424(b)(4)
Table of Contents

Filed Pursuant to Rule 424(b)(4)
Registration No. 333-196281

 

PROSPECTUS

 

 

11,700,000 Shares

 

LOGO

Civitas Solutions, Inc.

Common Stock

 

 

This is the initial public offering of shares of common stock of Civitas Solutions, Inc. We are offering 11,700,000 shares of our common stock. Prior to this offering, there has been no public market for our stock.

Our common stock has been approved for listing on the New York Stock Exchange under the symbol “CIVI.” Upon completion of this offering, we will be a “controlled company” as defined in the corporate governance rules of the New York Stock Exchange.

Investing in our common stock involves risks. See “Risk Factors” beginning on page 17.

 

     Per Share      Total  

Price to the public

   $ 17.000       $ 198,900,000   

Underwriting discounts and commissions

   $ 1.105       $ 12,928,500   

Proceeds, before expenses, to us (1)

   $ 15.895       $ 185,971,500   

 

(1) We refer you to “Underwriting” beginning on page 145 of this prospectus for additional information regarding underwriting compensation.

We have granted the underwriters a 30-day option to purchase up to 1,755,000 additional shares from us at the initial public offering price, less the underwriting discount.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares on or about September 22, 2014.

 

 

 

Barclays   BofA Merrill Lynch   UBS Investment Bank

 

 

 

Raymond James

    

SunTrust Robinson Humphrey

     BMO Capital Markets      Avondale Partners

Prospectus dated September 16, 2014


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     17   

FORWARD-LOOKING STATEMENTS

     38   

USE OF PROCEEDS

     40   

DIVIDEND POLICY

     41   

CAPITALIZATION

     42   

DILUTION

     44   

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

     46   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     48   

BUSINESS

     77   

MANAGEMENT

     94   

EXECUTIVE COMPENSATION

     102   

PRINCIPAL STOCKHOLDERS

     125   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     128   

DESCRIPTION OF CERTAIN INDEBTEDNESS

     133   

DESCRIPTION OF CAPITAL STOCK

     136   

SHARES ELIGIBLE FOR FUTURE SALE

     140   

CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS FOR NON-U.S. HOLDERS

     142   

UNDERWRITING

     145   

LEGAL MATTERS

     153   

EXPERTS

     153   

WHERE YOU CAN FIND MORE INFORMATION

     153   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

 

We have not and the underwriters have not authorized anyone to provide you with any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where such offers and sales are permitted. The information in this prospectus or any free writing prospectus is accurate only as of its date, regardless of its time of delivery or the time of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

 

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MARKET, RANKING AND OTHER INDUSTRY DATA

The data included in this prospectus regarding markets and ranking, including the size of certain markets and our position and the position of our competitors within these markets, are based on (1) published and unpublished industry sources and (2) our estimates based on our management’s knowledge and experience in the markets in which we operate. Unless otherwise stated, all statistical information in this prospectus relating to I/DD has been obtained from reports prepared by Dr. David Braddock, including annual and/or biennial data collected for inclusion in “The State of the States in Developmental Disabilities,” a research report prepared by Dr. Braddock, and data that was publicly presented by Dr. Braddock in 2013. Dr. Braddock is Associate Vice President of the University of Colorado (CU) System and Executive Director of the Coleman Institute for Cognitive Disabilities. We have provided the most recent market data available to us, including the data that was publicly presented by Dr. Braddock in February 2013. Our estimates have been based on these sources as well as information obtained from our customers, the federal government, trade and business organizations and other contacts in the markets in which we operate. We are responsible for all of the disclosure in this prospectus.

 

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PROSPECTUS SUMMARY

The following summary highlights information appearing elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully. In particular, you should read the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes relating to those statements included elsewhere in this prospectus. Some of the statements in this prospectus constitute forward-looking statements. See “Forward-Looking Statements.”

In this prospectus, unless the context requires otherwise, references to “Civitas” refer to Civitas Solutions, Inc. (formerly known as NMH Holdings, Inc.), the issuer of the common stock offered hereby, and references to the “Company,” “we,” “our” or “us” refer to Civitas and its consolidated subsidiaries. Throughout this prospectus we use the term “must serve” to describe the people we serve. We consider “must-serve individuals” to be those that public policy has recognized a responsibility to care for because they are highly vulnerable by virtue of a condition acquired at birth or after birth or their status as minors or as elders and have special needs and/or disabilities such that they need to be supported or cared for in the daily activities of living.

Company Overview

We are the leading national provider of home- and community-based health and human services to must-serve individuals with intellectual, developmental, physical or behavioral disabilities and other special needs. These populations are large, growing and increasingly being served in home- and community-based settings such as those we provide. Our clinicians and caregivers develop customized service plans, delivered in non-institutional settings, designed to address a broad range of often life-long conditions and to enable those we serve to thrive in less restrictive settings.

We believe we offer a powerful value proposition to government and non-public payors, referral sources, and individuals and families by providing a continuum of high quality, cost-effective residential, day and vocational programs, and periodic services. We currently offer our services through a variety of models, including (i) neighborhood group homes, most of which are residences for six or fewer individuals, (ii) host homes, or the “Mentor” model, in which a client lives in the private home of a licensed caregiver, (iii) in-home settings, within which we support clients’ independent living or provide therapeutic services, (iv) specialized community facilities to support individuals with more complex medical, physical and behavioral challenges, and (v) non-residential care, consisting primarily of day and vocational programs and periodic services that are provided outside the client’s home.

During our nearly 35-year history, we have evolved from a single residential program serving at-risk youth to a diversified national network providing an array of high-quality services and care in large, growing and highly-fragmented markets. As of June 30, 2014, we operated in 36 states, serving more than 12,500 clients in residential settings and more than 15,700 clients in non-residential settings. We have a diverse group of hundreds of public payors that fund our services with a combination of federal, state and local funding, as well as an increasing number of non-public payors in our newest service lines. Our services are provided by over 20,000 full-time equivalent employees, as well as approximately 5,500 independently-contracted host home caregivers.

For fiscal 2013, we generated net revenue of $1,199 million and a net loss of $(18.3) million, and for the nine months ended June 30, 2014, we generated net revenue of $938.9 million and a net loss of $(16.9) million. Over the last three fiscal years ended September 30, 2013, we grew our annual revenue 19%, or $195 million, 54% of which was from organic growth and 46% of which was attributable to businesses acquired during this period or in the preceding year. We believe that our new start investments and our substantial acquisition pipeline, coupled with new opportunities to expand our services in new and existing markets, position us for continued strong growth.

 

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Our Industry

While we have the capabilities to serve individuals with a wide variety of special needs and disabilities, the current principal focus of our business is on the provision of services to individuals with intellectual and/or developmental disabilities (“I/DD”), youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (“ARY”), and individuals with catastrophic injuries and illnesses, particularly acquired brain injury (“ABI”).

 

   

I/DD. The largest portion of our client base consists of adults and children with I/DD. Public spending on I/DD services was estimated to be $56.6 billion in 2011, of which approximately 80% was spent to provide services in community settings of six or fewer beds, our target market, and for other non-institutional services, including supported living, supported employment and family assistance. In 2012, there were approximately 4.9 million individuals with an intellectual or developmental disability across the nation.

 

   

ARY. We provide services to youth with emotional, behavioral and/or medically complex challenges, or at-risk youth. According to reports published by the organization Child Trends, an estimated $29.4 billion was spent in 2010 on child welfare, including spending on the support services we offer. Approximately 3.3 million referrals for abuse or neglect were investigated or assessed in the United States in 2010. Of that, approximately 663,000 were served by the foster care system. According to the Federal Department of Health and Human Services AFCARS data, there were nearly 400,000 children and adolescents in foster care as of September 30, 2012. Of those individuals, approximately 200,000 are living in non-relative foster family homes, which includes the therapeutic foster care market, the primary market for our residential ARY services.

 

   

ABI. We provide services to individuals with ABI and other catastrophic injuries and illnesses through our post-acute Specialty Rehabilitation Services (“SRS”) segment. The market for post-acute care and rehabilitation for individuals with ABI, the largest of these populations, is approximately $10 billion annually, according to the Centers for Disease Control and Prevention (the “CDC”). According to the Brain Injury Association of America (“BIAA”), there are more than 2.6 million new brain injuries each year, many of which result in complex, life-long medical and/or behavioral issues that require specialized care. Approximately 5.3 million individuals in the United States are living with permanent disability as a result of an ABI.

Industry Trends

We believe we are well positioned to benefit from a number of favorable trends in our industry:

There are large and growing must-serve populations for our services.

The markets we serve are growing as a result of changing demographics, shifts in public policy, consumer awareness and increased focus on cost-effectiveness.

There is an expanding population of individuals with I/DD eligible for residential and other support services. This growth has been driven by a number of factors, including the following:

 

   

Longer lifespan. Increasingly, individuals with I/DD are living longer lives, with life expectancy climbing from 59 years in the 1970s to 66 years in 1993, the most recent year for which data is available. As these individuals increasingly live longer lives, they require additional care and in many cases outlive the ability to live independently or with family caregivers.

 

   

Aging caregivers. In 2011, approximately 72% of individuals with I/DD, or 3.5 million, lived with family caregivers, including more than 850,000 with family caregivers aged 60 years or older. As these family caregivers age and become less capable of providing continuous care, we expect they will

 

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increasingly seek out-of-home or supported living arrangements, such as those we provide, for their relatives with disabilities.

 

   

Waiting lists. There is a significant unmet need for residential services for individuals with I/DD. Many states maintain waiting lists for individuals seeking placements for these services. Nationwide, as of 2010, there were an estimated 115,000 individuals with I/DD waiting for residential services, including 88,000 on formal waiting lists in 35 states. There are legislative, advocacy and litigation efforts currently under way in many states to reduce waiting lists and provide additional access to residential services, which we believe will continue to drive additional demand for services such as those we provide.

 

   

De-institutionalization. As of 2011, there were approximately 84,000 individuals with I/DD residing in institutions with 16 or more beds, including nearly 30,000 in public institutions. At the federal and state levels, policy changes, legal decisions and cost containment efforts are driving a continuing trend of de-institutionalization for the treatment of individuals with disabilities and special needs. Several states are currently in the process of downsizing or closing I/DD institutions, including California, New Jersey and Georgia.

We believe the ARY population is growing, along with the demand for many of the services we offer. Specific trends impacting the ARY population include:

 

   

Shifting demographics of children. An increasing number of children are living in poverty in the United States. According to the Children’s Defense Fund, the number of children living below the poverty line increased by more than 4.5 million from 2000 to 2012, and 2.75 million more children were categorized as poor in 2012 than before the economic downturn began in 2007. In addition, the number of children in single-parent families increased from 22.7 million in 2008 to 24.7 million in 2012, or an increase of approximately 9%. We believe these children are more likely to require the residential and periodic services offered through our ARY segment as their caregivers face greater demands.

 

   

Stabilization of the foster care population. The number of children in foster care reached a peak of 567,000 in 1999 and declined to nearly 400,000 as of September 30, 2012. The decline in the population was driven by several factors causing a shift in care delivery, but we believe the full impact of those factors has already been experienced. The population has stabilized, evidenced by the fact the number of children in foster care has been approximately 400,000 for each of 2010, 2011 and 2012.

 

   

Growing demand for periodic services. In an effort to prevent children and adolescents from requiring an out-of-home placement, public child welfare agencies have for several years been emphasizing periodic support services to strengthen families at-risk. Consistent with this trend, we have been expanding our ARY periodic services in existing and new markets to meet this demand and help more children and families in need of support.

The market for ABI services is growing due to several factors, including:

 

   

Advances in medical care. Advances in emergency care and medical technology are increasing the survival rate and extending the life span of those who suffer a catastrophic injury. This has served to both expand the overall population of these individuals and to place increased responsibility on payors and government agencies to seek cost-effective care.

 

   

Increasing public awareness. Increases in public awareness of the causes and potential complications of brain injury are driving an increased focus on the diagnosis and proper treatment of these injuries. In particular, the conflicts in Afghanistan and Iraq, where traumatic brain injury has been one of the signature wounds for our military, as well as significant research and media coverage related to the incidence of brain injury in contact sports, especially professional football, have contributed to this

 

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increased awareness. As a result, emergency room visits for traumatic brain injury increased by approximately 30% from 2006 to 2010, an eight times increase compared with the growth in emergency room visits generally.

 

   

Increasing demand for specialized care. Patients, families and payors are increasingly seeking specialized care provided in ABI-specific community-based settings such as those that we offer. There are tens of thousands of individuals with brain injuries currently in nursing facilities. We believe many of these patients, particularly younger individuals, would be better served in community-based rehabilitative programs, as evidenced and supported by growing advocacy, changes in public policy and legal precedents supporting their transition to specialized care settings.

 

   

Increasing funding for community-based settings. Both the public and private sectors finance post-acute services for individuals with ABI. We believe that payors are increasingly seeking to serve patients in more cost-effective and appropriate community-based settings. For example, in recent years the increase in state ABI waiver programs that provide easier access to Medicaid funds has expanded the number of individuals who can afford ABI services. According to the Kaiser Family Foundation, there were 17,193 individuals served through state waiver programs for brain injury in 2010, up from 11,214 in 2006, representing a compound annual growth rate of 11.3%.

Clients, caregivers and payors are increasingly recognizing the value of home- and community-based services.

We believe home- and community-based services are strongly preferred by clients and their caregivers. The less restrictive settings provide greater control over care delivery, support patient quality of life and independence, and facilitate stronger bonds between those we serve and their caregivers. Additionally, consumers are becoming increasingly aware of the full spectrum of services available in the market, and we believe they will continue to demand the type of tailored and cost-effective community-based care we offer.

Furthermore, we believe that in our target markets, both public and non-public payors will increasingly emphasize and fund community-based services that offer comprehensive care across the continuum at a better relative value. We believe tailored solutions and ongoing support, such as the services we provide, offer better overall outcomes for the populations we serve. For most of our patient populations, our customized service plans cost less than care plans in large-scale institutional settings. Home- and community-based services are also preferred as a clinically appropriate and less expensive “step-down” alternative for individuals who no longer require care in more expensive acute care settings.

Funding for home- and community-based services is expanding.

We believe funding for home- and community-based services is expanding for a variety of reasons, including the must-serve nature of our population, and legislation, legal precedents and advocacy efforts supporting the individuals we serve. Human services, including services for the I/DD and ARY populations, are generally funded by government programs, predominantly Medicaid, while ABI services are funded by a mix of government programs and private insurance. These programs are often administered on a state-wide level and, in selected states, decisions regarding funding for individual clients and programs occur at the county level, resulting in a large and diverse payor base. State governments are financially incentivized to continue funding services in our core markets because states receive matching federal funds for state expenditures. As a result of these factors, our rates have remained stable, with some rate contraction in 2009 through 2011 following the economic downturn and modest expansion starting in 2012. We believe improving state budgets resulting from a recovering economic environment will further drive growth in funding.

 

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The health and human services markets we serve are highly fragmented, and we expect continued consolidation of the numerous local and regional providers who lack our scale and resources.

The markets we serve are highly fragmented, with only a limited number of national providers of significant scale. We believe payors are demanding more sophisticated reporting, quality, billing and clinical outcomes data, which require complex and robust administrative and IT systems. Small providers often lack the resources to implement and the scale to leverage these systems. We also believe payors are seeking to contract with larger providers that can offer more comprehensive services across a continuum of care, deliver consistent quality and act quickly to establish new programs for populations in need of service.

Competitive Strengths

We believe we are uniquely positioned to be the preferred provider of home- and community-based health and human services in the markets we serve. In particular, our strengths include:

The Leading Provider of Home- and Community-Based Health and Human Services in the United States. As of June 30, 2014, we provided services to more than 12,500 clients in residential settings and more than 15,700 clients in non-residential settings across 36 states, which are home to approximately 85% of the U.S. population. Our national scale and breadth of service offerings provide us with significant competitive advantages:

 

   

Responsiveness. Our scale enables us to deliver a broad range of highly customized services across a continuum of care with a greater level of responsiveness than many of our regional or local service competitors. We have the knowledge, financial resources and relationships to anticipate and rapidly respond to customer needs and market opportunities, positioning us well to capture new business.

 

   

Clinical expertise. Given our extensive national network of clinicians and the wide variety of service models we use, we have developed a broad range of clinical expertise to address a range of disabilities and special needs. We leverage clinical best practices from across our network to expand into new markets and initiate new service lines and programs to address the needs of our payors, our clients and their caregivers. We believe our ability to serve individuals with the most complex physical and behavioral challenges distinguishes us from many of our competitors.

 

   

Infrastructure. Unlike smaller competitors that lack our scale and resources, we have developed a robust infrastructure, including functions such as quality assurance, compliance, risk management, information technology, human resources, billing and financial management, that we leverage across our care-delivery network. This infrastructure enables our operations to focus on efficiently delivering consistent, high-quality care and enables us to respond to the increasing compliance, regulatory and fiscal requirements of payors.

Powerful Value Proposition. We believe we offer a powerful value proposition to our payors, our clients and their caregivers through our ability to design customized service plans to meet the unique needs of our clients in cost-effective settings. We specialize in adapting our service offerings to a wide range of intensities of care and other client requirements.

Proven Ability to Make Acquisitions at Attractive Valuations. We believe our scale, in-depth industry knowledge, payor relationships, reputation for quality and operational expertise strategically position us as a preferred acquirer, with an ability to efficiently and opportunistically deploy capital. We are the only company with a national platform dedicated to serving each of the I/DD, ARY and ABI populations. This positions us as a prime exit option for small providers in these highly-fragmented markets. We have completed 36 acquisitions and deployed approximately $127 million of capital for acquisitions from the beginning of fiscal 2009 through June 30, 2014.

 

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Unique First Mover Advantage in SRS. Through our history of acquisitions and new starts, we now serve over 1,300 individuals in 26 states in our SRS segment. We are the only provider with a national platform dedicated to providing post-acute care for individuals with brain injuries or other catastrophic injuries and illnesses, and thus we believe we are the leader serving this market. Through our NeuroRestorative and CareMeridian business units, we offer solutions to SRS clients across the continuum of care, from post-acute care and neurorehabilitation to day treatment and supportive living services, that help individuals in their recovery and, in many cases, to regain independence. Our experience in SRS enables us to deliver high-quality specialized care and offer significant cost savings for payors, leading to an expanding pipeline of referrals. Our quality of care and outcomes, along with limited competition of scale in the underserved SRS market, position us to capitalize on this opportunity and benefit from its rapid growth.

Stable Cash Flows Fund Growth Opportunities. Our highly-diverse group of payors and the must-serve populations we support have insulated our revenue streams from significant and widespread rate reductions. This, coupled with our historically consistent annual capital expenditures of only 2% to 3% of net revenue and low working capital needs, has helped us achieve stable cash flows through periods of economic recession and prosperity. We have been able to utilize our stable cash flows to invest in new growth opportunities and fuel the expansion of our services.

Proven Management Team with a Track Record of Performance. Our management team, having served previously as policy makers, fiscal managers and service providers, has extensive public and private sector experience in health and human services. Our executive officers have been with us for an average of 13 years and average approximately 23 years in the human services industry. Our management team has demonstrated the ability and experience to ensure the delivery of high quality services to clients, pursue and integrate numerous acquisitions, manage critical human resources, develop and maintain robust IT and financial systems, mitigate risk in the business and oversee our significant growth and expansion.

Our Business Strategy

We intend to continue leveraging our strengths to capitalize on the market opportunity for home- and community-based health and human services. The primary aspects of our strategy include:

Leverage our Core Competencies to Drive Organic Growth. We expect to capture the embedded growth opportunities resulting from our recent initiatives and leverage our core competencies to further expand our presence in markets we already serve and to further expand our geographic footprint in our existing service lines. During our nearly 35-year history, we have developed and refined a core set of competencies through our experience developing customized service plans for complex cases and supporting our operations with expertise in areas such as risk management, compliance and quality assurance.

Continue to Invest in our New Start Programs. A key driver of growth has been our new start programs that have historically generated attractive returns on our investments. Our investment of approximately $8 million in new starts between fiscal 2007 and fiscal 2010 generated net revenues and new start operating income of approximately $70 million and $14 million, respectively, in fiscal 2013. We intend to continue to aggressively pursue new start opportunities with attractive rates of return on investment.

Pursue Opportunistic Acquisitions. We intend to continue to pursue acquisitions that are consistent with our mission and can be readily integrated into our existing operations. We have invested in a team dedicated to mergers and acquisitions, as well as the infrastructure and formalized processes to enable us to pursue acquisition opportunities and to integrate them into our business. We monitor the market nationally for businesses that we can acquire at attractive prices and efficiently integrate with our existing operations. From the beginning of fiscal 2009 through June 30, 2014, we have successfully acquired 36 companies, at an aggregate purchase price of approximately $127 million.

