Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 001-36623
 CIVITAS SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
65-1309110
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
313 Congress Street, 6th Floor
Boston, Massachusetts 02210
 
(617) 790-4800
(Address of principal executive offices, including zip code)
 
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
 
o
  
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
o  (Do not check if smaller reporting company)
  
Smaller reporting company
 
o
 
 
 
 
 
 
 
Emerging growth company

 
o
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of July 31, 2018, there were 36,229,167 shares outstanding of the registrant’s common stock, $0.01 par value.



TABLE OF CONTENTS
Civitas Solutions, Inc.
 
 
 
Page
 
Condensed Consolidated Balance Sheets as of June 30, 2018 and September 30, 2017
 
Condensed Consolidated Statements of Income for the three and nine months ended June 30, 2018 and 2017
 
 
 
Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2018 and 2017
 
 
 
 
 


2


PART I. FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Financial Statements
Civitas Solutions, Inc.
Condensed Consolidated Balance Sheets
(Amounts in thousands, except share and per share amounts)
(Unaudited) 
 
June 30,
2018
 
September 30,
2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
—

 
$
7,297

Restricted cash
330

 
327

Accounts receivable, net of allowances of $18,953 and $15,997 at June 30, 2018 and September 30, 2017
174,539

 
172,850

Prepaid expenses and other current assets
22,233

 
12,998

Total current assets
197,102

 
193,472

Property and equipment, net
192,025

 
183,338

Intangible assets, net
325,730

 
313,075

Goodwill
315,811

 
273,325

Restricted cash
50,000

 
50,000

Other assets
41,020

 
36,172

Total assets
$
1,121,688

 
$
1,049,382

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
34,088

 
$
35,275

Accrued payroll and related costs
67,770

 
78,011

Other accrued liabilities
40,690

 
42,284

Obligations under capital lease, current
757

 
608

Current portion of long-term debt
11,487

 
6,554

Total current liabilities
154,792

 
162,732

Other long-term liabilities
78,770

 
77,081

Deferred tax liabilities, net
13,713

 
22,349

Obligations under capital lease, less current portion
11,033

 
4,404

Long-term debt, less current portion
694,819

 
619,899

Commitments and Contingencies (Note 14)

 

Stockholders’ equity
 
 
 
Common stock, $0.01 par value; 350,000,000 shares authorized; and 36,229,067 and 37,441,257 shares issued and outstanding at June 30, 2018 and September 30, 2017, respectively
362

 
374

Additional paid-in capital
287,065

 
301,819

Accumulated gain (loss) on derivatives, net of tax expense (benefit) of $1,521 and ($62) at June 30, 2018 and September 30, 2017, respectively
3,988

 
(91
)
Accumulated deficit
(122,854
)
 
(139,185
)
Total stockholders’ equity
168,561

 
162,917

Total liabilities and stockholders’ equity
$
1,121,688

 
$
1,049,382

See accompanying notes to these condensed consolidated financial statements.

3


Civitas Solutions, Inc.
Condensed Consolidated Statements of Income
(Amounts in thousands, except share and per share amounts)
(Unaudited)
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net revenue
$
404,498

 
$
372,345

 
$
1,192,717

 
$
1,094,138

Cost of revenue
315,934

 
292,498

 
948,803

 
861,992

Operating expenses:
 
 
 
 
 
 
 
General and administrative
40,269

 
40,413

 
128,569

 
123,992

Depreciation and amortization
23,741

 
19,161

 
71,509

 
56,146

Total operating expenses
64,010

 
59,574

 
200,078

 
180,138

Income from operations
24,554

 
20,273

 
43,836

 
52,008

Other income (expense):
 
 
 
 
 
 
 
Other income (expense), net
(83
)
 
(149
)
 
(896
)
 
762

Interest expense
(10,229
)
 
(8,339
)
 
(28,815
)
 
(25,117
)
Income before income taxes
14,242

 
11,785

 
14,125

 
27,653

Provision (benefit) for income taxes
4,657

 
4,424

 
(2,366
)
 
10,634

Net income
$
9,585

 
$
7,361

 
$
16,491

 
$
17,019

 
 
 
 
 
 
 
 
Basic income per common share
$
0.26

 
$
0.20

 
$
0.44

 
$
0.46

Diluted income per common share
$
0.26

 
$
0.20

 
$
0.44

 
$
0.45

 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding, basic
36,503,170

 
37,323,458

 
37,136,375

 
37,278,760

Weighted average number of common shares outstanding, diluted
36,592,727

 
37,495,488

 
37,249,551

 
37,413,264

See accompanying notes to these condensed consolidated financial statements.


4


Civitas Solutions, Inc.
Condensed Consolidated Statements of Comprehensive Income
(Amounts in thousands)
(Unaudited)
 
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
9,585

 
$
7,361

 
$
16,491

 
$
17,019

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Gain (loss) on derivative instrument classified as cash flow hedge, net of tax of $105 and $1,583 for the three and nine months ended June 30, 2018, respectively, and ($339) and $2,074 for the three and nine months ended June 30, 2017, respectively
276

 
(499
)
 
4,079

 
3,055

Comprehensive income
$
9,861

 
$
6,862

 
$
20,570

 
$
20,074

See accompanying notes to these condensed consolidated financial statements.


5


Civitas Solutions, Inc.
Condensed Consolidated Statement of Stockholders’ Equity
(Amounts in thousands, except share amounts)
(Unaudited)
 
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Gain (Loss) on Derivatives
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Balance at September 30, 2017
37,441,257

 
$
374

 
$
301,819

 
$
(91
)
 
$
(139,185
)
 
$
162,917

Cumulative effect adjustment on adoption of ASU 2016-09, Compensation - Stock Compensation - Improvements to Employee Share-Based Payments Accounting
 
 
 
 
219

 
 
 
(160
)
 
59

Issuance of common stock under employee incentive plans, net of shares surrendered
139,702

 
1

 
(1,109
)
 
—

 
—

 
(1,108
)
Repurchase of common stock under stock repurchase program
(1,351,892
)
 
(13
)
 
(19,656
)
 
—

 
—

 
(19,669
)
Stock-based compensation
 
 
 
 
5,792

 
—

 
—

 
5,792

Other comprehensive income, net of tax
—

 
—

 
—

 
4,079

 
—

 
4,079

Net income
—

 
—

 
—

 
—

 
16,491

 
16,491

Balance at June 30, 2018
36,229,067


$
362


$
287,065


$
3,988


$
(122,854
)

$
168,561



See accompanying notes to these condensed consolidated financial statements.


6


Civitas Solutions, Inc.
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
 
Nine Months Ended
June 30,
 
2018
 
2017
Operating activities:
 
 
 
Net income
$
16,491

 
$
17,019

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for accounts receivable allowances
16,598

 
13,940

Depreciation and amortization
71,509

 
56,146

Amortization original issue discount and financing costs
1,657

 
1,407

Stock-based compensation
5,792

 
6,596

Deferred income taxes
(10,959
)
 
(8,205
)
Loss on disposal of assets
1,684

 
327

Gain from derivatives
(244
)
 
—

Company owned life insurance benefit
—

 
(501
)
Change in fair value of contingent consideration
—

 
194

Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
(13,953
)
 
(17,327
)
Other assets
(7,803
)
 
8,280

Accounts payable
(1,656
)
 
(1,896
)
Accrued payroll and related costs
(10,819
)
 
(5,202
)
Other accrued liabilities
(2,123
)
 
2,424

Other long-term liabilities
1,089

 
(3,182
)
Net cash provided by operating activities
67,263

 
70,020

Investing activities:
 
 
 
Acquisition of businesses, net of cash acquired
(97,465
)
 
(42,432
)
Acquisition of intangible assets
(1,200
)
 
—

Purchases of property and equipment
(35,645
)
 
(32,981
)
Deposit on acquisition
—

 
(9,451
)
Change in restricted cash
(3
)
 
751

Cash proceeds from Company owned life insurance policies
—

 
738

Proceeds from sale of assets
2,866

 
1,164

Net cash used in investing activities
(131,447
)
 
(82,211
)
Financing activities:
 
 
 
Proceeds from long term-debt, net of original issue discount
74,452

 
—

Repayments of long-term debt
(5,499
)
 
(4,916
)
Proceeds from borrowings under senior revolver
507,300

 
4,100

Repayments of borrowings under senior revolver
(497,800
)
 
(4,100
)
Repayments of capital lease obligations
(530
)
 
(407
)
Cash paid for earn out obligations
—

 
(6,109
)
Payments of deferred financing costs
(258
)
 
(878
)
Issuance of common stock under employee equity incentive plans
—

 
357

Taxes paid related to net share settlements of equity awards
(1,109
)
 
(436
)
Repurchase of common stock under stock repurchase program
(19,669
)
 
—

Net cash provided by (used in) financing activities
56,887

 
(12,389
)
Net decrease in cash and cash equivalents
(7,297
)
 
(24,580
)
Cash and cash equivalents at beginning of period
7,297

 
50,683

Cash and cash equivalents at end of period
$
—

 
$
26,103

Supplemental disclosure of cash flow information
 
 
 
Cash paid for interest
$
26,637

 
$
23,261

Cash paid for income taxes
$
12,277

 
$
13,493

Supplemental disclosure of non-cash activities:
 
 
 
Accrued property and equipment
$
756

 
$
946

Fair value of contingent consideration related to acquisitions
$
1,080

 
$
—

Property and equipment acquired through capital leases
$
7,308

 
$
—


7



See accompanying notes to these condensed consolidated financial statements.

