10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                         to

Commission File Number: 0-20372

RES-CARE, INC.

(Exact name of registrant as specified in its charter)

KENTUCKY	61-0875371
(State or other jurisdiction of	(IRS Employer Identification No.)
incorporation or organization)
9901 Linn Station Road	40223-3808
Louisville, Kentucky	(Zip Code)
(Address of principal executive offices)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12-b of the Act (Check one):

Large accelerated filer: o Accelerated filer: x Non-accelerated filer: o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o    No  x ..

The number of shares outstanding of the registrant’s common stock, no par value, as of October 31, 2007, was 29,164,659.

INDEX

RES-CARE, INC. AND SUBSIDIARIES

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets — September 30, 2007 and December 31, 2006
	Condensed Consolidated Statements of Income — Three Months Ended September 30, 2007 and 2006; Nine Months Ended September 30, 2007 and 2006
	Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2007 and 2006
	Notes to Condensed Consolidated Financial Statements — September 30, 2007
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 5.	Other Information
Item 6.	Exhibits
SIGNATURES
EXHIBITS

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PART I. FINANCIAL INFORMATION

Item 1.            Financial Statements

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

	September 30		December 31
	2007		2006
ASSETS
Current assets:
Cash and cash equivalents	$	9,783	$	5,541
Accounts receivable, net of allowance for doubtful accounts of $13,974 in 2007 and $11,327 in 2006	201,020		197,711
Deferred income taxes	16,589		15,110
Refundable income taxes	435		—
Non-trade receivables	10,490		6,517
Prepaid expenses and other current assets	10,800		11,412
Total current assets	249,117		236,291
Property and equipment, net	79,629		75,606
Goodwill	404,702		375,494
Other intangible assets, net	33,259		27,552
Other assets	14,240		14,288
	$	780,947	$	729,231
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	45,554	$	42,983
Accrued expenses	93,728		78,618
Current portion of long-term debt	3,501		4,368
Current portion of obligations under capital leases	74		170
Accrued income taxes	—		232
Total current liabilities	142,857		126,371
Long-term liabilities	31,445		28,445
Long-term debt	190,782		205,616
Obligations under capital leases	803		273
Deferred gains	4,733		4,056
Deferred income taxes	16,839		12,832
Total liabilities	387,459		377,593
Commitments and contingencies
Minority interests	43		161
Shareholders’ equity:
Preferred shares, authorized 1,000,000 shares, no par value, except 48,095 shares designated as Series A with stated value of $1,050 per share, 48,095 shares issued and outstanding in 2007 and 2006	46,609		46,609
Common stock, no par value, authorized 40,000,000 shares, issued and outstanding 29,156,709 shares in 2007 and 28,146,092 shares in 2006	50,395		50,210
Additional paid-in capital	84,953		75,773
Retained earnings	209,378		177,683
Accumulated other comprehensive income	2,110		1,202
Total shareholders’ equity	393,445		351,477
	$	780,947	$	729,231

See accompanying notes to condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2007			2006			2007				2006
Revenues	$	364,598		$	330,383		$	1,066,116			$	965,050
Facility and program expenses	326,838			295,106			956,595				861,187
Facility and program contribution	37,760			35,277			109,521				103,863
Corporate general and administrative expenses	15,035			13,857			45,137				41,435
Operating income	22,725			21,420			64,384				62,428
Interest expense, net	4,535			4,505			13,724				13,168
Income from continuing operations before income taxes	18,190			16,915			50,660				49,260
Income tax expense	6,667			6,186			18,567				18,965
Income from continuing operations	11,523			10,729			32,093				30,295
Loss from discontinued operations, net of tax	(136		)	(110		)	(398			)	(2,589		)
Net income	11,387			10,619			31,695				27,706
Net income attributable to preferred shareholders	1,637			1,572			4,571				4,127
Net income attributable to common shareholders	$	9,750		$	9,047		$		27,124		$	23,579
Basic earnings (loss) per common share:
From continuing operations	$	0.34		$	0.33		$		0.97		$	0.94
From discontinued operations	(0.00		)	(0.00		)	(0.01			)	(0.08		)
Basic earnings per common share	$	0.34		$	0.33		$		0.96		$	0.86
Diluted earnings (loss) per common share:
From continuing operations	$	0.34		$	0.32		$		0.96		$	0.92
From discontinued operations	(0.00		)	(0.00		)	(0.01			)	(0.08		)
Diluted earnings per common share	$	0.34		$	0.32		$		0.95		$	0.84
Weighted average number of common shares:
Basic	28,337			27,689			28,185				27,481
Diluted	28,648			28,122			28,538				28,108