 

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Expand our SRS Platform. We intend to leverage our unique scale and leadership position to continue to expand our SRS platform through continued organic growth in new and existing markets, as well as through opportunistic acquisitions. We are the only provider with a national platform dedicated to providing post-acute care for individuals with brain injuries or other catastrophic injuries and illnesses, and thus we believe we are the leader serving this market. We have more than doubled the size and contribution of our SRS segment since 2009, achieving a 21% compound annual growth rate in net revenue over that period. Furthermore, our SRS business is funded by a highly attractive payor mix, with 56% of net revenues in 2013 derived from commercial insurers and other private entities.

Pursue Opportunities in Adjacent Markets and Complementary Service Lines that Diversify our Service Offerings. We have a proven track record of expanding into adjacent markets, as evidenced by the growth of our SRS segment, and we intend to leverage our core competencies and relationships with state agencies to pursue opportunities in adjacent markets, including potentially those serving elders, youth with autism and individuals with mental health issues. We believe our periodic, day and residential services can be leveraged to address a portion of the estimated $75 billion spent in 2010 on residential and personal healthcare services and home healthcare services for individuals 64 years of age or older, based on data from the Centers for Medicare and Medicaid Services. More specifically, we initially intend to pursue the adult day services portion of this market, an estimated $6 billion market based on IBISWorld estimates for spending on adult day care in 2010, and we have recently agreed to acquire a company in this market, subject to customary closing conditions. See “—Recent Developments.”

Recent Developments

Acquisition of Massachusetts Adult Day Health Alliance

On June 30, 2014, Adult Day Health, Inc., a newly formed subsidiary of the Company, agreed to acquire Massachusetts Adult Day Health Alliance for an aggregate purchase price of up to $38.3 million in cash. The acquisition was completed on September 8, 2014. Massachusetts Adult Day Health Alliance operates adult day health facilities in the Boston area. Massachusetts Adult Day Health Alliance provides outpatient, center-based services that provide health, therapeutic and social support to adults in a group environment. The facilities are typically open 362 days a year between 8 a.m. and 4 p.m. The size of the centers range from 94 clients to 200 clients. Massachusetts Adult Day Health Alliance provides a structured six-hour day for clients, as well as round-trip transportation to and from the facility. In 2013, Massachusetts Adult Day Health Alliance generated approximately $17 million in revenue, which was almost entirely funded through Medicaid. For additional information, see “Risk Factors—Risk Related to the Acquisition of Massachusetts Adult Day Health Alliance.”

The acquisition is our first entry into adult day services, but it is a natural extension of our core competencies especially in regard to our high-quality day programs for individuals with intellectual and developmental disabilities as well as those who have suffered brain injuries. We believe that there will be a growing demand for adult day services for several reasons, including that the population of adults 65 and older is a growing demographic. Moreover, states are increasingly looking for alternatives to more expensive models of home-based, residential and institutional care. The adult day services market, like other markets in which we operate, is highly fragmented with opportunities for consolidation.

 

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Risk Factors

An investment in our common stock involves a high degree of risk. Any of the factors set forth under “Risk Factors” may limit our ability to successfully execute our business strategy. You should carefully consider all of the information set forth in this prospectus and, in particular, should evaluate the specific factors set forth under “Risk Factors” in deciding whether to invest in our common stock. Among these important risks are the following:

 

   

we rely on Medicaid funding as we derive approximately 90% of our revenue from contracts with state and local governments and a substantial portion of this revenue is state funded with federal matching Medicaid dollars; accordingly, reductions or changes in Medicaid funding or changes in budgetary priorities by the federal, state and local governments that pay for our services could have a material adverse effect on our revenue and profitability;

 

   

the nature of our operations subjects us to substantial claims, litigation and governmental proceedings;

 

   

an increase in labor costs or labor-related liability;

 

   

reductions in reimbursement rates, a failure to obtain increases in reimbursement rates or subsequent negative audit adjustments could adversely affect our revenue, cash flows and profitability;

 

   

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

 

   

we have a history of losses, and we might not be profitable in the future.

Our Corporate Information

Civitas Solutions, Inc. (formerly known as NMH Holdings, Inc.) is a Delaware corporation incorporated on June 15, 2007. Our business was originally formed in 1980. We were acquired in 2006 pursuant to the merger and contribution (the “Merger”) by affiliates of Vestar Capital Partners (“Vestar”). Our principal executive office is located at 313 Congress Street, Boston, Massachusetts 02210, and our telephone number is (617) 790-4800. The address of our main website is www.civitas-solutions.com. You should not consider any information on, or that can be accessed through, our website as part of this prospectus.

Civitas’ direct parent company, NMH Investment, LLC (“NMH Investment”) is controlled by investment funds managed by Vestar Capital Partners. The equity interests of NMH Investment are owned by Vestar and certain of our executive officers and directors and other members of management.

Civitas is the indirect parent of National Mentor Holdings, Inc. (“NMHI”), which is the issuer of 12.50% Senior Notes due 2018 (the “senior notes”) and the borrower under the Company’s senior secured credit facilities. NMHI is required by the terms of the indenture governing the senior notes to file reports with the Securities and Exchange Commission (the “SEC”), and under SEC rules, is a voluntary filer. We intend to use the net proceeds from the sale of common stock by us in this offering to redeem $162.0 million in aggregate principal amount of the outstanding senior notes.

 

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Corporate Structure

The chart below sets forth our current corporate structure and gives effect to the issuance of the shares in this offering. The ownership percentages are calculated as of the date of this prospectus (i) based on the initial public offering price of $17.00 per share, (ii) assuming no exercise by the underwriters of their option to purchase up to 1,755,000 additional shares from us, (iii) assuming the Class H Common Units of NMH Investment issued to management vest and (iv) excluding the issuance of the options and restricted stock units that we intend to grant in connection with this offering. Because NMH Investment will not distribute its shares of our common stock in connection with this offering, management’s ownership of up to 4% of the equity of NMH Investment represented by the Class H Common Units will remain unvested upon completion of this offering.

 

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Equity Sponsor

Founded in 1988, Vestar Capital Partners is a leading U.S. middle market private equity firm specializing in management buyouts and growth capital investments. Vestar invests and collaborates with incumbent management teams and private owners in a creative, flexible and entrepreneurial way to build long-term enterprise value. Since Vestar’s founding, Vestar funds have completed more than 70 investments in companies with a total value of more than $40 billion.

Vestar has extensive experience investing across a wide variety of industries, including healthcare, financial services, information services, consumer, digital media and diversified industries. Vestar Capital Partners has been making successful investments in the healthcare sector since the late 1990s, when the firm helped the physician managers of Sheridan Healthcare take the company private and build it from a local operation into a nationwide provider of outsourced medical services.

Since then, Vestar’s healthcare investments have spanned the healthcare spectrum, including, in addition to the Company, Essent Healthcare, a hospital management company, and more recently, healthcare information and measurement technologies investments, which include HealthGrades, Press Ganey and MediMedia.

Vestar currently manages funds with approximately $5 billion of assets and has offices in New York, Denver and Boston. Vestar’s investment in NMH Investment was funded by Vestar Capital Partners V, L.P., a $3.7 billion fund which closed in 2005, and affiliates.

 

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The Offering

 

Issuer

Civitas Solutions, Inc.

 

Common stock offered by us

11,700,000 shares

 

Underwriters’ option to purchase additional shares

We have granted the underwriters a 30-day option to purchase up to an additional 1,755,000 shares at the public offering price less underwriting discounts and commissions.

 

Common stock to be outstanding immediately after completion of this offering

36,950,000 shares

 

Use of proceeds

We intend to use the net proceeds from the sale of common stock by us in this offering and cash on hand to (i) redeem $162.0 million in aggregate principal amount of the outstanding senior notes issued by our subsidiary, NMHI, at a redemption price of 106.25% plus accrued and unpaid interest thereon to the date of redemption and (ii) pay a transaction advisory fee of $8.0 million to Vestar under the management agreement with Vestar, which agreement will terminate upon completion of this offering. We intend to use any remaining net proceeds for general corporate purposes.

 

Dividend policy

We currently intend to retain all available funds and any future earnings to fund the development and growth of our business, and therefore we do not anticipate paying any cash dividends in the foreseeable future. Additionally, our ability to pay dividends on our common stock will be limited by restrictions on the ability of our subsidiaries and us to pay dividends or make distributions under the terms of current and any future agreements governing our indebtedness. Any future determination to pay dividends will be at the discretion of our Board of Directors, subject to compliance with covenants in our current and future agreements governing our indebtedness, and will depend upon our results of operations, financial condition, capital requirements and other factors that our Board of Directors deems relevant.

 

Symbol

Our common stock has been approved for listing on the New York Stock Exchange under the symbol “CIVI.”

 

Risk factors

For a discussion of risks relating to us, our business and an investment in our common stock, see “Risk Factors” and all other information set forth in this prospectus before investing in our common stock.

 

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Unless otherwise indicated, all information in this prospectus relating to the number of shares of common stock to be outstanding immediately after this offering:

 

   

assumes the effectiveness of our amended and restated certificate of incorporation and amended and restated bylaws, which we will adopt prior to the completion of this offering;

 

   

gives effect to a 2,525,000-for-one stock split, which we effected on September 2, 2014 in anticipation of this offering;

 

   

excludes an aggregate of 3,325,500 shares of our common stock reserved for issuance under our 2014 Incentive Plan (as defined herein) that we intend to adopt in connection with this offering, including an aggregate of 559,572 shares of common stock issuable under options to be issued in connection with this offering with an aggregate value of $4.3 million, and an aggregate of 550,480 restricted stock units to be issued in connection with this offering with an aggregate value of $9.4 million; and

 

   

assumes no exercise by the underwriters of their option to purchase up to 1,755,000 additional shares from us.

 

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Summary Consolidated Financial Data

The following tables set forth our summary consolidated financial data as of and for the dates indicated. The consolidated financial data as of September 30, 2012 and 2013 and for the years ended September 30, 2011, 2012 and 2013 are derived from our audited consolidated financial statements, included elsewhere in this prospectus. The consolidated financial data as of September 30, 2011 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated financial data presented below as of and for the nine months ended June 30, 2013 and 2014 have been derived from our unaudited condensed consolidated financial statements, which are included elsewhere in this prospectus. Operating results for the nine months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the entire fiscal year ending September 30, 2014.

Our results included below and elsewhere in this prospectus are not necessarily indicative of our future performance. The following summary consolidated financial data are qualified in their entirety by reference to, and should be read in conjunction with, our audited consolidated financial statements and the accompanying notes, included elsewhere in this prospectus, and the information under “Selected Historical Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our financial statements and notes thereto and other financial information included in this prospectus.

 

    Fiscal Year Ended September 30,     Nine Months Ended June 30,  
    2011     2012     2013     2013     2014  
(dollars in thousands, except per share data)                              

Statements of Operations Data:

         

Net revenue

  $ 1,062,773      $ 1,123,118      $ 1,198,653      $ 893,541      $ 938,861   

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

    823,009        874,778        935,143        700,401        734,887   

General and administrative expenses

    144,011        140,221        146,040        110,879        108,811   

Depreciation and amortization

    61,330        60,534        64,146        47,970        50,987   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    34,423        47,585        53,324        34,291        44,176   

Management fee of related party

    (1,271     (1,325     (1,359     (985     (1,041

Other income (expense), net

    (142     2        929        628        499   

Extinguishment of debt

    (23,684     —         —         —         (14,699

Interest income

    22        332        137        109        163   

Interest expense

    (67,511     (79,445     (78,075     (58,482     (53,204
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

    (58,163     (32,851     (25,044     (24,439     (24,106

Benefit for income taxes

    (19,287     (19,283     (9,472     (8,437     (7,212
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

    (38,876     (13,568     (15,572     (16,002     (16,894

Loss from discontinued operations, net of tax (1)

    (4,625     (701     (2,724     (2,678     19   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (43,501   $ (14,269   $ (18,296   $ (18,680   $ (16,875
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share Data:

         

Net loss per common share:

         

Basic

  $ (1.72   $ (0.57   $ (0.72   $ (0.74   $ (0.67

Diluted

  $ (1.72   $ (0.57   $ (0.72   $ (0.74   $ (0.67

Weighted-average common shares outstanding:

         

Basic

    25,250,000        25,250,000        25,250,000        25,250,000        25,250,000   

Diluted

    25,250,000        25,250,000        25,250,000        25,250,000        25,250,000   

Pro Forma Per Share Data: (2)

         

Pro forma net income (loss) per common share:

         

Basic

  

  $ 0.11        $ (0.02

Diluted

  

  $ 0.11        $ (0.02

Pro forma weighted-average common shares outstanding:

         

Basic

  

    36,950,000          36,950,000   

Diluted

  

    36,950,000          36,950,000   

Balance Sheet Data (at end of period):

         

Cash and cash equivalents (3)

  $ 387      $ 125      $ 19,440      $ 16,211      $ 47,526   

Working capital (4)

    12,634        26,192        59,262        65,711        66,085   

Total assets

    1,011,360        1,045,880        1,021,269        1,034,817        1,031,494   

Total debt (5)

    784,124        799,895        803,464        806,447        817,128   

Shareholder’s equity (deficit)

    (16,917     (29,931     (46,515     (47,361     (62,047

 

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    Year Ended September 30,     Nine Months Ended June 30,  
    2011     2012     2013     2013     2014  
(dollars in thousands)                              

Other Financial Data:

         

Cash flows provided by (used in):

         

Operating activities

  $ 30,790      $ 29,251      $ 55,738      $ 32,654      $ 66,667   

Investing activities

    (82,542     (42,662     (39,377     (21,033     (39,711

Financing activities

    25,505        13,148        2,954        4,465        1,130   

Capital expenditures

    20,878        29,995        31,901        22,334        24,271   

Program rent expense (6)

    31,856        32,779        38,994        28,541        31,377   

EBITDA (7)

    70,656        106,796        117,040        81,904        79,922   

Adjusted EBITDA (7)

    110,624        108,793        117,888        82,358          95,765   

Operating losses from new starts (8)

    1,812        7,460        8,802        7,852        4,491   

 

(1) During fiscal 2011 and 2013, we sold our home health business, closed certain Human Services operations in the States of Maryland, Colorado, Nebraska, New Hampshire, New York and Virginia, sold our Rhode Island ARY business and closed our Rhode Island I/DD business. All fiscal years presented reflect the classification of these businesses as discontinued operations.
(2) Pro forma per share data gives effect to: (i) the refinancing of our senior secured credit facilities in January 2014; (ii) the redemption of $162.0 million of the senior notes using the net proceeds from this offering, as described in “Use of Proceeds”; (iii) the reduction of the interest rate payable under our senior secured credit facilities by 0.50% per annum as a result of the reduction in our consolidated leverage ratio following the completion of the redemption of the senior notes using the net proceeds from this offering; (iv) the elimination of the annual management fee to Vestar as a result of the termination of the management agreement with Vestar; and (v) the issuance of 11,700,000 shares of our common stock by us in this offering as if each of these events occurred at the beginning of the periods presented. Pro forma basic net income per share consists of pro forma net income divided by the pro forma basic weighted average common shares outstanding. Pro forma diluted net income per share consists of pro forma net income divided by the pro forma diluted weighted average common stock outstanding.

Pro forma per share data does not give effect to (i) the write-off of deferred financing costs of $0.8 million in connection with the redemption of the senior notes using the net proceeds from this offering and (ii) the write-off of unamortized debt issuance costs of $3.7 million related to the senior notes.

The following is a reconciliation of historical net loss to pro forma net income (loss) for the year ended September 30, 2013 and the nine months ended June 30, 2014:

 

(dollars in thousands, except share and per share data)    Fiscal Year Ended
September 30, 2013
    Nine Months Ended
June 30, 2014
 

Net loss

   $ (18,296 )   $ (16,875 )

Decrease in interest expense (a)

     34,901        21,936   

Management fees and expenses (b)

     1,359        1,041   

Decrease in benefit from income taxes (c)

     (13,907     (6,761
  

 

 

   

 

 

 

Pro forma net income (loss)

   $ 4,057     $ (659

Pro forma net income (loss) per common share:

    

Basic

   $ 0.11     $ (0.02 )

Diluted

   $ 0.11     $ (0.02 )

Pro forma weighted-average common shares outstanding: (d)

    

Basic

     36,950,000        36,950,000   

Diluted

     36,950,000        36,950,000   

 

  (a) Reflects the net adjustment to interest expense resulting from (i) the reduction of the interest rate as a result of the refinancing of our senior secured credit facilities in January 2014, partially offset by the increase in the principal amount of our term loan in that refinancing, and the reduction of our interest expense as a result of the redemption of $38 million in principal amount of our senior notes in February 2014, (ii) the redemption of $162.0 million in principal amount of the senior notes using the net proceeds from this offering, as described in “Use of Proceeds” and (iii) the reduction of the interest rate payable under our senior secured credit facilities by 0.50% per annum as a result of the reduction in our consolidated leverage ratio following the redemption of the senior notes using the net proceeds from this offering.
  (b) Reflects the elimination of management fees to Vestar for the periods presented as a result of the termination of the management agreement. In connection with the Merger, NMHI entered into a management agreement with Vestar, pursuant to which NMHI agreed to pay Vestar an annual management fee equal to the greater of (i) $850,000 and (ii) an amount per annum equal to 1.00% of NMHI’s consolidated earnings before depreciation, amortization, interest and taxes for each fiscal year before deduction of Vestar’s fee, determined as set forth in NMHI’s senior credit agreement. In connection with the consummation of this offering, we intend to pay Vestar a one-time transaction advisory fee under the management agreement of $8.0 million. The management agreement will terminate upon completion of this offering.

 

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  (c) Reflects adjustments to historical benefit from income taxes, assuming a pro forma effective tax rate of 40% for each period presented.
  (d) Reflects 11,700,000 shares of common stock to be issued by us in this offering.
(3) Excludes restricted cash.
(4) Calculated as current assets minus current liabilities.
(5) Includes obligations under capital leases.
(6) Program rent expense is defined as lease expenses related to buildings directly utilized in providing services to clients.
(7) We define “EBITDA” as income before interest expense and interest income, income taxes, depreciation and amortization. We define “Adjusted EBITDA” as EBITDA further adjusted to add back (i) items that are expected to terminate in connection with the offering, (ii) non-cash charges, (iii) non-recurring items that are not indicative of the underlying operating performance of the business and (iv) items that are solely related to changes in our capital structure, and therefore by definition are not indicative of the underlying operating performance of the business. EBITDA and Adjusted EBITDA are presented because they are important measures used by management to assess financial performance, and management believes they provide a transparent view of our operating performance and operating trends. We also believe these non-GAAP measures are useful to investors in assessing financial performance because these measures are similar to the metrics used by investors and other interested parties when comparing companies in our industry that have different capital structures, debt levels and/or income tax rates.

EBITDA and Adjusted EBITDA are not determined in accordance with GAAP and should not be considered in isolation or as an alternative to net income, income from operations, net cash provided by operating, investing or financing activities or other financial statement data presented as indicators of financial performance or liquidity, each as presented in accordance with GAAP. Neither EBITDA nor Adjusted EBITDA should be considered as a measure of discretionary cash available to us to invest in the growth of our business. While EBITDA and Adjusted EBITDA are frequently used as measures of operating performance and the ability to meet debt service requirements, they are not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the method of calculation.

Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual items.