8


Civitas Solutions, Inc.
Notes to Condensed Consolidated Financial Statements
June 30, 2018
(Unaudited)

1. Business Overview
Civitas Solutions, Inc. ("Civitas"), through its wholly-owned subsidiaries (collectively, the "Company"), is the leading provider of home- and community-based health and human services to adults and children with intellectual and/or developmental disabilities, acquired brain injury and other catastrophic injuries and illnesses; and to youth with emotional, behavioral and/or medically complex challenges. Since the Company’s founding in 1980, the Company has evolved into a diversified national network providing an array of high-quality services and care in large, growing and highly-fragmented markets. The Company currently provides services to individuals with intellectual and/or developmental disabilities (“I/DD”), individuals with catastrophic injuries and illnesses, particularly acquired brain injury (“ABI”), youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (“ARY”), and elders in need of day health services to support their independence, or adult day health (“ADH”). As of June 30, 2018, the Company operated in 36 states, serving approximately 12,500 individuals in residential settings and 19,000 individuals in non-residential settings.
The Company designs customized service plans to meet the individual needs of those served by the Company, which it delivers in home- and community-based settings. Most of the Company’s service plans involve residential support, typically in small group homes, host home settings, or specialized community facilities, designed to improve the quality of life of the individuals served by the Company and to promote their independence and participation in community life. Other services offered include supported living, day and transitional programs, vocational services, case management, family-based and outpatient therapeutic services, post-acute treatment and neurorehabilitation, neurobehavioral rehabilitation and physical, occupational and speech therapies, among others. The Company’s customized service plans offer individuals as well as the payors of these services, an attractive, cost-effective alternative to health and human services provided in large, institutional settings.
Civitas is the parent of a consolidated group of subsidiaries that market their services under The MENTOR Network tradename. NMH Holdings, LLC (“NMHH”) is a wholly owned subsidiary of Civitas and National Mentor Holdings, Inc. (“NMHI”) is a wholly owned subsidiary of NMHH. The financial results of Civitas are primarily composed of the financial results of NMHI and its subsidiaries on a consolidated basis.
2. Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The unaudited condensed consolidated financial statements herein should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2017, which is on file with the SEC. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal and recurring adjustments, necessary to present fairly the financial statements in accordance with GAAP. Intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. Operating results for the three and nine months ended June 30, 2018 may not necessarily be indicative of results to be expected for any other interim period or for the full year.
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.

9


Adoption of New Accounting Pronouncements
Stock Compensation—The Company adopted the guidance in Accounting Standards Update ("ASU") No. 2016-09 Compensation - Stock Compensation - Improvements to Employee Share-Based Payments Accounting, on October 1, 2017. Under this standard, entities are permitted to make an accounting policy election to either estimate forfeitures on share-based payment awards, as previously required, or to recognize forfeitures as they occur. The Company has elected to recognize forfeitures as they occur and the impact of that change in accounting policy has been recorded as a $0.2 million cumulative effect adjustment to increase accumulated deficit as of October 1, 2017.
ASU No. 2016-09 requires that all income tax effects related to settlements of share-based payment awards be reported in earnings as an increase (or decrease) to income tax expense (benefit). Previously, income tax benefits at settlement of an award were reported as an increase (or decrease) to additional paid-in capital to the extent that those benefits were greater than (or less than) the income tax benefits reported in earnings during the award’s vesting period. The requirement to report those income tax effects in earnings has been applied on a prospective basis to settlements occurring on or after October 1, 2017, and the impact of applying the guidance was not material to the consolidated financial statements for the three and nine months ended June 30, 2018. Application of the guidance may result in fluctuations in the Company’s effective tax rate depending on how many options are exercised, how many restricted stock units vest and the volatility of the Company’s stock price.
ASU No. 2016-09 also requires that all income tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows. Previously, income tax benefits at settlement of an award were reported as a reduction to operating cash flows and an increase to financing cash flows to the extent that those benefits exceeded the income tax benefits reported in earnings during the award’s vesting period. The Company has elected to apply the changes in cash flow classification on a prospective basis.
Income Taxes— In March 2018, the FASB issued ASU No. 2018-05—Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (ASU 2018-05). The update provides guidance associated with the accounting and disclosures around the enactment of the Act and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”). This guidance was effective upon issuance and has been applied to the condensed consolidated financial statements and related disclosures beginning in the second quarter of fiscal 2018, see Note 10 for the disclosures related to this amended guidance.
3. Recent Accounting Pronouncements
Revenue from Contracts with Customers— In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers Topic 606 (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The FASB has subsequently issued amendments to ASU No. 2014-09 that have the same effective date and transition date. ASU 2014-09, as amended, is effective for the Company’s fiscal year beginning October 1, 2018, and, at that time, the Company will adopt the new standard under the modified retrospective approach for contracts with customers. Under the modified retrospective approach, the guidance is applied to the most current period presented, recognizing the cumulative effect of the adoption change as an adjustment to beginning retained earnings. In fiscal 2017, the Company established a formal program and cross-functional implementation team to identify, design and implement changes to its accounting systems and policies and internal controls to support recognition and disclosure under the new standard. This process included a review of the requirements under the new standard compared to the current accounting policies for each of the Company’s revenue streams. As of the end of the third quarter of fiscal 2018, the Company substantially completed its review and does not expect a material impact on its consolidated financial statements upon implementation on October 1, 2018. The Company is currently preparing to implement changes to accounting policies and controls to support the new revenue recognition and disclosure requirements, which will be finalized during the fourth quarter of fiscal 2018.
Leases— In February 2016, the FASB issued ASU No. 2016-02—Leases (Topic 842) (ASU 2016-02). The new standard requires that all lessees recognize the assets and liabilities that arise from leases on the balance sheet and disclose qualitative and quantitative information about its leasing arrangements. The standard will be effective for the Company on October 1, 2019. In July 2018, the FASB issued ASU No. 2018-11—Leases (Topic 842): Targeted Improvements (ASU 2018-11). Prior to ASU 2018-11, a modified retrospective transition was required for financing or operating leases existing at or

10


entered into after the beginning of the earliest comparative period presented in the financial statements. ASU 2018-11 allows entities an additional transition method to the existing requirements whereby an entity could adopt the provisions of ASU 2016-02 by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption without adjustment to the financial statements for periods prior to adoption. The Company is still evaluating the method of adoption. The adoption of this standard is expected to have a material impact on the Company’s financial position. As of June 30, 2018, the Company had gross operating lease commitments of approximately $361 million. Upon adoption, a substantial portion of these lease commitments will be recorded at their net present value as a right of use asset and a lease obligation.
        
Statement of Cash Flows— In November 2016, the FASB issued ASU No. 2016-18—Statement of Cash Flows (Topic 230): Restricted Cash. The update requires that a statement of cash flows present the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard will be applied using a retrospective transition method to each period presented and will be effective for the Company on October 1, 2018. As of June 30, 2018 and September 30, 2017, the Company had total restricted cash of $50.3 million.
    
Business Combinations— In January 2017, the FASB issued ASU No. 2017-01—Business Combinations (Topic 805): Clarifying the Definition of a Business. The update provides guidance to determine when an integrated set of assets and activities is not a business. When substantially all of the fair value of the gross assets acquired, or disposed of, is concentrated in a single identifiable asset or a group of similar identifiable assets, then the acquisition, or disposition, is not a business. The amendments in this update should be applied prospectively on or after the effective date. No disclosures are required at transition. The new standard will be effective for the Company on October 1, 2018. Early application of the amendments in this update is permitted for transactions meeting certain criteria. This standard could reduce the number of acquisitions that are treated as business combinations in the future.
4. Long-Term Debt
As of June 30, 2018 and September 30, 2017, the Company’s long-term debt consisted of the following:
(in thousands)
June 30,
2018
 
September 30,
2017
Term loan principal; principal and interest are due in quarterly installments through January 31, 2021
$
701,978

 
$
632,476

Original issue discount on term loan, net of accumulated amortization
(1,130
)
 
(901
)
Deferred financing costs, net of accumulated amortization
(4,042
)
 
(5,122
)
Senior secured revolving credit facility
9,500

 
—

 
706,306

 
626,453

Less current portion of the term loan
7,331

 
6,554

Less current portion of the senior secured revolving credit facility; matures on January 31, 2019
4,156

 
—

Long-term debt
$
694,819

 
$
619,899

Senior Secured Credit Facilities

NMHI's senior credit agreement (the “senior credit agreement”), as amended, governs a $730.0 million (original $655.0 million term loan plus a $75.0 million incremental term loan funded on October 25, 2017) Tranche B 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 $160.0 million senior secured revolving credit facility (the “senior revolver”). The term loan facility matures on January 31, 2021, a portion of the commitments under the senior revolver matures on January 31, 2019 and a portion of the commitments under the senior revolver matures on January 31, 2021, as described below. All of the obligations under the senior secured credit facilities are guaranteed by NMHH and the subsidiary guarantors named therein. 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.
    

