10-K 1 d609927d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Form 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2013

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                      .

COMMISSION FILE NUMBER: 333-129179

 

 

NATIONAL MENTOR HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   31-1757086

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

313 Congress Street, 6th Floor

Boston, Massachusetts 02210

  (617) 790-4800
(Address of principal executive offices, including zip code)   (Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act:

None.

Securities Registered Pursuant to Section 12(g) of the Act:

None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  x    No  ¨

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

The Company is a voluntary filer of reports required of companies with public securities under Sections 13 or 15(d) of the Securities Exchange Act of 1934 and has filed all reports which would have been required of the Company during the past 12 months had it been subject to such provisions.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of March 31, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was zero.

As of December 18, 2013, there were 100 shares of the registrant’s common stock, $0.01 par value, issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

None.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

  PART I   

Item 1.

  Business      4   

Item 1A.

  Risk Factors      12   

Item 1B.

  Unresolved Staff Comments      22   

Item 2.

  Properties      22   

Item 3.

  Legal Proceedings      22   

Item 4.

  Mine Safety Disclosures      23   
  PART II   

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      24   

Item 6.

  Selected Financial Data      27   

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 7A.

  Quantitative and Qualitative Disclosures about Market Risk      42   

Item 8.

  Financial Statements and Supplementary Data      42   

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      42   

Item 9A.

  Controls and Procedures      42   

Item 9B.

  Other Information      43   
  PART III   

Item 10.

  Directors, Executive Officers and Corporate Governance      44   

Item 11.

  Executive Compensation      47   

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      63   

Item 13.

  Certain Relationships and Related Transactions, and Director Independence      63   

Item 14.

  Principal Accounting Fees and Services      66   
  PART IV   

Item 15.

  Exhibits and Financial Statement Schedules      67   

Signatures

     68   

 

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FORWARD-LOOKING STATEMENTS

Some of the matters discussed in this report may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

These statements relate to future events or our future financial performance, and include statements about our expectations for future periods with respect to demand for our services, the political climate and budgetary environment, our expansion efforts and the impact of our recent acquisitions, our plans for investments to further grow and develop our business, our margins and our liquidity. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

The information in this report is not a complete description of our business or the risks associated with our business. There can be no assurance that other factors will not affect the accuracy of these forward-looking statements or that our actual results will not differ materially from the results anticipated in such forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to, those factors or conditions described under “Part I. Item 1A. Risk Factors” in this report as well as the following:

 

    changes in Medicaid or other funding or changes in budgetary priorities by federal, state and local governments;

 

    changes in reimbursement rates, policies or payment practices by our payors;

 

    our substantial amount of debt, our ability to meet our debt service obligations and our ability to incur additional debt;

 

    an increase in the number and nature of pending legal proceedings and the outcomes of those proceedings;

 

    an increase in our self-insured retentions and changes in the insurance market for professional and general liability, workers’ compensation and automobile liability and our claims history that affect our ability to obtain coverage at reasonable rates;

 

    our ability to control labor costs, including healthcare costs imposed by the Patient Protection and Affordable Care Act;

 

    our ability to control operating costs and collect accounts receivable;

 

    failure to take advantage of organic growth opportunities;

 

    our ability to maintain, expand and renew existing services contracts and to obtain additional contracts;

 

    our ability to establish and maintain relationships with government agencies and advocacy groups;

 

    our ability to acquire new licenses or to maintain our status as a licensed service provider in certain jurisdictions;

 

    our ability to attract and retain experienced personnel, including members of our senior management team;

 

    our ability to successfully integrate acquired businesses;

 

    government regulations, changes in government regulations and our ability to comply with such regulations;

 

    increased or more effective competition;

 

    credit and financial market conditions;

 

    changes in interest rates; and

 

    the potential for conflict between the interests of our majority equity holder and those of our debt holders.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, we do not assume responsibility for the accuracy and completeness of the forward-looking statements. All written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the “Risk Factors” and other cautionary statements included herein. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

 

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PART I

 

Item 1. Business

Company Overview

We are a leading provider of home and community-based health and human services to adults and children with intellectual and/or developmental disabilities (“I/DD”), acquired brain injury (“ABI”) and other catastrophic injuries and illnesses, and to youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (“ARY”). Since our founding in 1980, our operations have grown to 35 states. We provide services to approximately 12,300 clients in residential settings, some of whom also receive periodic services. Approximately 16,700 clients receive periodic services from us in non-residential settings.

We design customized service plans to meet the unique needs of our clients, which we deliver in home and community-based settings. Most of our service plans involve residential support, typically in small group homes, host home settings or specialized community facilities, designed to improve our clients’ quality of life and to promote client independence and participation in community life. Other services offered include supported living, day and transitional programs, vocational services, case management, family-based and outpatient therapeutic services, post-acute treatment and neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and speech therapies, among others. Our customized service plans offer our clients, as well as the payors for these services, an attractive, cost-effective alternative to health and human services provided in large, institutional settings.

We believe that our broad range of services, high-quality reputation and longstanding relationships with a diverse group of payors have made us one of the largest providers of home and community-based health and human services in the United States. We believe that our substantial experience in the industry coupled with our ability to offer clinical resources and share best practices across our organization has made us a preferred provider for many of our referral sources. We derive approximately 87% of our revenue from a diverse group of state and local government payors.

We offer our services through a variety of models, including (i) small group homes, most of which are residences for six people or fewer, (ii) host homes, or the “Mentor” model, in which a client lives in the home of a trained Mentor, (iii) in-home settings, in which we support clients’ independence with 24-hour services in their own homes, (iv) small, specialized community facilities which provide post-acute, specialized rehabilitation and comprehensive care for individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses and (v) non-residential settings, consisting primarily of day programs and periodic services in various settings.

As of September 30, 2013, we provided our services through approximately 20,200 full-time equivalent employees, as well as approximately 5,700 independently contracted host home caregivers, or Mentors. We generated net revenue of $1,198.7 million, $1,123.1 million and $1,062.8 million during fiscal 2013, 2012 and 2011, respectively.

Description of Services by Segment

We have two reportable segments, Human Services and Post-Acute Specialty Rehabilitation Services (“SRS”).

Presently, we don’t derive any revenues from countries outside the United States.

Human Services

We are a leading provider of home and community-based human services to the I/DD and ARY populations. Our Human Services segment represented approximately 83% of our net revenue in fiscal 2013.

Delivery of services to adults and children with I/DD is the largest portion of our Human Services segment. Our I/DD programs include residential support, day habilitation, vocational services, case management and personal care. We provide services to these clients through small group homes, Intermediate Care Facilities for the Mentally Retarded (“ICFs-MR”), host homes, in-home settings and non-residential settings. We operate approximately 980 group homes and 150 ICFs-MR. As of September 30, 2013, we provided I/DD services to approximately 17,500 clients in 21 states. In fiscal 2013, our I/DD services generated net revenue of $772.1 million, representing 64% of our net revenue. We receive substantially all our revenue for I/DD services from a diverse group of state and local governmental payors.

Our Human Services segment also includes the delivery of ARY services. Our ARY programs include therapeutic foster care, family reunification, family preservation, early intervention and adoption services. Our individualized approach allows us to work with an ever-changing client population that is diverse demographically as well as in type and severity of condition. We provide services to these clients through host homes, group homes, educational settings, in their family homes and in other non-residential settings. As of September 30, 2013, we provided ARY services to approximately 10,500 children, adolescents and their families in 17 states. In fiscal 2013, our ARY services generated net revenue of $218.1 million, representing 19% of our net revenue. We receive substantially all our revenue for ARY services from a diverse group of state and local governmental payors.

 

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Post-Acute Specialty Rehabilitation Services

Our SRS segment delivers health care and community-based health and human services to individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses. Our services range from sub-acute healthcare for individuals with intensive medical needs to day treatment programs, and include skilled nursing, neurorehabilitation, neurobehavioral rehabilitation, physical, occupational and speech therapies, supported living, outpatient treatment, and pre-vocational services. Our goal is to provide a continuum of care that allows our clients to achieve the highest level of function possible while enhancing their quality of life. We provide services to these clients primarily through specialized community facilities, small group homes, in-home and non-residential settings. As of September 30, 2013, our SRS operations provided services in 25 states and served approximately 1,000 clients nationally. In fiscal 2013, our SRS operations generated net revenue of $208.4 million, representing 17% of our net revenue. In fiscal 2013, we received 56% of our SRS revenue from non-public payors, such as commercial insurers, workers’ compensation funds, managed care and other private payors and 44% from state, local and federal governmental payors.

For additional information on the Company’s segments, please see note 18 to the consolidated financial statements.

Industry Overview

The health and human services industry provides services to people with a range of disabilities and special needs, including adults and children with I/DD, ABI and other catastrophic injuries and illnesses, and to at-risk youth. The market for these services remains highly fragmented, with service providers consisting of both not-for-profit and for-profit entities, of varying sizes. The largest portion of this client base is adults and children with I/DD. Services for these clients are funded primarily through Medicaid, a joint federal and state health insurance program under which eligible state expenditures are matched with federal funding. In addition, funds are provided by other federal, state and local governmental programs and, to a lesser extent, private payors.

Intellectual and/or Developmental Disabilities

Unless otherwise stated, all statistical information in this section has been obtained from reports prepared by Dr. David Braddock. Dr. Braddock is Associate Vice President of the University of Colorado (CU) System and Executive Director of the Coleman Institute for Cognitive Disabilities.

Intellectual and developmental disabilities are life-long disabilities attributable to a mental or physical impairment. Individuals with I/DD live in supervised residential settings, including institutions, with family caregivers or on their own. The number of persons with I/DD who received residential services outside of their family homes increased from 440,000 in 2000 to an estimated 613,000 in 2011, and the utilization of residential services is projected to increase during the next decade, in part because parents of baby boomers with I/DD may be unable to continue caring for them. Over the past two decades, the delivery of services to the I/DD population in supervised residential settings has grown significantly and, at the same time, there has been a major shift from institutional settings to home and community-based settings, both in part due to the Americans with Disabilities Act (“ADA”) and the U.S. Supreme Court Olmstead decision in 1999. The U.S. Supreme Court held in its Olmstead decision that under the ADA, states are required to place persons with intellectual disabilities in community settings rather than in institutions when such placement is deemed appropriate by medical professionals, the affected individual does not oppose the transfer from institutional care to a less restrictive setting and the placement can be accommodated taking into account the resources available to the state and the needs of other individuals with intellectual disabilities. We believe that community settings provide a higher quality and, in most cases, lower-cost alternative to care provided in state institutions.

Public spending on I/DD services was an estimated $56.6 billion in 2011, of which approximately 80% was spent to provide services in community settings of six or fewer beds, our target market, and for other non-institutional services, including supported living and employment and family assistance.

The Home and Community-Based Services (“HCBS”) Waiver program, a Medicaid program in which the federal government has waived the requirement that services be delivered in institutional settings, is the primary funding vehicle for home and community-based services. The HCBS Waiver program was instituted as an alternative to the ICF-MR program, described below, and authorized federal reimbursement for a wide variety of community supports and services, including supported living, life-skills training, supported employment, case management, respite care and other family support. In this program, the provider responds to the client’s identified needs and typically is paid on a fee-for-service basis.

The federal ICF-MR program was established in 1971 when legislation was enacted to provide for federal financial participation for ICFs-MR as an optional Medicaid service. This congressional authorization allows states to receive federal matching funds for institutional services that are funded with state or local government dollars. To qualify for Medicaid reimbursement, ICFs-MR must be certified and comply with federal standards in eight areas: management, client protections, facility staffing, active treatment services, client behavior and facility practices, health care services, physical environment and dietetic services. The ICF-MR program is used by states to support I/DD housing programs in both smaller (up to 16 residents) and larger (16 residents or more) institutional settings. Individuals who live in ICFs-MR receive active treatment.

 

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We believe that the following factors will continue to benefit the I/DD sector within the human services industry, and in particular, providers of home and community-based programs:

 

    Continued Closure/Downsizing of State Institutions and Other Large, Congregate Care Facilities — Although most of the shift from institutions to home and community-based settings has already occurred, the closure of additional state institutions is ongoing. We currently provide I/DD services to individuals with I/DD in six of the ten states with the highest institutional populations, including the states of California, Illinois and New Jersey, which are currently downsizing their facilities. Many individuals with I/DD previously resided in large private facilities and nursing homes. These settings are often not as well equipped to care for individuals with I/DD and therefore represent an additional source of demand for services provided in home and community-based settings.

 

    Active Advocacy — Individuals with I/DD are supported by active and well-organized advocacy groups. Using legislation prompted by the Olmstead decision, as well as lawsuits filed on behalf of those on waiting lists for home and community-based services, policy makers, civil rights lawyers, social workers and advocacy groups are driving states to offer individuals with I/DD and other disabilities the option to live and receive services in home and community-based settings. The U.S. Justice Department has significantly intensified Olmstead enforcement actions in recent years, most notably in a 2010 settlement with the state of Georgia under which the state agreed to a five-year plan to fund residential waiver services for 1,150 people with I/DD living in state institutions or waiting for such residential services, providing the opportunity to transition these individuals to the most integrated setting appropriate for their needs by July 1, 2015.

 

    Aging Caregivers — Nationwide in 2011, more than 740,000 individuals with I/DD were living with a family caregiver aged 60 years or older. As the caregivers grow older and are not able to provide continuous care, we expect the demand for I/DD services, and home and community-based services in particular, to expand.

At-Risk Youth and Their Families

According to a July 2013 U.S. Department of Health and Human Services report, there were approximately 400,000 children and adolescents in foster care as of September 30, 2012 as a result of abuse and neglect. Approximately 185,000, or 47%, were living in nonrelative foster family homes. Although during the last decade public child welfare agencies have increasingly emphasized periodic support services intended to strengthen families and keep young people out of foster care, there were more entries into foster care than exits from the system in federal fiscal year 2012 for the second year in a row.

ARY services are funded from a variety of sources, including Title IV-E of the Social Security Act (“Title IV-E”), The Adoption Assistance and Child Welfare Act of 1980, Medicaid and other state and local government appropriations. Title IV-E provides for an uncapped federal entitlement program that supports states’ expenditures on foster care and adoption support. For states that meet certain requirements, including Florida, Indiana and Ohio, the federal government permits the allocation of Title IV-E funds for family preservation and other prevention services.

Post-Acute Specialty Rehabilitation Services

The SRS market includes community-based health and human services to individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses. We provide the largest portion of our SRS services to individuals who have ABI. ABI has drawn growing public awareness due to injuries of our soldiers returning from war and injuries acquired in contact sports.

The treatment of ABI is an important public health challenge in the United States. According to the Brain Injury Association of America, an estimated 4.2 million people in the U.S. are living with a permanent disability as a result of an ABI. Traumatic brain injury is considered the “signature wound” of soldiers involved in the conflicts in Iraq and Afghanistan. The Government Accountability Office estimates that 20% of these veterans experience a traumatic brain injury. There is a growing role for providers with respect to services for those in the military, and we have qualified as a provider in a pilot program with the Veterans Health Administration Assisted Living Pilot Program for Veterans with Traumatic Brain Injury. This pilot program is the first time that the Veterans Administration has contracted with civilian providers that offer post-acute brain injury rehabilitation services. Discussions are ongoing to extend the program’s five-year authorization, which is scheduled to expire in federal fiscal year 2014. There are currently twenty-one states participating in home and community-based waivers for people with brain injuries, and others, including Maine, Rhode Island, Texas and Virginia, that have established programs specifically to fund brain injury services.

SRS services are an attractive alternative to higher-cost and less personalized institutional care, and we believe that both public and non-public payors are emphasizing lower-cost community-based residential, outpatient and day treatment for effective and cost-efficient care for individuals recovering from ABI, spinal injuries and other catastrophic injuries and illnesses. SRS services are also sought out as a clinically appropriate and less expensive “step-down” for individuals who no longer require care in acute care settings.

Both the public and non-public sectors currently finance post-acute specialty rehabilitation services. Public funding for post-acute services for individuals with ABI are provided in some states under ABI waiver programs that provide access to Medicaid funds for ABI care, and other states utilize I/DD or global waivers to serve the same population. In addition, significant advocacy efforts are advancing at the federal and state levels to require insurers to pay for rehabilitative treatment for those who suffer a brain injury.

 

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Public funding for services for individuals with spinal injuries and other catastrophic injuries and illnesses is provided through specific Medicaid waivers for brain and spinal cord injuries, as well as other generic Medicaid waivers and state-specific programs. Non-public payors for SRS services include private insurance companies, workers’ compensation funds, managed care companies and private individuals.

Our Business Strategy

We believe home and community-based health and human services that increase client independence and participation in community life while reducing payor costs will continue to grow in market share. We intend to continue to capitalize on this trend, both in existing markets and in new markets where we believe significant opportunities exist. The primary aspects of our strategy include the following:

Maintain and Improve Quality of Care and Employee Engagement; Continue to Strengthen our Third-Party Payor Relationships. We focus on providing our clients and their families with an environment that minimizes the stress and uncertainty associated with their condition while fostering community integration and high quality living. We aim to enhance our clients’ overall quality of life by providing a broad range of services, delivered by carefully trained, qualified and engaged employees and Mentors, with access to best practices from across our organization. Our employees are at the heart of our mission and critical to our success. We have a number of initiatives throughout the organization that are focused on the engagement of our workforce. We believe our focus on and reputation for client service at both a local and national level has strengthened our relationship with the state and local government agencies that refer and pay for our services. As a result, our relationships with these agencies have enabled us to gain referrals and contract renewals and to introduce new services in existing markets. We further strengthen these relationships by maintaining quality assurance, reporting, billing, compliance and risk management programs designed to serve the needs of third-party payors. We seek recognition as the provider of choice to state and local governments and other third-party payors by finding solutions to their most challenging human service delivery problems.

Grow our Census and Expand our Services in New and Existing Markets. We believe that our future growth will depend on our ability to increase referrals in existing markets and expand our services into new markets. Our organic expansion activities consist of new starts in both new and existing markets. Our new starts typically require us to fund operating losses for a period of approximately 18 to 24 months. If a new start does not become profitable during such period, we may terminate it.

Continue to Expand in SRS Market and Further Diversify Payor Base. We believe the SRS market represents an attractive opportunity for us because (i) the demand for these services is growing, (ii) our SRS services typically generate a higher margin than our services in the Human Services segment and (iii) the SRS market represents an opportunity for us to diversify our payor base. In addition, the SRS market is highly fragmented and consists of many small providers, which we believe represents an opportunity for us to continue to grow through acquisitions. In recent years, our growth strategy has emphasized expanding our SRS segment through both organic growth and acquisitions, and we have achieved significant growth in both revenue and profitability to become a leading provider of these services.

Strategically Pursue Acquisitions. We have strategically supplemented our organic growth through acquisitions, which have allowed us to penetrate new geographies, leverage our systems, operating costs and best practices, and pursue cross-selling opportunities. The majority of our acquisitions are small and of a “tuck-in” nature, although we have completed larger acquisitions, particularly in the SRS segment, from time to time. We monitor the market nationally for human services businesses that we can purchase at an attractive price and efficiently integrate with our existing operations. We have invested in our infrastructure and formalized processes to enable us to pursue and integrate acquisition opportunities. We believe we are often seen as a preferred acquiror in these situations due to our service offerings, experience, payor relationships, infrastructure, reputation for quality and overall resources. We intend to continue to pursue acquisitions that are philosophically compatible and can be readily integrated into our existing operations.

Continue to Leverage Overhead and Reduce Costs. In recent years, we have launched a number of initiatives to leverage our overhead and reduce costs, including purchasing initiatives to obtain more favorable pricing for medical and office supplies, vehicles and technology, and establishing a shared services center (the “SSC”) that now houses certain Finance, Human Services and Information Technology teams. Moving forward, we will continue to explore other opportunities to leverage overhead and gain efficiencies.

Selectively Divest Underperforming or Non-Strategic Businesses. In order to continue to grow in market share and better utilize our capital, we regularly review and consider the divestiture of underperforming or non-strategic businesses to improve our operating results. We have made divestitures from time to time and expect that we may make additional divestitures in the future. Divestitures could have a material impact on our consolidated financial statements.

 

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Customers and Contracts

Our customers, which pay us to provide services to our clients, are governmental agencies, not-for-profit organizations and non-public payors. Our I/DD and ARY services, as well as a significant portion of our SRS services, are delivered pursuant to contracts with various governmental agencies, such as state departments of developmental disabilities, juvenile justice, child welfare as well as the Federal Veterans Health Administration. Such contracts may be issued at the county or state level, depending upon the structure of the service system of the state in question. In addition, a majority of our SRS revenue is derived from contracts with commercial insurers, workers’ compensation carriers and other non-public payors. Contracts may cover a range of individuals such as all children referred for host home services in a county or a particular set of individuals who will share group living arrangements. Contracts are sometimes issued for specific individuals, where rates are individually determined based on need. Although our contracts generally have a stated term of one year and generally may be terminated without cause on 60 days’ notice, the contracts are typically renewed annually if we have complied with licensing, certification, program standards and other regulatory requirements. As a provider of record, we contractually obligate ourselves to adhere to the applicable federal and state regulations regarding the provision of services, the maintenance of records and submission of claims for reimbursement under Medicaid.

During fiscal 2013 and 2012, revenue from our contracts with state and local governmental payors in the states of Minnesota, California, West Virginia, Florida and Indiana, our five largest revenue-generating states, comprised 42% of our revenue. Revenue from our contracts with state and local governmental payors in the state of Minnesota, our largest state, accounted for 14% and 15% of our revenue for fiscal 2013 and 2012, respectively.

Training and Supporting our Direct Service Professionals

We provide pre-service and in-service education to all of our direct service professionals, including employees and independent contractors, clinical and administrative staff, and we encourage staff and contractors to avail themselves of outside training opportunities whenever possible. Employees and independent contractors participate in orientation programs designed to increase understanding of our mission, philosophy of care, and our Code of Conduct and compliance program. In addition, education and skill development in competencies required for specific duties are provided in accordance with licensing and regulatory requirements and our internal operating standards. These include, but are not limited to, human rights, individual service plan development, universal precautions, first aid, mandated reporting of abuse and neglect, confidentiality, emergency procedures, medication management, risk management and incident reporting procedures. We maintain an extensive resource library of training materials and an intranet site that facilitates the identification and exchange of expertise across all of our operations. Pre-service and in-service education sessions are required as a condition of continued employment or a continued contractual relationship with us. This training helps our staff to understand their responsibilities to the program and its participants, and results in both personal and professional development of staff and contractors. We work to increase individual job satisfaction and retention of motivated and qualified employees and contractors.

In addition to pre-service and in-service orientation, the Mentors in our ARY business receive training which is specific to the individual or child placed in their home. A home study is conducted and interviews and criminal background checks are performed on all adult members of the Mentor household. Mentors are regularly monitored by our case manager or coordinator according to a prescribed schedule. Mentors have access to emergency telephone triage and on-site crisis intervention, when necessary. Many Mentors attend support groups offered at the program office.

Sales/Business Development and Marketing

Substantially all of our I/DD and ARY clients come to us through third-party referrals, most frequently through recommendations to family members from state or local agencies. Since our operations depend heavily on these referrals, we seek to ensure that we provide high-quality services in all states in which we operate, allowing us to enhance our name recognition and maintain a positive reputation with the state and local agencies.

Relationships with referral sources are cultivated and maintained at the local level by key operations managers. Local programs may, however, avail themselves of corporate resources to help grow and diversify their businesses. Staff across the country has business development and marketing services available to promote both new and existing product lines.

Our SRS sales activities are independently organized from those of our Human Services businesses. We have dedicated geographically assigned sales staff cultivating relationships with public and private payors and conducting our marketing and sales activities.

Competition

I/DD

The I/DD market is highly fragmented, with both not-for-profit and for-profit providers ranging in size from small, local agencies to large, national organizations. While state and local governments continue to supply a small percentage of services, the majority of services are provided by the private sector. Not-for-profit organizations are also active in all states and range from small agencies serving a limited area with specific programs to multi-state organizations. Many of the not-for-profit companies are affiliated with advocacy and sponsoring groups such as community mental health and mental retardation centers as well as religious organizations.

 

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ARY

The at-risk youth and troubled youth market is extremely fragmented, with several thousand providers in the United States. Competitors include both for-profit and not-for-profit local providers serving one particular geographic area to multi-state ARY providers, and to a very limited extent, state and county providers.

SRS

We compete with local providers, both large and small, including hospitals, post-acute rehabilitation facilities, residential community-based facilities, day treatment centers and outpatient centers specializing in long-term catastrophic care and short-term rehabilitation. This market also includes several large national providers of inpatient and outpatient rehabilitation services.

Regulatory Framework

We must comply with comprehensive government regulation of our business, including federal, state and local statutes, regulations and policies governing the licensing of facilities, the quality of service, the revenues received for services, and reimbursement for the cost of services. State and federal regulatory agencies have broad discretionary powers over the administration and enforcement of laws and regulations that govern our operations.

The following regulatory considerations are critical to our operations:

Funding. Federal and state funding for our services is subject to statutory and regulatory changes, contracting and managed care initiatives, level of care assessments, court orders, rate setting and state budgetary considerations, all of which may materially increase or decrease reimbursement for our services. We actively participate in local and national legislative initiatives that seek to impact funding and regulation of our services. We derive revenues for our I/DD and ARY services and a significant portion of our SRS services from Medicaid programs.

Licensure and qualification to deliver service. We are required to comply with extensive licensing and regulatory requirements applicable to the services we deliver. These include requirements for participation in the Medicaid program, state and local contractual obligations, and requirements relating to individual rights, the credentialing of all of our employees and contract Mentors (including background and Office of Inspector General checks), the quality of care delivered, the physical plant and facilitation of community participation. Compliance with state licensing requirements is a prerequisite for participation in government-sponsored health care assistance programs, such as Medicaid. To qualify for reimbursement under Medicaid, facilities and programs are subject to various requirements imposed by federal and state authorities. We maintain a licensing database that tracks activity on licenses governing the provision of services.

In addition to Medicaid participation requirements, our facilities and services are subject to annual or semi-annual licensing and other regulatory requirements of state and local authorities. These requirements relate to the condition of the facilities, the quality and adequacy of personnel and the quality of services provided. State licensing and other regulatory requirements vary by jurisdiction and are subject to change and local interpretation.

From time to time we receive notices from regulatory inspectors that, in their opinion, there are deficiencies resulting from a failure to comply with various regulatory requirements. We review such notices and take corrective action as appropriate. In most cases we and the reviewing agency agree upon the steps to be taken to address the deficiency and, from time to time, we or one or more of our subsidiaries may enter into agreements with regulatory agencies requiring us to take certain corrective action in order to maintain our licenses. Serious deficiencies, or failure to comply with any regulatory agreements, may result in the assessment of fines or penalties and/or decertification or de-licensure actions by the Centers for Medicare and Medicaid Services (“CMS”) or state regulatory agencies.

We deliver services and support under a number of different funding and program provisions. Our most significant sources of funding for our I/DD services are HCBS Waiver programs, Medicaid programs for which eligibility is based on a set of criteria (typically disability or age) established by the state and approved by the federal government. There is no uniformity among states and/or regulations governing our delivery of waivered services to individuals. Each state where we deliver services operates under a plan submitted by the state to CMS to use Medicaid funds in non-institutional settings. Typically the state writes its own regulations governing providers and services provided under the state waiver program. Consequently, there is no uniform method of describing or predicting the outcomes of regulations across states where we deliver HCBS Waiver services. In addition, our ICFs-MR are governed by federal regulations, and may also be subject to individual state rules that vary widely in application and content. Federal regulations require that in order to maintain Medicaid certification as an ICF-MR, the facility is subject to annual on site survey (a federal rule and process implemented by state agencies). Failure to successfully pass this inspection and remedy all defects or conditions cited may result in a finding of immediate jeopardy or other serious sanction and, ultimately, may cause a loss of both certification and funding for that particular facility.

 

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Similarly, child foster care and other children’s services are largely governed by individual state regulations which vary both in terms and regulatory content. Failure to comply with any state’s regulations requires remedial action on our part and a failure to adequately remedy the problem may result in provider or contract termination.

All states in which we operate have adopted laws or regulations which generally require that a state agency approve us as a provider, and many require a determination that a need exists prior to the addition of covered individuals or services. Provider licenses are not transferable. Consequently, should we intend to acquire, develop, expand or divest services in any state or to enter a new state, we may be required to undergo a rigorous licensing, transfer and approval process prior to conducting business or completing any transaction.

Similarly, some states have a formal Certificate of Need (“CON”) process, whereby the state health care authority must first determine that a service proposed is needed under the state health plan, prior to any service being licensed or applied for. The CON process varies by state and may be formal in design, encompassing any transfer, organizational change, capital improvements, divestitures or acquisitions. Formal processes may include public notice, opportunity for affected parties to request a hearing prior to the health care authority approving the project, as well as an opportunity for the state authority to deny the project. Other states have a less formal process for CON application and approval and may be limited to new or institutional projects. Very few states require CON approval for waivered services. Failure to comply with a state CON process may result in a prohibition on Medicaid billing and may subject the provider to fines, penalties, other civil sanctions or criminal penalties for the operators or owners of an unapproved health service.

Other regulatory matters. The Health Insurance Portability and Accountability Act of 1996, or “HIPAA,” set national standards for the protection of health information created, maintained or transmitted by health providers. Under the law and regulations known collectively as the privacy and security rules, covered entities must implement standards to protect and guard against the misuse of individually identifiable health information.

Federal regulations issued pursuant to HIPAA contain, among other measures, provisions that require organizations to implement significant and expensive computer systems, employee training programs and business procedures. Rules have been established to protect the integrity, security and distribution of electronic health and related financial information. Many states have also implemented extensive data privacy and security laws and regulations. Failure to timely implement or comply with HIPAA or other data privacy and security regulations may, under certain circumstances, trigger the imposition of civil or criminal penalties.

The federal False Claims Act imposes civil liability on individuals and entities that submit or cause to be submitted false or fraudulent claims for payment to the government. Violations of the False Claims Act may include treble damages and penalties of up to $11,000 per false or fraudulent claim. Similarly, retention of any overpayments may be regarded by the government as a false claim.

In addition to actions being brought by government officials under the False Claims Act, this statute and analogous state laws also allow a private individual with direct knowledge of fraud to bring a “whistleblower” claim on behalf of the government for violations. The whistleblower receives a statutory amount of up to 30% of the recovered amount from the government’s litigation proceeds if the litigation is successful or if the case is successfully settled. Recently, the number of whistleblower suits brought against healthcare providers has increased dramatically, and has included suits based (among other things) upon alleged violations of the Federal Anti-Kickback Law.

The Anti-Kickback Law prohibits kickbacks, rebates and any other forms of remuneration in return for referrals. Any remuneration, direct or indirect, offered, paid, solicited or received, in return for referrals of patients or business for which payment may be made in whole or in part under Medicaid, could be considered a violation of law. The language of the Anti-Kickback law also prohibits payments made to anyone to induce them to recommend purchasing, leasing, or ordering any goods, facility, service or item for which payment may be made in whole or in part by Medicaid. Criminal penalties under the Anti-Kickback Law include fines up to $25,000, imprisonment for up to 5 years, or both. In addition, acts constituting a violation of the Anti-Kickback Law may also lead to civil penalties, such as fines, assessments and exclusion from participation in the Medicaid program.

Additionally we must comply with local zoning and licensing ordinances and requirements. The Federal Fair Housing Amendments Act of 1988 protects the interests of the individuals we serve, prohibits local discriminatory ordinance practices and provides additional opportunities and accommodations for people with disabilities to live in their community of choice.

Federal regulations promulgated by the Occupational Safety and Health Administration (“OSHA”) require us to have safety plans for blood borne pathogens and other work place risks. At any point in time OSHA investigators may receive a complaint which requires on-site inspection and/or audit, the outcome of which may adversely affect our operations.

 

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Periodically, new statutes and regulations are written and adopted that directly affect our business. It is often difficult to predict the impact a new regulation will have on our operations until we have taken steps to implement its requirements. For example, the Patient Protection and Affordable Care Act of 2010 provided a mandate for more vigorous and widespread enforcement and directed state Medicaid agencies to establish Recovery Audit Contractor (“RAC”) programs. RACs are private entities which will perform audits on a contingency fee basis, giving them an incentive to identify discrepancies in payments, from which they may be permitted to extrapolate disproportionately large penalties and fines. States were required to be in compliance by January 1, 2012 unless granted an extension. To date, RAC activity has affected our business in a single state; however this remains a fairly new federal initiative and the ultimate impact remains unclear. Only the passage of time and our experience with enforcement and compliance will permit our assessment of the exact impact the new statute and regulations have on our business.

Similarly the new HIPAA Regulations increased both the scope of business associates liability and obligations, as well as increase disclosure obligations of providers in the event of a breach. The Federal enforcement agency has expressed an intent to increase investigations and potential penalties for noncompliance in part due to these new standards.

Managed care initiatives undertaken in a given state may impact our business by modifying the types of services eligible for payment, the qualifications required for payment and the rates that are paid for those services. Similarly, some states are pursuing waivers for dual-eligible populations (that is, persons eligible for both Medicare and Medicaid), and our ability to participate in such waivered services may depend on our ability to become a Medicare provider.

Conviction of abusive or fraudulent behavior with respect to one facility or program may subject other facilities and programs under common control or ownership to disqualification from participation in the Medicaid program. Executive Order 12549 prohibits any corporation or facility from participating in federal contracts if it or its principals (included but not limited to officers, directors, owners and key employees) have been debarred, suspended or declared ineligible or have been voluntarily excluded from participating in federal contracts. In addition, some state regulators provide that all facilities licensed with a state under common ownership or control are subject to delicensure if any one or more of such facilities are delicensed.

We must also comply with the standards set forth by the Office of Inspector General (“OIG”) governing internal compliance and external reporting requirements. We regularly review and monitor OIG advisory opinions, although they are limited in their application to Medicaid programs. Significant legislative, media and public attention has recently focused on health care. Because the law in this area is complex and continuously evolving, ongoing or future governmental investigations or litigation may result in interpretations that are inconsistent with our current practices. It is possible that outside entities could initiate investigations or future litigation impacting our services and that such matters could result in penalties and adverse publicity. It is also possible that our executive and other management personnel could be included in these investigations and litigation or be named defendants.

The Patient Protection and Affordable Care Act and Health Care and Education Reconciliation Act of 2010, and the rules and regulations thereunder (together, the “Affordable Care Act”) were signed into law in March 2010 and represent significant changes to the U.S. healthcare system. The legislation is far-reaching and is intended to expand access to health insurance coverage over time. The legislation includes requirements that most individuals obtain health insurance coverage beginning in 2014 and that most large employers offer coverage to their employees or they will be required to pay a financial penalty beginning in 2015. In addition, the new laws encompass certain new taxes and fees, including limitations on the amount of compensation that is tax deductible and new fees which may not be deductible for income tax purposes.

The legislation also imposes new requirements and restrictions, including, but not limited to, guaranteed coverage requirements, prohibitions on some annual and all lifetime limits on amounts paid on behalf of or to our employees, increased restrictions on rescinding coverage, establishment of minimum medical loss ratio requirements, the establishment of state insurance exchanges and essential benefit packages, and greater limitations on product pricing.

The Affordable Care Act has already had a significant impact on the structure of the health plans we offer our employees. We have recently redesigned our health benefits to only offer employees health coverage that meets the requirements of the Affordable Care Act.

Finally, we are also subject to a large number of employment related laws and regulations, including laws regarding discrimination, wrongful discharge, retaliation, and federal and state wage and hours laws.

A material violation of a law or regulation could subject us to fines and penalties and in some circumstances could disqualify some or all of the facilities and programs under our control from future participation in Medicaid or other government programs. Failure to comply with laws and regulations could have a material adverse effect on our business.

A Compliance Officer (vice president level position) oversees our compliance program and reports to our Chief Legal Officer, a management compliance committee, and a board compliance committee. The program activities are reported regularly to the management compliance committee which includes the CEO, COO, CFO, as well as medical, operations, HR, legal and quality expertise. In addition, the program activities are periodically reported at the board level.

