TABLE OF CONTENTS

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2001
	or
[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 0-20372

RES-CARE, INC.

(Exact name of registrant as specified in its charter)

KENTUCKY	61-0875371
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
10140 Linn Station Road Louisville, Kentucky	40223-3813
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (502) 394-2100

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 twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X    No      .

The number of shares outstanding of the registrant’s common stock, no par value, as of July 31, 2001, was 24,358,622.

INDEX

RES-CARE, INC. AND SUBSIDIARIES

		PAGE
PART I.	FINANCIAL INFORMATION	NUMBER
Item 1.	Unaudited Financial Statements
	Condensed Consolidated Balance Sheets – June 30, 2001 and December 31, 2000		2
	Condensed Consolidated Statements of Income – Three months ended June 30, 2001 and 2000; Six months ended June 30, 2001 and 2000		3
	Condensed Consolidated Statements of Cash Flows – Six months ended June 30, 2001 and 2000		4
	Notes to Condensed Consolidated Financial Statements – June 30, 2001		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10
Item 3.	Quantitative and Qualitative Disclosure about Market Risk		16
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings		17
Item 6.	Exhibits and Reports on Form 8-K		19
SIGNATURES

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PART I. FINANCIAL INFORMATION

ITEM 1. Unaudited Financial Statements

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

			June 30		December 31
			2001		2000
ASSETS
Current assets:
	Cash and cash equivalents		$	8,252	$	33,415
	Accounts and notes receivable, net			155,564		142,764
	Deferred income taxes			14,137		14,996
	Prepaid expenses and other current assets			9,630		11,444
		Total current assets		187,583		202,619
Property and equipment, net				63,776		85,074
Excess of acquisition cost over net assets acquired, net				212,978		218,012
Other assets				33,022		30,401
			$	497,359	$	536,106
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Trade accounts payable		$	25,231	$	21,715
	Current portion of long-term debt			17,526		3,113
	Accrued expenses			47,760		52,812
	Accrued income taxes			1,922		2,674
		Total current liabilities		92,439		80,314
Long-term liabilities				6,933		7,690
Long-term debt				216,227		269,164
Deferred income taxes				663		815
		Total liabilities		316,262		357,983
Commitments and contingencies
Shareholders’ equity:
	Preferred shares			—		—
	Common stock			47,856		47,833
	Additional paid-in capital			29,158		28,939
	Retained earnings			104,083		101,351
		Total shareholders’ equity		181,097		178,123
			$	497,359	$	536,106

See accompanying notes to unaudited condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)

			Three Months Ended					Six Months Ended
			June 30					June 30
			2001		2000			2001		2000
Revenues			$	221,047	$	213,471		$	440,770	$	424,238
Facility and program expenses				198,617		188,130			397,920		371,465
Facility and program contribution				22,430		25,341			42,850		52,773
Operating expenses (income):
	Corporate general and administrative			7,926		7,186			15,541		13,493
	Depreciation and amortization			5,434		5,621			10,851		10,993
	Special charges			—		1,997			1,729		1,997
	Other expense (income)			85		(45	)		90		239
		Total operating expenses		13,445		14,759			28,211		26,722
Operating income				8,985		10,582			14,639		26,051
Interest expense, net				4,825		5,599			9,804		11,005
Income before income taxes				4,160		4,983			4,835		15,046
Income tax expense				1,792		2,068			2,103		6,244
Net income			$	2,368	$	2,915		$	2,732	$	8,802
Basic earnings per share			$	0.10	$	0.12		$	0.11	$	0.36
Diluted earnings per share			$	0.10	$	0.12		$	0.11	$	0.36
Weighted average number of common shares:
	Basic			24,354		24,318			24,344		24,298
	Diluted			24,379		24,402			24,389		24,423

See accompanying notes to unaudited condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

			Six Months Ended
			June 30
			2001			2000
Cash (used in) provided by operating activities			$	(5,316	)	$	304
Cash flows from investing activities:
	Purchases of property and equipment			(3,456	)		(14,850	)
	Acquisitions of businesses, net of cash acquired			—			(2,002	)
	Proceeds from sales of assets			21,966			2,042
		Cash provided by (used in) investing activities		18,510			(14,810	)
Cash flows from financing activities:
	Net (repayments) borrowings under credit facilities with banks			(36,655	)		20,741
	Repayments of long-term debt			(1,944	)		(3,850	)
	Proceeds received from exercise of stock options			242			504
		Cash (used in) provided by financing activities		(38,357	)		17,395
(Decrease) increase in cash and cash equivalents			$	(25,163	)	$	2,889

See accompanying notes to unaudited condensed consolidated financial statements.