The following table provides a reconciliation from net loss to EBITDA and Adjusted EBITDA:

 

                                                                                                                                      
    Year Ended September 30,     Nine Months Ended June 30,  
    2011     2012     2013     2013     2014  
(dollars in thousands)                              

Net loss

  $ (43,501   $ (14,269   $ (18,296   $ (18,680   $ (16,875

Loss (gain) from discontinued operations, net of tax

    4,625        701        2,724        2,678        (19

Benefit for income taxes

    (19,287     (19,283     (9,472     (8,437     (7,212

Interest expense, net

    67,489        79,113        77,938        58,373        53,041   

Depreciation and amortization

    61,330        60,534        64,146        47,970        50,987   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

  $ 70,656      $ 106,796      $ 117,040      $ 81,904      $ 79,922   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjustments:

         

Management fee to related party (a)

  $ 1,271      $ 1,325      $ 1,359      $ 985      $ 1,041   

Stock based compensation (b)

    3,675        672        273        253        103   

Predecessor provider tax reserve adjustment (c)

    —          —          (2,118     (2,118     —     

Extinguishment of debt (d)

    23,684        —          —          —          14,699   

Discretionary recognition bonuses (e)

    2,361        —          —          —          —     

Non-cash impairment charges (f)

    5,993        —          1,334        1,334        —     

Restructuring (g)

    2,984        —          —         
—  
  
   
—  
  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA (h)

  $ 110,624      $ 108,793      $ 117,888      $ 82,358      $ 95,765   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a) Represents management fees incurred under our management agreement with Vestar, which agreement will terminate in connection with this offering.
  (b) Represents non-cash stock based compensation.
  (c) Represents an adjustment to a reserve for a provider tax that is not required to be paid.
  (d) Represents the write-off of the remaining deferred financings costs on debt that we refinanced in fiscal 2011 and in the nine months ended June 30, 2014.
  (e) Represents payment of one-time discretionary bonuses in recognition of extraordinary contributions of certain employees in connection with a refinancing transaction in February 2011.
  (f) Represents impairment charges associated with indefinite lived intangible assets and goodwill related to the closing of underperforming programs.

 

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  (g) Represents severance and other costs incurred as part of the restructuring of certain corporate and field functions.
  (h) Adjusted EBITDA does not include any adjustments for “pro forma acquired EBITDA.” Pro forma acquired EBITDA represents pre-closing EBITDA with respect to acquisitions made during the period based on actual EBITDA generated by the acquired entity or business from the most recent 12-month period that is available at the time of acquisition, after giving effect to identified adjustments as a result of the combination, pro-rated for the portion of that 12-month period that falls within the applicable reporting period. Pro forma acquired EBITDA was approximately $2.3 million for fiscal 2011, approximately $3.5 million for fiscal 2012, approximately $2.2 million for fiscal 2013, approximately $22 thousand for the nine months ended June 30, 2013 and approximately $1.7 million for the nine months ended June 30, 2014.
(8) Operating losses from new starts represents losses from any new start programs initiated within 18 months of the end of the period that had operating losses during the period. Net operating loss from a new start is defined as its revenue for the period less direct expenses but not including allocated overhead costs. For more information regarding operating income and losses related to new starts, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting our Operating Results—Expansion of Services—Organic Growth.”

 

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RISK FACTORS

Investing in our common stock involves a number of risks. Before you purchase our common stock, you should carefully consider the risks described below and the other information contained in this prospectus, including our consolidated financial statements and accompanying notes. If any of the following risks actually occurs, our business, financial condition, results of operation or cash flows could be materially adversely affected. In any such case, the trading price of our common stock could decline, and you could lose all or part of your investment.

Risks Related to Our Business

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

We currently derive approximately 90% of our revenue from contracts with state and local governments. These governmental payors fund a significant portion of their payments to us through Medicaid, a joint federal and state health insurance program through which state expenditures are matched by federal funds typically ranging from 50% to approximately 75% of total costs, a number based largely on a state’s per capita income. Our revenue, therefore, is largely determined by the level of federal, state and local governmental spending for the services we provide.

Efforts at the federal level to reduce the federal budget deficit pose risk for reductions in federal Medicaid matching funds to state governments. Previously, the Joint Select Committee on Deficit Reduction’s failure to meet the deadline imposed by the Budget Control Act of 2011 triggered automatic across-the-board cuts to discretionary funding, including a 2% reduction to Medicare, which went into effect April 1, 2013, but specifically exempted Medicaid payments to states. While this development did not reduce federal Medicaid funding, reductions in other federal payments to states will put additional stress on state budgets, with the potential to negatively impact the ability of states to provide the state Medicaid matching funds necessary to maintain or increase the federal financial contribution to the program. Although earlier this year the Congress and President reached an agreement on a two-year budget framework for federal fiscal years 2014 and 2015, negotiations in recent years regarding deficit reduction efforts have been contentious and, most recently, resulted in a 16-day government shutdown in October 2013. While Medicaid payments were not affected during this period, the potential of longer shutdowns in the future if new negotiations regarding the federal budget and/or the federal debt ceiling fail to produce a resolution could cause disruptions in Medicaid support and payments to states. In addition, the federal government may choose to adopt alternative proposals to reduce the federal budget deficit. These alternative reductions could have a negative impact on state Medicaid budgets, including proposals to provide states with more flexibility to determine Medicaid benefits, eligibility or provider payments through the use of block grants or streamlined waiver approvals, as well as those that would reduce the amount of federal Medicaid matching funding available to states by curtailing the use of provider taxes or by adjusting the Federal Medical Assistance Percentage (FMAP). Furthermore, any new Medicaid-funded benefits and requirements established by the Congress, particularly those included in the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, and the rules and regulations thereunder (together, the “Patient Protection and Affordable Care Act”), that mandate certain uses for Medicaid funds could have the effect of diverting those funds from the services we provide.

Budgetary pressures facing state governments, as well as other economic, industry and political factors, could cause state governments to limit spending, which could significantly reduce our revenue, referrals, margins and profitability, and adversely affect our growth strategy. Governmental agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If a government agency does not receive an appropriation sufficient to cover its contractual obligations with us, it may terminate a contract or defer or reduce our reimbursement. In addition, there is risk that previously appropriated funds could be reduced through

 

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subsequent legislation. Many states in which we operate experienced unprecedented budgetary deficits during and in the wake of the recession that began in 2008, and, as a result, implemented service reductions, rate freezes and/or rate reductions, including states such as Minnesota, California, Florida, Indiana and Arizona. Similarly, programmatic changes such as conversions to managed care with related contract demands regarding billing and services, unbundling of services, governmental efforts to increase consumer autonomy and reduce provider oversight, coverage and other changes under state Medicaid plans, may cause unanticipated costs and risks to our service delivery. The loss or reduction of or changes to reimbursement under our contracts could have a material adverse effect on our business, financial condition and operating results.

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

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

Professional and general liability expense totaled 0.8% and 1.2% of our net revenue for the nine months ended June 30, 2014 and 2013, respectively, as compared to 1.0% for the fiscal years ended September 30, 2013, 2012 and 2011. We incurred professional and general liability expenses of $8.0 million, $11.0 million, $12.2 million, $10.9 million and $10.2 million for the nine months ended June 30, 2014 and 2013 and the fiscal years ended September 30, 2013, 2012 and 2011, respectively. These expenses are incurred in connection with our claims reserve and insurance premiums. The expense for the nine months ended June 30, 2013 and fiscal year ended September 30, 2013 included expenses of $2.4 million and $3.4 million, respectively, related to an adjustment to our tail reserve for professional and general liability claims, which is required by accounting standards for companies with claims-made insurance. For more information, see “—Our financial results could be adversely affected if claims against us are successful, to the extent we must make payments under our self-insured retentions, or if such claims are not covered by our applicable insurance or if the costs of our insurance coverage increase.” Increased costs of insurance and claims have negatively impacted our results of operations and have resulted in a renewed emphasis on reducing the occurrence of claims. Although insurance premiums did not increase in fiscal 2013 and 2014, they have increased in prior years and may increase in the future.

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

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

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

 

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

Our revenue and operating profitability depend on our ability to maintain our existing reimbursement levels and to obtain periodic increases in reimbursement rates to meet higher costs and demand for more services. Approximately 13% of our revenue is derived from contracts based on a retrospective cost reimbursement model, whereby we are required to maintain a certain cost structure in order to realize the specified rate. For such programs, if our costs are less than the required amount, we are required to return a portion of the revenue to the payor. Some of our programs are also subject to prospective rate adjustments based on current spending levels. For such programs, we could experience reduced rates in the future if our current spending is not sufficient. If we are not entitled to, do not receive or cannot negotiate increases in reimbursement rates, or are forced to accept a reduction in our reimbursement rates at approximately the same time as our costs of providing services increase, including labor costs and rent, our margins and profitability could be adversely affected.

Changes in how federal and state government agencies operate reimbursement programs can also affect our operating results and financial condition. Some states have, from time to time, revised their rate-setting methodologies in a manner that has resulted in rate decreases. In some instances, changes in rate-setting methodologies have resulted in third-party payors disallowing, in whole or in part, our requests for reimbursement. Any reduction in or the failure to maintain or increase our reimbursement rates could have a material adverse effect on our business, financial condition and results of operations. Changes in the manner in which state agencies interpret program policies and procedures or review and audit billings and costs could also adversely affect our business, financial condition and operating results.

As a result of cost reporting, we have from time to time experienced negative audit adjustments which are based on subjective judgments of reasonableness, necessity or allocation of costs in our services provided to clients. These adjustments are generally required to be negotiated as part of the overall audit resolution and may result in paybacks to payors and adjustments of our rates. We cannot assure you that our rates will be maintained, or that we will be able to keep all payments made to us, until an audit of the relevant period is complete.

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

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

Although our employees are generally not unionized, we have one business in New Jersey with approximately 38 employees who are represented by a labor union and approximately 276 Connecticut direct care workers who are also represented by a labor union. We began negotiating a labor agreement with the Connecticut union in September 2012. Those negotiations, however, were recently suspended after our Connecticut-based business notified the State of Connecticut and the union of its intention to stop providing services under existing contracts due to rate cuts and a change in state policy. We are currently working with our public partners on a plan to effectively transition our programs to new providers, and we anticipate that this transition will be complete during the first quarter of fiscal 2015. From time to time, we experience attempts to unionize certain of our non-union employees. Future unionization activities could result in an increase of our

 

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labor and other costs. If employees covered by a collective bargaining agreement were to engage in a strike, work stoppage or other slowdown, we could experience a disruption of our operations and/or higher ongoing labor costs, which could adversely affect our business, financial condition and results of operations.

Matters involving employees may expose us to potential liability.

We are subject to United States federal, state and local employment laws that expose us to potential liability if we are determined to have violated such employment laws. Failure to comply with federal and state labor laws pertaining to minimum wage, overtime pay, meal and rest breaks, unemployment tax rates, workers’ compensation rates, citizenship or residency requirements, and other employment-related matters may have a material adverse effect on our business or operations. In addition, employee claims based on, among other things, discrimination, harassment or wrongful termination may divert financial and management resources and adversely affect operations. We are further subject to the Fair Labor Standards Act (which governs such matters as minimum wages, overtime and other working conditions) as well as state and local wage and hour laws.

We expect increases in payroll expenses as a result of recent state and federal policy initiatives to increase the minimum wage as well as potential new federal regulations increasing the scope of overtime eligibility. Although such increases are not expected to be material, we cannot assure you that there will not be material increases in the future.

The potential losses that may be incurred as a result of any violation of employment laws are difficult to quantify.

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

We have a significant amount of indebtedness and substantial leverage. As of June 30, 2014, we had total indebtedness of $817.1 million. As of June 30, 2014, after giving effect to this offering and the application of the net proceeds as described under “Use of Proceeds,” we would have had total indebtedness of $655.1 million and an ability to borrow up to an additional $100.0 million under our senior secured revolving credit facility, subject to limitation under NMHI’s indenture governing the senior notes. A portion of our indebtedness, including borrowings under the senior secured credit facilities, bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same. We expect to continue to make new investments in our growth that may reduce liquidity, and we may need to increase our indebtedness in the future.

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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

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

In addition to our significant amount of indebtedness, we have significant rental obligations under our operating leases for our group homes, other service facilities and administrative offices. For the nine months ended June 30, 2014, our aggregate rental payments for these leases were $42.9 million. We expect this number will increase during fiscal 2014 as a result of new leases entered into pursuant to acquisitions and new program starts. Our ongoing rental obligations could exacerbate the risks described above.

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

We have a history of losses, and we might not be profitable in the future.

Due in large part to our high levels of indebtedness, we have had a history of losses. For the years ended September 30, 2011, 2012, 2013 and the nine months ended June 30, 2014, we generated net losses of $43.5 million, $14.3 million, $18.3 million and $16.9 million, respectively. Although we will reduce our outstanding indebtedness using the proceeds of this offering, which will decrease our interest payments, we could report losses in the future. Other factors may cause us to report losses in the future, including reductions in funding for our services, reductions in reimbursement rates, increases in our costs, increased competition and other factors described elsewhere under “—Risks Related to our Business.”

State and local government payors with which we have contracts have complicated billing and collection rules and regulations, and if we fail to meet such requirements, our business could be materially impacted.

We derive approximately 90% of our revenue from contracts with state and local government agencies, and a substantial portion of this revenue is state-funded with federal Medicaid matching dollars. In billing for our services to third-party payors, we must follow complex documentation, coding and billing rules and there can be delays before we receive payment. These rules are based on federal and state laws, rules and regulations, various government pronouncements, and on industry practice. If we fail to comply with federal and state documentation, coding and billing rules, we could be subject to criminal and/or civil penalties, loss of licenses and exclusion from the Medicaid programs, which could materially harm us. Specifically, failure to follow these rules could result in potential criminal or civil liability under the False Claims Act and various federal and state criminal healthcare fraud statutes, under which extensive financial penalties and exclusion from participation in federal healthcare programs can be imposed.

Federal false claims laws prohibit any person from knowingly presenting or causing to be presented a false claim for payment to the federal government, or knowingly making or causing to be made a false statement to get a false claim paid. Penalties for a False Claims Act violation include three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim, the potential for exclusion from participation in federal healthcare programs and criminal liability. The majority of

 

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states also have statutes or regulations similar to the federal false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. See “—We are subject to extensive governmental regulations, which require significant compliance expenditures, and a failure to comply with these regulations could adversely affect our business.”

We annually submit a large volume of claims for Medicaid and other payments, and there can be no assurance that there have not been errors. The rules are frequently vague and confusing, and we cannot assure that governmental investigators, private insurers, private whistleblowers or Medicaid auditors will not challenge our practices. Such a challenge could result in a material adverse effect on our business.

We are routinely subject to governmental reviews, audits and investigations to verify our compliance with applicable laws and regulations. As a result of these reviews, audits and investigations, these governmental payors may be entitled to, in their discretion:

 

   

require us to refund amounts we have previously been paid;

 

   

terminate or modify our existing contracts;

 

   

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

 

   

impose referral holds on us;

 

   

impose fines, penalties or other sanctions on us; and

 

   

reduce the amount we are paid under our existing contracts.

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

Complicated billing and collection procedures can result in delays in collecting payment for our services, which may adversely affect our liquidity, cash flows and operating results.

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

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

Our government payors rely on tax revenue to pay for our services. In the wake of the last economic recession that began in 2008, most states faced unprecedented declines in tax revenues and, as a result, record

 

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budget gaps. Furthermore, even after four years of economic improvement, at the end of 2013, inflation-adjusted tax revenues remained below peak levels in many states. If the economy were to contract into recession again, our government payors or other counterparties that owe us money could be delayed in obtaining, or may not be able to obtain, necessary funding and/or financing to meet their cash flow needs. In 2011, Standard & Poor’s downgraded the Federal government’s credit rating and additional downgrades are possible in the future. In October 2013, Fitch Ratings placed the Federal government’s credit rating on negative watch. If the credit rating of the federal government is downgraded again, it is possible there will be related downgrades of state credit ratings as well. If this or unrelated state downgrades occur, this could make it more expensive for states to finance their cash flow needs and put additional pressure on state budgets. Delays in payment could have a material adverse effect on our cash flows, liquidity and financial condition. In the event that our payors or other counterparties are financially unstable or delay payments to us, our financial condition could be further impaired if we are unable to borrow additional funds under our senior credit agreement to finance our operations.

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

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

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

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

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

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

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

We estimate liabilities associated with workers’ compensation risk and establish reserves each quarter based on internal valuations, third-party actuarial advice, historical loss development factors and other assumptions

 

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believed to be reasonable under the circumstances. In prior years, our results of operations have been adversely impacted by higher than anticipated claims, and they may be adversely impacted in the future if actual occurrences and claims exceed our assumptions and historical trends.

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

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

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

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

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

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

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

Our success in obtaining new contracts and renewals of our existing contracts depends upon maintaining our reputation as a quality service provider among governmental authorities, advocacy groups, families of our clients, our clients and the public. Negative publicity, changes in public perception, legal proceedings and

 

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government investigations with respect to our operations could damage our reputation and hinder our ability to retain contracts and obtain new contracts, and could reduce referrals, increase government scrutiny and compliance or litigation costs, or generally discourage clients from using our services. Any of these events could have a material adverse effect on our business, financial condition and operating results.

Our reputation and prior experience with agency staff, care workers and others in positions to make referrals to us are important for building and maintaining our operations. Any event that harms our reputation or creates negative experiences with such third parties could impact our ability to receive referrals and maintain or grow our client base.

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

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

 

   

the failure by our direct care staff or host-home providers to properly care for clients;

 

   

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

 

   

the failure by our programs to abide by the applicable laws and regulations relating to the provision of health and human services; and

 

   

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

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

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

In order to grow our business, we must capitalize on opportunities to expand existing services and win new business, some of which require spending in advance of revenue. For example, states such as California and New Jersey are in the process of closing state institutions and transitioning individuals with intellectual and developmental disabilities into community-based settings such as ours. Responding to opportunities such as these typically requires significant investment of our resources in advance of revenue. In North Carolina, where we have made significant investments in an effort to expand periodic services for at-risk youth, the system continues to experience significant change that has required us to reorganize and restructure our operations. In fiscal 2012, fiscal 2013 and the beginning of fiscal 2014, we increased significantly the amount spent on growth initiatives, especially new starts. This elevated level of growth investments has had a negative effect on our operating margin, and we may not realize the anticipated benefits of the spending as soon as we expect to or at any point in the future. If we target the wrong areas, or fail to identify the evolving needs of our payors by responding with service offerings that meet their fiscal and programmatic requirements, we may not realize the anticipated benefits of our investments and the results of our operations may suffer.

 

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

we may be required to pay higher purchase prices for acquisitions than we have paid historically;

 

   

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

 

   

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

 

   

we may encounter unanticipated regulatory risk;

 

   

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

 

   

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

 

   

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

 

   

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

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

If we are not successful in expanding into adjacent markets, our growth strategy could suffer.

Our growth strategy depends on pursuing opportunities in adjacent markets, and we may not be successful in adapting our service models to markets or service lines in which we have little or no prior experience. Expanding into adjacent markets, such as services to elders and individuals with autism, mental health and substance abuse issues, will expose us to additional operational, regulatory and legal risks. Serving these populations may require compliance with additional federal and state laws and regulations, such as Medicare, which may differ from the laws and regulations that apply to the populations we currently serve. Compliance with new laws and regulations may result in unanticipated expenses or liabilities. Programs we open in adjacent markets may also take longer to reach expected revenue and profit levels on a consistent basis and may have higher occupancy or operating costs than programs in our existing markets, which may affect our overall profitability. Adjacent markets may have different payors, referral sources, staffing requirements, client preferences and competitive conditions. We may find it more difficult to hire, motivate and keep qualified direct care workers and other employees in these adjacent markets. We may need to augment our staffing to meet regulatory requirements, and the overall cost of labor may be higher. As a result, we may not be successful in diversifying the populations we serve, and we may fail to capture market share in adjacent markets. If any steps taken to expand our existing business into adjacent markets are unsuccessful, we may not be able to achieve our growth strategy and our business, financial condition or results of operations could be adversely affected.

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

We are required to comply with comprehensive government regulation of our business, including statutes, regulations and policies governing the licensing of our facilities, the maintenance and management of our work place for

 

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our employees, the quality of our service, the revenue we receive for our services and reimbursement for the cost of our services. Compliance with these laws, regulations and policies is expensive, and if we fail to comply with these laws, regulations and policies, we could lose contracts and the related revenue, thereby harming our financial results. State and federal regulatory agencies have broad discretionary powers over the administration and enforcement of laws and regulations that govern our operations. A material violation of a law or regulation could subject us to fines and penalties and in some circumstances could disqualify some or all of the facilities and programs under our control from future participation in Medicaid or other government programs.

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”) and other federal and state data privacy and security laws govern the collection, dissemination, security, use and confidentiality of patient-identifiable health information. HIPAA and the HITECH Act require us to comply with standards for the use and disclosure of health information within our company and with third parties, including, among other things, the adoption of administrative, physical and technical safeguards to protect such information. Additionally, certain states have adopted comparable privacy and security laws and regulations, some of which may be more stringent than HIPAA. While we have taken steps to comply with applicable health information privacy and security requirements to which we are aware that we are subject to, if we do not comply with existing or new federal or state laws and regulations related to patient health information, we could be subject to criminal or civil sanctions and any resulting liability could adversely affect our operations. The costs of complying with privacy and security related legal and regulatory requirements are burdensome and could have a material adverse effect on our operations.