Seasonablity. In general, our financial performance is not significantly impacted by fluctuations from seasonality.

Certain Transactions

On February 9, 2011, we completed a refinancing (the “February 2011 Refinancing”), which included entering into a senior credit agreement (the “senior credit agreement”) for senior secured credit facilities (the “senior secured credit facilities”) and issuing $250.0 million in aggregate principal amount of 12.50% senior notes due 2018 (the “senior notes”). We used the net proceeds from the senior secured credit facilities ($520.9 million) and the senior notes ($238.7 million), together with cash on hand, to: (i) repay all amounts owing under our old senior secured credit facilities and our mortgage facility; (ii) purchase $171.9 million of our senior subordinated notes (the “Senior Subordinated Notes”); (iii) pay $9.6 million to NMH Holdings, Inc. (“NMH Holdings”) related to a tax sharing arrangement; (iv) declare a $219.7 million dividend to NMH Holdings, LLC (“Parent”), which in turn made a distribution to NMH Holdings, which used $206.4 million cash proceeds of the distribution to repurchase $210.9 million aggregate principal amount of the NMH Holdings notes at a premium to market value (v) repurchase an additional $13.3 million principal amount of NMH Holdings notes we held as an investment and (vi) pay related fees and expenses.

 

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On October 15, 2012, we entered into an Amendment Agreement (the “Amendment Agreement”) to amend and restate the senior credit agreement governing the senior secured credit facilities. The Amendment Agreement converted the existing term loan facility into a tranche B-1 term loan facility in aggregate principal amount of $522.1 million (the “term loan”), the proceeds of which were used to prepay the existing term loan. The Amendment Agreement also replaced our existing $75.0 million revolving credit facility and the borrowings thereunder with a new $75.0 million revolving credit facility (the “senior revolver”). The Amendment Agreement had the effect of lowering the interest rate we pay on the borrowings under the senior secured credit facilities by 0.50%, by reducing the LIBOR floor from 1.75% to 1.25%.

On February 4, 2013, we entered into an Incremental Amendment No. 1 (the “Incremental Amendment No. 1”) to the Amendment Agreement. The Incremental Amendment No. 1 provided for an additional $30.0 million term loan (the “incremental term loan”) under our existing term loan. The net proceeds of the incremental term loan were used to repay $29.8 million of outstanding borrowings under the senior revolver. Total fees incurred related to the Incremental Amendment No.1 were $0.4 million which are being amortized over the remaining period of the term loan. We are required to repay the incremental term loan in quarterly principal installments of 0.25% of the principal amount, with the balance payable at maturity of the term loan. All of the other terms of the incremental term loan are identical to the term loan.

Our Sponsor

Vestar, certain affiliates of Vestar, members of management and certain directors own NMH Investment, LLC (“NMH Investment”), which indirectly owns the Company. Vestar is a leading private equity firm specializing in management buyouts and growth capital investments. Vestar’s investment in National Mentor Holdings, Inc. was funded by Vestar Capital Partners V, L.P., a $3.7 billion fund which closed in 2006, and an affiliate.

Since the firm’s founding in 1988, Vestar has completed 70 investments in North America and Europe in companies with a total value of over $40 billion. These companies have varied in size and geography and span a broad range of industries including healthcare, an area in which Vestar’s principals have had meaningful experience. Vestar currently manages funds totaling over $7 billion and has offices in New York, Denver and Boston. See “Certain Relationships and Related Party Transactions, and Director Independence,” “Security Ownership of Principal Shareholders and Management” and the documents incorporated by reference herein for more information with respect to our relationship with Vestar.

 

Item 1A. Risk Factors.

Reductions or changes in Medicaid funding or changes in budgetary priorities by the federal, state and local governments that pay for our services could have a material adverse effect on our revenue and profitability.

We derive the vast majority of our revenue from contracts with state and local governments. These governmental payors fund a significant portion of their payments to us through Medicaid, a joint federal and state health insurance program through which state expenditures are matched by federal funds typically ranging from 50% to approximately 75% of total costs, a number based largely on a state’s per capita income. Our revenue, therefore, is largely determined by the level of federal, state and local governmental spending for the services we provide.

Efforts at the federal level to reduce the federal budget deficit pose risk for reductions in federal Medicaid matching funds to state governments. The Joint Select Committee on Deficit Reduction’s failure to meet the deadline imposed by the Budget Control Act of 2011 triggered automatic across-the-board cuts to discretionary funding, including a 2% reduction to Medicare, effective March 1, 2013, but specifically exempted Medicaid payments to states. While this development did not reduce federal Medicaid funding, reductions in other federal payments to states will put additional stress on state budgets, with the potential to negatively impact the ability of states to provide the state Medicaid matching funds necessary to maintain or increase the federal financial contribution to the program. Negotiations surrounding deficit reduction efforts remain contentious, and most recently resulted in a 16 day government shutdown in October 2013. While Medicaid payments were not affected during this period, the potential for a longer shutdown if further negotiations fail to produce a resolution could cause disruptions in Medicaid support and payments to states. In addition, Congress and the Obama Administration may choose to adopt alternative proposals to reduce the federal budget deficit. These alternative reductions could have a negative impact on state Medicaid budgets, including proposals to provide states with more flexibility to determine Medicaid benefits, eligibility or provider payments through the use of block grants or streamlined waiver approvals, as well as those that would reduce the amount of federal Medicaid matching funding available to states by curtailing the use of provider taxes or by adjusting the Federal Medical Assistance Percentage (FMAP). Furthermore, any new Medicaid-funded benefits and requirements established by the Congress, particularly those included in the Patient Protection and Affordable Care Act of 2010, that mandate certain uses for Medicaid funds could have the effect of diverting those funds from the services we provide.

 

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Budgetary pressures facing state governments, as well as other economic, industry, and political factors, could cause state governments to limit spending, which could significantly reduce our revenue, referrals, margins and profitability, and adversely affect our growth strategy. Governmental agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If a government agency does not receive an appropriation sufficient to cover its contractual obligations with us, it may terminate a contract or defer or reduce our reimbursement. In addition, there is risk that previously appropriated funds could be reduced through subsequent legislation. Many states in which we operate experienced unprecedented budgetary deficits in recent years and implemented service reductions, rate freezes and/or rate reductions, including the states such as Minnesota, California, Florida, Indiana and Arizona. Similarly, programmatic changes such as conversions to managed care with related contract demands regarding billing and services, unbundling of services, governmental efforts to increase consumer autonomy and reduce provider oversight, coverage and other changes under state Medicaid plans, may cause unanticipated costs and risks to our service delivery. The loss or reduction of or changes to reimbursement under our contracts could have a material adverse effect on our business, financial condition and operating results.

Reductions in reimbursement rates or failure to obtain increases in reimbursement rates could adversely affect our revenue, cash flows and profitability.

Our revenue and operating profitability depend on our ability to maintain our existing reimbursement levels and to obtain periodic increases in reimbursement rates to meet higher costs and demand for more services. Approximately twelve percent of our revenue is derived from contracts based on a cost reimbursement model where we are reimbursed for our services based on our costs plus an agreed-upon margin. If we are not entitled to, do not receive or cannot negotiate increases in reimbursement rates, or are forced to accept a reduction in our reimbursement rates at approximately the same time as our costs of providing services increase, including labor costs and rent, our margins and profitability could be adversely affected. Changes in how federal and state government agencies operate reimbursement programs can also affect our operating results and financial condition. Some states have, from time to time, revised their rate-setting methodologies in a manner that has resulted in rate decreases. In some instances, changes in rate-setting methodologies have resulted in third-party payors disallowing, in whole or in part, our requests for reimbursement. Any reduction in or the failure to maintain or increase our reimbursement rates could have a material adverse effect on our business, financial condition and results of operations. Changes in the manner in which state agencies interpret program policies and procedures or review and audit billings and costs could also adversely affect our business, financial condition and operating results and our ability to meet obligations under our indebtedness.

Our level of indebtedness could adversely affect our liquidity and ability to raise additional capital to fund our operations, and it could limit our ability to invest in our growth initiatives or react to changes in the economy or our industry.

We have a significant amount of indebtedness and substantial leverage. As of September 30, 2013, we had total indebtedness of $803.5 million. Our increased cash interest payments after the February 2011 Refinancing and our investments in our growth initiatives have reduced the liquidity in our business. Although we used the net proceeds from the incremental term loan in February 2013 to pay the outstanding balance on our senior revolver, thereby increasing our liquidity, we expect to continue to make new investments in our growth that will reduce liquidity, and we may need to draw on the senior revolver in the future.

Our substantial degree of leverage could have important consequences, including the following:

 

    it may significantly curtail our acquisitions program and may limit our ability to invest in our infrastructure and in growth opportunities;

 

    it may diminish our ability to obtain additional debt or equity financing for working capital, capital expenditures, debt service requirements and general corporate or other purposes;

 

    a substantial portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness and will not be available for other purposes, including our operations, future business opportunities and acquisitions and capital expenditures;

 

    the debt service requirements of our indebtedness could make it more difficult for us to satisfy our indebtedness and contractual and commercial commitments;

 

    interest rates on the portion of our variable interest rate borrowings under the senior secured credit facilities that have not been hedged may increase;

 

    it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt and a lower degree of leverage; and

 

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    we may be vulnerable if the country falls into another recession, or if there is a downturn in our business, or we may be unable to carry out activities that are important to our growth.

Subject to restrictions in the indenture governing our senior notes and the senior credit agreement, we may be able to incur more debt in the future, which may intensify the risks described in this risk factor. All of the borrowings under the senior secured credit facilities are secured by substantially all of the assets of the Company and its subsidiaries.

In addition to our high level of indebtedness, we have significant rental obligations under our operating leases for our group homes, other service facilities and administrative offices. For the fiscal year ended September 30, 2013, our aggregate rental payments for these leases were $54.3 million. We expect this number will increase during fiscal 2014 as a result of new leases entered into pursuant to acquisitions and new program starts. Our ongoing rental obligations could exacerbate the risks described above.

Our increased cash interest payments after the February 2011 Refinancing and our investments in our growth initiatives have reduced the liquidity in our business. As we continue to make new investments in our growth that will reduce liquidity, we may need to draw on the senior revolver in the future. Our ability to generate sufficient cash flow to fund our debt service, rental payments and other obligations depends on many factors beyond our control. See “Risk Factors—Credit and economic conditions could have a material adverse effect on our cash flows, liquidity and financial condition.” In addition, possible acquisitions or investments in organic growth and other strategic initiatives could require additional debt financing. If our future cash flows do not meet our expectations and we are unable to service our debt, or if we are unable to obtain additional debt financing, we may be forced to take actions such as revising or delaying our strategic plans, reducing or delaying acquisitions, selling assets, restructuring or refinancing our debt, or seeking additional equity capital. We may be unable to effect any of these transactions on satisfactory terms, or at all. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to obtain additional financing on satisfactory terms, or at all, could have a material adverse effect on our business, financial condition and operating results.

Covenants in our debt agreements restrict our business in many ways.

The senior credit agreement governing the senior secured credit facilities and the indenture governing the senior notes contain various covenants that limit our ability and/or our subsidiaries’ ability to, among other things:

 

    incur additional debt or issue certain preferred shares;

 

    pay dividends on or make distributions in respect of capital stock or make other restricted payments;

 

    make certain investments;

 

    sell certain assets;

 

    create liens on certain assets to secure debt;

 

    enter into agreements that restrict dividends from subsidiaries;

 

    consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

    enter into certain transactions with our affiliates.

The senior credit agreement governing the senior secured credit facilities also requires the Company and its subsidiaries to maintain specified financial ratios and satisfy other financial condition tests, which over time will become more restrictive. Our ability to meet those financial ratios and tests may be affected by events beyond our control, and we cannot assure you that we will satisfy those tests. The breach of any of these covenants or financial ratios could result in a default under the senior secured credit facilities and the lenders could elect to declare all amounts borrowed thereunder, together with accrued interest, to be due and payable and could proceed against the collateral securing that indebtedness.

The nature of our operations subjects us to substantial claims, litigation and governmental investigations.

We are in the health and human services business and, therefore, we have been and continue to be subject to substantial claims alleging that we, our employees or our Mentors failed to provide proper care for a client. We are also subject to claims by our clients, our employees, our Mentors or community members against us for negligence and intentional misconduct, or violation of applicable laws. Included in our recent claims are claims alleging personal injury, assault, abuse, wrongful death and other charges. Several years ago, we experienced a spike in claims filed against the Company and we could face such a spike in the future. As a result of the increase in claims, we received less favorable insurance terms and expensed greater amounts to fund potential claims.

Regulatory agencies may initiate administrative proceedings alleging that our programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on us or ask for recoupment of amounts paid. We could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if we do not prevail, we could be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.

 

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A litigation award excluded by, or in excess of, our third-party insurance limits and self-insurance reserves could have a material adverse impact on our operations and cash flow and could adversely impact our ability to continue to purchase appropriate liability insurance. Even if we are successful in our defense, civil lawsuits or regulatory proceedings could also irreparably damage our reputation.

Our financial results could be adversely affected if claims against us are successful, to the extent we must make payments under our self-insured retentions, or if such claims are not covered by our applicable insurance or if the costs of our insurance coverage increase.

We have been and continue to be subject to substantial claims against our professional and general liability and automobile liability insurance. Professional and general liability claims, if successful, could result in substantial damage awards which might require us to make significant payments under our self-insured retentions and increase future insurance costs. For claims arising from occurrences from October 1, 2010 to September 30, 2011, we were self-insured for $2.0 million per claim and $8.0 million in the aggregate, and for $500,000 per claim in excess of the aggregate. From October 1, 2011 to September 30, 2013, we were self-insured for the first $4.0 million of each and every claim with no aggregate limit. Beginning October 1, 2013, we are self-insured for $4.0 million per claim and $28.0 million in the aggregate. We may be subject to increased self-insurance retention limits in the future which could have a negative impact on our results. An award may exceed the limits of any applicable insurance coverage, and awards for punitive damages may be excluded from our insurance policies either contractually or by operation of state law. In addition, our insurance does not cover all potential liabilities including, for example, those arising from employment practice claims, wage and hour violations, and governmental fines and penalties. As a result, we may become responsible for substantial damage awards that are uninsured.

Insurance against professional and general liability and automobile liability can be expensive and our insurance premiums may increase in the future. Insurance rates vary from state to state, by type and by other factors. Rising costs of insurance premiums, as well as successful claims against us, could have a material adverse effect on our financial position and results of operations.

It is also possible that our liability and other insurance coverage will not continue to be available at acceptable costs or on favorable terms.

If payments for claims exceed actuarially determined estimates, if claims are not covered by insurance, or if our insurers fail to meet their obligations, our results of operations and financial position could be adversely affected.

Our variable cost structure is directly related to our labor costs, which may be adversely affected by labor shortages, a deterioration in labor relations or increased unionization activities.

Our variable cost structure and operating profitability are directly related to our labor costs. Labor costs may be adversely affected by a variety of factors, including a limited supply of qualified personnel in any geographic area, local competitive forces, ineffective utilization of our labor force, increases in minimum wages or the need to increase wages to remain competitive, health care costs and other personnel costs, and adverse changes in client service models. We typically cannot recover our increased labor costs from payors and must absorb them ourselves. We have incurred higher labor costs in certain markets from time to time because of difficulty in hiring qualified direct service staff. These higher labor costs have resulted from increased wages and overtime and the costs associated with recruitment and retention, training programs and use of temporary staffing personnel. In part to help with the challenge of recruiting and retaining direct care employees, we offer these employees a benefits package that includes paid time off, health insurance, dental insurance, vision coverage, life insurance and a 401(k) plan, and these costs can be significant.

Although our employees are generally not unionized, we have one business in New Jersey with approximately 41 employees who are represented by a labor union and approximately 283 Connecticut direct care workers who are also represented by a labor union. We began negotiating a labor agreement with the Connecticut union in September 2012 and such negotiations are continuing. We may not be able to negotiate this or future labor agreements on satisfactory terms. Future unionization activities could result in an increase of our labor and other costs. If employees covered by a collective bargaining agreement were to engage in a strike, work stoppage or other slowdown, we could experience a disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.

The Patient Protection and Affordable Care Act may materially increase our costs and/or make it harder for us to compete as an employer.

        The Patient Protection and Affordable Care Act imposed new mandates on employers and individuals. Though the implementation of the requirement that all employers with 50 or more full-time employees provide “credible” health insurance to employees or pay a penalty has been delayed until January 1, 2015, the mandate requiring all individuals to enroll in a “credible” health insurance plan is scheduled to become effective on January 1, 2014. Despite the delayed implementation of the employer mandate, we have recently redesigned our health benefits for calendar year 2014 to offer employees health coverage that meets the requirements of the Affordable Care Act. Depending upon enrollment in our new plan, our cost for employee health insurance could materially increase. Moreover, if the coverage we are offering isn’t competitive with the health insurance benefits our employees could receive at other employers, we may become less attractive as an employer and it may be difficult for us to compete for qualified employees.

 

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If any of the state and local government agencies with which we have contracts determines that we have not complied with our contracts or have violated any applicable laws or regulations, our revenue may decrease, we may be subject to fines or penalties and we may be required to restructure our billing and collection methods.

We derive the vast majority of our revenue from state and local government agencies, and a substantial portion of this revenue is state-funded with federal Medicaid matching dollars. If we fail to comply with federal and state documentation, coding and billing rules, we could be subject to criminal and/or civil penalties, loss of licenses and exclusion from the Medicaid programs, which could materially harm us. In billing for our services to third-party payors, we must follow complex documentation, coding and billing rules. These rules are based on federal and state laws, rules and regulations, various government pronouncements, and on industry practice. Failure to follow these rules could result in potential criminal or civil liability under the False Claims Act, under which extensive financial penalties can be imposed. It could further result in criminal liability under various federal and state criminal statutes. We annually submit a large volume of claims for Medicaid and other payments and there can be no assurance that there have not been errors. The rules are frequently vague and confusing and we cannot assure that governmental investigators, private insurers, private whistleblowers, or Medicaid auditors will not challenge our practices. Such a challenge could result in a material adverse effect on our business.

If any of the state, local and other government payors determines that we have not complied with our contracts or have violated any applicable laws or regulations, our revenue may decrease, we may be subject to fines or penalties and we may be required to restructure our billing and collection methods. We are routinely subject to governmental reviews, audits and investigations to verify our compliance with applicable laws and regulations. As a result of these reviews, audits and investigations, these governmental payors may be entitled to, in their discretion:

 

    require us to refund amounts we have previously been paid;

 

    terminate or modify our existing contracts;

 

    suspend or prevent us from receiving new contracts or extending existing contracts;

 

    impose referral holds on us;

 

    impose fines, penalties or other sanctions on us; and

 

    reduce the amount we are paid under our existing contracts.

As a result of past reviews and audits of our operations, we have been and are subject to some of these actions from time to time. While we do not currently believe that our existing audit proceedings will have a material adverse effect on our financial condition or significantly harm our reputation, we cannot assure you that similar actions in the future will not do so. In addition, such proceedings could have a material adverse impact on our results of operations in a future reporting period.

In some states, we operate on a cost reimbursement model in which revenue is recognized at the time costs are incurred. In these states, payors audit our historical costs on a regular basis, and if it is determined that our historical costs are insufficient to justify our rates, our rates may be reduced, or we may be required to return fees paid to us in prior periods. In some cases we have experienced negative audit adjustments which are based on subjective judgments of reasonableness, necessity or allocation of costs in our services provided to clients. These adjustments are generally required to be negotiated as part of the overall audit resolution and may result in paybacks to payors and adjustments of our rates. We cannot assure you that our rates will be maintained, or that we will be able to keep all payments made to us, until an audit of the relevant period is complete. Moreover, if we are required to restructure our billing and collection methods, these changes could be disruptive to our operations and costly to implement. Failure to comply with laws and regulations could have a material adverse effect on our business.

Reimbursement procedures for the services we provide are time-consuming and complex, and failure to comply with these procedures could adversely affect our liquidity, cash flows and operating results.

The reimbursement process is time-consuming and complex, and there can be delays before we receive payment. Government reimbursement, group home credentialing and Medicaid recipient eligibility and service authorization procedures are often complicated and burdensome, and delays can result from, among other things, securing documentation and coordinating necessary eligibility paperwork between agencies. Similar issues arise in seeking payment from some of our private payors. These reimbursement and procedural issues occasionally cause us to have to resubmit claims several times before payment is remitted. If there is a billing error, the process to resolve the error may be time-consuming and costly. To the extent that complexity associated with billing for our services causes delays in our cash collections, we assume the financial risk of increased carrying costs associated with the aging of our accounts receivable as well as increased potential for write-offs. We can provide no assurance that we will be able to collect payment for claims at our current levels in future periods. The risks associated with third-party payors and the inability to monitor and manage accounts receivable successfully could have a material adverse effect on our liquidity, cash flows and operating results.

 

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We have increased and will continue to increase our expenditures to expand existing services, win new business and grow revenue, and we may not realize the anticipated benefits of such expenditures.

In order to grow our business, we must capitalize on opportunities to expand existing services and win new business, some of which require spending in advance of revenue. For example, states such as California and New Jersey are in the process of closing institutions and their former residents will need care in community-based settings such as ours. Responding to opportunities such as these typically require significant investment of our resources. In fiscal 2012 and 2013, we increased significantly the amount spent on growth initiatives, especially new starts. This elevated level of growth investments has had a negative effect on our operating margin, and we may not realize the anticipated benefits of the spending as soon as we expect to or at any point in the future. If we target the wrong areas, or fail to identify the evolving needs of our payors by responding with service offerings that meet their fiscal and programmatic requirements, we may not realize the anticipated benefits of our investments and the results of our operations may suffer.

If we fail to establish and maintain relationships with government agencies, we may not be able to successfully procure or retain government-sponsored contracts, which could negatively impact our revenue.

To facilitate our ability to procure or retain government-sponsored contracts, we rely in part on establishing and maintaining relationships with officials of various government agencies, primarily at the state and local level but also including federal agencies. These relationships enable us to maintain and renew existing contracts and obtain new contracts and referrals. The effectiveness of our relationships may be reduced or eliminated with changes in the personnel holding various government offices or staff positions. We also may lose key personnel who have these relationships and such personnel may not be subject to non-compete or non-solicitation covenants. Any failure to establish, maintain or manage relationships with government and agency personnel may hinder our ability to procure or retain government-sponsored contracts, and could negatively impact our revenue.

Negative publicity or changes in public perception of our services may adversely affect our ability to obtain new contracts and renew existing ones.

Our success in obtaining new contracts and renewals of our existing contracts depends upon maintaining our reputation as a quality service provider among governmental authorities, advocacy groups, families of our clients, our clients and the public. Negative publicity, changes in public perception, legal proceedings and government investigations with respect to our operations could damage our reputation and hinder our ability to retain contracts and obtain new contracts, and could reduce referrals, increase government scrutiny and compliance or litigation costs, or generally discourage clients from using our services. Any of these events could have a material adverse effect on our business, financial condition and operating results.

A loss of our status as a licensed service provider in any jurisdiction could result in the termination of existing services and our inability to market our services in that jurisdiction.

We operate in numerous jurisdictions and are required to maintain licenses and certifications in order to conduct our operations in each of them. Each state and local government has its own regulations, which can be complicated, and each of our service lines can be regulated differently within a particular jurisdiction. As a result, maintaining the necessary licenses and certifications to conduct our operations can be cumbersome. Our licenses and certifications could be suspended, revoked or terminated for a number of reasons, including:

 

    the failure by our employees or Mentors to properly care for clients;

 

    the failure to submit proper documentation to the applicable government agency, including documentation supporting reimbursements for costs;

 

    the failure by our programs to abide by the applicable regulations relating to the provision of human services; or

 

    the failure of our facilities to comply with the applicable building, health and safety codes and ordinances.

From time to time, some of our licenses or certifications, or those of our employees, are temporarily placed on probationary status or suspended. If we lost our status as a licensed provider of human services in any jurisdiction or any other required certification, we would be unable to market our services in that jurisdiction, and the contracts under which we provide services in that jurisdiction would be subject to termination. Moreover, such an event could constitute a violation of provisions of contracts in other jurisdictions, resulting in other contract, license or certification terminations. Any of these events could have a material adverse effect on our operations.

 

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The nature of services that we provide could subject us to significant workers’ compensation related liability, some of which may not be fully reserved for.

We use a combination of insurance and self-insurance plans to provide for potential liability for workers’ compensation claims. Because of our high ratio of employees per client, and because of the inherent physical risk associated with the interaction of employees with our clients, many of whom have intensive care needs, the potential for incidents giving rise to workers’ compensation liability is relatively high.

We estimate liabilities associated with workers’ compensation risk and establish reserves each quarter based on internal valuations, third-party actuarial advice, historical loss development factors and other assumptions believed to be reasonable under the circumstances. In prior years, our results of operations have been adversely impacted by higher than anticipated claims and they may be adversely impacted in the future if actual occurrences and claims exceed our assumptions and historical trends.

We face substantial competition in attracting and retaining experienced personnel, and we may be unable to maintain or grow our business if we cannot attract and retain qualified employees.

Our success depends to a significant degree on our ability to attract and retain qualified and experienced human service and other professionals who possess the skills and experience necessary to deliver quality services to our clients and manage our operations. We face competition for certain categories of our employees, particularly direct service professionals and managers, based on the wages, benefits and other working conditions we offer. Contractual requirements and client needs determine the number, education and experience levels of human service professionals we hire. Our ability to attract and retain employees with the requisite credentials, experience and skills depends on several factors, including, but not limited to, our ability to offer competitive wages, benefits and professional growth opportunities. The inability to attract and retain experienced personnel could have a material adverse effect on our business.

We may not realize the anticipated benefits of any future acquisitions and we may experience difficulties in integrating these acquisitions.

As part of our growth strategy, we intend to make acquisitions. Growing our business through acquisitions involves risks because with any acquisition there is the possibility that:

 

    the business we acquire may not continue to generate income at the same historical levels on which we based our acquisition decision;

 

    we may be unable to maintain and renew the contracts of the acquired business;

 

    unforeseen difficulties may arise in integrating the acquired operations, including employment practices, information systems and accounting controls;

 

    we may not achieve operating efficiencies, synergies, economies of scale and cost reductions as expected;

 

    management may be distracted from overseeing existing operations by the need to integrate the acquired business;

 

    we may acquire or assume unexpected liabilities or there may be other unanticipated costs;

 

    we may encounter unanticipated regulatory risk;

 

    we may experience problems entering new markets or service lines in which we have limited or no experience;

 

    we may fail to retain and assimilate key employees of the acquired business;

 

    we may finance the acquisition by incurring additional debt and further increase our leverage ratios; and

 

    the culture of the acquired business may not match well with our culture.

As a result of these risks, there can be no assurance that any future acquisition will be successful or that it will not have a material adverse effect on our financial condition and results of operations.

We are subject to extensive governmental regulations, which require significant compliance expenditures, and a failure to comply with these regulations could adversely affect our business.

We must comply with comprehensive government regulation of our business, including statutes, regulations and policies governing the licensing of our facilities, the maintenance and management of our work place for our employees, the quality of our service, the revenue we receive for our services and reimbursement for the cost of our services. Compliance with these laws, regulations and

 

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policies is expensive, and if we fail to comply with these laws, regulations and policies, we could lose contracts and the related revenue, thereby harming our financial results. State and federal regulatory agencies have broad discretionary powers over the administration and enforcement of laws and regulations that govern our operations. A material violation of a law or regulation could subject us to fines and penalties and in some circumstances could disqualify some or all of the facilities and programs under our control from future participation in Medicaid or other government programs. The Health Insurance Portability and Accountability Act of 1996 (as amended, “HIPAA”) and other federal and state data privacy and security laws, which require the establishment of privacy standards for health care information storage, retrieval and dissemination as well as electronic transmission and security standards, could result in potential penalties in certain of our businesses if we fail to comply with these privacy and security standards.

Expenses incurred under governmental agency contracts for any of our services, as well as management contracts with providers of record for such agencies, are subject to review by agencies administering the contracts and services. Representatives of those agencies visit our group homes to verify compliance with state and local regulations governing our home operations. A negative outcome from any of these examinations could increase government scrutiny, increase compliance costs or hinder our ability to obtain or retain contracts. Any of these events could have a material adverse effect on our business, financial condition and operating results.

The federal anti-kickback law and non-self referral statute, and similar state statutes, prohibit kickbacks, rebates and any other form of remuneration in return for referrals. Any remuneration, direct or indirect, offered, paid, solicited, or received, in return for referrals of patients or business for which payment may be made in whole or in part under Medicaid could be considered a violation of law. The language of the anti-kickback law also prohibits payments made to anyone to induce them to recommend purchasing, leasing, or ordering any goods, facility, service, or item for which payment may be made in whole or in part by Medicaid. Criminal penalties under the anti-kickback law include fines up to $25,000, imprisonment for up to five years, or both. In addition, acts constituting a violation of the anti-kickback law may also lead to civil penalties, such as fines, assessments and exclusion from participation in the Medicaid programs.

We are subject to many different and varied audit mechanisms for post payment review of claims submitted under the Medicaid program. These include Recovery Audit Contractor (“RAC”) auditors, State Medicaid auditors, surveillance integrity review audits and Payment Error Rate Measurement (“PERM”) audits, among others. Any one of these audit activities may identify claims that the auditors deem problematic and, following such determination, may be made recoupment of claims by Medicaid to us.

Should we be found out of compliance with these statutes, regulations and policies, depending on the nature of the findings, our business, our financial position and our results of operations could be materially adversely impacted.

If a federal or state agency asserts a different position or enacts new laws or regulations regarding illegal payments under Medicaid or other governmental programs, we may be subject to civil and criminal penalties, experience a significant reduction in our revenue or be excluded from participation in Medicaid or other governmental programs.

Any change in interpretations or enforcement of existing or new laws and regulations could subject our current business practices to allegations of impropriety or illegality, or could require us to make changes in our homes, equipment, personnel, services, pricing or capital expenditure programs, which could increase our operating expenses and have a material adverse effect on our operations or reduce the demand for or profitability of our services.

If we identify deficiencies in our internal control over financial reporting, our business may be adversely affected.

We are required to assess the effectiveness of our internal control over financial reporting and report on the effectiveness of our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. No evaluation can provide complete assurance that our internal controls will operate as intended.

The generally decentralized nature of our operations and manual nature of many of our controls increases our risk of control deficiencies. In connection with the transition of our billing, accounts receivable and general ledger functions to a shared services center, we have gradually been centralizing and automating certain of those controls, and we may in the future identify material weaknesses in connection with this implementation. In addition, future acquisitions may present challenges in implementing appropriate internal controls. Any future material weaknesses in internal control over financial reporting could result in material misstatements in our financial statements. Moreover, any future disclosures of additional material weaknesses, or errors as a result of those weaknesses, could result in a negative reaction in the financial markets if there is a loss of confidence in the reliability of our financial reporting.

 

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The high level of competition in our industry could adversely affect our contract and revenue base.

We compete with a wide variety of competitors, ranging from small, local agencies to a few large, national organizations. Competitive factors may favor other providers and reduce our ability to obtain contracts, which would hinder our growth. Not-for-profit organizations are active in all states and range from small agencies serving a limited area with specific programs to multi-state organizations. Smaller local organizations may have a better understanding of the local conditions and may be better able to gain political and public acceptance. Not-for-profit providers may be affiliated with advocacy groups, health organizations or religious organizations that have substantial influence with legislators and government agencies. Increased competition may result in pricing pressures, loss of or failure to gain market share or loss of clients or payors, any of which could harm our business.

Credit and economic conditions could have a material adverse effect on our cash flows, liquidity and financial condition.

Our government payors rely on tax revenue collections to pay for our services. In the wake of the last economic recession that began in 2008, most states faced unprecedented declines in tax revenues and, as a result, record budget gaps. Even after a full three years of continual gains, overall state tax collections remain below their previous peak when adjusted for inflation and population growth. Given the relatively weak recovery in state tax collections, if the economy were to contract into recession, our government payors or other counterparties that owe us money could be delayed in obtaining, or may not be able to obtain, necessary funding and/or financing to meet their cash flow needs. In 2011, Standard & Poor’s downgraded the Federal government’s credit rating and additional downgrades are possible in the future. In October 2013, Fitch Ratings placed the Federal government’s credit rating on negative watch. If the credit rating of the federal government is downgraded again, it is possible there will be related downgrades of state credit ratings as well and, if they occur, this could make it more expensive for states to finance their cash flow needs and put additional pressure on state budgets. Delays in payment could have a material adverse effect on our cash flows, liquidity and financial condition. In the event that our payors or other counterparties are financially unstable or delay payments to us, our financial condition could be further impaired if we are unable to borrow additional funds under our senior credit agreement to finance our operations.

Because a portion of our indebtedness bears interest at rates that fluctuate with changes in certain prevailing short-term interest rates, we are vulnerable to interest rate increases.

A portion of our indebtedness, including borrowings under the senior revolver and borrowings under the term loan facility for which we have not hedged our interest rate exposure under an interest rate swap agreement, bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same.

As of September 30, 2013, we had $546.5 million of floating rate term loan debt outstanding and no borrowings under our senior revolver before giving effect to the interest rate swap agreement. The Company entered into an interest rate swap, as amended in October 2012, in a notional amount of $400.0 million effective March 31, 2011 that matures September 30, 2014, in order to hedge the risk of changes in the floating rate of interest on borrowings under the term loan. As a result of the interest rate swap agreement, the floating rate debt has been effectively reduced to $146.5 million. A 1% increase in the interest rate on our floating rate debt would increase cash interest expense of the floating rate debt by approximately $1.5 million per annum. If interest rates increase dramatically, we could be unable to service our debt.

We rely on third parties to refer clients to our facilities and programs.

We receive substantially all of our clients from third-party referrals and are governed by the federal anti-kickback/non-self referral statute. Our reputation and prior experience with agency staff, care workers and others in positions to make referrals to us are important for building and maintaining our operations. Any event that harms our reputation or creates negative experiences with such third parties could impact our ability to receive referrals and grow our client base.

Home and community-based human services may become less popular among our targeted client populations and/or state and local governments, which would adversely affect our results of operations.

Our growth depends on the continuation of trends in our industry toward providing services to individuals in smaller, community-based settings and increasing the percentage of individuals served by non-governmental providers. The continuation of these trends and our future success are subject to a variety of political, economic, social and legal pressures, all of which are beyond our control. A reversal in the downsizing and privatization trends could reduce the demand for our services, which could adversely affect our revenue and profitability.

We conduct a significant percentage of our operations in Minnesota and, as a result, we are particularly susceptible to any reduction in budget appropriations for our services or any other adverse developments in that state.

For the fiscal year ended September 30, 2013, 14% of our revenue was generated from contracts with government agencies in the state of Minnesota. Accordingly, any reduction in Minnesota’s budgetary appropriations for our services, whether as a result of fiscal constraints due to recession, changes in policy or otherwise, could result in a reduction in our fees and possibly the loss of contracts. For example, our I/DD services in Minnesota were negatively impacted in 2009 and 2011 by rate cuts of 2.6% and 1.5%, respectively. We cannot assure you that we will not receive additional rate reductions this year or in the future. The concentration of our operations in Minnesota also makes us particularly susceptible to many of the other risks described above occurring in this state, including:

 

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    the failure to maintain and renew our licenses;

 

    the failure to maintain important relationships with officials of government agencies; and

 

    any negative publicity regarding our operations.

Any of these adverse developments occurring in Minnesota could result in a reduction in revenue or a loss of contracts, which could have a material adverse effect on our results of operations, financial position and cash flows.

We depend upon the continued services of certain members of our senior management team, without whom our business operations could be significantly disrupted.

