10-K405 1 l87273ae10-k405.txt RES-CARE, INC. FORM 10-K405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2000 [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for transition period from __________ to __________ Commission File Number: 0-20372 RES-CARE, INC. (Exact name of Registrant as specified in its charter) KENTUCKY 61-0875371 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 10140 LINN STATION ROAD 40223 LOUISVILLE, KENTUCKY (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (502) 394-2100 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------- ---------------- Common Stock, no par value NASDAQ National Market Securities registered pursuant to Section 12(g) of the Act: None 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 periods that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No __. Indicate by check mark if disclosure of delinquent filers pursuant to Rule 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [X] As of February 28, 2001, there were 24,348,947 shares of the Registrant's Common Stock, no par value, outstanding. The aggregate market value of the shares of Registrant held by non-affiliates of the Registrant, based on the closing price of such on the NASDAQ National Market System on February 28, 2001, was approximately $167,521,000. For purposes of the foregoing calculation only, all directors and executive officers of the Registrant have been deemed affiliates. DOCUMENTS INCORPORATED BY REFERENCE Part III is incorporated by reference from the Registrant's Proxy Statement for its 2001 Annual Meeting of Shareholders. 2 PART I ITEM 1. BUSINESS GENERAL Res-Care, Inc. (ResCare or the Company) is a leading provider of residential, training, educational and support services to populations with special needs, including persons with developmental and other disabilities and at-risk and troubled youths. The services provided by the Company have historically been provided by state and local government agencies and not-for-profit organizations. In recent years, service delivery has shifted from government agencies toward private organizations, both not-for-profit and for-profit. The Company's programs include an array of services provided in both residential and non-residential settings for adults and youths with mental retardation or other developmental disabilities (MR/DD) and disabilities caused by acquired brain injury (ABI), and youths who have special educational or support needs, are from disadvantaged backgrounds, or have severe emotional disorders. Some have entered the juvenile justice system. Because most of the Company's MR/DD consumers require services over their entire lives and many states have extensive waiting lists for services, the Company has experienced high occupancy rates in its MR/DD operations. Occupancy rates in ABI and youth services operations are affected by shorter lengths of stay. At December 31, 2000, the Company provided services to approximately 25,900 persons with special needs in 32 states, Washington, D.C., Canada and Puerto Rico, compared to approximately 24,500 persons at December 31, 1999. At December 31, 2000, the Company provided services to approximately 16,500 persons with disabilities in community group homes, personal residences and other community-based programs and in larger facilities, and to approximately 9,400 at-risk and troubled youths in federally-funded Job Corps centers and juvenile treatment programs and facilities operated for state and local agencies. There has been a trend throughout the United States toward privatization of service delivery functions for special needs populations as governments at all levels face continuing pressure to control costs and improve the quality of programs. The demands for services for special needs populations in the United States are large, growing and highly fragmented as evidenced by the following industry estimates: - Recent studies indicate that more than three million persons in the United States have some level of developmental disability to the extent that professional services are required throughout their lives; - Funding for MR/DD services approximates $25 billion annually; - Funding for the domestic youth services industry approximates $60 billion annually. - Most MR/DD and youth services providers are small and operate in limited geographic areas. The Company believes it will continue to have opportunities to participate in the privatization of these services because of its proven programs and operating systems, financial resources, economies of scale and experience working with special needs populations and governmental agencies. The Company strives to provide quality and caring services through the operation of efficient and flexible programs. The Company's business strategy is based upon the following key elements; (i) continuing to build upon the Company's leadership position as a provider of disabilities services and of training and support services for disadvantaged youths and other special needs populations; (ii) focusing on quality management of existing programs through models of ongoing program evaluation developed by the Company; and (iii) implementing and maintaining high quality, cost-effective alternatives to programs operated directly by governmental entities and others by providing proven management systems and procedures that assure efficient application of financial and human resources. The Company's current growth strategy is primarily to expand its existing programs in markets in which it currently operates, and to selectively pursue other opportunities to provide services. The markets for the Company's services are highly fragmented, and the Company believes that there are continuing opportunities to enhance its market positions through an increased focus on internal growth in the disabilities and youth sectors. As part of its internal growth strategy, the Company strives to build upon its established relationships with governmental entities. There are currently over 200,000 individuals who are on state-compiled waiting lists for various community-based 1 3 MR/DD services, and the Company is working with advocates and others to develop funding and find placements for these consumers, as well as to enhance the funding available for existing consumers. DESCRIPTION OF SERVICES BY SEGMENT The Company has three reportable operating segments: (i) disabilities services; (ii) Job Corps program; and (iii) other youth services programs. A description of services provided by each segment follows. Further information regarding each of these segments, including the required disclosure of certain financial information, is included in Note 9 of the Notes to Consolidated Financial Statements of the Company. Such disclosures are incorporated herein by reference and should be read in conjunction with this section. Disabilities Services The Company began providing services to persons with disabilities in 1978 through the operation and management of larger facilities (generally serving 40 or more individuals) that offered alternatives to placement in state institutions or traditional nursing homes or other long-term care facilities not capable of providing specialized active treatment required by these individuals. The Company began offering services in 1983 through community-based group homes (generally serving six or fewer individuals) and in 1992 through supported living programs in which persons with disabilities reside in their own residences or apartments with outside support provided as needed. Some of these individuals require 24-hour staffing while others need only periodic services, day programs, supported employment or transportation. Community-based settings enable persons with developmental or other disabilities to live and develop in an environment that encourages each person to achieve maximum independence and self-respect. Approximately 94% of the Company's clients with developmental disabilities are being served in community-based settings. The Company's service patterns to clients with ABI are similar to those with developmental disabilities. The Company's programs are based predominantly on individual habilitation plans designed to encourage greater independence and development of daily living skills through individualized support and training. Management believes that the breadth and quality of the Company's services and support and training programs makes the Company attractive to state and local governmental agencies and not-for-profit providers who may wish to contract with it. The Company's programs are designed to offer specialized support to these individuals not generally available in larger state institutions and traditional long-term care facilities. In each of the Company's programs, services are administered by Company employees and contractors, such as qualified mental retardation professionals (QMRPs) or service coordinators, physicians, psychologists, therapists, social workers and other direct service staff. These services include social, functional and vocational skills training, supported employment and emotional and psychological counseling or therapy as needed for each individual. Social Skills Training. The Company's social skills training focuses on problem solving, anger management and adaptive skills to allow individuals with disabilities to interact with others in the residential setting and in the community. Emphasis is placed on contact with the community at large as appropriate for each individual. The desired outcome is to enable each individual to participate in home, family and community life as fully as possible. Many individuals with developmental and other disabilities require behavioral intervention services. The Company provides these services through psychiatrists, psychologists and behavioral specialists, some of whom serve as consultants on a contract basis. All operations utilize a non-aversive approach to behavior management which has been pioneered by the Company and which is designed to avoid consequences involving punishment or extreme restrictions on individual rights. Behavior management techniques are employed by the interdisciplinary team and direct service staff rather than psychotropic medications to modify behavior, the goal being to minimize the use of medications whenever possible. When necessary, medications are handled in strict compliance with federal regulations. Functional Skills Training. The Company's functional skills training program encourages mastery of personal skills and the achievement of greater independence. As needed, individual habilitation plans may focus on basic skills training in such areas as personal hygiene and dressing, as well as more complex activities such as shopping and use of public transportation. Individuals are encouraged to participate in daily activities such as housekeeping and meal preparation as appropriate. 2 4 Vocational Skills Training and Day Programs. The Company provides extensive vocational training or specialized day programs for most individuals served. Some individuals are able to be placed in community-based jobs, either independently or with job coaches, or may participate as part of a work team contracted for a specific service such as cleaning, sorting or maintenance. Clients not working in the community may be served through vocational workshops or day programs appropriate for their needs. The Company operates such programs and also contracts for this service with outside providers. The Company's philosophy is to enable all persons served to perform productive work in the community or otherwise develop vocational skills based on their individual abilities. Clients participating in specialized day programs may be older or have physical or health restrictions which prevent them from being employed or participating in vocational programs. Specialized day programs may include further training in daily living skills, community integration or specialized recreation activities. Counseling and Therapy Programs. The Company's counseling and therapy programs address the physical, emotional and behavioral challenges of individuals with MR/DD or ABI. Goals of the programs include the development of enhanced physical agility and ambulation, acquisition of adaptive skills for both personal care and work, as well as the development of coping skills and the use of alternative, responsible, and socially acceptable interpersonal behaviors. Individualized counseling programs may include group and individual therapies. Occupational and physical therapies and therapeutic recreation are provided based on the assessed needs of the individual. At each of its operations, the Company provides comprehensive individualized support and training programs that encourage greater independence and the development of personal and vocational skills commensurate with the particular individual's capabilities. As the individual progresses, new programs are created to encourage greater independence, self-respect and the development of additional personal or vocational skills. Job Corps Program Since 1976, the Company has been operating programs for disadvantaged youths through the federal Job Corps program administered by the U.S. Department of Labor (DOL), which provides for the educational and vocational skills training, health care, employment counseling and other support necessary to enable disadvantaged youths to become responsible working adults. The Company operates 15 Job Corps centers with a contracted capacity of approximately 7,300 persons. The Job Corps program is designed to address the severe unemployment problem faced by disadvantaged youths throughout the country. The typical Job Corps student is a 16- to 24-year old high school dropout who reads at the seventh grade level, comes from a disadvantaged background, has not held a regular job, and was living in an environment characterized by a troubled home life or other disruptive condition. Each center offers training in several vocational areas depending upon the particular needs and job market opportunities in the region. Students are required to participate in basic education classes to improve their academic skills and to complement their vocational training. High school equivalency classes are available to obtain GED certificates. Upon graduation or other departure from the program, each student is referred to the nearest Job Corps placement agency for assistance in finding a job or enrolling in a school or training program. Approximately 70% of the students completing the program have obtained jobs or continued their education elsewhere. The Company also provides, under separate contracts with the Department of Interior or the primary operator, certain administrative, counseling, educational, vocational and other support services for several Job Corps centers not operated by the Company. Other Youth Services Programs In December 1995, the Company began a strategic initiative to expand its Division for Youth Services beyond the Job Corps program and develop services that are designed to address the specific needs of at-risk and troubled youths to enable each youth to be a more productive member of the community. The youths targeted to be served through the strategic initiative range from youths who have special educational or support needs, to youths who exhibit a variety of behavioral and emotional disorders and in some instances have been diagnosed with mental retardation or other developmental disability, to pre-adjudicated and adjudicated youths who have entered the 3 5 juvenile justice system. Special needs and at-risk youth programs operated through the Company's Alternative Youth Services (AYS) subsidiary include residential treatment programs, the operation of alternative schools, foster care programs and emergency shelters. The Company plans to selectively expand the services provided to these youths. Programs offered for troubled youths through the Company's Youthtrack subsidiary include secure and staff-secure detention programs, long-term treatment programs, secure transportation, day treatment programs and monitoring, and transition and after-care programs. The Company's programs include a variety of educational and vocational training programs and comprehensive programs for behavior change, including individual, group and family counseling and training in social and independent living skills. These programs emphasize self-esteem, academic achievement, empathy development, critical thinking and problem solving, anger management and coping strategies, substance abuse treatment and relapse prevention. Programs are designed to: (i) increase self-control and effective problem-solving; (ii) teach youths how to understand and consider other people's values, behaviors and feelings; (iii) show youths how to recognize the effects of their behavior on other people and why others respond to them as they do; and (iv) enable youths to develop alternative, responsible, interpersonal behaviors. Although certain youths in the Company's programs require both drug therapy and treatment for use or abuse of drugs, the Company's goal is to minimize or eliminate the use of medication whenever possible. When appropriate, medication is prescribed by independent physicians and may be administered by Company personnel. Management believes that the breadth of the Company's services and its history of working with youths make the Company attractive to local, state and federal governmental agencies. OPERATIONS Disabilities Services Disabilities services operations are organized under six geographic regions for MR/DD services, along with separate business units for Periodic Services and ABI operations. In general, each cluster of group homes, supported living program or larger facility is overseen by an administrator. In addition, a program manager supervises a comprehensive team of professionals and community-based consultants who participate in the design and implementation of individualized programs for each individual served. QMRPs work with direct service staff and professionals involved in the programs to ensure that quality standards are met and that progress towards each individual's goals and objectives is monitored and outcomes are achieved. Individual habilitation plans are reviewed and modified by the team as needed. The operations utilize community advisory boards and consumer satisfaction surveys to solicit input from professionals, family members and advocates, as well as from the neighboring community, on how to continue to improve service delivery and increase involvement with the neighborhood or community. The Company's direct service staff has the most frequent contact with, and generally are recruited from, the community in which the facility or program is located. These staff members are screened to meet certain qualification requirements and receive orientation, training and continuing education. The provision of disabilities services is subject to complex and substantial state and federal regulation and the Company strives to ensure that its internal controls and reporting systems comply with Medicaid reimbursement and other program requirements, policies and guidelines. The Company designs and implements programs, often in coordination with appropriate state agencies, in order to assist the state in meeting its objectives and to facilitate the efficient delivery of quality services. Management and personnel resources are devoted to keeping abreast of new laws, regulations and policy directives affecting the quality and reimbursement of the services provided. In addition, the Company believes it has developed expertise in accurately monitoring eligibility for Medicaid and other benefits and