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Res-Care, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2001
(Unaudited)

NOTE 1. Basis of Presentation

      Res-Care, Inc. and its subsidiaries (ResCare or the Company) are primarily engaged in the delivery of residential, training, educational and support services to various populations with special needs, including persons with mental retardation and other developmental disabilities and at-risk and troubled youth.

      The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial condition and results of operations for the interim periods have been included. Operating results for the three- and six-month periods ended June 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001.

      For further information, refer to the consolidated financial statements and footnotes thereto in ResCare’s annual report on Form 10-K for the year ended December 31, 2000.

NOTE 2.Long-term Debt

      Long-term debt consists of the following:

	June 30		December 31
	2001		2000
	(In thousands)
Credit facility with banks	$	93,697	$	130,000
6% convertible subordinated notes due 2004, net of unamortized discount of $1,597 and $1,830 in 2001 and 2000		107,763		107,530
5.9% convertible subordinated notes due 2005		19,613		19,613
Obligations under capital leases		8,151		8,479
Notes payable and other		4,529		6,655
		233,753		272,277
Less current portion		17,526		3,113
	$	216,227	$	269,164

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NOTE 3. Earnings Per Share

      The following table sets forth the computation of basic and diluted earnings per share:

		Three Months Ended				Six Months Ended
		June 30				June 30
		2001		2000		2001		2000
		(In thousands)
Net income available to shareholders for basic and diluted earnings per share		$	2,368	$	2,915	$	2,732	$	8,802
Weighted average number of common shares used in basic earnings per share			24,354		24,318		24,344		24,298
Effect of dilutive securities:
	Stock options		25		84		45		125
Weighted average number of common shares and dilutive potential common shares in diluted earnings per share			24,379		24,402		24,389		24,423

      The computation of diluted earnings per share did not assume conversion of the convertible subordinated notes in the three– and six–month periods ended June 30, 2001 and 2000, because to do so would have been antidilutive for the period.

NOTE 4. Sale and Leaseback Transactions

      During the second quarter of 2001, the Company entered into various transactions for the sale of certain real properties in which it conducts operations. Proceeds from the sales were approximately $19.7 million during the second quarter and were used to reduce indebtedness under the amended credit facility. The assets are being leased back from the purchasers over terms ranging from five years to 15 years. The leases are being accounted for as operating leases and contain certain renewal options at lease termination and purchase options at amounts approximating fair value. The transactions resulted in gains of approximately $3.0 million which will be amortized over the lease terms.

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NOTE 5. Segment Information

      The following table sets forth information about reportable segment profit or loss. Since 1998, the Company has disclosed information for three reportable operating segments, comprised of disabilities services, Job Corps program and other youth services programs. Effective January 1, 2001, in connection with changes in the Company’s management structure, the Job Corps program and other youth services programs were brought under the direction of one division president, resulting in the consolidation of these two programs into a single operating segment. The information for prior periods presented has been restated to reflect this change.

	Disabilities		Youth		All			Consolidated
	Services		Services		Other (1)			Totals
	(In thousands)
Quarter ended June 30:
2001
Revenues	$	172,343	$	48,704	$	—		$	221,047
Segment profit		13,623		4,041		(8,679	)		8,985
Total assets(2)		405,194		63,257		28,908			497,359
2000
Revenues	$	168,353	$	45,118	$	—		$	213,471
Segment profit		15,400		4,914		(9,732	)		10,582
Total assets		465,561		70,891		14,646			551,098
Six months ended June 30:
2001
Revenues	$	343,475	$	97,295	$	—		$	440,770
Segment profit		25,271		8,110		(18,742	)		14,639
2000
Revenues	$	334,003	$	90,235	$	—		$	424,238
Segment profit		33,387		9,619		(16,955	)		26,051

(1) All Other is comprised of corporate general and administrative expenses, corporate depreciation and amortization and all special charges.

(2) Total assets for the disabilities services segment decreased by approximately $13 million at June 30, 2001 compared to December 31, 2000, due principally to the sale and leaseback transactions completed during 2001. Total assets for the All Other segment decreased from $60.4 million at December 31, 2000 principally due to a decrease in cash and cash equivalents, as the proceeds from the sale and leaseback transactions were used to reduce indebtedness in 2001. The increase in total assets for the All Other segment from June 30, 2000 to December 31, 2000 results primarily from proceeds from the sale and leaseback transactions completed in December 2000.