See accompanying notes to condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Nine Months Ended
	September 30
	2007			2006
Cash flows from operating activities:
Net income	$	31,695		$	27,706
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization	14,654			12,643
Impairment charge	332			1,110
Amortization of discount and deferred debt issuance costs on notes	806			736
Share-based compensation	5,361			1,371
Deferred income tax expense	2,528			1,460
Excess tax benefit from share-based compensation	(1,724		)	(2,627		)
Provision for losses on accounts receivable	4,581			4,319
Loss on sale of assets	110			233
Changes in operating assets and liabilities	8,632			(24,283		)
Cash provided by operating activities	66,975			22,668
Cash flows from investing activities:
Purchases of property and equipment	(16,220		)	(11,746		)
Acquisitions of businesses	(33,444		)	(108,430		)
Proceeds from sale of assets	534			13
Proceeds from sales and maturities of short-term investments	—			66,850
Purchases of short-term investments	—			(39,200		)
Cash used in investing activities	(49,130		)	(92,513		)
Cash flows from financing activities:
Long-term debt repayments	(58,966		)	(3,550		)
Borrowings of long-term debt	40,000			40,000
Short-term borrowings — three months or less, net	—			19,500
Payments on obligations under capital lease, net	(174		)	(891		)
Proceeds from sale and leaseback transactions	1,669			2,651
Debt issuance costs	—			(468		)
Excess tax benefit from share-based compensation	1,724			2,627
Proceeds received from exercise of stock options	2,144			6,734
Cash (used in) provided by financing activities	(13,603		)	66,603
Increase (decrease) in cash and cash equivalents	4,242			(3,242		)
Cash and cash equivalents at beginning of period	5,541			9,894
Cash and cash equivalents at end of period	$	9,783		$	6,652

See accompanying notes to condensed consolidated financial statements.

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RES-CARE, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

September 30, 2007

(Unaudited)

Note 1.                   Basis of Presentation

                Res-Care, Inc. is a human service company that provides residential, therapeutic, job training and educational supports to people with developmental or other disabilities, to youth with special needs, to adults who are experiencing barriers to employment and to older people who need home care assistance. All references in this Quarterly Report on Form 10-Q to “ResCare”, “our company”, “we”, “us”, or “our” mean Res-Care, Inc. and, unless the context otherwise requires, its consolidated subsidiaries.

                The accompanying condensed consolidated financial statements of ResCare have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all information and footnotes required by accounting principles generally accepted in the United States (GAAP) for comprehensive annual financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial condition and results of operations for the interim periods have been included. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full year.

                The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts and related disclosures of commitments and contingencies. We rely on historical experience and on various other assumptions that we believe to be reasonable under the circumstances to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

                For further information refer to the consolidated financial statements and footnotes thereto in our annual report on Form 10-K for the year ended December 31, 2006.

Note 2.                   Reclassifications

                During the first and fourth quarters of 2006, we ceased providing community services in the District of Columbia (the District) and the state of New Mexico, respectively. In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), the withdrawals have been accounted for as discontinued operations. Accordingly, the results of our community services in the District and New Mexico for all periods presented and the related exit costs have been classified as discontinued operations, net of income taxes, in the accompanying condensed consolidated statements of income. Additional information regarding discontinued operations can be found in Note 11.

                Beginning with June 2007, receivables related to recoveries from insurance companies, and the related liabilities where we are primary obligor, have been presented on a gross basis. The gross amount of insurance receivables were reclassified from the insurance reserve, which is a component of long-term liabilities, to other assets. The reclassification had no effect on the condensed consolidated

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statements of income or cash flows. Prior period financial information has been conformed to this presentation.

Note 3.                   Acquisitions

                We completed nine acquisitions during the first nine months of 2007. Aggregate consideration for these acquisitions was approximately $36.7 million, including $3.3 million of notes issued. These acquisitions are expected to generate annual revenues of approximately $92 million. The operating results of the acquisitions are included in the condensed consolidated financial statements from the date of acquisition.