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

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

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

On March 17, 2014, a newly promulgated federal regulation governing home- and community-based services became effective. The rule establishes eligibility requirements for Medicaid home and community-based services provided under the “waiver” program. The waiver program allows the states to furnish an array of home- and community-based services and avoid institutional care. Under the new rule, home- and community-based settings must be integrated in and support full access to the greater community, be selected by the individual from different setting options, ensure individual rights of privacy, and optimize autonomy and independence in making life choices. The rule includes additional requirements for provider-owned or controlled home and community-based residential settings, including that the individual has a lease or other legally enforceable

 

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agreement, and standards related to the individual’s privacy, control over schedule and visitors, and physical accessibility of the setting. At this juncture it is unclear how individual states will seek to implement this newly adopted regulation. The rule presents some implementation challenges, as some of the broad requirements may conflict with the needs and/or precautions that we must take for some of the individuals that we serve. It is unclear how each state will seek to address this potential conflict, and the impact and costs of implementation and compliance with this regulation are currently unknown. States have the option to request a variation or delay of compliance with the federal standards for as long as five years from the effective date. Moreover, each state Medicaid agency may interpret and submit different requests and extension timelines.

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

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

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

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

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

Our growth depends on the continuation of trends in our industry toward providing services to individuals in smaller, community-based settings and increasing the percentage of individuals served by non-governmental providers. For example, during the course of much of the last decade, state governments increasingly adopted policies that emphasized greater family preservation and family reunification for at-risk youth, which reduced the demand for foster care services and required that we adapt our service offerings. Shifts in public policy and, therefore, our future success, are subject to a variety of political, economic, social and legal pressures, all of which are beyond our control. A reversal in the downsizing and privatization trends could reduce the demand for our services, which could adversely affect our revenue and profitability.

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

For the fiscal year ended September 30, 2013 and the nine months ended June 30, 2014, 14% of our net revenue was derived from contracts with government agencies in the State of Minnesota. Accordingly, any reduction in Minnesota’s budgetary appropriations for our services, whether as a result of fiscal constraints due to recession, changes in policy or otherwise, could result in a reduction in our fees and possibly the loss of contracts. For example, our I/DD services in Minnesota were negatively impacted in 2009 and 2011 by rate cuts

 

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of 2.6% and 1.5%, respectively. We cannot assure you that we will not receive additional rate reductions this year or in the future. The concentration of our operations in Minnesota also makes us particularly susceptible to many of the other risks described above occurring in this state, including:

 

   

the failure to maintain and renew our licenses;

 

   

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

 

   

any negative publicity regarding our operations.

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

Covenants in NMHI’s debt agreements impose several restrictions on our business.

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

 

   

incur additional debt or issue certain preferred shares;

 

   

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

 

   

make certain investments;

 

   

sell certain assets;

 

   

create liens on certain assets to secure debt;

 

   

enter into agreements that restrict dividends from subsidiaries;

 

   

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

 

   

enter into certain transactions with our affiliates.

The senior credit agreement governing the senior secured credit facilities also requires NMHI and its subsidiaries to maintain a specified financial ratio, starting with the quarter ended June 30, 2014, in the event that NMHI draws more than $30.0 million under its senior revolver. NMHI’s ability to meet this financial ratio may be affected by events beyond its control, and we cannot assure you that it will satisfy that test. The breach of any of these covenants or financial ratio could result in a default under the senior secured credit facilities and the lenders could elect to declare all amounts borrowed thereunder, together with accrued interest, to be due and payable and could proceed against the collateral securing that indebtedness.

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

Our success depends, in part, on the continued contributions of our senior officers and other key employees. Our management team has significant industry experience and a long history with us, and would be difficult to replace. If we lose or suffer an extended interruption in the service of one or more of our key employees, our financial condition and operating results could be adversely affected. The market for qualified individuals is highly competitive and we may not be able to attract and retain qualified personnel to replace or succeed members of our senior management or other key employees, should the need arise.

Our success depends on our ability to manage and integrate key administrative functions.

Our operations and administrative functions are largely decentralized and subject to disparate accounting and billing requirements established and often modified by our local payors and referral sources. Although in recent years we have undertaken an effort to consolidate accounting, billing, cash collections and other financial and administrative functions which may have mitigated this risk to some degree, there remains a substantial

 

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portion of the business that has not yet been centralized and some risk in the centralization process itself. If we encounter difficulties in integrating our operations further or fail to effectively manage these functions to ensure compliance with disparate and evolving requirements imposed by our payors and referral sources, it could have a material adverse effect on our results of operations, financial position and cash flows.

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

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

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

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

 

   

accounting and financial reporting;

 

   

billing and collecting accounts;

 

   

coding and compliance;

 

   

clinical systems, including census and incident reporting;

 

   

records and document storage; and

 

   

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

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

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

A large portion of our total assets consists of goodwill and other intangible assets. Goodwill and other intangible assets, net of accumulated amortization, accounted for 54.1% and 56.0% of the total assets on our consolidated balance sheets as of June 30, 2014 and September 30, 2013, respectively. We may not realize the value of our goodwill or other intangible assets and we expect to engage in additional transactions that will result in our recognition of additional goodwill or other intangible assets.

We evaluate on a regular basis whether events and circumstances have occurred that indicate that all or a portion of the carrying amount of goodwill or other intangible assets may no longer be recoverable, and is

 

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therefore impaired. Under current accounting rules, any determination that impairment has occurred would require us to write-off the impaired portion of our goodwill or the unamortized portion of our intangible assets, resulting in a charge to our earnings.

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

Our primary clients are individuals with developmental disabilities, brain injuries, or emotionally, behaviorally and/or medically complex challenges, many of whom would be more vulnerable than the general public in a natural disaster or public health catastrophe. In a natural disaster, we could be forced to relocate some of our clients on short notice under dangerous conditions and our new program starts could experience delays. Accordingly, natural disasters and certain public health catastrophes could have a material adverse effect on our financial condition and results of operations.

Risk Related to the Acquisition of Massachusetts Adult Day Health Alliance

We may fail to realize the anticipated benefits of the acquisition of Massachusetts Adult Day Health Alliance.

The anticipated benefits of the Massachusetts Adult Day Health Alliance acquisition will depend on, among other things, our ability to operate it and realize revenue growth. In particular, the anticipated benefits are subject to the following risks:

 

   

our expansion into the adult day services market, in which we have no prior experience, may be significantly more difficult to accomplish or take longer to achieve than expected, or may not be achieved in its entirety or at all as a result of unexpected factors or events;

 

   

Massachusetts Adult Day Health Alliance’s business prospects, financial condition or reputation may deteriorate prior to or after the completion of the acquisition;

 

   

employees of Massachusetts Adult Day Health Alliance whom we wish to retain may elect to terminate their employment as a result of the acquisition, which could delay or disrupt the transition of ownership and inhibit our ability to achieve revenue growth in this new market; and

 

   

the allocation of our existing resources to the operation of the adult day services business may reduce the resources available to, and divert the attention of management from, our existing businesses.

If any of these risks occur, we may not be able to realize the anticipated benefits of the acquisition, or they may take longer to realize than expected.

Risks Related to this Offering and Ownership of Our Common Stock

Following the offering, we will be classified as a “controlled company” and, as a result, we will qualify for, and intend to rely on, certain exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.

Upon completion of this offering, Vestar, through its interest in NMH Investment, will continue to control a majority of the voting power of our outstanding common stock. Vestar owns a voting majority of the outstanding voting units of NMH Investment, and NMH Investment will own a majority of our shares of outstanding common stock upon completion of this offering. Through this ownership, Vestar will control a majority of the voting power of our outstanding common stock and, as a result, we will be a “controlled company” within the meaning of the New York Stock Exchange corporate governance standards. Under the rules of the New York Stock Exchange, a company of which more than 50% of the outstanding voting power is held by an individual, group or another

 

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company is a “controlled company” and may elect not to comply with certain stock exchange corporate governance requirements, including:

 

   

the requirement that a majority of the Board of Directors consists of independent directors;

 

   

the requirement that nominating and corporate governance matters be decided solely by independent directors; and

 

   

the requirement that employee and officer compensation matters be decided solely by independent directors.

Following this offering, we intend to utilize these exemptions. As a result, we may not have a majority of independent directors and our audit, nominating and corporate governance and compensation functions may not be decided solely by independent directors. Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all of the stock exchange corporate governance requirements.

An active trading market for our common stock may not develop.

Prior to this offering, there has been no public market for our common stock or the common stock of our subsidiaries. The initial public offering price for our common stock will be determined through negotiations among us, Vestar and the underwriters, and market conditions, and may not be indicative of the market price of our common stock after this offering. If you purchase shares of our common stock, you may not be able to resell those shares at or above the initial public offering price. We cannot predict the extent to which investor interest in the Company will lead to the development of an active trading market on or how liquid that market might become. An active public market for our common stock may not develop or be sustained after the offering. If an active public market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that is attractive to you, or at all.

Our stock price may be volatile or may decline regardless of our operating performance, and you may not be able to resell your shares at or above the initial public offering price.

After this offering, the market price for our common stock is likely to be volatile, in part because our shares have not been traded publicly. In addition, the market price of our common stock may fluctuate significantly in response to a number of factors, many of which we cannot control, including those described under “—Risks Related to Our Business” and the following:

 

   

changes in financial estimates by any securities analysts who follow our common stock, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our common stock;

 

   

downgrades by any securities analysts who follow our common stock;

 

   

future sales of our common stock by our officers, directors and significant stockholders;

 

   

market conditions or trends in our industry or the economy as a whole and, in particular, in the healthcare environment;

 

   

investors’ perceptions of our prospects;

 

   

announcements by us of significant contracts, acquisitions, joint ventures or capital commitments; and

 

   

changes in key personnel.

In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies, including companies in the healthcare industry. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were involved in securities litigation, we could incur substantial costs, and our resources and the attention of management could be diverted from our business.

 

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Our equity sponsor will have the ability to control significant corporate activities after the completion of this offering and our majority stockholder’s interests may not coincide with yours.

After the consummation of this offering, NMH Investment will own approximately 68% of our common stock, assuming the underwriters do not exercise their option to purchase additional shares. If the underwriters exercise in full their option to purchase additional shares, NMH Investment will own approximately 65% of our common stock. Vestar controls the decisions of NMH Investment with respect to the voting and disposition of our shares held by NMH Investment. As a result, so long as NMH Investment holds a majority of our outstanding shares, Vestar will have the ability to control the outcome of matters submitted to a vote of stockholders and, through our Board of Directors, the ability to control decision-making with respect to our business direction and policies. In addition, under the new director nominating agreement that we intend to enter into with NMH Investment prior to the completion of this offering (the “Nominating Agreement”), NMH Investment will have the right to nominate directors for election to our Board of Directors, and we will agree to support those nominees. Under certain circumstances, those nominees could constitute a majority of our Board of Directors even though NMH Investment at the time owns less than a majority of our common stock, giving Vestar decision-making control over us. Matters over which Vestar will, directly or indirectly, exercise control following this offering include:

 

   

the election of our Board of Directors and the appointment and removal of our officers;

 

   

mergers and other business combination transactions, including proposed transactions that would result in our stockholders receiving a premium price for their shares;

 

   

other material acquisitions or dispositions of businesses or assets;

 

   

incurrence of indebtedness and the issuance of equity securities;

 

   

repurchase of stock and payment of dividends; and

 

   

the issuance of shares to management under our equity incentive plans.

Even if Vestar’s ownership of our shares falls below a majority, Vestar may continue to be able to influence or effectively control our decisions. Under our amended and restated certificate of incorporation, Vestar and its affiliates will not have any obligation to present to us, and Vestar may separately pursue, corporate opportunities of which they become aware, even if those opportunities are ones that we would have pursued if granted the opportunity. See “Description of Capital Stock—Corporate Opportunity.”

Future sales of our common stock, or the perception in the public markets that these sales may occur, may depress our stock price.

Sales of substantial amounts of our common stock in the public market after this offering, or the perception that these sales could occur, could adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional shares. Upon completion of this offering, we will have 36,950,000 shares of common stock outstanding. The shares of common stock offered in this offering will be freely tradable without restriction under the Securities Act, except for any shares of our common stock that may be held or acquired by our directors, executive officers and other affiliates, as that term is defined in the Securities Act, which will be restricted securities under the Securities Act. Restricted securities may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available.

We, each of our officers and directors and our sole stockholder, NMH Investment, have agreed, subject to certain exceptions, with the underwriters not to dispose of or hedge any of the shares of common stock or securities convertible into or exchangeable for shares of common stock during the period from the date of this prospectus continuing through the date that is 180 days after the date of this prospectus (subject to extension in certain circumstances). Barclays Capital Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and UBS Securities LLC may, in their discretion, release any of these shares from these restrictions at any time without notice. See “Underwriting.”

 

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All of our shares of common stock outstanding as of the date of this prospectus may be sold in the public market by our sole stockholder 180 days after the date of this prospectus (subject to extension in certain circumstances), subject to applicable volume and other limitations imposed under federal securities laws. See “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling shares of our common stock after this offering.

NHM Investment, which will hold 25,250,000 shares, or approximately 68% of our common stock upon completion of this offering assuming the underwriters do not exercise their option to purchase additional shares, will have the right to require us to register such shares pursuant to the terms of a registration rights agreement to be entered into in connection with the consummation of this offering. See “Shares Eligible for Future Sale—Registration Rights” for a more detailed description of these rights.

In the future, we may also issue our securities in connection with acquisitions or investments. The amount of shares of our common stock issued in connection with an acquisition or investment could constitute a material portion of our then-outstanding shares of our common stock.

As a company with publicly traded equity, we will be subject to additional financial and other reporting and corporate governance requirements that may be difficult for us to satisfy and may divert management’s attention from our business.

We will be subject to other reporting and corporate governance requirements, including the New York Stock Exchange listing standards and certain additional provisions of the Sarbanes-Oxley Act and the regulations promulgated thereunder, which impose significant compliance obligations upon us. Specifically, we will be required to:

 

   

prepare and distribute periodic reports and other stockholder communications in compliance with our obligations under the federal securities laws and New York Stock Exchange rules;

 

   

create or expand the roles and duties of our Board of Directors and committees of the Board of Directors;

 

   

provide an attestation report of our independent registered public accounting firm on our internal control over financial reporting when we become an accelerated filer, in compliance with the requirements of Section 404 and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board;

 

   

enhance our investor relations function; and

 

   

involve outside legal counsel and accountants in connection with the activities listed above.

As a company with publicly traded equity, we will be required to commit significant resources and management time and attention to the above-listed requirements, which will cause us to incur significant costs and which may place a strain on our systems and resources. As a result, our management’s attention might be diverted from other business concerns. In addition, we might not be successful in implementing these requirements. Compliance with these requirements will place significant demands on our legal, accounting and finance staff and on our accounting, financial and information systems and will increase our legal and accounting compliance costs as well as our compensation expense as we may be required to hire additional accounting, tax, finance and legal staff to supplement our existing resources.

We expect to incur certain additional annual expenses related to, among other things, additional directors’ and officers’ liability insurance, director fees, reporting requirements, transfer agent fees, hiring additional accounting, legal and administrative personnel, increased auditing and legal fees and similar expenses.

 

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Failure to comply with requirements to design, implement and maintain effective internal controls could have a material adverse effect on our business and stock price.

As a company with public traded equity, we are required, pursuant to Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on the effectiveness of our internal control over financial reporting. Following the completion of this offering, we will be required, pursuant to Section 404, to furnish an attestation report of our independent registered public accounting firm on the effectiveness of our internal control over financial reporting when we become an accelerated filer.

No evaluation can provide complete assurance that our internal controls will operate as intended. Management’s report is required to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. Testing and maintaining internal controls may divert our management’s attention from other matters that are important to our business. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 or our independent registered public accounting firm may not issue an unqualified opinion. The generally decentralized nature of our operations and manual nature of many of our controls increases our risk of control deficiencies. In addition, future acquisitions may present challenges in implementing appropriate internal controls. Any future material weaknesses in internal control over financial reporting could result in material misstatements in our financial statements. Moreover, any future disclosures of additional material weaknesses, or errors as a result of those weaknesses, could result in a negative reaction in the financial markets if there is a loss of confidence in the reliability of our financial reporting. If either we are unable to conclude that we have effective internal control over financial reporting or our independent registered public accounting firm is unable to provide us with an unqualified report, investors could lose confidence in our reported financial information, which could have a material adverse effect on the trading price of our stock.

Anti-takeover provisions in our charter documents and Delaware law might discourage or delay acquisition attempts for us that you might consider favorable.

Our amended and restated certificate of incorporation and amended and restated bylaws will contain provisions that may make the acquisition of the Company more difficult without the approval of our Board of Directors. These provisions:

 

   

authorize the issuance of undesignated preferred stock, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend or other rights or preferences superior to the rights of the holders of common stock;

 

   

prohibit stockholder action by written consent, requiring all stockholder actions be taken at a meeting of our stockholders, if Vestar ceases to own more than 40% of our common stock;

 

   

provide that the Board of Directors is expressly authorized to make, alter or repeal our amended and restated bylaws;

 

   

establish advance notice requirements for nominations for elections to our Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings;

 

   

establish a classified Board of Directors, as a result of which our Board of Directors will be divided into three classes, with each class serving for staggered three-year terms, which prevents stockholders from electing an entirely new Board of Directors at an annual meeting;

 

   

limit the ability of stockholders to remove directors if Vestar ceases to own more than 40% of our common stock;

 

   

prohibit stockholders, other than Vestar for so long as it beneficially owns at least 40% of our common stock, from calling special meetings of stockholders; and

 

   

require the approval of holders of at least 75% of the outstanding shares of our voting common stock to amend our amended and restated certificate of incorporation and for shareholders to amend our amended and restated bylaws, in each case if Vestar ceases to own more than 40% of our common stock.

 

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These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of the Company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire. For a further discussion of these and other such anti-takeover provisions, see “Description of Capital Stock—Anti-takeover Effects of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws.”

Our amended and restated certificate of incorporation upon consummation of this offering will designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated certificate of incorporation upon consummation of this offering will provide that, subject to limited exceptions, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii) any action asserting a claim against us arising pursuant to any provision of the General Corporation Law of the State of Delaware (the “DGCL”), our certificate of incorporation or our by-laws or (iv) any other action asserting a claim against us that is governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to the provisions of our certificate of incorporation described above. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and employees. Alternatively, if a court were to find these provisions of our amended and restated certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business and financial condition.

If you purchase shares of common stock sold in this offering, you will incur immediate and substantial dilution.

If you purchase shares of common stock in this offering, you will incur immediate and substantial dilution in the amount of $29.64 per share because the initial public offering price is substantially higher than the pro forma net tangible book value per share of our outstanding common stock. Dilution results from the fact that the initial public offering price per share of the common stock is substantially in excess of the book value per share of common stock attributable to our existing stockholder for the presently outstanding shares of common stock. In addition, you may also experience additional dilution upon future equity issuances or the exercise of stock options to purchase common stock granted to our employees and directors under our management incentive plan. See “Dilution.”

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We may not obtain research coverage of our common stock by securities and industry analysts. If no securities or industry analysts commence coverage of our common stock, the trading price for our common stock would be negatively impacted. If we obtain securities or industry analyst coverage and if one or more of the analysts who covers us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our stock price and trading volume to decline.

 

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Because we do not intend to pay cash dividends in the foreseeable future, you may not receive any return on investment unless you are able to sell your common stock for a price greater than your purchase price.

The continued operation and expansion of our business will require substantial funding. Accordingly, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon results of operations, financial condition, contractual restrictions, including those under our senior secured credit facilities and the indenture governing our senior notes, any potential indebtedness we may incur, restrictions imposed by applicable law and other factors our Board of Directors deems relevant. Accordingly, if you purchase shares in this offering, realization of a gain on your investment will depend on the appreciation of the price of our common stock, which may never occur. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.

We are a holding company and rely on dividends, distributions and other payments, advances and transfers of funds from our subsidiaries to meet our obligations.

We are a holding company that does not conduct any business operations of our own. As a result, we are largely dependent upon cash dividends and distributions and other transfers from our subsidiaries to meet our obligations. The deterioration of income from, or other available assets of, our subsidiaries for any reason could limit or impair their ability to pay dividends or other distributions to us.