Our success depends, in part, on the continued contributions of our senior officers and other key employees. Our management team has significant industry experience and would be difficult to replace. We have recently announced a transition plan under which our current Chief Executive Officer will become the Executive Chair of the Board of Directors effective January 1, 2014. He will remain a full-time executive officer but will cease to be a co-principal executive officer. Effective January 1, 2014, the current President and Chief Operating Officer will become the Chief Executive Officer. If we lose or suffer an extended interruption in the service of one or more of our key employees, our financial condition and operating results could be adversely affected. The market for qualified individuals is highly competitive and we may not be able to attract and retain qualified personnel to replace or succeed members of our senior management or other key employees, should the need arise.

Our success depends on our ability to manage growing and changing operations.

Our operations are decentralized and subject to disparate accounting and billing requirements established and often modified by our local payors and referral sources. Although in recent years we have undertaken an effort to consolidate accounting, billing, cash collections and other financial and administrative functions which may have mitigated this risk to some degree, there remains a substantial portion of the business that has not yet been centralized and some risk in the centralization process itself. If we encounter difficulties in integrating our operations further or fail to effectively manage these functions to ensure compliance with disparate and evolving requirements imposed by our payors and referral sources, it could have a material adverse effect on our results of operations, financial position and cash flows.

Our information systems are critical to our business and a failure of those systems, or a failure to upgrade them when required, could materially harm us.

We depend on our ability to store, retrieve, process and manage a significant amount of information, and to provide our operations with efficient and effective accounting, census, incident reporting and scheduling systems. Our information systems require maintenance and upgrading to meet our needs, which could significantly increase our administrative expenses.

Any system failure that causes an interruption in service or availability of our critical systems could adversely affect operations or delay the collection of revenues. Even though we have implemented network security measures, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering. The occurrence of any of these events could result in interruptions, delays, the loss or corruption of data, or cessations in the availability of systems, all of which could have a material adverse effect on our financial position and results of operations and harm our business reputation. Furthermore, a loss of health care information could result in potential penalties in certain of our businesses if we fail to comply with privacy and security standards in violation of HIPAA.

The performance of our information technology and systems is critical to our business operations. Our information systems are essential to a number of critical areas of our operations, including:

 

    accounting and financial reporting;

 

    billing and collecting accounts;

 

    coding and compliance;

 

    clinical systems, including census and incident reporting;

 

    records and document storage; and

 

    monitoring quality of care and collecting data on quality and compliance measures.

 

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In addition, as we continue to upgrade our systems, we run the risk of ongoing disruptions while we transition from legacy, and sometimes paper-based, systems. Disruptions in our systems could result in delays and difficulties in billing, which could negatively affect our results from operations and cash flows. We may choose systems that ultimately fail to meet our needs, or that cost more to implement and maintain than we had anticipated. Such systems may become obsolete sooner than expected, our payors may require us to invest in other systems, and state and/or federal regulations may impose electronic records standards that we cannot easily address from our existing platform. If we fail to upgrade successfully and cost-effectively, or if we are forced to invest in new or incompatible technology, our financial condition, cash flows and results of operations may suffer.

Our financial results may suffer if we have to write off goodwill or other intangible assets.

A large portion of our total assets consists of goodwill and other intangible assets. Goodwill and other intangible assets, net of accumulated amortization, accounted for 56.0% and 58.1% of the total assets on our consolidated balance sheets as of September 30, 2013 and September 30, 2012, respectively. We may not realize the value of our goodwill or other intangible assets and we expect to engage in additional transactions that will result in our recognition of additional goodwill or other intangible assets.

We evaluate on a regular basis whether events and circumstances have occurred that indicate that all or a portion of the carrying amount of goodwill or other intangible assets may no longer be recoverable, and is therefore impaired. Under current accounting rules, any determination that impairment has occurred would require us to write-off the impaired portion of our goodwill or the unamortized portion of our intangible assets, resulting in a charge to our earnings.

We may be more susceptible to the effects of a natural disaster or public health catastrophe, compared with other businesses due to the vulnerable nature of our client population.

Our primary clients are individuals with developmental disabilities, brain injuries, or emotionally, behaviorally or medically complex challenges, many of whom would be more vulnerable than the general public in a natural disaster or public health catastrophe. For example, in a flu pandemic, we could suffer significant losses to our client population and, at a high cost, be required to pay overtime or hire replacement staff and Mentors for workers who drop out of the workforce. In a natural disaster, we could be forced to relocate some of our clients on very short notice under treacherous conditions and our new program starts could experience delays. Accordingly, natural disasters and certain public health catastrophes could have a material adverse effect on our financial condition and results of operations.

We are controlled by our principal equityholder, which has the power to take unilateral action.

Vestar controls our business affairs and material policies. Circumstances may occur in which the interests of Vestar could be in conflict with the interests of our debt holders. In addition, Vestar may have an interest in pursuing organic growth opportunities, acquisitions, divestitures or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to our debt holders. Vestar is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with us. Vestar may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. So long as investment funds associated with or designated by Vestar continue to own a significant amount of our equity interests, even if such amount is less than 50%, Vestar will continue to be able to significantly influence or effectively control our decisions.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

Our principal executive office is located at 313 Congress Street, Boston, Massachusetts 02210. We operate a number of facilities and administrative offices throughout the United States. As of September 30, 2013, we provided services in 383 owned facilities and approximately 1,224 leased facilities, as well as in homes owned by our Mentors. We also own three offices and lease approximately 259 offices. We believe that our properties are adequate for our business as presently conducted and we believe we can meet requirements for additional space by exercising options on leases or by finding alternative space.

 

Item 3. Legal Proceedings

We are in the health and human services business and, therefore, we have been and continue to be subject to substantial claims alleging that we, our employees or our Mentors failed to provide proper care for a client. We are also subject to claims by our clients, our employees, our Mentors or community members against us for negligence, intentional misconduct or violation of applicable laws. Included in our recent claims are claims alleging personal injury, assault, abuse, wrongful death and other charges. Regulatory agencies may initiate

 

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administrative proceedings alleging that our programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on us. We could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if we do not prevail, we could be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.

We also are subject to potential lawsuits under the False Claims Act and other federal and state whistleblower statutes designed to combat fraud and abuse in the health care industry. These lawsuits can involve significant monetary awards that may incentivize private plaintiffs to bring these suits. If we are found to have violated the False Claims Act, we could be excluded from participation in Medicaid and other federal healthcare programs. The Patient Protection and Affordable Care Act provides a mandate for more vigorous and widespread enforcement activity to combat fraud and abuse in the health care industry.

Finally, we are also subject to employee-related claims under state and federal law, including claims for discrimination, wrongful discharge or retaliation; claims for wage and hour violations under the Fair Labor Standards Act or state wage and hour laws.

We reserve for costs related to contingencies when a loss is probable and the amount is reasonably estimable. While we believe our provision for legal contingencies is adequate, the outcome of the legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that differ from our estimates.

See “Part I. Item 1A. Risk Factors” and “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

We are an indirect wholly owned subsidiary of NMH Investment. Accordingly, there is no public trading market for our common stock.

Stockholders

There was one owner of record of our common stock as of December 1, 2013.

Dividends

During fiscal 2013, 2012 and 2011, our indirect parent NMH Investment repurchased equity units from employees upon or after their departures of $39 thousand, $75 thousand, and $1.5 million, respectively. We accounted for these repurchases as dividends of $39 thousand, $75 thousand and $1.5 million, respectively, to our indirect parent NMH Investment to fund these repurchases.

Also, during fiscal 2011, we paid a dividend of $219.7 million to Parent, which in turn made a distribution of $219.7 million to NMH Holdings, Inc. NMH Holdings used the proceeds of the distribution to (i) repurchase $210.9 million aggregate principal amount of the Senior Floating Rate Toggle Notes due 2014 (the “NMH Holdings notes”) at a premium and (ii) pay related fees and expenses.

We do not anticipate that we will pay any dividends for the foreseeable future apart from dividends as needed to fund the repurchase of equity units from departing employees. Any determination to pay dividends will be at the discretion of our board of directors and will depend on then-existing conditions, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors our board of directors deems relevant. In addition, our current financing arrangements limit the cash dividends we may pay in the foreseeable future. We are restricted from paying dividends to Parent in excess of $15 million, except for dividends used for the repurchase of equity from former officers and employees and for the payment of management fees, taxes and certain other exceptions.

 

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Equity Compensation Plan Information

The following table lists the number of securities of NMH Investment available for issuance as of September 30, 2013 under the NMH Investment, LLC Amended and Restated 2006 Unit Plan, as amended. For a description of the plan, please see note 19 to the consolidated financial statements included elsewhere in this report.

 

                Number of
                Securities
                Remaining
                Available for
                Future Issuance
                under Equity
                Compensation
                Plans (excluding
    Number of Securities to be     Weighted-Average     Securities
    Issued Upon Exercise of     Exercise Price of     Reflected in
    Outstanding Options     Outstanding Options     Column(a))

Plan Category

  (a)     (b)    

(c)

Equity compensation plans approved by security holders

      Preferred Units: 21,419.50
      A Units: 221,795.03
      B Units: 55,870.08
      C Units: 58,624.28
      D Units: 128,558.47
      E Units: -
    N/A        N/A      F Units: 1,072,489.63
      G Units: -
      H Units: 200,000.00

Equity compensation plans not approved by security holders

    N/A        N/A      N/A

TOTAL

      Preferred Units: 21,419.50
      A Units: 221,795.03
      B Units: 55,870.08
      C Units: 58,624.28
      D Units: 128,558.47
      E Units: -
      F Units: 1,072,489.63
      G Units: -
    —          —        H Units: 200,000.00

Unregistered Sales of Equity Securities

No equity securities of the Company were sold during fiscal 2013; however, the Company’s indirect parent, NMH Investment, did issue equity securities during this period.

The following table sets forth the number of units of common equity of NMH Investment issued during fiscal 2013 pursuant to the NMH Investment, LLC Amended and Restated 2006 Unit Plan, as amended. The units were granted under Rule 701 promulgated under the Securities Act of 1933.

 

Dates

   Title of Securities      Amount      Purchasers      Consideration  

January 24, 2013

     Class F Common Units         129,761.63         Certain employees       $ —    

Repurchases of Equity Securities

No equity securities of the Company were repurchased during the three months ended September 30, 2013.

 

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The following table sets forth information in connection with repurchases made by NMH Investment of its common equity units during the three months ended September 30, 2013:

 

                    (d) Maximum  
                    Number (or  
              (c) Total Number     Approximate Dollar  
              of Units Purchased     Value) of Shares (or  
    (a) Class and   (b) Average     as Part of Publicly     Units) that May Yet  
    Total Number of   Price Paid     Announced Plans     be Purchased Under  
   

Units Purchased

  per Unit     or Programs     the Plans or Programs  

Month #1 (July 1, 2013 through July 31, 2013)

  — A Units     —          —          N/A   
 

— B Units

    —          —          N/A   
 

— C Units

    —          —          N/A   
 

— D Units

    —          —          N/A   
 

— F Units

  $ —          —          N/A   

Month #2 (August 1, 2013 through August 31, 2013)

  — A Units     —          —          N/A   
  — B Units     —          —          N/A   
 

— C Units

    —          —          N/A   
 

— D Units

    —          —          N/A   
 

— F Units

    —          —          N/A   

Month #3 (September 1, 2013 through September 30, 2013)

  — A Units   $ —          —          N/A   
  1,443.75 B Units   $ 0.05        —          N/A   
 

1,515.00 C Units

  $ 0.03        —          N/A   
 

1,605.00 D Units

  $ 0.01        —          N/A   
 

6,212.11 F Units

  $ —          —          N/A   

The Company did not repurchase any of its common stock as part of an equity repurchase program during the three months ended September 30, 2013. NMH Investment purchased all of the units listed in the table from one of its employees after her departure.

 

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Item 6. Selected Financial Data

We derived the selected historical consolidated financial data as of and for the years ended September 30, 2011, 2012, and 2013 from the historical consolidated financial statements of the Company and the related notes included elsewhere in this Annual Report on Form 10-K.

We have derived the selected historical consolidated financial data as of and for the years ended September 30, 2009 and 2010 from the historical consolidated financial statements of the Company and the related notes not included or incorporated by reference in this Annual Report on Form 10-K.

The selected information below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical consolidated financial statements and notes included elsewhere in this report.

 

     Year Ended September 30,(3)  
     2009     2010     2011     2012     2013  

Statements of Operations Data:

          

Net revenue

   $ 949,582      $ 1,004,192      $ 1,062,773      $ 1,123,118      $ 1,198,653   

Cost of revenue (exclusive of depreciation expense shown separately below)

     725,275        771,066        823,009        874,778        935,143   

General and administrative expenses

     125,076        133,114        143,949        140,221        146,040   

Depreciation and amortization

     55,069        55,918        61,330        60,534        64,146   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     44,162        44,094        34,485        47,585        53,324   

Management fee of related party

     (1,146     (1,208     (1,271     (1,325     (1,359

Other income (expense), net

     (503     (339     (142     2        929   

Extinguishment of debt

     —          —          (19,278     —          —     

Gain from available for sale investment security

     —          —          3,018        —          —     

Interest income

     193        42        22        332        137   

Interest income from related party

     1,202        1,921        684        —          —     

Interest expense

     (48,254     (46,693     (61,718     (79,445     (78,075
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

     (4,346     (2,183     (44,200     (32,851     (25,044

Benefit for income taxes

     (1,294     (464     (14,683     (19,172     (9,472
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (3,052     (1,719     (29,517     (13,679     (15,572

Loss from discontinued operations, net of tax

     (2,404     (5,148     (4,625     (701     (2,724
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (5,456   $ (6,867   $ (34,142   $ (14,380   $ (18,296
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet Data (at end of period):

          

Cash and cash equivalents

   $ 23,650      $ 26,448      $ 263      $ —        $ 19,315   

Working capital(1)

     47,836        34,904        12,028        25,198        58,267   

Total assets

     995,610        1,015,885        1,010,850        1,044,983        1,020,372   

Total debt(2)

     509,976        506,182        784,124        799,895        803,464   

Shareholder’s equity (deficit)

     223,728        225,133        (31,123     (44,247     (60,831

 

(1) Calculated as current assets minus current liabilities.
(2) Includes obligations under capital leases.
(3) During fiscal 2010, 2011 and 2013, the Company sold its home health business, closed certain Human Services operations in the state of Maryland, Colorado, Nebraska, New Hampshire, New York and Virginia, and sold its Mentor Rhode Island business. All fiscal years presented reflect the classification of these businesses as discontinued operations.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the historical consolidated financial statements and the related notes included elsewhere in this report. This discussion may contain forward-looking statements about our markets, the demand for our services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons, including those discussed in the “Risk factors” and “Forward-looking statements” sections of this report.

Overview

We are a leading provider of home and community-based health and human services to adults and children with intellectual and/or developmental disabilities (“I/DD”), acquired brain injury (“ABI”) and other catastrophic injuries and illnesses, and to youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (“ARY”). Since our founding in 1980, our operations have grown to 35 states. We provide services to approximately 12,300 clients in residential settings, some of whom also receive periodic services. Approximately 16,700 clients receive periodic services from us in non-residential settings.

We design customized service plans to meet the unique needs of our clients, which we deliver in home and community-based settings. Most of our service plans involve residential support, typically in small group homes, host home settings or specialized community facilities, designed to improve our clients’ quality of life and to promote client independence and participation in community life. Other services offered include supported living, day and transitional programs, vocational services, case management, family-based and outpatient therapeutic services, post-acute treatment and neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and speech therapies, among others. Our customized service plans offer our clients, as well as the payors for these services, an attractive, cost-effective alternative to health and human services provided in large, institutional settings.

We offer our services through a variety of models, including (i) small group homes, most of which are residences for six people or fewer, (ii) host homes, or the “Mentor” model, in which a client lives in the home of a trained Mentor, (iii) in-home settings, in which we support clients’ independence with 24-hour services in their own homes, (iv) small, specialized community facilities which provide post-acute, specialized rehabilitation and comprehensive care for individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses and (v) non-residential settings, consisting primarily of day programs and periodic services in various settings.

We have two reportable segments, Human Services and Post-Acute Specialty Rehabilitation Services (“SRS”). The Human Services segment provides home and community-based human services to adults and children with intellectual and/or developmental disabilities and to youth with emotional, behavioral and/or medically complex challenges. The SRS segment provides a mix of health care and community-based health and human services to individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses.

Delivery of services to adults and children with I/DD is the largest portion of our Human Services segment. Our I/DD programs include residential support, day habilitation, vocational services, case management and personal care. Our Human Services segment also includes the delivery of ARY services. Our ARY programs include therapeutic foster care, family reunification, family preservation, early intervention and adoption services. Our SRS segment delivers healthcare and community-based human services to individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses. Our services range from sub-acute healthcare for individuals with intensive medical needs to day treatment programs, and include skilled nursing, neurorehabilitation, neurobehavioral rehabilitation, physical, occupational, and speech therapy, supported living, outpatient treatment and pre-vocational services.

Factors Affecting our Operating Results

Demand for Home and Community-Based Health and Human Services

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

Demographic trends have a particular impact on our I/DD business. Increases in the life expectancy of individuals with I/DD, we believe, have resulted in steady increases in the demand for I/DD services. In addition, caregivers currently caring for their relatives at home are aging and may soon be unable to continue with these responsibilities. Many states continue to downsize or close large, publically run facilities for individuals with I/DD and refer those individuals to private providers of community-based services. Each of these factors affects the size of the I/DD population in need of services. And while our residential ARY services were negatively impacted by a substantial

 

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decline in the number of children and adolescents in foster care placements during the last decade, this trend has contributed significant increased demand for periodic, non-residential services to support at-risk youth and their families. It is noteworthy, however, that after declining by nearly 30% from its peak, the general foster care population across the country have recently stabilized. Demand for our SRS services has also grown as faster emergency response and improved medical techniques have resulted in more people surviving a catastrophic injury. SRS services are increasingly sought out as a clinically-appropriate and less-expensive alternative to institutional care and as a “step-down” for individuals who no longer require care in acute settings.

Political and economic trends can also affect our operations. In particular, state budgetary pressures, especially within Medicaid programs, may influence the overall level of payments for our services, the number of clients and the preferred settings for many of the services we provide. For example, during the economic downturn that began in 2008, our government payors in several states responded to deteriorating revenue collections by implementing provider rate reductions. More recently, the rate environment has improved and, as a result, for state fiscal year 2014, which began July 1, 2013 in most states, we expect to receive modest pricing increases in some jurisdictions.

Historically, pressure from client advocacy groups for the populations we serve has generally helped our business, as these groups generally seek to pressure governments to fund residential services that use our small group home or host home models, rather than large, institutional models. In addition, our ARY services have historically been positively affected by the trend toward privatization of these services. Furthermore, we believe that successful lobbying by these groups has preserved I/DD and ARY services and, therefore, our revenue base, from significant cutbacks as compared with certain other human services, although we did suffer rate reductions during and since the recession that began in 2008. In addition, a number of states have developed community-based waiver programs to support long-term care services for survivors of a traumatic brain injury. The majority of our specialty rehabilitation services revenue is derived from non-public payors, such as commercial insurers, managed care and other private payors.

Expansion

We have grown our business through expansion of existing markets and programs as well as through acquisitions.

Organic Growth

Various economic, fiscal, public policy and legal factors are contributing to an environment with an increased number of organic growth opportunities, particularly within the Human Services segment, and, as a result, we have a renewed emphasis on growing our business organically and making investments to support the effort. Our future growth will depend heavily on our ability to expand our current programs and identify and execute upon new opportunities. Our organic expansion activities consist of both new program starts in existing markets and expansion into new geographical markets. Our new programs in new and existing geographic markets typically require us to incur and fund operating losses for a period of approximately 18 to 24 months (we refer to such new programs as “new starts”). If a new start does not become profitable during such period, we may terminate it. During the fiscal year ended September 30, 2013, operating losses on new starts for programs started within the previous 18 months were $8.8 million, as compared to $7.5 million during the fiscal year ended September 30, 2012. During the quarter ended September 30, 2013, operating losses on new starts for programs started within the previous 18 months were $1.9 million as compared to $3.6 million during the quarter ended September 30, 2012. These increased losses reflect a substantial increase in both the number of new starts and the substantial investments we are making in these new starts.

During fiscal 2012 and 2013, we made substantial investments in our core Human Services business, especially in new start spending, as described above. That spending produced an increase in organic revenue growth but it also had the effect of reducing our operating margin. We expect that our level of new start spending will remain well above historical levels in fiscal 2014 and, as a result, continue to depress our operating margin. Management’s goal is to improve our operating margin as our newly begun programs stabilize and our new start spending begins to decline.

Acquisitions

As of September 30, 2013, we have completed 37 acquisitions since the acquisition by Vestar on September 29, 2006 including several acquisitions of rights to government contracts or fixed assets from small providers, which we integrate with our existing operations. We have pursued larger strategic acquisitions in markets with significant opportunities. Acquisitions could have a material impact on our consolidated financial statements.

During the fiscal year ended September 30, 2013, we acquired two companies complementary to our business in the Human Services segment and one company in the SRS segment, for a total cash consideration of $9.3 million.

 

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Divestitures

We regularly review and consider the divestiture of underperforming or non-strategic businesses to improve our operating results and better utilize our capital. We have made divestitures from time to time and expect that we may make additional divestitures in the future. Divestitures could have a material impact on our consolidated financial statements.

Net revenue

Revenue is reported net of allowances for unauthorized sales and estimated sales adjustments. Revenue is also reported net of any state provider taxes or gross receipts taxes levied on services we provide. During the fiscal year ended September 30, 2013, we derived approximately 87% of our revenue from state, local and other government payors and approximately 13% of our revenue from non-public payors. Substantially all of our non-public revenue is generated by our SRS business through contracts with commercial insurers, workers’ compensation carriers and other private payors. The payment terms and rates of our contracts vary widely by jurisdiction and service type, and may be based on per person per diems, rates established by the jurisdiction, cost-based reimbursement, hourly rates and/or units of service. We bill most of our residential services on a per diem basis, and we bill most of our non-residential services on an hourly basis. Some of our revenue is billed pursuant to cost-based reimbursement contracts, under which the billed rate is tied to the underlying costs. Lower than expected cost levels may require us to return previously received payments after cost reports are filed. In such instances, we estimate and record a liability from such excess payments. In addition, our revenue may be affected by adjustments to our billed rates as well as adjustments to previously billed amounts. Revenue in the future may be affected by changes in rates, rate-setting structures, methodologies or interpretations that may be proposed in states where we operate or by the federal government which provides matching funds. We cannot determine the impact of such changes or the effect of any possible governmental actions.

Occasionally, timing of payment streams may be affected by delays by the state related to bill processing systems, staffing or other factors. While these delays have historically impacted our cash position in particular periods, they have not resulted in long-term collections problems.

Expenses

Expenses directly related to providing services are classified as Cost of revenue. Direct costs and expenses principally include salaries and benefits for service provider employees; per diem payments to our Mentors; residential occupancy expenses, which are primarily comprised of rent and utilities related to facilities providing direct care; certain client expenses such as food, medicine and transportation costs for clients requiring services; and professional and general liability expense. General and administrative expenses primarily include salaries and benefits for administrative employees, or employees that are not directly providing services, administrative occupancy costs as well as professional expenses such as accounting, consulting and legal services. Depreciation and amortization includes depreciation for fixed assets utilized in both facilities providing direct care and administrative offices, and amortization related to intangible assets.

Wages and benefits to our employees and per diem payments to our Mentors constitute the most significant operating cost in each of our operations. Most of our employee caregivers are paid on an hourly basis, with hours of work generally tied to client need. Our Mentors are paid on a per diem basis, but only if the Mentor is currently caring for a client. Our labor costs are generally influenced by levels of service and these costs can vary in material respects across regions.

Occupancy costs represent a significant portion of our operating costs. As of September 30, 2013, we owned 383 facilities and three offices, and we leased approximately 1,234 facilities and approximately 259 offices. We expect occupancy costs to increase during fiscal 2014 as a result of new leases entered into pursuant to acquisitions and new starts. We incur no facility costs for services provided in the home of a Mentor.

Professional and general liability expense totaled 1.0% of our net revenue for the fiscal year ended September 30, 2013, 2012 and 2011, respectively. We incurred professional and general liability expenses of $12.2 million, $10.9 million and $10.2 million for the fiscal year ended September 30, 2013, 2012 and 2011, respectively. These expenses are incurred in connection with our claims reserve and insurance premiums. The expense for the fiscal year ended September 30, 2013 included an expense of $3.4 million that was not incurred in the fiscal year ended September 30, 2012. This represents an adjustment to our tail reserve for professional and general liability claims which is required by accounting standards for companies with claims-made insurance (the “PL/GL Tail Reserve”). Claims paid by us and our insurers for professional and general liability increased sharply in the 2007 to 2008 time period. Commencing October 1, 2010, our self-insured retentions and premiums increased dramatically. For claims arising from occurrences between October 1, 2010 and September 30, 2011, we were self-insured for $2.0 million per claim and $8.0 million in the aggregate, and for $500 thousand per claim in excess of the aggregate. From October 1, 2011 to September 30, 2013, we were self-insured for the first $4.0 million of each and every claim without an aggregate limit. Beginning October 1, 2013, we are self-insured for $4.0 million per claim and $28.0 million in the aggregate. These increased costs have negatively impacted our results of operations and have resulted in a renewed emphasis on reducing our claims exposure. Although insurance premiums did not increase in fiscal 2013, they have increased in recent years and may increase in the future.

 

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Results of Operations

The following table sets forth income (loss) from operations as a percentage of net revenue (operating margin) for the periods indicated:

 

For the Year Ended September 30,

   Human
Services
    Post-Acute Specialty
Rehabilitation
Services
    Corporate     Consolidated  
     (In thousands)  

2013

        

Net revenue

   $ 990,232      $ 208,421      $ —       $ 1,198,653   

Income (loss) from operations

     91,667        17,293        (55,636     53,324   

Operating margin

     9.3     8.3       4.4

2012

        

Net revenue

   $ 937,652      $ 185,466      $ —       $ 1,123,118   

Income (loss) from operations

     80,280        20,376        (53,071     47,585   

Operating margin

     8.6     11.0       4.2

2011

        

Net revenue

   $ 887,297      $ 175,476      $ —       $ 1,062,773   

Income (loss) from operations

     77,209        18,434        (61,158     34,485   

Operating margin

     8.7     10.5       3.2

Fiscal Year Ended September 30, 2013 compared to Fiscal Year Ended September 30, 2012

Consolidated revenue for the fiscal year ended September 30, 2013 (“fiscal 2013”) increased by $75.5 million, or 6.7%, compared to revenue for the fiscal year ended September 30, 2012 (“fiscal 2012”). Revenue increased $55.6 million from organic growth, including growth related to new programs and a $2.1 million adjustment to our state provider tax reserve relating to pre-Merger periods, and $23.5 million from acquisitions that closed during and after the twelve months ended September 30, 2012. The organic revenue growth was partially offset by a reduction in revenue of $3.6 million from businesses we divested during the same period.

Consolidated income from operations increased from $47.6 million for fiscal 2012 to $53.3 million for fiscal 2013, and our operating margin increased from 4.2% of revenue to 4.4% of revenue for the same periods.

Our operating margin increased primarily due to the increase in revenue as noted above partially offset by a $48.3 million increase in direct labor costs as we increased staffing in connection with acquisitions, new programs and new starts for programs started within the previous 18 months. Additionally, we increased our staffing to maintain and strengthen the quality and service of our businesses.

Total occupancy costs increased approximately $6.9 million during fiscal 2013 as compared to fiscal 2012. The increase in occupancy expense is primarily attributable to acquisitions that have closed during and after the twelve months ended September 30, 2012, new programs primarily within our Post-Acute Specialty Rehabilitation Services segment, and new starts. Total occupancy expense has also been affected by the increase in rent, utilities and repairs and maintenance expense related to our businesses.

Depreciation and amortization expense increased $3.6 million during fiscal 2013 from fiscal 2012 but remained relatively flat as a percent of revenue of 5.4% for the same periods. The increase in depreciation and amortization expense is primarily due to an increase in leasehold improvements to our properties and the acquisition of amortizable assets. Partially offsetting this increase was a decrease in depreciation and amortization expense as certain assets became fully depreciated.

In addition, we wrote off goodwill and intangible assets related to underperforming programs within the Human Services segment which were closed during fiscal 2013. The total impairment charge was $2.3 million and included the write-off of $1.0 million of intangible assets recorded in Depreciation and amortization expense and the write-off of $1.3 million of goodwill recorded in General and administrative expense in the accompanying consolidated statements of operations.

Additionally, our health insurance expense and professional and general liability expense increased in fiscal 2013 as compared to fiscal 2012 primarily as a result of a change in reserves. Health insurance expense increased approximately $3.0 million; $2.4 million of the increase in health insurance expense is included in Cost of revenue and $0.6 million is included in General and administrative expenses within the accompanying consolidated statements of operations. Professional and general liability expense increased approximately $1.4 million as compared to fiscal 2012. In fiscal 2013, we increased the PL/GL Tail Reserve by an additional $3.4 million which was partially offset by the decrease in our professional and general liability claims expense as compared to fiscal 2012. The expense relating to the professional and general liability claims expense and the PL/GL Tail Reserve is included in Cost of revenue in the accompanying consolidated statements of operations.

 

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During fiscal 2013, we also recorded $1.0 million related to a cash bonus to our direct care workers. This was a decrease of approximately $1.5 million compared to fiscal 2012. This bonus is recorded in Cost of Revenue in the accompanying consolidated statement of operations.

Interest expense for fiscal 2013 decreased $1.4 million to $78.1 million as compared to fiscal 2012. The decrease is due to the lower interest rate we pay on our borrowings under the senior secured credit facilities as a result of the Amendment Agreement we entered into during fiscal 2013. (Refer to Debt and Financing Arrangements for further detail.)

For fiscal 2013, our effective income tax rate was 37.8% compared to an effective tax rate of 58.4% for fiscal 2012. These rates differ from the federal statutory income tax rate primarily due to nondeductible permanent differences such as meals and nondeductible compensation, and net operating losses not benefited. In addition, our effective tax rate for fiscal 2012 was impacted by a reduction in our reserve for uncertain income tax positions, including interest and penalties, as a result of favorable settlement of audits.

Loss from discontinued operations net of taxes for fiscal 2013 was $2.7 million as compared to $0.7 million for fiscal 2012. During the second quarter of fiscal 2013, we adopted a plan to sell certain Human Services operations in the state of Rhode Island and completed the sale in the third quarter of fiscal 2013. Additionally, we closed certain Human Services operations in the state of Virginia during the second quarter of fiscal 2013. We recorded a total impairment charge of $4.1 million to write off the related intangible assets. The impairment charge and operations of these businesses including the expenses to close these operations are included in discontinued operations.

Human Services

Human Services revenue for fiscal 2013 increased by $52.6 million, or 5.6%, compared to fiscal 2012. Revenue increased $45.2 million from organic growth, including growth related to new programs, and $11.0 million from acquisitions that closed during and after the twelve months ended September 30, 2012. The organic revenue growth was partially offset by a reduction in revenue of $3.6 million from businesses we divested during the same period.

Income from operations increased from $80.3 million, or 8.6% of revenue, during fiscal 2012 to $91.7 million, or 9.3% of revenue, during fiscal 2013. Operating margin was positively impacted primarily due to the increase in revenue noted. In addition, during fiscal 2013, we recognized a decrease of $1.8 million in professional and general liability claims expense as compared to fiscal 2012 due to a change in reserves.

Our operating margin was also positively impacted by a $1.5 million decrease in a cash bonus that was paid to our direct care workers as compared to fiscal 2012.

The decreased expenses from fiscal 2012 to fiscal 2013 as noted above were partially offset by a $31.2 million increase in direct labor costs and an increase of $5.3 million in occupancy costs as compared to fiscal 2012.

Depreciation and amortization expense increased $2.4 million during fiscal 2013 from fiscal 2012. The increase in depreciation and amortization expense is primarily due to an increase in leasehold improvements to our properties and the acquisition of amortizable assets. Partially offsetting this increase was a decrease in depreciation and amortization expense as certain assets became fully depreciated.

Additionally, we wrote off goodwill and intangible assets related to underperforming programs which were closed during fiscal 2013. The total impairment charge was $2.3 million and included the write-off of $1.0 million of intangible assets recorded in Depreciation and amortization expense and the write-off of $1.3 million of goodwill recorded in General and administrative expense in the accompanying consolidated statements of operations.

Our health insurance expense also increased by $2.1 million as a result of a change in reserves, as compared to fiscal 2012.

Post-Acute Specialty Rehabilitation Services

Post-Acute Specialty Rehabilitation Services revenue for fiscal 2013 increased by $22.9 million, or 12.4%, compared to fiscal 2012. Revenue increased $10.4 million as a result of organic growth, including growth from new programs, and $12.5 million from acquisitions that closed during and after the twelve months ended September 30, 2012.

 

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Income from operations decreased from $20.4 million, or 11.0% of revenue, during fiscal 2012 to $17.3 million, or 8.3% of revenue, during fiscal 2013.

The decrease in operating margin is primarily due to a $17.1 million increase in direct labor costs, an increase of $4.4 million in occupancy expense, and a $1.6 million increase in depreciation and amortization expense as compared to fiscal 2012.

Corporate

Total corporate expenses increased from $53.1 million for fiscal 2012 to $55.6 million for fiscal 2013. During fiscal 2013, we incurred an additional $3.4 million of expense related to the PL/GL Tail Reserve as compared to fiscal 2012. The expense relating to the PL/GL Tail Reserve is included in Cost of revenue in the accompanying consolidated statements of operations. Additionally, corporate expenses have also increased slightly due to the increase in staffing and other general and administrative costs as compared to fiscal 2012.

Fiscal Year Ended September 30, 2012 compared to Fiscal Year Ended September 30, 2011

Consolidated revenue for the fiscal year ended September 30, 2012 (“fiscal 2012”) increased by $60.3 million, or 5.7%, compared to revenue for the fiscal year ended September 30, 2011 (“fiscal 2011”). Revenue increased $41.5 million from organic growth, including growth related to new programs, and $22.2 million from acquisitions that closed during and after fiscal 2011. The organic revenue growth was partially offset by a reduction in revenue of $3.4 million from businesses we divested during the same period and rate reductions in some states, including Arizona, Florida and Minnesota.

Consolidated income from operations increased from $34.5 million for fiscal 2011 to $47.6 million for fiscal 2012, and our margin increased from 3.2% of revenue to 4.2% of revenue for the same periods.

The increase in our operating margin was primarily due to the non-recurrence of certain expenses incurred during fiscal 2011, namely accelerated stock-based compensation expense, discretionary bonuses, cost structure optimization efforts, and an impairment charge to long-lived assets.

Stock-based compensation expense decreased $3.0 million during fiscal 2012 as compared to fiscal 2011. Although NMH Investment issued equity units to members of management in both 2012 and 2011, most of the Class F Common Units issued in fiscal 2011 were fully vested upon issuance, and previously outstanding and unvested Class B, Class C and Class D Common Units also became vested. The fiscal 2012 Class G and Class H equity issuances will not vest until a liquidity event and/or upon the occurrence of certain investment return conditions. As such, there was no stock-based compensation expense associated with the Class G and Class H issuances in fiscal 2012. Stock-based compensation expense is included in General and administrative expenses in the accompanying consolidated statements of operations.

During fiscal 2012, there was a decrease of $2.4 million in bonus-related costs as compared to fiscal 2011. In connection with the February 2011 Refinancing, discretionary recognition bonuses were given to certain individuals. These bonuses were included in General and administrative expenses in the accompanying consolidated statements of operations.

As compared to fiscal 2011, we also reduced our restructuring costs by $2.2 million in fiscal 2012. These costs are included as part of General and administrative expenses in the accompanying consolidated statements of operations.

In addition, as part of our annual impairment test of indefinite lived intangible assets during fiscal 2011, we concluded that our trade names were impaired by $5.3 million. This impairment charge is included in General and administrative expenses in the accompanying consolidated statements of operations. There was no impairment on our indefinite lived intangible assets during fiscal 2012.