in processing reimbursement claims. The Company has developed a model of ongoing program evaluation and quality management which the Company believes provides critical feedback to measure the quality of its various operations. Each operation conducts its own quality assurance program, the Best in Class (BIC) performance benchmarking system. BIC performance results are reviewed by management on an on-going basis. Management and operational goals and objectives are established for each facility and program as part of an annual budget and strategic planning process. A weekly statistical reporting system and quarterly statement of progress provide management with relevant and timely information on the operations of each facility. Survey results from governmental agencies for each operation 4 6 are recorded in a database and summary reports are reviewed by senior management. The Company believes the BIC system is a vital management tool to evaluate the quality of its programs and has been useful as a marketing tool to promote the Company's programs, since it provides more meaningful information than is usually provided by routine monitoring by governmental agencies. All disabilities services senior staff participate in a performance-based management system which evaluates individual performance based on critical job function outcomes. Additionally, the Company demonstrates its commitment to the professional development of its employees by offering classes and training programs, as well as tuition reimbursement benefits. Job Corps Program The Company's Job Corps centers are operated under contract with the DOL which provides the physical plant and equipment. The Company is directly responsible for the management, staffing and administration of Job Corps centers. A typical ResCare Job Corps operation consists of a three-tier management staff structure. The center director has the overall responsibility for day-to-day management at each facility and is assisted by several senior staff managers who typically are responsible for academics, vocational training, social skills, safety and security, health services and behavior management. Managers are assisted by front line supervisors who have specific responsibilities for such areas as counseling, food services, maintenance, finance, residential life, recreation, property, purchasing, human resources and transportation. An outcome performance measurement report for each center, issued by the DOL monthly, measures two primary categories of performance: (i) education results, as measured by GED/HSD achievement and/or vocational completion and attainment of employability skills; and (ii) placement of graduates. These are then combined into an overall performance rating. Centers are ranked on a 100-point scale by the DOL. Performance standards reports are reviewed by management and acted upon as appropriate to address areas where improvement is needed. Other Youth Services Programs The Company's youth programs are designed to provide consistent, high quality and cost-effective education and treatment to address the needs of the various segments of the special needs, at-risk and troubled youth populations. The Company generally is responsible for the overall operation of its facilities and programs, including management, general administration, staff recruitment, security and supervision of the youths in their programs. The Company has assembled an experienced team of managers, counselors and staff that blends program expertise with business and financial experience. The Company believes that its recruitment, selection and training programs develop personnel capable of implementing the Company's systems and procedures. The Company's staff includes teachers, counselors, mental health professionals, juvenile justice administrators and licensed clinicians. The Company's internal policies require its teachers, counselors, security and other direct service staff to complete extensive training. Core training includes courses in the major Company program components, such as behavior change education, positive peer culture, nonviolent crisis intervention, discipline and limit-setting, anger management and social skills training. Continuing education also is required for all staff. The Company demonstrates its commitment to its employees' professional development by offering classes and training programs, as well as tuition reimbursement benefits. The Company has also implemented its BIC system at the majority of its youth services programs. The Company recognizes that, in the operation of programs for at-risk and troubled youths, a primary mission is to protect the safety of the staff and youths within a facility, as well as the neighboring community. Thus, the Company's programs emphasize security, risk assessment and close supervision by responsible and well-trained staff. 5 7 FACILITIES AND PROGRAMS The following tables set forth information as of December 31, 2000 regarding the Company's disabilities services and youth services operations, respectively: DIVISION FOR PERSONS WITH DISABILITIES
Contract Initial Operation Location Types of Programs Capacity (1) in Location -------- ------------------ ------------ ------------ Alabama............................. Group Homes 50 1998 Arizona............................. Periodic Services, Supported Living 1,015 1998 California.......................... Larger Facilities, Group Homes 965 1995 Colorado............................ Supported Living, Group Homes 351 1992 Delaware............................ Group Homes 21 1999 Florida............................. Larger Facilities, Group Homes, ABI, 340 1983 Supported Living Georgia............................. Supported Living, Periodic Services, 2,306 1997 Group Homes Illinois............................ Larger Facilities, ABI, Group Homes 114 1995 Indiana............................. Larger Facilities, Group Homes, 1,507 1983 Supported Living Iowa................................ ABI 9 1998 Kansas.............................. Supported Living, Day Programs, 390 1995 Group Homes Kentucky............................ Larger Facilities, Group Homes, Supported 675 1978 Living, Day Programs Louisiana........................... Group Homes, Supported Living 478 1984 Maryland............................ Group Homes 19 1999 Missouri............................ Supported Living, ABI, Group Homes 467 1997 Nebraska............................ Group Homes, Supported Living, Day 290 1992 Program, Periodic Services Nevada.............................. Group Homes 280 1999 New Jersey.......................... Supported Living, Group Homes 138 1997 New Mexico.......................... Supported Living, Group Homes 288 1994 North Carolina...................... Periodic Services, Supported Living, 1,569 1997 Group Homes Ohio................................ Larger Facility, Group Homes, Supported 1,108 1995 Living Oklahoma............................ Supported Living 203 1995 Ontario, Canada..................... ABI 42 1999 Pennsylvania........................ Supported Living 21 1997 South Carolina...................... Periodic Services 200 1998 Tennessee........................... Group Homes, Supported Living 395 1993
6 8 FACILITIES AND PROGRAMS (CONTINUED) DIVISION FOR PERSONS WITH DISABILITIES
Contract Initial Operation Location Types of Programs Capacity (1) in Location -------- ------------------ ------------ ------------ Texas............................... Larger Facilities, Group Homes, Supported 2,803 1993 Living, Day Programs, ABI Virginia............................ Supported Living 6 1999 Washington.......................... Supported Living 70 1998 Washington, D.C..................... Group Homes 228 1999 West Virginia....................... Group Homes, Supported Living 562 1987 ------ Total............................... 16,910 =======
--------------- (1) Contract capacity includes, in the case of licensed facilities, the number of persons covered by the applicable license or permit, and generally in other cases, the number of persons covered by the applicable contract. Contract capacity does not include capacity for day programs. 7 9 DIVISION FOR YOUTH SERVICES
Initial Contract Operation Location Types of Programs Capacity (1) in Location -------- ----------------- ------------ ----------- Arizona....................... Job Corps (2 centers) 1,038 1997 Residential, Alternative School California.................... Job Corps 850 1999 Colorado...................... Residential, Non-Residential, Secure, 634 1996 Day Treatment, Apartment Living Florida....................... Job Corps, Residential 528 1983 Georgia....................... Residential, Alternative School 92 1997 Indiana....................... Foster Care, Residential 131 1997 Kentucky...................... Residential, Alternative School, 2,204 1996 Foster Care, Job Corps Maryland...................... Residential 18 1997 Mississippi................... Alternative School 59 1998 New Jersey.................... Job Corps 530 1995 New York...................... Job Corps (2 centers) 520 1986 Ohio.......................... Foster Care 65 1997 Oklahoma...................... Job Corps 650 1997 Pennsylvania.................. Job Corps 800 1997 Puerto Rico................... Job Corps (3 centers), Secure Treatment 915 1990 Tennessee..................... Alternative School, Shelter, 102 1997 Wilderness Program Utah.......................... Residential 27 1998 Virginia...................... Job Corps (2 centers) 550 1997 Washington, D.C............... Residential 45 1999 --------- Total.................... 9,758 ======
--------------- (1) Contract capacity includes, in the case of licensed facilities, the number of persons covered by the applicable license or permit, and generally in other cases, the number of persons covered by the applicable contract. CONTRACTS State Contracts. Contracts for participation as a provider of services in the Medicaid programs are regulated by federal and state agencies. Although the contracts 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 the Company has complied with licensing, certification, program standards and other regulatory requirements. Serious deficiencies can result in delicensure or decertification actions by these agencies. As provider of record, the Company contractually obligates itself 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 the Medicaid Assistance Program, Title XIX of the Social Security Act and pertinent state medical assistance programs. Pursuant to provider agreements, the Company agrees to accept the payment received from the government entity as payment in full for the services administered to the individuals and to provide the government entity with information regarding the owners and managers of the Company, as well as to comply with requests and audits of information pertaining to the services rendered. Provider agreements can be terminated at any time for non-compliance with the federal, state or local regulations. Reimbursement methods vary by state and service type and can be based on a flat-rate or cost-based reimbursement system on a per person, per diem or per unit-of-service basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements." 8 10 Contracts for the Company's youth services programs, excluding Job Corps, are regulated by state and local governmental entities. Contracts generally have one-year terms, subject to annual renewal, or cover individuals for specific terms. The contract rate is also accepted as payment in full for services rendered. Management Contracts. Management contracts with states, local agencies or other providers of record typically call for the Company to manage the day-to-day operations of facilities or programs. Many of these contracts are short-term (generally one year in duration) and are subject to renewal or re-negotiation provided that program standards and regulatory requirements are met. Depending upon the state's reimbursement policies and practices, management contracts provide fees to the Company computed on the basis of a fixed fee per individual (which may include some form of incentive payment), a percentage of operating expenses (cost-plus contracts), a percentage of revenue or an overall fixed fee paid regardless of occupancy. Historically, the Company's Medicaid provider contracts and management contracts have been renewed or satisfactorily renegotiated. The Company believes its experience in this regard is consistent with the overall experience of other operators in the disabilities services business. Job Corps Contracts. Contracts for Job Corps centers are awarded pursuant to a rigorous bid process. After successfully bidding, the Company operates the Job Corps centers under comprehensive contracts negotiated with the DOL. Under Job Corps contracts, the Company is reimbursed for all facility and program costs related to Job Corps center operations and allowable indirect costs for general and administrative expenses, plus a predetermined management fee, normally a fixed percentage of facility and program expense. The contracts cover a five-year period, consisting of an initial two-year term with three one-year renewal terms exercisable at the option of the DOL. The contracts specify that the decision to exercise an option is based on an assessment of: (i) the performance of the center as compared to its budget; (ii) compliance with federal, state and local regulations; (iii) qualitative assessments of center life, education, outreach efforts and placement record; and (iv) the overall rating received by the center. Shortly prior to the expiration of the five-year contract period (or earlier if the DOL elects not to exercise a renewal term), the contract is re-bid, regardless of the operator's performance. The current operator may participate in the re-bidding process. In situations where the DOL elects not to exercise a renewal term, however, it is unlikely that the current operator will be successful in the re-bidding process. It is the Company's experience that there is usually an inverse correlation between the performance ratings of the current operator and the number of competitors who will participate in the re-bidding process, with relatively fewer competitors expected where such performance ratings are high. The Company operates 15 Job Corps centers under twelve separate contracts with the DOL in South Bronx, New York, New York (2); Miami, Florida; Edison, New Jersey; Puerto Rico (3); Pittsburgh, Pennsylvania; Monroe, Virginia; Guthrie, Oklahoma; Phoenix and Tucson, Arizona; Marion, Virginia; Morganfield, Kentucky and San Francisco, California. Of the five-year periods covered by the Company's Job Corps contracts, one expires in 2001, one in 2002, two in 2003, three in 2004 and five in 2005. The Company intends to selectively pursue additional centers through the Request for Proposals (RFP) process. The Company also provides, under separate contracts with the Department of Interior or the primary operator, certain administrative, counseling, educational, vocational and other support services for several Job Corps centers not operated by the Company. MARKETING AND DEVELOPMENT The Company's marketing activities focus on initiating and maintaining contacts and working relationships with state and local governments and governmental agencies responsible for the provision of the types of disabilities services and youth services offered by the Company, and identifying other providers who may consider a management contract arrangement or other transaction with the Company. The Company's Chief Development Officer directs the Company's marketing efforts for disabilities services and youth services, except Job Corps. Responsibility for marketing activities also extends to other officers of the Company and its subsidiaries. Marketing activities are reviewed on a regular basis by senior management. 9 11 In its pursuit of government contracts, the Company contacts governments and governmental agencies in geographical areas in which it operates and in others in which it has identified expansion potential. Contacts are made and maintained by both regional operations personnel and corporate development personnel, augmented as appropriate by other senior management. The Company targets new areas based largely on its assessment of the need for its services, the system of reimbursement, the receptivity to out-of-state and proprietary operators, expected changes in the service delivery system (i.e., privatization or downsizing), the labor climate and existing competition. The Company also seeks to identify service needs or possible changes in the service delivery or reimbursement system of governmental entities that may be driven by changes in administrative philosophy, budgetary considerations, pressure or legal actions brought by advocacy groups. As needs or possible changes are identified, the Company attempts to work with and provide input to the responsible governmental personnel and to work with provider associations and consumer advocacy groups to this end. If an RFP results from this process, the Company then determines whether and on what terms it will respond and participate in the competitive process. With regard to identifying other providers who may be management contract or other transaction candidates, the Company attempts to establish relationships with providers through presentations at national and local conferences, membership in national and local provider associations, direct contact by mail, telephone or personal visits and follow up with information packets . In some cases, the Company may be contacted directly and requested to submit proposals or become a provider in order to provide services to address specific problems. These may include an emergency takeover of a troubled operation or the need to develop a large number of community placements within a certain time period. REFERRAL SOURCES The Company receives substantially all of its MR/DD clients from third party referrals. Generally, family members of persons with MR/DD are made aware of available residential or alternative living arrangements through a state or local case management system. Case management systems are operated by governmental or private agencies. The Company's ABI services receive referrals from doctors, hospitals, private and workers' compensation insurers and attorneys. In either case, where it is determined that some form of MR/DD or ABI service is appropriate, a referral of one or more providers of such services is then made to family members or other interested parties. The Company generally receives referrals or placements of individuals to its AYS and Youthtrack programs through state or local agencies or entities responsible for such services. Individuals are recruited to the Company's Job Corps programs largely through private contractors. The Company also has contracts directly with the DOL to recruit students to its own centers. The Company's reputation and prior experience with agency staff, case workers and others in positions to make referrals to the Company are important for building and maintaining census in the Company's operations. COMPETITION The provision of disabilities services and youth services is subject to a number of competitive factors, including range and quality of services provided, cost-effectiveness, reporting and regulatory expertise, reputation in the community, and the location and appearance of facilities and programs. These markets are highly fragmented, with no single company or entity holding a dominant market share. The Company competes with other for-profit companies, not-for-profit entities and governmental agencies. With regard to disabilities services, individual states remain a major provider of MR/DD services, primarily through the operation of large institutions. 