 

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FORWARD-LOOKING STATEMENTS

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

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

 

   

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

 

   

substantial claims, litigation and governmental proceedings;

 

   

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

 

   

an increase in labor costs or labor-related liability;

 

   

matters involving employees that expose us to potential liability;

 

   

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

 

   

our history of losses;

 

   

our ability to comply with complicated billing and collection rules and regulations;

 

   

failure to comply with reimbursement procedures and collect accounts receivable;

 

   

changes in economic conditions;

 

   

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

 

   

an increase in workers’ compensation related liability;

 

   

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

 

   

our ability to attract and retain experienced personnel;

 

   

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

 

   

negative publicity or changes in public perception of our services;

 

   

our ability to maintain our status as a licensed service provider in certain jurisdictions;

 

   

our ability to maintain, expand and renew existing services contracts and to obtain additional contracts or acquire new licenses;

 

   

our ability to successfully integrate acquired businesses;

 

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our inability to successfully expand into adjacent markets;

 

   

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

 

   

increased competition;

 

   

decrease in popularity of home- and community-based human services among our targeted client populations and/or state and local governments;

 

   

our susceptibility to any reduction in budget appropriations for our services in Minnesota or any other adverse developments in that state;

 

   

our ability to operate our business due to constraints imposed by covenants in NMHI’s senior credit agreement;

 

   

our ability to retain the continued services of certain members of our management team;

 

   

our ability to manage and integrate key administrative functions;

 

   

failure of our information systems or failure to upgrade our information systems when required;

 

   

write-offs of goodwill or other intangible assets;

 

   

natural disasters or public health catastrophes; and

 

   

our ability to realize the anticipated benefits of the Massachusetts Adult Day Health Alliance acquisition.

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

 

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USE OF PROCEEDS

We estimate that the proceeds to us from this offering, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, will be approximately $182.2 million.

We intend to use the net proceeds from the sale of common stock by us in this offering and cash on hand to (i) redeem $162.0 million in aggregate principal amount of the senior notes issued by NMHI at a redemption price of 106.25% plus accrued and unpaid interest thereon to the date of redemption and (ii) pay a transaction advisory fee of $8.0 million to Vestar under the management agreement with Vestar, which agreement will terminate upon completion of this offering. The senior notes mature on February 15, 2018 and have an interest rate of 12.50% per annum. See “Description of Certain Indebtedness.” We intend to use any remaining net proceeds for general corporate purposes.

 

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DIVIDEND POLICY

During fiscal 2012 and 2013 and the nine months ended June 30, 2014, we paid dividends of $75,000, $39,000 and $110,000, respectively, to NMH Investment to fund repurchases of equity units from employees upon or after their departures.

We currently intend to retain all available funds and any future earnings to fund the development and growth of our business, and therefore we do not anticipate paying any cash dividends in the foreseeable future. Additionally, our ability to pay dividends on our common stock will be limited by restrictions on the ability of our subsidiaries and us to pay dividends or make distributions under the terms of NMHI’s current and any future agreements governing our indebtedness. Any future determination to pay dividends will be at the discretion of our Board of Directors, subject to compliance with covenants in NMHI’s current and any future agreements governing our indebtedness, and will depend upon our results of operations, financial condition, capital requirements and other factors that our Board of Directors deems relevant.

In addition, since we are a holding company, substantially all of the assets shown on our consolidated balance sheet are held by our subsidiaries. Accordingly, our earnings, cash flow and ability to pay dividends are largely dependent upon the earnings and cash flows of our subsidiaries and the distribution or other payment of such earnings to us in the form of dividends.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and our capitalization as of June 30, 2014 on:

 

   

an actual basis; and

 

   

an as adjusted basis to give effect to the sale of 11,700,000 shares of our common stock in this offering by us after deducting underwriting discounts and commissions and estimated offering expenses payable by us and the application of the net proceeds therefrom as described under “Use of Proceeds.”

You should read the following table in conjunction with the sections entitled “Use of Proceeds,” “Selected Historical Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     June 30, 2014  
     Actual     As Adjusted  
(in thousands)             

Cash and cash equivalents:

    

Available cash (1)

   $ 47,526      $ 42,346   

Restricted cash (2)

     50,000        50,000   
  

 

 

   

 

 

 

Total cash and cash equivalents

     97,526        92,346   
  

 

 

   

 

 

 

Debt:

    

Senior revolver (3)

     —          —     

Term loan facility (4)

     598,500        598,500   

Senior notes (5)

     212,000        50,000   
  

 

 

   

 

 

 

Total long-term debt (6)

     810,500        648,500   

Stockholders’ equity:

    

Preferred stock, $0.01 par value, no shares authorized or outstanding on an actual basis; 50,000,000 shares authorized and no shares outstanding on an as adjusted basis

     —          —     

Common stock, $0.01 par value, 350,000,000 authorized;
25,250,000 shares outstanding on an actual basis;
36,950,000 shares outstanding on an as adjusted basis

     253        370   

Additional paid-in-capital

     90,065        264,151   

Accumulated other comprehensive loss

     (530     (530

Accumulated deficit

     (151,835     (163,061
  

 

 

   

 

 

 

Total stockholders’ (deficit) equity (7)

     (62,047     100,930   
  

 

 

   

 

 

 

Total capitalization

   $ 748,453      $ 749,430   
  

 

 

   

 

 

 

 

(1) As adjusted available cash assumes the payment of accrued and unpaid interest of $7.6 million as of June 30, 2014 in connection with the redemption of a portion of the outstanding senior notes. Assuming a redemption date of October 17, 2014, the accrued and unpaid interest on the senior notes being redeemed would be $3.5 million, which gives effect to the scheduled semi-annual interest payment of $13.3 million, which was paid on August 15, 2014.
(2) Represents cash deposited in a cash collateral account in support of the issuance of undrawn letters of credit.
(3) As of June 30, 2014, on an actual and as adjusted basis, we had $100.0 million of availability under our senior revolver. However, despite the contractual availability, the covenants in the indenture governing the senior notes effectively limit our ability to draw on the senior revolver.
(4) Excludes the impact of original issue discount, net of accumulated amortization of $1.3 million.
(5) Excludes the impact of original issue discount and initial purchasers discount, net of accumulated amortization of $4.9 million.
(6) Includes current portion but excludes $6.6 million in obligations under capital leases.

 

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(7) Assumes that each of (i) the unamortized debt issuance costs of the senior notes of $3.7 million, (ii) the unamortized deferred financing costs of $0.8 million, (iii) the $4.0 million cash payment to certain non-executive officer employees who participate in the CareMeridian, LLC Management Cash Incentive Plan that will be paid in two installments, the first occurring in January 2015 and the second in January 2016, and (iv) the call premium of $10.1 million on the senior notes are expensed, net of related taxes, upon completion of this offering.

 

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DILUTION

If you invest in our common stock, your ownership interest will be immediately diluted to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock after this offering. Dilution results from the fact that the initial public offering price per share of the common stock is substantially in excess of the book value per share of common stock attributable to our existing stockholder for the presently outstanding shares of common stock.

Our net tangible book value (deficit) as of June 30, 2014 was $(631.0) million, or $(24.99) per share of common stock (after giving effect to the 2,525,000-for-one stock split that occurred on September 2, 2014). Net tangible book value (deficit) per share represents the amount of our total tangible assets (which for the purpose of this calculation excludes $10.8 million of deferred financing costs and $0.3 million of capitalized offering costs that have been paid) less total liabilities, divided by the basic weighted average number of shares of common stock outstanding.

After giving effect to the sale of the 11,700,000 shares of common stock offered by us in this offering, and after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value (deficit) as of June 30, 2014 would have been approximately $(466.9) million, or $(12.64) per share of common stock (after giving effect to the 2,525,000-for-one stock split that occurred on September 2, 2014). This represents an immediate increase in net tangible book value (deficit) to our existing stockholders of $12.35 per share and an immediate dilution to new investors in this offering of $29.64 per share. The following table illustrates this pro forma per share dilution in net tangible book value (deficit) to new investors.

 

Initial public offering price per share

  

  $ 17.00   

Historical net tangible book value (deficit) per share as of June 30, 2014

   $ (24.99  

Increase per share attributable to new investors

     12.35     
  

 

 

   

Pro forma net tangible book value (deficit) per share after this offering

  

    (12.64
    

 

 

 

Dilution per share to new investors

  

  $ 29.64   
    

 

 

 

The following table summarizes as of June 30, 2014, on an as adjusted basis, after giving effect to the offering and the consummation of the 2,525,000-for-one stock split, the number of shares of common stock purchased, the total consideration paid and the average price per share paid by our existing stockholder and by new investors, before deducting estimated underwriting discounts and commissions and offering expenses:

 

     Shares Purchased     Total Consideration
(in thousands)
    Average Price
Per Share
 
     Number      Percent     Amount      Percent    

Existing stockholder

     25,250,000         68.3   $ 90,318         31.2   $ 3.58   

New investors

     11,700,000         31.7        198,900         68.8        17.00   
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

     36,950,000         100   $ 289,218         100  
  

 

 

    

 

 

   

 

 

    

 

 

   

Except as otherwise indicated, the discussion and tables above assume no exercise of the underwriters’ option to purchase additional shares from us. If the underwriters’ option to purchase additional shares is exercised in full, our existing stockholder would own approximately 65% and our new investors would own approximately 35% of the total number of shares of our common stock outstanding after this offering.

 

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The tables and calculations above are based on 36,950,000 shares of common stock outstanding as of June 30, 2014 and assume no exercise by the underwriters of their option to purchase up to an additional 1,755,000 shares from us. This number excludes an aggregate of 3,325,500 shares of common stock reserved for issuance under our equity incentive plan that we intend to adopt in connection with this offering, including an aggregate of 559,572 shares of common stock issuable under options to be issued in connection with this offering with an aggregate value of $4.3 million, and an aggregate of 550,480 shares of common stock issuable under restricted stock units to be issued in connection with this offering with an aggregate value of $9.4 million.

 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

The following table sets forth our selected historical consolidated financial data as of September 30, 2012 and 2013 and for the years ended September 30, 2011, 2012 and 2013 and are derived from the audited historical consolidated financial statements of the Company and the related notes included elsewhere in this prospectus. The selected consolidated financial data as of September 30, 2009, 2010 and 2011 and for the years ended September 30, 2009 and 2010 are derived from the Company’s audited consolidated financial statements not included in this prospectus, as adjusted for discontinued operations. All adjustments necessary for a fair presentation have been included. All such adjustments are considered to be of a normal recurring nature.

The statement of operations for each of the nine-month periods ended June 30, 2013 and June 30, 2014 and the balance sheet as of June 30, 2014 set forth below are derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus and the balance sheet as of June 30, 2013 is derived from unaudited financial statements not included in this prospectus and contain all adjustments, consisting of normal recurring adjustments, that management considers necessary for a fair presentation of our financial position and results of operations for the periods presented. Operating results for the nine-month periods are not necessarily indicative of results for a full financial year, or any other periods.

You should read the following data in conjunction with “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited historical consolidated financial statements and the accompanying notes, included elsewhere in this prospectus, and other financial information included in this prospectus.

 

    Fiscal Year Ended September 30,     Nine Months Ended June 30,  
    2009     2010     2011     2012     2013             2013                     2014          
(Dollars in thousands, except
per share data)
                                         

Statements of Operations Data:

             

Net revenue

  $ 949,582      $ 1,004,192      $ 1,062,773      $ 1,123,118      $ 1,198,653      $ 893,541      $ 938,861   

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

    725,275        771,066        823,009        874,778        935,143        700,401        734,887   

General and administrative expenses

    125,110        133,114        144,011        140,221        146,040        110,879        108,811   

Depreciation and amortization

    55,069        55,918        61,330        60,534        64,146        47,970        50,987   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    44,128        44,094        34,423        47,585        53,324        34,291        44,176   

Management fee of related party

    (1,146     (1,208     (1,271     (1,325     (1,359     (985     (1,041

Other income (expense), net

    (503     (339     (142     2        929        628        499   

Gain (loss) on extinguishment of debt

    11,946       —         (23,684     —         —         —           (14,699

Interest income

    193        42        22        332        137        109        163   

Interest expense

    (66,084     (62,233     (67,511     (79,445     (78,075     (58,482 )       (53,204
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

    (11,466     (19,644     (58,163     (32,851     (25,044     (24,439     (24,106

Benefit for income taxes

    (3,467     (7,517     (19,287     (19,283     (9,472     (8,437     (7,212
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

    (7,999     (12,127     (38,876     (13,568     (15,572     (16,002     (16,894

Loss from discontinued operations, net of tax (1)

    (2,404     (5,148     (4,625     (701     (2,724     (2,678     19   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (10,403   $ (17,275   $ (43,501   $ (14,269   $ (18,296   $ (18,680   $ (16,875
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per common share:

             

Basic

  $ (0.41   $ (0.68   $ (1.72   $ (0.57   $ (0.72   $ (0.74   $ (0.67

Diluted

  $ (0.41   $ (0.68   $ (1.72   $ (0.57   $ (0.72   $ (0.74   $ (0.67

Weighted-average common shares outstanding:

             

Basic

    25,250,000        25,250,000        25,250,000        25,250,000        25,250,000        25,250,000        25,250,000   

Diluted

    25,250,000        25,250,000        25,250,000        25,250,000        25,250,000        25,250,000        25,250,000   

Balance Sheet Data (at end of period):

             

Cash and cash equivalents

  $ 23,837      $ 26,635      $ 387      $ 125      $ 19,440      $ 16,211      $ 47,526   

Working capital (2)

    49,907        44,848        12,634        26,192        59,262        65,711        66,085   

Total assets

    989,387        1,006,998        1,011,360        1,045,880        1,021,269        1,034,817        1,031,494   

Total debt (3)

    702,087        713,242        784,124        799,895        803,464        806,447        817,128   

Shareholder’s equity (deficit)

    37,661        28,377        (16,917     (29,931     (46,515     (47,361     (62,047

 

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

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

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

Overview

We are the leading national provider of home- and community-based health and human services to must-serve individuals with intellectual, developmental, physical or behavioral disabilities and other special needs. Since our founding in 1980, we have been a pioneer in the movement to provide home- and community-based services for people who would otherwise be institutionalized. During our nearly 35-year history, we have evolved from a single residential program serving at-risk youth to a diversified national network providing an array of high-quality services and care in large, growing and highly-fragmented markets. While we have the capabilities to serve individuals with a wide variety of special needs and disabilities, we currently provide our services to individuals with intellectual and/or developmental disabilities (I/DD), youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (ARY), and individuals with catastrophic injuries and illnesses, particularly acquired brain injury (ABI). As of June 30, 2014, we operated in 36 states, serving more than 12,500 clients in residential settings and more than 15,700 clients in non-residential settings. We have a diverse group of hundreds of public payors which fund our services with a combination of federal, state and local funding, as well as an increasing number of non-public payors related to our services for ABI and other catastrophic injuries and illnesses.

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

Delivery of services to adults and children with I/DD is the largest portion of our Human Services segment. Our I/DD programs include residential support, day habilitation, vocational services, case management, crisis intervention and hourly support care. Our Human Services segment also includes the delivery of ARY services. Our ARY programs include therapeutic foster care, family preservation, adoption services, early intervention, school-based services and juvenile offender programs. Within our SRS segment, our CareMeridian business unit is focused on the more medically-intensive post-acute care services, and our NeuroRestorative business unit is focused on rehabilitation and transitional living services. Our SRS services range from sub-acute healthcare for individuals with intensive medical needs to day treatment programs, and include: neurorehabilitation; neurobehavioral rehabilitation; specialized nursing; physical, occupational and speech therapies; supported living; outpatient treatment; and pre-vocational services.

Factors Affecting our Operating Results

Demand for Home and Community-Based Health and Human Services

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

 

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Demographic trends have a particular impact on our I/DD business. Increases in the life expectancy of individuals with I/DD, we believe, have resulted in steady increases in the demand for I/DD services. In addition, caregivers currently caring for their relatives at home are aging and many may soon be unable to continue with these responsibilities. Many states continue to downsize or close large, publicly-run facilities for individuals with I/DD and refer those individuals to private providers of community-based services. Each of these factors affects the size of the I/DD population in need of services. And while our residential ARY services were negatively impacted by a substantial decline in the number of children and adolescents in foster care placements during the last decade, this trend has contributed to significant increased demand for periodic, non-residential services to support at-risk youth and their families. It is also noteworthy that in recent years the general foster care population across the country has stabilized. Demand for our SRS services has also grown as emergency response and improved medical techniques have resulted in more people surviving a catastrophic injury. SRS services are increasingly sought out as a clinically-appropriate and less-expensive alternative to institutional care and as a “step-down” for individuals who no longer require care in acute settings.

Political and economic trends can also affect our operations. Budgetary pressures facing state governments, especially within Medicaid programs, as well as other economic, industry and political factors could cause state governments to limit spending, which could significantly reduce our revenue, referrals, margins and profitability, and adversely affect our growth strategy. Government agencies generally condition their contracts with us upon a sufficient budgetary appropriation. If the government agency does not receive an appropriation sufficient to cover its obligations with us, it may terminate a contract or defer or reduce our reimbursements. For example, during the economic downturn that began in 2008, our government payors in several states responded to deteriorating revenue collections by implementing service reductions, rate freezes and/or rate reductions. Beginning in fiscal 2012, the rate environment improved and, as a result, for fiscal years 2012, 2013 and 2014, pricing increases contributed to revenue growth. With new state fiscal 2015 budgets effective on July 1, 2014 in most jurisdictions, this positive trend is continuing as we plan for our fiscal year 2015.

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

Expansion of Services

We have grown our business through expansion of existing markets and programs, entry into new geographical markets as well as through acquisitions.

Organic Growth

Various economic, fiscal, public policy and legal factors are contributing to an environment with an increased number of organic growth opportunities, particularly within the Human Services segment, and, as a result, we have a renewed emphasis on growing our business organically and making investments to support the effort. Our future growth will depend heavily on our ability to expand our current programs and identify and execute upon new opportunities. Our organic expansion activities consist of both new program starts in existing markets and expansion into new geographical markets. Our new programs in new and existing geographic markets typically require us to incur and fund operating losses for a period of approximately 18 to 24 months (we refer to these new programs as “new starts”). Net operating loss or income of a new start is defined as its revenue for the period less direct expenses but not including allocated overhead costs. The aggregation of all programs

 

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with net operating losses that are less than 18 months old comprises the new start operating loss for such period. During fiscal 2013, new starts generated operating losses of $8.8 million and operating income of $3.3 million. During the nine months ended June 30, 2013, new starts generated operating losses of $7.9 million and operating income of $2.2 million. During the nine months ended June 30, 2014, new starts generated operating losses of $4.5 million and operating income of $1.5 million. As indicated above, during fiscal 2012 and 2013 demand for new programs increased. These new start investment opportunities increased our organic growth but also had the effect of reducing our operating margin. In fiscal 2014, our investment level is expected to be slightly lower than recent years, but still at a rate higher than fiscal 2011 and earlier periods.

Acquisitions

From the beginning of fiscal 2009 through June 30, 2014, we have completed 36 acquisitions, including several acquisitions of rights to government contracts or fixed assets from small providers, which we have integrated with our existing operations. We have pursued larger strategic acquisitions in the past and may opportunistically continue to do so in the future. Acquisitions could have a material impact on our consolidated financial statements.

During the nine months ended June 30, 2014, we acquired five companies complementary to our business in the Human Services segment and two companies in the SRS segment for total cash consideration of $16.6 million, of which $1.5 million was paid in July 2014.

During the nine months ended June 30, 2013, we acquired one company complementary to our business in the Human Services segment for total cash consideration of $0.5 million.

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

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

Divestitures

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

In August 2014, our Connecticut-based business notified the State of Connecticut of its intention to stop providing services under existing contracts due to rate cuts and a change in state policy. We are currently working with our public partners on a plan to effectively transition our programs to new providers, and we anticipate that this transition will be complete during the first quarter of fiscal 2015.

Revenue

Revenue is reported net of allowances for unauthorized sales and estimated sales adjustments, and net of any state provider taxes or gross receipts taxes levied on services we provide. We derive revenue from contracts with state, local and other government payors and non-public payors. During the fiscal year ended September 30, 2013, we derived 87% of our net revenue from contracts with state, local and other government payors and 13% of our net revenue from non-public payors. During the nine months ended June 30, 2014, we derived 90% of our net revenue from contracts with state, local and other government payors and 10% of our net revenue from non-public payors. Substantially all of our non-public revenue is generated by our SRS business through contracts with commercial insurers, workers’ compensation carriers and other private payors. The payment terms and rates of our contracts vary widely by jurisdiction and service type. We have four types of contractual arrangements with payors which include negotiated contracts, fixed fee contracts, retrospective reimbursement contracts and prospective payments contracts. See “—Critical Accounting Policies—Revenue Recognition” for further information. Our revenue may be affected by adjustments to our billed rates as well as adjustments to previously billed amounts. Revenue in the future may be affected by changes in rates, rate-setting structures, methodologies or interpretations that may be proposed in states where we operate or by the federal government which provides matching funds. We cannot

 

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determine the impact of such changes or the effect of any possible governmental actions. In general, we take prices set by our payors and do not compete based on pricing.