The aggregate purchase price for these acquisitions was allocated as follows (in thousands):

Property and equipment	$	1,088
Other intangibles	7,130
Liabilities assumed	(298		)
Goodwill	28,790
Aggregate purchase price	$	36,710

                The allocations of purchase price are preliminary and will be subjected to further analysis during the remainder of 2007. The other intangible assets consist primarily of customer relationships and will be amortized over 10 years.

Note 4.                   Income Taxes

                The effective tax rate was 36.7% for the three and nine months ended September 30, 2007 and 36.6% for the three months ended and 38.5% for the nine months ended September 30, 2006. The difference in the effective tax rates was primarily due to the impact of jobs tax credits and the reversal of certain income tax reserves upon the expiration of the applicable statute of limitations during the third quarter of 2006. The jobs tax credit programs expired on January 1, 2006 and were retroactively renewed during December 2006. Accordingly, income tax expense for 2006 did not reflect the full benefits of the jobs tax credits until the program was reinstated in December 2006.

                In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, (FIN 48) which clarifies the criteria that a tax position must satisfy for some or all of the benefits of that position to be recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold of more-likely-than-not and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 was effective for ResCare as of January 1, 2007.

                We file numerous consolidated and separate income tax returns in the U.S. and various state and foreign jurisdictions. With few exceptions, we are no longer subject to income tax examinations by the taxing authorities for years prior to 2003. Our policy is to recognize interest related to unrecognized tax benefits as interest expense and penalties as corporate general and administrative expense. We believe that we have appropriate support for the income tax positions taken and to be taken on our income tax

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returns and that our accruals for income tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of the tax laws as applied to the facts of each matter.

                The adoption of FIN 48 did not have a significant impact on our consolidated financial position, results of operations or cash flows. As of January 1, 2007, we have provided a liability of $0.5 million for unrecognized tax benefits related to various state income tax matters. Of this amount, the amount that would impact our effective tax rate, if recognized, is $0.2 million. Interest and penalties were not significant at the adoption date or for the nine months ended September 30, 2007. There has been no change in the reserve for uncertain tax positions in the nine months ended September 30, 2007 and we do not expect that the amounts of unrecognized tax benefits will change significantly within the next twelve months.

Note 5.                   Comprehensive Income

The following table sets forth the computation of comprehensive income:

	Three Months Ended				Nine Months Ended
	September 30				September 30
	2007		2006		2007		2006
	(In thousands)
Net income	$	11,387	$	10,619	$	31,695	$	27,706
Foreign currency translation adjustments arising during the period	381		1		908		356
Comprehensive income	$	11,768	$	10,620	$	32,603	$	28,062

Note 6.                   Debt

                Long-term debt and obligations under capital leases consist of the following:

                                                                                                                                                     & #160;                                               

	September 30 2007		December 31 2006
	(In thousands)
7.75% senior notes due 2013, net of discount of approximately $0.8 million in 2007 and $0.9 million in 2006	$	149,169	$	149,065
Senior secured credit facility	40,000		55,000
Obligations under capital leases	877		443
Notes payable and other	5,114		5,919
	195,160		210,427
Less current portion	3,575		4,538
	$	191,585	$	205,889

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Note 7.                   Earnings Per Share

                The following data shows the amounts used in computing earnings per common share and the effect on income and the weighted average number of shares of dilutive potential common stock.

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2007			2006			2007			2006
	(In thousands, except per share data )
Income from continuing operations	$	11,523		$	10,729		$	32,093		$	30,295
Attributable to preferred shareholders	1,657			1,588			4,629			4,513
Attributable to common shareholders	$	9,866		$	9,141		$	27,464		$	25,782
Loss from discontinued operations, net of tax	$	(136	)	$	(110	)	$	(398	)	$	(2,589	)
Attributable to preferred shareholders	(20		)	(16		)	(58		)	(386		)
Attributable to common shareholders	$	(116	)	$	(94	)	$	(340	)	$	(2,203	)
Net income	$	11,387		$	10,619		$	31,695		$	27,706
Attributable to preferred shareholders	1,637			1,572			4,571			4,127
Attributable to common shareholders	$	9,750		$	9,047		$	27,124		$	23,579
Weighted average number of common shares used in basic earnings per common share	28,337			27,689			28,185			27,481
Effect of dilutive securities:
Stock options	246			409			263			548
Restricted stock	65			24			90			79
Weighted average number of common shares and dilutive potential common shares used in diluted earnings per common share	28,648			28,122			28,538			28,108
Basic earnings (loss) per common share:
From continuing operations	$	0.34		$	0.33		$	0.97		$	0.94
From discontinued operations	(0.00		)	(0.00		)	(0.01		)	(0.08		)
Basic earnings per common share	$	0.34		$	0.33		$	0.96		$	0.86
Diluted earnings (loss) per common share:
From continuing operations	$	0.34		$	0.32		$	0.96		$	0.92
From discontinued operations	(0.00		)	(0.00		)	(0.01		)	(0.08		)
Diluted earnings per common share	$	0.34		$	0.32		$	0.95		$	0.84