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 these organizations are affiliated with advocacy and sponsoring groups such as community mental health and mental retardation centers and religious organizations. The other youth services business in which the Company engages is one that other entities may easily enter without substantial capital investment or experience in management of education or treatment facilities. In addition, certain not-for-profit entities may offer education and treatment programs at a lower cost than the Company due in 10 12 part to government subsidies, foundation grants, tax deductible contributions or other financial resources not available to for-profit companies. Currently, only a limited number of companies actively seek Job Corps contracts because the bidding process is highly specialized and technical and requires a significant investment of personnel and other resources over a period of several months. Approximately one-half of the privately-operated centers are operated by the three largest operators. Competition for Job Corps contracts has increased as the DOL has made efforts to encourage new participants in the program, particularly minority-owned businesses. Certain proprietary competitors operate in multiple jurisdictions and may be well capitalized. The Company also competes in some markets with smaller local companies that may have a better understanding of the local conditions and may be better able to gain political and public acceptance. Such competition may adversely affect the Company's ability to obtain new contracts and complete transactions on favorable terms. The Company faces significant competition from all of these providers in the states in which it now operates and expects to face similar competition in any state that it may enter in the future. Professional staff retention and development is a critical factor in the successful operation of the Company's business. The competition for talented professional personnel, such as therapists and QMRPs, is intense. The Company typically utilizes a standard professional service agreement for provision of services by certain professional personnel, which is generally terminable on 30 or 60-day notice. The demands of providing the requisite quality of service to persons with special needs contribute to a high turnover rate of direct service staff leading to increased overtime and the use of outside consultants and other personnel. Consequently, a high priority is placed on recruiting, training and retaining competent and caring personnel. In some tight labor markets, the Company has experienced difficulty in hiring direct service staff. This has resulted in higher labor costs to the Company in recent years. GOVERNMENT REGULATION AND REIMBURSEMENT The operations of the Company are subject to compliance with various federal, state and local statutes and regulations. Compliance with state licensing requirements is a prerequisite for participation in government-sponsored health care assistance programs, such as Medicaid. The following sets forth in greater detail certain regulatory considerations applicable to the Company: Funding Levels. Federal and state funding for the Company's disabilities services business is subject to statutory and regulatory changes, administrative rulings, interpretations of policy, intermediary determinations and governmental funding restrictions, all of which may materially increase or decrease program reimbursement. Congress has historically attempted to curb the growth of federal funding of such programs, including limitations on payments to programs under the Medicaid program. Although states in general have historically increased rates to compensate for inflationary factors, some have curtailed funding due to state budget deficiencies or other reasons. In such instances, providers acting through their state health care trade associations, may attempt to negotiate or employ legal action in order to reach a compromise settlement. Future revenues may be affected by changes in rate-setting structures, methodologies or interpretations that may be proposed or under consideration in states where the Company operates. Reimbursement Requirements. To qualify for reimbursement under Medicaid programs, facilities and programs are subject to various requirements of participation and other requirements imposed by federal and state authorities. In order to maintain a Medicaid or state contract, certain statutory and regulatory requirements must be met. These participation requirements relate to client rights, quality of services, physical plant and administration. Long-term providers, like the Company, are subject to periodic unannounced inspection by state authorities, often under contract with the appropriate federal agency, to ensure compliance with the requirements of participation in the Medicaid or state program. Licensure. In addition to the requirements to be met by the Company for participation in the Medicaid program, the Company's facilities and programs are usually subject to 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. State licensing and other regulatory requirements vary from jurisdiction to jurisdiction and are subject to change. 11 13 Regulatory Enforcement. From time to time, the Company receives notices from regulatory inspectors that, in their opinion, there are deficiencies for failure to comply with various regulatory requirements. The Company reviews such notices and takes corrective action as appropriate. In most cases, the Company and the reviewing agency agree upon the steps to be taken to bring the facility or program into compliance with regulatory requirements, and from time to time, the Company or one or more of its subsidiaries may enter into agreements with regulatory agencies requiring the Company to take certain corrective action in order to maintain licensure. Serious deficiencies, or failure to comply with any regulatory agreement, may result in the assessment of fines or penalties and/or decertification or delicensure actions by the Health Care Financing Administration or state regulatory agencies, as appropriate. Restrictions on Acquisitions and Additions. All states in which the Company currently operates have adopted laws or regulations which generally require that a state agency approve the Company as provider, and many require a determination that a need exists prior to the addition of beds or services. Cross Disqualifications and Delicensure. In certain circumstances, 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 (including 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. Regulation of Certain Transactions. The Social Security Act, as amended by the Health Insurance Portability and Accountability Act of 1996 (the "Health Insurance Act"), provides for the mandatory exclusion of providers and related persons from participation in the Medicaid program if the individual or entity has been convicted of a criminal offense related to the delivery of an item or service under the Medicaid program or relating to neglect or abuse of residents. Further, individuals or entities may be, but are not required to be, excluded from the Medicaid program under certain circumstances including, but not limited to, the following: convictions relating to fraud; obstruction of an investigation of a controlled substance; license revocation or suspension; exclusion or suspension from a state or federal health care program; filing claims for excessive charges or unnecessary services or failure to furnish medically necessary services; or ownership or control by an individual who has been excluded from the Medicaid program, against whom a civil monetary penalty related to the Medicaid program has been assessed, or who has been convicted of a crime described in this paragraph. The illegal remuneration provisions of the Social Security Act make it a felony to solicit, receive, offer to pay, or pay any kickback, bribe, or rebate in return for referring a resident for any item or service, or in return for purchasing, leasing or ordering any good, service or item, for which payment may be made under the Medicaid program. Other provisions in the Health Insurance Act proscribe false statements in billing and in meeting reporting requirements and in representations made with respect to the conditions or operations of facilities. A violation of the illegal remuneration statute is a felony and may result in the imposition of criminal penalties, including imprisonment for up to five years and/or a fine of up to $25,000. Further, a civil action to exclude a provider from the Medicaid program could occur. There are also other civil and criminal statutes applicable to the industry, such as those governing false billings and anti-supplementation restrictions and the new health care offenses contained in the Health Insurance Act, including health care fraud, theft or embezzlement, false statements and obstruction of criminal investigation of health care offenses. Criminal sanctions for these new health care criminal offenses can be severe. Sanctions for health care fraud offense, for example, include imprisonment for up to 20 years. The agencies administering the Medicaid program have increased their criminal and civil enforcement activity in the prevention of program fraud and abuse, including the payment of illegal remuneration. Environmental Laws. Certain federal and state laws govern the handling and disposal of medical, infectious, and hazardous waste. Failure to comply with those laws or the regulations promulgated under them could subject an entity covered by these laws to fines, criminal penalties, and other enforcement actions. OSHA. Federal regulations promulgated by the Occupational Safety and Health Administration impose additional requirements on the Company including those protecting employees from exposure to elements such as blood-borne pathogens. The Company cannot predict the frequency of compliance, monitoring, or enforcement 12 14 actions to which it may be subject as regulations are implemented and there can be no assurance that such regulations will not adversely affect the operations of the Company. INSURANCE The Company maintains professional and general liability, auto, workers' compensation and other business insurance coverages. As a result of decreasing availability of coverage at historical rates, the Company entered into new risk management programs pertaining to these coverages in December 2000, with certain of these programs providing for significantly higher self-insured retention limits and higher deductibles. The most significant change occurred in the Company's program for professional and general liability coverages. The previous program was generally fully insured after a deductible of $10,000 per occurrence. The new program provides for a $250,000 deductible per occurrence and claims limits of $1.0 million per occurrence up to a $3.0 million annual aggregate limit. Additionally, the program for auto insurance was revised to increase the deductible from $0 to $100,000 per occurrence. Umbrella coverages are in place for the auto and property insurance programs. The risk management programs for professional and general liability do not provide for umbrella coverages. As a result, the estimated cost for the Company's new business insurance programs is expected to be approximately $10 million more in 2001 than in 2000. All of the Company's business insurance programs are due for renewal July 1, 2001. The Company has implemented increased risk management initiatives and believes its insurance coverages and self-insurance reserves are adequate for its current operations. However, there can be no assurance that any potential losses on asserted claims will not exceed such insurance coverages and self-insurance reserves or that costs will not further increase. EMPLOYEES As of December 31, 2000, the Company employed approximately 30,000 employees. As of that date, the Company was subject to collective bargaining agreements with approximately 1,200 of its employees. The Company has not experienced any work stoppages and believes it has good relations with its employees. ITEM 2. PROPERTIES As of December 31, 2000, the Company owned approximately 300 properties and operated facilities and programs at approximately 2,100 leased properties. Other facilities and programs are operated under management contracts. See "Business - Facilities and Programs." ITEM 3. LEGAL PROCEEDINGS From time to time, the Company (or a provider with whom the Company has a management agreement), becomes a party to legal and/or administrative proceedings involving state program administrators and others that, in the event of unfavorable outcomes, may adversely affect revenues and period to period comparisons. In September 1997, a lawsuit, styled Cause No.: 98-00740, Nancy Chesser v. Normal Life of North Texas, Inc., and Normal Life, Inc. District Court of Travis County, Texas (Chesser) was filed against a Texas facility being operated by the former owners of Normal Life, Inc. and Normal Life of North Texas, Inc., subsidiaries of the Company, asserting causes of action for negligence, intentional infliction of emotional distress and retaliation regarding the discharge of residents of the facility. In May 2000, a judgment was entered in favor of the plaintiff awarding the plaintiff damages, prejudgment interest and attorneys' fees totaling $4.8 million. In October 2000, the Company and American International Specialty Lines Insurance Company (AISL) entered into an agreement whereby any settlement reached in Chesser and a related lawsuit also filed in District Court of Travis County, Texas would not be dispositive of whether the claims in the suits were covered under the policies issued by AISL. AISL thereafter settled the suits and filed a Complaint for Declaratory Judgment against Normal Life of North Texas, Inc. and Normal Life, Inc. in the U.S. District Court for the Northern District of Texas, Dallas Division. In the Complaint, AISL seeks a declaration of what insurance coverage is available to the Company in the lawsuits. It is the Company's position that the lawsuits initiated coverage under the primary policies of insurance, thus affording adequate coverage to settle the lawsuits within coverage and policy limits. The Company does not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operation or liquidity. In August 1998, with the approval of the State of Indiana, the Company relocated approximately 100 individuals from three of its larger facilities to community-based settings. In June 1999, in a lawsuit styled Omega Healthcare Investors, Inc. v. Res-Care Health Services, Inc., the owner of these facilities filed suit against the 13 15 Company in U.S. District Court, Southern District of Indiana, alleging in connection therewith breach of contract, conversion and fraudulent concealment. The Company, on the advice of counsel, believes that the amount of damages being sought by the plaintiffs is approximately $21 million. It appears the claims for compensatory damages may be duplicative. Management believes that this lawsuit is without merit and will defend it vigorously. The Company does not believe the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operations or liquidity. The Texas Attorney General, on behalf of the Texas Department of Human Services, filed suit in the District Court of Harris County, Texas initially seeking civil penalties of approximately $2.7 million in connection with the operation of one group home in Texas. The complaint alleged that the Company failed to ensure that the needs of the individuals residing in this home were being adequately assessed and provided for, including appropriate medical care. In December 2000, the Company entered into a Compromise and Settlement Agreement with the State which settles any and all disputes between the parties regarding the State's claim for civil penalties. In consideration for the settlement, the Company agreed to pay $1.0 million, which is comprised of $600,000 in compensatory and remedial costs and $400,000 in attorneys' fees and other costs. In July 2000, AISL filed a Complaint for Declaratory Judgment against the Company and one of its subsidiaries in the U.S. District Court for the Southern District of Texas, Houston Division. In the Complaint, AISL seeks a declaration of what insurance coverage is available to the Company in Cause No. 299291-401; In re: Estate of Trenia Wright, Deceased, et al. v. Res-Care, Inc., et al. which was filed in Probate Court No. 1 of Harris County, Texas (the Lawsuit). Subsequent to the filing, the Company and AISL entered into an agreement whereby any settlement reached in the Lawsuit would not be dispositive of whether the claims in the Lawsuit were covered under the policies issued by AISL. AISL thereafter settled the Lawsuit. It is the Company's position that the Lawsuit initiated coverage under the primary policies of insurance in more than one policy year, thus affording adequate coverage to settle the lawsuit within coverage and policy limits. The Company does not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operations or liquidity. Also, in October 2000, the Company and a subsidiary, Res-Care Florida, Inc., f/k/a Normal Life Florida, Inc., entered into an agreement with AISL to resolve through binding arbitration a dispute as to the amount of coverage available to settle a lawsuit which had previously been filed in Pinellas County Circuit Court, Florida and subsequently settled after the agreement was entered into. AISL contends that a portion of the settlement reached was comprised of punitive damages and, therefore, not the responsibility of AISL. It is the Company's position that the settlement was an amount which a reasonable and prudent insurer would pay for the actual damages alleged and that AISL had opportunities to settle all claims within available coverage limits. The Company does not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operation or liquidity. In addition, the Company is a party to various other legal and/or administrative proceedings arising out of the operation of its facilities and programs and arising in the ordinary course of business. The Company believes that most of these claims are without merit. Further, many of such claims may be covered by insurance. The Company does not believe the results of these proceedings or claims, individually or in the aggregate, will have a material adverse effect on its consolidated financial condition, results of operations or liquidity. Defaults Upon Senior Securities Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 14 16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock began trading on the NASDAQ National Market on December 15, 1992, under the symbol "RSCR". As of February 28, 2001, the Company had approximately 6,100 shareholders based on the number of holders of record and an estimate of the number of individual participants represented by security position listings. The following table sets forth the reported high and low sale prices for Res-Care's common stock as reported by NASDAQ.
2000 1999 ---------------------------------- ------------------------------------- QUARTER ENDED HIGH LOW HIGH LOW ------------- ---- --- ---- --- March 31 16.625 7.250 26.000 19.500 June 30 14.125 4.313 23.500 16.000 September 30 7.500 3.940 24.500 16.500 December 31 6.000 3.630 17.625 10.750
The Company currently does not pay dividends and does not anticipate doing so in the foreseeable future. 15 17 ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related notes.
