Natl Home Health Care Corp (NHHC) - Description of business
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General National Home Health Care Corp. (the "Company") is a Delaware corporation that is a provider of home health care and staffing services in the Northeast region. Industry Overview United States health care spending continues to outpace the rate of inflation, and the population of older Americans continues to increase. The Company believes that alternatives to costly hospital and nursing home stays will continue to create demand for home health care. Medicare, Medicaid and other managed care insurance companies continue to look for a setting whereby the aged population can receive health care services most cost efficiently. Home health care has evolved as the acceptable and most preferred alternative in this continuum. Patient comfort and substantial cost savings can generally be realized through treatment at home as an alternative to traditional institutional settings. Continuing economic pressures within the home health care industry and the changes to Medicare reimbursement have forced providers to modify the manner in which they provide home health care services. Those companies that successfully operate with efficient business models can provide quality patient care and manage costs under the current reimbursement system. The home health care industry has traditionally been highly fragmented, composed of not-for-profit and for-profit smaller local home health agencies offering limited services. These smaller agencies do not generally have the necessary capital to expand their operations or services and are often unable to achieve the cost efficiencies to compete effectively. The implementation of the Medicare Prospective Payment system and other legislation at the state levels has created major industry consolidation. -1- Home Health Care Services Home health care services include four broad categories: (1) home health nursing services, (2) infusion therapy, (3) respiratory therapy and (4) home medical equipment. According to statistics from the Centers for Medicare and Medicaid Services (CMS) Office of the Actuary, total expenditures by payers on home health nursing services was approximately $43 billion in 2004. Medicare is the largest single payer, accounting for approximately $16 billion in 2004. The Company currently operates 31 offices consisting of one parent corporate office, twenty-one offices that coordinate home health care services and nine satellite offices. The Company has two Medicare provider numbers and is a Medicaid provider in each of the four states in which it operates. The Company provides a wide variety of home health care services including: Registered nurses who provide specialty services, such as skilled monitoring, clinical nursing assessments, evaluations, clinical interventions, medication supervision and/or administration. Licensed practical nurses who perform technical procedures, administer medications and change surgical and medical dressings. Physical and occupational therapists who work to strengthen muscles, restore range of motion and help patients perform the activities of daily living. Speech pathologists/therapists who work to restore communication and oral skills. Medical social workers who help families address the problems associated with acute and chronic illnesses. Home health aides who perform personal care such as bathing or assistance in walking. Private duty services such as continuous hourly nursing care and sitter services. The Company has five principal operating subsidiaries: Health Acquisition Corp., formerly Allen Health Care Services, Inc. ("Allen Health Care"), a New York corporation that conducts home health care operations in New York. New England Home Care, Inc. ("New England"), a Connecticut corporation that conducts home health care operations in Connecticut. Connecticut Staffing Works Corp. ("Connecticut Staffing"), a Connecticut corporation that conducts healthcare staffing operations in Connecticut. Accredited Health Services, Inc. ("Accredited"), a New Jersey corporation that conducts home health care operations in New Jersey. -2- Medical Resources Home Health Corp. ("Medical Resources"), a Delaware corporation that conducts home health care operations in Massachusetts. During the fiscal year ended July 31, 2004, the Company terminated its healthcare staffing operations in both New York and New Jersey. Health Acquisition Corp. d/b/a Allen Health Care Services. Allen Health Care is a provider of home health care services in New York State. Services are provided by personal care aides, home health aides and homemakers (collectively, caregivers). Allen Health Care is licensed by the State of New York Department of Health (DOH). Allen Health Care maintains its principal administrative office in Jamaica, New York and has a branch office in Hempstead, New York. Case coordinating of patients is performed at these two offices. In addition, Allen Health Care has satellite offices in Brooklyn, Mount Vernon and the Bronx, New York. The satellite offices are primarily used for the recruitment and training of home health aides. Services are provided in the following counties in the State of New York: Nassau, Westchester, Queens, Kings, New York and the Bronx. Home health care personnel are licensed or certified under a New York State approved program and can be engaged on a full-time, part-time or live-in basis. Since July 1996, Allen Health Care has required criminal background investigations for all new personnel. In addition, urine drug testing is part of the pre-employment screening process and thereafter is performed annually. In accordance with DOH regulations, effective April 1, 2005, all new non-licensed employees who are employed to provide direct care or supervision to clients of Allen Health Care will undergo a criminal history record