11


On October 24, 2017, NMHI entered into Amendment No. 6 to its senior credit agreement which provided for an incremental $75.0 million term loan. The net proceeds of the incremental term loan were used by the Company for the acquisition of Mentis Neuro Rehabilitation, LLC, with any excess proceeds used for general corporate purposes.

On November 21, 2017, NMHI entered into Amendment No. 7 to its senior credit agreement which increased the aggregate revolving commitments from $120.0 million to $160.0 million and extended the maturity date for $90.0 million of the revolving commitments (the “Extended Revolving Commitments") to January 31, 2021. The terms of the remaining $70.0 million of the revolving commitments (the "Initial Revolving Commitments"), which mature on January 31, 2019, remain unchanged. All of the other terms of the Extended Revolving Commitments are identical to the Initial Revolving Commitments, except that the applicable margin for the Extended Revolving Commitments will decrease by 0.25% per annum when the Initial Revolving Commitments are terminated or expire.
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 borrowing on a swingline loan will reduce the amount available under the senior revolver. As of June 30, 2018, NMHI had $702.0 million of borrowings outstanding under the term loan facility, $9.5 million of borrowings outstanding under the senior revolver, $48.5 million of letters of credit issued under the institutional letter of credit facility and $2.9 million of standby letters of credit under the senior revolver.
Borrowings under the term loan facility bear interest, at our option, at: (i) an alternate base rate ("ABR") 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 plus 100 basis points (provided that the ABR applicable to the term loan facility will not be less than 2.00% per annum), plus 2.00%; or (ii) the Eurodollar rate (provided that the Eurodollar rate applicable to the term loan facility will not be less than 0.75% per annum), plus 3.00%. Borrowings under the revolving and swingline loans bear interest at our option at (i) an ABR 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 plus 100 basis points (provided that the ABR applicable to the term loan facility will not be less than 2.00% per annum), plus 2.25%; or (ii) the Eurodollar rate (provided that the Eurodollar rate applicable to the term loan facility will not be less than 0.75% per annum), plus 3.25%. 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.
The senior credit agreement requires NMHI to make mandatory prepayments, subject to certain exceptions, on a percentage of NMHI's annual Excess Cash Flow, as defined in the senior credit agreement. NMHI determines whether or not a mandatory prepayment is required at the end of each fiscal year. NMHI was not required to make a prepayment for the fiscal year ended September 30, 2017.
Covenants
The senior credit agreement contains negative covenants, including, among other things, limitations on the Company’s ability to incur additional debt, create liens on assets, transfer or sell assets, pay dividends, redeem stock or make other distributions or investments, and engage in certain transactions with affiliates. The senior credit agreement contains a springing financial covenant. If, at the end of any fiscal quarter, the Company’s outstanding borrowings under the senior revolver exceeds 30% of the commitments thereunder, it is required to maintain at the end of each such fiscal quarter a consolidated first lien leverage ratio of not more than 5.00 to 1.00. The springing financial covenant was not in effect as of June 30, 2018 or September 30, 2017 as the Company’s usage of the senior revolver did not exceed the threshold for each quarter.
Derivatives
    
On January 20, 2015, NMHI entered into two interest rate swap agreements in an aggregate notional amount of $375.0 million in order to reduce the variability of cash flows of the Company’s variable rate debt. NMHI entered into these interest rate swaps to hedge the risk of changes in the floating rate of interest on borrowings under the term loan. Under the terms of the swaps, NMHI will receive from the counterparty a quarterly payment based on a rate equal to the greater of 3-month LIBOR or 1.00% per annum, and NMHI will make payments to the counterparty based on a fixed rate of 1.795% per annum, in each case on the notional amount of $375.0 million, settled on a net payment basis. The swap agreements expire on March 31, 2020.

The fair value of the swap agreements, which represents the price that would be received to transfer the agreement in an orderly transaction between market participants, was an asset of $5.8 million and a liability of $0.2 million as of June 30, 2018 and September 30, 2017, respectively. Based on the timing of the associated cash flows, the fair value was split between current and long-term classification on the Company’s consolidated balance sheet in Prepaid expenses and other current assets and Other assets as of June 30, 2018 and in Other accrued liabilities as of September 30, 2017. The fair value was determined

12


based on pricing models and independent formulas using current assumptions. Hedge ineffectiveness, if any, associated with the swap is recorded as income or expense in the period incurred. During the three and nine months ended June 30, 2018, the ineffective portion of gains resulting from changes in fair value was $0.1 million and $0.2 million which was recorded in Other income (expense), net. There was no hedge ineffectiveness recorded during the three and nine months ended June 30, 2017. No amounts were excluded from ineffectiveness testing for the three and nine months ended June 30, 2018 and 2017.

5. Stock-Based Compensation

2014 Plan

Civitas maintains a 2014 Omnibus Incentive Plan (“2014 Plan”). As of June 30, 2018, the 2014 Plan authorized the issuance of up to 7,786,478 shares of common stock as stock-based awards, including incentive stock options (“ISOs”), non-qualified stock options (“NSOs”), restricted stock units (“RSUs”) and performance based restricted stock units (“PRSUs”).

Stock Options

Stock option activity for the nine months ended June 30, 2018 is presented below:
(in thousands, except share and per share amounts)
Number of
Shares
 
Weighted-
Average
Exercise Price
per Share
 
Weighted-
Average
Remaining Life
(Years)
 
Aggregate
Intrinsic
Value (in thousands)
Outstanding at September 30, 2017
877,781

 
$
18.65

 
 
 
 
Granted
155,041

 
18.80

 
 
 
 
Exercised
17,608

 
17.00

 
 
 
 
Forfeited
36,381

 
18.64

 
 
 
 
Expired
23,081

 
19.87

 
 
 
 
Outstanding at June 30, 2018
955,752

 
$
18.67

 
7.6
 
$
13

Exercisable at June 30, 2018
566,980

 
$
18.55

 
6.8
 
$
—

Vested or expected to vest as of June 30, 2018
955,752

 
$
18.67

 
7.6
 
$
13


The Company utilizes the Black-Scholes valuation model for estimating the fair value of stock options. Options granted under the 2014 Plan during the nine months ended June 30, 2018 were valued using the following assumptions:
 
2018
Risk-free interest rate
2.22% - 2.74%

Expected term
6 years

Expected volatility
33.56% - 35.81%

Expected dividend yield
—
%

The Company recognizes the fair value of the stock option awards as stock-based compensation expense over the requisite service period of the individual grantee, which equals the vesting period. The total intrinsic values of options exercised was less than $0.1 million for the nine months ended June 30, 2018. As of June 30, 2018, there was $1.9 million of unrecognized compensation cost related to unvested stock options. This cost is expected to be recognized over a weighted-average period of 1.8 years.

Restricted Stock Unit Awards (RSUs)


13


Restricted stock unit activity for the nine months ended June 30, 2018 is presented below:
 
Number of
Restricted Stock Units
 
Weighted Average
Grant-Date Fair Value
Non-vested units at September 30, 2017
677,406

 
$
19.20

Granted
405,011

 
18.21

Forfeited
63,764

 
18.74

Vested
197,105

 
19.94

Non-vested units at June 30, 2018
821,548

 
$
18.56


The fair value of each restricted stock unit was determined based on the Company's closing stock price on the date of grant. The Company recognizes the fair value of the RSUs as stock-based compensation expense over the requisite service period of the individual grantee, which equals the vesting period. The total fair values of RSUs that vested during the three and nine months ended June 30, 2018 was $0.1 million and $3.5 million, respectively. As of June 30, 2018, there was $10.8 million of unrecognized compensation expense related to unvested restricted stock unit awards. This cost is expected to be recognized over a weighted-average period of 1.9 years.

Performance Based Restricted Stock Units (PRSUs)
    
During the nine months ended June 30, 2018, the Company awarded 50,834 PRSUs. These PRSUs vest based upon the achievement of established performance targets over the three year performance period which ends September 30, 2020. The number of PRSUs that may vest varies between 0%- 200% based on the achievement of such goals. The PRSUs were valued at $18.76 per share based on the closing price of the Company’s common stock on the date of grant.

To calculate compensation expense, the Company forecasts the likelihood of achieving the predefined performance targets and calculates the number of PRSUs expected to be earned. As of June 30, 2018, the Company expects to recognize $1.0 million of stock-based compensation expense related to outstanding PRSUs based on the expected attainment levels. This cost is expected to be recognized over a weighted-average period of 2.0 years.
    