Year Ended December 31 ---------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- FINANCIAL DATA (1): (In thousands, except per share and operating data) Revenues ............................ $865,796 $824,479 $702,914 $468,108 $315,589 Operating income (2) ................ 47,382 38,639 52,310 32,362 20,108 Income from continuing operations ... 14,176 9,736 22,932 15,631 10,822 Net income (3) ...................... 14,176 6,338 22,932 15,631 10,822 Basic earnings per share: From continuing operations ..... $ 0.58 $ 0.40 $ 0.96 $ 0.69 $ 0.54 Net income ..................... 0.58 0.26 0.96 0.69 0.54 Diluted earnings per share: From continuing operations ..... 0.58 0.39 0.90 0.68 0.52 Net income ..................... 0.58 0.25 0.90 0.68 0.52 Pro forma net earnings per share (1): Basic .......................... 0.58 0.26 0.96 0.69 0.53 Diluted ........................ 0.58 0.25 0.90 0.68 0.51 Working capital ..................... $122,305 $102,141 $ 75,524 $106,001 $ 39,475 Total assets ........................ 536,106 523,131 493,793 344,301 190,029 Long-term obligations ............... 269,164 285,039 251,682 150,910 63,870 Shareholders' equity ................ 178,123 163,384 154,587 124,325 77,117 OPERATING DATA (1): Disabilities Services: Contract capacity (4) .......... 16,910 16,219 12,271 6,831 5,031 Persons served ................. 16,561 15,927 11,952 6,628 4,899 Capacity utilized .............. 97.9% 98.2% 97.4% 97.0% 97.4% Job Corps and Other Youth Services: Contract capacity (4) .......... 9,758 10,151 8,572 5,455 2,670 Persons served ................. 9,410 8,340 8,395 5,323 2,605 Capacity utilized .............. 96.4% 82.2% 97.9% 97.6% 97.6%
----------------------- (1) In June 1999, the Company completed a merger with PeopleServe, Inc. and in January 1997, the Company acquired the partnership interests in Premier Rehabilitation Centers. Both transactions were accounted for as poolings-of-interests. Accordingly, the Company's financial statements have been restated for all periods presented to include the financial condition and results of operations of PeopleServe and Premier. Pro forma amounts have been presented to reflect the tax effect of the Premier partnership interests in 1996. Operating data for years prior to merger has not been restated to reflect the operations of PeopleServe and Premier. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". (2) Operating income for 2000 includes the following: (1) a charge of $1.8 million ($1.1 million net of tax, or $0.04 per share) related to the write-off of costs associated with the terminated management-led buyout, and (2) a charge of $1.7 million ($1.0 million net of tax, or $0.04 per share) related to the Company's 2000 restructuring plan. Operating income for 1999 includes an additional provision for doubtful accounts of $8.0 million ($4.6 million net of tax, or $0.19 per diluted share). Operating income for 1999 also includes the merger-related charge of $20.5 million ($13.7 million net of tax, or $0.55 per share) recorded in connection with the PeopleServe merger. (3) Net income for 1999 includes a charge of $3.9 million ($0.16 per basic and diluted share) for the cumulative effect of the adoption of Statement of Position 98-5, Reporting on the Costs of Start-up Activities, effective January 1, 1999. Net income also includes a gain recognized on the sale of a discontinued operation of $534 thousand in 1999 ($0.02 per basic and diluted share). (4) Contract capacity includes, in the case of licensed facilities, the number of persons covered by the applicable license or permit and, in all other cases, the number of persons covered by the applicable contract. Contract capacity does not include capacity for day programs. 16 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW ResCare receives revenues primarily from the delivery of residential, training, educational and support services to populations with special needs. The Company has three reportable operating segments: (i) disabilities services; (ii) Job Corps program; and (iii) other youth services programs. Management's discussion and analysis of each segment follows. Further information regarding each of these segments, including the required disclosure of certain segment financial information, is included in Note 9 of the Notes to Consolidated Financial Statements of the Company. Revenues for the Company's disabilities services operations are derived primarily from state government agencies under the Medicaid reimbursement system and from management contracts with private operators, generally not-for-profit providers, who contract with state government agencies and are also reimbursed under the Medicaid system. Reimbursement methods vary by state, and service type, and have historically been based on a flat rate or cost-based reimbursement system on a per person, per diem or per unit-of-service basis. Generally, rates are adjusted annually based primarily upon historical costs experienced by the Company and by other service providers, and on inflation. At facilities and programs where it is the provider of record, the Company is directly reimbursed under state Medicaid programs for services it provides and such reimbursement is affected by occupancy levels. At most facilities and programs that the Company operates pursuant to management contracts, the management fee is negotiated based upon the reimbursement amount expected to be earned by the provider of record, which is affected by occupancy levels. Under certain management contracts, the Company is paid a fixed fee regardless of occupancy levels. See Note 1 of Notes to Consolidated Financial Statements for a further discussion of the Company's revenue recognition policies with respect to Medicaid contracts. The Company operates 15 vocational training programs under the federal Job Corps program administered by the United States Department of Labor (DOL). Under the Job Corps program, the Company is reimbursed for direct costs related to Job Corps center operations and allowable indirect costs for general and administrative expenses, plus a predetermined management fee, normally a fixed percentage of facility and program expenses. All of such amounts are reflected as revenue, and all such direct costs are reflected as facility and program expenses. Final determination of amounts due under Job Corps contracts is subject to audit and review by the DOL, and renewals and extension of Job Corps contracts are based in part on performance reviews. In 1996, the Company began operating other programs for at-risk and troubled youths through its Alternative Youth Services (AYS) and Youthtrack (Youthtrack) subsidiaries. Most of the youth services programs are funded directly by federal, state and local government agencies including school systems. Under these contracts, the Company is typically reimbursed based on fixed contract amounts, flat rates or cost-based rates. Expenses incurred under federal, state and local government agency contracts for disabilities services, Job Corps and other youth services, as well as management contracts with providers of record for such agencies, are subject to examination by agencies administering the contracts and services. The Company's revenues and net income may fluctuate from quarter to quarter, in part because annual Medicaid rate adjustments may be announced by the various states inconsistently and are usually retroactive to the beginning of the particular state's fiscal reporting period. The Company expects that future adjustments in reimbursement rates in most states will consist primarily of cost-of-living adjustments, adjustments based upon reported historical costs of operations, or other negotiated increases. However, in some cases states have revised their rate-setting methodologies, which has resulted in rate decreases as well as rate increases. Current initiatives at the federal or state level may materially change the Medicaid system as it now exists. Retroactively calculated contractual adjustments are estimated and accrued in the periods the related services are rendered and recorded as adjustments in future periods as final adjustments are received. Because the cumulative effect of rate adjustments may differ from previously estimated amounts, net income as a percentage of revenues for a period in which an adjustment occurs may not be indicative of expected results in succeeding periods. Future revenues may be affected by changes in rate-setting structures, methodologies or interpretations that may be proposed or are under consideration in states where the Company operates. Also, some states have considered initiating managed care 17 19 plans for persons currently in Medicaid programs. At this time, the Company cannot determine the impact of such changes, or the effect of various federal initiatives that have been proposed. RECENT DEVELOPMENTS Amended Credit Agreement On February 28, 2001, the Company amended and restated its credit agreement with a group of banks to provide for an $80.0 million revolving credit facility (including a $35.0 million letter of credit sub-limit) and an $80.0 million term loan. The amended revolving credit facility expires on January 2, 2003 and bears interest at LIBOR plus an applicable margin based on a debt to cash flow ratio, as defined in the credit agreement. The term loan provides for increasing quarterly principal reductions beginning on June 30, 2001 with the balance due at January 2, 2003. The agreement also specifies additional reductions in the term loan based on the Company's cash flow from operations, as defined, and substantially all proceeds from future property sale and leaseback transactions during the term of the loan. Interest on the outstanding term loan is also based on LIBOR plus an applicable margin. The amended agreement provides for higher margins over LIBOR compared to the previous agreement. During 2000, the Company's weighted average interest rate on its revolving credit facility approximated LIBOR plus 200 basis points. The Company expects the average interest rate for 2001 under the amended agreement to approximate LIBOR plus 325 basis points. Management expects this increase in margin to result in approximately $1.2 million in additional interest expense for 2001 under the amended agreement as compared to the prior credit agreement. Borrowings under the amended credit agreement are secured by the Company's assets, including accounts receivable, owned property and equipment and intangible assets. Additionally, the amended credit agreement contains revised financial covenants. Pending Cessation of Certain Operations in Tennessee Since 1993, the Company has operated various group homes in the state of Tennessee under its disabilities services division. Discussions in February 2001 with the applicable regulatory bodies in Tennessee have caused management to begin implementing plans to cease certain operations in the state. This is due in part to management's expectation that the rate environment in Tennessee will be inadequate to achieve its desired level of profitability commensurate with its assumed risk. These operations accounted for revenues of $9.3 million in 2000. Management is currently evaluating the recoverability of certain related long-lived assets, including intangibles. As of December 31, 2000, the unamortized balances of goodwill and covenants not to compete were approximately $1.2 million and $800,000, respectively. Management expects to adjust the carrying value of the related long-lived assets to their estimated fair value during the first quarter of 2001. The estimated fair value will be based on anticipated future cash flows discounted at a rate commensurate with the risk involved. Based on current estimates, management expects to record a charge of approximately $1.0 million to $2.0 million in the first quarter of 2001 related to this development. Sale and Leaseback Transactions In December 2000, the Company entered into several transactions for the sale of certain real properties in which it conducts operations. Proceeds from the sales were approximately $26.5 million. The assets are being leased back from the purchasers over terms ranging from five years to 18 years. The leases are being accounted for as operating leases. Certain of the transactions resulted in a loss of approximately $357,000, which was recognized in 2000 and is included in special charges in the Company's consolidated statement of income. The remaining transactions resulted in a gain of approximately $2.4 million, which is being amortized over the respective lease terms. The leases contain purchase options at amounts approximating fair value and renewal options at lease termination. During 2001, the Company is pursuing opportunities for additional sale and leaseback transactions in an effort to reduce amounts borrowed under its amended credit agreement. 18 20 Insurance Programs The Company maintains professional and general liability, auto, workers' compensation and other business insurance coverages. As a result of decreasing availability of coverage at historical rates, the Company entered into new risk management programs pertaining to these coverages in December 2000, with certain of these programs providing for significantly higher self-insured retention limits and higher deductibles. The most significant change occurred in the Company's program for professional and general liability coverages. The previous program was generally fully insured after a deductible of $10,000 per occurrence. The new program provides for a $250,000 deductible per occurrence and claims limits of $1.0 million per occurrence up to a $3.0 million annual aggregate limit. Additionally, the program for auto insurance was revised to increase the deductible from $0 to $100,000 per occurence. Umbrella coverages are in place for the auto and property insurance programs. The risk management programs for professional and general liability do not provide for umbrella coverages. As a result, the estimated cost for the Company's new business insurance programs is expected to be approximately $10 million more in 2001 than in 2000. All of the Company's business insurance programs are due for renewal July 1, 2001. The Company has implemented increased risk management initiatives and believes its insurance coverages and self-insurance reserves are adequate for its current operations. However, there can be no assurance that any potential losses on asserted claims will not exceed such insurance coverages and self-insurance reserves or that costs will not further increase. RESULTS OF OPERATIONS Revenues for 2000 increased to a record $865.8 million, or 5% over 1999. This represents, however, a significantly lower growth rate than in recent years as the Company has shifted its focus from acquisition-related growth to internally generated growth. Revenues grew 17% in 1999 over 1998 resulting primarily from a full year of revenues from operations which were added in 1998. As discussed below, this change in growth strategy is due in part to limitations on the Company's ability to raise additional capital to support development-driven activities. Operating results of the Company for 2000 reflect increased costs from a highly competitive labor market. The Company is continuing several initiatives to manage these labor cost increases, including improved recruitment and retention programs, evaluating and monitoring staff patterns and negotiating improved reimbursement rates from certain states. The consolidated results for 2000 were also negatively impacted by certain special charges. Operating income for 2000 included a charge of $1.8 million related to the write-off of costs associated with the terminated management-led buyout and a charge of $1.7 million related to the Company's 2000 restructuring plan implemented in the third quarter of 2000. Operating results of each segment are discussed below. Operating results for 1999 were negatively impacted by an additional provision for doubtful accounts of $8.0 million. The Company is continuing the process of implementing a new comprehensive accounts receivable system. As a result, improvements in monitoring and collection of accounts receivable have been realized during 2000, and management expects continued improvement throughout 2001. Also in 1999, the Company recorded a charge of approximately $2.5 million as a result of higher claims incurred as the Company transitioned to a new employee medical plan with a fixed level of self-insurance exposure. Looking forward to 2001, contribution margins across all segments are expected to be negatively impacted by the increased insurance costs described above. The increase in insurance costs is an industry-wide issue affecting long-term care providers. These cost increases, however, are expected to be offset by benefits from the restructuring plan implemented in 2000, efforts to control labor costs and initiatives seeking improved rates from various states. As a percentage of total revenues, corporate general and administrative expenses were 3.2% in 2000, 3.4% in 1999 and 3.9% in 1998. Savings achieved from the 2000 restructuring plan contributed to the decrease in 2000 while the decrease in 1999 primarily reflected savings resulting from the PeopleServe merger. In connection with the merger with PeopleServe, ResCare recorded a pretax merger-related charge of $20.5 million in 1999. This consisted primarily of $7.3 million in severance and employee-related costs (principally related to the elimination of PeopleServe's corporate offices and various other administrative costs), $2.8 million in lease termination costs, $3.0 million in information system conversion and integration costs and $4.5 million in transaction costs, including investment banking, legal, accounting and other professional fees and transaction costs. Through December 31, 2000, approximately $20.1 million of the charge had been utilized through $15.1 million in cash payments (principally severance and transaction costs), $4.7 million in asset write-downs (relating principally to the discontinued PeopleServe information systems) and $300,000 in adjustments to the reserve in 2000 resulting from revised estimates of costs associated with the closure of duplicate facilities. The Company believes the 19 21 remaining balance of accrued merger-related costs of $400,000 at December 31, 2000 reflects its remaining cash obligations. Interest expense increased $3.5 million in 2000 compared to 1999 and $4.4 million in 1999 compared to 1998. These increases resulted from increased utilization of the credit facility primarily for working