We bill the majority of our residential services on a per person per-diem basis. We believe the key factors affecting our revenues in residential service business include gross revenue, average residential census and average daily rates. We bill the majority of our non-residential service on a per service unit basis. These service units, which vary in length, are converted to billable units which are the hourly equivalent for the service provided. We believe the key factors affecting our revenues in our non-residential service business include gross revenue, non-residential billable units and average billable unit rates. We define these factors as follows:

 

   

Gross Revenue: Revenues before adjusting for sales adjustments and state provider and gross receipts taxes.

 

   

Average Residential Census: The average daily residential census over the respective period.

 

   

Average Daily Rate: A mathematical calculation derived by dividing the gross residential revenue by the residential census and the resulting quotient by the number of days during the respective period.

 

   

Non-Residential Billable Units: The hourly equivalent of non-residential services provided.

 

   

Average Billable Unit Rate: Gross non-residential revenue divided by the billable units provided during the period.

A comparative summary of gross revenues by service line and our key metrics is as follows (dollars in thousands, except for daily and billable unit rates):

 

     Nine Months Ended June 30,      Year Ended September 30,  
     2014     2013      2013     2012     2011  

I/DD Services

           

Gross Revenues

   $ 628,118      $ 578,257       $ 783,018      $ 731,309      $ 693,703   

Average Residential Census

     7,419        6,934         6,983        6,562        6,326   

Average Daily Rate

   $ 231      $ 224       $ 226      $ 220      $ 221   

Non-Residential Billable Units

     8,547,105        8,374,228         8,457,522        8,914,988        8,603,223   

Average Non-Residential Billable Unit Rate

   $ 19      $ 18       $ 25      $ 23      $ 21   

Gross Revenue Growth %

     8.6        7.1     5.4  

Gross Revenue growth due to:

           

Volume Growth

     5.8        3.2     3.8  

Average Rate Growth

     2.8        3.9     1.6  

At-Risk Youth Services

           

Gross Revenues

   $ 154,408      $ 170,459       $ 224,717      $ 218,040      $ 206,136   

Average Residential Census

     3,889        4,114         4,125        3,888        4,024   

Average Daily Rate

   $ 101      $ 97       $ 97      $ 98      $ 97   

Non-residential Billable Units

     549,223        725,339         931,646        949,982        827,188   

Average Non-Residential Billable Unit Rate

   $ 86      $ 84       $ 84      $ 82      $ 77   

Gross Revenue Growth %

     (9.4 )%         3.1     5.8  

Gross Revenue growth due to:

           

Volume Growth

     (13.2 )%         3.0     2.8  

Average Rate Growth

     3.8        0.1     2.9  

Special Rehabilitation Services

           

Gross Revenues

   $ 172,256      $ 158,547       $ 213,465      $ 189,561      $ 177,122   

Average Residential Census

     1,053        993         996        916        900   

Average Daily Rate

     599        585       $ 587      $ 565      $ 539   

Gross Revenue Growth %

     8.6        12.6     7.0  

Gross Revenue growth due to:

           

Volume Growth

     6.2        8.8     1.9  

Average Rate Growth

     2.4        3.8     5.1  

 

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Expenses

Expenses directly related to providing services are classified as cost of revenue. These expenses consist of direct labor costs which principally include salaries and benefits for service provider employees and per diem payments to our Mentors; client program costs such as food, medicine and professional and general liability and employment practices liability expenses; residential occupancy expenses which are primarily comprised of rent and utilities related to facilities providing direct care; travel and transportation costs for clients requiring services; and other ancillary direct costs associated with the provision of services to clients including workers’ compensation expense.

General and administrative expenses primarily include salaries and benefits for administrative employees, or employees that are not directly providing services, administrative occupancy costs as well as professional expenses such as accounting, consulting and legal services. Depreciation and amortization includes depreciation for fixed assets utilized in both facilities providing direct care and administrative offices, and amortization related to intangible assets.

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

Occupancy costs represent a significant portion of our operating costs. As of June 30, 2014, we owned 378 facilities and three offices, and we leased 1,318 facilities and 263 offices. We expect occupancy costs to increase during fiscal 2014 as a result of new leases entered into pursuant to acquisitions and new starts. We incur no facility costs for services provided in the home of a Mentor.

Professional and general liability expense totaled 0.8% of our net revenue for the nine months ended June 30, 2014, as compared to 1.0% for the fiscal years ended September 30, 2013, 2012 and 2011. We incurred professional and general liability expenses of $0.8 million, $11.0 million, $12.2 million, $10.9 million and $10.2 million for the nine months ended June 30, 2014 and 2013, and the fiscal years ended September 30, 2013, 2012 and 2011, respectively. These expenses are incurred in connection with our claims reserve and insurance premiums. The expense for the nine months ended June 30, 2013 and fiscal year ended September 30, 2013 included expenses of $0.8 million and $3.4 million, respectively, related to adjustments to professional liability claims to our tail reserve for professional and general liability claims, which is required by accounting standards for companies with claims-made insurance (the “PL/GL Tail Reserve”). For claims made between October 1, 2010 and September 30, 2011, we were self-insured for $2.0 million per claim and $8.0 million in the aggregate, and for $500 thousand per claim in excess of the aggregate. From October 1, 2011 to September 30, 2013, we were self-insured for the first $4.0 million of each and every claim without an aggregate limit. Beginning October 1, 2013, we are self-insured for $4.0 million per claim and $28.0 million in the aggregate. Increased costs of insurance and claims have negatively impacted our results of operations and have resulted in a renewed emphasis on reducing the occurrence of claims. Although insurance premiums did not increase in fiscal 2013 and 2014, they have increased in prior years and may increase in the future.

Stock based compensation expense is recorded for equity awards based on the estimated fair value on the grant date. Historically, we issued equity awards under the equity-based compensation plan of NMH Investment, our parent company, and we recognize stock-based compensation expense for those awards. Following the completion of this offering, we intend to make equity awards based on shares of our common stock under the Civitas Solutions, Inc. 2014 Omnibus Incentive Plan (the “2014 Incentive Plan”), for which we will recognize stock based compensation expense. In connection with this offering, we intend to grant equity awards under the 2014 Incentive Plan to our employees and our non-management directors who are not affiliated with Vestar. The awards to our employees, including our executive officers, are expected to be in the form of stock options and restricted stock

 

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units that vest in equal annual increments over a three-year period. We expect to award stock options to purchase an aggregate of 559,572 shares of common stock with an aggregate value of $4.3 million and an aggregate of 523,422 restricted stock units with an aggregate value of $8.9 million to our employees. The awards to our non-management directors who are not affiliated with Vestar are expected to be in the form of restricted stock units that vest in one year. We expect to award an aggregate of 27,058 restricted stock units with an aggregate value of $0.5 million to these four directors. We expect to recognize approximately $12.5 million of stock based compensation expense in connection with these awards.

As a result of this offering, we intend to make a $4.0 million cash payment to certain of our non-executive officer employees who participate in CareMeridian, LLC Management Cash Incentive Plan (the “CareMeridian Plan”), in two installments, the first occurring in January 2015 and the second in January 2016, in satisfaction of their existing awards under the plan. The payments to these non-executive officer employees is contingent upon such individual’s continued employment with the Company or any of its subsidiaries through the applicable payment dates. We expect to recognize cash compensation expense of approximately $4.0 million as a result of these payments.

Results of Operations

The following table sets forth our Consolidated Statements of Operations as a percentage of total net revenues for the periods indicated.

 

     Nine months ended June 30,     Year ended September 30,  
         2014             2013         2013     2012     2011  

Revenues:

          

Net revenues

     100.0     100.0     100.0     100.0     100.0

Cost of Revenue

     78.3     78.4     78.0     77.9     77.4

Operating Expenses:

          

General and Administrative

     11.6     12.4     12.2     12.5     13.6

Depreciation and Amortization

  

 

 

 

5.4

 

 

 

 

 

5.4

 

    5.4     5.4     5.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

  

 

 

 

17.0

 

 

 

 

 

17.8

 

    17.5     17.9     19.3

Income from operations

     4.7     3.8     4.4     4.2     3.2

Other income (expense):

          

Management fee of related party

     (0.1 )%      (0.1 )%      (0.1 )%      (0.1 )%      (0.1 )% 

Other income (expense), net

     0.1     0.1     0.1     0.0     0.0

Extinguishment of debt

     (1.6 )%      0.0     0.0     0.0     (2.2 )% 

Interest Income

     0.0     0.0     0.0     0.0     0.0

Interest Expense

     (5.7 )%      (6.5 )%      (6.5 )%      (7.1 )%      (6.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

     (2.6 )%      (2.7 )%      (2.1 )%      (2.9 )%      (5.5 )% 

Benefit for income taxes

     (0.8 )%      (0.9 )%      (0.8 )%      (1.7 )%      (1.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (1.8 )%      (1.8 )%      (1.3 )%      (1.2 )%      (3.7 )% 

Gain (loss) from discounted operations, net of tax

     0.0     (0.3 )%      (0.2 )%      (0.1 )%      (0.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss

     (1.8 )%      (2.1 )%      (1.5 )%      (1.3 )%      (4.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Nine Months Ended June 30, 2014 compared to Nine Months Ended June 30, 2013

Consolidated overview

 

     Nine months ended June 30,  
     2014     2013     Increase
(Decrease)
 

Gross revenue

   $ 954,782      $ 907,263      $ 47,519   

Sales adjustments

     (15,921     (13,722     (2,199
  

 

 

   

 

 

   

 

 

 

Net revenue

   $ 938,861      $ 893,541      $ 45,320   
  

 

 

   

 

 

   

 

 

 

Income from operations

   $ 44,176      $ 34,291      $ 9,885   

Operating margin

     4.7     3.8     0.9

Consolidated gross revenue for the nine months ended June 30, 2014 increased by $47.5 million, or 5.2%, compared to gross revenue for the nine months ended June 30, 2013. Sales adjustments as a percentage of gross revenue increased from 1.5% to 1.7% during the nine months ended June 30, 2014. Gross revenue increased $28.4 million from organic growth, including growth related to new programs, and $19.1 million from acquisitions that closed during and after the nine months ended June 30, 2013. Our Human Services segment contributed 67.9% of the organic revenue growth with the remaining 32.1% contributed by our SRS segment.

Consolidated income from operations increased from $34.3 million, or 3.8% of net revenue, for the nine months ended June 30, 2013 to $44.2 million, or 4.7% of net revenue, for the nine months ended June 30, 2014. The increase in our operating margin was primarily due to the increase in revenue, expense leveraging and cost containment efforts in our direct labor costs and general administrative expenses. The improvement in operating margin was partially offset by the increase in client occupancy costs due to new programs with higher levels of open occupancy and increases in rent, utilities and repair and maintenance costs related to our business. The improvement was also partially offset by a $2.1 million favorable revenue adjustment to our state provider tax reserve relating to pre-Merger periods during the nine months ended June 30, 2013.

Revenues by segment

The following table sets forth net revenue for the Human Services segment for the periods indicated (in thousands):

 

     Nine months ended June 30,     Percentage
Increase
(Decrease)
 
     2014     2013     Increase
(Decrease)
   

I/DD gross revenue

   $ 628,118      $ 578,257      $ 49,861        8.6

ARY gross revenue

     154,408       170,459       (16,051     (9.4 )% 
  

 

 

   

 

 

   

 

 

   

Total Human Services gross revenue

   $ 782,526      $ 748,716      $ 33,810        4.5

Sales adjustments

     (13,340     (10,833     (2,507  

Sales adjustments as a percentage of gross revenue

     (1.7 )%      (1.4 )%      (0.3 )%   
  

 

 

   

 

 

   

 

 

   

Total Human Services net revenue

   $ 769,186      $ 737,883      $ 31,303        4.2
  

 

 

   

 

 

   

 

 

   

Human Services gross revenue for the nine months ended June 30, 2014 increased by $33.8 million, or 4.5%, compared to the nine months ended June 30, 2013. The $33.8 million increase in gross revenue was driven by a $49.9 million increase in I/DD gross revenue while ARY gross revenue decreased by $16.1 million.

The increase in I/DD gross revenue included $35.3 million from organic growth and $14.6 million from acquisitions that closed during and after the nine months ended June 30, 2013. The organic growth was the result of a 3.9% increase in volume coupled with a 2.3% increase in average billing rates for the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013.

 

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The $16.1 million decrease in ARY gross revenue was due to a 13.2% decrease in volume partially offset by a 3.7% increase in the average billing rate during the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013. The majority of the decrease in volume was caused by a reduction in services in North Carolina due to a state wide redesign of these programs and the voluntary termination of our contracts to provide services with a managed care organization. The impact of this reduction accounted for approximately $14 million of the decrease in net revenue.

Sales adjustments for the nine months ended June 30, 2014 increased by $2.5 million compared to the nine months ended June 30, 2013. The increase is primarily due to a one-time $2.1 million favorable revenue adjustment to our state provider tax reserve during the nine months ended June 30, 2013 relating to pre-Merger periods.

The following table sets forth net revenue for the SRS segment for the periods indicated (in thousands):

 

     Nine months ended June 30,     Percentage
Increase
(Decrease)
 
     2014     2013     Increase
(Decrease)
   

SRS gross revenue

   $ 172,256      $ 158,547      $ 13,709        8.6

Sales adjustments

     (2,581     (2,889     308    

Sales adjustments as a percentage of gross revenue

     (1.5 )%      (1.8 )%      0.3  
  

 

 

   

 

 

   

 

 

   

SRS net revenue

   $ 169,675      $ 155,658      $ 14,017        9.0
  

 

 

   

 

 

   

 

 

   

SRS gross revenue for the nine months ended June 30, 2014 increased by $13.7 million, or 8.6%, compared to the nine months ended June 30, 2013. The increase included $9.2 million from organic growth and $4.5 million from acquisitions that closed during and after the nine months ended June 30, 2013. The organic growth was driven by an increase in the average billing rate of 4.1% and a slight increase in volume of 1.7%.

Cost of revenues by segment

The following table sets forth cost of revenues for the Human Services segment for the periods indicated (in thousands):

 

     Nine months ended June 30,     Increase
(Decrease)
    Change in %
of net revenue
 
     2014     2013      
     Amount      % of net
revenue
    Amount      % of net
revenue
     

Direct labor costs

   $ 499,173         64.9   $ 479,849         65.0   $ 19,324        (0.1 )% 

Client program costs

     30,873        4.0     31,842        4.3     (969     (0.3 )% 

Client occupancy costs

     41,244        5.4     37,838        5.1     3,406       0.2

Travel & transportation costs

     20,779        2.7     19,939        2.7     840       (0.0 )% 

Other direct costs

     16,874        2.2     16,587        2.2     287       (0.1 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total cost of revenues

   $ 608,943         79.2   $ 586,055         79.4   $ 22,888        (0.3 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Human Services cost of revenue for the nine months ended June 30, 2014 increased by $22.9 million, or 3.9%, as compared to the nine months ended June 30, 2013 primarily due to an increase in direct labor costs of $19.3 million and an increase in client occupancy costs of $3.4 million. The increases in direct labor costs and client occupancy costs were primarily attributable to additional costs associated with new programs and acquisitions that closed during and after the nine months ended June 30, 2013, as well as a new compensation program for our direct care workers.

The decrease of direct labor costs as a percentage of net revenue was primarily due to expense leveraging. The increase in client occupancy costs as a percentage of net revenue was the result of new programs with higher levels of open occupancy and an increase in rent, utilities and repairs and maintenance expense related to our business.

 

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The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):

 

     Nine months ended June 30,     Increase
(Decrease)
     Change in  %
of net revenue
 
     2014     2013       
     Amount      % of  net
revenue
    Amount      % of  net
revenue
      

Direct labor costs

   $ 88,754         52.3   $ 82,207         52.8   $ 6,547         (0.5 )% 

Client program costs

     12,575        7.4     10,975        7.1     1,600        0.4

Client occupancy costs

     19,151        11.3     16,388        10.5     2,763        0.8

Travel & transportation costs

     2,271        1.3     1,937        1.2     334        0.1

Other direct costs

     3,065        1.8     2,853        1.8     212        (0.0 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total cost of revenues

   $ 125,816         74.2   $ 114,360         73.5   $ 11,456         0.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

SRS cost of revenue for the nine months ended June 30, 2014 increased by $11.5 million, or 10.0%, as compared to the nine months ended June 30, 2013 due to an increase in direct labor costs of $6.5 million, an increase in client program costs of $1.6 million and an increase in client occupancy costs of $2.8 million. These increases were primarily attributable to additional costs associated with new programs and acquisitions that closed during and after the nine months ended June 30, 2013.

The decrease of direct labor costs as a percentage of revenue was primarily due to expense leveraging. The increase in client program costs as a percentage of net revenue during the nine months ended June 30, 2014 was due to an increase in medical expense relating to the client mix. The increase in client occupancy costs as a percentage of net revenue during the nine months ended June 30, 2014 was due to new programs with higher levels of open occupancy and an increase in rent, utilities and repairs and maintenance expense related to our business.

Consolidated operating expenses

General and administrative and depreciation and amortization expense were as follows (in thousands):

 

     Nine months ended June 30,     Increase
(Decrease)
    Change in  %
of net revenue
 
     2014     2013      
     Amount      % of  net
revenue
    Amount      % of  net
revenue
     

General and administrative

   $ 108,811         11.6   $ 110,879         12.4   $ (2,068     (0.8 )% 

Depreciation and amortization

     50,987        5.4     47,970        5.4     3,017       0.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total operating expense

   $ 159,798         17.0   $ 158,849         17.8   $ 949        (0.8 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

General and administrative expenses for the nine months ended June 30, 2014 decreased by $2.1 million, or 1.9%, as compared to the nine months ended June 30, 2013. As a percentage of net revenue, general and administrative expenses decreased by 0.8% as compared to the nine months ended June 30, 2013. This decrease was attributable to cost containment efforts in administrative staffing, business and office related costs.

Depreciation and amortization expense increased $3.0 million during the nine months ended June 30, 2014 from the prior year period primarily due to an increase in leasehold improvements to our properties and the acquisition of amortizable assets. Depreciation and amortization expense as a percentage of net revenue remained consistent.

 

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Other (income) expense

Management fee of related party: Management fee remained consistent during the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013.

Other income, net: Other income, net, which primarily consists of mark to market adjustments of the cash surrender value of Company owned life insurance policies, decreased slightly from $0.6 million to $0.4 million in the nine months ended June 30, 2013 and 2014, respectively

Loss on extinguishment of debt: Extinguishment of debt was $14.7 million in the nine months ended June 30, 2014. The prior senior secured credit facilities were repaid and replaced with the senior secured credit facilities on January 31, 2014, and $38 million of the senior notes were redeemed on February 26, 2014, resulting in the write-off of deferred financing fees, original issue discount, redemption premium and initial purchase discount related to the prior senior secured credit facilities and the partial redemption of the senior notes totaling $14.7 million.

Interest Expense: Interest expense decreased by $5.3 million during the nine months ended June 30, 2014 compared to the nine months ended June 30, 2013 due to lower interest expense on the senior secured credit facilities as a result of the refinancing on January 31, 2014 and the redemption of $38 million of the senior notes on February 26, 2014.

Benefit for income taxes

For the nine months ended June 30, 2014, our effective income tax rate was 29.9% compared to an effective tax rate of 34.5% for the nine months ended June 30, 2013. These rates differ from the federal statutory income tax rate primarily due to nondeductible permanent differences such as meals and nondeductible compensation, and net operating losses not benefited.

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

Consolidated overview

 

     Year ended September 30,  
     2013     2012     Increase
(Decrease)
 

Gross revenue

   $ 1,221,200      $ 1,138,910      $ 82,290   

Sales adjustments

     (22,547     (15,792     (6,755
  

 

 

   

 

 

   

 

 

 

Net revenue

   $ 1,198,653      $ 1,123,118      $ 75,535   
  

 

 

   

 

 

   

 

 

 

Income from operations

   $ 53,324      $ 47,585      $ 5,739   

Operating margin

     4.4     4.2     0.2

Consolidated gross revenue for the fiscal year ended September 30, 2013 (“fiscal 2013”) increased by $82.3 million, or 7.2%, compared to gross revenue for the fiscal year ended September 30, 2012 (“fiscal 2012”). Sales adjustments as a percentage of gross revenue increased by 0.46% to 1.85% from 1.39% for the same period. The increase in sales adjustments was partially offset by a $2.1 million adjustment to our state provider tax reserve relating to pre-merger periods. The increase in sales adjustments was primarily in our Human Services segment. Gross revenue increased $57.8 million from organic growth, including growth related to new programs and $24.5 million from acquisitions that closed during and after fiscal 2012. The organic growth was partially offset by a reduction in revenue of $3.6 million from businesses we divested during the same period.