A summary of PRSU activity for the nine months ended June 30, 2018 is as follows:
 
Number of Performance Based Restricted Stock Units
 
Weighted Average
Grant-Date Fair Value
Non-vested units at September 30, 2017
84,505

 
$
19.85

Granted
50,834

 
18.76

Forfeited
—

 
—

Vested
—

 
—

Non-vested units at June 30, 2018
135,339

 
$
19.44

Units expected to vest as of June 30, 2018
73,646

 
$
19.09

    
Stock-based Compensation Expense
 
The Company recorded stock-based compensation expense for stock options, RSUs and PRSUs under the 2014 Plan of $2.0 million and $5.8 million during the three and nine months ended June 30, 2018, respectively, and $2.2 million and $6.6 million during the three and nine months ended June 30, 2017, respectively. Stock-based compensation expense is included in general and administrative expense in the consolidated statements of income.

6. Stockholders' Equity

On February 8, 2018, the Company announced that the Board of Directors approved a stock repurchase program under which the Company is authorized to repurchase up to $25.0 million of the Company’s outstanding common stock from time to time in the open market, through negotiated transactions or otherwise (including, without limitation, the use of Rule 10b5-1 plans).  The stock repurchase program will expire on August 12, 2018 or the date on which the total repurchase amount has been spent, whichever occurs first. The Company intends to conduct any open market stock repurchase activities in compliance with the safe harbor provisions of Rule 10b-18 of the Exchange Act. During the nine months ended June 30 2018, the Company repurchased 1,351,892 shares for $19.7 million under the program, which has been implemented through a 10b5-1 plan. As of June 30, 2018, the Company has remaining authorization to repurchase up to $5.3 million of common stock under the program.

7. Business Combinations
The operating results of the businesses acquired are included in the consolidated statements of income from the date of acquisition. The Company accounted for the acquisitions under the acquisition method and, as a result, the purchase price was allocated to the assets acquired and liabilities assumed based upon their respective fair values. The excess of the purchase price

14


over the estimated fair value of net tangible assets was allocated to specifically identified intangible assets, with the residual being allocated to goodwill.
Fiscal 2018 Acquisitions
During the nine months ended June 30, 2018, the Company acquired the assets or equity interests of nine companies for total consideration of $96.4 million, net of $0.8 million of cash acquired, and including $1.1 million of contingent consideration.
Mentis Neuro Rehabilitation, LLC (“Mentis”). On October 25, 2017, the Company acquired all of the outstanding membership interests of Mentis for $74.7 million, net of $0.8 million of cash acquired. Mentis is located in Texas and provides specialty rehabilitation services to individuals recovering from acquired brain injuries. The Company acquired $35.3 million of identifiable intangible assets which included approximately $30.2 million of agency contracts with a weighted average useful life of 12 years, $3.8 million of licenses and permits with a weighted average useful life of 10 years, and $0.9 million in tradenames with a weighted average useful life of 5 years. The Company also acquired $4.9 million of other assets, net of liabilities, consisting primarily of accounts receivable and fixed assets. The estimated fair values of the intangible assets acquired at the date of acquisition were determined based on a preliminary valuation that has yet to be finalized. In addition, the accounting for the acquired deferred tax assets and liabilities is provisional and subject to further refinement as the tax basis of assets acquired and liabilities assumed is finalized. As a result of the acquisition, the Company recorded $34.5 million of goodwill in the SRS segment, which is not expected to be deductible for tax purposes.
Unique Options, LLC (“Unique”). On December 4, 2017, the Company acquired the assets of Unique for $5.9 million. Unique is located in Michigan and provides vocational rehabilitation, training and similar services to individuals with acquired brain injuries and similar conditions. The Company acquired $3.9 million of identifiable intangible assets which included $3.7 million of agency contracts with a weighted average useful life of 11 years. The estimated fair values of the intangible assets acquired at the date of acquisition were determined based on a preliminary valuation that has yet to be finalized. As a result of this acquisition, the Company recorded $2.0 million of goodwill in the SRS segment, which is expected to be deductible for tax purposes.
Hartwell Healthcare, LLC, and Polyclinic, LLC (“Aging Well and Living Well”). On April 2, 2018, the Company acquired the assets of Aging Well and Living Well for $13.2 million. Aging Well and Living Well are located in Massachusetts and provide person-centered day services to elders, including medication management and nutritional and nursing support. The Company acquired $9.0 million of identifiable intangible assets which included $8.1 million of agency contracts with a weighted average useful life of 12 years and $0.9 million of licenses and permits with a weighted average useful life of 10 years. The estimated fair values of the intangible assets acquired at the date of acquisition were determined based on a preliminary valuation that has yet to be finalized. As a result of this acquisition, the Company recorded $4.1 million of goodwill in the Corporate and Other segment, which is expected to be deductible for tax purposes.
Other Acquisitions. During the nine months ended June 30, 2018, the Company acquired the assets of Powell Life Skills Inc. (“Powell”), Jac-Lin Manor, Inc. (“Jac-Lin”), Dungarvin Wisconsin, LLC (“Dungarvin”), Resources for Human Development, Inc. (“RHD”), Circle of Support, Inc. (“Circle”), and Wexner Heritage Village, Inc. (“Shalom House South”). Total cash consideration for these companies was $1.6 million and total contingent consideration was $1.1 million.

The following table summarizes the recognized amounts of identifiable net assets acquired at the date of each acquisition:
(in thousands)
Identifiable
Intangible Assets
 
Other Assets, Net
 
Total Identifiable
Assets
 
Goodwill
 
Purchase Consideration
Mentis
$
35,300

 
$
4,885

 
$
40,185

 
$
34,502

 
$
74,687

Unique
3,939

 
22

 
3,961

 
1,985

 
5,946

Aging Well and Living Well
9,035

 
12

 
9,047

 
4,105

 
13,152

Other acquisitions
2,534

 
111

 
2,645

 
—

 
2,645

Total
$
50,808

 
$
5,030

 
$
55,838

 
$
40,592

 
$
96,430


The Company’s consolidated statement of income for the nine months ended June 30, 2018 included revenue totaling approximately $33.2 million from the acquisition date of each respective acquisition. The Company has not disclosed income from operations because it is immaterial.

Fiscal 2018 Pro Forma Results of Operations


15


The following table reflects the unaudited pro forma results of operations for the three and nine months ended June 30, 2018 and 2017 assuming that the acquisitions made during the three and nine months ended June 30, 2018 and 2017 had occurred on October 1, 2016 and 2015, respectively.
(in thousands)
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net revenue
$
404,498

 
$
391,043

 
$
1,201,302

 
$
1,160,366

Net income
9,585

 
10,641

 
17,343

 
22,392


The unaudited pro forma information is presented for informational purposes only and is not necessarily indicative of the actual results that would have been achieved had the acquisitions occurred as of October 1, 2016 and 2015, or the results that may be achieved in future periods.
8. Goodwill and Intangible Assets
Goodwill
The changes in goodwill for the nine months ended June 30, 2018 are as follows (in thousands):
 
I/DD
 
SRS
 
ARY
 
Corporate and Other
 
Total
Balance as of September 30, 2017
$
159,316

 
$
85,525

 
$
28,484

 
$
—

 
$
273,325

Goodwill acquired through acquisitions
—

 
36,487

 
—

 
4,105

 
40,592

Adjustments to prior acquisitions (1)
1,894

 
—

 
—

 
—

 
1,894

Balance as of June 30, 2018
$
161,210

 
$
122,012

 
$
28,484

 
$
4,105

 
$
315,811

 

(1) Includes amounts paid in fiscal 2018 associated with the net working capital settlement for the Habilitative Services, Inc. acquisition in fiscal 2017.
Intangible Assets
Intangible assets consist of the following as of June 30, 2018 (in thousands):
Description
Weighted
Average
Amortization Period
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Intangible
Assets,
Net
Agency contracts
6 years

 
$
578,930

 
$
317,220

 
$
261,710

Non-compete/non-solicit agreements
1 year

 
7,453

 
5,748

 
1,705

Trade names
1 year

 
8,161

 
6,267

 
1,894

Trade names (indefinite life)
—

 
42,400

 
—

 
42,400

Licenses and permits
3 years

 
61,980

 
43,959

 
18,021

 
 
 
$
698,924

 
$
373,194

 
$
325,730

Intangible assets consist of the following as of September 30, 2017 (in thousands):
Description
Weighted
Average
Amortization Period
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Intangible
Assets,
Net
Agency contracts
7 years

 
$
540,826

 
$
290,687

 
$
250,139

Non-compete/non-solicit agreements
1 year

 
7,196

 
5,228

 
1,968

Trade names
2 years

 
7,138

 
4,779

 
2,359

Trade names (indefinite life)
—

 
42,400

 
—

 
42,400

Licenses and permits
3 years

 
58,443

 
42,234

 
16,209

 
 