capital and, to some extent, higher interest rates. The Company's effective income tax rates were 42.9%, 51.0% and 40.3% in 2000, 1999 and 1998, respectively. The higher effective rate in 1999 is attributable to nondeductible amortization of goodwill recorded in the PeopleServe merger and nondeductible portions of the merger-related charge. The rate for 2000 was negatively impacted by reduced earnings combined with a fixed level of nondeductible goodwill amortization, offset to an extent by increased estimated jobs tax credits. Disabilities Services The disabilities services segment was the most significantly impacted by the slowed growth and labor cost pressures described above. Disabilities services revenues increased by 4% in 2000 compared to a 15% increase in 1999 over 1998. Revenues increased in 2000 due primarily to rate adjustments and the expansion of existing programs while acquisition growth primarily fueled the increase in 1999. Segment profit as a percentage of revenue declined to 9.4% in 2000 compared to 10.8% in 1999 and 11.7% in 1998. As discussed above, tight labor market conditions have resulted in higher labor costs and reduced margins. Labor costs, as a percentage of segment revenues, were approximately 54%, 52% and 50% in 2000, 1999 and 1998, respectively. During 1999, results for the disabilities division were negatively affected by the additional allowance for doubtful accounts of $8.0 million ($0.19 per share after tax) described above. Also during 1999, operating results for the disabilities services division were negatively affected by an incremental charge of approximately $2.3 million related to the transition to a new employee medical plan as described above. Job Corps Program Job Corps revenues increased by 6% in 2000 over 1999 and 25% in 1999 over 1998, resulting primarily from the addition of the Treasure Island Job Corps Center in early 1999. Segment profit as a percentage of revenues remained stable at 10.9% in 2000 compared to 10.6% in 1999 while 1999 margins decreased from 11.4% in 1998 due principally to increased costs associated with the start-up of the Treasure Island Job Corps Center. Other Youth Services Programs (Youthtrack and AYS) Other youth services revenues increased by 16% in 2000 compared to 1999 and 38% in 1999 over 1998, resulting primarily from increased occupancy at its AYS operations and a full year of operations for a Youthtrack program acquired in the fourth quarter of 1998. Segment profit declined from 10.1% in 1999 to 7.8% in 2000 due primarily to higher labor costs. LIQUIDITY AND CAPITAL RESOURCES During the year ended December 31, 2000, cash provided by operating activities was $39.3 million compared to $5.5 million for 1999 and $5.7 million for 1998. The increase in 2000 from 1999 was due primarily to the significant improvements made in the collection of accounts receivable resulting from initiatives undertaken in 2000 coupled with an increase in average days outstanding in accounts payable. During the year ended December 31, 2000, cash provided by investing activities was $6.7 million, while in 1999 and 1998, cash used in investing activities was $38.4 million and $139.6 million, respectively. Cash provided by investing activities in 2000 resulted primarily from the sale and leaseback of certain of the Company's owned properties in the fourth quarter with cash proceeds of $26.5 million. Cash used in investing activities in 1999 and 1998 relate primarily to acquisitions and purchases of property and equipment. Financing activities for 2000 resulted in the use of cash amounting to $19.7 million, primarily related to repayment of borrowings under the revolving line-of-credit. During 1999 and 1998, financing activities provided cash of $29.5 million and $74.6 million, respectively, primarily related to borrowings under the revolving line-of- 20 22 credit. The shift in 2000 from increased borrowings to net repayment of debt is a direct result of the Company's slowed growth strategy and improvements in accounts receivable and accounts payable management discussed above. Days revenue in accounts receivable were 59 days at December 31, 2000, compared to 62 days at December 31, 1999, and 60 days at December 31, 1998. Accounts receivable at December 31, 2000 increased to $142.8 million, compared to $141.8 million at December 31, 1999 and $127.1 million at December 31, 1998. Growth in these amounts from 1998 to 1999 was primarily related to delays in payment from certain state Medicaid programs relating to the integration of acquired operations. The improvement from 1999 to 2000 reflects successful initiatives undertaken in 2000 to improve collection procedures and enhance billing capabilities. The Company's capital requirements relate primarily to the working capital needed for general corporate purposes and the Company's plans to expand through the development of new facilities and programs. The Company has historically satisfied its working capital requirements, capital expenditures and scheduled debt payments from its operating cash flow and utilization of its credit facility. Cash requirements for the acquisition of new business operations have generally been funded through a combination of these sources, as well as the issuance of long-term obligations and common stock. Current conditions in the capital markets, especially for companies identified as health-care related, have limited the Company's ability to raise capital. As a result, the Company's growth rate going forward, with its emphasis on internally generated growth, will be lower than in recent years when acquisition activity, combined with the Company's internal growth, produced higher overall growth rates. The Company continues to explore other sources of capital, including additional sale and leaseback transactions involving its owned real estate properties, and believes such sources in addition to cash generated from operations and amounts remaining available under its credit facility will be sufficient to meet its working capital, planned capital expenditure and scheduled debt repayment requirements for the next twelve months. As discussed above, in February 2001, the Company amended its credit facility with a group of banks. As of the date of the amendment, the Company had borrowings under the previous facility of approximately $123.7 million and outstanding letters-of-credit of approximately $24.8 million, for a total of $148.5 million. Upon execution of the amendment, $80.0 million of the borrowings were converted to term indebtedness providing for quarterly payments totaling $10.5 million in 2001, and $17.0 million in 2002. The remaining borrowings of $68.5 million and standby letters of credit constituted borrowings under the new $80.0 million revolving credit facility. As a result, as of February 28, 2001, in addition to cash and cash equivalents of $25.0 million, the Company had approximately $11.5 million available under its amended credit facility. The amended credit agreement expires in January 2003. The amended facility also contains various financial covenants relating to indebtedness, capital expenditures, acquisitions and dividends and requires the Company to maintain specified ratios with respect to fixed charge coverage, leverage and cash flow from operations. The Company's ability to achieve the thresholds provided for in the financial covenants is largely dependent upon the maintenance of continued profitability and/or reductions of amounts borrowed under the amended facility. CERTAIN RISK FACTORS The Company's historical growth in revenues and earnings per share has been directly related to significant increases in the number of individuals served in each of its operating segments. This growth has depended largely upon development-driven activities, including the acquisitions of other businesses or facilities, the acquisition of management contract rights to operate facilities, the award of contracts to open new facilities or start new operations or to assume management of facilities previously operated by governmental agencies or other organizations, and the extension or renewal of contracts previously awarded to the Company. As discussed above, the Company's ability to raise additional capital to support development-driven activities, particularly acquisitions, is currently limited and management expects the Company's growth over the next twelve months to be consistent with 2000. In this environment, the Company's future revenues will depend significantly upon the Company's ability to maintain and renew its existing service contracts and its existing leases, and to a lesser extent upon the Company's ability to obtain, without significant outlays of capital, additional contracts to provide services to the special needs populations it serves, whether through awards in response to requests for proposals for new programs or in connection with facilities being privatized by governmental agencies, or by selected acquisitions. Changes in the market for services and contracts, including increasing competition, transition costs or costs to implement 21 23 awarded contracts, could also adversely affect the timing and/or viability of future development activities. Additionally, many of the Company's contracts are subject to state or federal government procurement rules and procedures; changes in procurement policies that may be adopted by one or more of these agencies could adversely affect the Company's abilities to obtain and retain these contracts. Revenues of the Company's disabilities services segment depend highly on reimbursement under federal and state Medicaid programs. Generally, each state has its own Medicaid reimbursement regulations and formula. The Company's revenues and operating profitability depend on the Company's ability to maintain its existing reimbursement levels and to obtain periodic increases in reimbursement rates. Changes in the manner in which Medicaid reimbursement rates are established in one or more of the states in which the Company conducts its operations could adversely affect revenues and profitability. Other changes in the manner in which federal and state reimbursement programs are operated, including changes in the interpretation of program policies and procedures by the current administrations, and in the manner in which billings/costs are reviewed and audited could also affect revenues and operating profitability. Additionally, the Health Care Financing Administration is undertaking initiatives that are expected to result in increased scrutiny of state-funded programs. Such initiatives, including audits of state-funded programs and reviews of waiver programs administered by states in which the Company operates, could adversely affect revenues and profitability. The Company's cost structure and ultimate operating profitability significantly depend on its labor costs, the availability of qualified personnel in each geographic area and the effective utilization of its labor force. These may be adversely affected by a variety of factors, including local competitive forces, changes in minimum wages or other direct personnel costs, strikes or work stoppages by certain of its employees represented by labor unions, the Company's future effectiveness in managing its direct service staff, and changes in consumer services models, such as the trends toward supported living and managed care. The difficulty experienced in hiring direct service staff in certain markets has resulted in higher labor costs in certain operating units of the Company. These include costs associated with increased overtime, recruitment and retention and training programs, and use of temporary staffing personnel and outside clinical consultants. Additionally, the Company's continued maintenance and expansion of its operations depend on the continuation of trends toward downsizing, privatization and consolidation and the Company's ability to tailor its services to meet the specific needs of the populations it serves. The Company's success in a changing operational environment is subject to a variety of political, economic, social and legal pressures, including desires of governmental agencies to reduce costs and increase levels of services, federal, state and local budgetary constraints, and actions brought by advocacy groups and the courts to change existing service delivery systems. Material changes resulting from these trends and pressures could adversely affect the demand for and reimbursement of the Company's services and its operating flexibility, and ultimately its revenues and profitability. Recent media coverage of the health care industry, including operators of facilities and programs for persons with mental retardation and other developmental disabilities, has included reports critical of the current trend toward privatization and of the operation of certain of these facilities and programs, including some operated by the Company. Adverse media coverage about providers of these services in general and the Company in particular has led to increased regulatory scrutiny in some areas, and could, among other things, adversely affect the Company's ability to obtain or retain contracts, discourage government agencies from privatizing facilities and programs, increase regulation and resulting compliance costs, discourage clients from using the Company's services, or otherwise adversely affect the Company's revenues and profitability. Recently Proposed Accounting Standard In February 2001, the Financial Accounting Standards Board issued a revision to its September 1999 Exposure Draft, Business Combinations and Intangible Assets, that proposes to change the accounting for goodwill acquired in a purchase business combination. Under the revised proposal, goodwill would not be amortized but would be reviewed for impairment, using a complex methodology, when an event occurs indicating the potential for impairment. The non-amortization approach would apply to previously recorded goodwill as well as goodwill arising from acquisitions completed after the application of the new standard. If approved for issuance, the rules would be effective in the third quarter of 2001. It is unclear as to whether the proposed statement as currently drafted will be issued in its final form. As a result, management is unable to 22 24 determine whether adoption of these proposed rules will have a material effect on the Company's consolidated financial position or results of operations. FORWARD-LOOKING STATEMENTS Certain statements contained in this report which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the Act). In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward-looking statements. These forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per share, capital structure and other financial items; (2) statements of plans and objectives of the Company or its management or Board of Directors; (3) statements of future actions or economic performance, including development activities; and (4) statements of assumptions underlying such statements. Words such as "believes," "anticipates," "expects," "intends," "plans," "targeted," and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from those in such statements. Some of the events or circumstances that could cause actual results to differ from those discussed in the forward-looking statements are discussed in the "Certain Risk Factors" section above. Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date on which such statement is made. 23 25 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK While the Company is exposed to changes in interest rates as a result of its outstanding variable rate debt, the Company does not currently utilize any derivative financial instruments related to its interest rate exposure. The Company believes that its exposure to market risk will not result in a material adverse effect on the Company's consolidated financial condition, results of operations or liquidity. 24 26 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Financial Statements - Res-Care, Inc. and Subsidiaries: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements Refer to pages F-1 through F-20. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 25 27 PART III ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by these Items is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report which includes the required information. The required information contained in the Company's proxy statement is incorporated herein by reference. 26 28 PART IV ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Documents filed as part of this Report (1) Consolidated Financial Statements - Res-Care, Inc. and Subsidiaries (refer to "F" pages): Independent Auditors' Report Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements (2) All financial statement schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or related notes. (3) Listing of Exhibits: 3.1 Amended and Restated Articles of Incorporation of the Company dated December 18, 1992 incorporating the Amendment to Amended and Restated Articles of Incorporation dated May 29, 1997. Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 is hereby incorporated by reference. 3.2 Amended and Restated Bylaws of the Company. Exhibit 4.5 to the Company's Registration Statement on Form S-8 (Reg. No. 333-50726) is hereby incorporated by reference. 4.1 Article VI of the Amended and Restated Articles of Incorporation of the Company included in Exhibit 3.1. 4.2 Indenture, dated as of November 21, 1997, between the Company and PNC Bank, Kentucky, Inc. Exhibit 4.3 to the Company's Registration Statement on Form S-3, (Reg. No. 333-44029) is hereby incorporated by reference. 4.3 Statement of Additional Terms and Conditions dated as of March 15, 1998 relating to $22,000,000 of 5.9% Convertible Subordinated Notes due 2005. Exhibit 2.2 of the Company's Report on Form 8-K dated March 12, 1998 and filed on March 27, 1998 is hereby incorporated by reference. 10.1 1991 Incentive Stock Option Plan of the Company (adopted April 24, 1991, amended and restated as of February 23, 1995). Exhibit 4 to the Company's Registration Statement on Form S-8 (Reg. No. 33-80331) is hereby incorporated by reference. 10.2 Amendment to Amended and Restated 1991 Incentive Stock Option Plan of the Company. Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997 is hereby incorporated by reference. 10.3 1993 Non-Employee Directors Stock Ownership Incentive Plan of the Company (adopted October 28, 1993). Exhibit 4.1 to the Company's Registration Statement on Form S-8 (Reg. No. 33-76612) is hereby incorporated by reference.