check by the Federal Bureau of Investigation. In March 2005, Allen Health Care was re-surveyed by the Joint Commission of Accreditation of Health Care Organizations (JCAHO), an accrediting body for health care providers. JCAHO accreditation is associated with providing quality services. This status is required by many of the certified home health care agencies (CHHAs) and long-term home health care programs (LTHHCPs) that Allen Health Care currently services. The re-survey resulted in Allen Health Care extending its accredited status through March 2008. Allen Health Care is reimbursed primarily by CHHAs and LTHHCPs that subcontract their home health aides from Allen Health Care, as well as by private payers and the Nassau and Westchester County Departments of Social Services Medicaid Programs, for which Allen Health Care is a participating provider. Allen Health Care provides home health aide services to its clients twenty-four hours per day, seven days per week. Although Allen Health Cares offices are open during normal business hours, personnel are available twenty-four hours per day to respond to emergencies and to provide other service requests. The registered nurses of Allen Health Care, in accordance with DOH regulations and contract requirements, visit patients regularly and review records of service completed by the home health aide and personnel care aides daily. These records are maintained by Allen Health Care. In addition, a home care coordinator ensures that appropriate coverage is maintained for all patients and acts as the liaison among family members, aides and professional staff. Allen Health Care has expanded in recent years through selected acquisitions of complementary businesses or assets in its geographic region. These acquisitions included the August 1998 acquisition of certain assets of Bryan Employment Agency, Inc., d/b/a Bryan Home Care Services (Bryan HomeCare), a New York licensed home health care agency that provided home health aide services in Westchester -3-County, New York. This acquisition expanded the geographic presence of Allen Health Care and enabled it to become a participating provider in the Westchester County Department of Social Services Medicaid Program. To a large extent, Allen Health Cares continued growth depends on, among other things, its ability to recruit and maintain qualified personnel. Allen Health Cares training programs for home health aides and personal care aides have been approved by the New York State Department of Health. Allen Health Care believes that it offers competitive salaries and fringe benefits and has been able to keep its caregivers working on a steady basis. New England Home Care, Inc. In August 1995, the Company acquired New England. New England is a Medicare certified and state licensed home health care company in Connecticut. In February 2005, New England was re-surveyed by JCAHO, resulting in New England extending its accredited status through February 2008. New England provides services throughout Connecticut. Services include skilled nursing, physical therapy, occupational therapy, medical social services, home health aide and homemaker services. In addition, New England provides specialty services consisting of adult/geriatric, pediatric, post-acute rehabilitation and behavioral health. New England provides full-service home health care twenty-four hours per day, seven days per week. Weekends, holidays and after-hours are supported by an on-call system for each office location with medical supervision by a registered nurse at all times. All home health care personnel are licensed or certified under a Connecticut state-approved program and can be engaged on a full-time, part-time or live-in basis. New England performs a multi-state pre-employment criminal background check on all new hires. In addition, a Social Security number verification, satisfactory employer references and a pre-employment drug screen are required. New England maintains its principal administrative office in Cromwell, Connecticut. In addition, New England has administrative offices in Milford, West Hartford, Shelton and Waterbury, Connecticut, and a satellite office in Norwich, Connecticut. Case coordinating of patients is performed at the administrative offices. Reimbursement for New Englands services is primarily provided by the State of Connecticut Department of Social Services Medicaid Program, the Federal Medicare Program, managed care companies, private payers, hospices and other Medicare certified home health agencies and long-term care providers that subcontract their home health aides from New England. New England has expanded its operations through increased penetration of market share in Connecticut and selected acquisitions of complementary assets in its geographic region. In November 1999, New England acquired certain assets of Optimum Care Services of Connecticut, Inc., Optimum Home Health of Connecticut, Inc. and Optimum Home Care of Connecticut, Inc. (collectively, the Optimum Entities). The Optimum Entities included a Medicare certified and licensed home health care company engaged in providing home health care services in Connecticut. The acquisition of these assets was coupled with a successful penetration of the market share made available as a result of the liquidation of the Optimum Entities. In October 2004, New England acquired certain assets from On Duty Metropolitan Connecticut, LLC, a Medicare certified and licensed home health care company engaged in providing nursing and home health care services in New Haven and Fairfield Counties, Connecticut. The continued growth of New England depends on, among other things, its ability to recruit and retain qualified personnel. New England recruits personnel through employee referrals, newsprint media, -4-internet sourcing, direct mailings and industry networking. New England believes that it offers