 
$
656,003

 
$
342,928

 
$
313,075


16


Amortization expense was $12.8 million and $39.4 million for the three and nine months ended June 30, 2018, respectively, and $9.4 million and $27.4 million for the three and nine months ended June 30, 2017, respectively. Amortization expense for the three and nine months ended June 30, 2018 includes $1.8 million and $6.0 million of accelerated amortization related to definite-lived intangible assets associated with the divestitures described in Note 12.
The estimated remaining amortization expense related to intangible assets with finite lives for the three months remaining in fiscal 2018 and each of the four succeeding years and thereafter is as follows:
Year Ended September 30,
(in thousands)
2018
$
11,469

2019
43,432

2020
42,359

2021
38,944

2022
37,140

Thereafter
109,986

Total
$
283,330

9. Fair Value Measurements
The Company measures and reports its financial assets and liabilities on the basis of fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
A three-level hierarchy for disclosure has been established to show the extent and level of judgment used to estimate fair value measurements, as follows:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Significant other observable inputs (quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability).
Level 3: Significant unobservable inputs for the asset or liability. These values are generally determined using pricing models which utilize management estimates of market participant assumptions.
Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach, and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data. These unobservable inputs are only utilized to the extent that observable inputs are not available or cost-effective to obtain.
A description of the valuation methodologies used for instruments measured at fair value as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
The following table sets forth the Company’s assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2018.
(in thousands)
Total
 
Quoted
Market Prices
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Interest rate swap agreements (current)
$
2,786

 
$
—

 
$
2,786

 
—

Interest rate swap agreements (long-term)
2,968

 
—

 
2,968

 
—

Total
$
5,754

 
$
—

 
$
5,754

 
$
—

Liabilities
 
 
 
 
 
 
 
Contingent consideration
$
1,080

 
$
—

 
$
—

 
$
1,080


17


The following table sets forth the Company’s assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2017.
(in thousands)
Total
 
Quoted
Market Prices
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Liabilities
 
 
 
 
 
 
 
Interest rate swap agreements
$
153

 
$
—

 
$
153

 
$
—


Interest rate-swap agreements. The Company’s interest rate-swap agreements are classified within Level 2 of the fair value hierarchy. Based on the timing of the associated cash flows, the fair value of the swap agreements was recorded in Prepaid expenses and other current assets, Other assets, or Other accrued liabilities in the Company’s consolidated balance sheets. The fair value of these agreements was determined based on pricing models and independent formulas using current assumptions that included swap terms, interest rates and forward LIBOR curves and the Company’s credit risk.
The following table presents a summary of changes in fair value of the Company’s Level 3 liabilities (acquisition related contingent consideration) measured on a recurring basis for the nine months ended June 30, 2018.
(in thousands)
Nine Months Ended June 30, 2018
Balance at September 30, 2017
$
—

Acquisition date fair value of contingent consideration obligations recorded
1,080

Balance at June 30, 2018
$
1,080

The following table presents a summary of changes in fair value of the Company’s Level 3 liabilities (acquisition related contingent consideration) measured on a recurring basis for the nine months ended June 30, 2017.
(in thousands)
Nine Months Ended
June 30, 2017
Balance at September 30, 2016
$
5,915

Fair value adjustments
194

Payment
(6,109
)
Balance at June 30, 2017
$
—


As of June 30, 2018, the Company had $1.1 million of contingent consideration liabilities, which was reflected in Other accrued liabilities. As of September 30, 2017, the Company had no contingent consideration liability.

At June 30, 2018 and September 30, 2017, the carrying values of cash, accounts receivable, accounts payable and variable rate debt approximated fair value.
10. Income Taxes
The Company’s effective income tax rate for the interim periods is based on management’s estimate of the Company’s annual effective tax rate for the applicable year. It is also affected by discrete items that may occur in any given period. The rates differ from the federal statutory income tax rate primarily due to state income taxes and nondeductible permanent differences such as meals and nondeductible compensation. For the three and nine months ended June 30, 2018, the Company had a provision from income taxes of $4.7 million, or a 32.7% effective income tax rate, and a benefit of $2.4 million, or a (16.8)% effective income tax rate, respectively. This compares to a provision for income taxes of $4.4 million, or a 37.5% effective income tax rate, and $10.6 million, or a 38.5% effective income tax rate, for the three and nine months ended June 30, 2017, respectively. The benefit from income taxes for the nine months ended June 30, 2018 was primarily due to revaluing of the Company’s deferred tax liabilities as a result of the lower corporate tax rate established by the Tax Cuts and Jobs Act (the “Tax Act”) enacted in the first quarter of fiscal 2018.
The Tax Act significantly revises corporate income tax law by, among other things, lowering the corporate income tax rates from 35% to 21%. Under GAAP, deferred taxes must be adjusted for enacted changes in tax laws or rates during the period in which new tax legislation is enacted. ASU 2018-05 allows a company to record a provisional amount when it does not have the necessary information available, prepared, or analyzed in reasonable detail to complete its accounting for the changes in the Tax Act. The measurement period ends when the company has obtained, prepared and analyzed the information

18


necessary to finalize its accounting, but cannot extend beyond one year from the date of enactment of the Tax Act. As of June 30, 2018, the Company has not completed the accounting for the tax effects of the enactment of the Tax Act; however, in certain cases, as described below, the Company has made a reasonable estimate of the effects on existing deferred tax balances and the one-time transition tax. These amounts may require further adjustments as a result of additional future guidance from the U.S. Department of the Treasury, changes in assumptions, and the availability of further information and interpretations. For the items for which the Company was able to determine a reasonable estimate, a provisional tax benefit of $6.7 million was recognized which is included as a component of income tax expense for the nine months ended June 30, 2018. The accounting for the tax effects of the enactment of the Tax Act will be finalized during the fourth quarter of fiscal 2018.

The Company remeasured certain deferred tax assets and liabilities based on an estimate of the rates at which they are expected to reverse in the future. However, the Company is still analyzing certain aspects of the Tax Act and refining calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. Additionally, the estimates for when timing differences will reverse could differ from actual results at year end, impacting the provisional tax benefit.
The Company files a federal consolidated return and files various state income tax returns and, generally, is no longer subject to income tax examinations by the taxing authorities for years prior to September 30, 2015. The Company did not have a reserve for uncertain income tax positions at June 30, 2018 and September 30, 2017. The Company does not expect any significant changes to unrecognized tax benefits within the next twelve months. The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits as charges to income tax expense.
11. Segment Information

The Company conducts its business through three reportable business segments: the Intellectual and Developmental Disabilities (“I/DD”) segment, the Post-Acute Specialty Rehabilitation Services (“SRS”) segment, and the At-Risk Youth (“ARY”) segment.

The Company evaluates performance based on EBITDA. EBITDA for each segment is defined as income (loss) from continuing operations for the segment before income taxes, depreciation and amortization, and interest income (expense).

Activities classified as “Corporate and Other” in the table below relate to the results of the ADH operating segment and unallocated home office expenses and stock-compensation expense. Total assets included in the Corporate and Other segment include assets associated with our ADH operating segment and assets maintained by our corporate entity including cash, restricted cash, and other current and non-current assets.
The following table is a financial summary by reportable segments for the periods indicated (in thousands):
For the three months ended June 30,
I/DD
 
SRS
 
ARY
 
Corporate and Other
 
Consolidated
2018
 
 
 
 
 
 
 
 
 
Net revenue
$
256,454

 
$
90,574

 
$
38,266

 
$
19,204

 
$
404,498

EBITDA
38,035

 
17,428

 
6,623

 
(13,959
)
 
48,127

Total assets
489,092

 
334,265

 
77,084

 
221,247

 
1,121,688

Depreciation and amortization
10,258

 
7,192

 
1,398

 
4,893

 
23,741

Purchases of property and equipment
6,686

 
3,509

 
657

 
1,843

 
12,695

2017
 
 
 
 
 
 
 
 
 
Net revenue
$
243,496

 
$
77,758

 
$
35,368

 
$
15,723

 
$
372,345

EBITDA
34,098

 
13,778

 
5,786

 
(14,377
)
 
39,285

Depreciation and amortization
9,451

 
5,858

 
1,407

 
2,445

 
19,161

Purchases of property and equipment
7,093

 
2,865

 
329

 
1,899

 
12,186



19


A reconciliation of EBITDA to income before income taxes on a consolidated basis is as follows (in thousands):
 
For the three months ended June 30,
 
2018
 
2017
EBITDA
$
48,127

 
$
39,285

Less:
 
 
 
Depreciation and amortization
23,741

 
19,161

Interest expense, net 
10,144

 
8,339

Income before income taxes
$
14,242

 
$
11,785

The following table is a financial summary by reportable segments for the periods indicated (in thousands):
For the nine months ended June 30, 2018
I/DD
 
SRS
 
ARY
 
Corporate and Other
 
Consolidated
2018
 
 
 
 
 
 
 
 
 
Net revenue
$
764,388

 
$
264,388

 
$
110,738

 
$
53,203

 
$
1,192,717

EBITDA
104,743

 
41,366

 
17,224

 
(49,132
)
 