27 29 10.4 Res-Care, Inc. 1998 Omnibus Stock Plan effective June 18, 1998. Exhibit 4.1 to the Company's Registration Statement on Form S-8 (No. 333-57167) is hereby incorporated by reference. 10.5 1994 Employee Stock Purchase Plan effective July 1, 1995. Exhibit 4.1 to the Company's Registration Statement on Form S-8 (Reg. No. 33-85964) is hereby incorporated by reference. 10.6 Res-Care, Inc. 401(K) Restoration Plan effective December 1, 1995. (filed herewith) 10.7 Amended and Restated Employment Agreement dated as of October 26, 1995, and amended November 5, 1996, between the Company and Ronald G. Geary. Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 is hereby incorporated by reference. 10.8 Res-Care, Inc. 2000 Stock Option and Incentive Compensation Plan. Exhibit 4.1 to the Company's Registration Statement on Form S-8 (Reg. No. 333-50726) is hereby incorporated by reference. 10.9 Res-Care, Inc. 2000 Nonemployee Directors Stock Ownership Incentive Plan. Exhibit 4.2 to the Company's Registration Statement on Form S-8 (Reg. No. 333-50726) is hereby incorporated by reference. 10.10 Employment Agreement between the Company and Ralph G. Gronefeld, Jr., dated February 14, 2001. (filed herewith) 10.11 Employment Agreement between the Company and Vincent F. Doran, dated August 1, 2000. (filed herewith) 10.12 Employment Agreement between the Company and Paul G. Dunn, dated February 14, 2001. (filed herewith) 10.13 Employment Agreement between the Company and Jeffrey M. Cross, dated February 6, 2001. (filed herewith) 10.14 Employment Agreement between the Company and L. Bryan Shaul dated February 16, 2001. (filed herewith) 10.15 Employment Agreement between the Company and Katherine W. Gilchrist dated January 25, 2001. (filed herewith) 10.16 Amended and Restated Senior Secured $80,000,000 Revolving Credit Facility and $80,000,000 Term Loan Credit Agreement by and among Res-Care, Inc., PNC Bank, National Association, and the Banks identified on Schedule 1.1(B) thereto, dated February 28, 2001. (filed herewith) 21.1 Subsidiaries of the Company (filed herewith) 23.1 Consent of Independent Auditors (filed herewith) 24.1 Power of Attorney (included on signature page) (b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended December 31, 2000. 28 30 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. RES-CARE, INC Date: March 22, 2001 By: /s/ Ronald G. Geary -------------- ------------------------------------ Ronald G. Geary Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Ronald G. Geary Chairman of the Board, President, Chief March 22, 2001 ------------------------------- Executive Officer and Director Ronald G. Geary (Principal Executive Officer) /s/ Ralph G. Gronefeld, Jr. Executive Vice President, Operations March 22, 2001 ------------------------------- Division for Persons with Disabilities Ralph G. Gronefeld, Jr. (Principal Financial and Accounting Officer) /s/ Seymour L. Bryson Director March 22, 2001 ------------------------------- Seymour L. Bryson /s/ James R. Fornear Director March 22, 2001 ------------------------------- James R. Fornear /s/ Olivia F. Kirtley Director March 22, 2001 ------------------------------- Olivia F. Kirtley /s/ W. Bruce Lunsford Director March 22, 2001 ------------------------------- W. Bruce Lunsford /s/ Spiro B. Mitsos Director March 22, 2001 ------------------------------- Spiro B. Mitsos /s/ Vincent D. Pettinelli Director March 22, 2001 ------------------------------- Vincent D. Pettinelli /s/ E. Halsey Sandford Director March 22, 2001 ------------------------------- E. Halsey Sandford
29 31 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Independent Auditors' Report........................................................................................ F-2 Consolidated Balance Sheets - As of December 31, 2000 and 1999...................................................... F-3 Consolidated Statements of Income - Years Ended December 31, 2000, 1999 and 1998.................................... F-4 Consolidated Statements of Shareholders' Equity - Years Ended December 31, 2000, 1999 and 1998...................... F-5 Consolidated Statements of Cash Flows - Years Ended December 31, 2000, 1999 and 1998................................ F-6 Notes to Consolidated Financial Statements.......................................................................... F-7
F-1 32 INDEPENDENT AUDITORS' REPORT The Board of Directors Res-Care, Inc.: We have audited the accompanying consolidated balance sheets of Res-Care, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Res-Care, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with auditing standards generally accepted in the United States of America. /s/ KPMG LLP Louisville, Kentucky March 4, 2001 F-2 33 RES-CARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31 ----------- 2000 1999 ---- ---- (In thousands, except share data) ASSETS Current assets: Cash and cash equivalents...................................................... $ 33,415 $ 7,057 Accounts and notes receivable, net of allowance for doubtful accounts of $18,192 in 2000 and $17,163 in 1999............................ 142,764 141,807 Deferred income taxes.......................................................... 14,996 14,406 Prepaid expenses and other current assets...................................... 11,444 7,286 ----------- ----------- Total current assets................................................ 202,619 170,556 ----------- ----------- Property and equipment, net......................................................... 85,074 102,739 Excess of acquisition cost over net assets acquired, less accumulated amortization of $24,148 in 2000 and $16,199 in 1999............................ 218,012 220,493 Other assets........................................................................ 30,401 29,343 ----------- ----------- $ 536,106 $ 523,131 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Trade accounts payable......................................................... $ 21,715 $ 13,388 Accrued expenses............................................................... 52,812 47,208 Accrued income taxes........................................................... 2,674 1,145 Current portion of long-term debt.............................................. 2,499 6,047 Current portion of obligations under capital leases............................ 614 627 ----------- ----------- Total current liabilities........................................... 80,314 68,415 ----------- ----------- Long-term liabilities............................................................... 3,289 4,572 Long-term debt .................................................................... 261,299 276,537 Obligations under capital leases.................................................... 7,865 8,502 Deferred gains .................................................................... 4,401 1,612 Deferred income taxes............................................................... 815 109 ----------- ----------- Total liabilities................................................... 357,983 359,747 ----------- ----------- Commitments and contingencies Shareholders' equity: Preferred shares, no par value, authorized 1,000,000 shares, no shares issued or outstanding...................................................... -- -- Common stock, no par value, authorized 40,000,000 shares, issued 28,727,027 shares in 2000 and 1999......................................... 50,770 50,770 Additional paid-in capital..................................................... 28,939 28,413 Retained earnings.............................................................. 101,351 87,175 ----------- ----------- 181,060 166,358 Less cost of common shares in treasury (4,408,575 shares in 2000 and 4,474,139 shares in 1999).............................................. 2,937 2,974 ----------- ----------- Total shareholders' equity.......................................... 178,123 163,384 ----------- ----------- $ 536,106 $ 523,131 =========== ===========
See accompanying notes to consolidated financial statements. F-3 34 RES-CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31 ---------------------- 2000 1999 1998 --------- --------- --------- (In thousands, except per share data) Revenues ........................................................................... $ 865,796 $ 824,479 $ 702,914 Facility and program expenses ....................................................... 763,576 716,469 604,760 --------- --------- --------- Facility and program contribution ................................................... 102,220 108,010 98,154 Operating expenses (income): Corporate general and administrative ........................................... 28,111 27,726 27,590 Depreciation and amortization .................................................. 22,308 21,107 18,561 Special charges ................................................................ 4,149 20,498 -- Other operating expenses (income) .............................................. 270 40 (307) --------- --------- --------- Total operating expenses ............................................ 54,838 69,371 45,844 --------- --------- --------- Operating income ............................................................... 47,382 38,639 52,310 Other expenses (income): Interest expense ............................................................... 23,446 19,925 15,556 Interest income ................................................................ (887) (1,175) (1,662) --------- --------- --------- Total other expenses ................................................ 22,559 18,750 13,894 --------- --------- --------- Income from continuing operations before income taxes ............................... 24,823 19,889 38,416 Income tax expense .................................................................. 10,647 10,153 15,484 --------- --------- --------- Income from continuing operations ................................................... 14,176 9,736 22,932 Gain from sale of unconsolidated affiliate, net of tax .............................. -- 534 -- Cumulative effect of accounting change, net of tax .................................. -- (3,932) -- --------- --------- --------- Net income .................................................................... $ 14,176 $ 6,338 $ 22,932 ========= ========= ========= Basic earnings per share from continuing operations ................................. $ 0.58 $ 0.40 $ 0.96 Gain from sale of unconsolidated affiliate, net of tax .............................. -- 0.02 -- Cumulative effect of accounting change, net of tax .................................. -- (0.16) -- --------- --------- --------- Basic earnings per share ............................................................ $ 0.58 $ 0.26 $ 0.96 ========= ========= ========= Diluted earnings per share from continuing operations ............................... $ 0.58 $ 0.39 $ 0.90 Gain from sale of unconsolidated affiliate, net of tax .............................. -- 0.02 -- Cumulative effect of accounting change, net of tax .................................. -- (0.16) -- --------- --------- --------- Diluted earnings per share .......................................................... $ 0.58 $ 0.25 $ 0.90 ========= ========= ========= Weighted average number of common shares: Basic .......................................................................... 24,309 24,184 23,898 Diluted ........................................................................ 24,354 24,970 31,225
See accompanying notes to consolidated financial statements. F-4 35 RES-CARE, INC. AND SUBSIDIARES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional Treasury Stock ----------------- Paid-In Retained ----------------- Shares Amount Capital Earnings Shares Amount Total ------ ------ ------- -------- ------ ------ ----- (In thousands) Balance at January 1, 1998............... 28,727 $ 50,770 $ 18,991 $ 57,905 5,034 $ (3,341) $ 124,325 Net income............................... -- -- -- 22,932 -- -- 22,932 Exercise of stock options, including related tax benefit....... -- -- 6,630 -- (337) 220 6,850 Issuance of shares in connection with an acquisition................. -- -- 463 -- (26) 17 480 --------- ---------- ---------- --------- ------- -------- ----------- Balance at December 31, 1998............. 28,727 50,770 26,084 80,837 4,671 (3,104) 154,587 Net income............................... -- -- -- 6,338 -- -- 6,338 Exercise of stock options, including related tax benefit....... -- -- 2,329 -- (197) 130 2,459 --------- ---------- ---------- --------- ------- -------- ----------- Balance at December 31, 1999............. 28,727 50,770 28,413 87,175 4,474 (2,974) 163,384 Net income............................... -- -- -- 14,176 -- -- 14,176 Purchase of treasury stock............... -- -- -- -- 2 (8) (8) Exercise of stock options, including related tax benefit....... -- -- 526 -- (67) 45 571 --------- ---------- ---------- --------- ------- -------- ----------- Balance at December 31, 2000............. 28,727 $ 50,770 $ 28,939 $ 101,351 4,409 $ (2,937) $ 178,123 ========= ========== ========== ========= ======= ======== ===========
See accompanying notes to consolidated financial statements. F-5 36 RES-CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- (In thousands) OPERATING ACTIVITIES: Net income..................................................................... $ 14,176 $ 6,338 $ 22,932 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization.............................................. 22,308 21,107 18,561 Amortization of discount on notes.......................................... 659 723 467 Deferred income taxes...................................................... 116 (3,891) (598) Loss (gain) from sale of assets............................................ 627 40 (307) Special charges............................................................ 1,457 3,726 -- Provision for losses on accounts receivable, net of recoveries............. 3,707 10,533 2,136 Tax benefit from exercise of stock options................................. 51 1,348 3,370 Gain from sale of unconsolidated affiliate, net of tax..................... -- (534) -- Cumulative effect of change in accounting, net of tax...................... -- 3,932 -- Changes in operating assets and liabilities: Accounts and notes receivable.............................................. (3,184) (22,868) (34,784) Prepaid expenses and other current assets.................................. (4,154) (2,095) (1,476) Other assets............................................................... (8,658) (358) (1,109) Accounts payable........................................................... 7,769 (2,306) (5,398) Accrued expenses........................................................... 4,108 (7,433) 3,954 Deferred gains............................................................. 326 1,574 (4) Accrued income taxes....................................................... 1,529 (2,511) (794) Long-term liabilities...................................................... (1,493) (1,779) (1,254) ----------- ----------- ----------- Cash provided by operating activities................................. 39,344 5,546 5,696 ----------- ----------- ----------- INVESTING ACTIVITIES: Proceeds from sale of assets............................................... 28,671 -- -- Purchases of property and equipment........................................ (20,914) (23,604) (16,677) Acquisitions of businesses, net of cash acquired........................... (1,045) (14,780) (121,813) Other .................................................................... -- -- (1,115) ----------- ----------- ----------- Cash provided by (used in) investing activities....................... 6,712 (38,384) (139,605) ----------- ----------- ----------- FINANCING ACTIVITIES: Net borrowings (repayments) under notes payable to bank.................... (10,802) 56,987 79,244 Repayment of notes payable................................................. (8,758) (20,786) (7,456) Payments on obligations under capital lease................................ (650) (7,794) (721) Proceeds from sale of common stock, net of expenses........................ -- -- 45 Repurchase of treasury shares.............................................. (8) -- -- Proceeds received from exercise of stock options........................... 520 1,112 3,480 ----------- ----------- ----------- Cash provided by (used in) financing activities....................... (19,698) 29,519 74,592 ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents.................................... 26,358 (3,319) (59,317) Cash and cash equivalents at beginning of year...................................... 7,057 10,376 69,693 ----------- ----------- ----------- Cash and cash equivalents at end of year............................................ $ 33,415 $ 7,057 $ 10,376 =========== =========== =========== Supplemental Disclosures of Cash Flow Information: Cash paid for: Interest................................................................... $ 23,771 $ 18,806 $ 13,665 Income taxes............................................................... 11,073 15,567 16,085 Supplemental Schedule of Non-cash Investing and Financing Activities: Issuance of common stock in connection with acquisitions....................... $ -- $ -- $ 480 Issuance of notes in connection with acquisitions.............................. -- 2,504 30,289