competitive salaries and fringe benefits and has been able to keep its employees working on a steady basis. Connecticut Staffing Works Corp. Connecticut Staffing was organized in October 1999 to operate certain of the assets acquired from the Optimum Entities. Connecticut Staffing is a full-service health care staffing company, maintaining its main administrative office in Cromwell, Connecticut. It provides temporary staffing to hospitals, skilled nursing facilities, long-term care centers, occupational health sites, juvenile detention centers, correctional facilities, group homes, schools and other institutions. Staffing personnel include registered nurses, licensed practical nurses, certified nursing assistants, medical secretaries and medical assistants. Staffing services are provided twenty-four hours per day, seven days per week. Staffing coordinators are available in the office Monday to Friday 6:00 a.m. to 5:00 p.m, Saturday 6:00 a.m. to 2:00 p.m. and Sunday 6:00 a.m. to 12 noon. Holidays and after hours are supported by an on-call system which pages a staffing coordinator. Connecticut Staffing performs a multi-state pre-employment criminal background check on all new hires. In addition, a Social Security number verification, satisfactory employer references and a pre-employment drug screen are required. Connecticut Staffing maintains a roster of quality professional personnel. The continued success of Connecticut Staffing is dependent on, among other things, its ability to maintain a steady roster of per diem workers to meet the staffing requirements of its clients. Connecticut recruits personnel through employee referrals, newsprint media, internet sourcing, direct mailings and industry networking. Connecticut Staffing believes that it offers competitive salaries and fringe benefits and has been able to keep its personnel working on a steady basis. Accredited Health Services, Inc. In October 1998, the Company acquired Accredited. Accredited is a licensed health care service firm that provides home health aide services in Bergen, Hudson, Passaic, Essex, Morris, Union, Somerset, Middlesex, Monmouth and Ocean Counties, New Jersey. Accredited maintains its principal administrative office in Hackensack, New Jersey and has branch offices in East Orange and Toms River, New Jersey. Case coordinating of patients is performed in Hackensack and the other two branch offices. Accredited also has satellite offices in Jersey City, Union City, Paterson and Elizabeth, New Jersey that are used for recruitment, in services and orientation of home health aides. Accredited provides home health care services to its clients twenty-four hours per day, seven days per week. Weekends, holidays and after-hours are supported by an on-call system for each office. All home health aides are certified under a New Jersey state-approved program and can be engaged on a full-time, part-time or live-in basis. Accredited has been approved by the New Jersey Board of Nursing for the training of home health aides in the State of New Jersey. Effective November 2003, all home health aides of Accredited have criminal background checks performed by the State of New Jersey. In November 2005, Accredited was re-surveyed by the Commission on Accreditation for Home Care (CAHC), one of the accrediting bodies required for participation as a Medicaid provider in New Jersey. This accreditation was extended for an additional year. Reimbursement for Accrediteds services is primarily by the State of New Jersey Medicaid Program, Medicare certified home health care agencies that subcontract their home health aides from Accredited and private payers. In May 2005, Accredited completed the acquisition of Helping Hands Health Care (Helping Hands). Helping Hands provided home health aide services in Bergen, Hudson, Passaic, Essex, Morris, Union, Middlesex, Somerset, Monmouth and Ocean Counties, New Jersey. -5- Accrediteds growth depends on, among other things, its ability to recruit and retain qualified home health aides. Recruiting is conducted primarily through advertising, direct contact with community groups and employment programs, and programs designed to encourage new employee referrals by existing employees. Accredited believes that it offers competitive salaries and fringe benefits and has been able to keep its caregivers working on a steady basis. Medical Resources Home Health Corp. In September 2002, the Company, through a wholly-owned subsidiary, acquired certain assets of Medical Resources, Inc. and related entities (collectively, the Medical Resources Entities). The Medical Resources Entities provided home care services in Massachusetts. The Massachusetts State Home Care Program provides services to approximately 33,000 frail, low income elders throughout the state. The funds and services are managed through twenty-seven Aging Service Access Points (ASAPs) that are not-for-profit organizations geographically dispersed throughout the state. Services provided through this state program include homemaking, personal care, companion and shopping. Medical Resources has contracts with certain of these ASAPs to provide homemaking and personal care services. Services are provided twenty-four hours per day, seven days per week. Weekends, holidays and after-hours are supported by an on-call system staffed by coordinators and registered nurses. From inception, Medical Resources has performed criminal background investigations on all new personnel. Medical Resources maintains its principal administrative office in Newton, Massachusetts and has satellite offices in Boston, Lynn, Framingham, North Andover, Leominster, Worcester, Chicopee, Bellingham, North Dartmouth and North Easton, Massachusetts. Case coordinating of patients is performed in Newton and the satellite offices. The satellite offices are also used as drop-off offices for paperwork, recruitment, in services, training