114,201

Total assets
489,092

 
334,265

 
77,084

 
221,247

 
1,121,688

Depreciation and amortization
31,690

 
23,720

 
4,036

 
12,063

 
71,509

Purchases of property and equipment
19,829

 
9,243

 
1,435

 
5,138

 
35,645

2017
 
 
 
 
 
 
 
 
 
Net revenue
$
719,207

 
$
229,301

 
$
106,784

 
$
38,846

 
$
1,094,138

EBITDA
99,971

 
40,670

 
16,614

 
(48,344
)
 
108,911

Depreciation and amortization
27,988

 
17,483

 
4,255

 
6,420

 
56,146

Purchases of property and equipment
18,390

 
8,016

 
961

 
5,614

 
32,981


A reconciliation of EBITDA to income before income taxes on a consolidated basis is as follows (in thousands):
 
For the nine months ended June 30, 2018
 
2018
 
2017
EBITDA
$
114,201

 
$
108,911

Less:
 
 
 
Depreciation and amortization
71,509

 
56,146

Interest expense, net 
28,567

 
25,112

Income before income taxes
$
14,125

 
$
27,653

Revenue derived from contracts with state and local governmental payors in the state of Minnesota, the Company’s largest state operation, which is included in the I/DD segment, accounted for approximately 16% of the Company’s net revenue for the three and nine months ended June 30, 2018, and 15% of the Company’s net revenue for the three and nine months ended June 30, 2017. California, the Company’s second largest state operation, accounted for approximately 10% of net revenue for the three and nine months ended June 30, 2018 and 2017. No other states accounted for 10% or more of our net revenue during the three and nine months ended June 30, 2018 and 2017.

12. Disposition of Business

In connection with a review of under-performing and/or non-strategic programs during the second and third quarters of fiscal 2018, the Company decided to close and/or consolidate a number of programs primarily within the SRS and I/DD segments. During the nine months ended June 30, 2018, the Company incurred exit costs associated with these completed and planned divestitures of $5.5 million, including $4.8 million in lease termination costs, and $0.7 million in severance. In addition, the Company recorded $6.0 million of accelerated amortization related to definite-lived intangible assets and a $1.1 million loss on the disposition of fixed assets associated with these programs.


20



13. Net Income Per Share
The following table sets forth the computation of basic and diluted earnings per share (“EPS”):
 
Three Months Ended
June 30,
 
Nine Months Ended June 30,
 (in thousands, except share and per share amounts)
2018
 
2017
 
2018
 
2017
Numerator
 
 
 
 
 
 
 
Net income
$
9,585

 
$
7,361

 
$
16,491

 
$
17,019

Denominator
 
 
 
 
 
 
 
Weighted average shares outstanding, basic
36,503,170

 
37,323,458

 
37,136,375

 
37,278,760

Weighted average common equivalent shares
89,557

 
172,030

 
113,176

 
134,504

Weighted average shares outstanding, diluted
36,592,727

 
37,495,488

 
37,249,551

 
37,413,264

Net income per share, basic
$
0.26

 
$
0.20

 
$
0.44

 
$
0.46

Net income per share, diluted
$
0.26

 
$
0.20

 
$
0.44

 
$
0.45

Equity instruments excluded from diluted net income per share calculation as the effect would have been anti-dilutive:
 
 
 
 
 
 
 
Stock options
959,614

 
936,459

 
815,246

 
891,187

Performance and restricted stock units
407,774

 
129,440

 
375,398

 
99,489


14. Other Commitments and Contingencies
    
The Company is in the health and human services business and, therefore, has been and continues to be subject to numerous claims alleging that the Company, its employees or its independently contracted host-home caregivers (“Mentors”) failed to provide proper care for an individual served by the Company. The Company is also subject to claims by these individuals, its employees, its Mentors or community members against the Company for negligence, intentional misconduct or violation of applicable laws. Included in the Company’s recent claims are claims alleging personal injury, assault, abuse, wrongful death and other charges. Regulatory agencies may initiate administrative proceedings alleging that the Company’s programs, employees or agents violate statutes and regulations and seek to impose monetary penalties on the Company. The Company could be required to incur significant costs to respond to regulatory investigations or defend against civil lawsuits and, if the Company does not prevail, the Company could be required to pay substantial amounts of money in damages, settlement amounts or penalties arising from these legal proceedings.

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

The Company is also subject to employee-related claims under state and federal law, including claims for wage and hour violations under the Fair Labor Standards Act or state wage and hour laws, and claims for discrimination, wrongful discharge or retaliation. The Company currently has two pending complaints in California state court that allege certain
wage and hour violations of California labor laws and seek to be designated as class-action. Two additional wage and hour claims have been settled, one of which was settled and approved by the court on January 31, 2018 and and one of which has been preliminarily approved by the court.  Final approval and payment for this claim is expected in September 2018. The Company’s policy is to accrue for all probable and estimable claims using information available at the time the financial statements are issued. Actual claims could settle in the future at materially different amounts due to the nature of litigation.

15. Subsequent Event

On July 2, 2018 the Company acquired the assets of Creative Connections, Inc. (“CCI”) for consideration of approximately $2.9 million, including up to $1.5 million of contingent consideration. CCI is located in California and provides community-based services for individuals with intellectual and developmental disabilities. CCI will be included in the Company’s I/DD segment.

On August 1, 2018 the Company acquired the assets of Maintaining Independence Adult Day Services, Inc. (“Maintaining Independence”) for a purchase price of approximately $1.2 million. Maintaining Independence is located in New

21


Hampshire and provides adult day health care services. Maintaining Independence will be included in the Company’s Corporate and Other segment.

Item 2.
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 our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, as well as our reports on Form 8-K and other publicly available information. This discussion may contain forward-looking statements about our markets, the demand for our services and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons, including those discussed in the “Risk Factors” and “Forward-Looking Statements” sections of this report.
Overview
We are 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. Our clinicians and direct support professionals 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 innovative, high-quality and cost-effective services that enable greater independence, skill building and community involvement.
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 more than 37-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”), individuals with catastrophic injuries and illnesses, particularly acquired brain injury (“ABI”) that we serve through our Post-Acute Specialty Rehabilitation Services (“SRS”), youth with emotional, behavioral and/or medically complex challenges, or at-risk youth (“ARY”), and elders in need of day health services to support their independence, or adult day health (“ADH”). As of June 30, 2018, we operated in 36 states, serving approximately 12,500 individuals in residential settings and 19,000 individuals 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 for our services to individuals with acquired brain injuries or other catastrophic injuries and illnesses.
We have four service lines, I/DD, SRS, ARY and ADH. Each service line represents a reportable segment except ADH which is included within Corporate and Other.
Our I/DD service line is the largest portion of our business. Through the I/DD service line, we provide home- and community-based human services to adults and children with intellectual and developmental disabilities. Our I/DD programs include residential support, day habilitation, vocational services, case management, crisis intervention and hourly support care.
Through the SRS service line, which is our second largest service line, we deliver services to individuals who have suffered ABI, spinal injuries and other catastrophic injuries and illnesses. 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.
Through the ARY service line we provide home- and community-based human services to youth with emotional, behavioral and/or medically complex challenges. Our ARY programs include therapeutic foster care, family preservation, adoption services, early intervention, school-based services and juvenile offender programs.
Our newest service line, ADH, delivers elder services including case management, nursing oversight, medication management, nutrition, daily living assistance, transportation, and therapeutic services. The results of our ADH service line are included within Corporate and Other.     

22



Factors Affecting our Operating Results

Demand for Home and Community-Based Health and Human Services
Our growth in revenue has historically come from 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 acquisitions, development-driven activities, including the maintenance and expansion of existing contracts and the award of new contracts, and our new start program. We also attribute the long-term growth in our base of individuals served to certain trends that are increasing demand in our industry, including demographic, health-care and political developments.

Demographic trends have had 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, family members 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. 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.
    
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, although the population has increased in recent years.
Political and economic trends can also affect our operations. 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 have recently faced efforts at the federal level to reduce the federal budget deficit, repeal and/or replace the Patient Protection and Affordable Care Act and/or restructure the Medicaid program which pose risk for significant reductions in federal Medicaid matching funds to state governments. In addition, 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. In the past, certain states in which we operate, including Minnesota, California, Florida and West Virginia implemented rate reductions, rate freezes and service reductions, in response to state budgetary deficits. For fiscal 2018, we expect the rate environment to remain stable to positive in most of our markets. However, we are experiencing rate reductions for some of our services in a small number of states, particularly in Iowa, Minnesota, North Dakota and Wisconsin. Reductions in several of these states were due to system changes.
Historically, our business has benefited from the trend toward privatization and 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. Furthermore, we believe that successful lobbying by advocacy groups has preserved I/DD and ARY services and, therefore, our revenue base for these services, from significant reductions as compared with certain other human services, although in the past certain states have imposed rate reductions, rate freezes, and service reductions in response to state budgetary pressures. In addition, a number of states have developed community-based waiver programs to support long-term services for survivors of a traumatic brain injury. However, approximately half 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.

23


Organic Growth
Various economic, fiscal, public policy and legal factors are contributing to an environment with a number of organic growth opportunities, particularly within the I/DD and SRS segments, and, as a result, we have a continued 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 with net operating losses that are less than 18 months old comprise the new start operating loss and the aggregation of all programs with net operating income that are less than 18 months old comprise the new start operating income for such period. During the three months ended June 30, 2018 and 2017, new starts generated operating losses of $1.6 million and $1.4 million, respectively, and operating income of $0.5 million and $1.4 million, respectively. During the nine months ended June 30, 2018 and 2017, new starts generated operating losses of $4.4 million and $4.8 million, respectively, and operating income of $2.3 million and $3.8 million, respectively.
Acquisitions
From the beginning of fiscal 2013 through June 30, 2018, we have completed 56 acquisitions, including several acquisitions of small providers, which we have integrated with our existing operations. Acquisitions could have a material impact on our consolidated financial statements.
During the nine months ended June 30, 2018, we acquired the assets or equity interests of nine companies for total consideration of $96.4 million, net of $0.8 million of cash acquired and including $1.1 million of contingent consideration. During the nine months ended June 30, 2017, we acquired the assets of eight companies for total consideration of $42.5 million.
Divestitures

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

During the second and third quarters of fiscal 2018, as part of a larger, multi-year, multi-pronged effort to improve the efficiency of our operations and mitigate margin erosion created by increasing labor and healthcare costs, we recently raised the program performance standard and commenced a comprehensive, top-to-bottom examination of each program’s performance across all of our service lines. As a result of this initiative, during the second and third quarters of fiscal 2018 we decided to close and/or consolidate 39 programs primarily within our SRS and I/DD service lines (the “Program Closures”). During the nine months ended June 30, 2018, we incurred exit costs associated with these completed and planned closures of $5.5 million, including $4.8 million in lease termination costs, and $0.7 million in severance. In addition, we recorded $6.0 million of accelerated amortization related to definite-lived intangible assets and a $1.1 million loss on the disposition of fixed assets associated with these locations. These closures are expected to generate savings of $1.7 million annually. In addition, we expect some additional margin benefit from the closure and/or the consolidation of programs with lower profitability. During the fourth quarter of fiscal 2018, we anticipate closing additional programs in connection with this initiative.  We expect that this examination will be completed by the end of fiscal 2018 and that the total cost of the additional closures are expected to be lower than the amounts recorded during second and third quarters of fiscal 2018.
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 three months ended June 30, 2018 and June 30, 2017, we derived 90% and 89% of our net revenue from contracts with state, local and other government payors, respectively, and 10% and 11% of our net revenue from non-public payors, respectively. During the nine months ended June 30, 2018 and  June 30, 2017, we derived 89% of our net revenue from contracts with state, local and other government payors, and 11% 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

24


negotiated contracts, fixed fee contracts, retrospective reimbursement contracts and prospective payments contracts. Our revenue may be affected by adjustments to our billed rates as well as adjustments to previously billed amounts. Revenue in the future may be affected by changes in rates, rate-setting structures, methodologies or interpretations that may be proposed in states where we operate or by the federal government which provides matching funds. We cannot determine the impact of such changes or the effect of any possible governmental actions. 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 important performance measures of revenues in our residential service business include average daily residential census and average daily billing 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 important performance measures of revenues in our non-residential service business include billable units and average billable unit rates. We calculate the impact of these measures on gross revenue rather than net revenue because the timing of sales adjustments, both positive and negative, is unpredictable. We define these measures and gross revenue 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.

25


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):
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
2018
 
2017
 
2018
 
2017
I/DD Services
 
 
 
 
 
 
 
Gross Revenues
$
259,759

 
$
246,497

 
$
774,904

 
$
729,104

Average Residential Census
8,842

 
8,308

 
8,799

 
8,229

Average Daily Rate
$
249.59

 
$
247.11

 
$
248.61

 
$
246.46

Non-Residential Billable Units
3,113,136

 
3,192,750

 
9,375,331

 
9,453,052

Average Non-Residential Billable Unit Rate
$
18.93

 
$
18.69

 
$
18.95

 
$
18.56

Gross Revenue Growth %
5.4
 %
 
 
 
6.3
%
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
4.3
 %
 
 
 
5.1
%
 
 
Average Rate Growth
1.1
 %
 
 
 
1.2
%
 
 
Specialty Rehabilitation Services
 
 
 
 
 
 
 
Gross Revenues
$
92,658

 
$
80,163

 
$
271,204

 
$
234,592

Average Residential Census
1,427

 
1,325

 
1,425

 
1,313

Average Daily Rate
$
673.09

 
$
636.98

 
$
660.29

 
$
627.90

Non-residential Billable Units
64,747

 
43,346

 
187,568

 
124,199

Average Non-Residential Billable Unit Rate
$
80.91

 
$
77.79

 
$
76.65

 
$
77.34

Gross Revenue Growth %
15.6
 %
 
 
 
15.6
%
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
9.5
 %
 
 
 
10.3
%
 
 
Average Rate Growth
6.1
 %
 
 
 
5.3
%
 
 
At-Risk Youth Services
 
 
 
 
 
 
 
Gross Revenues
$
38,450

 
$
35,235

 
$
111,131

 
$
106,887

Average Residential Census
2,271

 
2,144

 
2,198

 
2,139

Average Daily Rate
$
129.25

 
$
123.05

 
$
128.93

 
$
126.00

Non-residential Billable Units
134,589

 
131,967

 
394,860

 
398,416

Average Non-Residential Billable Unit Rate
$
87.23

 
$
85.06

 
$
85.55

 
$
83.57

Gross Revenue Growth %
9.1
 %
 
 
 
4.0
%
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
4.7
 %
 
 
 
1.6
%
 
 
Average Rate Growth
4.4
 %
 
 
 
2.4
%
 
 
Adult Day Health Services
 
 
 
 
 
 
 
Gross Revenues
$
19,476

 
$
15,873

 
$
53,854

 
$
39,381

Non-residential Billable Units
1,101,088

 
885,372

 
3,007,406

 
2,244,585

Average Non-Residential Billable Unit Rate
$
17.69

 
$
17.93

 
$
17.91

 
$
17.54

Gross Revenue Growth %
22.7
 %
 
 
 
36.8
%
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
24.4
 %
 
 
 
34.0
%
 
 
Average Rate Growth
(1.7
)%
 
 
 
2.8
%
 
 
Consolidated Results
 
 
 
 
 
 
 
Gross Revenues
$
410,343

 
$
377,768

 
$
1,211,093

 
$
1,109,964

Gross Revenue Growth %
8.6
 %
 
 
 
9.1
%
 
 
Gross Revenue growth due to:
 
 
 
 
 
 
 
Volume Growth
6.2
 %
 
 
 
6.9
%
 
 
Average Rate Growth
2.4
 %
 
 
 
2.2
%
 
 



26


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; direct program costs such as food, medicine and professional and general liability and employment practices liability expenses; residential occupancy expenses which are primarily composed of rent and utilities related to facilities providing direct care; and other direct costs which include travel and transportation costs and other ancillary direct costs associated with the provision of services to individuals including workers’ compensation expense.
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 direct support professionals are paid on an hourly basis, with hours of work generally tied to an individual’s need. Our Mentors are paid on a per diem basis, but only if the Mentor is currently caring for an individual. Our labor costs are generally influenced by levels of service, and these costs can vary in material respects across regions. In addition, our labor costs can be negatively impacted by higher rates of caregiver turnover, vacant positions and overtime utilization, as well as regulatory actions at the Federal, state, and local levels. For example, states and local governments set localized minimum wage increases, which in turn impact labor costs.
Occupancy costs represent a significant portion of our operating costs. As of June 30, 2018, we owned 351 facilities and 4 offices, and we leased 1,861 facilities and 204 offices. We expect occupancy costs of the continuing business to increase during fiscal 2018 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.
Our business insurance programs include professional and general liability insurance, for which we are self-insured for $3.0 million per claim and $28.0 million in the aggregate, among others. We incurred professional and general liability expenses of $3.2 million and $7.7 million during the three and nine months ended June 30, 2018, respectively, and $2.9 million and $5.6 million during the three and nine months ended June 30, 2017, respectively. These expenses are incurred in connection with our claims reserves and insurance premiums. Our expenses during the nine months ended June 30, 2017 were positively impacted by a favorable adjustment to our reserves that was attributable to changes in certain assumptions used by our actuaries as a result of historical claims experience.
For our employment practices liability, we are fully self insured. We currently have two pending complaints in California state court that allege certain wage and hour violations of California labor laws and seek to be designated as class-actions. Two additional wage and hour class action claims have been settled; one of which was settled and approved by the court on January 31, 2018 and one of which has been preliminarily approved by the court. Final approval and payment for this claim is expected in September 2018. These actions increased our expenses, particularly during the three and nine months ended June 30, 2017. For the three and nine months ended June 30, 2018, we incurred employment practices liability expenses of $0.3 million and $2.0 million, respectively. For the three and nine months ended June 30, 2017, we incurred employment practices liability expenses of $0.8 million and $4.8 million, respectively.
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, and stock-based compensation expense.
Depreciation and amortization includes depreciation for fixed assets utilized in both facilities providing direct care and administrative offices, and amortization related to intangible assets.
    
We continue to review our operations in an effort to improve efficiencies, reduce overtime expenses, and implement cost saving measures throughout the Company. This multi-year project has two components: the first, initiated in fiscal 2017, focused on optimizing our cost structure by targeting total company-wide expenses, inclusive of labor management, purchasing and organizational structure; and a second, which we initiated during the second quarter of fiscal 2018, focuses on the closure of under-performing programs, which is described above under “Divestitures.” In connection with our efforts to reduce expenses, we incurred $0.8 million and $2.7 million in consulting, severance and contract termination costs in the three and nine months ended June 30, 2018, respectively. We incurred $0.9 million and $2.7 million in consulting, severance and contract termination costs in the three and nine months ended June 30, 2017, respectively. The cost savings associated with this project was approximately $5.0 million in fiscal year 2017, and, by the end of fiscal year 2018, we anticipate achieving additional in-the-year cost savings of at least $3.0 million.


27


Results of Operations

The following table sets forth our consolidated results of operations as a percentage of total gross revenues for the periods indicated.
 
Three Months Ended June 30,
 
Nine Months Ended June 30,
2018
 
2017
 
2018
 
2017
Gross revenue
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Sales adjustments
(1.5
)%
 
(1.4
)%
 
(1.5
)%
 
(1.4
)%
Net revenue
98.5
 %
 
98.6
 %
 
98.5
 %
 
98.6
 %
Cost of revenue
77.0
 %
 
77.4
 %
 
78.3
 %
 
77.7
 %
Operating expenses:
 
 
 
 
 
 
 
General and administrative
9.8
 %
 
10.7
 %
 
10.6
 %
 
11.2
 %
Depreciation and amortization
5.8
 %
 
5.1
 %
 
5.9
 %
 
5.1
 %
Total operating expense
15.6
 %
 
15.8
 %
 
16.5
 %
 
16.3
 %
Income from operations
6.0
 %
 
5.4
 %
 
3.6
 %
 
4.6
 %
Other income (expense):
 
 
 
 
 
 
 
Other income (expense), net
—
 %
 
—
 %
 
(0.1
)%
 
0.1
 %
Interest expense
(2.5
)%
 
(2.2
)%
 
(2.4
)%
 
(2.3
)%
Income before income taxes
3.4
 %
 
3.2
 %
 
1.1
 %
 
2.4
 %
Provision (benefit) for income taxes
1.1
 %
 
1.2
 %
 
(0.2
)%
 
1.0
 %
Net income
2.3
 %
 
2.0
 %
 
1.3
 %
 
1.4
 %
Three Months Ended June 30, 2018 and 2017
Consolidated Overview
 
Three Months Ended June 30,
 
Increase
(in thousands)
2018
 
2017
 
(Decrease)
Gross Revenue
$
410,343

 
$
377,768

 
$
32,575

Sales Adjustments
(5,845
)
 
(5,423
)
 
(422
)
        Net Revenue
$
404,498

 
$
372,345

 
$
32,153

Income from Operations
24,554

 
20,273

 
4,281

        Operating Margin (as a % of gross revenue)
6.0
%
 
5.4
%
 


Consolidated gross revenue for the three months ended June 30, 2018 increased by $32.6 million, or 8.6%, compared to the three months ended June 30, 2017. Gross revenue increased $28.6 million from acquisitions that closed during and after the third quarter of fiscal 2017 and $4.0 million from organic growth. Sales adjustments increased by $0.4 million, or 0.1% of gross revenue, compared to the three months ended June 30, 2017.

Consolidated income from operations was $24.6 million, or 6.0% of gross revenue, for the three months ended June 30, 2018 compared to $20.3 million, or 5.4% of gross revenue, for the three months ended June 30, 2017. The increase in our operating margin was primarily due to a decrease in direct labor costs and general and administrative expenses as a percentage of gross revenue. The decrease in direct labor costs was primarily due to the growth in our SRS segment and a positive adjustment to reflect a reduction in our estimated annual incentive compensation expense, partially offset by an increase in overtime costs compared to the three months ended June 30, 2017. The decrease in general and administrative expenses was primarily due to cost containment efforts and efficiencies gained through our project to optimize the Company’s cost structure. The increase in our operating margin was partially offset by increases in direct occupancy costs and in depreciation and amortization expense as a percentage of revenue. The increase in direct occupancy costs was primarily due to higher levels of open occupancy within our waiver group home programs and an increase in rent expense that was partially driven by the Mentis acquisition. The increase in depreciation and amortization was due to $1.8 million of accelerated amortization on intangible assets associated with a program closure and additional quarterly amortization from intangibles acquired in acquisitions that closed during and after the three months ended June 30, 2017.

28


I/DD Results of Operations
The following table sets forth the results of operations for the I/DD segment for the periods indicated (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2018
 
2017
 
 
 
 Change in %
of gross
revenue
 
Amount
 
% of gross
revenue
 
Amount
 
% of gross
revenue
 
Increase
(Decrease)
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
I/DD gross revenue
$
259,759

 
100.0
 %
 
$
246,497

 
100.0
 %
 
$
13,262

 

Sales adjustments
(3,305
)
 
(1.3
)%
 
(3,001
)
 
(1.2
)%
 
(304
)
 
(0.1
)%
I/DD net revenue
256,454

 
98.7
 %
 
243,496

 
98.8
 %
 
12,958

 
(0.1
)%
 
 
 
 
 
 
 
 
 
 
 
 
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Direct labor costs
165,229

 
63.6
 %
 
158,516

 
64.3
 %
 
6,713

 
(0.7
)%
Direct program costs
10,542

 
4.1
 %
 
10,330

 
4.2
 %
 
212

 
(0.1
)%
Direct occupancy costs
18,716

 
7.2
 %
 
16,732

 
6.8
 %
 
1,984

 
0.4
 %
Other direct costs
11,770

 
4.5
 %
 
10,888

 
4.4
 %
 
882

 
0.1
 %
Total cost of revenue
206,257

 
79.4
 %
 
196,466

 
79.7
 %
 
9,791

 
(0.3
)%
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative
12,162

 
4.7
 %
 
12,932

 
5.2
 %
 
(770
)
 
(0.5
)%
I/DD EBITDA
38,035

 
14.6
 %
 
34,098

 
13.9
 %
 
3,937

 
0.7
 %
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
10,258

 
3.9
 %
 
9,451

 
3.8
 %
 
807

 
0.1
 %
Income from Operations
$
27,777

 
10.7
 %
 
$
24,647

 
10.1
 %
 
$
3,130

 
0.6
 %
I/DD gross revenue
I/DD gross revenue for the three months ended June 30, 2018 increased by $13.3 million, or 5.4%, compared to the three months ended June 30, 2017. The increase in I/DD gross revenue included $12.4 million from acquisitions that closed during and after the three months ended June 30, 2017 and $0.9 million from organic growth.
I/DD EBITDA
    
I/DD EBITDA was $38.0 million, or 14.6% of gross revenue, for the three months ended June 30, 2018 compared to $34.1 million, or 13.9% of gross revenue, for the three months ended June 30, 2017. The increase in our I/DD EBITDA margin was primarily due to a decrease in cost of revenues and general and administrative expense as a percentage of gross revenue compared to the three months ended June 30, 2017.
I/DD cost of revenues for the three months ended June 30, 2018 decreased by 0.3% of gross revenue, compared to the three months ended June 30, 2017. This was primarily due to a 0.7% decrease in direct labor costs as a percentage of gross revenue partially offset by a 0.4% increase in direct occupancy costs as a percentage of gross revenue. The decrease in direct labor costs was primarily due to a decrease in incentive compensation expense that was the result of an adjustment to reduce our estimated annual incentive compensation based on the Company’s forecasted results for fiscal 2018. The increase in direct occupancy costs was primarily due to higher levels of open occupancy within the Company’s waiver group home programs.
I/DD general and administrative expenses for the three months ended June 30, 2018 decreased by $0.8 million, or 0.5% of gross revenue, compared to the three months ended June 30, 2017. The decrease as percentage of gross revenue was primarily due to our cost containment efforts and efficiencies gained through our project to optimize the Company’s cost structure.
I/DD Depreciation and amortization expense

Depreciation and amortization expense for the three months ended June 30, 2018 increased by $0.8 million, or 0.1% of gross revenue, compared to the three months ended June 30, 2017.

29


SRS Results of Operations
The following table sets forth the results of operations for the SRS segment for the periods indicated (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2018
 
2017
 
 
 
 Change in %
of gross
revenue
 
Amount
 
% of gross
revenue
 
Amount
 
% of gross
revenue
 
Increase
(Decrease)
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
SRS gross revenue
$
92,658

 
100.0
 %
 
$
80,163

 
100.0
 %
 
$
12,495

 
 
Sales adjustments
(2,084