See accompanying notes to consolidated financial statements. F-6 37 RES-CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Description of Business The consolidated financial statements include the accounts of Res-Care, Inc. and its subsidiaries (ResCare or the Company). Significant intercompany accounts and transactions have been eliminated in consolidation. The Company receives revenues primarily from the delivery of residential, training, educational and support services to various populations with special needs. As more fully described in Note 9, the Company has three reportable operating segments: (i) disabilities services; (ii) Job Corps program; and (iii) other youth services programs. Revenue Recognition Disabilities Services: Client services are provided at rates established at the time services are rendered. Payments for services rendered to clients covered by Medicaid are generally less than the Company's established rates. Contractual allowances and adjustments are recorded to reflect the difference between established rates and expected reimbursement. Retroactively calculated contractual adjustments are accrued on an estimated basis in the periods the related services are rendered. Final settlements are recorded as adjustments in future periods when they are determined. Revenues are derived primarily from state government agencies under the Medicaid reimbursement system and from management contracts with private operators, generally not-for-profit providers, who contract with state government agencies and are also reimbursed under the Medicaid system. Revenues in the future may be affected by changes in rate-setting structures, methodologies or interpretations that may be proposed in states where the Company operates. Some states are considering initiating managed care plans for persons served in the Medicaid programs and expanding Medicaid waiver funding for community residential services. At this time, the Company cannot determine the impact of such changes, or the effect of any possible governmental actions. Job Corps Program: Revenues include amounts reimbursable under cost reimbursement contracts with the U.S. Department of Labor for operating Job Corps centers. The contracts provide reimbursement for all facility and program costs related to Job Corps center operations and allowable indirect costs for general and administrative expenses, plus a predetermined management fee, normally a fixed percentage of facility and program expenses. Final determination of amounts due under the contracts is subject to audit and review by the U.S. Department of Labor. Other Youth Services Programs: Juvenile treatment revenues are derived primarily from state-awarded contracts from state agencies under various reimbursement systems. Reimbursement from state or locally awarded contracts varies per facility or program, and is typically paid under fixed contract amounts, flat rates, or cost-based rates. For each operating segment, expenses are subject to examination by agencies administering the contracts and services. Management believes that adequate provisions have been made for potential adjustments arising from such examinations. Provision for bad debt expense is provided for in the period the expense is determined by management. Cash Equivalents The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. F-7 38 Depreciation and Amortization Depreciation and amortization are provided by the straight-line method over the estimated useful lives of the assets. Estimated useful lives for buildings are 20 - 40 years. Assets under capital lease and leasehold improvements are generally amortized over the life of the respective lease. The useful lives of furniture and equipment vary from three to seven years. Depreciation expense includes amortization of assets under capital lease. The Company acts as custodian of assets where it has contracts to operate facilities or programs owned or leased by the U.S. Department of Labor, various states and private providers. The excess of acquisition cost over net assets acquired and the cost of licenses are amortized over 20-40 years using the straight-line method. Covenants not to compete are amortized over the terms of the respective agreements which are generally five to ten years. The Company assesses the recoverability of goodwill and other intangibles as events or circumstances indicate a possible inability to recover their carrying amount. Such evaluation is based on cash flow, profitability and projections that incorporate current operating results. This analysis involves significant management judgment. Deferred Gains on Sale and Leaseback of Assets Gains resulting from the sale and leaseback of assets are deferred and amortized over the term of the operating lease as a reduction of rental expense. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Per Share Data The Company's Board of Directors authorized a three-for-two stock split which was distributed on June 4, 1998, to shareholders of record on May 22, 1998. All share and per share data included in this annual report have been restated to reflect the stock split. Per share amounts have also been restated to reflect the issuance of approximately 5,145,000 shares of common stock in the merger with PeopleServe, Inc. (PeopleServe) on June 28, 1999. Insurance The Company maintains commercial general and professional liability insurance and management is of the opinion that insurance coverages and self-insured reserves are adequate to cover any potential losses on asserted claims. Management is unaware of any incidents that would ultimately result in a loss in excess of the Company's insurance coverages and self-insured reserves. In addition, the Company self-insures group health insurance for its employees. Such self-insurance costs are accrued based upon the aggregate of the liability for reported claims and an estimated liability for claims incurred but not reported. The Company has aggregate stop-loss limits in place to mitigate any material exposure. Workers' compensation claims are covered either under large deductible or retrospective policies or through sponsored insurance funds. Financial Instruments Various methods and assumptions were used by the Company in estimating the fair value disclosures for significant financial instruments. Fair values of cash and cash equivalents, short-term investments, accounts and notes receivable and trade accounts payable approximate their carrying amount because of the short maturity of those investments. The fair value of long-term debt is based on the present value of the underlying cash flows discounted at the current estimated borrowing rates available to the Company, and approximates its carrying value as interest rates are variable. F-8 39 Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Reclassifications Certain amounts in the 1999 financial statements have been reclassified to conform with the 2000 presentation. 2. MERGER AND ACQUISITIONS On June 28, 1999, ResCare completed a merger with PeopleServe, which primarily operates facilities and programs for persons with mental retardation and other developmental disabilities. In connection with the merger, ResCare recorded a pretax merger-related charge of $20.5 million in 1999. This consisted primarily of $7.3 million in severance and employee-related costs (principally related to the elimination of PeopleServe's corporate offices and various other administrative costs), $2.8 million in lease termination costs, $3.0 million in information system conversion and integration costs and $4.5 million in transaction costs, including investment banking, legal, accounting and other professional fees and transaction costs. Through December 31, 2000, approximately $20.1 million of the charge had been utilized through $15.1 million in cash payments (principally severance and transaction costs), $4.7 million in asset write-downs (relating principally to the discontinued PeopleServe information systems) and $300,000 in adjustments to the reserve in 2000 resulting from revised estimates of costs associated with the closure of duplicate facilities. The Company believes the remaining balance of accrued merger-related costs of $400,000 at December 31, 2000 represents its remaining cash obligations. During the two years ended December 31, 2000, the Company has made various acquisitions as set forth below. Except for the PeopleServe merger which was accounted for as a pooling-of-interests, all have been accounted for as purchases. The consolidated financial statements include the operating results of each business acquired for as a purchase from the date of its acquisition. Pro forma results of operations have not been presented because the effects of these acquisitions were not significant. The following table sets forth information regarding acquisitions during 2000 and 1999 which were accounted for as purchases:
Year Ended December 31 ---------------------- 2000 1999 ---- ---- Number of acquisitions: Disabilities services.......................................................... 3 10 Job Corps program.............................................................. -- -- Other youth services programs.................................................. -- -- ----------- ----------- 3 10 =========== =========== Allocation of purchase price: Buildings, land and equipment.................................................. $ 327 $ 844 Excess of acquisition cost over net assets acquired............................ 4,207 11,113 Other intangible assets........................................................ 238 85 Other.......................................................................... 146 549 ----------- ----------- $ 4,918 $ 12,591 =========== ===========
F-9 40 3. OTHER ASSETS Other assets are as follows:
December 31 ----------- 2000 1999 ---- ---- Long-term receivables and advances to managed facilities............................ $ 8,492 $ 10,716 Licenses, net of accumulated amortization........................................... 2,644 2,757 Covenants not to compete, net of accumulated amortization........................... 8,712 10,441 Deposits ........................................................................... 4,100 2,951 Other assets........................................................................ 6,453 2,478 ----------- ----------- $ 30,401 $ 29,343 =========== ===========
4. PROPERTY AND EQUIPMENT Property and equipment is summarized as follows:
December 31 ----------- 2000 1999 ---- ---- Property and Equipment: Land and land improvements..................................................... $ 10,652 $ 11,108 Leasehold improvements......................................................... 11,514 9,448 Buildings...................................................................... 58,982 73,500 Land and buildings under capital lease......................................... 8,618 7,849 Equipment under capital lease.................................................. 1,445 1,514 Furniture and equipment........................................................ 42,694 38,887 ----------- ----------- 133,905 142,306 Less accumulated depreciation and amortization...................................... 48,831 39,567 ----------- ----------- Net property and equipment $ 85,074 $ 102,739 =========== ===========
5. DEBT Long-term debt consists of the following:
December 31 ----------- 2000 1999 ---- ---- Revolving credit facilities with banks.............................................. $ 133,056 $ 144,181 6% convertible subordinated notes due 2004, net of unamortized discount of $1,830 in 2000 and $2,298 in 1999........................................... 107,530 107,062 5.9% convertible subordinated notes due 2005........................................ 19,613 22,000 Notes payable and other............................................................. 3,599 9,341 ----------- ----------- 263,798 282,584 Less current portion........................................................... 2,499 6,047 ----------- ----------- $ 261,299 $ 276,537 =========== ===========
As of December 31, 2000, the Company had $20.1 million available on its revolving credit facility with PNC Bank. Outstanding at that date were irrevocable standby letters of credit in the principal amount of $24.9 million issued in connection with workers' compensation insurance and certain facility leases. Interest on the revolving credit facility is based on margins over LIBOR. The rate being paid on the six-month LIBOR borrowings at December 31, 2000 was approximately 8.82%. In February 2001, the Company amended and restated its credit facility. As of the date of the amendment, the Company had borrowings under the previous facility of approximately $123.7 million and outstanding letters-of-credit of approximately $24.8 million. Upon execution of the amendment, $80.0 million of the borrowings were converted to term indebtedness providing for quarterly payments totaling $10.5 million in 2001, and $17.0 million in 2002. The remaining borrowings and standby letters of credit thereby constituted borrowings under the new $80.0 million revolving credit facility. As a result, as of February 28, 2001, the Company had approximately $11.5 million F-10 41 available under its amended credit facility. The amended credit facility expires in January 2003. The amended facility also contains various financial covenants relating to indebtedness, capital expenditures, acquisitions and dividends and requires the Company to maintain specified ratios with respect to fixed charge coverage, leverage and cash flow from operations. The Company's ability to achieve the thresholds provided for in the financial covenants is largely dependent upon the maintenance of continued profitability and reductions of amounts borrowed under the amended facility. Borrowings under the amended credit agreement bear interest at LIBOR plus an applicable margin based on a debt to cash flow ratio. Borrowings are secured by the Company's assets, including accounts receivable, owned property and equipment and intangible assets. Maturities of long-term debt, restated for the amended credit agreement effective February 28, 2001, are as follows:
Year Ended December 31 ----------- 2001 .....................................................................................................$ 12,950 2002 ..................................................................................................... 17,729 2003 ..................................................................................................... 102,785 2004 ..................................................................................................... 110,599 2005 ..................................................................................................... 19,628 Thereafter................................................................................................ 107 -------- $263,798 ========
6. ACCRUED EXPENSES Accrued expenses are summarized as follows:
December 31 ----------- 2000 1999 ---- ---- Trade payables...................................................................... $ 5,010 $ 5,143 Wages and payroll taxes............................................................. 18,473 15,024 Vacation ........................................................................... 7,757 7,745 Workers' compensation............................................................... 5,124 5,635 Taxes other than income taxes....................................................... 2,940 5,506 Interest............................................................................ 2,005 2,329 Other............................................................................... 11,503 5,826 ----------- ----------- $ 52,812 $ 47,208 =========== ===========
F-11 42 7. INCOME TAXES Income tax expense attributable to income from continuing operations is summarized as follows:
Year Ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- Federal: Current........................................................................ $ 8,160 $ 11,296 $ 12,558 Deferred (benefit)............................................................. 53 (3,200) (380) ----------- ----------- ----------- Total federal.............................................................. 8,213 8,096 12,178 State and local: Current........................................................................ 2,371 2,748 3,524 Deferred (benefit)............................................................. 63 (691) (218) ----------- ----------- ----------- Total state and local...................................................... 2,434 2,057 3,306 ----------- ----------- ----------- Total income tax expense.............................................. $ 10,647 $ 10,153 $ 15,484 =========== =========== ===========
A reconciliation of the U.S. Federal income tax rate of 35% to income tax expense expressed as a percent of pretax income follows:
Year Ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- Federal income tax at the statutory rate............................................ 35.0% 35.0% 35.0% Increase (decrease) in income taxes: State taxes, net of federal benefit............................................ 5.6 5.1 5.2 Surtax exemption............................................................... -- -- (0.2) Nondeductible amortization of goodwill......................................... 5.7 5.8 2.5 Nondeductible portion of merger-related charge................................. -- 7.5 -- Jobs tax credits, net.......................................................... (3.7) (2.0) (0.4) Other.......................................................................... 0.3 (0.4) (1.8) --------- --------- --------- 42.9% 51.0% 40.3% ========= ========= =========
During the years ended December 31, 2000, 1999 and 1998, the Company credited additional paid-in capital for the tax benefits associated with the exercise of stock options in the amounts of $51, $1,348 and $3,370, respectively. F-12 43 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below:
December 31 ----------- 2000 1999 ---- ---- Deferred tax assets: Accounts receivable, principally due to provision for losses................... $ 6,958 $ 6,515 Workers' compensation costs, principally due to accrual for financial reporting purposes......................................................... 1,781 2,277 Compensated absences, due to accrual for financial reporting purposes.......... 2,236 2,412 Other liabilities and reserves, deductible in different periods for financial reporting and tax purposes....................................... 3,298 2,656 Capital lease obligations and related capitalized property..................... 766 765 Deferred gains and revenues, taxable in different periods for financial reporting and tax purposes................................................. 2,047 946 Property and equipment due to differences in depreciation...................... 476 358 ----------- ----------- Total deferred tax assets........................................... 17,562 15,929 Deferred tax liabilities: Accounts receivable, principally due to experience-rated revenue recognition for income tax reporting purposes.............................. 241 140 Goodwill and other intangible assets, principally due to capitalization for financial reporting purposes and differences in amortization........... 3,045 1,232 Change in accounting method for income tax purposes............................ 95 260 ----------- ----------- Total deferred tax liabilities...................................... 3,381 1,632 ----------- ----------- Net deferred tax asset..................................................... $ 14,181 $ 14,297 =========== =========== Classified as follows: Current deferred income tax asset.............................................. $ 14,996 $ 14,406 Noncurrent deferred income tax liability....................................... (815) (109) ----------- ----------- Net deferred tax asset..................................................... $ 14,181 $ 14,297 =========== ===========
No valuation allowance for deferred tax assets was required as of December 31, 2000 and 1999, nor was there any change in the total valuation allowance for the years ended December 31, 2000, 1999 and 1998. The realization of deferred tax assets is dependent upon the Company generating future taxable income when temporary differences become deductible. Based upon the historical and projected levels of taxable income, management believes it is more likely than not the Company will realize the benefits of the deductible differences. F-13 44 8. EARNINGS PER SHARE The following data shows the amounts used in computing earnings per share from continuing operations and the effect on income and the weighted average number of shares of dilutive potential common stock.