and orientation of new personnel. In April 2003, Medical Resources received its Medicare certification from the CMS. In June 2003, Medical Resources received its Medicaid provider number from the Commonwealth of Massachusetts. As a result of receiving these certifications, Medical Resources expanded its services to include nursing, physical therapy, occupational therapy, speech therapy, medical social services and home health aide services to Medicare and Medicaid recipients. The growth of Medical Resources depends on, among other things, its ability to recruit and retain staff as well as its ability to generate referrals of Medicare and Medicaid patients. Medical Resources believes that it offers competitive salaries and fringe benefits and has been able to keep its employees working on a steady basis. Organization The Companys corporate headquarters is located in Scarsdale, New York, where all senior corporate administrative functions are performed. The Companys operations are conducted by its five operating subsidiaries. Although the Company maintains separate subsidiaries in its various jurisdictions of operations, it reviews its operations primarily on an integrated rather than geographic or separate-subsidiary basis. Each subsidiary has a main administrative office where all management functions are performed and overseen by the subsidiary President. Each administrative office performs intake and case -6-coordinating of patients, corporate compliance, human resources, marketing and all financial and accounting functions. Insurance The Company and its subsidiaries maintain casualty coverages for all of its operations, including professional and general liability, workers compensation, automobile, property, fiduciary liability and directors and officers insurance. The Company reviews its insurance coverages throughout the year to insure that adequate coverages are in place. In New York State, the Company self insures up to specified limits certain risks related to workers compensation. While the Company believes its insurance policies are adequate, in the wake of the terrorist events of September 11, 2001, the Company has experienced substantial increases in the cost of its insurance coverage. As a result, there can be no assurance that coverage will continue to be available in adequate amounts or at a reasonable cost. Employees and Labor Relations As of October 27, 2006, the Company had approximately 3,410 full and part-time employees. The Company currently employs the following classifications of personnel: administrative employees which consist of a senior management team (CEO and CFO) of the parent company and a COO, CFO and vice-presidents at each subsidiary company; office administrative staff, nursing directors and clinical managers; sales and marketing executives; licensed and certified professional staff (RNs, LPNs, therapists); and non-licensed care givers (home health and personal care aides). The Company has standardized procedures for recruiting, interviewing and reference checking prospective health care personnel. All nurses and home health aides must be licensed or certified by appropriate authorities. Effective May 1, 2004, Allen Health Care and District Council 1707, American Federation of State, County and Municipal Employees (AFSCME), concluded negotiations on an initial three-year labor contract. The labor contract provided covered home health aides with some new benefits, consisting of an immediate wage increase, eligibility for paid time off, increase in minimum hourly base rates, holiday premium pay and representation by the Union in procedures and personnel matters. The Company has no other union contracts with any of its employees. The Company believes its relationship with its employees is satisfactory. On February 28, 2006, Lerai Jones, individually and on behalf of all other persons similarly situated, filed a lawsuit against the Company for alleged unpaid overtime wages pursuant to the New York Labor Law. In this lawsuit, the plaintiff seeks to certify a class of regular full-time hourly employees employed by Allen Health Care located and working within the State of New York. The legal issues in this case are closely intertwined and connected to the legal issues currently being litigated in the matter of Coke v. Long Island Care at Home , 376 F.3d 118 (2d Cir. 2004) which involves the exemption for home health care aides under the Fair Labor Standards Act. On August 31, 2006, upon a remand from the United States Supreme Court, the United States District Court for the Second Circuit affirmed the decision of the United States District Court for the Southern District of New York ruling that the exemption did not apply to home health aides employed by third parties. This decision, however, has been stayed pending an appeal to the United States Supreme Court and the defendant in the Coke decision is currently in the process of appealing this decision to the United States Supreme Court. Thus, because of this pending appeal of the Coke decision, the parties in the matter of Lerai Jones, et al. v. National Home Health Care , have agreed to enter into a stipulation extending the defendants time to answer the complaint or agreeing -7-to have plaintiff stipulate to a discontinuance of this matter within thirty (30) days after a ruling in the Coke decision by the United States Supreme Court. Based on the United States Supreme Courts earlier remand, the Company believes that the Supreme Court will overturn the decision of the United States Court of Appeals for the Second Circuit and uphold the exemption from overtime wages for home health aides. If the decision is not overturned on appeal, the Companys labor cost in New York will increase, but the Company does not believe that such increase would have a material adverse effect on its operating results. On May 13, 2005, Accredited received