Our operating margin was also positively impacted by a decrease of $4.8 million in workers’ compensation insurance costs and employment practices liabilities claims during fiscal 2012 as compared to fiscal 2011. The decrease is primarily attributable to the change in reserves due to favorable settlement of prior period claims. During fiscal 2011, we recognized more workers’ compensation expense, which resulted in an additional $3.5 million of costs as compared to fiscal 2012. We also recorded an additional $1.3 million due to higher self-insurance reserves for employment practices liability claims in fiscal 2011 as compared to fiscal 2012. The expense relating to workers’ compensation liability and employment practices liability claims are included in Cost of revenue in the accompanying consolidated statements of operations.

The decreased expenses from fiscal 2011 to fiscal 2012 as noted above were partially offset by the increased staffing to strengthen quality and service and rate cuts mentioned above. In addition, we have continued spending on growth initiatives, such as new starts, especially in our Human Services segment. Within this segment, we continued to navigate a shift in market demand for models of service for at-risk youth. Many payors were emphasizing non-residential periodic support services to keep a greater number of children and adolescents within their families rather than moving them to out-of-home placements, including therapeutic foster care.

 

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During fiscal 2012, we also recorded an additional $5.2 million in travel and transportation expense, primarily increased cost for mileage reimbursement, auto insurance and gasoline, of which $4.6 million related to the Human Services segment.

During fiscal 2011, we recorded an additional $19.3 million of expenses related to the February 2011 Refinancing including (i) $10.8 million related to the tender premium and consent fees paid in connection with the repurchase of the Senior Subordinated Notes, (ii) $7.9 million in connection with the acceleration of deferred financing costs related to the prior indebtedness and (iii) $0.6 million related to transaction costs. These expenses are recorded on our fiscal 2011 consolidated statements of operations as Extinguishment of debt.

Also, during fiscal 2011, we recorded a $3.0 million gain as NMH Holdings repurchased the NMH Holdings notes (which we had purchased on the open market at a discount) from us at a premium to the carrying value. The gain was recorded on our statements of operations as Gain from available for sale investment security.

Interest expense increased by $17.7 million from fiscal 2011 as compared to fiscal 2012, as a result of the February 2011 Refinancing. Our weighted average debt balance increased by $107.9 million and our weighted average interest rate increased from 8.2% during fiscal 2011 to 9.2% for fiscal 2012.

For fiscal 2012, our effective income tax rate was a benefit of 58.4% compared to an effective tax rate benefit of 33.2% for fiscal 2011. These rates differ from the federal statutory income tax rate primarily due to nondeductible permanent differences and net operating losses not benefited. In addition, our effective tax rate for the twelve months ended September 30, 2012 was impacted by a $6.1 million reduction in our reserve for uncertain income tax positions, including interest and penalties, as a result of favorable settlement of audits.

Human Services

Human Services revenue for fiscal 2012 increased by $50.3 million, or 5.7%, as compared to fiscal 2011. Revenue increased $35.0 million from organic growth, including growth related to new programs, and $15.9 million from acquisitions that closed during and after fiscal 2011. The organic revenue growth was partially offset by a reduction in revenue of $0.6 million from businesses we divested during the same period. Modest organic growth was achieved despite the negative impact of rate reductions in some states, including Arizona, Florida and Minnesota.

Income from operations increased from $77.2 million during fiscal 2011 to $80.3 million during fiscal 2012 and operating margin decreased slightly from 8.7% of revenue to 8.6% of revenue for the same periods.

Operating margin was negatively impacted by increased staffing in anticipation of growth opportunities, additional staffing to strengthen quality and service and the rate reductions discussed above. In addition, we have continued spending on growth initiatives, such as new starts. Within this segment, we continued to navigate a shift in market demand for models of service for at-risk youth. Many payors were emphasizing non-residential periodic support services to keep a greater number of children and adolescents within their families rather than moving them to out-of-home placements, including therapeutic foster care.

The increase in expenses noted above was offset by a $4.0 million decrease in reserves related to workers’ compensation insurance cost and employment practices liability during fiscal 2012 as compared to fiscal 2011 as a result of a change in reserves due to favorable settlement of prior period claims. During fiscal 2011, we recorded an additional $2.9 million due to an increase in workers’ compensation costs as compared to fiscal 2012. Also, during fiscal 2011, we recognized higher self-insurance reserves for employment practices liability claims, which resulted in an additional $1.1 million of expense during fiscal 2011 as compared to fiscal 2012.

During the fiscal 2012, we also incurred an additional $4.6 million in travel and transportation expense, primarily increased cost for mileage reimbursement, auto insurance and gasoline.

In addition, during fiscal 2011, we recorded $3.8 million related to a discretionary cash bonus to direct care workers as compared to $2.5 million in fiscal 2012. This bonus is recorded in cost of revenue in the accompanying consolidated statements of operations.

Post-Acute Specialty Rehabilitation Services

Post-Acute Specialty Rehabilitation Services revenue for fiscal 2012 increased by $10.0 million, or 5.7%, as compared to fiscal 2011. Revenue increased $6.5 million from organic growth, including growth related to new programs, and $6.3 million related to acquisitions that closed during and after fiscal 2011. The organic growth was offset by a reduction in revenue of $2.8 million from businesses we divested during the same period.

 

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Income from operations increased from $18.4 million during fiscal 2011 to $20.4 million during fiscal 2012 and our operating margin improved from 10.5% to 11.0% for the same periods. The increase is primarily due to the increase in revenue stated above. In addition, during fiscal 2012, our workers’ compensation expense decreased by $0.6 million and our employment practices liability expense decreased by $0.2 million as compared to fiscal 2011 as a result of a change in reserves due to favorable settlement of prior period claims. The decrease in expenses was partially offset by an increase of $0.8 million in occupancy expense as a result of acquisitions in this segment.

Corporate

Total corporate expenses decreased by $8.1 million, from $61.2 million for fiscal 2011 to $53.1 million for fiscal 2012, as our expenses for fiscal 2011 included certain costs which did not recur during fiscal 2012.

During fiscal 2011, we recorded an additional $5.3 million expense related to the impairment of our indefinite lived intangible assets that we did not record during fiscal 2012. Additionally, stock based compensation expense decreased by $3.0 million in fiscal 2012 as compared to fiscal 2011. The Company also recorded $2.4 million of discretionary recognition bonuses during fiscal 2011 of which was not recorded in fiscal 2012. The decrease in expenses was partially offset by the increase in staffing and other general and administrative employee-related costs.

Liquidity and Capital Resources

Our principal uses of cash are to meet working capital requirements, fund debt obligations and finance capital expenditures and acquisitions. Cash flows from operations have historically been sufficient to meet these cash requirements. Our principal sources of funds are cash flows from operating activities, cash on hand and available borrowings under our senior revolver (as defined below).

Operating activities

Cash flows provided by operating activities were $55.7 million, $29.3 million, and $30.2 million for fiscal 2013, 2012 and 2011, respectively. The increase in cash provided by operating activities is primarily attributable to the decrease in our days sales outstanding. Our days sales outstanding decreased from 52 days to 47 days at September 30, 2013 as compared to September 30, 2012 primarily due to some efficiencies resulting from the centralization of certain billing and accounts receivable functions as well as the process improvement of our billing and collections process and review of aged receivables.

The decrease in cash flows provided by operating activities from fiscal 2011 to fiscal 2012 was primarily due to an increase in our working capital. Our days sales outstanding increased to 52 days at September 30, 2012 from 48 days at September 30, 2011, as we were still continuing to centralize certain billing and accounts receivable functions and utilize a new billing and accounts receivable system in certain locations.

Investing activities

Net cash used in investing activities was $39.4 million, $42.7 million, and $82.5 million for fiscal 2013, 2012 and 2011, respectively.

Cash paid for acquisitions was $9.3 million, $16.5 million, and $12.7 million for fiscal 2013, 2012 and 2011, respectively. We acquired three companies in fiscal 2013, and seven companies in each of 2012 and 2011, respectively.

Cash paid for property and equipment for fiscal 2013 was $31.9 million, or 2.7% of revenue, compared to $30.0 million, or 2.7% of revenue for fiscal 2012, and $20.9 million or 2.0% of revenue for fiscal 2011. We plan to continue allocating approximately 2.7% of revenue to spending on property and equipment during fiscal 2014. During fiscal 2012, we sold certain real estate assets for total cash proceeds of $2.8 million, which we subsequently leased back.

In addition, during fiscal 2011, our restricted cash balance increased by $49.9 million primarily due to $50.0 million which was deposited in a cash collateral account in support of issuance of letters of credit under the institutional letter of credit facility (the “institutional letter of credit facility”).

Financing activities

Net cash provided by financing activities was $3.0 million, $13.1 million, and $26.2 million for fiscal years 2013, 2012, and 2011, respectively. The decrease in net cash provided by financing activities in fiscal 2013 as compared to fiscal 2012 and fiscal 2011 is primarily due to the repayment of any outstanding borrowings under our senior revolver. In February 2013, we increased our term loan by an additional $30.0 million to effectively lower the interest rate on our borrowings.

 

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Net cash provided by financing activities for fiscal 2011 was primarily due to the February 2011 Refinancing. In addition, net cash used in financing activities for fiscal 2011 included an earn-out payment of $3.4 million to the former owners of IFCS, a company that we acquired in fiscal 2009.

Our principal sources of funds are cash flows from operating activities, cash on hand, and available borrowings under our senior revolver. Our increased cash interest payments after the February 2011 Refinancing and our use of cash to fund investments in our growth initiatives have reduced our liquidity in the business. During fiscal 2013, we borrowed an aggregate of $469.4 million under our senior revolver and repaid $488.4 million during the same period. At September 30, 2013, we had no outstanding borrowings and $75.0 million of availability under the senior revolver. However, despite the contractual availability, our leverage covenants could effectively limit our ability to draw on the senior revolver. Letters of credit can be issued under our institutional letter of credit facility up to the $50.0 million limit and letters of credit in excess of that amount reduce availability under our senior revolver. We expect to continue to draw on the revolver during fiscal 2014 and we believe that available funds will provide sufficient liquidity and capital resources to meet our financial obligations for the next twelve months, including scheduled principal and interest payments, as well as to provide funds for working capital, acquisitions, capital expenditures and other needs. No assurance can be given, however, that this will be the case.

Also during fiscal 2013, 2012 and 2011, our indirect parent NMH Investment repurchased equity units from employees upon or after their departures from the Company for $39 thousand, $75 thousand, and $1.5 million, respectively. We accounted for these repurchases as dividends of $39 thousand, $75 thousand and $1.5 million, respectively, up to NMH Investment which used the proceeds to fund the repurchases.

Senior Secured Credit Facilities

In the February 2011 Refinancing, we entered into senior secured credit facilities, consisting of a (i) six-year $530.0 million term loan facility, of which $50.0 million was deposited in a cash collateral account in support of issuance of letters of credit under the institutional letter of credit facility and a (ii) $75.0 million five-year senior secured revolving credit facility. The $530.0 million term loan was issued at a price equal to 98.5% of its face value and amortizes one percent per year, paid quarterly, with the remaining balance payable at maturity. We refer to these facilities, as amended on October 15, 2012, as the “senior secured credit facilities”.

On October 15, 2012, we entered into an Amendment Agreement (the “Amendment Agreement”) to amend and restate the senior credit agreement governing the senior secured credit facilities. The Amendment Agreement converted the existing term loan facility into a tranche B-1 term loan facility in aggregate principal amount of $522.1 million (the “term loan”), the proceeds of which were used to prepay the existing term loan. The Amendment Agreement also replaced our existing $75.0 million revolving credit facility and the borrowings thereunder with a new $75.0 million revolving credit facility (the “senior revolver”). The Amendment Agreement had the effect of lowering the interest rate we pay on the borrowings under the senior secured credit facilities by 0.5%, by reducing the LIBOR floor from 1.75% to 1.25%.

All of our obligations under the senior secured credit facilities are guaranteed by Parent and certain of our existing subsidiaries. The obligations under the senior secured credit facilities are secured by a pledge of 100% of our capital stock and the capital stock of domestic subsidiaries owned by us and any other domestic subsidiary guarantor and 65% of the capital stock of any first tier foreign subsidiaries, and a security interest in substantially all of our tangible and intangible assets and the tangible and intangible assets of Parent and each guarantor.

At our option, we may add one or more new term loan facilities or increase the commitments under the senior revolver (collectively, the “incremental borrowings”) in an aggregate amount of up to $125.0 million so long as certain conditions, including a consolidated leverage ratio (as defined in the senior credit agreement) of not more than 6.00 to 1.00 on a pro forma basis, are satisfied. The covenants in the indenture governing the senior notes effectively limit the amount of incremental borrowings that we may incur to not more than $75.0 million. In February 2013, we entered into an amendment related to our senior credit agreement for an incremental borrowing of $30.0 million under our term loan. See “Term Loan” for more details.

The senior credit agreement contains a number of covenants including, among other things, limitations on our ability to incur additional debt, create liens on assets, transfer or sell assets, pay dividends, redeem stock or make other distributions or investments, and engage in certain transactions with affiliates. The senior credit agreement contains affirmative covenants and events of default. The senior credit agreement also requires us to maintain certain financial covenants, as described under “Covenants”.

The interest rates under the senior secured credit facilities were unchanged by the Amendment Agreement, except that the LIBOR floor applicable to borrowings under the senior secured credit facilities was reduced by 0.50%. As a result, borrowings under the senior secured credit facilities bear interest as follows: (1) in the case of base rate loans, at a rate equal to the greater of (a) the prime rate of UBS AG, Stamford Branch, (b) the federal funds rate plus 1/2 of 1% and (c) the Eurodollar rate for an interest period of one-month beginning on such day plus 100 basis points (subject to an ABR floor of 2.25% per annum), plus 4.25%, and (2) in the case of Eurodollar loans, at the Eurodollar rate (subject to a LIBOR floor of 1.25% per annum), plus 5.25%.

 

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Term loan

The original $530.0 million term loan was issued at a price equal to 98.5% of its face value. The senior credit agreement includes a provision for the prepayment of a portion of the outstanding term loan amounts equal to an amount ranging from 0 to 50% of a calculated amount, depending on our leverage ratio, if we generate certain levels of cash flow, sell certain assets or incur other indebtedness, subject to certain exceptions. We have not been required to make such a prepayment as of September 30, 2013. We are required to repay the term loan in quarterly principal installments of 0.25% of the original principal amount, which the balance payable at maturity.

On February 4, 2013, we also entered into an Incremental Amendment No. 1 (the “Incremental Amendment No. 1”) to the senior credit agreement. The Incremental Amendment No. 1 provided for an additional $30.0 million term loan (the “incremental term loan”) under our existing term loan. The net proceeds were used to repay a majority of the outstanding borrowings under our senior revolver. We are required to repay the incremental term loan in quarterly installments of 0.25% of its principal amount, with the balance payable at maturity. All of the other terms of the incremental term loan are identical to the term loan.

At September 30, 2013, we had $546.5 million of borrowings under the term loan (including the incremental term loan). At September 30, 2013, the variable interest rate on the term loan was 6.5%.

Senior revolver

We had no borrowings and $75.0 million of availability under the senior revolver September 30, 2013 and had $42.2 million of standby letters of credit issued under the institutional letter of credit facility primarily related to our workers’ compensation insurance coverage. Letters of credit can be issued under our institutional letter of credit facility up to the $50.0 million credit collateral account. Letters of credit in excess of that amount reduce availability under our senior revolver. The interest rate for any borrowings under the senior revolver was 7.5% at September 30, 2013.

The senior revolver includes borrowing capacity available for letters of credit and for borrowings on same-day notice, referred to as the “swingline loans.” Any issuance of letters of credit in excess of the $50 million credit collateral account or making of a swingline loan will reduce the amount available under the senior revolver.

Senior Notes

On February 9, 2011, we issued $250.0 million in aggregate principal amount of the senior notes at a price equal to 97.7% of their face value. The senior notes mature on February 15, 2018 and bear interest at a rate of 12.50% per annum, payable semi-annually on February 15 and August 15 of each year, beginning on August 15, 2011. The senior notes are our unsecured obligations and are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by certain of our existing subsidiaries.

We may redeem the senior notes at our option, in whole or part, at any time prior to February 15, 2014, at a price equal to 100% of the principal amount of the senior notes redeemed plus accrued and unpaid interest to the redemption date and plus an applicable premium. We may redeem the senior notes, in whole or in part, on or after February 15, 2014, at the redemption prices set forth in the indenture plus accrued and unpaid interest to the redemption date. At any time on or before February 15, 2014, we may choose to redeem up to 35% of the aggregate principal amount of the senior notes at a redemption price equal to 112.5% of the principal amount thereof, plus accrued and unpaid interest to the redemption date, with the net proceeds of one or more equity offerings, so long as at least 65% of the original aggregate principal amount of the senior notes remain outstanding after each such redemption.

Covenants

The senior credit agreement and the indenture governing the senior notes contain negative financial and non-financial covenants, including, among other things, limitations on our ability to incur additional debt, create liens on assets, transfer or sell assets, pay dividends, redeem stock or make other distributions or investments, and engage in certain transactions with affiliates. We were in compliance with these covenants as of September 30, 2013. In addition, in the case of the senior credit agreement, we are required to maintain at the end of each fiscal quarter a consolidated leverage ratio. At September 30, 2013, the maximum consolidated leverage ratio was not more than 6.50 to 1.00. This consolidated leverage ratio will step down over time, starting on December 31, 2013 when we will be required to maintain a consolidated leverage ratio of not more than 6.00 to 1.00. The consolidated leverage ratio is defined as the ratio of total debt, net of cash and cash equivalents, to consolidated EBITDA, as defined in the senior credit agreement, for the most recently completed four fiscal quarters. We are also required to maintain at the end of each fiscal quarter a minimum consolidated interest coverage ratio. At September 30, 2013, the minimum consolidated interest coverage ratio was 1.55 to 1.00 and this ratio will continue to step up over time. The next step up is on September 30, 2014 when we will be required to maintain a minimum interest coverage ratio of 1.70 to 1.00. The consolidated interest coverage ratio is defined as the ratio of consolidated EBITDA to consolidated interest expense, both as defined under the senior credit agreement, for the most recently completed four fiscal quarters.

 

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As of September 30, 2013, our consolidated leverage ratio was 5.49 to 1.00, as calculated in accordance with the senior credit agreement and our consolidated interest coverage ratio was 1.85 to 1.00, as calculated in accordance with the senior credit agreement. As of September 30, 2013, total debt, net of cash and cash equivalents, was $734.1 million. Under the senior credit agreement, consolidated EBITDA is defined as net income before interest expense and interest income, income taxes, depreciation and amortization, further adjusted to add back certain non-cash charges, fees under the management agreement with our equity sponsor, proceeds of business insurance, certain expenses incurred under indemnification or refunding provisions for acquisitions, certain start-up losses, non-cash compensation expense, transaction bonuses, unusual or non-recurring losses, charges, severance costs and relocation costs and deductions attributable to minority interests, business optimization expenses and further adjusted to subtract unusual or non-recurring income or gains, income tax credits to the extent not netted, non-cash income and interest income and gains on interest rate hedges, and further adjusted for certain other items including EBITDA and pro forma adjustments from acquired businesses and exclusion of discontinued operations.

Set forth below is a reconciliation of consolidated EBITDA, as calculated under the senior credit agreement, to net loss for the four fiscal quarters ended September 30, 2013.

 

     (in thousands)  

Net loss

   $ (18,296

Loss from discontinued operations, net of tax

     2,724   

Benefit for income taxes

     (9,472

Interest expense

     78,075   

Interest income

     (137

Management fee of related party

     1,359   

Depreciation and amortization

     64,146   

Claims made insurance liability

     3,445   

Non-cash charges

     (784

Restructuring expense

     703   

Acquisition costs

     238   

Franchise taxes, transaction fees, costs, and expenses

     208   

Stock-based compensation

     273   

Loss on disposal of assets

     165   

Operating losses from new starts

     8,000   

Business optimization expenses

     183   

Acquired EBITDA

     2,229   

Professional liability claims expense in excess of cash payments

     545   
  

 

 

 

Consolidated EBITDA per the senior credit agreement

   $ 133,604   
  

 

 

 

Set forth below is an annualized calculation of consolidated interest expense as of September 30, 2013, as calculated under the credit agreement:

 

     (in thousands)  

Senior term loan

   $ 35,605   

Senior notes

     31,250   

Interest rate swap agreements

     3,358   

Senior revolver and unused line of credit

     1,079   

Capital leases

     815   

Standby letters of credit

     105   

Interest income

     (137
  

 

 

 

Consolidated interest expense per the senior credit agreement

   $ 72,075   
  

 

 

 

 

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The consolidated leverage ratio and the consolidated interest coverage ratios are material components of the senior credit agreement and non-compliance with these ratios could prevent us from borrowing under the senior revolver and would result in a default under the senior credit agreement.

Contractual Commitments Summary

The following table summarizes our contractual obligations and commitments as of September 30, 2013:

 

     Total      Less Than
1 Year
     1-3 Years      3-5 Years      More Than
5 Years
 
     (In thousands)  

Long-term debt obligations(1)

   $ 1,056,391       $ 72,729       $ 144,447       $ 839,215       $ —     

Operating lease obligations(2)

     198,150         47,261         67,893         40,934         42,062   

Capital lease obligations

     6,939         430         948         1,157         4,404   

Purchase obligations (3)

     4,421         824         2,161         1,436         —     

Standby letters of credit

     42,211         42,211         —          —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations and commitments

   $ 1,308,112       $ 163,455       $ 215,449       $ 882,742       $ 46,466   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts represent the principal amount of our long-term debt and the expected cash payments for interest on our long-term debt based on the interest rates in place and amounts outstanding at September 30, 2013. As a result of the amendment of the senior credit agreement governing our senior secured credit facilities on October 15, 2012, the LIBOR floor applicable to borrowings under the senior secured credit facilities was reduced by 0.50%.
(2) Includes the fixed rent payable under the leases and does not include additional amounts, such as taxes, that may be payable under the leases.
(3) Amounts represent purchase obligations related to information technology services and maintenance contracts.

Inflation

We do not believe that general inflation in the U.S. economy has had a material impact on our financial position or results of operations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet transactions or interests.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

We believe our application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change.

The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Revenue is reported net of allowances for unauthorized sales and estimated sales adjustments. Revenue is also reported net of any state provider taxes or gross receipts taxes levied on services we provide. Sales adjustments are estimated based on an analysis of historical sales adjustments and recent developments in the payment trends. Revenue is recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectibility is reasonably assured.

We recognize revenue for services performed pursuant to contracts with various state and local government agencies and private health care agencies as follows: cost-reimbursement contract revenue is recognized at the time the service costs are incurred and units-of-service contract revenue is recognized at the time the service is provided. For our cost-reimbursement contracts, the rate provided by the payor is based on a certain level of service and types of costs incurred in delivering the service. From time to time, we receive payments under cost-reimbursement contracts in excess of the allowable costs required to support those payments. In such instances, we estimate and record a liability for such excess payments. At the end of the contract period, any balance of excess payments is maintained as a liability until it is reimbursed to the payor. Revenue in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be enacted in states where we operate or by the federal government.

 

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Accounts Receivable

Accounts receivable primarily consist of amounts due from government agencies, not-for-profit providers and commercial insurance companies. An estimated allowance for doubtful accounts 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 payment trends in individual states, age of the accounts and the status of ongoing disputes with third party payors. 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 revenue as a contractual allowance in the consolidated statements of operations in the period of the change in estimate.

Goodwill and Indefinite-lived Intangible Assets

We review costs of purchased businesses in excess of the fair value of net assets acquired (goodwill), and indefinite-lived intangible assets for impairment at least annually, unless significant changes in circumstances indicate a potential impairment may have occurred sooner. We conduct our annual impairment test for both goodwill and indefinite-lived intangible assets on July 1 of each year. We are required to test goodwill on a reporting unit basis, which is the same level as our operating segments. We have the option to first assess qualitative factors to determine whether further impairment testing is necessary. We have elected to bypass the qualitative assessments for the fiscal year ended 2013 and proceed directly to the two-step impairment test. The first step is to compare the fair value of the reporting unit with its carrying value. If the carrying amount of the reporting unit exceeds its fair value then the second step of the goodwill impairment test is performed. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill in order to determine the amount of impairment to be recognized. The excess of the carrying value of goodwill above the implied goodwill, if any, would be recognized as an impairment charge. Fair values are established using discounted cash flow and comparative market multiple methods.

For its indefinite-lived intangible assets, we have the option to first assess qualitative factors to determine whether further impairment testing is necessary. The Company has elected to bypass the qualitative assessments for fiscal year 2013 and proceed directly to the quantitative impairment test. The impairment test for indefinite-lived intangible assets requires the determination of the fair value of the intangible asset. If the fair value of the indefinite-lived intangible asset is less than its carrying value, an impairment loss is recognized in an amount equal to the difference. Fair values are established using the relief from royalty method.

The fair value of a reporting unit is based on discounted estimated future cash flows. The assumptions used to estimate fair value include management’s best estimates of future growth, capital expenditures, discount rates and market conditions over an estimate of the remaining operating period. As such, actual results may differ from these estimates and lead to a revaluation of our goodwill and indefinite-lived intangible assets. If updated estimates indicate that the fair value of goodwill or any indefinite-lived intangibles is less than the carrying value of the asset, an impairment charge is recorded in the consolidated statements of operations in the period of the change in estimate.

Impairment of Long-Lived Assets

We review long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded.

Income Taxes

We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. These deferred tax assets and liabilities are separated into current and long-term amounts based on the classification of the related assets and liabilities for financial reporting purposes and netted by jurisdiction. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts.

We also recognize the benefits of tax positions when certain criteria are satisfied. Companies may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. We recognize interest and penalties related to uncertain tax positions as a component of income tax expense which is consistent with the recognition of these items in prior reporting periods.

 

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Stock-Based Compensation

NMH Investment, our indirect parent, adopted an equity-based compensation plan, and issued units of limited liability company interests consisting of Class B Units, Class C Units, Class D Units, Class E Units, Class F Units, Class G Units, and Class H Units pursuant to such plan. The units are limited liability company interests and are available for issuance to our employees and members of the Board of Directors for incentive purposes. For purposes of determining the compensation expense associated with these grants, management values the business enterprise using a variety of widely accepted valuation techniques which considered a number of factors such as our financial performance, the values of comparable companies and the lack of marketability of our equity. We then used the option pricing method to determine the fair value of these units at the time of grant using valuation assumptions consisting of the expected term in which the units will be realized; a risk-free interest rate equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend yield, for which there is none; and expected volatility based on the historical data of equity instruments of comparable companies. For Class B Units, Class C Units, Class D Units, Class E Units and Class F Units, the estimated fair value of the units, less an assumed forfeiture rate, is recognized in expense on a straight-line basis over the requisite service periods of the awards. The Class G Units and Class H Units vest upon a liquidity event and/or upon the occurrence of certain investment return conditions, for which the compensation expense will then be recognized in its entirety when probable.

Derivative Financial Instruments

We report derivative financial instruments on the balance sheet at fair value and establish criteria for designation and effectiveness of hedging relationships. Changes in the fair value of derivatives are recorded each period in current operations or in the consolidated statements of comprehensive income (loss) depending upon whether the derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction.

We, from time to time, enter into interest rate swap agreements to hedge against variability in cash flows resulting from fluctuations in the benchmark interest rate, which is LIBOR, on our debt. These agreements involve the exchange of variable interest rates for fixed interest rates over the life of the swap agreement without an exchange of the notional amount upon which the payments are based. On a quarterly basis, the differential to be received or paid as interest rates change is accrued and recognized as an adjustment to interest expense in the accompanying consolidated statement of operations. In addition, on a quarterly basis the mark to market valuation is recorded as an adjustment to gain (loss) on derivative within the consolidated statements of comprehensive income (loss). The related amount receivable from or payable to counterparties is included as an asset or liability, respectively, in our consolidated balance sheets.

Accruals for Self-Insurance

We maintain employment practices liability, professional and general liability, workers’ compensation, automobile liability and health insurance with policies that include self-insured retentions. Employment practices liability is fully self-insured. We record expenses related to claims on an incurred basis, which includes estimates of fully developed losses for both reported and unreported claims. The accruals for the health, workers’ compensation, automobile, employment practices liability and professional and general liability programs are based on analyses performed internally by management and may take into account reports by independent third parties. Accruals relating to prior periods are periodically reevaluated and increased or decreased based on new information. Changes in estimates are charged or credited to the consolidated statements of operations in a period subsequent to the change in estimate. In addition, we report insurance liabilities on a gross basis without giving effect to insurance recoveries.

Legal Contingencies

We are regularly involved in litigation and regulatory proceedings in the operation of our business. We reserve for costs related to contingencies when a loss is probable and the amount is reasonably estimable. While we believe our provision for legal contingencies is adequate, the outcome of our legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that differ from our estimates. In addition, legal contingencies could have a material adverse impact on our results of operations in any given future reporting period. See “Part I, Item 1A. Risk Factors” for additional information.

 

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Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to changes in interest rates as a result of our outstanding variable rate debt. To reduce the interest rate exposure related to the variable debt, we entered into an interest rate swap in a notional amount of $400.0 million effective March 31, 2011 and ending September 30, 2014. Under the terms of the swap, as amended on October 15, 2012, we receive from the counterparty a quarterly payment based on a rate equal to the greater of 3-month LIBOR and 1.25% per annum, and we make payments to the counterparty based on a fixed rate of 2.08% per annum, in each case on the notional amount of $400.0 million, settled on a net payment basis. Based on the applicable margin of 5.25% under our term loan facility, this swap effectively fixes our cost of borrowing for $400.0 million of our term loan debt at 7.3% per annum for the term of the swap.

As a result of the interest rate swap, the variable rate debt outstanding was effectively reduced from $546.5 million outstanding to $146.5 million outstanding as of September 30, 2013. The variable rate debt outstanding relates to the term loan and the senior revolver, which bear interest at (i) a rate equal to the greater of (a) the prime rate (b) the federal funds rate plus 1/2 of 1% and (c) the Eurodollar rate for an interest period of one-month beginning on such day plus 100 basis points (subject to a LIBOR floor of 2.25% per annum), plus 4.25%; or (ii) the Eurodollar rate (subject to a LIBOR floor of 1.25%), plus 5.25%, at our option. A 1% increase in the interest rate on our floating rate debt would increase cash interest expense on the floating rate debt by approximately $1.5 million per annum.

 

Item 8. Financial Statements and Supplementary Data

Our consolidated financial statements required by this Item are on pages F-1 through F-32 of this report.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

 

Item 9A. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC, and is accumulated and communicated to management, including the Chief Executive Officer and the President (principal executive officers) and the Chief Financial Officer (principal financial officer), to allow for timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. As of September 30, 2013, the end of the period covered by this Annual Report on Form 10-K, our management, with the participation of our principal executive officers and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation, our principal executive officers and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2013.

(b) Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d — 15(f) of the Exchange Act. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officers, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of September 30, 2013.

Management’s evaluation did not include assessing the internal controls of three businesses that were acquired by us in purchase business combination transactions during fiscal 2013. The combined financial statements of these companies are included in our consolidated financial statements for the fiscal year ended September 30, 2013, and represented 1.1% of our total assets as of September 30, 2013 and 0.2% of our net revenue for the fiscal year ended September 30, 2013.

 

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(c) Changes in Internal Control over Financial Reporting

During the fiscal year ended September 30, 2013, we continued to transition and evaluate the transition of certain field billing and accounts receivable functions into a centralized shared services center. This centralization is expected to continue in a phased approach over the next several years. As part of this centralization, we continue to refine and optimize our billing and accounts receivable process and related system in a majority of our operations. This has affected, and will continue to affect, the processes that impact our internal control over financial reporting. We will continue to review the related controls and may take additional steps to ensure that they remain effective.

During the fiscal year ended September 30, 2013, we transitioned certain field general ledger functions into a centralized shared services center. This centralization is expected to continue in a phased approach over the next several years.

Except for the continuing centralization and optimization of our billing and accounts receivable process and related system, as well as the centralization of certain general ledger functions, during the most recent fiscal quarter, there were no significant changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to an exemption for issuers that are not “large accelerated filers” nor “accelerated filers” set forth in Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

 

Item 9B. Other Information

 

Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers

On December 16, 2013, the Company amended and restated The Mentor Network Human Services and Corporate Management Incentive Plan, effective October 1, 2013. The amended and restated plan applies to fiscal years beginning with fiscal 2014. The plan was amended to include a further modifier to the plan to increase or decrease (up to a maximum increase or decrease of ten percent (10%) of the amount of incentive compensation to be paid to certain employees based on the actual number of days sales outstanding (“DSO”) achieved by the Company as of the end of fiscal 2014 compared to the target approved by the Compensation Committee at the beginning of each fiscal year (the “DSO Target”).

For a description of the terms of The Mentor Network Human Services and Corporate Management Incentive Plan, see “Item 11. Executive Compensation—Compensation Discussion and Analysis—Annual Incentive Compensation.”

On October 11, 2013, we announced an executive transition plan under which Bruce F. Nardella, currently President and Chief Operating Officer, will become Chief Executive Officer and the sole principal executive officer effective January 1, 2014. Mr. Nardella will also become a member of the Board of Directors and will serve on the Company’s Compliance Committee. On December 16, 2013, the Compensation Committee of the Company’s Board of Directors approved certain compensation arrangements that will become effective January 1, 2014, to effectuate the executive transition plan. Specifically, on December 16, 2013, the Company entered into the following agreements: (1) Second Amended and Restated Employment Agreement between the Company and Edward M. Murphy (the “Murphy Employment Agreement”), (2) Employment Agreement between the Company and Bruce F. Nardella (the “Nardella Employment Agreement”), and (3) Termination Agreement between the Company and Gregory Torres (the “Torres Termination Agreement”). On December 16, 2013, the Board of Directors also increased the size of the Board of Directors from seven (7) Directors to eight (8) and appointed Mr. Nadella to the Board of Directors.

        Pursuant to the Murphy Employment Agreement, effective January 1, 2014, Mr. Murphy will resign as Chief Executive Officer of the Company and will be elected as Executive Chair of the Board of Directors. The initial term of the Murphy Employment Agreement is one year, after which the agreement renews automatically each year for a one-year term, unless terminated earlier by the parties. The Murphy Employment Agreement provides a base salary of $400,000 per year, subject to review and adjustment from time to time, with an annual bonus from the incentive compensation plan equal to no less than Mr. Murphy’s base salary if the Company reaches certain yearly determined performance objectives. Under the terms of the agreement, if Mr. Murphy is terminated by the Company without “cause” or Mr. Murphy resigns with “good reason”, the Company is obligated to continue to pay him his base salary and targeted incentive compensation for two years following the date of such termination, as well as a pro rata incentive compensation amount for the year in which such termination occurs. The definition of “cause” includes the commission of fraud or embezzlement, an indictment or conviction for a felony or a crime involving moral turpitude, willful misconduct, violation of any material written policy of the Company, material neglect of duties, failure to comply with reasonable Board directives and material breach of any agreement with the Company or its securityholders or affiliates. The definition of “good reason” includes a material change in title, duties and responsibilities, a reduction in Mr. Murphy’s annual base salary or annual bonus opportunity (subject to certain exclusions), a material breach by the Company of the amended and restated employment agreement, and relocation of Mr. Murphy’s principal place of work from its current location to a location that is beyond a 50-mile radius of such location. The Murphy Employment Agreement contains provisions pursuant to which Mr. Murphy has agreed not to disclose our confidential information. Mr. Murphy has also agreed not to solicit our employees or contractors, nor compete with us for a period of two years after his employment with us has been terminated.