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NOTE 6. Contingencies

      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 (Chesser lawsuits) 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 Chesser lawsuits 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 declaratory judgment, AISL seeks a declaration of what insurance coverage is available to the Company in the Chesser lawsuits. It is the Company’s position that the Chesser lawsuits initiated coverage under the primary policies of insurance, thus affording adequate coverage to settle the lawsuits within coverage and policy limits. The declaratory judgment is currently scheduled for trial in January 2002. 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.

      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 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 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.

      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 of Harris County, Texas (the Wright lawsuit). Subsequent to the filing, the Company and AISL entered into an agreement whereby any settlement reached in the Wright lawsuit would not be dispositive of whether the claims in the Wright lawsuit were covered under the policies issued by AISL. AISL thereafter settled the Wright lawsuit. It is the Company’s position that the Wright 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 declaratory judgment is currently scheduled for trial in October 2001. 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

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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 binding arbitration is currently scheduled for September 2001. 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.

      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.

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

Overview

      Res-Care, Inc. (ResCare or the Company) receives revenues primarily from the delivery of residential, training, education and support services to populations with special needs. The Company has two reportable operating segments: (i) disabilities services and (ii) youth services. Since 1998, the Company has disclosed information for three reportable operating segments, comprised of disabilities services, Job Corps program and other youth services programs. Effective January 1, 2001, in connection with changes in the Company’s management structure, the Job Corps program and other youth services programs were brought under the direction of one division president, resulting in the consolidation of these two programs into a single operating segment. The information for prior periods presented has been restated to reflect this change. Management’s discussion and analysis of each segment follows.

Recent Developments

Sale and Leaseback Transactions

      During the second quarter of 2001, the Company entered into various transactions for the sale of certain real properties in which it conducts operations. Proceeds from the sales were approximately $19.7 million in the second quarter and were used to reduce indebtedness under the amended credit facility. The assets are being leased back from the purchasers over terms ranging from five years to 15 years. The leases are being accounted for as operating leases and contain certain renewal options at lease termination and purchase options at amounts approximating fair value. The transactions resulted in gains of approximately $3.0 million which will be amortized over their lease terms.

Results of Operations

      Revenues for the second quarter of 2001 were $221.0 million, or 4% over the same period for 2000. For the six months ended June 30, 2001, revenues were $440.8 million, also a 4% increase over the same period for 2000. This represents a continuation of the lower growth rates experienced beginning in the second half of 2000 and a significantly lower growth rate than in recent years as the Company has shifted its focus from acquisition-related growth to internally generated growth as well as infrastructure enhancements.

      Operating results of the Company for the second quarter of 2001 as compared to the same period of 2000 reflect increased costs from a highly competitive labor market. The Company is continuing several initiatives to manage these labor cost increases, including enhanced recruitment and retention programs in order to reduce the need for overtime and temporary staffing, evaluating and monitoring staff patterns and negotiating improved reimbursement rates from certain states. As a result of the Company’s initiatives, the second quarter reflects improvements in labor costs as a percent of revenue as compared to the fourth quarter of 2000 and the first quarter of 2001. Additionally, results for the second quarter and first six months of 2001 were negatively impacted by increased energy and insurance costs. As discussed in its annual report on Form 10-K for the year ended December 31, 2000, as a result of decreasing availability of coverage at historical rates, the Company

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entered into certain new insurance programs in December 2000 providing for significantly higher self-insured retention limits and higher deductibles, resulting in higher estimated costs for the Company’s business insurance programs in 2001 compared to 2000.

      The consolidated results for the first six months of 2001 were negatively impacted by certain special charges. Operating income for the first quarter of 2001 included a charge of $1.6 million related to the write-off of certain assets and costs associated with the cessation of certain operations in Tennessee, and the write-off of $134,000 in deferred debt issuance costs resulting from the amended and restated credit agreement.

      As a percentage of total revenues, corporate general and administrative expenses for the second quarter and six months ended June 30, 2001, were 3.6% and 3.5%, respectively. For the same periods in 2000, these expenses were 3.4% and 3.2% of total revenues, respectively. This relative increase was due primarily to expanding the management infrastructure during 2001 and the effect of rent expense resulting from the sale and leaseback of the corporate office building in December 2000. The change in management structure includes the addition of the positions of executive vice president and of vice president and chief financial officer of the division for persons with disabilities.

      Net interest expense decreased to $4.8 million in the second quarter of 2001 compared to $5.6 million for the same period in 2000. For the six months, net interest expense was $9.8 million and $11.0 million for 2001 and 2000, respectively. This decrease resulted primarily from reduced utilization of the Company’s credit facility and the reduction in indebtedness under the facility paid with proceeds from the sale and leaseback transactions completed during the second quarter of 2001 and December 2000.