a copy of a Petition for Certification of Representative, pursuant to the provisions of the National Labor Relations Act. On March 21, 2006 the home health aides of Accredited, in a mail ballot election, rejected union representation by SEIU 1199 New Jersey. Competition The home health care field is highly competitive in each state in which the Company operates. The Company is competing with numerous other licensed as well as certified home health care agencies in each of the markets it serves. In addition, the Company competes with companies that, in addition to providing home health aide and skilled nursing services, also, unlike the Company, provide pharmaceutical products and other home health care services that generate additional referrals. The Company believes it is one of the largest competitors in the state of Connecticut. However, the Company believes that numerous competitors in the other principal markets served by the Company ( i.e., the states of Massachusetts, New York and New Jersey) have substantially greater personnel, financial and other resources than the Company. Competition also involves the quality of services provided and the pricing for such services. The Companys largest competitors include Gentiva Health Services, Inc., Premier Health Services, Patient Care, Inc., New York Health Care, Inc. and Personal Touch Home Care, Inc. As a result of changes in Medicare reimbursement and the competitive pressures of managed care, the home health care industry continues to experience consolidation. In addition, the Company believes that smaller, less financially secure home health agencies will continue to find it difficult to compete for market share and comply with regulatory compliance standards. The Companys ability to attract a staff of highly trained personnel is a material element of its business. There currently is intense competition for qualified personnel and there can be no assurance that the Company will be successful in maintaining or in securing additional qualified personnel. The Companys competition for personnel comes from other industries as well. If and to the extent that reimbursement rates and other factors constrain wages and other benefits to caregivers, other industries offering more attractive compensation and other benefits also may attract eligible home health care personnel. The Company recruits personnel principally through newspaper advertisements and through referrals from existing personnel. Customers The Company provides its services to four types of payer sources. These sources include federal and state funded public assistance programs (Medicare and Medicaid), other third party payers (subcontracts), insurance companies and private payers. A substantial portion of the Companys revenue is derived from subcontracts that the Company has with Medicare certified home health care agencies and long-term health care provider programs that subcontract our caregivers. From time to time, some of these agencies have requested bids from the home -8-care agencies to which they subcontract. If the Company is not successful in maintaining these contracts as they come up for bid, it could have a materially adverse effect on the Companys results of operations. For the fiscal years ended July 31, 2006, 2005 and 2004, the State of Connecticut Department of Social Services Medicaid Program accounted for 27%, 28% and 27%, respectively, of the Companys net patient revenue and the New Jersey Department of Human Services Division of Medical Assistance and Health Services program accounted for 13%, 12% and 9%, respectively, of the Companys net patient revenue. The loss of or a significant adverse change in the business terms with either of the foregoing customers would have a material adverse effect on the Company. Government Regulation and Licensing The health care industry is highly regulated. The Companys business is subject to substantial and frequently changing regulations by federal, state and local authorities. The Company must comply with state licensing along with federal and state eligibility standards for certification as a Medicare and Medicaid provider. The ability of the Company to operate profitably will depend in part upon the Company obtaining and maintaining all necessary licenses and other approvals in compliance with applicable health care regulations. The Health Insurance Portability and Accountability Act. The Health Insurance Portability and Accountability Act (HIPAA), enacted by the Federal government on August 12, 1996, requires organizations to adhere to certain standards to protect data integrity, confidentiality and availability. HIPAA mandates, among other things, that the Department of Health and Human Services adopt standards for the exchange of electronic health information in an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the health care industry. Organizations were required to be in compliance with certain HIPAA provisions relating to security and privacy beginning April 14, 2003. Organizations are subject to significant fines and penalties if found not to be compliant with the provisions outlined in the regulations. Regulations issued pursuant to HIPAA impose ongoing obligations relative to training, monitoring and enforcement, and management has implemented processes and procedures to ensure continued compliance with these regulations. Medicare. Title XVIII of the Social Security Act authorizes Part A of the Medicare program, the health insurance program that pays for home health care services for covered persons (typically, those aged 65 and older and long-term disabled). Home health care providers may participate in the Medicare program subject to certain conditions of participation and upon acceptance of a provider agreement by the Secretary of Health and Human Services. Only enumerated services, upon satisfaction of certain coverage criteria, are