The Company entered into the Nardella Employment Agreement in connection with Mr. Nardella’s promotion to Chief Executive Officer of the Company. The Nardella Employment Agreement has an initial term of three years, after which the agreement renews automatically each year for a one-year term, unless terminated earlier by the parties. The Nardella Employment Agreement provides for a base salary of $500,000 per year, subject to review and adjustment from time to time, with an annual bonus from the incentive compensation plan equal to no less than Mr. Nardella’s base salary if the Company reaches certain yearly determined performance objectives. Under the terms of the agreement, if Mr. Nardella is terminated by the Company without “cause” or Mr. Nardella resigns with “good reason”, the Company is obligated to continue to pay him his base salary and targeted incentive compensation for two years following the date of such termination, as well as a pro rata incentive compensation amount for the year in which such termination occurs. The definition of “cause” includes the commission of fraud or embezzlement, an indictment or conviction for a felony or a crime involving moral turpitude, willful misconduct, violation of any material written policy of the Company, material neglect of duties, failure to comply with reasonable Board directives and material breach of any agreement with the Company or its securityholders or affiliates. The definition of “good reason” includes a material change in title, duties and responsibilities, a material reduction in Mr. Nardella’s annual base salary or annual bonus opportunity (subject to certain exclusions), a material breach by the Company of the amended and restated employment agreement, and relocation of Mr. Nardella’s principal place of work from its current location to a location that is beyond a 50-mile radius of such location. The Nardella Employment Agreement contains provisions pursuant to which Mr. Nardella has agreed not to disclose our confidential information. Mr. Nardella has also agreed not to solicit our employees or contractors, nor compete with us for a period of two years after his employment with us has been terminated. In connection with his promotion to Chief Executive Officer of the Company, Mr. Nardella was granted 100,000 Class F Units and 100,000 Class H Units by NMH Investment on December 16, 2013.

On December 16, 2013, the Board of Directors accepted the resignation of Mr. Torres as Chairman of the Board of Directors and employee of the Company, effective as of January 1, 2014. In connection with Mr. Torres’ resignation, the Company entered into a Termination of Amended and Restated Employment Agreement (the “Torres Termination Agreement”). Pursuant to the terms of the Torres Termination Agreement, the Company has agreed to make a donation in the amount of $100,000 to MassINC. Although Mr. Torres will no longer be Chairman of the Board of Directors or an employee of the Company as of January 1, 2014, he will remain a Director of the Company.

 

Item 5.03 Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year

On December 16, 2013, pursuant to a unanimous written consent of the board of directors of the Company, the bylaws of the Company were amended. First, the Amendment replaces the position of the Chairman of the Board with the position of the Executive Chair. Second, the Amendment adds a separate position of Chief Executive Officer of the Company. This Amendment was adopted in connection with the management transition, pursuant to which, effective January 1, 2014, Edward M. Murphy will become the Executive Chair of the board of directors and Bruce N. Nardella will become the Chief Executive Officer of the Company.

 

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PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

The following table sets forth the name, age and position of each of our directors and executive officers as of December 1, 2013:

 

Name

   Age   

Position

Gregory T. Torres

   64    Chairman and Director

Edward M. Murphy

   66    Chief Executive Officer and Director

Bruce F. Nardella

   56    President and Chief Operating Officer

Denis M. Holler

   59    Chief Financial Officer and Treasurer

Robert M. Melia

   57    Cambridge Operating Group President

David M. Petersen

   65    Redwood Operating Group President

Jeffrey M. Cohen

   45    Chief Information Officer

Linda DeRenzo

   54    Chief Legal Officer, General Counsel and Secretary

Kathleen P. Federico

   54    Chief Human Resources Officer

Dwight D. Robson

   42    Chief Public Strategy and Marketing Officer

Chris A. Durbin

   48    Director

James L. Elrod, Jr.

   59    Director

Pamela F. Lenehan

   61    Director

Kevin A. Mundt

   59    Director

Guy Sansone

   49    Director

Directors are elected at the annual meeting of our sole stockholder and hold office until the next annual meeting or a special meeting in lieu thereof, and until their successors are elected and qualified, or upon their earlier resignation or removal. There are no family relationships between any of the directors and executive officers listed in the table. There are no arrangements or understandings between any executive officer and any other person pursuant to which he or she was selected as an officer.

Gregory T. Torres has served as Chairman of the board of directors since September 2004. He was also the Company’s Chief Executive Officer from January 1996 to January 2005, as well as its President from January 1996 until September 2004. Mr. Torres joined the Company in 1980 as a member of its first board of directors. Prior to joining the Company, Mr. Torres held prominent positions within the public sector, including chief of staff of the Massachusetts Senate Committee on Ways and Means and assistant secretary of human services. Since May 2007, Mr. Torres has been president and chief executive officer of the Massachusetts Institute for a New Commonwealth, known as “MassINC”, an independent, nonpartisan research and educational institute in Boston. On December 16, 2013, the Board of Directors accepted the resignation of Mr. Torres as Chairman and employee of the Company, effective as of January 1, 2014. In connection with Mr. Torres’ resignation, the Company entered into a Termination of Amended and Restated Employment Agreement (the “Torres Termination Agreement”). Mr. Torres was selected as a director for his knowledge and experience in the human services industry, in the nonprofit, public and private sectors. On October 11, 2013, we announced that Mr. Torres will step down as Chairman effective January 1, 2014 but will remain a director.

Edward M. Murphy has served as Chief Executive Officer since January 2005 and was elected to the Board of Directors in September 2004. He also served as our President from September 2004 until December 2009. Mr. Murphy founded Alliance Health and Human Services, Inc. (“Alliance”) in 1999 and served as the organization’s President and CEO until September 2004. Prior to founding Alliance, he was a Senior Vice President at Tucker Anthony and President and Chief Operating Officer of Olympus Healthcare Group. Mr. Murphy is a former Commissioner of the Massachusetts Department of Youth Services and the Massachusetts Department of Mental Health, and the former Executive Director of the Massachusetts Health and Educational Facilities Authority. On December 16, 2013, the Board of Directors accepted the resignation of Mr. Murphy as Chief Executive Officer of the Company effective as of January 1, 2014. Effective as of January 1, 2014, Mr. Murphy will assume the position of Executive Chair of the board of directors and has entered into the Second Amended and Restated Employment Agreement dated December 16, 2013. Mr. Murphy was selected as a director for his knowledge and experience in finance and the human services industry and experience in the public, private and nonprofit sectors. On October 11, 2013, we announced that Mr. Murphy will become Executive Chair of the board of directors and will remain a full-time executive of the company but will cease to serve as Chief Executive Officer effective January 1, 2014.

        Bruce F. Nardella was appointed President and Chief Operating Officer in December 2009, after being appointed Executive Vice President and Chief Operating Officer in May 2007. Mr. Nardella joined the Company in 1996 as a state director and in May 2003 he was named President of our Eastern Division. Prior to that, he was a deputy commissioner for the Massachusetts Department of Youth Services. On December 16, 2013, the Board of Directors unanimously approved the promotion of Mr. Nardella as the Chief Executive Officer of the Company effective as of January 1, 2014. Mr. Nardella will remain as President of the Company but will resign as the Chief Operating Officer. Mr. Nardella will resign his position as Chief Operating Officer, effective as of January 1, 2014. In connection with his promotion to Chief Executive Officer, Mr. Nardella has entered into an Employment Agreement with the Company dated December 16, 2013. Effective January 1, 2014, Mr. Nardella will also become a member of Board of Directors and a member of the Compliance Committee.

Denis M. Holler has served as our Chief Financial Officer and Treasurer since May 2007. Mr. Holler was named Senior Vice President of Finance in January 2002 and led the Company’s corporate finance functions through the Merger in 2006. In addition to overseeing all finance functions of the Company, he manages external relationships with our equity sponsor, banking partners and high-yield investors. Prior to joining the Company in October 2000 as Vice President of Financial Operations, Mr. Holler was Chief Financial Officer of the Fortress Corporation.

 

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Robert M. Melia was named Cambridge Operating Group President in March 2011, having joined the Company in November 2007, first as the head of our affiliated employment services business and then as Senior Vice President, Mergers & Acquisitions. Prior to joining the Company, Mr. Melia was employed at Maximus, Inc. from 1998 to 2007, ending as President of the Workforce Services Division. He also served for 12 years in a variety of positions at Massachusetts state agencies.

David M. Petersen served as our Redwood Operating Group President since June 2007. He had been serving as Senior Vice President and President of our Central Division since May 2003. Prior to joining the Company, Mr. Petersen worked for REM beginning in 1972, managing various operations in Minnesota, Montana, North Dakota and Wisconsin.

Jeffrey M. Cohen joined the Company as its Chief Information Officer in November 2011. From 2008 until joining the Company, Mr. Cohen served as Vice President of Information Technology for Magellan Biosciences, a private equity backed medical device company, where he oversaw the strategic transformation of its worldwide IT and communications systems. Prior to that, Mr. Cohen was Director of Information Technology at Biogen Idec, where he was responsible for its ERP, SOX program and ancillary systems for finance, human resources, legal and business development. He started his career at Cambridge Technology Partners, in various consulting roles culminating as a Vice President for its eBusiness practice.

Linda DeRenzo was named our Chief Legal Officer in March 2011, and has served as our General Counsel and Secretary since March 2006. Ms. DeRenzo oversees the litigation and risk management, regulatory, compliance, labor and employment and corporate legal functions. An 18-year business law veteran before joining the Company, Ms. DeRenzo represented high-growth companies and their financiers in a variety of industries including information technology, life sciences and health services. Prior to joining the Company, Ms. DeRenzo was a partner at Testa, Hurwitz & Thibeault, LLP in Boston from 1992 to 2004.

Kathleen P. Federico joined the Company in December 2008 as our Senior Vice President, Human Resources, and was named our Chief Human Resources Officer in March 2011. From 2005 until joining the Company, Ms. Federico served as Senior Vice President, Sales and Human Resources, for World Travel Holdings in Woburn, Massachusetts, and was its Senior Vice President, Human Resources, from 2002 to 2005. Prior to that, she served as Vice President of Human Resources for KaBloom LLC, NE Restaurant Company and Sodexho Marriott Services. Ms. Federico was also Chief Operating Officer for Sheehan Associates, an employee benefits brokerage firm.

Dwight D. Robson was named Chief Public Strategy and Marketing Officer in March 2011 after serving as Vice President of Public Strategy since joining the Company in 2003. He leads the work of the Public Strategy Group, which is responsible for developing and implementing the Company’s agenda with respect to communications, investor relations, marketing and proposal development, and government and community affairs. Mr. Robson’s experience prior to joining the Company includes senior policy and management positions in Massachusetts state government, most recently as Assistant State Treasurer.

Chris A. Durbin was elected to our board of directors in December 2010. He is a Managing Director in the Vestar Resources group of Vestar Capital Partners. Before joining Vestar in 2007, Mr. Durbin was Managing Director of Strategy and Business Development in Bank of America’s Global Wealth and Investment business from 2001 to 2007. Prior to this, he worked at Mercer Management Consulting and Corporate Decisions, Inc., where he designed and implemented growth strategies for clients including several Vestar portfolio companies. Mr. Durbin is currently a director of Triton Container International Limited and DeVilbiss Healthcare. Mr. Durbin was selected as a director for his knowledge and experience in strategy and operations.

James L. Elrod, Jr. joined our board of directors in June 2006. Mr. Elrod is a Managing Director of Vestar Capital Partners, having joined Vestar in 1998. Previously, he was Executive Vice President, Finance and Operations, for Physicians Health Service, a public managed care company. Prior to that, he was a Managing Director and Partner of Dillon, Read & Co. Inc. Mr. Elrod is currently a director of Radiation Therapy Services, Inc. Mr. Elrod was selected as a director for his knowledge and experience in finance and the health care industry.

Pamela F. Lenehan was elected to our board of directors in December 2008. Ms. Lenehan has served as President of Ridge Hill Consulting, a strategy consulting firm, since 2002. Prior to this, Ms. Lenehan was self-employed as a private investor. From 2000 to 2001, she was vice president and chief financial officer of Convergent Networks. From 1995 to 2000, she was senior vice president of corporate development and treasurer of Oak Industries Inc., which was acquired by Corning Inc. in 2000. Prior to that, Ms. Lenehan was a Managing Director in Credit Suisse First Boston’s Investment Banking division and a vice president of Corporate Banking at Chase Manhattan Bank. Ms. Lenehan is currently a member of the boards of directors of Monotype Imaging Holdings Inc., where she is a member of the Audit Committee and chair of the Management Development and Compensation Committee, and American Superconductor Corporation where she chairs the Audit Committee. From 2004-2013 she was a member of the board of directors and chair of the Compensation Committee of Spartech Corporation until it was acquired by PolyOne and from 2001 to 2007, she was a member of the board of directors of Avid Technology and at various times chair of the board, chair of the Audit Committee and a member of the Compensation Committee. Ms. Lenehan was selected as a director for her knowledge and experience in finance and strategy and holds a Masters Professional Director Certification from the American College of Corporate Directors, a national public company director education organization.

 

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Kevin A. Mundt joined our board of directors in March 2008. He is a Managing Director at Vestar Capital Partners, and is President of the Vestar Resources group. Before joining Vestar in 2004, Mr. Mundt spent 23 years as a strategy and operations consultant specializing in consumer products, retailing and multi-point distribution, as well as healthcare and industrial marketing. For 11 of those years, Mr. Mundt was a strategic adviser to Vestar, and served on the boards of several Vestar portfolio companies. He began his consulting career at Bain and Company, and went on from there to co-found Corporate Decisions, Inc. When that firm was acquired by Marsh and McLennan, Mr. Mundt became a Managing Director of Marsh and McLennan’s financial consulting arm, Mercer Oliver Wyman. Mr. Mundt is currently a Director and serves on the Compensation Committee of Del Monte Foods and The Sun Products Corp., companies in which Vestar or its affiliates have a significant equity interest. In addition, Mr. Mundt is a member of the President’s Leadership Council at Brigham & Women’s Hospital and a member of the Corporation of Brown University. He is also a past director of Medimedia USA, Inc., Solo Cup Company, Fiorucci Foods, Birds Eye Foods, Sunrise Medical and Duff & Phelps. Mr. Mundt was selected as a director for his knowledge and experience in strategy and operations.

Guy Sansone was elected to our Board of Directors in December 2009. Mr. Sansone is a Managing Director at Alvarez & Marsal in New York and serves as head of its Healthcare Industry Group. Over the past 20 years, he has invested in and consulted as an executive to numerous companies, focusing on developing and evaluating strategic and operating alternatives designed to enhance value. While at Alvarez & Marsal, Mr. Sansone served as Chief Executive Officer and Chief Restructuring Officer at Saint Vincent Catholic Medical Centers in New York from October 2005 to August 2007 and as interim Chief Financial Officer of HealthSouth Corporation from March 2003 to October 2004, among other positions. He most recently served as Chief Restructuring Officer for Erickson Retirement Communities, which filed for bankruptcy protection in October 2009. Mr. Sansone is currently a director of NextCare Urgent Care and was a director of Rotech Healthcare, Inc. from March 2002 to August 2005. Mr. Sansone was selected as a director for his knowledge and experience in strategy and operations, with an emphasis on the health care industry.

Code of Ethics

We have adopted a code of ethics that applies to our directors, officers and employees, including our principal executive officers and our principal financial and accounting officer. The MENTOR Network Code of Conduct is publicly available on our website at www.thementornetwork.com, via a link from our “Quality” page under the tab “Compliance”. If we make any substantive amendments to the Code, or grant any waiver from a provision of the Code to our principal executive officers, principal financial officer or principal accounting officer, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K.

Audit Committee Financial Expert

The Board of Directors has determined that Ms. Lenehan, the chairman of the Company’s Audit Committee, is an Audit Committee financial expert. Our securities are not listed on any stock exchange, so we are not subject to listing standards requiring that we maintain an Audit Committee consisting of independent directors, but Ms. Lenehan would likely qualify as an independent director based on the definition of independent director set forth in Rule 5605(a)(2) of the Nasdaq Stock Market, LLC Listing Rules.

 

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Item 11. Executive Compensation

Compensation Discussion and Analysis

General Overview. The Company is an indirect wholly owned subsidiary of NMH Investment. NMH Investment is beneficially owned by Vestar and certain affiliates, certain of our directors and members of our management team. The Company’s board of directors consists of representatives of Vestar (Chris Durbin, James Elrod Jr. and Kevin Mundt) and representatives of management (Gregory Torres and Edward Murphy), as well as two outside directors (Pamela Lenehan and Guy Sansone). Messrs. Elrod, Durbin and Sansone serve as the members of the Company’s Compensation Committee (the “Committee”), and Mr. Durbin is the Committee’s chairman.

In connection with the Company’s acquisition by Vestar on June 29, 2006 (the “Merger”), the Company entered into an amended and restated employment agreement with its Chief Executive Officer, Edward Murphy. It also entered into severance agreements with its other named executive officers, Bruce Nardella, the Company’s President and Chief Operating Officer, Denis Holler, the Company’s Chief Financial Officer, David Petersen, President of the Redwood Operating Group, Linda DeRenzo, the Company’s Chief Legal Officer, and, subsequently upon her hire, Kathleen P. Federico, Chief Human Resources Officer. The compensation initially paid to Mr. Murphy reflects negotiations at the time of the Merger, which has been adjusted since the Merger as described below. Messrs. Holler, Nardella, Petersen and Ms. DeRenzo and Ms. Federico have all received raises since the Merger, upon being promoted or otherwise. Also in connection with the Merger, or after joining the Company, most of the Company’s executive officers invested in the Preferred Units and Class A Common Units of NMH Investment. As of September 30, 2013, the Company’s executive officers (including the named executive officers) have invested approximately $3.0 million. The Company’s executive officers also hold earned equity in NMH Investment.

On December 16, 2013, the Company entered into a further amended and restated employment agreement with Mr. Murphy and an employment agreement with Bruce Nardella. Pursuant to Mr. Murphy’s amended and restated employment agreement, effective January 1, 2014, Mr. Murphy will resign his position as Chief Executive Officer and will become Executive Chair of the board of directors. Pursuant to Mr. Nardella’s employment agreement, effective January 1, 2014, Mr. Nardella will resign his position as Chief Operating Officer of the Company and will be promoted to Chief Executive Officer. Mr. Nardella will retain the title of President of the Company and will become a member of the Company’s board of directors. The severance agreement between the Company and Mr. Nardella has been superseded by his employment contract.

Compensation Policies and Practices. The primary objectives of our executive compensation program are to:

 

    attract and retain top executive talent;

 

    achieve accountability for performance by linking annual cash incentive awards to achievement of measurable performance objectives; and

 

    align short and longer-term incentives with equity value creation.

Our executive compensation programs are designed to encourage our executive officers to operate the business in a manner that best serves our clients, payors and other public partners, as well as our employees, thereby enhancing equity value. They do this by awarding a significant portion of our executives’ overall compensation based on the Company’s financial performance, specifically, revenue and achievement of earnings before interest, taxes, depreciation and amortization, or EBITDA (with certain adjustments). Our compensation philosophy provides for a direct relationship between compensation and the achievement of our goals and seeks to include management in upside rewards.

 

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We seek to achieve an overall compensation program that provides foundational elements such as base salary and benefits, as well as an opportunity for variable incentive compensation that constitutes a significant portion of an executive officer’s annual compensation in order to drive the Company’s achievement of performance goals.

The Company’s executive compensation program is overseen by the Committee. The role of the Committee is, among other things, to review and approve salaries and other compensation of the executive officers of the Company, to review and recommend equity grants under NMH Investment’s equity plan, and to review and approve payments under the annual cash incentive plan in which the executive officers participate. During fiscal 2012, the Wilson Group (“Wilson”), a boutique consulting firm that specializes in designing compensation programs that drive organizational performance, conducted an extensive competitive analysis and review of certain compensation elements for executives. Following Wilson’s review and analysis, the Committee considered Wilson’s recommendations and approved certain changes to executive compensation.

Elements of Compensation. Each element of the executive compensation program works to fulfill one or more of the objectives of the program. The elements of our compensation program are as follows:

 

    base salary;

 

    annual cash bonus incentives;

 

    long-term incentive compensation in the form of equity-based units, including equity units which vest upon the achievement of certain investment returns by Vestar Capital Partners;

 

    deferred compensation;

 

    severance benefits and equity vesting upon a change in control; and

 

    other benefits.

Base salaries for our executive officers are designed to recognize the contributions of our senior management team and provide a stable source of income in line with the market for comparable positions. Our annual bonuses are designed to reward executive officers for achievement of business performance, primarily EBITDA (with certain adjustments) and revenue. In addition, we consider quality of services managed and work performed by the executive officers. Our equity component of compensation, in the form of equity units in NMH Investment, is designed to reward equity value creation over a longer period of time.

 

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Executive Compensation Study. With the approval of the Committee, in fiscal 2012 the Company retained the Wilson compensation consulting firm to evaluate our executive compensation program. Wilson conducted an extensive analysis of the competitiveness and appropriateness of the Company’s cash and equity executive compensation opportunity and made recommendations based on this analysis. Wilson conducted interviews with senior management and members of the Committee, reviewed market data from multiple commercial survey sources and reviewed public company peer group data. Set forth below is the public company peer group that Wilson used in fiscal 2012 to evaluate compensation. The companies were chosen based on industry (health and human services), and size (revenue and number of employees) as of their then-most recent SEC filings. There were 17 US-based companies, with a median revenue of $1.48 billion and a median employee population of 18,800.

 

Name of Company

   Revenue
(In thousands)
     Employees  

Amsurg Corp.

   $ 710,409         3,100   

Bioscrip, Inc.

   $ 1,638,623         2,589   

Emeritus Corp.

   $ 1,007,065         29,300   

Five Star Quality Care, Inc.

   $ 1,240,728         22,500   

Gentiva Health Services, Inc.

   $ 1,447,029         18,950   

HealthSouth Corp.

   $ 1,999,300         23,000   

Healthways, Inc.

   $ 695,974         2,800   

Lincare Holdings Inc.

   $ 1,669,205         10,225   

Mednax, Inc.

   $ 1,401,559         6,270   

National Healthcare Corp.

   $ 701,594         12,760   

Providence Service Corp.

   $ 879,697         10,309   

Psychiatric Solutions, Inc.

   $ 1,805,361         23,000   

Rehabcare Group, Inc.

   $ 1,329,443         18,800   

Res-Care, Inc.

   $ 1,579,255         45,700   

Skilled Healthcare Group, Inc.

   $ 820,238         9,736   

Sun Healthcare Group, Inc.

   $ 1,906,861         29,922   

Sunrise Senior Living, Inc.

   $ 1,409,501         31,700   

Wilson reviewed base salary, annual cash bonus incentives and long-term incentive compensation in the form of equity-based units of executive officers in health and human services public companies with similar revenue base and/or employee base. After completing its review, and presenting its findings to the Committee and to the Board of Directors in executive session, Wilson recommended that the Company: (i) increase the base salaries of its executive officers, to align them more closely with median salaries for comparably situated executive officers, and (ii) issue additional equity to the executive officers in order to more tightly align management and equity sponsor interests in creating stockholder value. Wilson did not recommend changes to the annual cash bonus incentives.

Base Salary. Base salary provides executives with a fixed amount of compensation paid on a regular basis throughout the year. The Committee’s charter charges the Committee with reviewing and determining each executive’s base salary on an annual basis. The named executive officers’ base salaries were reviewed in December 2012 as required by the Committee’s charter. Wilson found that base salaries were significantly under market at the executive officer level and recommended increases to raise each named executive officer’s base salary to align them more closely with the median salary of their respective counterparts at companies in the public company peer group and in comparison to commercial survey data, in order to remain competitive for executive talent. The salary of Mr. Petersen, as an Operating Group President, was increased based on commercial survey data and relative to the other executive officers and the respective size of the business he manages. Effective January 1, 2013, the salary of Mr. Murphy was increased from $350,000 to $500,000; the salary of Mr. Nardella was increased from $302,500 to $400,000; the salary of Mr. Holler was increased from $285,000 to $335,000; the salary of Mr. Petersen was increased from $270,000 to $320,000; the salary of Ms. DeRenzo was increased from $250,000 to $285,000; and the salary of Ms. Federico was increased from $250,000 to $280,000.

The named executive officers’ base salaries were reviewed in December 2013 as required by the Committee’s charter. The salaries of each of the named executive officers, other than Messrs. Murphy and Nardella, are expected to remain the same in fiscal year 2014. In connection with Mr. Murphy’s election to Executive Chair of the Board of Directors and resignation as Chief Executive Officer, effective as of January 1, 2014, Mr. Murphy’s salary will be decreased from $500,000 to $400,000. In connection with Mr. Nardella’s promotion to Chief Executive Officer and his continuing service as President, effective January 1, 2014, Mr. Nardella’s salary will be increased from $400,000 to $500,000.

Annual Incentive Compensation. In addition to base salary, each named executive officer participates in The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, an annual cash incentive plan, which constitutes the variable, performance-based component of an executive’s annual cash compensation. The objective of this element of executive compensation is to drive individual performance and the achievement of organizational goals, particularly those pertaining to the provision of quality services. The plan provides the executive officers with the opportunity to earn significant annual cash bonuses.

 

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Wilson did not recommend any changes to the incentive compensation plan because, assuming adequate salaries, the payout opportunities were deemed adequate compared with survey data and with data for similarly situated executive officers at companies in the public company peer group and, accordingly, the payout opportunities and the plan were left unchanged in fiscal 2012.

On December 20, 2012, the Company amended and restated The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, effective October 1, 2012. The amended and restated plan applies to fiscal years beginning with fiscal 2013. Two changes were made. First, the scorecard element was eliminated from the plan in order to simplify plan administration. Instead of an individual scorecard, named executive officers (except for the Chief Executive Officer) are assessed by the Chief Executive Officer or the President (based on whether the Executive Officer reports to Chief Executive Officer or President) on the individual quality of their work (which includes workforce management and employee engagement). The Chief Executive Officer’s performance is assessed by the Committee. The assessment of each executive’s quality of work may result in a downward adjustment of up to 50% of their payout if the quality of their work is less than satisfactory. Second, the payout scale for the Operating Group targets was also modified to reflect the payout of maximum incentive compensation at a lower percentage of the target. The maximum payout of 150% would be payable for achievement of 104% of the adjusted EBITDA target for the Operating Groups, as well as for 104% of the revenue target for the Operating Groups. This change was intended to motivate Operating Group leaders to focus equally on margin and revenue growth when they are undertaking new business ventures. The payout scales for the Company-wide targets were unchanged. That is, the maximum payout of 150% is payable for achievement of 107.5% of the adjusted EBITDA and revenue targets.

For fiscal 2013, the incentive compensation payout opportunity at threshold, target and maximum performance levels was as follows:

 

Officers

  Threshold payout
(% of base
salary)
    Target payout
(% of base
salary)
    Maximum payout
(% of base
salary)
 

Mr. Murphy

    50.0        100.0        150.0   

Mr. Nardella

    37.5        75.0        112.5   

Messrs. Holler, Petersen and Mses. DeRenzo and Federico

    25.0        50.0        75.0   

The annual incentive plan for fiscal 2013 was structured to provide incentive compensation based upon the Company’s and/or relevant Operating Group’s attainment of certain financial targets for fiscal 2013, which were approved by the Committee, and includes a ratings system that considers an individual participant’s quality of work or quality of services managed. The Chief Executive Officer and President are responsible for certification of the quality ratings of the executive officers and the Compensation Committee is responsible for the certification of the CEO’s quality rating.

The calculation of awards under the plan followed a two-step process in fiscal 2013.

First, a “potential payout” was calculated. As in prior years, the potential payout was based on achievement of revenue and adjusted EBITDA goals, adjusted to exclude the revenue and costs relating to companies that were acquired for more than $3 million during fiscal 2013, certain new program starts that were identified at the beginning of fiscal 2013, and operations identified as Discontinued operations in our financial statements, as well as certain additional operations that were closed or sold during fiscal 2013. In fiscal 2013, adjusted EBITDA was weighted 50 percent and revenue was weighted 50 percent for all participants in the plan. The weighting reflects an equal emphasis on promoting organic growth in addition to profitability. For Mr. Peterson, an Operating Group President, the Company’s consolidated performance on these two measures was weighted 25 percent, and the Operating Group’s revenue performance was weighted 75 percent, in order to emphasize and reward expansion and performance of the relevant business organization that he manages. Potential payouts for the rest of the named executive officers were calculated based on the Company’s consolidated Adjusted EBITDA and revenue results.

On November 7, 2012, the Committee approved the following financial targets for fiscal 2013:

 

 

     Target Revenue      Target Adjusted
EBITDA
 

Company

   $ 1,206.6 million       $ 129.2 million   

Cambridge Operating Group

   $ 376.9 million       $ 51.8 million   

Redwood Operating Group

   $ 620.9 million       $ 89.2 million   

The Committee chose these targets as profitability continues to be a major objective of the Company, while the continuing focus on revenue is meant to incentivize management to expand the Company’s overall business in order to grow its adjusted EBITDA.

 

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In the case of the named executive officers other than the Operating Group President, the potential payout ranges from 50% of target for achievement of 92.5% of the Adjusted EBITDA or revenue goals, to 150% of target for achievement of 107.5% of the Adjusted EBITDA or revenue goals. For Mr. Peterson, an Operating Group President, 75% of the potential payout that is based on Operating Group performance ranges from 50% of target for achievement of 92.5% of organizational unit revenue goals and 150% of target for achievement of 104.0% of organizational unit revenue and EBITDA goals and 25% of the potential payout that is based on the Company’s consolidated performance as calculated in a manner consistent with the other named executive officers. Payouts for performance levels between threshold and target, and between target and maximum, are calculated proportionately. This year, the Company’s performance was close to the financial goals and the Redwood Operating Group, managed by Mr. Petersen, exceeded its financial goals. Performance on the respective goals for fiscal 2013 was as follows:

 

     Actual Revenue      Actual Adjusted
EBITDA
 

Company

   $ 1,186.1 million       $ 129.6 million   

Cambridge Operating Group

   $ 354.1 million       $ 49.9 million   

Redwood Operating Group

   $ 625.9 million       $ 93.5 million   

As a result of this performance, Mr. Petersen received 121.6% of his target payout based on achievement toward the targets by the Company and in excess of the targets by Redwood. The remaining named executive officers were potentially eligible to receive 96.6% of the target payout based on Company-wide financial performance.

Second, one-half of the potential payout was subject to reduction of up to 50% based on the participant’s quality of services or work. A participant could also receive no incentive payout, notwithstanding the potential payout calculation or quality rating, if he or she engaged in exceptionally poor conduct or poor performance during the fiscal year.

In fiscal 2013, Messrs. Murphy, Nardella and Holler each received a satisfactory quality rating with a reduction in incentive compensation of 2.5% in total. The Committee, in the case of the Chief Executive Officer, and the Chief Executive Officer, in the case of Messrs. Nardella and Holler, decided to assign a 2.5% quality modifier primarily because the Company failed to achieve a satisfactory number of days sales outstanding (“DSO”) in fiscal year 2013. The quality modifier was considered in the calculation of incentive compensation because it reinforces our primary mission of providing high-quality services to individuals with disabilities and other challenges and because management strongly believes that service, quality and growth are inextricably linked, with service outcomes and the satisfaction of those we serve and our payor and referral sources driving our ability to maintain existing levels of service and expand our operation by receiving additional referrals and winning new contracts.

Based on the Revenue, Adjusted EBITDA and quality ratings, Messrs. Murphy, Nardella and Holler received 94.2% of their target payout. Mr. Petersen received 121.6% of his target payout; Ms. DeRenzo and Ms. Federico, who are not responsible for the Company’s DSO results, each received a satisfactory quality rating and each received 96.6% of her target payout.

Each participant may receive additional discretionary incentive compensation. In the case of executive officers, discretionary incentive compensation is determined by the Chief Executive Officer and approved by the Compensation Committee. In fiscal 2013, none of the named executive officers received a discretionary award.

On December 16, 2013, the Company amended and restated The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, effective October 1, 2013. The amended and restated plan applies to fiscal years beginning with fiscal 2014. The plan was amended to include a further modifier to the plan to increase or decrease (up to a maximum increase or decrease of ten percent (10%)) of the amount of incentive compensation to be paid to certain employees based on the DSO achieved by the Company as of the end of fiscal 2014 compared to the target approved by the Compensation Committee at the beginning of each fiscal year. Each of the named executive officers (other than Mses. DeRenzo and Federico) are subject to the DSO modifier in the calculation of the amount of incentive compensation due to such executive officer in fiscal year 2014.

Equity-Based Compensation. Long-term incentive compensation is provided in the form of non-voting equity units in the Company’s indirect parent company, NMH Investment, pursuant to the NMH Investment 2006 Unit Plan. The plan allows certain officers, employees, directors and consultants of the Company to participate in the long-term growth and financial success of the Company through acquisition of equity interests in NMH Investment, including Class B, Class C, Class D, Class E, Class F, Class G and Class H Common Units of NMH Investment. The purpose of the plan is to promote the Company’s long-term growth and profitability by aligning the interests of the Company’s management with the interests of the ultimate parent of the Company and by encouraging retention. The plan is administered by the Committee which recommends awards to the management committee of NMH Investment. The management committee determines, among other things, specific participants in the plan as well as the amount and value of any units awarded.

 

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As part of the Merger, a pool of units had been set aside for management employees, including the named executive officers, and granted to executive officers during the second quarter of fiscal 2007. Messrs. Holler and Nardella received additional grants of B, C and D Common Units during fiscal 2007 in recognition of their promotions, and all of the named executive officers received subsequent grants of B, C and D Common Units during the fourth quarter of fiscal 2008. All of the B, C and D Units that had been unvested became vested during fiscal 2011 concurrently with the creation of a new pool of Class F Common Units. In June 2011, the F Units were issued to management employees, including the named executive officers. As of December 15, 2012, all of the F Units issued to the named executive officers were vested. The earned equity program was designed to motivate management to achieve financial results that would enhance the valuation of the Company upon a sale of the Company or other liquidity event. Pursuant to the terms of NMH Investment’s limited liability company agreement, holders of the Class B, C, D and F Units would receive distributions representing 10% of the total increase in common equity value upon a sale or other liquidity event involving NMH Investment.

Consistent with Wilson’s recommendation in fiscal 2012 and following numerous conversations between the Chief Executive Officer and members of the Board of Directors in which equity compensation was considered and discussed, NMH Investment decided to grant earned equity to the executive officers and certain other senior leaders of the Company. On August 13, 2012, a new pool of Class G Common Units and Class H Common Units was created and on September 20, 2012, 1,000,000 Class H Common Units were issued to the named executive officers and other executive officers and 130,000 Class G Common Units were issued to non-executive employees and one executive officer. The Compensation Committee designed the Class H Common Units to have the potential to more tightly align management and equity sponsor interests in creating shareholder value. The Class H Common Units vest upon a sale of the Company and may receive up to 5.0% (or as little as 0.0%) of the increase in common equity value upon the sale of the Company, depending upon the multiple of investment received by Vestar and its affiliates. However, upon an initial public offering of the Company, the management committee of NMH Investment may convert the Class H Common Units into options of equivalent value if and to the extent Vestar and its affiliates achieve a certain multiple of investment. The Class G Common Units will share any common equity appreciation pro rata with the Class A Common Units, within a range from 84.9235% (assuming the Class H Common Units receive the full 5.0%) to 89.9190% (assuming the Class H Common Units do not vest) of the increase in common equity value upon a sale or other liquidity event. The B, C, D and F Units will continue to receive 10% of the equity appreciation upon a sale or other liquidity event involving NMH Investment.

In connection with his promotion to Chief Executive Officer of the Company, NMH Investment has authorized the issuance of 100,000 Class F Units and 100,000 Class H Units to Mr. Nardella.

If an executive’s employment is terminated, NMH Investment may repurchase the executive’s B, C, D and F Units, and all unvested Class H Units will be forfeited (or Class G Units, as applicable). Class B, C, D and F Units that are already vested would be purchased for fair market value, except in the case of a termination for cause. In the case of a termination for cause, the Units would be purchased at cost (or forfeited with no payment, in the case of the F Units and H Units, or Class G Units, as applicable). If an executive officer’s employment is terminated due to death, disability or retirement prior to the earlier of (i) an initial public offering by or involving NMH Investment or any of its subsidiaries or (ii) a sale of the Company, the named executive officer and each of his or her permitted transferees (collectively, the “NEO group”) has the right, subject to certain limitations, for 45 days following the six month anniversary of his or her termination, to sell to NMH Investment, on one occasion, a number of Class F Common Units equal to a specified percentage (the “specified percentage”) of the total number of Class F Common Units held by the NEO group, at a purchase price equal to fair market value (the “put right”). In order to exercise this put right, the NEO group will also be required to simultaneously sell to NMH Investment a number of Class B, C and D Common Units equal to the specified percentage of the total number of such Class B, C and D Common Units held by the NEO group. The specified percentages for each of the named executive officers are as follows: Mr. Murphy, 38.15%; Mr. Nardella, 52.23%; Mr. Holler, 65.29%; Mr. Petersen, 59.37%; Ms. DeRenzo, 75.26%, and Ms. Federico, 34.61%.