      The Company’s effective income tax rates were 43.1% and 41.5% for the second quarter of 2001 and 2000, respectively. The higher estimated annual rate of 43.5% used in the second quarter is a result of a fixed level of nondeductible goodwill amortization combined with lower projected profitability in 2001 as compared to 2000.

      Disabilities Services

      Results for the disabilities services segment for the second quarter and the six months ended June 30, 2001 as compared to the same periods in 2000 were significantly impacted by the slowed growth and labor cost pressures described above. Revenues increased by 2.4% to $172.3 million for the second quarter of 2001 and by 2.8% to $343.5 million for the six months ended June 30, 2001 compared to the same periods in 2000, due primarily to rate adjustments and the expansion of existing programs. Segment profit as a percentage of revenue for the quarter and the first six months of 2001 declined to 7.9% and 7.4%, respectively, compared to 9.1% and 10.0% for the same periods in 2000. As discussed above, competitive labor market conditions have resulted in higher labor costs and reduced margins. Labor cost as a percent of segment revenue for 2001 as compared to 2000 have increased to 62.8% from 61.7% for the quarter and to 62.8% from 61.2% for the six month periods. Higher utility and insurance costs also negatively impacted the segment’s profitability for the quarter. When compared to the second quarter of 2000, utilities increased approximately $250,000, while insurance costs increased approximately $1.6 million. For the six month periods, utilities increased approximately $849,000, while insurance costs increased approximately $3.5 million.

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      Youth Services

      Youth services revenues for the second quarter of 2001 increased by 7.9% to $48.7 million for the second quarter of 2001 and by 7.8% to $97.3 million for the six months ended June 30, 2001 compared to the same periods in 2000, primarily from increased student levels at the Treasure Island Job Corps center in California, offset somewhat by reduced census at the Youthtrack operation in Colorado. Segment profit for the quarter declined from 10.9% in 2000 to 8.3% in 2001. For the six months ended June 30, segment profit as a percentage of revenues declined from 10.7% in 2000 to 8.3% in 2001. These decreases were due primarily to reduced census and higher labor, utility and insurance costs as a percentage of segment revenues.

      Liquidity and Capital Resources

      For the first half of 2001, cash used in operating activities was $5.3 million compared to cash provided of $304,000 for the same period of 2000. This decrease was primarily related to an increase in accounts receivable in certain states in which the Company is deploying its new comprehensive billing system coupled with decreases in accrued expenses for certain required payments. This was offset to some extent by an increase in trade payables.

      For the first half of 2001, cash provided by investing activities was $18.5 million compared to cash used of $14.8 million in the same period of 2000. This shift in cash flows from investing activities is primarily due to the acquisition of formerly leased homes in 2000 versus the sale and leaseback of certain properties during 2001.

      For the first half of 2001, cash used in financing activities was $38.4 million compared to cash provided of $17.4 million in the same period of 2000. The first half of 2000 included borrowings for the acquisition of formerly leased homes, while 2001 reflects the repayment of debt with cash provided primarily from proceeds from the sale and leaseback transactions in December 2000 and during 2001.

      At June 30, 2001, the Company had $21.2 million available under its amended credit agreement and $8.3 million in cash and cash equivalents. Outstanding at that date were irrevocable standby letters of credit in the principal amount of $25.3 million issued in connection with workers’ compensation insurance and certain facility leases.

      Days revenue in accounts receivable were 64 days at June 30, 2001, compared to 59 days at December 31, 2000. Accounts receivable were $155.6 million and $142.8 million at June 30, 2001 and December 31, 2000, respectively. The increase in days is attributable primarily to slower collections on certain accounts receivable from the Department of Labor and a temporary slowing of collections while deploying the Company’s new accounts receivable system at certain operations. The Company continues to expand implementation of its comprehensive accounts receivable system to operations in various states, which is expected to facilitate improvements in collections. Approximately 60% of the Company’s operations are currently utilizing the new system with the remainder of the targeted operations expected to be completed by the end of 2001.