eligible for reimbursement as a Medicare provider. The Company is currently Medicare certified in Connecticut and Massachusetts. Approximately 4%, 6% and 5% of revenue for the fiscal years ended July 31, 2006, 2005 and 2004, respectively, were derived from the Medicare program (see Risk Factors Risks Related to Federal and State Regulations below for a discussion regarding the Companys participation in the Connecticut Medicare program). Medicare Fraud and Abuse. Provisions of the Social Security Act under Medicare and Medicaid generally prohibit soliciting, receiving, offering or paying, directly or indirectly, any form of remuneration in return for the referral of Medicare or state health care program patients or patient care opportunities, or in return for the purchase, lease or order of any facility item or service that is covered by Medicare or a state health care program. The federal government has published regulations that provide exceptions, or -9-safe harbors, for business transactions that will be deemed not to violate the anti-kickback statute. Violations of the statute may result in civil and criminal penalties and exclusion from participation in the Medicare and Medicaid programs. The Company believes that its current operations are not in violation of the anti-kickback statute. Medicaid. Approximately 47%, 46% and 43% of revenue for the fiscal years ended July 31, 2006, 2005 and 2004, respectively, were derived from state sponsored Medicaid programs. Reimbursement for home health care services rendered to eligible Medicaid recipients is made in an amount determined in accordance with procedures and standards established by state law under federal guidelines. States differ as to reimbursement policies and rates. The Company is a licensed Medicaid provider in Connecticut, New Jersey, Massachusetts and in Nassau and Westchester Counties, New York. Future Medicaid reimbursement rates may be reduced in response to state economic and budgetary constraints, as well as in response to changes in the Medicare program (see Risk Factors Risks Related to Federal and State Regulations below for a discussion regarding the Companys participation in the Connecticut Medicaid program). Surveys . From March 1, 2004 through August 23, 2005, the Division of Health Services Regulation for the Connecticut Department of Public Health (the DPH) conducted various licensing and certification inspections of New England. In December 2005, New England and the DPH entered into a Consent Order for the purpose of resolving the DPHs findings at the conclusion of those inspections. The Consent Order provides for the adoption of certain policies and procedures pursuant to a Plan of Correction approved by the DPH. The terms of the Consent Order will generally remain in effect until the fall of 2007 . A failure by New England to achieve Medicare certification would result in New Englands termination from participation in the Medicare and Medicaid programs. Revenues derived from New Englands participation in these programs for the fiscal year ended July 31, 2006 were 30% of the Companys total revenues. Audit . In August 2005, the Connecticut Department of Social Services, Office of Quality Assurance (the Department) performed an audit of Medical Assistance claims paid to New England covering the period April 1, 2003 through March 31, 2005. The audit included a review of relevant claim information maintained by the Department and a review of the appropriate medical and administrative records maintained by New England. New England received approximately $53,000,000 in reimbursement during the audit period. In October 2006, the Company received the results of the audit, which resulted in a liability of $247,000 to the Department. The Company has recorded a liability in the financial statements to reflect the audit findings. Item 1A. Risk Factors This section summarizes certain risks, among others, that should be considered by stockholders and prospective investors in the Company. Many of these risks are also discussed in other sections of this report. Risks Related to the Companys Ability to Attract Qualified Caregivers. The Company relies significantly on its ability to attract and retain caregivers who possess the skills, experience and licenses necessary to meet the requirements of the Companys customers. The Company competes for home health care services personnel with other providers of home health care -10-services. The Company must continually evaluate and expand its network of caregivers to keep pace with its customers needs. Currently, there is a shortage of qualified nurses and a diminishing pool of home health aides in the states in which the Company conducts its business, competition for nursing personnel is increasing and wages and benefit costs have risen. The Company may be unable to continue to increase the number of caregivers that it recruits, adversely affecting the potential for growth of the Companys business. The Companys ability to attract and retain caregivers depends on several factors, including the Companys ability to provide such caregivers with assignments that they view as attractive and with competitive wages and benefits. There can be no assurance that the Company will be successful in any of these areas. The cost of attracting caregivers and providing them with attractive benefit packages may be higher than the Company anticipates and, as a result, if it is unable to obtain increased reimbursement rates, the Companys profitability could decline. Moreover, if the Company is unable to attract and retain caregivers, the quality of its services to its customers may decline and, as a result, it could lose certain customers. Risks Related to Collective Bargaining. Effective May 1, 2004, Allen Health Care and District Council 1707, AFSCME concluded negotiations on an initial three-year labor contract. The Company is