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        There were no average shares excluded from the computation of diluted earnings per common share for the three and nine months ended September 30, 2007 and 2006.

Note 8.                   Segment Information

The following table sets forth information about reportable segment operating results and assets:

			Job Corps		Employment
	Community		Training		Training		All			Consolidated
Three months ended September 30:	Services		Services		Services		Other (1)			Totals
	(In thousands)
2007
Revenues (2)	$	270,354	$	40,074	$	50,904	$	3,266		$	364,598
Operating income (2)	28,355		3,891		6,001		(15,522		)	22,725
Total assets	538,580		31,833		136,321		74,213			780,947
Capital expenditures	2,468		—		296		2,296			5,060
Depreciation and amortization (2)	2,586		—		492		2,026			5,104
2006
Revenues (2)	$	238,618	$	39,404	$	48,344	$	4,017		$	330,383
Operating income (2)	28,017		4,350		3,393		(14,340		)	21,420
Total assets (3)	494,003		31,706		135,540		62,330			723,579
Capital expenditures	2,068		—		125		1,524			3,717
Depreciation and amortization (2)	2,235		—		502		1,603			4,340

Nine months ended September 30:
2007
Revenues (2)	$	781,856	$	122,626	$	147,087	$	14,547		$	1,066,116
Operating income (2)	83,094		12,001		13,436		(44,147		)	64,384
Capital expenditures	7,285		—		807		8,128			16,220
Depreciation and amortization (2)	7,391		—		1,494		5,745			14,630
2006
Revenues (2)	$	672,406	$	118,733	$	158,848	$	15,063		$	965,050
Operating income (2)	77,552		12,732		12,254		(40,110		)	62,428
Capital expenditures	5,554		—		307		5,885			11,746
Depreciation and amortization (2)	6,546		—		1,347		4,568			12,461

(1)All Other is comprised of our international operations, schools and corporate general and administrative expenses.

(2)Amounts for both Community Services and the Consolidated Totals have been restated to exclude the operations of Washington, D.C. and New Mexico, which were discontinued effective March 31, 2006 and October 31, 2006, respectively.

(3)Amounts have been conformed to include a reclassification adjustment for receivables related to insurance recoveries. This reclassification, which commenced in the second quarter of 2007, had no effect on the reported results of operations, cash flows, or compliance with our debt covenants.

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Note 9.           Share-Based Compensation

                A summary of changes to outstanding shares during the nine months ended September 30, 2007 follows:

			Restricted Stock
	Options		Performance- Based		Service-Based
Outstanding at December 31, 2006	861,940		465,691		155,193
Grants	—		—		472,325
Exercised/issued	(273,440	)	(60,000	)	(114,024	)
Forfeited/cancelled	(4,500	)	(11,950	)	(31,300	)
Outstanding at September 30, 2007	584,000		393,741		482,194

                Total share-based compensation expense by type of award was as follows:

	Three Months Ended					Nine Months Ended
	September 30					September 30
	2007			2006		2007		2006
	(In thousands)
Stock options	$		16	$	158	$	49	$	476
Restricted stock, service-based	683			155		2,940		435
Restricted stock, performance-based	290			368		2,372		460
Total share-based compensation expense	989			681		5,361		1,371
Tax effect	385			205		2,086		356
Share-based compensation expense, net of tax	$	604		$	476	$	3,275	$	1,015

                Total share-based compensation expense by operating segment was as follows:

	Three Months Ended				Nine Months Ended
	September 30				September 30
	2007		2006		2007		2006
	(In thousands)
Community Services	$	420	$	—	$	2,044	$	—
Job Corps Training Services	12		—		74		—
Employment Training Services	102		—		293		—
All Other	455		681		2,950		1,371
Total	$	989	$	681	$	5,361	$	1,371

Note 10.         Legal Proceedings

                From time to time, we, or a provider with whom we have a management agreement, become a party to legal and/or administrative proceedings that, in the event of unfavorable outcomes, may adversely affect revenues and period to period comparisons.