Deferred Compensation. Under the National Mentor Holdings, LLC Executive Deferred Compensation Plan, the named executive officers receive an allocation to their account based on a percentage of base salary, as follows: Mr. Murphy, 13%; Mr. Nardella, 12%; Mr. Holler, 11%; and Mr. Petersen, Ms. DeRenzo and Ms. Federico, 9%. These allocations are made as of the end of the plan year, December 31, for service rendered during the prior fiscal year. The balances earn a return, which for plan years 2013, 2012 and 2011, was a fixed rate of 6%. The plan is an unfunded, nonqualified deferred compensation arrangement, which provides deferred compensation to the executive officers. We may make additional discretionary allocations to the plan, although we did not do so in fiscal 2013. A participant’s account balance is 100% vested and non-forfeitable and will be distributed to a participant following his or her retirement or termination from the Company, disability or death, or at the Company’s direction under certain circumstances. In connection with Mr. Nardella’s promotion, the percentage of base salary allocated to Mr. Nardella as of January 1, 2014 will be increased to 13%.

 

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A 401(k) plan is available to eligible employees, including the named executive officers. Under the plan, we may make an annual discretionary matching contribution and/or profit-sharing contribution. To supplement the 401(k) plan, the National Mentor Holdings, LLC Executive Deferral Plan is available to highly compensated employees (as defined by Section 414(q) of the Internal Revenue Code), including the named executive officers. Participants may contribute up to 100% of salary and/or incentive compensation bonus earned during the plan year. This plan is a nonqualified deferred compensation arrangement and is coordinated with our 401(k) plan so as to maximize a participant’s contributions and the Company’s matching contributions to the 401(k) plan, with the residual remaining in the Executive Deferral Plan. Amounts contributed to the 401(k) and/or Executive Deferral Plan are matched by the Company up to 1.5% of base salary. Distributions are made upon a participant’s termination of employment, disability, death, retirement or at a time specified by the participant when he or she makes a deferral election. Participants can elect to have distributions made in a lump sum or in monthly installments over a five-year period. A specific-date election may be made only in a lump sum. We have established a grantor trust to accumulate assets to provide for the obligations under the plan. Any assets of the grantor trust are subject to the claims of our general creditors.

Severance and Change-in-Control Benefits. As part of the Merger, the Company entered into an amended and restated employment agreement with Mr. Murphy, which was further amended on December 16. 2013, effective as of January 1, 2014, and entered into severance agreements with each of the other named executive officers who were employed by the Company at that time. Ms. Federico entered into a severance agreement when she joined the Company in December 2008. Each of these agreements provides for severance benefits to be paid to the named executive officer if the Company terminates his or her employment without “cause” or he or she resigns for “good reason”, each as defined in the applicable agreement. See “— Severance Agreements”. Mr. Nardella’s severance agreement will be superseded effective as of January 1, 2014, by his employment agreement with the Company.

If any of the named executive officers terminates employment, for any reason other than by the Company for cause, he or she would be entitled to receive fair market value for his or her vested B, C, D and F units. Under each executive officer’s management unit subscription agreement, NMH Investment has the right to repurchase the units upon termination of employment. Fair market value is as determined in good faith by the management committee of NMH Investment (valuing the Company and its subsidiaries as a going concern, disregarding any discount for minority interest or marketability of the units).

In addition, upon a change in control of the Company, the Class H Common Units will vest immediately. The Company believes that this accelerated vesting could align the interests of the named executive officers with the interests of the indirect parent of the Company in the event of a sale of the Company by encouraging the named executive officers to remain with the Company and enhancing their focus on the Company during a sale of the Company.

Other Benefits. The named executive officers are entitled to participate in group health and welfare benefits on the same basis as all regular, full-time employees. These benefits include medical, dental, vision care, flexible spending accounts, term life insurance, short-term and long-term disability insurance and other benefits. In addition, all employees, including the executive officers, have the option of purchasing supplemental group term life insurance for themselves as well as coverage for their spouses and dependent children. Executive officers may also elect to receive Company-paid parking and supplemental disability insurance and long-term care insurance, with the premiums, plus gross-up for tax liability, paid for by the Company.

Compensation Risk. The Compensation Committee has considered the compensation policies and practices throughout the Company to assess the risks presented by such policies and practices. Based on this review, we have determined that such policies and practices are not reasonably likely to have a material adverse effect on the Company. In reaching this determination, we have taken into account the following design elements of our compensation programs and policies and practices: mixture of cash and equity opportunities, use of performance-based pay vehicles, use of financial metrics that are easily capable of review and avoidance of uncapped rewards.

 

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Compensation Committee Report

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management. Based on that review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.

 

Respectfully submitted,

Chris A. Durbin (Chairman)

James L. Elrod Jr.

Guy Sansone

Fiscal 2013 Summary Compensation Table

 

Name and Principal Position

   Fiscal
Year
     Salary
($)(a)
     Bonus
($)(b)
     Equity
Awards
($)(c)
     Non-Equity
Incentive
Plan
Compensation
($)(d)
     Nonqualified
Deferred
Compensation
Earnings
($)(e)
     All Other
Compensation
($)(f)
     Total
($)
 

Edward M. Murphy

     2013         461,923         —          —          470,858         12,577         82,269         1,027,627   

Chief Executive Officer

     2012         350,000         —          —          335,760         11,217         68,092         765,068   
     2011         350,000         175,000         715,270         302,406         4,585         112,526         1,659,787   

Bruce F. Nardella

     2013         375,250         —          —          282,515         61,289         57,354         776,408   

President and Chief

     2012         302,500         —          —          217,644         47,829         48,097         616,070   

Operating Officer

     2011         302,500         150,000         464,730         196,025         3,204         77,535         1,193,994   

Denis M. Holler

     2013         322,308         —          —          157,737         65,449         47,613         593,107   

Chief Financial Officer

     2012         285,000         —          —          136,702         73,353         43,318         538,373   

and Treasurer

     2011         280,962         135,000         362,730         123,123         3,110         72,653         977,578   

David M. Petersen

     2013         305,417         —          —          194,635         15,720         40,667         556,439   

President, Redwood

     2012         270,000         —          —          149,041         17,192         36,600         472,833   

Operating Group

     2011         265,833         112,000         321,076         116,643         3,096         59,157         877,805   

Linda DeRenzo

     2013         276,115         —          —          137,635         5,225         35,794         454,770   

Chief

     2012         250,000         —          —          129,914         4,042         33,351         417,307   

Legal Officer

     2011         243,942         108,500         244,809         108,003         1,880         73,517         780,651   

Kathleen P. Federico

     2013         267,308         —          —          135,221         36,151         34,979         473,659   

Chief Human Resources

Officer

                       

 

(a) Includes individual’s pre-tax contributions to health plans and contributions to retirement plans.
(b) During fiscal 2011, all the named executive officers received discretionary recognition bonuses, and Ms. DeRenzo received an additional $8,500 bonus as part of a retroactive salary adjustment.
(c) Figures represent respective grant date fair value of the Class H Common Units and Class F Common Units awarded during fiscal 2012 and fiscal 2011, respectively, under the NMH Investment, LLC Amended and Restated 2006 Unit Plan (as amended) in accordance with Accounting Standards Codification Topic 718 (ASC 718, formerly FAS 123R). Please refer to Note 19 in the Notes to Consolidated Financial Statements for the relevant assumptions used to determine the compensation expense of our equity awards. The figures in this column also represent the value of the Class H Common Unit awards at the grant date assuming that the highest level of performance conditions will be achieved, in accordance with an analysis performed as of September 30, 2012.
(d) Represents cash bonuses under The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan.
(e) Represents earnings in excess of the applicable federal long-term rate under the Executive Deferred Compensation Plan and the Executive Deferral Plan.

 

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(f) Includes Company contributions to the Executive Deferred Compensation Plan and the Company match on executive contributions to the 401(k) plan and Executive Deferral Plan, which has been estimated for fiscal 2013 in advance of the actual determination. The fiscal 2012 and 2011 amounts in this column were estimated at the time and have not been restated, as any differences were immaterial. Also included are Company paid parking, tax gross-ups for Company paid parking, imputed income on group term life insurance premiums and Company contributions for supplemental disability insurance and long-term care insurance premiums available to the executive officers. For fiscal 2013, the components of All Other Compensation were as follows:

 

     Company
Contributions
to Executive
Deferred
Compensation
Plan ($)
     Company
Match on
Contributions
to 401(k) and
Executive
Deferral Plan
($)
     Company
Paid Parking
($)
     Gross-ups
($)
     Group
Term Life
Insurance
($)
     Supplemental
Disability
Insurance ($)
     Long-Term
Care
Insurance
($)
 

Edward M. Murphy

     60,125         3,806         1,320         614         3,038         5,563         7,803   

Bruce F. Nardella

     45,075         3,806         1,320         614         1,642         2,313         2,583   

Denis M. Holler

     35,475         3,806         1,320         614         1,386         2,565         2,446   

David M. Petersen

     27,675         3,806         —          —          2,360         3,652         3,174   

Linda DeRenzo

     24,863         3,806         1,320         614         617         2,162         2,412   

Kathleen P. Federico

     24,075         3,806         1,320         614         590         2,162         2,412   

Grants of Plan-Based Awards in Fiscal 2013

Estimated Possible Payouts Under Non-Equity Incentive Plan

 

Name

   Threshold(a) ($)      Target(a) ($)      Maximum(a) ($)  

Edward M. Murphy

     250,000         500,000         750,000   

Bruce F. Nardella

     150,000         300,000         450,000   

Denis M. Holler

     83,750         167,500         251,250   

David M. Petersen

     80,000         160,000         240,000   

Linda DeRenzo

     71,250         142,500         213,750   

Kathleen P. Federico

     70,000         140,000         210,000   

 

(a) Amounts represent potential payouts relating to fiscal 2013 under The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, based on percentages of base salary as in effect at September 30, 2013. For a description of the plan, see “Compensation Discussion and Analysis — Annual Incentive Compensation”.

 

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Outstanding Equity Awards at Fiscal 2013 Year-End

Shares and stock options are not included in this table because none were issued during the fiscal year and none were outstanding at fiscal year-end.

 

    

Equity Incentive Plan Awards

 

Name

  

Number and Class

of Earned Units

Not Vested (#)

   Payout Value
of Earned Units
Not Vested ($)(g)
    

Number and Class

of Unearned Units

Not Vested (#)

   Payout Value
of Unearned
Units Not
Vested ($)(g)
 

Edward M. Murphy

   664.13 B Common Units(a)      345.35         
   696.90 C Common Units(a)      348.45         
   26,095.96 D Common Units(a)      12,526.06         
   6,737.50 B Common Units(b)      3,503.50         
   7,070.00 C Common Units(b)      3,535.00         
   7,490.00 D Common Units(b)      3,595.20         
   701,245.51 F Common Units(c)      329,585.39        
         200,000 H Common Units(d)      —    

Bruce F. Nardella

   664.13 B Common Units(a)      345.35         
   696.90 C Common Units(a)      348.45         
   21,723.95 D Common Units(a)      10,427.50         
   962.50 B Common Units(e)      500.50         
   1,010.00 C Common Units(e)      505.00         
   1,070.00 D Common Units(e)      513.60         
   5,775.00 B Common Units(b)      3,003.00         
   6,060.00 C Common Units(b)      3,030.00         
   6,420.00 D Common Units(b)      3,081.60         
   455,617.52 F Common Units(c)      214,140.23        
         150,000 H Common Units(d)      —    

Denis M. Holler

   664.13 B Common Units(a)      345.35         
   696.90 C Common Units(a)      348.45         
   21,723.95 D Common Units(a)      10,427.50         
   481.25 B Common Units(e)      250.25         
   505.00 C Common Units(e)      252.50         
   535.00 D Common Units(e)      256.80         
   6,256.25 B Common Units(b)      3,253.25         
   6,565.00 C Common Units(b)      3,282.50         
   6,955.00 D Common Units(b)      3,338.40         
   355,617.52 F Common Units(c)      167,140.23         
         150,000 H Common Units(d)      —    

David M. Petersen

   664.13 B Common Units(a)      345.35         
   696.90 C Common Units(a)      348.45         
   15,603.14 D Common Units(a)      7,489.51         
   5,775.00 B Common Units(b)      3,003.00         
   6,060.00 C Common Units(b)      3,030.00         
   6,420.00 D Common Units(b)      3,081.60         
   314,780.83 F Common Units(c)      147,946.99        
         100,000 H Common Units(d)      —    

Linda DeRenzo

   664.13 B Common Units(a)      345.35         
   696.90 C Common Units(a)      348.45         
   13,854.33 D Common Units(a)      6,650.08         
   6,256.25 B Common Units(b)      3,253.25         
   6,565.00 C Common Units(b)      3,282.50         
   6,955.00 D Common Units(b)      3,338.40         
   240,008.39 F Common Units(c)      112,803.94        
         100,000 H Common Units(d)      —    

Kathleen P. Federico

   4,990.33 B Common Units(f)      2,594.97         
   5,236.60 C Common Units(f)      2,618.30         
   5,547.68 D Common Units(f)      2,662.89         
   259,225.39 F Common Units(c)      121,835.93         
         100,000 H Common Units(d)      —    

 

(a) Granted on August 22, 2008 in connection with compensatory grants under the NMH Investment, LLC 2006 Unit Plan, as amended. The units fully vested on May 10, 2011. Because payment of the value of the B, C and D Common Units is deferred until termination of a recipient’s employment with the Company or the occurrence of a liquidity event, we have included all such awards under the column for equity incentive plan awards that have been earned but have not vested. Vesting is explained in more detail above, under “Compensation Discussion and Analysis — Equity-Based Compensation”.

 

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(b) Granted on January 12, 2007 in connection with the initial compensatory grants under the NMH Investment, LLC 2006 Unit Plan. The units fully vested on May 10, 2011. Because payment of the value of the B, C and D Common Units is deferred until termination of a recipient’s employment with the Company or the occurrence of a liquidity event, we have included all such awards under the column for equity incentive plan awards that have been earned but have not vested. Vesting is explained in more detail above, under “Compensation Discussion and Analysis — Equity-Based Compensation”.
(c) Granted on June 15, 2011, in connection with compensatory grants under the NMH Investment, LLC 2006 Unit Plan, as amended. The units were 75% vested upon grant date, and the remaining 25% vested on December 15, 2012. Because payment of the value of the F Common Units is deferred until termination of a recipient’s employment with the Company or the occurrence of a liquidity event, we have included all such awards under the column for equity incentive plan awards that have been earned but have not vested. Vesting is explained in more detail above, under “Compensation Discussion and Analysis — Equity-Based Compensation”. The F Common Units are subject to a put right of the named executive officers, as described under “Compensation Discussion and Analysis — Equity-Based Compensation”.
(d) Granted on September 20, 2012 in connection with compensatory grants under the NMH Investment, LLC 2006 Unit Plan, as amended. The units will vest if and to the extent that the multiple of investment received by Vestar and its affiliates meets or exceeds 1.5. Because payment of the value of the H Common Units is deferred until the occurrence of a specified liquidity threshold, we have included all such awards under the column for equity incentive plan awards that have not been earned and have not vested. Vesting is explained in more detail above, under “Compensation Discussion and Analysis — Equity-Based Compensation”.
(e) Granted on August 14, 2007 under the NMH Investment, LLC 2006 Unit Plan, as amended, in recognition of the named executive officer’s promotion. The units fully vested on May 10, 2011, to the extent not already vested. Because payment of the value of the B, C and D Common Units is deferred until termination of a recipient’s employment with the Company or the occurrence of a liquidity event, we have included all such awards under the column for equity incentive plan awards that have been earned but have not vested. Vesting is explained in more detail above, under “Compensation Discussion and Analysis — Equity-Based Compensation”.
(f) Granted on April 7, 2009 in connection with compensatory grants under the NMH Investment, LLC 2006 Unit Plan, as amended. The units fully vested on May 10, 2011, to the extent not already vested. Because payment of the value of the B, C and D Common Units is deferred until termination of a recipient’s employment with the Company or the occurrence of a liquidity event, we have included all such awards under the column for equity incentive plan awards that have been earned but have not vested. Vesting is explained in more detail above, under “Compensation Discussion and Analysis — Equity-Based Compensation”.
(g) Payout value represents fair market value determined as of fiscal year-end, which has been determined to be $0.52 per Common B Unit, $0.50 per Common C Unit, $0.48 per Common D Unit, $0.47 per Common F Unit and $0.0 per Common H Unit. For purposes of calculating fair market value, we assumed hypothetical transaction costs in a change in control of the Company.

 

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Option Exercises and Stock Vested

No options were issued, outstanding or exercised during fiscal 2013. For purposes of this disclosure item, certain of the units vested during fiscal 2013 such that if the named executive officer terminated his or her employment voluntarily during fiscal 2013 and NMH Investment had elected to repurchase his or her units, it would have been required to repurchase them at fair market value. The units that vested in fiscal 2013 are set forth in the table below.

 

Name    Number of F Common
Units Acquired on
Vesting
 

Edward M. Murphy

     175,311.38   

Bruce F. Nardella

     113,904.38   

Denis M. Holler

     88,904.38   

David M. Petersen

     78,695.21   

Linda DeRenzo

     60,002.10   

Kathleen P. Federico

     6,486.35   

Pension Benefits

The Company has no pension plans.

Fiscal 2013 Nonqualified Deferred Compensation

 

Name

   Executive
Contributions
in Last
Fiscal Year
($)(a)(b)
     Company
Contributions
in Last
Fiscal Year
($)(b)(c)
     Aggregate
Earnings
in Last
Fiscal
Year
($)(b)(d)
     Aggregate
Withdrawals/
Distributions
($)(e)
     Aggregate
Balance
at
Last
Fiscal
Year End
($)(f)
 

Edward M. Murphy

     13,771         63,931         27,268         —          535,367   

Bruce F. Nardella

     51,750         48,881         81,011         2,750         701,681   

Denis M. Holler

     8,400         39,281         94,732         31         930,256   

David M. Petersen

     37,260         31,481         28,552         8,800         451,747   

Linda DeRenzo

     5,509         28,669         11,231         4,720         223,320   

Kathleen P. Federico

     27,580         27,881         45,409         1,900         326,083   

 

(a) Represents amounts contributed to the Executive Deferral Plan during fiscal 2013. The Executive Deferral Plan is available to highly compensated employees to supplement the 401(k) plan. For details about the plan, see “Compensation Discussion and Analysis — Deferred Compensation”, above.

 

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(b) All of the amounts reported under “Executive Contributions in Last Fiscal Year” and “Company Contributions in Last Fiscal Year” are reported as compensation for fiscal 2013 in the Summary Compensation Table. Under “Aggregate Earnings in Last Fiscal Year”, the following amounts are reported as compensation in the Summary Compensation Table that were in excess of the applicable federal long-term rate are as follows:

 

Edward M. Murphy

   $ 12,577   

Bruce F. Nardella

     61,289   

Denis M. Holler

     65,449   

David M. Petersen

     15,720   

Linda DeRenzo

     5,225   

Kathleen P. Federico

     36,151   

 

(c) Represents Company match (up to 1.5% of base salary) on executive contributions to the Executive Deferral Plan, plus Company contributions to the Executive Deferred Compensation Plan. The Executive Deferred Compensation Plan is an unfunded, nonqualified deferred compensation arrangement to provide deferred compensation to executive officers. For details about both these plans, see “Compensation Discussion and Analysis — Deferred Compensation” above.
(d) Represents the 6% return credited to the participant’s account in the Executive Deferred Compensation Plan for balances in fiscal 2013, plus the executives’ respective returns for amounts invested in the Executive Deferral Plan.
(e) Represents amounts withdrawn from the Executive Deferral Plan and deposited into the executive’s respective 401(k) account in accordance with IRS rules.
(f) Represents aggregate balances in Executive Deferral Plan and Executive Deferred Compensation Plan for each executive as of fiscal year-end. Of the amounts in this column, the following amounts have been reported as compensation in the Summary Compensation Table for fiscal 2013, fiscal 2012 and fiscal 2011.

 

     Fiscal
2013
     Fiscal
2012
     Fiscal
2011
 

Edward M. Murphy

   $ 63,931       $ 49,231       $ 94,675   

Bruce F. Nardella

     48,881         40,031         69,831   

Denis M. Holler

     39,281         35,081         64,358   

David M. Petersen

     31,481         28,031         50,625   

Linda DeRenzo

     28,669         26,231         66,725   

Kathleen P. Federico

     27,881         N/A         N/A   

Severance Agreements

Mr. Murphy entered into an amended and restated employment agreement at the time of the Merger, which was amended in 2009 (for compliance with Section 409A under the Internal Revenue Code) and further amended and restated on December 16, 2013, effective as of January 1, 2014, to reflect his resignation as Chief Executive Officer and his election to Executive Chair of the board of directors of the Company (the “Amended and Restated Employment Agreement”). The initial term of the further Amended and Restated Employment Agreement is one year, after which the agreement renews automatically each year for a one-year term, unless terminated earlier by the parties. The Amended and Restated Employment Agreement provides for a base salary of $400,000 per year, subject to review and adjustment from time to time, with an annual bonus from the incentive compensation plan equal to no less than Mr. Murphy’s base salary if the Company reaches certain yearly determined performance objectives. Under the terms of the agreement, if Mr. Murphy is terminated by the Company without “cause” or Mr. Murphy resigns with “good reason”, the Company is obligated to continue to pay him his base salary and targeted incentive compensation for two years following the date of such termination, as well as a pro rata incentive compensation amount for the year in which such termination occurs. The definition of “cause” includes the commission of fraud or embezzlement, an indictment or conviction for a felony or a crime involving moral turpitude, willful misconduct, violation of any material written policy of the Company, material neglect of duties, failure to comply with reasonable Board directives and material breach of any agreement with the Company or its securityholders or affiliates. The definition of “good reason” includes a material change in title, duties and responsibilities, a reduction in Mr. Murphy’s annual base salary or annual bonus opportunity (subject to certain exclusions), a material breach by the Company of the amended and restated employment agreement, and relocation of Mr. Murphy’s principal place of work from its current location to a location that is beyond a 50-mile radius of such location.

The Amended and Restated Employment Agreement contains provisions pursuant to which Mr. Murphy has agreed not to disclose our confidential information. Mr. Murphy has also agreed not to solicit our employees or contractors, nor compete with us for a period of two years after his employment with us has been terminated.

 

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Messrs. Holler, Nardella and Petersen and Ms. DeRenzo entered severance agreements with us at the time of the Merger, and Ms. Federico entered into the same form of severance agreement upon her hire in December 2008. These agreements were amended and restated during the first quarter of fiscal 2009 for compliance with Section 409A under the Internal Revenue Code. Pursuant to these agreements, in the event that the employment of any such employees is terminated by the Company without “cause” or the named executive officer resigns with “good reason”, they will be entitled to (i) the payment of an aggregate amount equal to their base salary for one year, (ii) the payment of an amount equal to their annual cash bonuses earned in the year prior to their termination and (iii) continued coverage under our health, medical and welfare benefit plans for a period of one year from the date of termination. “Cause” and “good reason” are defined as such terms are defined in Mr. Murphy’s Amended and Restated Employment Agreement. The severance agreements also contain provisions pursuant to which the executive officer agrees not to disclose our confidential information, solicit our employees or contractors or compete with us for a period of one year after his or her employment with us has been terminated.

On December 16, 2013, the Company entered into an employment agreement with Bruce Nardella, effective as of January 1, 2014, in connection with his promotion to Chief Executive Officer of the Company. The employment agreement has an initial term of three years, after which the agreement renews automatically each year for a one-year term, unless terminated earlier by the parties. The employment agreement provides for a base salary of $500,000 per year, subject to review and adjustment from time to time, with an annual bonus from the incentive compensation plan equal to no less than Mr. Nardella’s base salary if the Company reaches certain yearly determined performance objectives. Under the terms of the agreement, if Mr. Nardella is terminated by the Company without “cause” or Mr. Nardella resigns with “good reason”, the Company is obligated to continue to pay him his base salary and targeted incentive compensation for two years following the date of such termination, as well as a pro rata incentive compensation amount for the year in which such termination occurs. The definition of “cause” includes the commission of fraud or embezzlement, an indictment or conviction for a felony or a crime involving moral turpitude, willful misconduct, violation of any material written policy of the Company, material neglect of duties, failure to comply with reasonable Board directives and material breach of any agreement with the Company or its securityholders or affiliates. The definition of “good reason” includes a material change in title, duties and responsibilities, a material reduction in Mr. Nardella’s annual base salary or annual bonus opportunity (subject to certain exclusions), a material breach by the Company of the amended and restated employment agreement, and relocation of Mr. Nardella’s principal place of work from its current location to a location that is beyond a 50-mile radius of such location.

Mr. Nardella’s severance agreement will be superseded effective as of January 1, 2014 by his employment agreement.

Estimated Severance and Change-in-Control Payments

Mr. Murphy’s amended and restated employment agreement and the severance agreements of the other named executive officers provide for severance benefits in the event of termination under certain circumstances. The following table shows the amount of potential severance benefits for the named executive officers pursuant to their employment or severance arrangements, assuming the named executive officer was terminated under circumstances qualifying for the benefits and that termination occurred as of September 30, 2013, our fiscal year-end. The table also shows the estimated present value of continuing coverage for the benefits and the amount that would be paid for the repurchase of the B, C, D and F Common Units in NMH Investment, assuming a termination without cause.

 

Name

   Salary
($)(a)
     Bonus
($)(b)
     Repurchase of
Restricted
B, C, D and F
Common
Units ($)(c)
     Value of
Continued
Benefits
($)(d)
     Total
($)
 

Edward M. Murphy

     1,000,000         1,000,000         353,439        65,460         2,418,899   

Bruce F. Nardella

     400,000         282,515         235,895        21,566         939,976   

Denis M. Holler

     335,000         157,737         188,895        26,768         708,400   

David M. Petersen

     320,000         194,635         165,245        23,512         703,392   

Linda DeRenzo

     285,000         137,635         130,022        5,389         558,046   

Kathleen P. Federico

     280,000         135,221         129,712        5,155         550,088   

 

(a) Under Mr. Murphy’s employment agreement, salary would continue for two years. For each of the other named executive officers, salary would have continued for one year upon a termination as of September 30, 2013. These amounts would be payable over time in accordance with the Company’s regular payroll practices. Effective as of January 1, 2014, under Mr. Nardella’s employment agreement, Mr. Nardella’s salary would continue for two years.
(b) Mr. Murphy would receive an amount equal to his target annual bonus of 100 percent of base salary under the incentive compensation plan for two years after termination. Each of the other named executive officers would have received an amount equal to the actual annual bonus for the prior fiscal year upon a termination as of September 30, 2013. Effective as of January 1, 2014, under Mr. Murphy’s further amended and restated employment agreement, Mr. Murphy would receive base salary plus an amount equal to his target bonus of 100% of his salary under the incentive compensation plan for two years after termination. Effective January 1, 2014, under Mr. Nardella’s employment agreement, Mr. Nardella would receive base salary plus an amount equal to his target bonus of 100% of his salary under the incentive compensation plan for two years after termination. These amounts would be payable over time in accordance with the Company’s regular payroll practices.

 

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(c) Represents the amount the executive officer would receive for the B, C, D and F Common Units, including the original purchase price. The units may be repurchased upon the executive officer’s termination. Assuming a termination without cause on September 30, 2013, the named executive officers would receive fair market value determined as of year-end to be $0.52 per Common B Unit, $0.50 per Common C Unit, $0.48 per Common D Unit, $0.47 per Common F Unit. For all of the B Common Units, C Common Units, D Common Units and F Common Units, as set forth below:

 

     Number of B
Common
Units
Purchased at
Fair Market
Value
     Number of C
Common
Units
Purchased at
Fair Market
Value
     Number of D
Common
Units
Purchased at
Fair Market
Value
     Number of F
Common
Units
Purchased at
Fair Market
Value
 

Edward M. Murphy

     7,402         7,767         33,586         701,246   

Bruce F. Nardella

     7,402         7,767         29,214         455,618   

Denis M. Holler

     7,402         7,767         29,214         355,618   

David M. Petersen

     6,439         6,757         22,023         314,781   

Linda DeRenzo

     6,920         7,262         20,809         240,008   

Kathleen P. Federico

     4,990         5,237         5,548         259,225   

For purposes of calculating fair market value, we assumed hypothetical transaction costs assuming a change in control of the Company. The purchase price may be paid in the form of a promissory note at the discretion of NMH Investment.

 

(d) Mr. Murphy would continue to participate in health and welfare benefit plans at the Company’s expense for two years. All other named executive officers would participate in the health and welfare benefit plans for one year. Amounts are estimated based on the respective named executive officer’s current benefit elections. Effective as of January 1, 2014, Messrs. Murphy and Nardella will be permitted to participate in the health and welfare benefit plans at their own expense.

Neither Mr. Murphy’s employment agreement nor the named executive officer’s severance agreements contain provisions for payments upon a change of control of the Company. However, assuming a change of control occurred at September 30, 2013, the Company’s fiscal year-end, under the governing documents, all of the H Common Units would vest. The payout based on estimated fair market value of each named executive officer’s B, C, D, F and H Common Units, as of September 30, 2013, would be as set forth in the following table.

 

Name

   B Common
Units ($)
     C Common
Units ($)
     D Common
Units ($)
     F Common
Units ($)
     H Common
Units ($)
     Total ($)  

Edward M. Murphy

     3,849         3,883         16,121         329,586        —          353,439   

Bruce F. Nardella

     3,849         3,883         14,023         214,140        —          235,895   

Denis M. Holler

     3,849         3,883         14,023         167,140        —          188,895   

David M. Petersen

     3,348         3,379         10,571         147,947        —          165,245   

Linda DeRenzo

     3,599         3,631         9,988         112,804        —          130,022   

Kathleen P. Federico

     2,595         2,618        2,663        121,836        —          129,712   

For purposes of calculating fair market value, we assumed hypothetical transaction costs assuming a change in control of the Company. As of fiscal year-end the fair market value has been determined to be $0.52 per Common B Unit, $0.50 per Common C Unit, $0.48 per Common D Unit, $0.47 per Common F Unit and $0.00 per H Common Unit. The purchase price may be paid in the form of a promissory note at the discretion of NMH Investment.

 

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Director Compensation

We reimburse directors for any out-of-pocket expenses incurred by them in connection with services provided in such capacity. We compensate our outside directors as set out in the table below. Mr. Murphy receives no additional compensation for his service as a director, apart from his compensation as Chief Executive Officer. Messrs. Durbin, Elrod and Mundt are employees of Vestar and do not receive any additional compensation for their service as directors of the Company.

 

Name

   Fees Earned or
Paid in Cash
($)
    Equity
Awards
($)(e)
     Nonqualified
Deferred
Compensation
Earnings ($)
    All Other
Compensation ($)
    Total ($)  

Gregory T. Torres

     100,000 (a)      —          7,330 (b)      396 (c)      107,726   

Pamela F. Lenehan

     30,000 (d)      —          —         —         30,000   

Guy Sansone

     25,000 (d)      —          —         —         25,000   

 

(a) Mr. Torres is paid a salary of $100,000 per year in accordance with his amended and restated employment agreement. Pursuant to the terms of the Termination Agreement dated December 16, 2013, by and between Gregory T. Torres and the Company, the Company has agreed to make a donation in the amount of $100,000 to Mass INC. Effective as of January 1, 2014, Mr. Torres will receive a fee of $5,000 for each meeting of the Board of Directors attended in person and a fee of $1,000 for each meeting attended by phone.
(b) Represents earnings in excess of the applicable federal long-term rate. Mr. Torres continues to accrue interest on amounts credited to him in the Executive Deferred Compensation Plan during his service as the Company’s President and Chief Executive Officer.
(c) Represents imputed income for payment of premiums for group term life insurance.
(d) Ms. Lenehan and Mr. Sansone received a fee of $5,000 for each meeting of the Board of Directors attended in person and a fee of $1,000 for each meeting attended by phone and each committee meeting attended.
(e) At September 30, 2013, the last day of our fiscal year, Ms. Lenehan held 3,188.00 E Common Units and Mr. Sansone held 3,187.00 E Common Units.

Compensation Committee Interlocks and Insider Participation

Messrs. Durbin, Elrod and Sansone are the members of the Company’s Compensation Committee, and none of them is or has been an officer or employee of the Company. Messrs. Durbin and Elrod are managing directors of Vestar, which controls the Company. For a description of the transactions between the Company and Vestar, see Item 13, “Certain Relationships and Related Transactions, and Director Independence”. Apart from these relationships, no member of the Compensation Committee has any relationship that would be required to be reported under Item 404 of Regulation S-K. No member of the Compensation Committee serves or served during the fiscal year as a member of the board of directors or compensation committee of a company that has one or more executive officers serving as a member of the Company’s Board of Directors or Compensation Committee.

 

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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

NMH Investment is our ultimate parent and indirectly owns 100% of our equity securities. The following table sets forth information with respect to the beneficial ownership of voting equity interests of NMH Investment by (i) each person or entity known to us to beneficially hold five percent or more of equity interests of NMH Investment, (ii) each of our directors, (iii) each of our named executive officers and (iv) all of our executive officers and directors as a group.

Under SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares voting power or investment power, which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Securities that can be so acquired are deemed to be outstanding for purposes of computing such person’s ownership percentage, but not for purposes of computing any other person’s percentage. Under these rules, more than one person may be deemed to be a beneficial owner of the same securities and a person may be deemed to be a beneficial owner of securities as to which such person has no economic interest.

Except as otherwise indicated in the footnotes below, each of the beneficial owners has, to the Company’s knowledge, sole voting and investment power with respect to the indicated Class A Common Units which is the only class of voting equity interests in NMH Investment.

Beneficial ownership has been determined as of December 1, 2013 in accordance with the relevant rules and regulations promulgated under the Exchange Act.