unable to estimate how upcoming negotiations will affect the Companys future results of operations or financial condition. On May 13, 2005, Accredited received a copy of a Petition for Certification of Representative, pursuant to the provisions of the National Labor Relations Act. Although on March 21, 2006, the home health aides of Accredited, in a mail ballot election, rejected union representation by SEIU 1199 New Jersey, there can be no assurance that further unionizing activity will not occur at this or other subsidiaries of the Company or that any such activity or any new collective bargaining agreements will not have a material adverse effect on the Company. Risks Related to Competition. The home health care business is highly competitive. Some of the Companys competitors, unlike the Company, provide pharmaceutical products and other home health care services that generate additional referrals. Some of the Companys competitors also may have greater marketing and financial resources than the Company. The Company believes that the primary competitive factors in obtaining and retaining customers are the quality of services provided and the pricing of such services. Competition for referrals may increase in the future and, as a result, the Company may not be able to remain competitive. To the extent competitors gain or retain market share by reducing prices or increasing marketing expenditures, the Company could lose market share or otherwise experience a material adverse effect. The Company does not have long-term agreements or exclusive guaranteed order contracts with its customers. The success of the Companys business is dependent upon its ability to continually secure new business from its customers and to service such new business with its caregivers. The Companys customers are free to seek services from the Companys competitors and to use caregivers that such competitors offer them. Therefore, the Company must maintain positive relationships with its customers; otherwise, the Company may be unable to generate new business for its caregivers, which could have a material adverse effect on the Company. Risks Related to Medicaid Retroactive Adjustments and Recoupments. -11- New England, as a Connecticut Medicaid provider, is subject to retroactive adjustments due to prior year audits, reviews and investigations, government fraud and abuse initiatives and other similar actions. Federal regulations also provide for withholding payments to recoup amounts payable under the Medicaid program. While the Company believes it is in material compliance with applicable Medicaid reimbursement regulations, there can be no assurance that the Company, pursuant to such audits, reviews and investigations, among other things, will be found to be in compliance in all respects with such reimbursement regulations. A determination that the Company is in violation of any such reimbursement regulations could result in retroactive adjustments and recoupments and have a material adverse effect on the Company. As a Medicaid provider, the Company is also subject to routine, unscheduled audits, which may have an adverse impact on the Companys results of operations. For information on a recent audit performed by the Connecticut Department of Social Services, Office of Quality Assurance, see Government Regulation and Licensing Audit. Risks Related to Federal and State Regulations. The Company is subject to substantial and frequently changing federal, state and local regulations. The Company must also comply with state licensing along with federal and state eligibility standards for certification as a Medicare and Medicaid provider. In addition, new laws and regulations are adopted periodically to regulate new and existing services in the health care industry. Changes in laws or regulations or new interpretations of existing laws or regulations can have a dramatic effect on operating methods, costs and reimbursement amounts provided by government and other third-party payers. Federal laws governing the Companys activities include regulation of Medicare reimbursement and certification and certain financial relationships with health care providers (collectively, the fraud and abuse laws). Although the Company intends to comply with all applicable federal and state fraud and abuse laws, these laws are not always clear and may be subject to a range of potential interpretations. (For further discussion on such fraud and abuse laws, see Government Regulation and Licensing Medicare Fraud and Abuse.) There can be no assurance that administrative or judicial clarification or interpretation of existing laws or regulations, or legislative enactment of new laws or regulations, will not have a material adverse effect on the Company. In addition, the Balanced Budget Act of 1997, as amended (the Balanced Budget Act), introduced several government initiatives causing changes to Medicare reimbursement. These changes have resulted in the Company experiencing a decline in revenue from its Medicare certified subsidiary in Connecticut. (For further discussion on the Balanced Budget Act, see Government Regulation and Licensing Medicare.) New England, as a participant in the State of Connecticut Department of Social Services Medicaid program, is subject to survey and audits of operational, clinical and financial records with respect to proper applications of general regulations governing operations and billing of claims. These audits can result in retroactive adjustments for payments received from this program. There can be no assurance that federal, state or local governments will not change existing standards or impose additional standards. Any failure to comply with existing or future standards could have a material adverse effect on the Company. For information as to surveys of New England conducted by DPH, see Government Regulation and Licensing Surveys. A failure