Consolidated income from operations increased from $47.6 million, or 4.2%, of net revenue in fiscal 2012 to $53.3 million, or 4.4% of net revenue, in fiscal 2013. The increase in our operating margin was primarily due

 

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to the increase in revenue noted above as well as expense leveraging and cost containment efforts in our direct labor costs and general and administrative expenses. The improvement in operating margin was partially offset by the increase in cost of other revenues. The increase in cost of other revenues was primarily due to the increase in client occupancy expense of $10.2 million attributable to new programs and acquisitions that have closed during and after fiscal 2012. Additionally, our health insurance expense and professional and general liability expense increased in fiscal 2013 as compared to fiscal 2012 primarily as a result of a change in reserves. Health insurance expense increased approximately $3.0 million, $2.4 million of which was included in consolidated cost of revenue and $0.6 million was included in General and administrative expenses. Professional and general liability expense increased by approximately $1.4 million as compared to fiscal 2012. In fiscal 2013, we increased the PL/GL Tail Reserve by $3.4 million which was partially offset by a decrease in our professional and general liability claims expense as compared to fiscal 2012. The expense relating to the professional and general liability claims expense and the PL/GL Tail Reserve is included in consolidated cost of revenue in the accompanying consolidated statements of operations.

Revenues by segment

The following table sets forth net revenue for the Human Services segment for the periods indicated (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
    Percentage
Increase
(Decrease)
 
     2013     2012      

I/DD gross revenue

   $ 783,018      $ 731,309      $ 51,709        7.1

ARY gross revenue

     224,717        218,040        6,677        3.1
  

 

 

   

 

 

   

 

 

   

Total Human Services gross revenue

   $ 1,007,735      $ 949,349      $ 58,386        6.2

Sales adjustments

     (17,503     (11,697     (5,806  

Sales adjustments as a percentage of revenue

     1.7     1.2     0.5  
  

 

 

   

 

 

   

 

 

   

Total Human Services net revenue

   $ 990,232      $ 937,652      $ 52,580        5.6
  

 

 

   

 

 

   

 

 

   

Human Services gross revenue for fiscal 2013 increased by $58.4 million, or 6.2%, compared to fiscal 2012. The increase was driven by a 7.1% increase in I/DD gross revenue and 3.1% increase in ARY gross revenue.

The increase in I/DD gross revenue included $39.8 million from organic growth and $11.9 million from acquisitions that closed during and after fiscal 2012. The increase from organic growth was driven by an increase in volume of 2.2% and an increase in average billing rate of 3.3% during fiscal 2013 compared to fiscal 2012. The organic growth was partially offset by a reduction in revenue of $3.6 million from businesses we divested during the same period.

The increase of $6.7 million in ARY gross revenue was derived from organic growth which was driven by a 3.0% increase in volume and a slight increase of 0.1% in the average billing rate during fiscal 2013 compared to fiscal 2012.

Sales adjustments increased by $5.8 million in fiscal 2013 compared to fiscal 2012. Sales adjustments as a percentage of gross revenue increased by 0.5% from 1.2% for fiscal 2012 to 1.7% for fiscal 2013. In fiscal 2013, we made a significant increase to the sales adjustments allowance in our Florida, North Carolina and Pennsylvania business units for the potential write-off of outstanding aged receivables that are in dispute with payors.

 

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The following table sets forth net revenue for the SRS segment for the periods indicated (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
    Percentage
Increase
(Decrease)
 
           2013                 2012            

SRS gross revenues

   $ 213,465      $ 189,561      $ 23,904        12.6

Sales adjustments

     (5,044     (4,095     (949     23.2

Sales adjustments as a percentage of revenue

     2.4     2.2     0.2  
  

 

 

   

 

 

   

 

 

   

Total SRS net revenues

   $ 208,421      $ 185,466      $ 22,955        12.4
  

 

 

   

 

 

   

 

 

   

SRS gross revenue for fiscal 2013 increased by $23.9 million, or 12.6%, compared to fiscal 2012. The increase in gross revenue included $11.0 million from organic growth and $12.9 million from acquisitions that closed during and after fiscal 2012. The organic growth was driven by an increase in volume of 2.3% and an increase in average billing rate of 3.5% during fiscal 2013 compared to fiscal 2012.

Cost of revenues by segment

The following table sets forth cost of revenues for the Human Services segment for the periods indicated (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
    Change in %
of net
revenue
 
     2013     2012      
     Amount      % of net
revenue
    Amount      % of net
revenue
     

Direct labor costs

   $ 643,478         65.0   $ 612,260         65.3   $ 31,218        (0.3 )% 

Client program costs

     40,220         4.1     39,222         4.2     998        (0.1 )% 

Client occupancy costs

     51,324         5.2     45,285         4.8     6,039        0.4 

Travel & transportation costs

     26,996         2.7     26,531         2.8     465        (0.1 )% 

Other direct costs

     18,737         1.9     20,911         2.2     (2,174     (0.3 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total cost of revenues

   $ 780,755         78.8   $ 744,209         79.4   $ 36,546        (0.5 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Human Services cost of revenue for fiscal 2013 increased by $36.6 million, or 4.9%, compared to fiscal 2012. This increase was driven by $31.2 million increase in direct labor costs and a $6.0 million increase in client occupancy costs and was offset by a $2.2 million decrease in other direct costs.

The increase in direct labor costs was primarily due to increased staffing in connection with new programs and acquisitions that closed during and after fiscal 2012.

The increase in client occupancy costs period to period and as a percentage of revenue was attributable to acquisitions and new programs with higher levels of open occupancy and increases in rent, utilities and repairs and maintenance expense related to our businesses.

The decrease in other direct costs was primarily due to a reduction of $1.5 million in the cash bonus provided to our direct care workers in fiscal 2013 compared to fiscal 2012.

 

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The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
     Change in %
of net
revenue
 
     2013     2012       
     Amount      % of net
revenue
    Amount      % of net
revenue
      

Direct labor cost

   $ 110,508         53.0   $ 93,412         50.4   $ 17,096         2.7

Client program costs

     14,486         7.0     13,634         7.4     852         (0.4 )% 

Client occupancy costs

     22,662         10.9     18,291         9.9     4,371         1.0

Travel & transportation costs

     2,635         1.3     2,383         1.3     252         0.0

Other direct costs

     3,144         1.5     2,935         1.6     209         (0.1 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total cost of revenues

   $ 153,435         73.6   $ 130,655         70.4   $ 22,780         3.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

SRS cost of revenue for fiscal 2013 increased by $22.8 million, or 17.4%, compared to fiscal 2012. This increase was driven by $17.1 million increase in direct labor costs, a $4.4 million increase in client occupancy costs and a $0.9 million increase in client program costs.

The increase in direct labor costs period to period and as a percentage of revenue was primarily due to increased staffing in connection with new programs and acquisitions and due to additional staff to facilitate higher quality and service.

The increase in client occupancy expense was primarily attributable to acquisitions that have closed during and after fiscal 2012, new programs and new starts. Client occupancy costs have also been affected by the increase in rent, utilities and repairs and maintenance expense related to our existing businesses.

Consolidated operating expenses

General and administrative and depreciation and amortization expense were as follows (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
     Change in %
of net
revenue
 
     2013     2012       
     Amount      % of net
revenue
    Amount      % of net
revenue
      

General and administrative

   $ 146,040         12.2   $ 140,221         12.5   $ 5,819         (0.3 )% 

Depreciation and amortization

     64,146         5.4     60,534         5.4     3,612         0.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total operating expense

   $ 210,186         17.5   $ 200,755         17.9   $ 9,431         (0.3 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

General and administrative expenses for fiscal 2013 increased by $5.8 million, or 4.1%, as compared to fiscal 2012 due to increases in professional service fees and administrative staffing costs. Additionally, we wrote off goodwill and intangible assets related to underperforming programs within the Human Services segment which were closed during fiscal 2013. The total impairment charge was $2.3 million and included a $1.3 million write off of goodwill that was recorded in general and administrative expense.

Depreciation and amortization expense increased $3.6 million, or 6.0%, during fiscal 2013 from fiscal 2012 but remained relatively flat as a percent of net revenue at 5.4% for both periods. The increase in depreciation and amortization expense was primarily due to an increase in leasehold improvements to our properties and the acquisition of amortizable assets. Partially offsetting this increase was a decrease in depreciation and amortization expense as certain assets became fully depreciated. Additionally, as noted above, we wrote off goodwill and intangible assets related to underperforming programs within the Human Services segment which were closed during fiscal 2013. The total impairment charge was $2.3 million and included the write-off of $1.0 million of intangible assets recorded in depreciation and amortization expense.

 

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Non-operating (income) expense

Management fee of related party: Management fee has remained consistent during fiscal 2013 compared to fiscal 2012.

Other income, net: Other income, net which primarily consists of mark to market adjustments of the cash surrender value of Company owned life insurance policies, increased from zero in fiscal 2012 to $0.9 million in fiscal 2013.

Interest Income: Interest income decreased to $0.1 million in fiscal 2013 from $0.3 million in fiscal 2012. Interest income is derived from interest earned on interest bearing bank accounts.

Interest Expense: Interest expense for fiscal 2013 decreased $1.4 million to $78.1 million as compared to fiscal 2012. The decrease is due to the lower interest rate we pay on our borrowings under the prior senior secured credit facilities as a result of the amendment to our prior senior credit agreement during fiscal 2013.

Benefit for income taxes

For fiscal 2013, our effective income tax rate was 37.8% compared to an effective tax rate of 58.7% for fiscal 2012. These rates differ from the federal statutory income tax rate primarily due to nondeductible permanent differences such as meals and nondeductible compensation, and net operating losses not benefited. In addition, our effective tax rate for fiscal 2012 was impacted by a $5.6 million reduction in our reserve for uncertain income tax positions, including interest and penalties, as a result of favorable settlement of an audit.

Loss from discontinued operations

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

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

Consolidated overview

     Year ended September 30,  
     2012     2011     Increase
(Decrease)
 

Gross revenue

   $ 1,138,910      $ 1,076,961      $ 61,949   

Sales adjustments

     (15,792     (14,188     (1,604
  

 

 

   

 

 

   

 

 

 

Net revenue

   $ 1,123,118      $ 1,062,773      $ 60,345   
  

 

 

   

 

 

   

 

 

 

Income from operations

   $ 47,585      $ 34,423      $ 13,162   

Operating margin

     4.2     3.2     1.0

Consolidated gross revenue for the fiscal 2012 increased by $61.9 million, or 5.8%, compared to gross revenue for the fiscal year ended September 30, 2011 (“fiscal 2011”). Sales adjustments as a percentage of gross revenue increased by 0.1% to 1.4% from 1.3% for the same period. Gross revenue increased $36.6 million from organic growth, including growth related to new programs, and $25.3 million from acquisitions that closed during and after fiscal 2011. The organic growth was partially offset by a reduction in revenue of $3.4 million from businesses we divested during the same period.

 

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Consolidated income from operations increased from $34.4 million, or 3.2% of revenue, in fiscal 2011 to $47.6 million, or 4.2% of revenue, in fiscal 2012. Operating margin was positively impacted by a $4.8 million decrease in worker’s compensation insurance costs and employment practices liability expense during fiscal 2012 as compared to fiscal 2011. The increase in our operating margin was also primarily due to the non-recurrence of certain general and administrative expenses incurred during fiscal 2011, namely accelerated stock-based compensation expense, discretionary bonuses, cost structure optimization efforts and an impairment charge to long-lived assets. The improvement in operating margin was partially offset by the increase in direct labor costs in fiscal 2012 as we increased staffing to strengthen quality and service, and an increase in travel and transportation expense primarily from cost for mileage reimbursement, auto insurance and gasoline.

Revenues by segment

The following table sets forth net revenue for the Human Services segment for the periods indicated (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
    Percentage
Increase
(Decrease)
 
           2012                 2011            

I/DD gross revenue

   $ 731,309      $ 693,703      $ 37,606        5.4

ARY gross revenue

     218,040        206,136        11,904        5.8
  

 

 

   

 

 

   

 

 

   

Total Human Services gross revenue

   $ 949,349      $ 899,839      $ 49,510        5.5

Sales adjustments

     (11,697     (12,542     845     

Sales adjustments as a percentage of gross revenue

     1.2     1.4     (0.2 )%   
  

 

 

   

 

 

   

 

 

   

Total human services net revenue

   $ 937,652      $ 887,297      $ 50,355        5.7
  

 

 

   

 

 

   

 

 

   

Human Services gross revenue for fiscal 2012 increased by $49.5 million, or 5.5%, as compared to fiscal 2011. The increase was driven by a 5.4% increase in I/DD gross revenue and a 5.8% increase in ARY gross revenue.

The increase in I/DD gross revenue included $28.0 million from organic growth and $9.6 million from acquisitions that closed during and after fiscal 2011. The organic growth was driven by an increase in volume of 2.5% and an increase in average billing rate of 1.5% during fiscal 2012 compared to fiscal 2011. The increase in the average billing rate was partially offset by rate reductions in some states, including Arizona, Florida and Minnesota. The organic growth was also partially offset by a reduction in revenue of $0.6 million from businesses we divested during the same period.

The increase of $11.9 million in ARY gross revenue included $4.7 million of organic growth and $7.2 million from acquisitions that closed during and after fiscal 2011. The organic growth was driven by an increase in the average billing rate of 4.3% offset by a decrease in volume of 2.0% during fiscal 2012 compared to fiscal 2011.

The following table sets forth net revenue for the SRS segment for the periods indicated (in thousands):

 

     Year ended September 30,     Increase
(Decrease)
    Percentage
Increase
(Decrease)
 
           2012                 2011            

SRS gross revenue

   $ 189,561      $ 177,122      $ 12,439        7.0

Sales adjustments

     (4,095     (1,646     (2,449  

Sales adjustments as a percentage of gross revenue

     2.2     0.9     1.3  
  

 

 

   

 

 

   

 

 

   

Total SRS net revenue

   $ 185,466      $ 175,476      $ 9,990        5.7
  

 

 

   

 

 

   

 

 

   

 

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SRS gross revenue for fiscal 2012 increased by $12.4 million, or 7.0%, as compared to fiscal 2011. Gross revenue increased $3.9 million from organic growth, including growth related to new programs, and $8.5 million related to acquisitions that closed during and after fiscal 2011. The organic growth was primarily due to an increase in average daily rate of 3.5% offset by a decrease in volume of 1.1% during fiscal 2012 compared to fiscal 2011. The organic growth was also partially offset by a reduction in revenue of $2.8 million from businesses we divested during the same period.

Sales adjustments as a percentage of gross revenue increased by 1.3% from 0.9% for fiscal 2011 to 2.2% for fiscal 2012. In fiscal 2012, we made a significant increase to our sales adjustments allowance for the amounts that were in dispute with payors.

Cost of revenues by segment

The following table sets forth cost of revenues for the Human Services segment for the periods indicated (in thousands):

 

     Year ended September 30,      Increase
(Decrease)
    Change in %
of net
revenue
 
     2012      2011       
     Amount      % of net
revenue
     Amount      % of net
revenue
      

Direct labor costs

   $ 612,260         65.3%       $ 569,522         64.2%       $ 42,738        1.1 %   

Client program costs

     39,222         4.2%         38,891         4.4%         331        (0.2)%   

Client occupancy costs

     45,285         4.8%         43,390         4.9%         1,895        (0.1)%   

Travel & transportation costs

     26,531         2.8%         22,746         2.6%         3,785        0.3 %   

Other direct costs

     20,911         2.2%         24,185         2.7%         (3,274     (0.5)%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total cost of revenues

   $ 744,209         79.4%       $ 698,734         78.7%       $ 45,475        0.6 %   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Human Services cost of revenues increased by $45.5 million, or 6.5%, for fiscal 2012 compared to fiscal 2011. The increase was driven by a $42.7 million increase in direct labor costs, a $0.4 million increase in client program costs, a $1.9 million increase in client occupancy costs, and a $3.8 million increase in travel and transportation costs offset by a $3.3 million decrease in other direct costs.

The increase in direct labor costs is primarily due to increased staffing in connection with new programs and acquisitions. Additionally, we increased staffing to strengthen the quality and service during fiscal 2012 which had a negative impact on operating margin compared to fiscal 2011.

The increase in program related costs was primarily due to new programs and acquisitions. This increase was offset by a decrease of $1.1 million in employment practices liability claims expense in fiscal 2012 as a result of favorable settlements of prior period claims.

The increase in client occupancy costs was primarily attributable to acquisitions that have closed during and after fiscal 2012, new programs primarily and new starts as we continued to spend on growth initiatives.

During fiscal 2012, we also recorded an additional $3.8 million in travel and transportation costs, primarily from increased cost for mileage reimbursement, auto insurance and gasoline.

The decrease in other direct costs was primarily due to a decrease of $2.9 million in workers’ compensation insurance costs in fiscal 2012 compared to fiscal 2011 as a result of a change in our reserves due to favorable settlements of prior period claims and a $1.3 million decrease in discretionary bonus to direct care workers in fiscal 2012 compared to fiscal 2011 partially offset by increases in other direct costs due to new programs and acquisitions.

 

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The following table sets forth cost of revenues for the SRS segment for the periods indicated (in thousands):

 

     Year ended September 30,      Increase
(Decrease)
    Change in %
of net
revenue
 
     2012      2011       
     Amount      % of net
revenue
     Amount      % of net
revenue
      

Direct labor costs

   $ 93,412         50.4%       $ 88,503         50.4%       $ 4,909        (0.1)%   

Client program costs

     13,634         7.4%         12,892         7.3%         742        0.0 %   

Client occupancy costs

     18,291         9.9%         17,235         9.8%         1,056        0.1 %   

Travel & transportation costs

     2,383         1.3%         2,185         1.2%         198        0.0 %   

Other direct costs

     2,935         1.6%         3,466         2.0%         (531     (0.4)%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total cost of revenues

   $ 130,655         70.4%       $ 124,281         70.8%       $ 6,374        (0.4)%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

SRS costs of revenues increased by $6.3 million, or 5.1%, for fiscal 2012 compared to fiscal 2011. The increase was driven by a $4.9 million increase in direct labor expense, a $0.7 million increase in client program costs, and a $1.1 million increase in client occupancy costs offset by a $0.5 million decrease in other direct costs.

The increase in direct labor costs was primarily due to increased staffing in connection with new programs and acquisitions. Additionally, we increased staffing to strengthen the quality of service which negatively impacted operating margin.

The increase in client program related costs was primarily due to new programs and acquisitions. This increase was offset by a decrease of $0.2 million in employment practices liability claims expense in fiscal 2012 as a result of favorable settlements of prior period claims.

The increase in client occupancy costs was primarily attributable to acquisitions that have closed during and after fiscal 2012, new programs and new starts. Client occupancy costs were also affected by the increase in rent, utilities and repairs and maintenance expense related to our businesses.

The decrease in other direct costs was primarily due to a decrease of $0.6 million in workers’ compensation insurance costs in fiscal 2012 compared to fiscal 2011 as a result of a change in our reserves due to favorable settlements of prior period claims.

Consolidated operating expenses

General and administrative and depreciation and amortization expense were as follows (in thousands):

 

     Year ended September 30,      Increase
(Decrease)
    Change in %
of net
revenue
 
     2012      2011       
     Dollar
Amount
     % of net
revenue
     Dollar
Amount
     % of net
revenue
      

General and administrative

   $ 140,221         12.5%       $ 144,011         13.6%       $ (3,790     (1.1)%   

Depreciation and amortization

     60,534         5.4%         61,330         5.8%         (796     (0.4)%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total operating expense

   $ 200,755         17.9%       $ 205,341         19.3%       $ (4,586     (1.4)%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

General and administrative expense decreased by $3.8 million, or 2.6%, for fiscal 2012 compared to fiscal 2011. The decrease in general and administrative expense was the result of a $5.3 million impairment that was recorded in 2011 for certain trade names while there was no impairment in fiscal 2012, $2.4 million of discretionary recognition bonuses recorded during fiscal 2011 which were not recorded in 2012, a decrease of approximately $3.0 million in stock compensation expense due to the majority of the unvested Class B Common Units, Class C Common Units and Class D Common Units becoming fully vested in fiscal 2011, and a

 

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$2.2 million decrease in restructuring costs during fiscal 2012 compared to fiscal 2011. The impact of these items was partially offset by the increase in staffing and other general and administrative employee-related costs in fiscal 2012 compared to fiscal 2011.