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      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. 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 of June 30, 2001, the Company had borrowings under its amended credit facility with banks of approximately $93.7 million and outstanding letters-of-credit of approximately $25.3 million, for a total of $119.0 million. Of this amount, $60.2 million represents term indebtedness which requires quarterly installments totaling $7.5 million for the remainder of 2001, and $17.0 million in 2002. Standby letters of credit and borrowings totaling $58.8 million were drawn against an $80.0 million revolving credit facility as of June 30, 2001. The amended credit agreement expires in January 2003. The amended facility 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. As of June 30, 2001, the Company was in compliance with all financial covenants related to its credit agreement. The Company’s future ability to achieve the thresholds provided for in the financial covenants largely depends upon continued profitability and/or reductions of amounts borrowed under the amended facility.

Risk Factors

      As discussed above, as a result of a shift in focus from acquisition-related growth to internally-generated growth, the Company experienced lower overall growth rates in 2000 and the first half of 2001 compared to earlier years. As part of its strategy to achieve a higher internal growth rate in 2002, the Company has enhanced its management structure and is implementing other administrative initiatives. 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. The Company’s future revenues will depend significantly upon its ability to maintain and renew existing service contracts and existing leases, and to a lesser extent upon its ability to obtain 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 awarded contracts, could 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 also adversely affect the Company’s ability to obtain and retain these contracts.

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      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 reimbursement levels and its ability to obtain periodic increases in reimbursement rates. Changes in the manner in which Medicaid reimbursement rates are established in the states where the Company operates could adversely affect revenues and profitability. Other changes in the operation of federal and state reimbursement programs, 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 continuing initiatives that increase scrutiny of state-funded programs. Such initiatives include audits of state-funded programs and reviews of waiver programs administered by states. To date, such activities have not adversely affected the Company’s programs; however, the initiatives 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 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 some 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 both 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. Media coverage of the health care industry, including operators of facilities and programs for persons with mental retardation and other developmental disabilities, has from time to time included reports critical of the current trend toward privatization and of the operation of certain of these facilities and programs. Adverse media coverage about providers of these services in general and the Company in particular could lead 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.

Impact of Recently Issued Accounting Standards

      In July 2001, the Financial Accounting Standards Board issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of Statement

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142. The Company is required to adopt the provisions of Statement 141 immediately, and the provisions of Statement 142 effective January 1, 2002.

      As of the date of adoption, the Company expects to have unamortized goodwill in the amount of approximately $209 million, which will be subject to the transition provisions of Statements 141 and 142. Amortization expense related to goodwill was approximately $8 million and $4 million for the year ended December 31, 2000 and the six months ended June 30, 2001, respectively. Because of the extensive effort needed to comply with adopting the new rules and in anticipation of final implementation guidance, it is not practicable to reasonably estimate the impact of adopting these statements on the Company’s financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle.

Forward-Looking Statements

      Statements in this report that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. In addition, the Company expects to make such forward-looking statements in future filings with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Company. These forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per share, capital structure, growth rate 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 that 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 “Risk Factors” section above. The Company’s 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.

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Item 3. 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. At June 30, 2001 and December 31, 2000, a hypothetical 100 basis point change in interest rates on the average balance of the outstanding variable rate debt would result in a change of approximately $1 million and $1.3 million, respectively, in annual income before income taxes. The estimated impact assumes no changes in volume or composition of debt. 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.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

      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 (Chesser lawsuits) 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 Chesser lawsuits 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 declaratory judgment, AISL seeks a declaration of what insurance coverage is available to the Company in the Chesser lawsuits. It is the Company’s position that the Chesser lawsuits initiated coverage under the primary policies of insurance, thus affording adequate coverage to settle the lawsuits within coverage and policy limits. The declaration judgment is currently scheduled for trial in January 2002. 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.

      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 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 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.

      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 of Harris County, Texas (the Wright lawsuit). Subsequent to the filing, the Company and AISL entered into an agreement whereby any settlement reached in the Wright lawsuit would not be dispositive of whether the claims in the Wright lawsuit were covered under the policies issued by AISL. AISL thereafter settled the Wright lawsuit. It is the Company’s position that the Wright 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 declaratory judgment is currently scheduled for trial in October 2001. 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

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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 binding arbitration is currently scheduled for September 2001. 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.

      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.

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Item 6. Exhibits and Reports on Form 8-K

      (a) Reports on Form 8-K:

      On June 21, 2001, the Company filed a Current Report on Form 8-K announcing the schedule for its annual meeting with shareholders.

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SIGNATURES

      Pursuant to the requirements 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. Registrant
Date:	August 14, 2001	By: /s/ Ronald G. Geary
		Ronald G. Geary Chairman, President and Chief Executive Officer
Date:	August 14, 2001	By: /s/ L. Bryan Shaul
		L. Bryan Shaul Executive Vice President of Finance & Administration and Chief Financial Officer

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