by New England to retain Medicare certification would result in New Englands termination from participating in the Medicare and Medicaid programs. Revenues derived from New Englands participation in these programs for the fiscal year ended July 31, 2006 were 30% of the Companys total revenues. Risks Related to the Companys Exposure to Professional Liabilities. -12- Provision of home health care services entails an inherent risk of liability. Certain participants in the home health care industry may be subject to lawsuits that may involve large claims and significant defense costs. It is expected that the Company periodically will be subject to such suits as a result of the nature of its business. The Company currently maintains professional liability insurance intended to cover such claims in amounts which management believes are in accordance with industry standards. There can be no assurance that the Company will be able to obtain liability insurance coverage in the future on acceptable terms, if at all. There can be no assurance that claims in excess of the Companys insurance coverage or claims not covered by the Companys insurance coverage will not arise. A successful claim against the Company in excess of the Companys insurance coverage could have a material adverse effect on the Company. Claims against the Company, regardless of their merit or eventual outcome, may also have a material adverse effect on the Companys ability to attract customers or to expand its business. In addition, one of the Companys subsidiaries is self-insured for its workers compensation and is at risk for claims up to certain levels. Risks Related to Third Party Payers. For the twelve months ended July 31, 2006, 2005 and 2004, the percentage of the Companys revenues derived from Medicare and Medicaid was 51%, 51% and 48%, respectively. The revenues and profitability of the Company are affected by the continuing efforts of all third-party payers to contain or reduce the costs of health care by lowering reimbursement rates, narrowing the scope of covered services, increasing case management review of services and negotiating reduced contract pricing. Any changes in reimbursement levels under Medicare, Medicaid or other payer sources and any changes in applicable government regulations could have a material adverse effect on the Company. See Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations Certain Trends Expected to Impact Future Results of Operations. Changes in the mix of the Companys patients among Medicare, Medicaid and other payer sources may also affect the Companys revenues and profitability. Risks Related to the Companys Acquisition Strategy. In recent years, the Companys strategic focus has been on the acquisition of small to medium sized home health care agencies, or of certain of their assets, in targeted markets. These acquisitions involve significant risks and uncertainties, including difficulties integrating acquired personnel and other corporate cultures into the Companys business, the potential loss of key employees or customers of acquired companies, the assumption of liabilities and exposure to unforeseen liabilities of acquired companies and the diversion of management attention from existing operations. The Company may not be able to fully integrate the operations of the acquired businesses with its own in an efficient and cost-effective manner. The failure to effectively integrate any of these businesses could have a material adverse effect on the Company. In addition, the Companys growth over the last several years has principally resulted from acquisitions and penetration of markets abandoned by competitors. There can be no assurance that the Company will be able to identify suitable acquisitions or available market share in the future nor that any such opportunities, if identified, will be consummated on terms favorable to the Company, if at all. In the absence of such successful transactions, there can be no assurance that the Company will experience further growth, nor that such transactions, if consummated, will result in further growth. -13- In addition, although the Company attempted in its acquisitions to determine the nature and extent of any pre-existing liabilities, and has obtained indemnification rights from the previous owners for acts or omissions arising prior to the date of the acquisition, resolving issues of liability between the parties could involve a significant amount of time, manpower and expense on the part of the Company. If the Company or any of its subsidiaries were to be unsuccessful in a claim for indemnity from a seller, the liability imposed on the Company or its subsidiary could have a material adverse effect on the Company. The Company has grown significantly over the past few years. This growth, which has resulted primarily from acquisitions and which management intends to continue to pursue, poses a number of difficulties and risks for the Company. As the Company has grown and may continue to grow (as to which there can be no assurance) in both revenue and geographical scope, such growth stretches the various resources of the Company, including management, information systems, regulatory compliance, logistics and other controls. There can be no assurance that such resources will keep pace with such growth. If the Company does not maintain such pace, then its prospects would be materially adversely affected. Risks Related to the Companys Dependence on Senior Management. The Company believes that the success of its business strategy and its ability to operate profitably depends on the continued employment of its senior management team. If any member of the Companys senior management team becomes unable or unwilling to continue in his present position, the Companys business and financial results could be materially adversely affected. Item 1B. Unresolved Staff Comments. None.