 

Name and Address of Beneficial Owner

   Number of
Class A
Units(1)(2)
     Percent
of
Class A

Units
 

Vestar Capital Partners V, L.P.(3)

     6,918,627         94.12

Gregory T. Torres

     25,000         *   

Edward M. Murphy

     130,000         1.8

Bruce F. Nardella

     30,000         *   

Denis M. Holler

     40,169         *   

David M. Petersen

     31,200         *   

Linda DeRenzo

     20,000         *   

Kathleen Federico

     3,450         *   

Chris A. Durbin(4)

     —          —    

James L. Elrod, Jr.(4)

     —          —    

Pamela F. Lenehan

     2,750         *   

Kevin A. Mundt(4)

     —          —    

Guy Sansone

     —          —    

All directors and executive officers (15 persons)

     303,069         4.1

 

* Less than 1.0%.
(1) In addition, certain executive officers own non-voting Preferred Units, Class B Units, Class C Units, Class D Units, Class F Units, and/or Class G Units or Class H Units, Ms. Lenehan owns non-voting Preferred Units and Class E Units, and Mr. Sansone owns Class E Units which are not reflected in the table above. See “Certain Relationships and Related Party Transactions — Management Unit Subscription Agreements” and “— Director Unit Subscription Agreement” for additional information.
(2) The Preferred Units and 30% of Class A Common Units held by the management investors were vested with respect to appreciation immediately upon issuance, assuming continued employment with the Company, and the remaining 70% of Class A Common Units vested (or are still vesting) ratably over 49 months. See “Certain Relationships and Related Party Transactions — Management Unit Subscription Agreements” for additional information.
(3) Includes 6,915,196 Class A Common Units held by Vestar Capital Partners V, L.P. (the “Fund”) and 3,431 Class A Common Units held by Vestar/NMH Investors, LLC. In addition, the Fund owns 1,727,280 Preferred Units and Vestar/NMH Investors, LLC owns 857 Preferred Units, representing approximately 97.5% of the Preferred Units, of NMH Investment. Vestar Associates V, L.P. is the general partner of the Fund, having voting and investment power over membership interests held or controlled by the Fund. Vestar Managers V, Ltd. (“VMV”) is the general partner of Vestar Associates V, L.P. Each of Vestar Associates V, L.P. and VMV disclaims beneficial ownership of any membership interests in NMH Investment beneficially owned by the Fund. The address of Vestar Capital Partners V, L.P. is 245 Park Avenue, 41st Floor, New York, NY 10167.
(4) Messrs. Elrod, Mundt and Durbin are Managing Directors of Vestar. Each of Messrs. Elrod, Mundt and Durbin disclaims beneficial ownership of any membership interests in NMH Investment beneficially owned by the Fund, except to the extent of his indirect pecuniary interest therein.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

Limited Liability Company Agreement

Under the Sixth Amended and Restated Limited Liability Company Agreement (as amended, the “Limited Liability Company Agreement”) of NMH Investment, by and among NMH Investment, Vestar, an affiliate of Vestar, the management and director investors and future parties to such agreement, the initial management committee consists of members elected by a plurality vote of the holders of NMH Investment’s Class A Common Units consisting of the designees of Vestar as determined in accordance with the Securityholders Agreement described below and one additional person. The management committee currently has seven members and on January 1, 2014, the size of the management committee will be increased to eight members. Any member of the management committee may be removed at any time by the holders of a majority of the total voting power of the outstanding Class A Common Units. The management committee currently consists of the same individuals as our board of directors.

 

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The management committee manages and controls the business and affairs of NMH Investment and has the power to, among other things, amend the Limited Liability Company Agreement, approve any significant corporate transactions and appoint officers. It can also delegate such authority by agreement or authorization.

The Limited Liability Company Agreement also contains agreements among the parties with respect to the allocation of net income and net loss and the distribution of assets among the holders of the Preferred Units and the Common Units. The value of the Preferred Units accrues over time so that holders of the Preferred Units are entitled to receive a specified rate of return upon distributions by NMH Investment prior to any distributions in respect of the Common Units. On July 5, 2007, NMH Holdings paid a dividend to its parent, NMH Investment, which was used by NMH Investment to pay a return of capital with respect to its Preferred Units. NMH Investment froze the accrual of the Preferred Units as of December 31, 2010, and NMH Investment restarted the accrual of the Preferred Units from July 1, 2013.

Management Unit Subscription Agreements

In connection with the Merger, NMH Investment entered into several agreements with management investors and with the Chairman, Mr. Torres, pursuant to which such investors subscribed for and purchased Preferred Units and Class A Common Units (which is the only class of voting equity interests in NMH Investment). Robert Melia, our Cambridge Operating Group President, and Kathleen Federico, our Chief Human Resources Officer, also subscribed for and purchased Preferred Units and Class A Common Units after their respective start dates with the Company. The Preferred Units and 30% of the Class A Common Units were vested with respect to appreciation upon issuance. The remaining 70% of the units vest ratably over 49 months, and thus all of the issuances except for Mr. Melia’s and Ms. Federico’s were fully vested as of July 2010. On July 5, 2007, NMH Holdings paid a dividend to its parent, NMH Investment, which was used by NMH Investment to pay a return of capital with respect to its Preferred Units.

In addition, NMH Investment has previously entered into agreements with management investors, including all of the executive officers, whereby such management investors were granted non-voting Class B management Common Units, Class C Common Units, Class D Common Units, Class F Common Units and/or, for certain investors, Class G Common Units or Class H Common Units, all at either nominal or no cost. The Class B, Class C and Class D Units’ rights to share in an increase in value of NMH Investment are fully vested for all holders. With respect to the executive officers except for Mr. Cohen, based on the fact they were hired before December 31, 2008, the Class F units were 75% vested when issued, and the remaining 25% vested as of December 15, 2012. Mr. Cohen was issued Class F Units at no cost in December 2011 after he joined the Company. His Class F units are vesting over a three-year period, with one-third vesting each year upon the anniversary of the date the units were issued to him. The Class G Common Units vest upon the consummation of a sale of the Company or an initial public offering of the Company. The Class H Common Units vest upon the consummation of a sale of the Company, although their value, if any, will depend on the multiples of investment return achieved by Vestar Capital Partners V, L.P. (“Vestar”) and certain of its affiliates. Additionally, upon an initial public offering of the Company, the Class H Common Units vest if certain multiples of investment return are achieved by Vestar and certain of its affiliates.

In the aggregate, the Class B, Class C, Class D and Class F Units represent the right to receive 10.0% of the increase in value of the common equity interests in NMH Investment. The Class G Units will share with the Class A Units the increase in value of the common equity interests in NMH Investment that was formerly allocated solely to the Class A Units. The Class H Units were issued only to certain executive officers and as such their terms are described in “Executive Compensation — Compensation Discussion and Analysis —Equity-Based Compensation”.

NMH Investment may be required to purchase a certain percentage of an executive officer’s Preferred, Class A, Class B, Class C, Class D and Class F Units in the event of such investor’s disability, death or retirement. In addition, NMH Investment has the right to purchase all or a portion of a management investor’s units upon the termination of such investor’s active employment with the Company or its affiliates. The price at which the units will be purchased will vary depending on a number of factors, including (i) the circumstances of such termination of employment and whether the management investor engages in certain proscribed competitive activities following employment, (ii) the length of time such units were held and (iii) the financial performance of NMH Investment over a certain specified time period. However, NMH Investment shall not be obligated to purchase any units at any time to the extent that the purchase of such units, or a payment to NMH Investment by one of its subsidiaries in order to fund such purchase, would result in a violation of law, a financing default or adverse accounting consequences, or if a financing default exists which prohibits such purchase or payment. From time to time, NMH Investment may enter into additional management subscription agreements with the management investors or additional members of management pursuant to which it may issue additional units.

 

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Director Unit Subscription Agreements

In connection with her election to our board of directors in December 2008, Pamela F. Lenehan entered into a Director Unit Subscription Agreement with NMH Investment. Ms. Lenehan subscribed for specified amounts of Preferred Units, Class A Common Units and Class E Common Units of NMH Investment for an aggregate of $125,159. These units were issued to Ms. Lenehan in January 2009. In connection with his election to our board of directors in December 2009, Guy Sansone was offered the opportunity to subscribe for 3,187 Class E Common Units of NMH Investment for an aggregate of $159.35. These units were issued to Mr. Sansone in September 2010.

Securityholders Agreement

Pursuant to the Securityholders Agreement among NMH Investment, Vestar, an affiliate of Vestar, the management and director investors, Mr. Torres and any future parties to such agreement as amended, (collectively, the “Securityholders”), the units of NMH Investment beneficially owned by the Securityholders are subject to certain restrictions on transfer, as well as the other provisions described below.

The Securityholders Agreement provides that the Securityholders will vote all of their units to elect and continue in office a management committee or board of directors of NMH Investment and each of its subsidiaries composed of:

(a) up to six designees of Vestar; and

(b) the Company’s chief executive officer.

The Securityholders Agreement was amended on December 16, 2013 to provide that, effective as of January 1, 2014, the management committee or board of directors of NMH Investment and each of its subsidiaries will be composed of up to seven designees of Vestar.

In addition, each Securityholder has agreed, subject to certain limited exceptions, that he or she will vote all of his units as directed by Vestar in connection with amendments to NMH Investment’s organizational documents, mergers or other business combinations, the disposition of all or substantially all of NMH Investment’s property and assets, reorganizations, recapitalizations or the liquidation, dissolution or winding up of NMH Investment.

Prior to the earlier of (i) a sale of a majority of the equity or voting interests of NMH Investment, NMH Holdings, LLC or certain of their holding company subsidiaries, or in a sale of all or substantially all of the assets of NMH Investment and its subsidiaries, except for any transactions with a wholly-owned subsidiary of Vestar or of NMH Investment and (ii) the fifth anniversary of the date of purchase, the investors will be prohibited from transferring units to a third party, subject to certain exceptions.

The Securityholders Agreement provides (i) the management with “tag-along” rights with respect to transfers of securities beneficially owned by Vestar, its partners or their transferees, and (ii) Vestar with “take-along” rights with respect to securities owned by the investors in a sale of a majority of the equity or voting interests of NMH Investment, Parent or certain of their holding company subsidiaries, or in a sale of all or substantially all of the assets of NMH Investment and its subsidiaries. In addition, Vestar has certain rights to require NMH Investment (or its successors) to register securities held by it under the Securities Act up to eight times, and Vestar and the other Securityholders have certain rights to participate in publicly registered offerings of NMH Investment’s common equity initiated by NMH Investment or other third parties.

Management Agreement

Vestar and the Company are parties to a management agreement relating to certain advisory and consulting services rendered by Vestar. In consideration of those services, the Company has agreed to pay to Vestar an aggregate per annum management fee equal to the greater of (i) $850,000 or (ii) an amount per annum equal to 1.00% of the Company’s consolidated earnings before depreciation, amortization, interest and taxes for each fiscal year before deduction of Vestar’s fee, determined as set forth in the Company’s senior credit agreement. The Company also agreed to indemnify Vestar and its affiliates from and against all losses, claims, damages and liabilities arising out of the performance by Vestar of its services pursuant to the management agreement. The management agreement will terminate at such time as Vestar and its partners and their respective affiliates hold, directly or indirectly in the aggregate, less than 20% of the voting power of the Company’s outstanding voting stock, upon a sale of the Company or upon the completion of an initial public offering. This agreement also provides for the payment of reasonable and customary fees to Vestar for services in connection with a sale of the Company, an initial public offering by or involving NMH Investment or any of its subsidiaries or any extraordinary acquisition by or involving NMH Investment or any of its subsidiaries; provided that such fees shall be paid only with the consent of the directors of the Company who are not affiliated with or employed by Vestar.

 

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Indemnification Agreements

The Company and NMH Holdings are parties to an indemnification agreement with each of the Company’s directors and executive officers. Under the form of indemnification agreement, directors and executive officers are indemnified against certain expenses, judgments and other losses resulting from involvement in legal proceedings arising from service as a director or executive officer. NMH Holdings will advance expenses incurred by directors or executive officers in defending against such proceedings, and indemnification is generally not available for proceedings brought by an indemnified person (other than to enforce his or her rights under the indemnification agreement). If an indemnified person elects or is required to pay all or any portion of any judgment or settlement for which NMH Holdings is jointly liable, NMH Holdings will contribute to the expenses, judgments, fines and amounts paid in settlement incurred by the indemnified person in proportion to the relative benefits received by NMH Holdings (and its officers, directors and employees other than the indemnified person) and the indemnified person, as may, to the extent necessary to conform to law, be further adjusted by reference to the relative fault of the Company (and its officers, directors and employees other than the indemnified person) and the indemnified person in connection with the events that resulted in such losses, as well as any other equitable considerations which the law may require to be considered. The Company is a guarantor of NMH Holdings’ obligations under this agreement.

Policies and Procedures for Related Party Transactions

As a debt-only issuer, our related party transactions with executive officers and directors are generally reviewed by our board of directors or Audit Committee, although we have not historically had formal policies and procedures regarding the review and approval of related party transactions.

Director Independence

Our board is currently composed of seven directors: Gregory T. Torres and Edward M. Murphy, who are employed by the Company; James L. Elrod, Jr., Kevin A. Mundt and Chris A. Durbin, who are employed by Vestar; and Pamela F. Lenehan and Guy Sansone. Of these directors, only Ms. Lenehan and Mr. Sansone would likely qualify as independent directors based on the definition of independent director set forth in Rule 5605(a)(2) of the Nasdaq Stock Market, LLC Listing Rules (the “Nasdaq Listing Rules”). Under the Nasdaq Listing Rules, we would be considered a “controlled company” because more than 50% of our voting power is held by a single person. Accordingly, even if we were a listed company on Nasdaq, we would not be required by Nasdaq Listing Rules to maintain a majority of independent directors on our board, nor would we be required by Nasdaq Listing Rules to maintain a Compensation Committee or nominating committee comprised entirely of independent directors. No members of management serve on either the Audit or Compensation Committees. Ms. Lenehan and Messrs. Durbin and Mundt serve on our Audit Committee, and Mr. Durbin, Mr. Elrod and Mr. Sansone serve on our Compensation Committee.

Effective as of January 1, 2014, the size of our board will be increased and Bruce F. Nardella will become a member of the board and will join the Company’s Compliance Committee. Also effective as of January 1, 2014, Mr. Torres will remain as a director but will cease to be chairman and an employee of the Company. Effective January 1, 2014, the current Chief Executive Officer, Edward M. Murphy, will become Executive Chair of the Board and will remain a full-time executive of the Company.

 

Item 14. Principal Accounting Fees and Services

Aggregate fees for professional services rendered for us by Deloitte & Touche LLP for the years ended September 30, 2013 and September 30, 2012, were:

 

     2013      2012  
     (In thousands)  

Audit fees(1)

   $ 1,190       $ 1,150   

Other audit fees(2)

     —           80   

Tax fees(3)

     33         35   
  

 

 

    

 

 

 

Total fees

   $ 1,223       $ 1,265   
  

 

 

    

 

 

 

 

(1) Audit fees primarily include professional services rendered for the audits of our consolidated financial statements and for our quarterly reviews, as well as, services related to other statutory and regulatory filings.
(2) Additional audit fees incurred for professional services rendered for the audits of our consolidated financial statements as of and for the year ended September 30, 2012.
(3) Tax fees primarily include professional services rendered for tax services during the fiscal year indicated.

Preapproval Policies and Procedures

The Audit Committee has preapproved all related fees and services provided by Deloitte & Touche LLP.

 

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PART IV

 

Item 15. Exhibits, Financial Statement Schedules

(a)(1) Financial Statements

The following consolidated financial statements on pages F-1 through F-32 are filed as part of this report.

 

    Consolidated Balance Sheets as of September 30, 2013 and 2012;

 

    Consolidated Statements of Operations for the years ended September 30, 2013, 2012 and 2011;

 

    Consolidated Statements of Comprehensive Loss for the years ended September 30, 2013, 2012 and 2011;

 

    Consolidated Statements of Shareholder’s Equity (Deficit) for the years ended September 30, 2013, 2012 and 2011; and

 

    Consolidated Statements of Cash Flows for the years ended September 30, 2013, 2012 and 2011.

(2) Financial Statement Schedules: Financial statement schedules have been omitted because they are not applicable or not required, or because the required information is provided in our consolidated financial statements or notes thereto.

(3) Exhibits: The Exhibit Index is incorporated by reference herein.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

NATIONAL MENTOR HOLDINGS, INC.
By:  

/s/ Edward M. Murphy

 

Edward M. Murphy

Its: Chief Executive Officer

Date: December 18, 2013

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of December 18, 2013 by the following persons on behalf of the registrant and in the capacities indicated.

 

Signature

  

Title

/s/ Edward M. Murphy

Edward M. Murphy

  

Chief Executive Officer

(principal executive officer) and Director

/s/ Bruce F. Nardella

Bruce F. Nardella

  

President and Chief Operating Officer

(principal executive officer)

/s/ Denis M. Holler

Denis M. Holler

  

Chief Financial Officer and Treasurer

(principal financial officer and principal accounting officer)

/s/ Gregory T. Torres

Gregory T. Torres

   Chairman and Director

/s/ Chris A. Durbin

Chris A. Durbin

   Director

/s/ James L. Elrod, Jr.

James L. Elrod, Jr.

   Director

/s/ Pamela F. Lenehan

Pamela F. Lenehan

   Director

/s/ Kevin A. Mundt

Kevin A. Mundt

   Director

/s/ Guy Sansone

Guy Sansone

   Director

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description

  2.1    Merger Agreement between National MENTOR Holdings, Inc., NMH Holdings, LLC, and NMH MergerSub Inc., dated as of March 22, 2006.    Incorporated by reference to Exhibit 2.1 of National Mentor Holdings, Inc. Form S-4 Registration Statement (Registration No. 333-138362) filed on November 1, 2006 (the “S-4”)
  3.1    Amended and Restated Certificate of Incorporation of National Mentor Holdings, Inc.    Incorporated by reference to Exhibit 3.1 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended March 31, 2007 (the “March 2007 10-Q”)
  3.2    By-Laws of National Mentor Holdings, Inc.   

Filed herewith

  3.3    Amendment No. 1 to the By-Laws of National Mentor Holdings, Inc.    Filed herewith
  4.1    Indenture, dated as of February 9, 2011, among National Mentor Holdings, Inc., the subsidiary guarantors named therein, and Wells Fargo, National Association, as trustee.    Incorporated by reference to Exhibit 4.1 of National Mentor Holdings, Inc. Current Report on Form 8-K filed on February 10, 2011 (the “February 10, 2011 8-K”)
  4.2    Form of 12.50% Senior Note due 2018 (attached as exhibit to Exhibit 4.1).    Incorporated by reference to Exhibit 4.1
  4.3    Supplemental Indenture of REM East, LLC dated August 14, 2012.   

Incorporated by reference to Exhibit 4.3 of National Mentor Holdings, Inc. Form 10-K for the fiscal year ended September 30, 2012.

  4.4    Supplemental Indenture of Illinois Mentor Community Services, LLC dated December 27, 2012.    Incorporated by reference to Exhibit 4.1 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended December 31, 2012
10.1    Credit Agreement, dated February 9, 2011, among NMH Holdings, LLC, as parent guarantor, National Mentor Holdings, Inc., as borrower, the several lenders from time to time party thereto and UBS, as Administrative Agent.    Incorporated by reference to Exhibit 10.1 of the February 10, 2011 8-K
10.2    Amendment to Credit Agreement, dated October 15, 2012, among NMH Holdings, LLC, as parent guarantor, National Mentor Holdings, Inc., as borrower, the several lenders from time to time party thereto and UBS, as Administrative Agent.    Incorporated by reference to Exhibit 10.1 of National Mentor Holdings, Inc. Current Report on Form 8-K filed on October 17, 2012.
10.3    Guarantee and Security Agreement, dated as of February 9, 2011, among NH Holdings, LLC, as parent guarantor, National Mentor Holdings, Inc., as borrower, certain subsidiaries of National Mentor Holdings, Inc., as subsidiary guarantors, and UBS AG, as administrative agent.    Incorporated by reference to Exhibit 10.2 of the February 10, 2011 8-K
10.4    Management Agreement, dated as of February 9, 2011, among National Mentor Holdings, Inc., National Mentor Holdings, LLC, NMH Investment, LLC, NMH Holdings, Inc., NMH Holdings, LLC and Vestar Capital Partners.    Incorporated by reference to Exhibit 10.3 of the February 10, 2011 8-K
10.5*    Amended and Restated Employment Agreement, dated June 29, 2006, between National Mentor Holdings, Inc. and Gregory Torres.    Incorporated by reference to Exhibit 10.5 of the S-4
10.6*    First Amendment to Amended and Restated Employment Agreement dated December 31, 2008 between National Mentor Holdings, Inc. and Gregory Torres.    Incorporated by reference to Exhibit 10.2 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended December 31, 2008 (the “December 2008 10-Q”)

 

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Exhibit No.

  

Description

10.7*    Amended and Restated Employment Agreement dated December 30, 2008, between National Mentor Holdings, Inc. and Edward Murphy.    Incorporated by reference to Exhibit 10.3 of the December 2008 10-Q
10.8*    Form of Amended and Restated Severance and Noncompetition Agreement.    Incorporated by reference to Exhibit 10.1 of the December 2008 10-Q
10.9*    National Mentor Holdings, LLC Executive Deferred Compensation Plan, Third Amendment and Restatement Adopted Effective as of December 4, 2009.    Incorporated by reference to Exhibit 10.11 of National Mentor Holdings, Inc. Form 10-K for the fiscal year ended September 30, 2009 (the “2009 10-K”)
10.10*    National Mentor Holdings, LLC Executive Deferred Compensation Plan, Fourth Amendment and Restatement Adopted December 27, 2011, Effective as of January 1, 2011    Incorporated by reference to Exhibit 10.8.1 of National Mentor Holdings, Inc. Form 10-K for the fiscal year ended September 30, 2011 (the “2011 10-K”)
10.11*    National Mentor Holdings, LLC Executive Deferral Plan, Second Amendment and Restatement Adopted June 17, 2009 and Effective as of January 1, 2009.    Incorporated by reference to Exhibit 10.13 of the 2009 10-K
10.12*    The MENTOR Network Incentive Compensation Plan effective March 4, 2011.    Incorporated by reference to Exhibit 10.5 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended March 31, 2011 (the “March 2011 10-Q”)
10.13*    The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, Second Amendment and Restatement, effective October 1, 2011.    Incorporated by reference to Exhibit 10.2 of the 2011 10-K
10.14*    NMH Investment, LLC Amended and Restated 2006 Unit Plan.    Incorporated by reference to Exhibit 10.17 of National Mentor Holdings, Inc. Form S-4/A Amendment No. 1 to the Registration Statement (Registration No. 333-138362) filed on January 12, 2007 (the “S-4/A”)
10.15*    Amendment to NMH Investment, LLC Amended and Restated 2006 Unit Plan.    Incorporated by reference to Exhibit 10.1 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended the June 30, 2008
10.16*    Second Amendment to NMH Investment, LLC Amended and Restated 2006 Unit Plan.    Incorporated by reference to Exhibit 10.6 of the March 2011 10-Q
10.17*    Third Amendment to NMH Investment, LLC Amended and Restated 2006 Unit Plan.    Incorporated by reference to Exhibit 10.1 of National Mentor Holdings, Inc. Form 10-Q for the quarterly period ended the June 30, 2012 (the “June 2012 10-Q”)
10.18*    Form of Management Unit Subscription Agreement.    Incorporated by reference to Exhibit 10.15 of the S-4/A
10.19*    Form of Amendment to Management Unit Subscription Agreement.    Incorporated by reference to Exhibit 10.19 of the 2009 10-K
10.20*    Form of Management Unit Subscription Agreement (Series 1 Class F Common Units)    Incorporated by reference to Exhibit 10.7 of the March 2011 10-Q
10.21*    Form of Management Unit Subscription Agreement (Class G Common Units).    Incorporated by reference to Exhibit 10.2 of the June 2012 10-Q
10.22*    Form of Management Unit Subscription Agreement (Class H Common Units).    Incorporated by reference to Exhibit 10.3 of the June 2012 10-Q
10.23*    Form of Director Unit Subscription Agreement.    Incorporated by reference to Exhibit 10.13 of National Mentor Holdings, Inc. Form 10-K for the fiscal year ended September 30, 2008
10.24*    Form of Amendment to Director Unit Subscription Agreement.    Incorporated by reference to Exhibit 10.21 of the 2009 10-K

 

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Exhibit No.

  

Description

10.25*    Form of Indemnification Agreement.    Incorporated by reference to Exhibit 10.1 of National Mentor Holdings, Inc. Current Report on Form 8-K filed on December 10, 2008
10.26*    The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, Third Amendment and Restatement dated December 20, 2012 and effective October 1, 2012.   

Incorporated by reference to Exhibit 10.26 of National Mentor Holdings, Inc. Form 10-K for the fiscal year ended September 30, 2012

10.27    Incremental Amendment No. 1 dated as of February 4, 2013, by and among National Mentor Holdings, Inc., NMH Holdings, LLC and the subsidiary guarantor party thereto and UBS AG, Stanford Branch, as administrative agent, and UBS Loan Finance LLC, as Swingline Lender   

Incorporated by reference to Exhibit 10.1 of National Mentor Holdings, Inc. Form 8-K filed February 4, 2013

10.28*    Termination of Amended and Restated Employment Agreement, effective as of January 1, 2014, by and between Gregory Torres and National Mentor Holdings, Inc.   

Filed herewith

10.29*    Second Amended and Restated Employment Agreement, effective as of January 1, 2014 by and between Edward M. Murphy and National Mentor Holdings, Inc.   

Filed herewith

10.30*    Employment Agreement, effective as of January 1, 2014, by and between Bruce F. Nardella and National Holdings, Inc.   

Filed herewith

10.31*    The MENTOR Network Human Services and Corporate Management Incentive Compensation Plan, Fourth Amendment and Restatement dated December 16, 2013 and effective October 1, 2013.   

Filed herewith

21    Subsidiaries.    Filed herewith
31.1    Certification of principal executive officer.    Filed herewith
31.2    Certification of principal executive officer.    Filed herewith
31.3    Certification of principal financial officer.    Filed herewith
32    Certifications furnished pursuant to 18 U.S.C. Section 1350.    Filed herewith
101    Interactive Data Files    Filed herewith

 

* Management contract or compensatory plan or arrangement.

 

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National Mentor Holdings, Inc.

Audited Consolidated Financial Statements

Contents

 

Audited Consolidated Financial Statements for the years ended September 30, 2013, 2012 and 2011

  

Report of Independent Registered Public Accounting Firm

     F-2  

Consolidated Balance Sheets as of September 30, 2013 and 2012

     F-3  

Consolidated Statements of Operations for the years ended September 30, 2013, 2012 and 2011

     F-4  

Consolidated Statements of Comprehensive Loss for the years ended September 30, 2013, 2012 and 2011

     F-5  

Consolidated Statements of Shareholder’s Equity (Deficit) for the years ended September  30, 2013, 2012 and 2011

     F-6  

Consolidated Statements of Cash Flows for the years ended September 30, 2013, 2012 and 2011

     F-7  

Notes to Consolidated Financial Statements

     F-8  

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Audit Committee of

National Mentor Holdings, Inc.

Boston, Massachusetts

We have audited the accompanying consolidated balance sheets of National Mentor Holdings, Inc. and subsidiaries (the “Company”) as of September 30, 2013 and 2012, and the related consolidated statements of operations, comprehensive loss, shareholder’s equity (deficit), and cash flows for each of the three years in the period ended September 30, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of National Mentor Holdings, Inc. and subsidiaries as of September 30, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2013, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Boston, Massachusetts

December 18, 2013

 

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National Mentor Holdings, Inc.

Consolidated Balance Sheets

(Amounts in thousands, except share and per share amounts)

 

     September 30,  
     2013     2012  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 19,315      $ —     

Restricted cash

     807        1,134   

Accounts receivable, net of allowances of $12,494 and $9,250 at September 30, 2013 and 2012, respectively

     144,954        153,991   

Deferred tax assets, net

     18,424        18,764   

Prepaid expenses and other current assets

     17,771        20,104   
  

 

 

   

 

 

 

Total current assets

     201,271        193,993   

Property and equipment, net

     153,635        151,548   

Intangible assets, net

     336,191        372,385   

Goodwill

     235,623        234,361   

Restricted cash

     50,000        50,000   

Other assets

     43,652        42,696   
  

 

 

   

 

 

 

Total assets

   $ 1,020,372      $ 1,044,983   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDER’S DEFICIT     

Current liabilities:

    

Accounts payable

   $ 26,568      $ 33,640   

Accrued payroll and related costs

     65,340        60,010   

Other accrued liabilities

     45,066        50,384   

Obligations under capital lease, current

     430        461   

Current portion of long-term debt

     5,600        24,300   
  

 

 

   

 

 

 

Total current liabilities

     143,004        168,795   

Other long-term liabilities

     68,936        64,893   

Deferred tax liabilities, net

     83,235        94,760   

Obligations under capital lease, less current portion

     6,509        8,384   

Long-term debt, less current portion

     779,519        752,398   

Commitments and contingencies

    
SHAREHOLDER’S DEFICIT     

Common stock, $0.01 par value; 1,000 shares authorized and 100 shares issued and outstanding

     —          —     

Additional paid-in capital

     33,929        33,695   

Accumulated other comprehensive loss

     (1,880     (3,358

Accumulated deficit

     (92,880     (74,584
  

 

 

   

 

 

 

Total shareholder’s deficit

     (60,831     (44,247
  

 

 

   

 

 

 

Total liabilities and shareholder’s deficit

   $ 1,020,372      $ 1,044,983   
  

 

 

   

 

 

 

See accompanying notes.

 

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National Mentor Holdings, Inc.

Consolidated Statements of Operations

(Amounts in thousands)

 

     Year Ended September 30,  
     2013     2012     2011  

Net revenue

   $ 1,198,653      $ 1,123,118      $ 1,062,773   

Cost of revenue (exclusive of depreciation expense shown separately below)

     935,143        874,778        823,009   

Operating expenses:

      

General and administrative

     146,040        140,221        143,949   

Depreciation and amortization

     64,146        60,534        61,330   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     210,186        200,755        205,279   
  

 

 

   

 

 

   

 

 

 

Income from operations

     53,324        47,585        34,485   

Other income (expense):

      

Management fee of related party

     (1,359     (1,325     (1,271

Other income (expense), net

     929        2        (142

Extinguishment of debt

     —          —          (19,278

Gain from available for sale investment security

     —          —          3,018   

Interest income

     137        332        22   

Interest income from related party

     —          —          684   

Interest expense

     (78,075     (79,445     (61,718
  

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

     (25,044     (32,851     (44,200

Benefit for income taxes

     (9,472     (19,172     (14,683
  

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (15,572     (13,679     (29,517

Loss from discontinued operations, net of tax of $1,731, $446 and $2,937

     (2,724     (701     (4,625
  

 

 

   

 

 

   

 

 

 

Net loss

   $ (18,296   $ (14,380   $ (34,142
  

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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National Mentor Holdings, Inc.

Consolidated Statements of Comprehensive Loss

(Amounts in thousands)

 

     Year Ended September 30,  
     2013     2012     2011  

Net loss

   $ (18,296   $ (14,380   $ (34,142

Other comprehensive loss (gain), net of tax:

      

Gain (loss) on derivative instrument classified as cash flow hedge net of tax for the fiscal year ended September 30, 2013, 2012 and 2011 of $1,027, $447 and $(2,727), respectively

     1,478        659        (4,017

Gain on available-for-sale debt securities net of taxes of $(390) for the year ended September 30, 2011

     —          —          (575
  

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (16,818   $ (13,721   $ (38,734
  

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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National Mentor Holdings, Inc.

Consolidated Statements of Shareholder’s Equity (Deficit)

(Amounts in thousands, except share and per share amounts)

 

     Common Stock      Additional
Paid-in
    Accumulated
Other
Comprehensive
    Accumulated
    Total
Shareholder’s
Equity
 
     Shares      Amount      Capital     (Loss) Income     Deficit     (Deficit)  

Balance at September 30, 2010

     100       $ —         $ 250,620      $ 575      $ (26,062   $ 225,133   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss, net of tax

     —           —           —          (4,592     —          (4,592

Stock-based compensation

     —           —           3,675        —          —          3,675   

Dividend to parent

     —           —           (221,197     —          —          (221,197

Net loss

     —           —           —          —          (34,142     (34,142
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

     100       $ —         $ 33,098      $ (4,017   $ (60,204   $ (31,123
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax

     —           —           —          659        —          659   

Stock-based compensation

     —           —           672        —          —          672   

Dividend to parent

     —           —           (75     —          —          (75

Net loss

     —           —           —          —          (14,380     (14,380

Balance at September 30, 2012

     100       $ —         $ 33,695      $ (3,358   $ (74,584   $ (44,247
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax

     —           —           —          1,478        —          1,478   

Stock-based compensation

     —           —           273        —          —          273   

Dividend to parent

     —           —           (39     —          —          (39

Net loss

     —           —           —          —          (18,296     (18,296
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2013

     100       $ —         $ 33,929      $ (1,880   $ (92,880   $ (60,831
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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National Mentor Holdings, Inc.

Consolidated Statements of Cash Flows

(Amounts in thousands)

 

     Year Ended September 30,  
     2013     2012     2011  

Operating activities

      

Net loss

   $ (18,296   $ (14,380   $ (34,142

Adjustments to reconcile net loss to net cash provided by operating activities:

      

Accounts receivable allowances

     18,286        12,902        11,670   

Depreciation and amortization of property and equipment

     25,753        24,118        23,306   

Amortization of other intangible assets

     37,600        36,885        39,755   

Amortization of original issue discount and initial purchasers discount

     2,946        2,956        1,924   

Amortization and write-off (in 2011) of financing costs

     2,851        2,395        10,545   

Accretion of investment in related party debt securities

     —          —          (325

Stock-based compensation

     273        672        3,675   

Deferred income taxes

     (12,212     (14,561     (19,524

Gain from available for sale investment security

     —          —          (3,018

Loss (gain) on disposal of assets

     165        283        (56

Change in the fair value of contingent consideration

     —          —          (2,545

Non-cash impairment charge

     6,344        955        11,893   

Non-cash interest income from related party

     —          —          (359

Changes in operating assets and liabilities:

      

Accounts receivable

     (9,249     (33,092     (19,424

Other assets

     553        (1,699     2,928   

Accounts payable

     (5,930     5,961        (1,045

Accrued payroll and related costs

     5,330        3,324        6,580   

Other accrued liabilities

     (2,719     6,562        (2,009

Other long-term liabilities

     4,043        (4,030     370   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     55,738        29,251        30,199   

Investing activities

      

Cash paid for acquisitions, net of cash received

     (9,275     (16,544     (12,688

Purchases of property and equipment

     (31,901     (29,995     (20,878

Changes in restricted cash

     327        (198     (49,890

Proceeds from sale of assets

     1,472        4,075        914   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (39,377     (42,662     (82,542

Financing activities

      

Repayments of long-term debt

     (5,525     (5,300     (507,114

Issuance of long term-debt, net of original issue discount

     30,000       —          760,767  

Proceeds from borrowings under senior revolver

     469,400        679,200        30,600  

Repayments of borrowings under senior revolver

     (488,400     (660,200     (30,600

Repayments of capital lease obligations

     (434     (399     (244

Cash paid for contingent consideration

     —          —          (4,975

Dividend to parent

     (39     (75     (207,855

Payments of financing costs

     (2,048     (78     (14,421
  

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     2,954        13,148        26,158   

Net increase (decrease) in cash and cash equivalents

     19,315        (263     (26,185

Cash and cash equivalents at beginning of period

     —          263        26,448   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 19,315     $ —        $ 263   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information

      

Cash paid for interest

   $ 71,670      $ 73,110      $ 57,827   

Cash paid for income taxes, net

   $ 1,665      $ 441      $ 1,601   

Supplemental disclosure of non-cash investing activities:

      

Accrued property, plant and equipment

   $ 919      $ 2,093      $ 1,601  

Supplemental disclosure of non-cash financing activities:

      

Capital lease obligation incurred to acquire assets

   $ —        $ 2,434      $ 5,302   

Dividend to parent

   $ —        $ —        $ (13,342

See accompanying notes.

 

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National Mentor Holdings, Inc.

Notes to Consolidated Financial Statements

September 30, 2013

1. Basis of Presentation

National Mentor Holdings, Inc., through its wholly owned subsidiaries (collectively, the “Company”), is a leading provider of home and community-based health and human services to adults and children with intellectual and/or developmental disabilities, acquired brain injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and/or medically complex challenges. Since the Company’s founding in 1980, the Company’s operations have grown to 35 states. The Company provides residential services to approximately 12,300 clients, some of whom also receive periodic services. Approximately 16,700 clients receive periodic services from the Company in non-residential settings.

The Company designs customized service plans to meet the unique needs of its clients, which it delivers in home- and community-based settings. Most of the Company’s service plans involve residential support, typically in small group homes, host home settings, or specialized community facilities, designed to improve the clients’ quality of life and to promote their independence and participation in community life. Other services offered include supported living, day and transitional programs, vocational services, case management, family-based and outpatient therapeutic services, post-acute treatment and neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and speech therapies, among others. The Company’s customized service plans offer its clients as well as the payors of these services, an attractive, cost-effective alternative to health and human services provided in large, institutional settings.

2. Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change.

Cash Equivalents

The Company considers short-term investments with maturity dates of 90 days or less at the date of purchase to be cash equivalents. Cash equivalents primarily consist of bank deposits and the carrying value of cash equivalents approximates fair value.