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In July 2000, American International Specialty Lines Insurance Company, or AISL, filed a Complaint for Declaratory Judgment against us and certain of our subsidiaries in the U.S. District Court for the Southern District of Texas, Houston Division. In the Complaint, AISL sought a declaration of what insurance coverage was available to ResCare in the case styled In re: Estate of Trenia Wright, Deceased, et al. v. Res-Care, Inc., et al., which was filed in Probate Court No. 1 of Harris County, Texas (the Lawsuit). After the filing, we entered into an agreement with AISL whereby any settlement reached in the Lawsuit would not be dispositive of whether the claims in the Lawsuit were covered under the insurance policies issued by AISL. AISL thereafter settled the Lawsuit for $9.0 million. It is our position that: (i) the Lawsuit initiated coverage under policies of insurance in more than one policy year, thus affording adequate coverage to settle the Lawsuit within coverage and policy limits, (ii) AISL waived any applicable exclusions for punitive damages by its failure to send a timely reservation of rights letter and (iii) the decision by the Texas Supreme Court in King v. Dallas Fire Insurance Company, 85 S.W.3d 185 (Tex. 2002) controls. Prior to the Texas Supreme Court’s decision in the King case, summary judgment was granted in favor of AISL but the scope of the order was unclear. Based on the King decision, the summary judgment was set aside. Thereafter, subsequent motions for summary judgment filed by both AISL and ResCare were denied. The case was tried, without a jury, in late December 2003. On March 31, 2004, the Court entered a judgment in favor of AISL in the amount of $5.0 million. It is our belief that the Court improperly limited the evidence ResCare could place in the record at trial and the type of claims it could present. Accordingly, an appeal of the Court’s decision has been filed with the Fifth Circuit Court of Appeals and a supersedes bond has been filed with the Court of $6.0 million. Oral arguments were held on August 31, 2005. We have not made any provision in our condensed consolidated financial statements for the potential liability that may result from final adjudication of this matter, as we do not believe it is probable that an unfavorable outcome will result from this matter. Based on the advice of counsel, we do not believe it is probable that the ultimate resolution of this matter will result in a material liability to us nor have a material adverse effect on our condensed consolidated financial condition, results of operations or liquidity.

In January 2007, the U.S. Court of Appeals for the Seventh Circuit reversed a Summary Judgment we had received from the U.S. District Court, Southern District of Indiana, in Omega Healthcare Investors, Inc. v. Res-Care Health Services, Inc. In the case, Omega was initially seeking $3.7 million for breach of contract in the closing of a facility in 1999 located in Lexington, Kentucky. The Court of Appeals issued a ruling granting judgment for Omega and remanded the proceedings to the District Court to establish the actual amount of damages. A Petition for Writ of Certiorari filed with the U.S. Supreme Court in April 2007, was denied. We have made a provision in our condensed consolidated financial statements for the final adjudication of this matter. We do not believe that the ultimate resolution of this matter will have a material adverse effect on our condensed consolidated financial condition, results of operations or liquidity.

In January 2006, a lawsuit was filed in San Mateo County Superior Court styled Conservatorship of the Person and Estate of Theresa Rodriguez v. Res-Care, Inc, Res-Care California, Inc. dba RCCA Services, et al. The lawsuit alleges violations of the Elder and Dependent Adult Abuse Act, Breach of Fiduciary Duty, Negligence and Unfair Business Practices as a result of Ms. Rodriguez being severely burned in May 2004 one week after the replacement of a water heater at a group home in California where she resided. Plaintiff also seeks attorneys fees and punitive damages against RCCA Services. Settlement discussions have been unsuccessful. We have filed a Motion to Disqualify the Judge which has not yet been assigned to a neutral court for a determination. Therefore, a scheduled November trial date has been postponed. We have made provisions in our condensed consolidated financial statements for the final adjudication of this matter. Furthermore, we have preserved our rights for indemnity against

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the plumbing installers/manufacturers of the water heater. We do not believe that the ultimate resolution of this matter will have a material adverse effect on our condensed consolidated financial condition, results of operations or liquidity.

