a $174.1 million goodwill impairment charge in 2010 and approximately $0.7 million of higher share-based compensation expense in 2010, as well as savings and efficiencies in 2011 from our reorganization efforts.    Residential Services revenues increased 1.9% in 2010 over 2009 due primarily to acquisition growth. Operating margin decreased from 10.1% in 2009 to (9.5%) in 2010 due primarily to the $174.1 million goodwill impairment charge in 2010 and a $5.0 million increase in legal costs in 2009.    ResCare HomeCare    ResCare HomeCare revenues increased 5.3% in 2011 over 2010 due primarily to $31.3 million from 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 million goodwill impairment charge in 2010, as well as $3.7 million and $1.3 million of higher bad debt and amortization expenses, respectively, in 2010.    ResCare HomeCare revenues increased 3.9% in 2010 over 2009 due primarily to acquisition growth. Operating margin decreased from 8.2% in 2009 to (14.0%) in 2010 due primarily to the $59.8 million goodwill impairment charge in 2010, as well as higher incremental bad debt expense of $4.4 million in 2010.    Youth Services    Youth Services revenues increased 2.5% in 2011 over 2010 due primarily to increases in the Job Corps business, 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 million and $4.3 million in our Residential Youth and Education reporting units, respectively. Exclusive of the 2010 impairment charge,                                           39 

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the operating income and margins for 2011 decreased from 2010 levels due primarily to lower margins in our Residential Youth reporting unit.

    Youth Services revenues decreased 16.3% from 2009 to 2010 due primarily to loss of the Pittsburgh and Treasure Island Job Corps contracts in the second quarter of 2009 and the Phoenix Job Corps contract in the first quarter of 2010, as well as lost contracts in our alternative education business. Operating margin decreased from 4.0% in 2009 to (0.7%) in 2010 due primarily to the 2010 goodwill impairment charges discussed above, while 2009 operating results also included a $10.0 million goodwill impairment charge in our Education reporting unit.    Workforce Services    Workforce Services revenues decreased 11.7% from 2010 to 2011 due primarily to the loss of contracts in Texas and 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. In February 2012, we were informed by the New York City Human Resources Administration that the WeCARE contract had been awarded to another operator through the competitive bid process. We anticipate that our performance will continue under a contract extension until December 2012. Annual revenues for this contract are $28 million. We have filed a formal protest and are exploring all available options to challenge the contract award and the bid process.    Workforce Services revenues increased 5.3% in 2010 over 2009 levels due primarily to $37 million in revenue for contracts awarded in 2010 and a $9 million increase in revenue from existing contracts, partially offset by $34 million in lost contracts. Operating margin increased from (16.0%) in 2009 to 6.7% in 2010 due primarily to a $53.1 million goodwill impairment charge recorded in 2009.    Corporate    Total Corporate operating expenses represent corporate general and administrative expenses, as well as other operating income and expenses. 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 million and 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.    

Total corporate operating expenses increased $12.4 million, or 21%, in 2010 from 2009 due primarily to $12.4 million of Onex transaction costs incurred in 2010.

    Discontinued Operations    The discontinued operations relate to the international Workforce Services segment's closure of the operations in Germany and the Netherlands in the first quarter of 2011 and the sale of the United Kingdom operations on July 1, 2011. Total exit costs of $0.8 million were 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 million in the second quarter of 2011 to adjust assets and liabilities to their net realizable value.    Net income from discontinued operations was $11.2 million for 2011 compared to net losses of $18.1 million in 2010. The 2011 net income includes tax benefits of $19.8 million, while the 2010 net loss includes a $13 million goodwill 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.    Net loss from discontinued operations was $18.1 million for 2010 compared to $14.0 million for 2009. Goodwill impairment charges were recorded in 2010 and 2009 for $13 million and $8.9 million, respectively.    

Financial Condition, Liquidity and Capital Resources

    Total assets increased $27.3 million, or 2.8%, in 2011 over 2010. This increase was primarily a result of 2011 acquisitions, which caused goodwill to increase $20.5 million from December 31, 2010. Cash and cash equivalents were $25.7 million at December 31, 2011, compared to $27.6 million at December 31, 2010. Cash provided by operating activities for 2011 was $72.6 million compared to $85.3 million for 2010 and $104.6 million for 2009. The decrease from 2010 to 2011 was primarily due to the change in trade accounts payable. The decrease from 2009 to 2010 was primarily due to decreased accounts receivable collections in 2010.                                           40 

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    Days revenue in net accounts receivable were 49 days at December 31, 2011 and December 31, 2010, and 51 days at December 31, 2009. Net accounts receivable at December 31, 2011 increased to $221.1 million, compared to $215.9 million at December 31, 2010 and $211.4 million at December 31, 2009. The increase in net accounts receivable 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 $13.5 million for the year ended December 31, 2011, compared to $10.7 million for the year ended December 31, 2010. For 2011, we invested $27.9 million ($23.1 million in cash and $2.1 million in seller notes and $2.7 million in forgiven seller obligations to company) on acquisitions. We invested $32.5 million ($28.4 million in cash and $4.1 million in seller notes) on acquisitions in 2010. We invested $22.2 million ($20.4 million in cash and $1.8 million in seller notes) on acquisitions in 2009.    

Our financing activities for 2011 included payments of $38.9 million on long-term debt and capital lease obligations. We also received $1.4 million in funds contributed by co-investors.