Year Ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- Income from continuing operations and income available to shareholders for basic earnings per share...................................... $ 14,176 $ 9,736 $ 22,932 Interest expense, net of income tax effect, on convertible subordinated notes............................................................. -- -- 5,041 ----------- ----------- ----------- Income available to shareholders after assumed conversion of convertible subordinated notes.............................................. $ 14,176 $ 9,736 $ 27,973 =========== =========== =========== Weighted average number of common shares used in basic earnings per share............................................................. 24,309 24,184 23,898 Effect of dilutive securities: Stock options.................................................................. 45 786 825 Convertible subordinated notes................................................. -- -- 6,502 ----------- ----------- ----------- Weighted number of common shares and dilutive potential common shares used in diluted earnings per share............................... 24,354 24,970 31,225 =========== =========== ===========
The shares issuable upon conversion of the convertible subordinated notes of 6,574,000 and 6,666,000, respectively, were not included in the computation of diluted earnings per share for the years ended December 31, 2000 and 1999 because to do so would have been antidilutive. 9. SEGMENT INFORMATION The Company has three reportable operating segments: disabilities services, Job Corps program and other youth services programs. The Company's disabilities services division offers services for individuals with developmental and other disabilities, including acquired brain injury. These services are provided through supported living and supported employment programs, community group homes, and facility-based operations. The Job Corps segment operates various centers under the federal Job Corps program administered by the U.S. Department of Labor which provides for the educational and vocational training and other support necessary to enable disadvantaged youths to become responsible working adults. The other youth services segment provides services to address the specific needs of at-risk and troubled youths to enable each youth to be a more productive member of the community. The Company's reportable segments are business units that offer distinct services to different special needs populations and are managed separately. The Company evaluates performance and allocates resources based on profit or loss from operations before interest, income taxes, accounting changes and non-recurring items. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales and transfers are not significant. F-14 45 The following table sets forth information about reportable segment profit or loss and segment assets:
Other Disabilities Job Youth All Consolidated As of and for the year ended December 31: Services Corps Services Other (1) Totals ----------------------------------------- -------- ----- -------- --------- ------ 2000 Revenues............................................. $ 680,629 $ 123,868 $ 61,299 $ -- $ 865,796 Segment profit (2)................................... 63,939 13,543 4,810 (30,761) 51,531 Total assets......................................... 418,309 24,354 33,024 60,419 536,106 Capital expenditures................................. 16,523 -- 3,325 1,066 20,914 Depreciation and amortization........................ 17,900 294 1,712 2,402 22,308 1999 Revenues............................................. $ 654,553 $ 117,237 $ 52,689 $ -- $ 824,479 Segment profit (2)................................... 70,562 12,427 5,313 (29,165) 59,137 Total assets......................................... 433,086 20,942 33,670 35,433 523,131 Capital expenditures................................. 14,665 -- 4,863 4,076 23,604 Depreciation and amortization........................ 17,885 294 1,487 1,441 21,107 1998 Revenues............................................. $ 570,626 $ 94,006 $ 38,282 $ -- $ 702,914 Segment profit (2)................................... 67,019 10,753 3,964 (29,426) 52,310 Total assets......................................... 387,677 21,055 26,269 58,792 493,793 Capital expenditures................................. 12,939 -- 1,191 2,547 16,677 Depreciation and amortization........................ 15,070 296 1,282 1,913 18,561
(1) All Other is comprised of Corporate general and administrative expenses and Corporate depreciation and amortization. (2) Segment profit equals operating income before special charges. 10 BENEFIT PLANS The Company sponsors savings plans which were established to assist eligible employees in providing for their future retirement needs. The Company's contributions to the plans were $3,097, $2,581 and $2,607 in 2000, 1999, and 1998, respectively. The Company's stock-based compensation plans are fixed stock option plans. The Company may grant options to its salaried officers and employees for up to 5,826,095 shares of common stock. Under the plans, the exercise price of each option equals the market price of the Company's stock on the date of grant, and an option's maximum term is normally five years. Generally all options, except those granted to certain key executives which have varied vesting schedules, vest 20 percent at date of grant and 20% per year over four years. Under separate stock option plans, the Company may grant up to 190,000 shares to non-employee members of the Board of Directors at an exercise price which cannot be less than the fair market value on the date of grant. F-15 46 Stock option activity is shown below:
2000 1999 1998 ---------------------- ---------------------- ------------------------ Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- ----------- --------- ----------- --------- ---------- Outstanding at beginning of year............... 2,781,127 $ 14.83 2,981,127 $ 14.34 1,590,840 $ 10.25 Granted........................................ 408,750 8.20 126,750 19.93 1,805,754 17.26 Exercised...................................... (67,064) 7.75 (196,610) 9.21 (337,211) 10.37 Canceled....................................... (723,224) 18.33 (130,140) 17.02 (78,256) 15.35 ----------- ----------- ----------- Outstanding at end of year..................... 2,399,589 12.85 2,781,127 14.83 2,981,127 14.34 =========== =========== =========== Exercisable at end of year..................... 1,725,169 $ 12.92 1,794,701 $ 13.92 1,379,802 $ 12.92 =========== =========== ===========
The following table summarizes information about fixed stock options outstanding at December 31, 2000:
Options Outstanding Options Exercisable ---------------------------------------------------------------------------- -------------------------------------- Range of Number Weighted-Average Number Exercise Outstanding at Remaining Weighted-Average Exercisable at Weighted-Average Prices December 31, 2000 Contractual Life Exercise Price December 31, 2000 Exercise Price ------------------ ----------------- ---------------- ---------------- ------------------ ----------------- $ 4.50 to 9.99 610,895 2.7 years $ 7.42 341,595 $ 7.14 10.00 to 14.99 1,340,642 2.3 years 13.24 1,050,541 13.07 15.00 to 19.99 253,500 2.6 years 16.23 219,750 16.05 20.00 to 23.50 194,552 2.6 years 22.87 113,283 22.92 ----------- ----------- 2,399,589 2.5 years $ 12.85 1,725,169 $ 12.92 ========== ===========
For financial statement reporting purposes, the Company continues to use the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined consistent with the fair value method prescribed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company's income from continuing operations, net income and earnings per share amounts would have been reduced to the following pro forma amounts:
Year Ended December 31 ---------------------- 2000 1999 1998 ----------------------- ----------------------- --------------------- As Reported Pro forma As Reported Pro forma As Reported Pro forma ----------- --------- ----------- --------- ----------- --------- Income from continuing operations...... $ 14,176 $12,256 $9,736 $6,760 $22,932 $17,599 Net income ............................ 14,176 12,256 6,338 3,362 22,932 17,599 Basic earnings per share: From continuing operations......... 0.58 0.50 0.40 0.28 0.96 0.73 Net income......................... 0.58 0.50 0.26 0.14 0.96 0.73 Diluted earnings per share: From continuing operations......... 0.58 0.50 0.39 0.27 0.90 0.72 Net income......................... 0.58 0.50 0.25 0.13 0.90 0.72
F-16 47 The following table sets forth the fair value of each option grant using the Black-Scholes option-pricing model and the applicable weighted-average assumptions:
Year Ended December 31 ---------------------- 2000 1999 1998 ---- ---- ---- Fair value per option .. $3.87 $8.25 $7.83 Risk-free interest rate 5.17% 6.69% 4.66% Dividend yield ......... 0% 0% 0% Expected volatility .... 0.60 0.49 0.48 Expected life (in years) 2-4 3-4 4-5
11. SALE AND LEASEBACK TRANSACTIONS In December 2000, the Company entered into various transactions for the sale of certain real properties in which it conducts operations. Proceeds from the sales were approximately $26.5 million. The assets are being leased back from the purchasers over terms ranging from five years to 18 years. The leases are being accounted for as operating leases. Certain of the transactions resulted in a loss of approximately $357,000, which was recognized in 2000 and is included in special charges in the Company's consolidated statement of income. The remaining transactions resulted in a gain of approximately $2.4 million, which is being amortized over the respective lease terms. The leases contain renewal options at lease termination and purchase options at amounts approximating fair value. 12. RESTRUCTURING AND TRANSACTION COSTS During 2000, the Company approved and implemented a restructuring and operational reorganization plan. In connection with the plan, the Company recorded a pre-tax charge of approximately $1.7 million ($1.0 million, net of tax, or $0.04 per share), which is reflected as a special charge in the Company's consolidated statement of income. This charge consisted primarily of $700,000 in severance and employee-related costs, $500,000 in lease termination costs, $300,000 in asset write-offs (principally deferred costs associated with pending acquisitions which were discontinued as a result of the plan) and $200,000 in transaction and other costs. Through December 31, 2000, approximately $900,000 of the costs had been utilized. On June 29, 2000, the Company announced that an agreement had been mutually terminated with an investor group which had proposed to acquire all the outstanding shares of ResCare common stock for $15.75 per share in cash. Although the termination did not result in the payment by ResCare of any cancellation or breakup fees, $1.8 million ($1.1 million, net of tax, or $0.04 per share) of previously deferred costs associated with the transaction was expensed in 2000 and is included in special charges in the Company's consolidated statement of income. 13. COMMITMENTS AND CONTINGENCIES The Company leases certain operating facilities, office space, vehicles and equipment under operating leases which expire at various dates. Total rent expense was approximately $38,600, $39,196 and $32,598 for the years ended December 31, 2000, 1999 and 1998, respectively. The Company also leases certain land and buildings used in operations under capital leases. These leases expire at various dates through 2022 (including renewal operations) and generally require the Company to pay property taxes, insurance and maintenance costs. F-17 48 Future minimum lease payments under capital leases, together with the minimum lease payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year at December 31, 2000, are as follows:
Capital Lease Capital Under Operating Year Ended December 31 Leases Sublease Leases ---------------------- -------- ---------- ------- 2001 .................................................................. $ 1,342 $ 147 $ 24,099 2002 ................................................................... 1,342 142 19,420 2003 ................................................................... 1,342 137 13,531 2004 ................................................................... 1,276 132 9,684 2005 ................................................................... 988 127 7,671 Thereafter ............................................................. 5,999 523 36,541 -------- -------- -------- Total minimum lease payments ...................................... 12,289 1,208 $110,946 ======== Less amounts representing interest ..................................... 4,610 408 -------- -------- Present value of minimum lease payments ................................ 7,679 800 Less current maturities ................................................ 545 69 -------- -------- Total long-term obligations under capital leases .................. $ 7,134 $ 731 ======== ========
The Company leases certain of its facilities under capital leases with various partnerships controlled by a director of the Company. Annual payments under these lease arrangements approximate $1.0 million. The Company also leases certain of its facilities under an operating lease with a real estate investment trust in which the Company's chairman and another director are members of the trust's board of directors. The lease commenced in October 1998 and extends through 2009. Lease payments to the trust approximated $754 and $735 in 2000 and 1999, respectively. Annual rentals, included in the future minimum rental amounts above, are estimated to be approximately $750, subject to annual increases based on the consumer price index. In September 1997, a lawsuit, styled Cause No.: 98-00740, Nancy Chesser v. Normal Life of North Texas, Inc., and Normal Life, Inc. District Court of Travis County, Texas (Chesser) was filed against a Texas facility being operated by the former owners of Normal Life, Inc. and Normal Life of North Texas, Inc., subsidiaries of the Company, asserting causes of action for negligence, intentional infliction of emotional distress and retaliation regarding the discharge of residents of the facility. In May 2000, a judgment was entered in favor of the plaintiff awarding the plaintiff damages, prejudgment interest and attorneys' fees totaling $4.8 million. In October 2000, the Company and American International Specialty Lines Insurance Company (AISL) entered into an agreement whereby any settlement reached in Chesser and a related lawsuit also filed in District Court of Travis County, Texas would not be dispositive of whether the claims in the suits were covered under the policies issued by AISL. AISL thereafter settled the suits and filed a Complaint for Declaratory Judgment against Normal Life of North Texas, Inc. and Normal Life, Inc. in the U.S. District Court for the Northern District of Texas, Dallas Division. In the Complaint, AISL seeks a declaration of what insurance coverage is available to the Company in the lawsuits. It is the Company's position that the lawsuits initiated coverage under the primary policies of insurance, thus affording adequate coverage to settle the lawsuits within coverage and policy limits. The Company does not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operation or liquidity. The Texas Attorney General, on behalf of the Texas Department of Human Services, filed suit in the District Court of Harris County, Texas initially seeking civil penalties of approximately $2.7 million in connection with the operation of one group home in Texas. The complaint alleged that the Company failed to ensure that the needs of the individuals residing in this home were being adequately assessed and provided for, including appropriate medical care. In December 2000, the Company entered into a Compromise and Settlement Agreement with the State which settles any and all disputes between the parties regarding the State's claim for civil penalties. In consideration for the settlement, the Company agreed to pay $1.0 million, which is comprised of $600,000 in compensatory and remedial costs and $400,000 in attorneys' fees and other costs. F-18 49 In July 2000, AISL filed a Complaint for Declaratory Judgment against the Company and one of its subsidiaries in the U.S. District Court for the Southern District of Texas, Houston Division. In the Complaint, AISL seeks a declaration of what insurance coverage is available to the Company in Cause No. 299291-401; In re: Estate of Trenia Wright, Deceased, et al. v. Res-Care, Inc., et al. which was filed in Probate Court No. 1 of Harris County, Texas (the Lawsuit). Subsequent to the filing, the Company and AISL entered into an agreement whereby any settlement reached in the Lawsuit would not be dispositive of whether the claims in the Lawsuit were covered under the policies issued by AISL. AISL thereafter settled the Lawsuit. It is the Company's position that the Lawsuit initiated coverage under the primary policies of insurance in more than one policy year, thus affording adequate coverage to settle the lawsuit within coverage and policy limits. The Company does not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operations or liquidity. Also, in October 2000, the Company and a subsidiary, Res-Care Florida, Inc., f/k/a Normal Life Florida, Inc., entered into an agreement with AISL to resolve through binding arbitration a dispute as to the amount of coverage available to settle a lawsuit which had previously been filed in Pinellas County Circuit Court, Florida and subsequently settled after the agreement was entered into. AISL contends that a portion of the settlement reached was comprised of punitive damages and, therefore, not the responsibility of AISL. It is the Company's position that the settlement was an amount which a reasonable and prudent insurer would pay for the actual damages alleged and that AISL had opportunities to settle all claims within available coverage limits. The Company does not believe it is probable that the ultimate resolution of this matter will have a material adverse effect on its consolidated financial condition, results of operation or liquidity. The Company is a party to various legal proceedings arising out of the operation of its facilities and programs and arising in the ordinary course of business. The Company provides for costs related to contingencies when a loss is probable and the amount is reasonably determinable. After conferring with counsel, it is the opinion of management that the ultimate resolution of these claims will not have a material adverse effect on the consolidated financial condition, results of operations, or liquidity of the Company. 14. QUARTERLY DATA (UNAUDITED)
First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- 2000 Revenues............................................... $ 210,767 $ 213,471 $ 218,246 $ 223,312 $ 865,796 Facility and program contribution...................... 27,432 25,341 25,512 23,935 102,220 Net income............................................. 5,887 2,915 3,059 2,315 14,176 Basic earnings per share............................... 0.24 0.12 0.13 0.10 0.58 Diluted earnings per share............................. 0.23 0.12 0.13 0.10 0.58 1999 Revenues............................................... $ 198,483 $ 206,211 $ 208,758 $ 211,027 $ 824,479 Facility and program contribution...................... 28,385 29,755 29,954 19,916 108,010 Net income (loss)...................................... 2,678 (6,427) 8,504 1,583 6,338 Basic earnings (loss) per share........................ 0.11 (0.27) 0.35 0.07 0.26 Diluted earnings (loss) per share...................... 0.13 (0.27) 0.31 0.06 0.25
F-19 50 15. SUBSEQUENT EVENT Since 1993, the Company has operated various group homes in the state of Tennessee under its disabilities services division. Discussions in February 2001 with the applicable regulatory bodies in Tennessee have caused management to begin implementing plans to cease certain operations in the state. This is due in part to management's expectation that the rate environment in Tennessee will be inadequate to achieve management's desired level of profitability commensurate with the assumed risk. These operations accounted for revenues of $9.3 million in 2000. Management is currently evaluating the recoverability of certain related long-lived assets, including intangibles. As of December 31, 2000, the unamortized balances of goodwill and covenants not to compete were approximately $1.2 million and $800,000, respectively. Management expects to adjust the carrying value of the related long-lived assets to their estimated fair value during the first quarter of 2001. The estimated fair value will be based on anticipated future cash flows discounted at a rate commensurate with the risk involved. Based on current estimates, management expects to record a charge of approximately $1.0 million to $2.0 million in the first quarter of 2001 related to this development. F-20