                In addition, we are a party to various other legal and/or administrative proceedings arising out of the operation of our facilities and programs and arising in the ordinary course of business. We believe that, generally, these claims are without merit. Further, many of such claims may be covered by insurance. We do not believe the results of these proceedings or claims, individually or in the aggregate, will have a material adverse effect on our condensed consolidated financial condition, results of operations or liquidity.

Note 11.         Discontinued Operations

                During the first quarter of 2006, we ceased providing community services in the District of Columbia due to high operating costs and substantial losses resulting from changes in regulatory oversight requirements. Effective October 31, 2006, pursuant to the contract terms, the state of New Mexico canceled our contract without cause and we ceased providing services to people with developmental disabilities in New Mexico. In accordance with SFAS 144, the withdrawals have been accounted for as discontinued operations. Accordingly, the results of our community services in the District and New Mexico for all periods presented and the related exit costs have been classified as discontinued operations, net of income taxes, in the accompanying condensed consolidated statements of income.

                In connection with the withdrawals, we recorded exit cost charges for the District and New Mexico during the year ended December 31, 2006. The following table describes the 2007 activity for the exit liability, comprised only of lease terminations, as of September 30, 2007:

	Beginning Balance at January 1, 2007		Accruals/ (Reversals)			Payments			Ending Balance at September 30,  2007
	(In thousands)
Lease terminations	$	2,603	$	(94	)	$	(1,976	)	$	533

12

                Summarized financial information for the discontinued operations is set forth below:

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2007			2006			2007			2006
	(In thousands)
Revenues	$	(16	)	$	5,875		$	13		$	21,616
Facility and program expenses	91			5,982			735			23,608
Facility and program loss	(107		)	(107		)	(722		)	(1,992		)
Exit costs and impairment (charges) reversals	(107		)	—			94			(2,217		)
Loss from discontinued operations, before income taxes	(214		)	(107		)	(628		)	(4,209		)
Income tax benefit (expense)	78			(3		)	230			1,620
Loss from discontinued operations, net of tax	$	(136	)	$	(110	)	$	(398	)	$	(2,589	)

Included in the nine months ended September 30, 2007 were reversals of previous exit cost charges due to favorable settlements.

Included in the nine months ended September 30, 2006 was an exit cost charge of $1.6 million for the District. An additional charge of $0.6 million was recorded for impaired assets, which were principally leaseholds and furniture.

Note 12.         Impact of Recently Issued Accounting Pronouncements

                In June 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 06-03, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (EITF 06-03). EITF 06-03 provides that the presentation of taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and customer on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. Additionally, if the amounts are significant, taxes that are reported on a gross basis are required to be disclosed in interim and annual financial statements for each period in which an income statement is presented. The provisions of EITF 06-03 became effective for us as of January 1, 2007. We report applicable taxes on a net basis and thus they are excluded from revenues.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies when using other accounting pronouncements that require or permit fair value measurements, and does not require any new fair value measurements. SFAS 157 is effective for fiscal years beginning after December 15, 2007. We are currently evaluating the impact, if any, of adopting SFAS 157 on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 expands the use of fair value measurement by permitting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 is effective for fiscal years

13

beginning after December 15, 2007. We are currently evaluating the impact, if any, of adopting SFAS 159 on our consolidated financial statements.

Note 13.         Goodwill

A summary of changes to goodwill during the nine months ended September 30, 2007 are as follows:

			Job Corps		Employment
	Community		Training		Training
	Services		Services		Services		Other			Total
	(In thousands)
Balance at December 31, 2006	$	302,587	$	7,589	$	60,457	$	4,861		$	375,494
Goodwill added through acquisitions	28,790		—		—		—			28,790
Goodwill impairment charge	—		—		—		(332		)	(332		)
Adjustments to previously recorded goodwill	750		—		—		—			750
Balance at September 30, 2007	$	332,127	$	7,589	$	60,457	$	4,529		$	404,702

A goodwill impairment charge of $332,000 was recorded in the first quarter of 2007 for goodwill associated with our charter schools reporting unit. The carrying value of goodwill was higher than the fair value, thereby requiring an impairment charge in accordance with SFAS No. 142, Goodwill and Other Intangible Assets.