Restricted Cash

Restricted cash consists of a cash collateral account set up to support the issuance of letters of credit under the Company’s institutional letter of credit facility and funds provided from government payors restricted for client use.

Financial Instruments

Financial instruments include cash, accounts receivables, variable and fixed rate debt, self-insurance assets and liabilities and accounts payable. The carrying value of these instruments approximates their fair values with the exception of the fixed rate debt.

Concentrations of Credit and Other Risks

Financial instruments that potentially subject the Company to credit risk primarily consist of cash and cash equivalents, self-insurance receivables and accounts receivable. Cash and cash equivalents are deposited with federally insured commercial banks in the United States, which, at times may exceed federally insured limits. The unlimited coverage by the Federal Deposit Insurance Corporation (“FDIC”) expired on December 31, 2012. Accounts are currently guaranteed by the FDIC up to $250 thousand. The Company has not experienced any losses in such accounts. The Company derives approximately 87% of its revenue from state and local government payors. These entities fund a significant portion of their payments to the Company through federal matching funds, which pass through various state and local government agencies.

 

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Revenue Recognition

Revenue is reported net of allowances for unauthorized sales and estimated sales adjustments. Revenue is also reported net of any state provider taxes or gross receipts taxes levied on services the Company provides. Sales adjustments are estimated based on an analysis of historical sales adjustments and recent developments in payment trends. Revenue is recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectibility is reasonably assured.

The Company recognizes revenue for services performed pursuant to contracts with various state and local government agencies and private health care agencies as follows: cost-reimbursement contract revenue is recognized at the time the service costs are incurred and units-of-service contract revenue is recognized at the time the service is provided. For the Company’s cost-reimbursement contracts, the rate provided by the payor is based on a certain level of service and types of costs incurred in delivering the service. From time to time, the Company receives payments under cost-reimbursement contracts in excess of the allowable costs required to support those payments. In such instances, the Company estimates and records a liability for such excess payments. At the end of the contract period, any balance of excess payments is maintained as a liability until it is reimbursed to the payor. Revenue in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be enacted in states where the Company operates or by the federal government.

Cost of Revenue

The Company classifies expenses directly related to providing services as Cost of revenue, except for depreciation and amortization related to cost of revenue, which are shown separately in the consolidated statements of operations. Direct costs and expenses principally include salaries and benefits for service provider employees, per diem payments to independently contracted host-home caregivers (“Mentors”), residential occupancy expenses, which are primarily comprised of rent and utilities related to facilities providing direct care, certain client expenses such as food and medicine and transportation costs for clients requiring services, and professional and general liability expense.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation. The Company provides for depreciation using straight-line methods over the estimated useful lives of the related assets. Estimated useful lives for buildings are 30 years. The useful lives for computer hardware and software are three years, the useful lives for furniture and equipment range from three to five years and the useful lives for vehicles are five years. Leasehold improvements are depreciated on a straight-line basis over the lesser of the remaining lease term or seven years. Capital lease assets are depreciated over the lesser of the lease term or the useful life of the asset. Expenditures for maintenance and repairs are charged to operating expenses as incurred. When assets are sold or retired, the corresponding cost and accumulated depreciation are removed from the related accounts and any gain or loss is recorded in the period of the sale or retirement.

Internal Use Software Development Costs

The Company capitalizes certain costs associated with its internally developed software that are incurred subsequent to the preliminary project stage. Specifically, the Company capitalizes the payroll and payroll-related costs of employees who are directly involved with and who devote time to the Company’s software development project and other applicable third-party costs, and amortizes these costs on a straight-line basis over the estimated useful life of the software of three years. Amortization begins when the internal-use software is ready for its intended use.

Internal use software development costs of $1.3 million have been capitalized for the year ended September 30, 2013. The capitalized amounts were included as part of construction in progress on the consolidated balance sheets in Property and equipment. Because the Company believes that the project is not substantially complete and ready for its intended use, no amortization expense has been recorded to date.

Accounts Receivable

Accounts receivable primarily consist of amounts due from government agencies, not-for-profit providers and commercial insurance companies. An estimated allowance for doubtful accounts 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, the Company considers a number of factors, including payment trends in individual states, age of the accounts and the status of ongoing disputes with third party payors. 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 revenue as a contractual allowance in the consolidated statements of operations in the period of the change in estimate.

 

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Goodwill and Indefinite-lived Intangible Assets

The Company reviews costs of purchased businesses in excess of the fair value of net assets acquired (goodwill), and indefinite-lived intangible assets for impairment at least annually, unless significant changes in circumstances indicate a potential impairment may have occurred sooner. The Company conducts its annual impairment test for both goodwill and indefinite-lived intangible assets on July 1 of each year.

The Company is required to test goodwill on a reporting unit basis, of which there are two for each of the Company’s operating segments. The Company has the option to first assess qualitative factors to determine whether further impairment testing is necessary. The Company has elected to bypass the qualitative assessments for fiscal 2013 and proceed directly to the two-step impairment test. The first step is to compare the fair value of the reporting unit with its carrying value. If the carrying amount of the reporting unit exceeds its fair value then the second step of the goodwill impairment test is performed. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill in order to determine the amount of impairment to be recognized. The excess of the carrying value of goodwill above the implied goodwill, if any, would be recognized as an impairment charge. Fair values are established using discounted cash flow and comparative market multiple methods.

For its indefinite-lived intangible assets, the Company has the option to first assess qualitative factors to determine whether further impairment testing is necessary. The Company has elected to bypass the qualitative assessments for fiscal 2013 and proceed directly to the quantitative impairment test. The impairment test for indefinite-lived intangible assets requires the determination of the fair value of the intangible asset. If the fair value of the indefinite-lived intangible asset is less than its carrying value, an impairment loss is recognized in an amount equal to the difference. Fair values are established using the Relief from Royalty method.

The fair value of a reporting unit is based on discounted estimated future cash flows. The assumptions used to estimate fair value include management’s best estimates of future growth, capital expenditures, discount rates and market conditions over an estimate of the remaining operating period. As such, actual results may differ from these estimates and lead to a revaluation of the Company’s goodwill and indefinite-lived intangible assets. If updated estimates indicate that the fair value of goodwill or any indefinite-life intangibles is less than the carrying value of the asset, an impairment charge is recorded in the consolidated statements of operations in the period of the change in estimate.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. If the carrying amount of the asset is determined not to be recoverable, a write-down to fair value is recorded.

Income Taxes

The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. These deferred tax assets and liabilities are separated into current and long-term amounts based on the classification of the related assets and liabilities for financial reporting purposes and netted by jurisdiction. Valuation allowances on deferred tax assets are estimated based on the Company’s assessment of its ability to realize such amounts.

The Company also recognizes the benefits of tax positions when certain criteria are satisfied. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense which is consistent with the recognition of these items in prior reporting periods.

Derivative Financial Instruments

The Company reports derivative financial instruments on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. Changes in the fair value of derivatives are recorded each period in current operations or in the consolidated statements of comprehensive income (loss) depending upon whether the derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction.

The Company, from time to time, enters into interest rate swap agreements to hedge against variability in cash flows resulting from fluctuations in the benchmark interest rate, which is LIBOR, on the Company’s debt. These agreements involve the exchange of variable interest rates for fixed interest rates over the life of the swap agreement without an exchange of the notional amount upon which the payments are

 

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based. On a quarterly basis, the differential to be received or paid as interest rates change is accrued and recognized as an adjustment to interest expense in the accompanying consolidated statements of operations. In addition, on a quarterly basis the mark to market valuation is recorded as an adjustment to gain (loss) on derivative instrument within the consolidated statements of comprehensive income (loss). The related amount receivable from or payable to counterparties is included as an asset or liability, respectively, in the Company’s consolidated balance sheets.

Available-for-Sale Securities

The Company’s investments in related party marketable debt securities have been classified as available-for-sale securities and, accordingly, are valued at fair value at the end of each reporting period. Unrealized gains and losses arising from such valuation are reported within the Company’s consolidated statements of comprehensive income (loss).

Stock-Based Compensation

NMH Investment, LLC (“NMH Investment”), the Company’s indirect parent, adopted an equity-based compensation plan in 2006, and from time to time it has issued units of limited liability company interests pursuant to such plan, consisting of Class B Units, Class C Units, Class D Units, Class E Units, Class F Units, Class G Units and Class H Units. The units are limited liability company interests and are available for issuance to the Company’s employees and members of the Board of Directors for incentive purposes. For purposes of determining the compensation expense associated with these grants, management values the business enterprise using a variety of widely accepted valuation techniques which considered a number of factors such as the Company’s financial performance, the values of comparable companies and the lack of marketability of the Company’s equity. The Company then uses the option pricing method to determine the fair value of these units at the time of grant using valuation assumptions consisting of the expected term in which the units will be realized; a risk-free interest rate equal to the U.S. federal treasury bond rate consistent with the term assumption; expected dividend yield, for which there is none; and expected volatility based on the historical data of equity instruments of comparable companies. For Class B Units, Class C Units, Class D Units, Class E Units and Class F Units, the estimated fair value of the units, less an assumed forfeiture rate, is recognized in expense on a straight-line basis over the requisite service periods of the awards. The Class G Units and Class H Units vest upon a liquidity event and/or upon the occurrence of certain investment return conditions, for which the compensation expense will then be recognized in its entirety when probable.

Accruals for Self-Insurance

The Company maintains professional and general liability, workers’ compensation, automobile liability and health insurance with policies that include self-insured retentions. It is fully self-insured for employment practices liability claims. The Company records expenses related to claims on an incurred basis, which includes estimates of fully developed losses for both reported and unreported claims. The accruals for the health and workers’ compensation, automobile, employment practices and professional and general liability programs are based on analyses performed internally by management and may take into account reports by independent third parties. Accruals relating to prior periods are periodically re-evaluated and increased or decreased based on new information.

Self-Insurance Gross versus Net Presentation

The Company reports its insurance liabilities on a gross basis without giving effect to insurance recoveries. Anticipated insurance recoveries are presented in Prepaid expenses and other current assets and Other assets on the consolidated balance sheets. Self-insured liabilities are presented in Accrued payroll and related costs, Other accrued liabilities and Other long-term liabilities on the Company’s consolidated balance sheets.

Legal Contingencies

The Company is regularly involved in litigation and regulatory proceedings in the operation of its business. For claims that are not accounted for in its self-insurance reserves, the Company reserves for costs when a loss is probable and the amount is reasonably estimable. While the Company believes its provision for legal contingencies is adequate, the outcome of its legal proceedings is difficult to predict and it may settle legal claims or be subject to judgments for amounts that differ from its estimates. In addition, legal contingencies could have a material adverse impact on the Company’s results of operations in any given future reporting period.

Discontinued Operations

The Company analyzes its operations that have been divested or classified as held-for-sale to determine if they qualify for discontinued operations accounting. Only operations that qualify as a component of an entity, as defined by the Accounting Standards Codification (“ASC”), can be classified as a discontinued operation. In addition, only components where the cash flows of the component have been or will be eliminated from ongoing operations by the end of the assessment period and where the Company does not have significant continuing involvement with the divested operations would qualify for discontinued operations accounting.

 

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3. Recent Accounting Pronouncements

Presentation of Comprehensive Income — In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 eliminated the option to report other comprehensive income and its components in the statement of changes in equity. The final standard requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. ASU 2011-05 is effective for the Company beginning in the first quarter of fiscal 2013 and was applied retrospectively. Additionally, the FASB issued ASU 2013-02 Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”) in February 2013. Under ASU 2013-02, an entity is required to provide information about the amounts reclassified from accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the income statement or in the notes, significant amounts reclassified from accumulated other comprehensive income by the net income line item. ASU 2013-02 was effective for the Company beginning in the second quarter of fiscal 2013. The adoption of ASU 2011-05 and ASU 2013-02 impacted the presentation of other comprehensive loss as the Company previously presented the components of other comprehensive loss as part of the statement of changes in stockholder’s equity (deficit).

Intangibles — Goodwill and Other — In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment (“ASU 2011-08”). Under ASU 2011-08, an entity has the option to first assess qualitative factors to determine whether further impairment testing is necessary. Additionally, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the impairment test, and perform the qualitative assessment in any subsequent period. ASU 2011-08 was effective for the Company in fiscal 2013. The adoption of this provision did not impact the consolidated financial statements as the Company has elected to proceed directly to the first step of the impairment test.

Intangibles-Goodwill and Other — In July 2012, the FASB issued Accounting Standards Update No. 2012-02, Intangibles — Goodwill and Other (Topic 350): Testing Indefinite-lived Intangible Assets for Impairment (“ASU 2012-02”). ASU 2012-02 amends the guidance in ASC 350, to provide an option to first make a qualitative assessment of whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount before applying the quantitative impairment test. An entity is required to perform the quantitative test only if it determines that it is more likely than not that the fair value of an indefinitely-lived intangible asset is less than its carrying amount. ASU 2012-02 was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption being permitted. The adoption of this provision did not impact the consolidated financial statements as the Company has elected to proceed directly to the first step of the impairment test.

Technical Corrections and Improvements — In October 2012, the FASB issued Accounting Standards Update No. 2012-04, Technical Corrections and Improvements (“ASU 2012-04”). The amendments in this update cover a wide range of Topics in the Accounting Standards Codification. These amendments include technical corrections and improvements to the Accounting Standards Codification and conforming amendments related to fair value measurements. The amendments in this update are effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 will not have a material impact to its consolidated financial statements.

4. Business Combinations

The operating results of the businesses acquired are included in the consolidated statements of operations from the date of acquisition. The Company accounted for the acquisitions under the purchase method of accounting and, as a result, the purchase price was allocated to the assets acquired and liabilities assumed based upon their respective fair values. The excess of the purchase price over the estimated fair value of net tangible assets was allocated to specifically identified intangible assets, with the residual being allocated to goodwill.

Fiscal 2013 Acquisitions

During the fiscal year ended September 30, 2013, the Company acquired three companies complementary to its business for total fair value consideration of $9.3 million.

 

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Beyond Abilities. On September 20, 2013, the Company acquired the assets of Beyond Abilities for $4.4 million. Beyond Abilities is located in Wisconsin and provides residential and support services to individuals with cognitive disabilities and challenging behaviors. As a result of this acquisition, the Company recorded $1.3 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.1 million of tangible assets and $3.0 million of intangible assets, which included $1.5 million of agency contracts with a weighted average useful life of twelve years, $0.9 million of non-compete/non-solicit agreement with a useful life of 5 years, and $0.6 million of licenses and permits with a weighted average useful life of 10 years.

Community Links. On August 30, 2013, the Company acquired the assets of Community Links for $4.4 million. Community Links is located in Michigan and provides comprehensive supportive services to adults with traumatic brain injury. As a result of this acquisition, the Company recorded $1.3 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes. The Company acquired $3.1 million of intangible assets which primarily included $3.0 million of agency contracts with a weighted average useful life of twelve years. The remaining purchase price was allocated to tangible assets.

Carolina Autism. On November 1, 2012, the Company acquired the assets of Carolina Autism for $0.5 million. Carolina Autism is located in South Carolina and provides group home services, behavioral services and related services primarily to individuals diagnosed with autism and pervasive development disorders. As a result of this acquisition, the Company recorded $14 thousand of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.4 million of intangible assets which included $0.2 million of licenses and permits with a weighted average useful life of 10 years, $0.1 million of non-complete/non-solicit agreement with a useful life of five years and $0.1 million of agency contracts with a weighted average useful life of 12 years. The remaining purchase price was allocated to tangible assets.

The following table summarizes the recognized amounts of identifiable assets acquired and liabilities assumed at the date of the acquisition:

 

(in thousands)

   Beyond
Abilities
     Community
Links
     Carolina
Autism
     TOTAL  

Identifiable intangible assets

   $ 2,984       $ 3,078       $ 420       $ 6,482   

Other assets, current and long term

     —           16         2         18   

Property and equipment

     136         46         39         221   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total identifiable net assets

   $ 3,120       $ 3,140       $ 461       $ 6,721   

Goodwill

   $ 1,280       $ 1,260       $ 14       $ 2,554   

Fiscal 2012 Acquisitions

During the fiscal year ended September 30, 2012, the Company acquired seven companies complementary to its business for total fair value consideration of $16.5 million.

Families Together. On November 30, 2011, the Company acquired the assets of Families Together, Inc. (“Families Together”) for $3.0 million. Families Together is located in North Carolina and provides intensive in-home services, day treatment, case management, outpatient therapy and similar periodic services to children and their families. As a result of this acquisition, the Company recorded $0.9 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $2.1 million of intangible assets which included $1.0 million of non-compete agreement with a useful life of five years, $0.8 million of agency contracts with a weighted average useful life of eleven years, and $0.3 million of licenses and permits with a weighted average useful life of ten years.

SCVP. On March 26, 2012, the Company acquired the assets of SCVP, Inc. (“SCVP”) for $0.4 million. SCVP is located in Oregon and provides day program services and related services to individuals with developmental disabilities. The Company acquired $0.3 million of agency contracts with a weighted average useful life of ten years and $0.1 million of goodwill in the Human Services segment. The goodwill is expected to be deductible for tax purposes.

Copper Family Community Care. On April 5, 2012, the Company acquired the assets of Copper Family Community Care, Inc. (“Copper Family”) for $2.6 million. Copper Family is located in Wisconsin and provides group home services and related services to individuals with developmental disabilities. As a result of the acquisition, the Company recorded $0.7 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.1 million of tangible assets and $1.8 million of intangible assets, which included $1.4 million of agency contracts with a weighted average useful life of eleven years and $0.4 million of licenses and permits with a weighted average useful life of ten years.

 

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Alpha Group Administrators. On August 31, 2012, the Company acquired the assets of Alpha Group Administrators, Inc. (“Alpha Group”) for $2.3 million. Alpha Group is located in Arizona and provides specialized care through group home services and day treatment services for clients with complex behavioral challenges, as well as intellectual and developmental disabilities. As a result of the acquisition, the Company recorded $0.1 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.3 million of tangible assets and $1.9 million of intangible assets, which included $1.6 million of agency contracts with a weighted average useful life of twelve years and $0.3 million of licenses and permits with a weighted average useful life of ten years.

Radical Rehab Solutions. On August 31, 2012, the Company acquired the assets of Radical Rehab Solutions, LLC (“Radical Rehab”) for $8.0 million. Radical Rehab is located in Kentucky and provides community-based, post-acute rehabilitation programs for clients with acquired brain injury. As a result of the acquisition, the Company recorded $1.6 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.1 million of tangible assets and $6.3 million of intangible assets which included $5.4 million of agency contracts with a weighted average useful life of twelve years, $0.7 million of licenses and permits with a weighted average useful life of ten years, and $0.2 million of non-compete/non-solicit with a weighted average useful life of five years.

Other Acquisitions. Additionally, during the first quarter of 2012, the Company acquired selected assets of Zumbro House, Inc., which provides group home services to individuals with developmental disabilities in the Mankato, Minnesota area and Georgia Rehabilitation Institute d/b/a Walton Rehabilitation Health System, a provider of acquired brain injury services in Georgia, for total cash of $0.2 million, $0.1 million of which was allocated to intangible assets.

 

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The following table summarizes the recognized amounts of identifiable assets acquired and liabilities assumed at the date of the acquisition:

 

(in thousands)

   Families
Together
     SCVP      Copper
Family
     Alpha
Group
     Radical
Rehab
     Other
Acquisitions
     TOTAL  

Identifiable intangible assets

   $ 2,102       $ 291       $ 1,836       $ 1,927       $ 6,340       $ 89       $ 12,585   

Other assets, current and long term

     —          —          —          —          41         —          41   

Property and equipment

     6         5         116         288         62         20         497   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total identifiable net assets

   $ 2,108       $ 296       $ 1,952       $ 2,215       $ 6,443       $ 109       $ 13,123   

Goodwill

   $ 892       $ 154       $ 687       $ 85       $ 1,557       $ 46       $ 3,421   

Fiscal 2011 Acquisitions

During fiscal 2011, the Company acquired seven companies complementary to its business for total fair value consideration of $12.6 million.

New Start Homes. On October 1, 2010, the Company acquired the assets of New Start Homes, Inc. (“New Start Homes”) for total fair value consideration of $0.7 million. New Start Homes is a health facility located in California that provides congregate living inpatient services to mentally alert individuals who have spinal cord injuries, neurological illnesses or injuries or similar conditions and may be ventilator dependent. As a result of the New Start Homes acquisition, the Company recorded $0.2 million of goodwill in the Post-Acute Specialty Rehabilitation segment, which is expected to be deductible for tax purposes. The Company acquired $0.5 million of intangible assets which included $0.3 million in agency contracts with a weighted average useful life of eleven years and $0.2 million in license and permits with a weighted average useful life of ten years.

ViaQuest Behavorial Health. On October 26, 2010, the Company acquired the assets of ViaQuest Behavorial Health of Pennsylvania, LLC (“ViaQuest”) for total cash of $1.1 million. ViaQuest provides residential and periodic services to individuals with behavioral health issues. As a result of the ViaQuest acquisition, the Company initially recorded $0.4 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $0.6 million of intangibles assets which primarily included $0.5 million of agency contracts with a weighted average useful life of eleven years. The remaining purchase price was allocated to tangible assets. During fiscal 2011, the Company wrote off $0.2 million of goodwill and $0.2 million of intangible assets related to underperforming programs within the Viaquest operations.

Phoenix Homes. On December 31, 2010, the Company acquired the assets of Phoenix Homes, Inc. (“Phoenix Homes”) for total cash of $1.1 million. Phoenix Homes is a licensed child-placing agency that provides community-based, family focused therapeutic foster care to families and children in crisis or at risk in Maryland and Rhode Island. As a result of this acquisition, the Company initially recorded $0.1 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The Company acquired $1.0 million of intangibles assets which primarily included $0.7 million of agency contracts with a weighted average useful life of eleven years. During fiscal 2012, the Company wrote off $0.1 million of goodwill and $0.9 million of intangible assets related to underperforming programs within the Phoenix Homes operations.

Inclusive Solutions. On June 1, 2011, the Company acquired the assets of MEIS, LLC and New Life Enterprises N.W. Ohio, Inc., d/b/a Inclusive Solutions (“Inclusive Solutions”) for total cash of $2.0 million. Inclusive Solutions operates in Ohio and provides community based services to individuals with developmental disabilities. As a result of this acquisition, the Company recorded $0.6 million of goodwill in the Human Services segment, which is expected to be deductible for tax purposes. The acquired intangible assets included $0.5 million of agency contracts with a weighted average useful life of eleven years and $0.4 million of license and permits with a weighted average useful life of ten years. The remaining purchase price was allocated to tangible assets.

Communicare. On June 23, 2011, the Company acquired the assets of Communicare, LLC (“Communicare”) for total fair value consideration of $8.1 million, which initially included $0.8 million of accrued contingent consideration. The fair value of the contingent consideration on the date of acquisition was $0.8 million and was subsequently reduced to zero at September 30, 2011. The subsequent adjustment was recognized as an increase to earnings and included in General and administrative expenses in the consolidated statements of operations. As of June 23, 2012, the termination date of the contingency payout, the purchased entity did not meet certain earnings targets and therefore no additional earn out payment was made related to the $0.8 million accrued contingency consideration.

Communicare provides health, rehabilitation and residential services in the state of Florida to individuals with brain injuries, neuromuscular disorders, spinal cord injuries, pulmonary disorders, congenital anomalies, developmental disabilities and similar conditions. The Company recorded $3.8 million of goodwill in the Post-Acute Specialty Rehabilitation Services segment as a result of the Communicare acquisition, which is expected to be deductible for tax purposes. The Company acquired $4.2 million of intangible assets which primarily included $2.0 million of agency contracts with a weighted average useful life of eleven years and $1.6 million of non-compete with an estimated useful life of five years. The remaining purchase price was allocated to tangible assets and liabilities.

 

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Other Acquisitions. During fiscal 2011, the Company acquired the assets of SunnySide Homes of Redwood Falls, Inc., which consists of two group homes and TheraCare of New Jersey, Inc., a provider of behavioral health services for total cash of $0.3 million and $0.2 million of which was allocated to intangible assets.

The following table summarizes the recognized amounts of identifiable assets acquired and liabilities assumed at the date of the acquisition:

 

(in thousands)

   New Start
Homes
     ViaQuest     Phoenix      Inclusive
Solutions
     Communicare     Other
Acquisitions
     TOTAL  

Accounts receivable

   $ —        $ 191      $ —        $ —        $ —       $ —        $ 191   

Other assets, current and long term

     —          —         4         —          —         —          4   

Identifiable intangible assets

     450         641        951         984         4,238        317         7,581   

Property and equipment

     3         —         —          413         91        —          507   

Accounts payable and accrued expenses

     —          (116     —          —          (800     —          (916
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total identifiable net assets

   $ 453       $ 716      $ 955       $ 1,397       $ 3,529      $ 317       $ 7,367   

Goodwill

   $ 197       $ 384      $ 120       $ 603       $ 3,795      $ 122       $ 5,221   

Pro forma Results of Operations

The unaudited pro forma results of operations provided below for fiscal 2013, 2012 and 2011 are presented as though acquisitions made during fiscal 2013, 2012 and 2011 had occurred at the beginning of the periods presented. The pro forma information presented below does not intend to indicate what the Company’s results of operations would have been if the acquisitions had in fact occurred at the beginning of the earliest period presented nor does it intend to be a projection of the impact on future results or trends. The Company has determined that the presentation of the results of operations for each of these acquisitions, from the date of acquisition, is impracticable due to the integration of the operations upon acquisition.

 

(in thousands)

   Year Ended
September 30,
2013
     Year Ended
September 30,
2012
     Year Ended
September 30,
2011
 

Net revenue

   $ 1,208,808       $ 1,144,739       $ 1,075,251   

Income from operations

     55,591         51,106         36,794   

5. Discontinued Operations

FAS Virginia

During fiscal 2013, the Company closed certain Human Services operations in the state of Virginia, Family Advocacy Services, LLC (“FAS Virginia”) and recorded a pre-tax loss of $3.6 million for fiscal 2013. FAS Virginia was included in the Human Services segment and the results of the operations are presented as discontinued operations in the consolidated statements of operations and the prior periods have been reclassified. Loss from discontinued operations for FAS Virginia for fiscal 2013 included a $3.4 million write-off of intangible assets.

Mentor Rhode Island

During fiscal 2013, the Company adopted a plan to sell its Human Services operations in the state of Rhode Island (“Mentor Rhode Island”). The Company completed the sale in the third quarter of fiscal 2013 and recorded a pre-tax loss of $0.8 million for fiscal 2013. The operations of Mentor Rhode Island are presented as discontinued operations in the consolidated statements of operations and the prior periods have been reclassified. Loss from discontinued operations for fiscal 2013 included a $0.7 million impairment charge related to the write-off of intangible assets.

RCDS

During fiscal 2011, the Company closed its business operations in the state of New York, Rockland Child Development Services, Inc. (“RCDS”) and recognized a pre-tax loss of $8.0 million during the fiscal year ended September 30, 2011. RCDS was acquired in December 2006 and, as a result of this closure, the Company no longer provides services in New York. RCDS was included in the Human Services segment and the results of operations are reported separately as discontinued operations in the consolidated statements of operations and the prior periods have been reclassified. Loss from discontinued operations for fiscal 2011 included a $3.1 million write-off of goodwill and a $2.8 million write-off of intangible assets.

 

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Other

Also during fiscal 2011, the Company closed its Human Services operations in the states of Nebraska and New Hampshire and recognized a total pre-tax loss of $0.2 million for fiscal 2011. The results of operations are reported separately as discontinued operations in the consolidated statements of operations and the prior periods have been reclassified.

The net revenue and loss before income taxes for the Company’s discontinued operations at September 30:

 

     2013     2012     2011  
     (In thousands)  

Net revenue

   $ 2,339      $ 6,455      $ 14,489   

Loss before income taxes

     (4,455     (1,147     (7,563

6. Goodwill and Intangible Assets

Goodwill

The changes in goodwill for the years ended September 30, 2013 and 2012 are as follows:

 

     Human
Services
    Post-Acute
Specialty
Rehabilitation
Services
     Total  
     (In thousands)  

Balance as of September 30, 2011

   $ 167,877      $ 63,138       $ 231,015   
  

 

 

   

 

 

    

 

 

 

Goodwill acquired through acquisitions

     1,860        1,561         3,421   

Goodwill written off related to disposal of businesses

     (75     —           (75
  

 

 

   

 

 

    

 

 

 

Balance as of September 30, 2012

     169,662        64,699         234,361   
  

 

 

   

 

 

    

 

 

 

Goodwill acquired through acquisitions

     1,294        1,260         2,554   

Goodwill written off related to disposal of businesses

     (1,334     —           (1,334

Adjustments to goodwill, net

     —          42         42   
  

 

 

   

 

 

    

 

 

 

Balance as of September 30, 2013

   $ 169,622      $ 66,001       $ 235,623   
  

 

 

   

 

 

    

 

 

 

During fiscal 2013, the Company wrote off goodwill of underperforming programs within the Human Services segment which were closed as of September 30, 2013. The total charge was $1.3 million and is included in General and administrative expense in the consolidated statements of operations. Additionally, the adjustments to goodwill reflect the final purchase price for acquisitions, as determined during the measurement period.

Annual Goodwill Impairment Testing

The Company tests goodwill at least annually for possible impairment. Accordingly, the Company completes the annual testing of impairment for goodwill on July 1 of each fiscal year. In addition to its annual test, the Company regularly evaluates whether events or circumstances have occurred that may indicate a potential impairment of these assets.

The Company elected to bypass the qualitative assessments for fiscal 2013 and proceed directly to the two-step impairment test. The process of testing goodwill for impairment involves the determination of the fair value of the applicable reporting units. The test consists of a two-step process. The first step is the comparison of the fair value to the carrying value of the reporting unit to determine if the carrying value exceeds the fair value. The second step measures the amount of an impairment loss, and is only performed if the carrying value exceeds the fair value of the reporting unit. The Company performed its annual impairment testing for its reporting units as of July 1, 2013, its annual impairment date, and concluded based on the first step of the process that there was no goodwill impairment.

The Company has consistently employed the income approach to estimate the current fair value when testing for impairment of goodwill. A number of significant assumptions and estimates are involved in the application of the income approach to forecast operating cash flows, including revenue growth, tax rates, capital spending, discount rate and working capital changes.

Cash flow forecasts are based on business unit operating plans and historical relationships. The income approach is sensitive to changes in long-term terminal growth rates and the discount rate. The long-term terminal growth rates are consistent with the Company’s historical long-term terminal growth rates, as the current economic trends are not expected to affect the long-term terminal growth rates of the Company. The discount rate was selected based on the estimated rate of return as well as time value of money.

 

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Intangible Assets

Intangible assets consist of the following as of September 30, 2013:

 

Description

   Weighted
Average
Remaining Life
     Gross
Carrying
Value
     Accumulated
Amortization
     Intangible
Assets, Net
 
(in thousands)       

Agency contracts

     9 years       $ 464,480       $ 195,737       $ 268,743   

Non-compete/non-solicit

     3 years         4,929         2,058         2,871   

Relationship with contracted caregivers

     3 years         10,963         7,905         3,058   

Trade names

     4 years         3,787         2,431         1,356   

Trade names (indefinite life)

     —          42,400         —           42,400   

Licenses and permits

     4 years         45,760         28,343         17,417   

Intellectual property

     3 years         904         558         346   
     

 

 

    

 

 

    

 

 

 
      $ 573,223       $ 237,032       $ 336,191   
     

 

 

    

 

 

    

 

 

 

Intangible assets consist of the following as of September 30, 2012:

 

Description

   Weighted
Average
Remaining Life
     Gross
Carrying
Value
     Accumulated
Amortization
     Intangible
Assets, Net
 
(in thousands)       

Agency contracts

     10 years       $ 467,639       $ 167,976       $ 299,663   

Non-compete/non-solicit

     3 years         3,949         1,301         2,648   

Relationship with contracted caregivers

     4 years         11,051         6,831         4,220   

Trade names

     5 years         3,774         2,078         1,696   

Trade names (indefinite life)

     —          42,400         —          42,400   

Licenses and permits

     5 years         45,194         23,911         21,283   

Intellectual property

     4 years         904         429         475   
     

 

 

    

 

 

    

 

 

 
      $ 574,911       $ 202,526       $ 372,385   
     

 

 

    

 

 

    

 

 

 

For fiscal years ended 2013, 2012 and 2011, the amortization expense for continuing operations was $38.4 million, $36.5 million and $38.2 million, respectively. The amortization expense for discontinued operations was $0.2 million, $0.4 million and $1.5 million for fiscal years ended 2013, 2012 and 2011, respectively.

Annual Indefinite Life Impairment Testing

The Company tests indefinite-lived intangible assets at least annually for possible impairment. Accordingly, the Company completes the annual testing of impairment for indefinite-lived intangible assets on July 1 of each fiscal year. In addition to its annual test, the Company regularly evaluates whether events or circumstances have occurred that may indicate a potential impairment of these assets.

The impairment test consists of a comparison of the fair value of the non-amortizing intangible asset with its carrying amount. If the carrying amount of an indefinite-lived intangible asset exceeds its fair value, an impairment loss in an amount equal to that excess is recognized. The Company has consistently employed the relief from royalty model to estimate the current fair value when testing for impairment of indefinite-lived intangible assets.

In addition, the Company evaluates the remaining useful life of its indefinite-lived intangible assets at least annually to determine whether events or circumstances continue to support an indefinite useful life. If events or circumstances indicate that the useful lives of indefinite-lived intangible assets are no longer indefinite, the assets will be tested for impairment.

The Company elected to bypass the qualitative assessments for fiscal 2013 and proceeded directly to the quantitative impairment test. The Company performed its annual impairment testing as of July 1, 2013, its annual impairment date, and concluded that there is no impairment to its indefinite lived trade names. The fair value of these assets was determined using management’s estimates about future cash flows.

 

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Long Lived Impairment Testing

During the assessment of long-lived assets that was performed during fiscal 2013, the Company determined that certain of its intangible assets were impaired related to underperforming programs within the Human Services segment, which consisted primarily of $0.9 million of agency contracts and $0.1 million of licenses and permits. Additionally in fiscal 2011, the Company determined that the carrying value of certain of its agency contracts and licenses and permits in the Human Services and Post-Acute Specialty Rehabilitation Services segments exceeded their fair value. The fair value of these assets was determined using management’s estimates about future cash flows, which is a Level 3 financial measurement.

As a result, the Company recorded $1.0 million and $2.7 million of amortization expense related to the write-off of these intangible assets for the years ended September 30, 2013 and 2011, respectively. This charge is included in Depreciation and amortization expense in the accompanying statements of operations.

The estimated remaining amortization expense related to intangible assets with finite lives for each of the five succeeding years and thereafter is as follows:

 

Year Ending September 30,

   (In thousands)  

2014

   $ 37,188   

2015

     35,385   

2016

     33,475   

2017

     29,284   

2018

     28,361   

Thereafter

     130,098   
  

 

 

 
   $ 293,791   
  

 

 

 

7. Property and Equipment

Property and equipment consists of the following at September 30:

 

     2013     2012  
     (In thousands)  

Buildings and land

   $ 123,046      $ 123,478   

Vehicles

     45,846        42,020   

Computer hardware

     29,661        25,233   

Leasehold improvements

     38,755        29,269   

Furniture and fixtures

     12,931        10,244   

Office and telecommunication equipment

     8,115        8,012   

Construction in progress

     2,246        1,539   
  

 

 

   

 

 

 
     260,600        239,795   

Less accumulated depreciation and amortization

     (106,965     (88,247
  

 

 

   

 

 

 

Property and equipment, net

   $ 153,635      $ 151,548   
  

 

 

   

 

 

 

For fiscal years ended 2013, 2012 and 2011, depreciation expense for continuing operations was $25.7 million, $24.1 million and $23.1 million, respectively, and depreciation expense for discontinued operations was $20 thousand, $47 thousand and $0.2 million, respectively.

 

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8. Certain Balance Sheet Accounts

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following at September 30: