| PROVIDENCE SERVICE CORP Item 1A Risk Factors The following risks should be read in conjunction with other information contained, or incorporated by reference, in this report, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” section and our historical consolidated financial statements and related notes and pro forma financial information |
| If any of the following risks actually occurs, our business, financial condition and operating results could be adversely affected |
| Changes in budgetary priorities of the government entities that fund the services we provide could result in our loss of contracts or a decrease in amounts payable to us under our contracts |
| Our revenue is largely derived from contracts that are directly or indirectly paid or funded by government agencies |
| All of these contracts are subject to legislative appropriations and state budget approval |
| Consequently, a significant decline in government expenditures, shift of expenditures or funding away from programs that call for the types of services that we provide or change in government contracting or funding policies could cause payers to terminate their contracts with us or reduce their expenditures under those contracts, either of which could have a negative impact on our future operating results |
| The availability for funding under our contracts with state governments is dependent in part upon federal funding to states |
| Recent changes in Medicaid methodology may further reduce the availability of federal funds to states in which we provide services |
| Among the alternative Medicaid funding approaches that states have explored are provider assessments as tools for leveraging increased Medicaid federal matching funds |
| Provider assessment plans generate additional federal matching funds to the states for Medicaid reimbursement purposes, and implementation of a provider assessment plan requires approval by the Centers for Medicare and Medicaid Services in order to qualify for federal matching funds |
| These plans usually take the form of a bed tax or a quality assessment fee, which were required to be imposed uniformly across classes of providers within the state, except that such taxes only applied to Medicaid health plans |
| However, the Deficit Reduction Act of 2005, which was signed into law on February 8, 2006, or Deficit Reduction Act, requires states that desire to impose provider taxes, subject to certain transitional periods, to impose taxes on all managed care organizations, not just Medicaid managed care organizations |
| This uniformity requirement as it relates to taxing all managed care organizations may make states more reluctant to use provider assessments as a vehicle for raising matching funds and, thus, reduce the amount of funding that the states receive and have available |
| Moreover, under the Deficit Reduction Act, states may be allowed to reduce the benefits provided to certain Medicaid enrollees, which could affect the services that states contract for with us |
| We cannot make any assurances that these Medicaid changes will not negatively affect the funding under our contracts |
| Currently, all of the states in which we operate are facing budgetary shortfalls |
| While to date we have not experienced any rate or contract reductions as a result of these budgetary shortfalls, we are not immune to such consequences |
| In addition, in some states eligibility requirements for social services clients have been tightened to stabilize the number of eligible clients, which reduces the size of our potential market in those states |
| While many of these states are dealing with budgetary concerns by shifting costs from institutional care to home and community based care such as we provide, there is no assurance that this trend will continue |
| Our contracts are not only short-term in nature but can also be terminated prior to expiration, without cause and without penalty to the payers, and there can be no assurance that they will survive until the end of their stated terms or that upon their expiration these contracts will be renewed or extended |
| While some of them also contain options for renewal, usually successive six month or one year terms, payers are not required to extend their contracts into these option periods |
| In addition, a significant number of our contracts not only allow the payer to terminate the contract immediately for cause (such as for our failure to meet our contract obligations) but also permit the payer 14 ______________________________________________________________________ [42]Table of Contents to terminate the contract at any time prior to its stated expiration date without cause, at will and without penalty to the payer, either upon the expiration of a short notice period, typically 30 days, and/or immediately, in the event federal or state appropriations supporting the programs serviced by the contract are reduced or eliminated |
| The failure of payers to renew or extend significant contracts or their early termination of significant contracts could adversely affect our financial performance |
| We cannot anticipate if, when or to what extent a payer might terminate its contract with us prior to its expiration or fail to renew or extend its contract with us |
| Each of our contracts is subject to audit and modification by the payers with whom we contract, in their sole discretion |
| Our business depends on our ability to successfully perform under various government funded contracts |
| The payers under these contracts can review our performance under these contracts, as well as our records, accounting and general business practices at any time and may, in their discretion: • suspend or prevent us from receiving new contracts or extending existing contracts because of violations or suspected violations of procurement laws or regulations; • terminate or modify our existing contracts; • reduce the amount we are paid under our existing contracts; and/or • audit and object to our contract related fees |
| As a government contractor, we are subject to an increased risk of litigation and other legal actions and liabilities |
| As a government contractor, we are subject to an increased risk of investigation, criminal prosecution, civil fraud, whistleblower lawsuits and other legal actions and liabilities not often faced by companies that do not provide government sponsored services |
| The occurrence of any of these actions, regardless of the outcome, could disrupt our operations and cause us added expense and could limit our ability to obtain additional contracts in other jurisdictions |
| A loss of our status as a licensed provider in any jurisdiction could result in the termination of a number of our contracts, which could negatively impact our revenues |
| If we lost our status as a licensed provider in any jurisdiction, the contracts under which we provide services in that jurisdiction would be subject to termination |
| Moreover, such an event could constitute a violation of provisions of our contracts in other jurisdictions, resulting in further contract terminations |
| If we fail to satisfy our contractual obligations, we could be liable for damages and financial penalties and harm our ability to keep our existing contracts or obtain new contracts |
| Our failure to comply with our contract obligations could, in addition to providing grounds for immediate termination of the contract for cause, negatively impact our financial performance and damage our reputation, which, in turn, could have a material adverse effect on our ability to obtain new contracts |
| Our failure to meet contractual obligations could also result in substantial actual and consequential damages |
| The termination of a contract for cause could, for instance, subject us to liability for excess costs incurred by a payer in obtaining similar services from another source |
| In addition, our contracts require us to indemnify payers for our failure to meet standards of care, and some of them contain liquidated damages provisions and financial penalties that we must pay if we breach these contracts |
| We derive a significant amount of our revenues from a few providers, which puts us at risk |
| We provide, or manage the provision of, government sponsored social services pursuant to 527 contracts |
| One of these contracts, our contract with The Community Partnership of Southern Arizona, referred to as CPSA, 15 ______________________________________________________________________ [43]Table of Contents an Arizona not-for-profit organization, which is our oldest contract and our only annual block purchase contract, generated approximately 11dtta6prca and 12dtta1prca of our revenues for the years ended December 31, 2004 and 2005 |
| Our next five largest revenue producing contracts represented, in the aggregate, approximately 23dtta2prca and 19dtta6prca of our revenues for such periods |
| The loss of, reduction in amounts generated by, or changes in methods or regulations governing payments for our services under these contracts could materially reduce our revenue |
| Effective July 1, 2005, our contract with CPSA requires us to provide a sufficient level of encounters to support the year-to-date payments received under the contract and provide necessary services that may exceed the associated reimbursement |
| Our agreement with CPSA specifies that we are to provide or arrange for behavioral health services to certain eligible populations of beneficiaries as defined in the contract |
| We must provide a full range of behavioral health clinical, case management, therapeutic and administrative services |
| There is no contractual limit to the number of eligible beneficiaries that may be assigned to us, or a specified limit to the level of services that may be provided to these beneficiaries |
| Therefore, we are at-risk if the costs of providing necessary services exceed the associated reimbursement |
| Under our CPSA contract, we are required to regularly submit service encounter data to CPSA electronically, and CPSA is obligated to monitor the service encounter value |
| If our service encounter value exceeds the year-to-date payments made to us, CPSA at its discretion (subject to available state funding) may compensate us for service encounter value in excess of the contractual amounts |
| Conversely, if at any time the service encounter value is not sufficient to support year-to-date payments made to us or if we fail to provide data sufficient to permit accurate monitoring of our service encounter value, CPSA has the right to suspend payments to us or recoup funds already paid to us |
| We recognize revenue from our CPSA contract equal to the service encounter value, which represents the value of the actual services rendered, as more fully described in “Item 7 |
| Management’s Discussion and Analysis of Financial Condition and Results of Operation” under the caption “Critical accounting policies and estimates” in this report |
| If our service encounter value exceeds amounts paid to us under this contract (equal to one-twelfth of the annual contract amount on a monthly basis), we recognize revenue equal to the amount that yields a ratio of the service encounter value to revenue of 90prca |
| For the first six months of this contract (July 1, 2005 to December 31, 2005), the amount of revenue we recognized in excess of amounts paid to us year-to-date amounted to approximately dlra2dtta0 million |
| While we believe the additional revenue over the contractual amount is collectible based on CPSA’s history of making additional payments to us, collection is subject to CPSA’s discretion and dependent upon sufficient funds allocated by the State of Arizona |
| If CPSA does not pay us for our service encounter value in excess of the contractual amount, the impact of not receiving such payment could have a material adverse affect on our financial position, results of operation and cash flows |
| If our encounter value is not sufficient to support year-to-date payments made to us or if we fail to provide data sufficient to permit accurate monitoring of our service encounter value, CPSA can suspend payments to us |
| CPSA has not suspended payments to us nor have we returned any amounts to the payer |
| While we do not anticipate that we will be required to return any amounts to CPSA, and while we believe that our service encounter value is sufficient to support all amounts paid to us under the contract, there can be no assurances that this will be the case |
| If we fail to estimate accurately the cost of performing certain contracts, we may incur losses on these contracts |
| Under our fee-for-service contracts, we receive fees based on our interactions with government sponsored clients |
| To earn a profit on these contracts, we must accurately estimate costs incurred in providing services |
| Our risk on these contracts is that our client population is not large enough to cover our fixed costs, such as rent and 16 ______________________________________________________________________ [44]Table of Contents other overhead |
| Our fee-for-service contracts are not reimbursed on a cost basis and therefore, if we fail to estimate our costs accurately, we may incur losses on these contracts |
| Approximately 16dtta2prca of our revenues for the year ended December 31, 2005 were derived from cost based service contracts for which we record revenue at one-twelfth of the annual contract amount less allowances for certain contingencies, which puts us at risk that we may be required to subsequently refund a portion of our recorded revenues for such contracts |
| With our acquisition of Choices Group, Inc, Aspen MSO, LLC and College Community Services in July 2004, we acquired certain cost based service contracts that require us to allow for contingencies such as budgeted costs not incurred, excess cost per service over the allowable contract rate and/or an insufficient number of encounters |
| For the year ended December 31, 2005, revenues from these contracts represented approximately 16dtta2prca of our total revenues for the period |
| In cases where funds paid to us exceed the allowable costs to provide services under the contracts, we may be required to pay back the excess funds |
| Our results of operations will fluctuate due to seasonality |
| Our quarterly operating results and operating cash flows normally fluctuate as a result of seasonal variations in our business, principally due to lower client demand for our home and community based services during the holiday and summer seasons |
| Historically, these seasonal variations have had a nominal affect on our operating results and operating cash flows |
| As we have grown our home and community based services business our exposure to seasonal variations has grown and will continue to grow, particularly with respect to our school based services, educational services and tutoring services with the acquisition of Children’s Behavioral Health, Inc |
| and A to Z In-Home Tutoring, LLC We experience lower home and community based services revenue when school is not in session |
| Our expenses, however, do not vary significantly with these changes and, as a result, such expenses do not fluctuate significantly on a quarterly basis |
| We expect quarterly fluctuations in operating results and operating cash flows to continue as a result of the uneven seasonal demand for our home and community based services |
| In addition, as we enter new markets, we could be subject to additional seasonal variations along with any competitive response to our entry by other social services providers |
| As a result of these factors, quarter-to-quarter comparisons of our operating results may not be a good indicator of our future performance |
| Further, it is possible that in any future quarter our operating results could be below the expectations of investors and any published reports or analyses regarding our company |
| In that event, the price of our common stock could decline substantially |
| While we obtain some of our business through responses to government requests for proposals, we may not be awarded contracts through this process in the future, and contracts we are awarded may not be profitable |
| We obtain, and will continue to seek to obtain, a significant portion of our business from state or local government entities |
| To obtain business from government entities, we are often required to respond to requests for proposals, or RFPs |
| To propose effectively, we must accurately estimate our cost structure for servicing a proposed contract, the time required to establish operations and the terms of the proposals submitted by competitors |
| We must also assemble and submit a large volume of information within rigid and often short timetables |
| Our ability to respond successfully to RFPs will greatly impact our business |
| We may not be awarded contracts through the RFP process, and our proposals may not result in profitable contracts |
| If we fail to establish and maintain important relationships with officials of government entities and agencies, we may not be able to successfully procure or retain government-sponsored contracts, which could negatively impact our revenues |
| To facilitate our ability to procure or retain government-sponsored contracts, we rely in part on establishing and maintaining relationships with officials of various government entities and agencies |
| These relationships enable us to provide informal input and advice to the government entities and agencies prior to the development 17 ______________________________________________________________________ [45]Table of Contents of an RFP or program for privatization of social services and enhance our chances of procuring contracts with these payers |
| The effectiveness of our relationships may be reduced or eliminated with changes in the personnel holding various government offices or staff positions |
| We also may lose key personnel who have these relationships |
| We may be unable to successfully manage our relationships with government entities and agencies and with elected officials and appointees |
| Any failure to establish, maintain or manage relationships with government and agency personnel may hinder our ability to procure or retain government-sponsored contracts |
| The federal government may refuse to grant consents and/or waivers necessary to permit for-profit entities to perform certain elements of government programs |
| Under current law, in order to privatize certain functions of government programs the federal government must grant a consent and/or waiver to the petitioning state or local agency |
| If the federal government does not grant a necessary consent or waiver or withdraw approval of any granted waiver, the state or local agency will be unable to contract with a for-profit entity, such as us, to provide the service |
| Failure by state or local agencies to obtain consents and/or waivers could adversely affect our continued business and future growth |
| Our business could be adversely affected by future legislative changes that hinder or reverse the privatization of social services |
| The market for our services depends largely on federal, state and local legislative programs |
| These programs can be modified or amended at any time |
| Moreover, part of our growth strategy includes aggressively pursuing opportunities created by the federal, state and local initiatives to privatize the delivery of social services |
| However, there are opponents to the privatization of social services and, as a result, future privatization of social services is uncertain |
| If additional privatization initiatives are not proposed or enacted, or if previously enacted privatization initiatives are challenged, repealed or invalidated, our growth could be adversely impacted |
| Since some government agencies prefer or require contracts for privatized social services to be administered through not-for-profit organizations, we rely heavily on our relationships with not-for-profit organizations to provide services to these government agencies |
| We currently maintain strategic relationships with 17 not-for-profit social services organizations with which we have management contracts, 14 of which are tax exempt organizations |
| Federal tax laws require that the boards of directors of not-for-profit tax exempt organizations be independent |
| Although currently the boards of directors of the tax exempt not-for-profit organizations for which we provide management services are independent, prior to July 2003, our employees constituted a majority of the boards of three of these organizations |
| If, as a result of such past practices, we and/or these managed entities were ever found to be in violation of these federal tax laws, we and they could be subject to penalties and, as described below, the tax exempt status of these managed entities could be jeopardized |
| Federal tax laws also require that the management fees we charge the not-for-profit entities we manage be at fair market rates |
| Prior to July 2003, however, these management contracts contained a provision that permitted us to earn bonuses to our management fee dependent upon the managed entity’s operating results |
| In connection with our renegotiation of our fee arrangement with these entities, we amended these agreements as of July 1, 2003, at which time we removed the bonus provision |
| If the Internal Revenue Service, referred to as the IRS, determined that any tax exempt organization was paying more than market rates for services performed by us, and further determined that we were, at the time those rates were set, in a position to exercise substantial influence over the affairs of the tax exempt organization (through our past majority positions on the board of directors or otherwise), the IRS could sanction us and the tax exempt organization, including levying a penalty against us of 25prca of the amount paid in excess of the market rates for the services provided and the return of all excess benefit amounts, plus interest, to the tax exempt organization |
| If the excess benefit amount were not returned, an additional penalty equal to 200prca of the excess benefit could be imposed on us |
| Generally, under state law, not-for-profit entities may pay no more than reasonable compensation for services rendered |
| If the compensation paid to us by these not-for-profit entities is deemed unreasonable, then the state could take action against the not-for-profit entity which could adversely effect us |
| 18 ______________________________________________________________________ [46]Table of Contents In addition, until September 2003, three of these not-for-profit organizations were co-borrowers on our credit facility and their receivables were pledged as additional collateral under the facility |
| As the manager of these entities, we drew down on the line of credit under our credit facility on their behalf and advanced the borrowings to them for their operating expenses |
| In September 2003, these entities were removed as co-borrowers under our credit facility, and their assets were removed as collateral from our line of credit |
| As a result of our relationships with these tax exempt organizations, including our employees’ past majority positions on the boards of directors of some of them, the terms of our management contracts with these organizations and/or the shared borrowing relationship we previously had with some of them, the IRS could propose to revoke the tax exempt status of some or all of these tax exempt organizations |
| If the IRS were successful in revoking the tax exempt status of any of these tax exempt organizations, such organization would likely be treated as a taxable entity from the time of the event or events that caused the exempt status to be revoked |
| In addition, state authorities could investigate and take action against the not-for-profit status of these organizations for similar reasons |
| A state attorney general could also take action to dissolve a state not-for-profit organization that could result in our loss of the organization’s contract(s) for services |
| The loss of federal tax exempt and/or not-for-profit status would adversely affect the ability of these organizations to be exempt from certain federal taxes and could have the same impact on state taxes |
| The imposition of federal and/or state taxes on such organizations could reduce the funds available to pay our management fees |
| Further, these organizations’ existing payers may terminate or fail to renew or extend their contracts with the tax exempt organizations if IRS or state controversies of this type were threatened or were to occur |
| The loss of such contracts could have a negative effect on our earnings |
| Government unions may oppose privatizing government programs to outside vendors such as us, which could limit our market opportunities |
| Our success depends in part on our ability to win contracts to administer and manage programs traditionally administered by government employees |
| Many government employees, however, belong to labor unions with considerable financial resources and lobbying networks |
| These unions could apply political pressure on legislators and other officials seeking to privatize government programs |
| Union opposition could result in our losing government contracts or being precluded from providing services under government contracts |
| Inaccurate, misleading or negative media coverage could damage our reputation and harm our ability to procure government sponsored contracts |
| The media sometimes provides news coverage about our contracts and the services we provide to clients |
| This media coverage, if negative, could influence government officials to slow the pace of privatizing government services |
| Moreover, inaccurate, misleading or negative media coverage about us could harm our reputation and, accordingly, our ability to obtain government sponsored contracts |
| We may incur costs before receiving related revenues, which could result in cash shortfalls |
| When we are awarded a contract to provide services, we may incur expenses before we receive any contract payments |
| These expenses include leasing office space, purchasing office equipment and hiring personnel |
| As a result, in certain large contracts where the government does not fund program start-up costs, we may be required to invest significant sums of money before receiving related contract payments |
| In addition, payments due to us from payers may be delayed due to billing cycles or as a result of failures to approve government budgets in a timely manner |
| Moreover, any resulting cash shortfall could be exacerbated if we fail to either invoice the payer or to collect our fee in a timely manner |
| Our business is subject to risks of litigation |
| We are in the human services business and therefore are subject to claims alleging we did not properly treat an individual or failed to properly diagnose and/or care for a client |
| We carry professional liability and general liability insurance and have an umbrella liability insurance policy, which provide us with aggregate coverage 19 ______________________________________________________________________ [47]Table of Contents limits of dlra2dtta0 million per occurrence and an annual combined policy aggregate limit of dlra4dtta0 million |
| A substantial award could have a material adverse impact on our operations and cash flow and could adversely impact our ability to continue to purchase appropriate liability insurance |
| We can be subject to claims for negligence or intentional misconduct (in addition to professional liability type claims) by an employee, including but not limited to, claims arising out of accidents involving employees driving to or from interactions with clients or assault and battery |
| We can be subject to employee related claims such as wrongful discharge or discrimination or a violation of equal employment law |
| While we are insured for these types of claims, damages exceeding our insurance limits or outside our insurance coverage, such as a claim for fraud, could adversely affect our cash flow and financial condition |
| Furthermore, we can be subject to miscellaneous errors and omissions liability relative to the various management agreements we have with the not-for-profit entities we manage |
| In the event of a claim and depending on, among other things, the circumstances, allegations, and size of the management contract, we could be subject to damages that could have a material adverse impact on our financial condition and results of operations |
| Our use of a self-insurance program to cover certain claims for losses suffered and costs or expenses incurred could negatively impact our business upon the occurrence of an uninsured event |
| In May 2005, we adopted a program of self-insurance with regard to a substantial portion of our general and professional liability and workers’ compensation costs and the general and professional liability and workers’ compensation costs of certain designated entities managed by us under reinsurance programs through our wholly-owned captive insurance subsidiary |
| In the event that our actual reinsured losses and the reinsured losses of the certain designated entities managed by us increase unexpectedly or exceed our estimated reinsured losses under the program, the aggregate of such losses could materially increase our liability and adversely affect our financial condition, liquidity, cash flows and results of operations |
| In addition, as the availability to us of certain traditional insurance coverage diminishes or increases in costs, we will continue to evaluate the levels of claims we include in our self-insurance program |
| Any increases to this program increase our risk exposure and therefore increase the risk of a possible material adverse effect on our financial condition, liquidity, cash flows and results of operations |
| We could be subject to significant state regulation and potential sanctions if our health care benefits program is deemed to be a multiple employer welfare arrangement |
| For the purpose of managing and providing employee healthcare benefits we deem ourselves to be a single employer under Section 3(5) of ERISA with regard to our own employees as well as the employees of certain of our managed entities covered by our healthcare benefit program |
| The Department of Labor, or DOL, or individual states could disagree with our interpretation and consider our program to be a multiple employer welfare arrangement, or MEWA, and, as such, subject to regulation by state insurance commissions |
| If involuntarily deemed a MEWA, our cost to manage the state-by-state regulatory environment for the self-funded portion of our health insurance program would be prohibitive and we could, as a result, elect to maintain our self-funded health insurance plan only for our owned entities, forcing the three managed entities currently included in our self-funded plan to negotiate and purchase their own health benefits |
| In addition, if our health care benefits program is determined to be a MEWA, civil and/or criminal sanctions are possible |
| We face substantial competition in attracting and retaining experienced social service professionals, and we may be unable to grow our business if we cannot attract and retain qualified employees |
| Our success depends to a significant degree on our ability to attract and retain highly qualified and experienced social service professionals who possess the skills and experience necessary to deliver high quality services to our clients |
| Our objective of providing the highest quality of service to our clients is strongly considered when we evaluate education, experience and qualifications of potential candidates for employment as direct care and administrative staff |
| To that end, we attempt to hire professionals who have attained a bachelors degree, masters degree or higher level of education and certification or licensure as direct care social service providers and administrators |
| These employees are in great demand and are likely to remain a limited resource 20 ______________________________________________________________________ [48]Table of Contents for the foreseeable future |
| We must quickly hire project leaders and case management personnel after a contract is awarded to us |
| Contract provisions and client needs determine the number, education and experience levels of social service professionals we hire |
| We continually evaluate client census, case loads and client eligibility to determine our staffing needs under each contract |
| Our ability to attract and retain employees with the requisite experience and skills depends on several factors including, but not limited to, our ability to offer competitive wages, benefits and professional growth opportunities |
| Some of the companies with which we compete for experienced personnel have greater financial resources and name recognition than we do |
| The inability to attract and retain experienced personnel could have a material adverse effect on our business |
| Our success depends on our ability to manage growing and changing operations |
| Since 1996, our business has grown significantly in size and complexity |
| This growth has placed, and is expected to continue to place, significant demands on our management, systems, internal controls and financial and physical resources |
| In addition, we expect that we will need to further develop our financial and managerial controls and reporting systems to accommodate future growth |
| This could require us to incur expenses for hiring additional qualified personnel, retaining professionals to assist in developing the appropriate control systems and expanding our information technology infrastructure |
| The nature of our business is such that qualified management personnel can be difficult to find |
| Our inability to manage growth effectively could have a material adverse effect on our financial results |
| Any acquisition that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results |
| We anticipate that we will continue making strategic acquisitions as part of our growth strategy |
| We have made a number of acquisitions since our inception, including eleven since our initial public offering in August 2003 |
| The success of these and other acquisitions depends in part on our ability to integrate acquired companies into our business operations |
| There can be no assurance that the companies acquired will continue to generate income at the same historical levels on which we based our acquisition decisions, that we will be able to maintain or renew the acquired companies’ contracts, that we will be able to realize operating and economic efficiencies upon integration of acquired companies or that the acquisitions will not adversely affect our results of operations or financial condition |
| We continually review opportunities to acquire other businesses that would complement our current services, expand our markets or otherwise offer growth opportunities |
| In connection with some acquisitions, we could issue stock that would dilute existing stockholders’ percentage ownership and/or we could incur or assume substantial debt or assume contingent liabilities |
| Acquisitions involve numerous risks, including, but not limited to, the following: • problems assimilating the purchased operations; • unanticipated costs and legal or financial liabilities associated with an acquisition; • diversion of management’s attention from our core businesses; • adverse effects on existing business relationships with customers; • entering markets in which we have limited or no experience; • potential loss of key employees of purchased organizations; • the incurrence of excessive leverage in financing an acquisition; • failure to maintain and renew contracts; • unanticipated operating, accounting or management difficulties in connection with an acquisition; and • dilution to our earnings per share |
| We cannot assure you that we will be successful in overcoming problems encountered in connection with any acquisition, and our inability to do so could disrupt our operations and adversely affect our business |
| 21 ______________________________________________________________________ [49]Table of Contents Our future debt obligations could impair our liquidity and financial condition |
| We may incur debt in the future in connection with our acquisition strategy and for other corporate opportunities |
| If we do so, these debt obligations could pose risk by: • making it more difficult for us to satisfy our obligations; • requiring us to dedicate a substantial portion of our cash flow to payments on our debt obligations, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements; • impeding us from obtaining additional financing in the future for working capital, capital expenditures, acquisitions and general corporate purposes; and • making us more vulnerable if a downturn in our business occurs and limiting our flexibility to plan for, or react to, changes in our business |
| If we were to fail to make any required payment under the agreements governing our indebtedness or fail to comply with the financial and operating covenants contained in these agreements, we would be in default |
| A default could have a significant adverse effect on the market value and marketability of our common stock |
| Our lenders would have the ability to require that we immediately pay all outstanding indebtedness |
| If the lenders were to require immediate payment, we might not have sufficient assets to satisfy our obligations under our credit facility, our subordinated notes or our other indebtedness |
| In such event, we could be forced to seek protection under bankruptcy laws, which could have a material adverse effect on our existing contracts and our ability to procure new contracts as well as our ability to recruit and/or retain employees |
| Our success depends on our ability to compete effectively in the marketplace |
| We compete for clients and for contracts with a variety of organizations that offer similar services |
| Most of our competition consists of local social service organizations that compete with us for local contracts, such as United Way supported agencies and faith-based agencies such as Catholic Social Services, Jewish Family and Children’s Services and the Salvation Army |
| Other competitors include local, not-for-profit organizations and community based organizations |
| Historically, these types of organizations have been favored in our industry as incumbent providers of services to government entities |
| We also compete with larger companies, such as Maximus, Inc, whose government operations group administers and manages welfare program services, childcare support enforcement, Medicaid enrollment and other consulting services for state and local governments |
| is the country’s largest provider of foster care services and competes with us in existing markets for foster care services |
| In addition, many institutional providers offer some type of community based care including such organizations as Cornell Companies, Inc, Res-Care, Inc, Psychiatric Solutions, Inc |
| and The Devereaux Foundation |
| Some of these companies have greater financial, technical, political, marketing, name recognition and other resources and a larger number of clients and/or payers than we do |
| In addition, some of these companies offer more services than we do |
| We have experienced, and expect to continue to experience, competition from new entrants into our markets |
| Increased competition may result in pricing pressures, loss of or failure to gain market share or loss of clients or payers, any of which could harm our business |
| Our business is subject to state licensing regulations and other regulatory provisions, including regulatory provisions governing surveys, audits, anti-kickbacks, self-referrals, false claims and The Health Insurance Portability and Accountability Act of 1996, and changes to or violations of these regulations could negatively impact our revenues |
| The applicable state and local licensing requirements govern the services we provide, the credentials of staff, record keeping, treatment planning, client monitoring and supervision of staff |
| The failure to maintain these licenses or the loss of a license could have a material adverse impact on our business and could prevent us from providing 22 ______________________________________________________________________ [50]Table of Contents services to clients in a given jurisdiction |
| We are also subject to regulations that restrict our ability to contract directly with a government agency in certain situations |
| Such restrictions could affect our ability to contract with certain payers |
| Violations of these laws may result in significant penalties, including repayment of any amounts alleged to be overpayments or in violation of such laws, criminal fines, civil money penalties, damages, imprisonment, a ban from participation in federally funded healthcare programs and/or bans from obtaining government contracts |
| Such fines and other penalties could negatively impact our business by decreasing profits due to repayment of overpayments or from the imposition of fines and damages, damaging our reputation and diverting our management resources |
| Due to our access, use or disclosure of health information relating to individuals, we are subject to the privacy mandates of the Health Insurance Portability and Accountability Act of 1996, or HIPAA HIPAA mandates, among other things, the adoption of standards to enhance the efficiency and simplify the administration of the nation’s healthcare system |
| HIPAA requires the DHHS to adopt standards for electronic transactions and code sets for basic healthcare transactions such as payment, eligibility and remittance advices, or “transaction standards,” privacy of individually identifiable health information, or “privacy standards,” security of individually identifiable health information, or “security standards,” electronic signatures, as well as unique identifiers for providers, employers, health plans and individuals and enforcement |
| Final regulations have been issued by DHHS for the privacy standards, certain of the transaction standards and security standards |
| As a healthcare provider, we are required to comply in our operations with these standards and are subject to significant civil and criminal penalties for failure to do so |
| In addition, in connection with providing services to customers that also are healthcare providers, we are required to provide satisfactory written assurances to those customers that we will provide those services in accordance with the privacy standards and security standards |
| HIPAA has and will require significant and costly changes for our company and others in the healthcare industry |
| Compliance with the privacy standards became mandatory in April 2003, compliance with the transaction standards became mandatory in October 2003 (although full implementation was delayed with respect to the Medicare program until October 2005), and compliance with the security standards became mandatory in April 2005 |
| In February 2006, DHHS published its Final Rule on Enforcement of the HIPAA Administrative Simplification provisions, including the transaction standards, the security standards and the privacy rule |
| This enforcement rule addresses, among other issues, DHHS’s policies for determining violations and calculating civil money penalties, how DHHS will address the statutory limitations on the imposition of civil money penalties, and various procedural issues |
| We have appointed an internal committee to maintain our privacy and security policies regarding client information in compliance with HIPAA This committee is responsible for training our employees, including our regional and local managers and staff, to comply with HIPAA and monitoring compliance with the policy |
| However, like other businesses subject to HIPAA regulations, we cannot fully predict the total financial or other impact of these regulations on us |
| The costs associated with our ongoing compliance could be substantial, which could negatively impact our profitability |
| Provisions in our corporate documents and our certificate of incorporation and bylaws, as well as Delaware General Corporation Law, may hinder a change of control |
| Provisions of our certificate of incorporation and bylaws, as well as provisions of the Delaware General Corporation Law, could discourage unsolicited proposals to acquire us, even though such proposals may be beneficial to you |
| These provisions include: • a classified board of directors that cannot be replaced without cause by a majority vote of our stockholders; 23 ______________________________________________________________________ [51]Table of Contents • our board of director’s authorization to issue shares of preferred stock, on terms as the board of directors may determine, without stockholder approval; and • provisions of Delaware General Corporation Law that restrict many business combinations |
| We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which could prevent us from engaging in a business combination with a 15prca or greater stockholder for a period of three years from the date it acquired such status unless appropriate board or stockholder approvals are obtained |