    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.    Our financing activities for 2009 included net payments of $59.8 million on the revolver with payments of $0.8 million on our long-term debt. Option exercise activity resulted in $0.4 million in proceeds and $0.4 million in tax expenses.    On December 22, 2010, we issued $200 million of 10.75% Senior Notes due January 15, 2019 in 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. The effective interest rate for these notes is approximately 10.75%. Proceeds were used to fund $120 million of our tendered 7.75% Senior Notes due October 2013. The remaining $30 million of 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, 2005 for $150 million under a private placement arrangement at an issue price of 99.261%. These securities were unsecured obligations. In addition, proceeds from the $200 million issuance 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 the revolving credit facility is $275 million until July 28, 2013, after which the revolving credit facility will be extended until December 22, 2015 for the extending revolving credit lenders. The aggregate amount available under the extended revolving credit facility will be $240 million. In addition, $175 million of additional borrowing capacity will be 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 facility will 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 continues to provide 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 is secured by a lien on all of our assets and, through secured guarantees, on all of our domestic subsidiaries' assets.                                           41 

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    On December 22, 2010, we issued a $170 million senior secured term loan (the Term Loan) due December 22, 2016, at a discounted price of 98% with realized net proceeds of $166.6 million. Additional capacity of $175 million will be available for use to increase the Term Loan, or to increase the revolving credit facility, subject to certain limitations and conditions in our other debt agreements. The Term Loan was used primarily to repay the $159.6 million of 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 contains various financial covenants similar with respect to the amended and restated revolving credit facility. The Term Loan will be an amortizing obligation, with principal payments of 1% of the outstanding Term Loan balance due annually. Pricing for the Term Loan will be 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 is secured by a lien on all of our assets and, through secured guarantees, on all of our domestic subsidiaries' assets.    As of December 31, 2011, we had irrevocable standby letters of credit in the principal amount of $59.6 million issued primarily in connection with our insurance programs. As of December 31, 2011, we had $215.4 million available under the amended and restated revolving credit facility, with no outstanding balance. Outstanding balances bear interest at 4.00% over the LIBOR or other bank developed rates at our option. As of December 31, 2011, the weighted average interest rate was not applicable as there were no outstanding borrowings. Letters of credit had a borrowing rate of 4.125% as of December 31, 2011. 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.    Our credit facility contains a total leverage ratio and an interest coverage ratio. As of December 31, 2011, the maximum leverage ratio allowed under the facility was 4.75. That maximum allowable leverage steps down to 4.50 at September 30, 2012 and to 4.25 at March 31, 2014. As of December 31, 2011, the minimum interest coverage ratio allowed under the facility was 2.25. That minimum allowable interest coverage steps up to 2.5 at September 30, 2012, to 2.75 at March 31, 2014 and to 3.00 at September 30, 2015. We were in compliance with our debt covenants as of December 31, 2011. 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 2011 were approximately 65% through Medicaid reimbursement, 8% from the DOL and 27% 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 30 of this report, a jury returned a verdict of approximately $53.9 million in damages against us in November 2009, consisting of approximately $4.7 million in compensatory damages and $49.2 million in punitive damages. Ruling on various post trial motions, on February 19, 2010, the New Mexico trial court judge reduced the jury award to $15.5 million, consisting of approximately $10.8 million in punitive damages and $4.7 million in compensatory damages. We believe the parent company is not liable for the actions of its subsidiary or its employees and that both the compensatory and punitive amounts awarded are excessive and contradict various United States Supreme Court and New Mexico Supreme Court decisions which would warrant a new trial or, in the alternative, would limit the amount of damages awarded to a significantly lower amount. We, as well as the plaintiffs, have appealed and we will continue to defend this matter vigorously. Oral arguments before the Court of Appeals were held on November 15, 2011. Although we have made provisions in our consolidated financial statements for this self-insured matter, the amount of our legal reserve is less than the amount of the damages awarded, plus accrued interest. If our appeal to obtain a new trial or reduce the amount of the damages does not succeed, it could have a material adverse effect on our financial condition, results of operations and cash flows.    

Contractual Obligations and Commitments

Information concerning our contractual obligations and commercial commitments follows (in thousands):

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   Table of Contents                                                         Payments Due by Period                                                Twelve Months Ending December 31,                                                                                        2017 and Contractual Obligations          Total        2012       2013-2014     2015-2016      Thereafter Long-term Debt                 $ 372,207    $   4,540    $    4,236    $  163,372    $    200,059 Capital Lease Obligations            431           89           149           154              39 Operating Leases                 217,671       60,462        87,460        48,901          20,848 Fixed interest payments on Long-term Debt and Capital Lease Obligations (1)            152,640       21,662        43,120        43,055          44,803 Total Contractual Obligations (2)                $ 742,949    $  86,753    $  134,965    $  255,482    $    265,749    

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(1)   Excludes any interest payments on our variable rate debt.   

(2) This amount excludes $0.8 million of unrecognized tax benefits, as we are unable to reasonably estimate the timing of these cash flows.

                                                           Amount of 

Commitments Expiring per Period

                                  Total                    Twelve Months Ending December 31,                                  Amounts                                                         2017 and Other Commercial Commitments    Committed          2012            

2013-2014      2015-2016    Thereafter Standby Letters-of-Credit      $    59,568   $          59,568               †              †             † Surety Bonds                   $    29,963   $          29,520     $       415     $       28   $         -    

We had no significant off-balance sheet transactions or interests in 2011.

New Accounting Pronouncements Not Yet Adopted

See Note 1 to the Notes to Consolidated Financial Statements.