Depreciation and amortization expense decreased by $0.8 million, or 1.3%, during fiscal 2012 compared to fiscal 2011 and decreased slightly as a percent of revenue from 5.7% in fiscal 2011 to 5.3% in fiscal 2012. The decrease was due to certain assets became fully depreciated during fiscal 2012.

Other (income) expense

Management fee of related party: Management fee has remained consistent during fiscal 2012 compared to fiscal 2011.

Other income, net: Other income, net, which primarily consists of mark to market adjustments for the cash surrender value of Company owned life insurance policies, remained consistent during fiscal 2012 compared to fiscal 2011.

Extinguishment of debt: During fiscal 2011, we incurred $23.7 million of net expenses related to refinancing transactions, including (i) $10.8 million related to the tender premium and consent fees paid in connection with the repurchase of the senior subordinated notes, (ii) $2.0 million related to the consent fees and repurchase discount in connection with the repurchase of the senior floating rate toggle notes, (iii) $9.8 million related to the acceleration of financing costs and original issue discount related to the prior indebtedness and (iv) $1.1 million related to other transaction costs. These expenses were recorded on our consolidated statements of operations as extinguishment of debt.

Interest Income: Interest income increased to $0.3 million in fiscal 2012 from $0.0 million in fiscal 2011. Interest income is derived from interest earned on interest bearing bank accounts.

Interest Expense: Interest expense increased by $11.9 million from fiscal 2011 as compared to fiscal 2012, as a result of the 2011 refinancing transactions. Our weighted average debt balance increased by $33.0 million in fiscal 2012 and our weighted average interest rate increased from 8.1% during fiscal 2011 to 9.2% for fiscal 2012.

Benefit for income taxes

For fiscal 2012, our effective income tax rate was 58.7% compared to an effective tax rate of 33.1% for fiscal 2011. These rates differ from the federal statutory income tax rate primarily due to nondeductible permanent differences and net operating losses not benefited. In addition, our effective tax rate for fiscal 2012 was impacted by a $5.6 million reduction in our reserve for uncertain income tax positions, including interest and penalties, as a result of favorable settlement of an audit.

Liquidity and Capital Resources

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

Operating activities

Cash flows provided by operating activities were $66.7 million for the nine months ended June 30, 2014 compared to cash flows provided by operating activities of $32.7 million for the nine months ended June 30, 2013. The increase in cash provided by operating activities is primarily attributable to the management of working capital items for the nine months ended June 30, 2014 as compared to the nine months ended June 30, 2013.

 

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Cash flows provided by operating activities were $55.7 million, $29.3 million and $30.8 million for fiscal 2013, 2012 and 2011, respectively. The increase in cash provided by operating activities in 2013 is primarily attributable to the decrease in our days sales outstanding. Our days sales outstanding decreased from 52 days to 47 days at September 30, 2013 as compared to September 30, 2012 primarily due to some efficiencies resulting from the centralization of certain billing and accounts receivable functions as well as the process improvement of our billing and collections process and review of aged receivables.

The decrease in cash flows provided by operating activities from fiscal 2011 to fiscal 2012 was primarily due to the increase in our days sales outstanding which increased to 52 days at September 30, 2012 from 48 days at September 30, 2011, as we were still continuing to centralize certain billing and accounts receivable functions and utilize a new billing and accounts receivable system in certain locations. The decrease in cash flows was offset by the timing of other working capital items which positively impacted our cash flows in the same comparative period.

Investing activities

Net cash used in investing activities was $39.7 million and $21.0 million for the nine months ended June 30, 2014 and 2013, respectively. Cash paid for property and equipment for the nine months ended June 30, 2014 was $24.3 million, or 2.6% of net revenue, compared to $22.3 million, or 2.5% of net revenue, for the nine months ended June 30, 2013. During the nine months ended June 30, 2014 we paid $15.2 million for six acquisitions. During the nine months ended June 30, 2013, we paid $0.5 million for one acquisition in our Human Services segment.

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

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

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

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

Financing activities

On January 31, 2014, NMHI replaced its prior senior secured credit facilities with the senior secured credit facilities consisting of a term loan facility and a senior revolver. The term loan facility has a seven-year maturity and the senior revolver has a five-year maturity: provided that if the senior notes are not refinanced in full on or prior to the date that is three months prior to February 15, 2018, such maturity will spring forward to November 15, 2017. NMHI redeemed $38 million in aggregate principal amount of its senior notes on February 26, 2014.

Net cash provided by financing activities was $1.1 million for the nine months ended June 30, 2014 as compared to $4.5 million of cash provided by financing activities for the nine months ended June 30, 2013. The decrease in cash provided by financing activities is primarily due to the $30.0 million additional term loan we obtained in February 2013, which had the effect of minimizing the need to draw on our senior revolver.

 

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Net cash provided by financing activities was $3.0 million, $13.1 million and $25.5 million for fiscal years 2013, 2012 and 2011, respectively. The decrease in net cash provided by financing activities in fiscal 2013 as compared to fiscal 2012 and fiscal 2011 is primarily due to the repayment of any outstanding borrowings under our senior revolver.

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

Our principal sources of funds are cash flows from operating activities, cash on hand and available borrowings under our senior revolver. During fiscal 2013, we borrowed an aggregate of $469.4 million under our senior revolver and repaid $488.4 million during the same period. During the nine months ended June 30, 2014, we borrowed an aggregate of $9.3 million under our senior revolver and repaid $9.3 million during the same period. At June 30, 2014, we had no outstanding borrowings and $100.0 million of availability under the senior revolver. However, despite the contractual availability, the covenants in NMHI’s indenture governing the senior notes effectively limit our ability to draw on the senior revolver. Letters of credit can be issued under our institutional letter of credit facility up to the $50.0 million limit and letters of credit in excess of that amount reduce availability under our senior revolver. Subject to the debt incurrence limitations imposed by the indenture governing the senior notes, we may draw on the revolver during fiscal 2014 and we believe that available funds will provide sufficient liquidity and capital resources to meet our financial obligations for the next twelve months, including scheduled principal and interest payments, as well as to provide funds for working capital, acquisitions, capital expenditures and other needs. No assurance can be given, however, that this will be the case.

Also during the nine months ended June 30, 2014 and fiscal 2013, 2012 and 2011, NMH Investment repurchased equity units from employees upon or after their departures from the Company for $110 thousand, $39 thousand, $75 thousand and $1.5 million, respectively. We accounted for these repurchases as dividends of $110 thousand, $39 thousand, $75 thousand and $1.5 million, respectively, up to NMH Investment which used the proceeds to fund the repurchases.

On January 31, 2014, NMHI replaced the prior senior secured credit facilities with new senior secured credit facilities. The new term loan facility has a seven-year maturity and the new senior revolver has a five-year maturity: provided that if the senior notes are not refinanced in full on or prior to the date that is three months prior to February 15, 2018, such maturity will spring forward to November 15, 2017. NMHI redeemed $38 million aggregate principal amount of the senior notes on February 26, 2014. If these refinancing transactions had occurred at the beginning of fiscal 2013, they would have reduced our interest expense by approximately $11.6 million, based on (i) a reduction in the applicable margin and “LIBOR floor” used to calculate interest rates under the senior secured credit facilities, partially offset by the increase in the principal amount outstanding under the term loan, and (ii) the elimination of interest expense on the $38 million principal amount of our senior notes that were redeemed. Assuming an effective tax rate of 40%, this reduction in interest expense would have reduced our fiscal 2013 net loss by approximately $7.0 million. See Note 9 to our consolidated financial statements included elsewhere herein for further information about our senior secured credit facilities.

We intend to use the net proceeds from the sale of common stock by us in this offering to redeem $162.0 million in aggregate principal amount of the senior notes at a redemption price of 106.25% plus accrued and unpaid interest thereon to the date of redemption. This redemption is expected to result in annual interest expense savings of approximately $23.3 million, assuming our debt levels stay the same, consisting of (i) $20.3 million of annual interest expense savings from the redemption of the senior notes, and (ii) $3 million of annual interest expense savings from the reduction of the interest rate payable under our senior secured credit facilities by 0.50% per annum as a result of the reduction in our consolidated leverage ratio following the redemption of the senior notes using the net proceeds from this offering. See “—Debt and Financing Arrangements—Senior Secured Credit Facilities.” Assuming an effective tax rate of 40% and that our consolidated leverage ratio remains consistent, this annual savings could have a positive net income impact of approximately $14.0 million annually.

 

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Debt and Financing Arrangements

Senior Secured Credit Facilities

On January 31, 2014, NMHI and NMH Holdings, LLC entered into a new senior credit agreement (the “senior credit agreement”) with Barclays Bank PLC, as administrative agent, and the other agents and lenders named therein, for the new senior secured credit facilities (the “senior secured credit facilities”), consisting of a $600.0 million term loan facility (the “term loan facility”), of which $50.0 million was deposited in a cash collateral account in support of the issuance of letters of credit under an institutional letter of credit facility (the “institutional letter of credit facility”), and a $100.0 million senior secured revolving credit facility (the “senior revolver”). The term loan facility has a seven-year maturity and the senior revolver has a five-year maturity; provided, that if the senior notes are not refinanced in full on or prior to the date that is three months prior to February 15, 2018, such maturity dates shall spring forward to November 15, 2017. The senior credit agreement provides that NMHI may make one or more offers to the lenders, and consummate transactions with individual lenders that accept the terms contained in such offers, to extend the maturity date of the lender’s term loans and/or revolving commitments, subject to certain conditions, and any extended term loans or revolving commitments will constitute a separate class of term loans or revolving commitments.

All of the obligations under the senior secured credit facilities are guaranteed by NMH Holdings, LLC and the subsidiary guarantors named therein (the “Subsidiary Guarantors”). Pursuant to the Guarantee and Security Agreement, dated as of January 31, 2014 (the “guarantee and security agreement”), among NMH Holdings, LLC, as parent guarantor, NMHI, certain of NMHI’s subsidiaries, as subsidiary guarantors and Barclays Bank, PLC, as administrative agent, subject to certain exceptions, the obligations under the senior secured credit facilities are secured by a pledge of 100% of NMHI’s capital stock and the capital stock of domestic subsidiaries owned by NMHI and any other domestic Subsidiary Guarantor and 65% of the capital stock of any first tier foreign subsidiaries and a security interest in substantially all of NMHI’s tangible and intangible assets and the tangible and intangible assets of NMH Holdings, LLC and each Subsidiary Guarantor.

The senior revolver includes borrowing capacity available for letters of credit and for borrowings on same-day notice, referred to as the “swingline loans.” Any issuance of letters of credit or making of a swingline loan will reduce the amount available under the senior revolver. As of June 30, 2014, NMHI had no borrowings under the senior revolver and $44.7 million of letters of credit issued under the institutional letter of credit facility.

At its option, NMHI may add one or more new term loan facilities or increase the commitments under the senior revolver (collectively, the “incremental borrowings”) in an aggregate amount of up to $125.0 million plus any additional amounts so long as certain conditions, including a consolidated first lien leverage ratio (as defined in the senior credit agreement) of not more than 4.50 to 1.00 on a pro forma basis, are satisfied. In addition, the covenants in NMHI’s indenture governing the senior notes effectively limit the amount of incremental borrowings that NMHI may incur based on a consolidated leverage ratio (as defined in the indenture) of not more than 6.00 to 1.00 on a pro forma basis.

Borrowings under the senior secured credit facilities bear interest, at NMHI’s option, at: (i) an ABR rate equal to the greater of (a) the prime rate of Barclays Bank PLC, (b) the federal funds rate plus 1/2 of 1.0%, and (c) the Eurodollar rate for an interest period of one-month beginning on such day plus 100 basis points, plus 2.75% (provided that the ABR rate applicable to the term loan facility will not be less than 2.00% per annum); or (ii) the Eurodollar rate (provided that the Eurodollar rate applicable to the term loan facility will not be less than 1.00% per annum), plus 3.75%. Following the completion of this offering, the applicable margin will be decreased by 0.50% per annum if our consolidated leverage ratio is less than or equal to 5.00 to 1.00. This decrease will become effective as of the first business day immediately following the first date on which NMHI delivers a quarterly compliance certificate setting forth such calculation. NMHI is also required to pay a commitment fee to the lenders under the senior revolver at an initial rate of 0.50% of the average daily unutilized commitments thereunder. NMHI must also pay customary letter of credit fees.

 

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The senior credit agreement requires us to make mandatory prepayments, subject to certain exceptions, with: (i) beginning in fiscal year 2015, 50% (which percentage will be reduced upon its achievement of certain first lien leverage ratios) of our annual excess cash flow; (ii) 100% of net cash proceeds of all non-ordinary course assets sales or other dispositions of property, subject to certain exceptions and thresholds; and (iii) 100% of the net cash proceeds of any debt incurrence, other than debt permitted under the senior credit agreement. Excess cash flow is defined in our senior credit agreement as (A) the sum of (i) consolidated net income (as defined in the senior credit agreement), plus (ii) the net decrease in working capital, plus (iii) noncash charges previously deducted from consolidated net income, plus (iv) non-cash losses from assets sales, minus (B) the sum of (i) certain amortization and other mandatory prepayment of indebtedness, plus (ii) unfinanced capital expenditures plus (iii) the cash portion of permitted investments plus (iv) noncash gains previously including in consolidated net income, plus (v) the net increase in working capital, plus (vi) certain cash payments of long-term liabilities, plus (vii) cash restricted payments, plus (viii) cash expenditures not expensed during such period, plus (ix) penalties paid in connection with the repayment of indebtedness, plus (x) certain cash distributions from the SRS business, plus (xi) aggregate unfinanced portion of contract consideration for acquisition or capital expenditures to be consummated, plus (xii) aggregate amount of cash amounts received in such period but excluded from consolidated net income, plus (xiii) certain cash payments in respect of earnout obligations, plus (xiv) certain voluntary prepayments of indebtedness, plus (xv) certain cash payments of non-cash charges added back in a prior period, plus (xvi) all charges or expenses incurred in such period but excluded from consolidated net income. NMHI is required to repay the term loan facility portion of the senior secured credit facilities in quarterly principal installments of 0.25% of the principal amount commencing on June 30, 2014, with the balance payable at maturity. The senior credit agreement permits NMHI to offer to the lenders newly issued notes in exchange for their term loans in one or more permitted debt exchange offers, subject to the conditions set forth in the senior credit agreement. In addition, if, on or prior to July 31, 2014, NMHI prepays or reprices any portion of the term loan facility, it will be required to pay a prepayment premium of 1% of the loans being prepaid or repriced.

Senior Notes

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

On February 26, 2014, NMHI redeemed $38 million aggregate principal amount of the outstanding principal amount of senior notes, in accordance with the provisions of the indenture governing the senior notes. The redemption price of the senior notes was 106.250% of the principal amount redeemed, plus accrued and unpaid interest to, but not including, the redemption date. We intend to use the net proceeds from the sale of common stock by us in this offering to redeem an additional $162 million in aggregate principal amount of the outstanding senior notes at a redemption price of 106.25% plus accrued and unpaid interest thereon to the date of redemption. After giving effect to that redemption, $50 million in aggregate principal amount of senior notes will remain outstanding.

Covenants

The senior credit agreement and the indenture governing the senior notes contain negative financial and non-financial covenants, including, among other things, limitations on our ability to incur additional debt, create liens on assets, transfer or sell assets, pay dividends, redeem stock or make other distributions or investments, and engage in certain transactions with affiliates. NMHI was in compliance with these covenants as of June 30, 2014.

In addition, the senior credit agreement contains a springing financial covenant. If, at the end of any fiscal quarter, NMHI’s usage of the senior revolver exceeds 30% of the commitments thereunder, NMHI is required to

 

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maintain at the end of each such fiscal quarter, commencing with the quarter ending June 30, 2014, a consolidated first lien leverage ratio of not more than 5.50 to 1.00. This consolidated first lien leverage ratio will step down to 5.00 to 1.00 commencing with the fiscal quarter ending March 31, 2017.

The senior credit agreement also contains a number of covenants that, among other things, restrict, subject to certain exceptions, our ability and the ability of its subsidiaries to: (i) incur additional indebtedness; (ii) create liens on assets; (iii) engage in mergers or consolidations; (iv) sell assets; (v) pay dividends and distributions or repurchase our capital stock; (vi) enter into swap transactions; (vii) make investments, loans or advances; (viii) repay certain junior indebtedness; (ix) engage in certain transactions with affiliates; (x) enter into sale and leaseback transactions; (xi) amend material agreements governing certain of our junior indebtedness; (xii) change our lines of business; (xiii) make certain acquisitions; and (xiv) limitations on the letter of credit cash collateral account. If NMHI withdraws any of the $50.0 million from the cash collateral account supporting the issuance of letters of credit, it must use the cash to either prepay the term loan facility or to secure any other obligations under the senior secured credit facilities in a manner reasonably satisfactory to the administrative agent. The senior credit agreement contains customary affirmative covenants and events of default.

Contractual Commitments Summary

The following table summarizes our contractual obligations and commitments as of June 30, 2014:

 

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

Long-term debt obligations (1)

   $ 1,100,539       $ 61,216         121,642         305,909         611,772   

Operating lease obligations (2)

     202,212         50,019         74,504         42,562         35,127   

Capital lease obligations

     6,615         441         1,020         1,249         3,905   

Purchase obligations (3)

     10,679         3,433         6,348         898         —     

Standby letters of credit

     44,736         44,736         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total obligations and commitments

   $ 1,364,781       $ 159,845         203,514         350,618         650,804   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents the principal amount of our long-term debt and the expected cash payments for interest on our long-term debt based on the interest rates in place and amounts outstanding at June 30, 2014, which does not reflect redemption of the $162 million of senior notes using net proceeds of this offering. See Note 3 to our unaudited consolidated financial statements included elsewhere herein for further information about our senior secured credit facilities.
(2) Includes the fixed rent payable under the leases and does not include additional amounts, such as taxes, that may be payable under the leases.
(3) Represents purchase obligations related to information technology services and maintenance contracts.

Inflation

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

Off-Balance Sheet Arrangements

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

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting

 

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

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

As of June 30, 2014, there has been no material change in our accounting policies or the underlying assumptions or methodology used to fairly present our financial position, results of operations and cash flows for the periods covered by this prospectus. In addition, no triggering events have come to our attention pursuant to our review of goodwill that would indicate impairment as of June 30, 2014.

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

Revenue Recognition

Revenue is reported net of allowances (discussed below) and state provider taxes. Revenue is recognized when evidence of an arrangement exists, the service has been provided, the price is fixed or determinable and collectability is reasonably assured.

Generally, we recognize revenue for services provided to our clients when earned. Our services fall into two general categories: residential and non-residential. In residential services, we are providing a living environment, usually a community residence, to a client and providing care on a 24-hour basis. Non-residential services are provided to a client on an hourly (or other unit of time) basis for therapy, community support or in our day program centers. Revenues for residential services are recognized for the number of days in the accounting period that the client is in our service. Periodic service revenue is recognized when the related services are performed.

In addition, we operate under four distinct types of contracting arrangements with our payors:

 

   

Negotiated Contracts. For these contracts, services are priced pursuant to a “plan of care” for the client which encompasses habilitation and therapies. Such contracts are not subject to retroactive adjustment or cost reimbursement requirements. However, we may petition for a change in rate based upon a change in circumstances with a particular client or in situations where additional services are needed. For these contracts, we recognize revenue at the negotiated rate when earned. Subsequent adjustments to rates, if any, are recognized when approved by the payor. For fiscal 2011, fiscal 2012, fiscal 2013 and the nine months ended June 30, 2014, 44.3%, 40.5%, 41.9% and 32.9%, respectively, of our revenues were earned from contracts that fall into this category.

 

   

Fixed Fee Contracts. For these contracts, payors set a standard rate or set of rates for a particular service usually dependent on the acuity of the client. These rates are the same for all agencies providing the service. For these contract types, there is generally no cost report required or if a cost report is required it is used for informational purposes only. For these contracts, we recognize revenue at the standard rate as earned. For fiscal 2011, fiscal 2012, fiscal 2013 and the nine months ended June 30, 2014, 35.5%, 38.2%, 37.2% and 45.4%, respectively, of our revenues were earned from contracts that fall into this category.

 

   

Retrospective reimbursement contrac