Note 14.         Subsidiary Guarantors

On October 3, 2005, we issued $150 million of 7.75% Senior Notes due October 15, 2013 (the Senior Notes) in a private placement under Rule 144A of the Securities Act of 1933. The Senior Notes are jointly, severally, fully and unconditionally guaranteed by our 100% owned U.S. subsidiaries. There are no restrictions on our ability to obtain funds from our U.S. subsidiaries by dividends or other means. The following are condensed consolidating financial statements of our company, including the guarantors. This information is provided pursuant to Rule 3 — 10 of Regulation S-X in lieu of separate financial statements of each subsidiary guaranteeing the Senior Notes. The following condensed consolidating financial statements present the balance sheet, statement of income and cash flows of (i) Res-Care, Inc. (in each case, reflecting investments in its consolidated subsidiaries under the equity method of accounting), (ii) the guarantor subsidiaries, (iii) the nonguarantor subsidiaries, and (iv) the eliminations necessary to arrive at the information for our company on a consolidated basis. The condensed consolidating financial statements should be read in conjunction with the accompanying Condensed Consolidated Financial Statements.

14

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET

September 30, 2007

(In thousands)

			Guarantor			Non-Guarantor						Consolidated
	ResCare, Inc.		Subsidiaries			Subsidiaries			Eliminations			Total
ASSETS
Current assets:
Cash and cash equivalents	$	7,195	$	486		$	2,102		$	—		$	9,783
Accounts receivable, net	38,604		161,655			761			—			201,020
Deferred income taxes	16,589		—			—			—			16,589
Refundable income taxes	159		353			(77		)	—			435
Non-trade receivables	1,613		8,874			3			—			10,490
Prepaid expenses and other current assets	5,454		5,303			43			—			10,800
Total current assets	69,614		176,671			2,832			—			249,117
Property and equipment, net	34,117		45,458			54			—			79,629
Goodwill	83,163		316,196			5,343			—			404,702
Other intangible assets, net	7,002		26,257			—			—			33,259
Investment in subsidiaries	533,178		—			—			(533,178		)	—
Other assets	9,404		4,836			—			—			14,240
	$	736,478	$	569,418		$	8,229		$	(533,178	)	$	780,947
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	28,688	$	16,804		$	62		$	—		$	45,554
Accrued expenses	48,538		45,077			113			—			93,728
Current portion of long-term debt	299		3,202			—			—			3,501
Current portion of obligations under capital leases	13		61			—			—			74
Total current liabilities	77,538		65,144			175			—			142,857
Intercompany	27,974		(27,963		)	(11		)	—			—
Long-term liabilities	29,774		1,671			—			—			31,445
Long-term debt	189,168		1,614			—			—			190,782
Obligations under capital leases	37		766			—			—			803
Deferred gains	1,698		3,035			—			—			4,733
Deferred income taxes	16,844		—			(5		)	—			16,839
Total liabilities	343,033		44,267			159			—			387,459
Minority interests	—		43			—			—			43
Total shareholders’ equity	393,445		525,108			8,070			(533,178		)	393,445
	$	736,478	$	569,418		$	8,229		$	(533,178	)	$	780,947

15

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET

December 31, 2006

(In thousands)

				Guarantor		Non-Guarantor						Consolidated
	ResCare, Inc.			Subsidiaries		Subsidiaries			Eliminations			Total
ASSETS
Current assets:
Cash and cash equivalents	$	2,196		$	26	$	3,319		$	—		$	5,541
Accounts receivable, net	38,486			158,554		671			—			197,711
Deferred income taxes	15,110			—		—			—			15,110
Non-trade receivables	1,175			5,339		3			—			6,517
Prepaid expenses and other current assets	6,270			5,108		34			—			11,412
Total current assets	63,237			169,027		4,027			—			236,291
Property and equipment, net	31,300			44,245		61			—			75,606
Goodwill	76,059			294,804		4,631			—			375,494
Other intangible assets, net	2,536			25,016		—			—			27,552
Investment in subsidiaries	414,506			—		—			(414,506		)	—
Other assets	9,384			4,904		—			—			14,288
	$	597,022		$	537,996	$	8,719		$	(414,506	)	$	729,231
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	31,072		$	11,627	$	284		$	—		$	42,983
Accrued expenses	39,430			39,046		142			—			78,618
Current portion of long-term debt	322			4,046		—			—			4,368
Current portion of obligations under capital leases	144			26		—			—			170
Accrued income taxes	195			—		37			—			232
Total current liabilities	71,163			54,745		463			—			126,371
Intercompany	(72,375		)	70,728		1,647			—			—
Long-term liabilities	27,982			463		—			—			28,445
Long-term debt	204,335			1,281		—			—			205,616
Obligations under capital leases	26			247		—			—			273
Deferred gains	1,578			2,478		—			—			4,056
Deferred income taxes	12,836			—		(4		)	—			12,832
Total liabilities	245,545			129,942		2,106			—			377,593
Minority interests	—			161		—			—			161
Total shareholders’ equity	351,477			407,893		6,613			(414,506		)	351,477
	$	597,022		$	537,996	$	8,719		$	(414,506	)	$	729,231

16

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF INCOME

Three Months Ended September 30, 2007

(In thousands)

				Guarantor			Non-Guarantor					Consolidated
	ResCare, Inc.			Subsidiaries			Subsidiaries		Eliminations			Total
Revenues	$	72,500		$	290,986		$	1,112	$	—		$	364,598
Operating expenses	76,078			264,810			985		—			341,873
Operating income (loss)	(3,578		)	26,176			127		—			22,725
Other (income) expenses:
Interest, net	(737		)	5,196			76		—			4,535
Equity in earnings of subsidiaries	(13,187		)	—			—		13,187			—
Total other expenses	(13,924		)	5,196			76		13,187			4,535
Income from continuing operations, before income taxes	10,346			20,980			51		(13,187		)	18,190
Income tax (benefit) expense	(1,041		)	7,689			19		—			6,667
Income from continuing operations	11,387			13,291			32		(13,187		)	11,523
Loss from discontinued operations, net of tax	—			(136		)	—		—			(136		)
Net income	$	11,387		$	13,155		$	32	$	(13,187	)	$	11,387

17

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF INCOME

Nine Months Ended September 30, 2007

(In thousands)

				Guarantor			Non-Guarantor					Consolidated
	ResCare, Inc.			Subsidiaries			Subsidiaries		Eliminations			Total
Revenues	$	216,908		$	846,359		$	2,849	$	—		$	1,066,116
Operating expenses	223,092			776,190			2,450		—			1,001,732
Operating (loss) income	(6,184		)	70,169			399		—			64,384
Other (income) expenses:
Interest, net	3,483			10,100			141		—			13,724
Equity in earnings of subsidiaries	(37,819		)	—			—		37,819			—
Total other expenses	(34,336		)	10,100			141		37,819			13,724
Income from continuing operations, before income taxes	28,152			60,069			258		(37,819		)	50,660
Income tax (benefit) expense	(3,543		)	22,015			95		—			18,567
Income from continuing operations	31,695			38,054			163		(37,819		)	32,093
Loss from discontinued operations, net of tax	—			(398		)	—		—			(398		)
Net income	$	31,695		$	37,656		$	163	$	(37,819	)	$	31,695

18

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF INCOME

Three Months Ended September 30, 2006

(In thousands)

				Guarantor			Non-Guarantor						Consolidated
	ResCare, Inc.			Subsidiaries			Subsidiaries			Eliminations			Total
Revenues	$	61,143		$	271,660		$	(2,420	)	$	—		$	330,383
Operating expenses	55,714			256,240			(2,991		)	—			308,963
Operating income	5,429			15,420			571			—			21,420
Other (income) expenses:
Interest, net	2,205			2,304			(4		)	—			4,505
Equity in earnings of subsidiaries	(8,639		)	—			—			8,639			—
Total other expenses	(6,434		)	2,304			(4		)	8,639			4,505
Income from continuing operations, before income taxes	11,863			13,116			575			(8,639		)	16,915
Income tax expense	1,244			4,721			221			—			6,186
Income from continuing operations	10,619			8,395			354			(8,639		)	10,729
Loss from discontinued operations, net of tax	—			(110		)	—			—			(110		)
Net income	$	10,619		$	8,285		$	354		$	(8,639	)	$	10,619

19

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF INCOME

Nine Months Ended September 30, 2006

(In thousands)

				Guarantor			Non-Guarantor					Consolidated
	ResCare, Inc.			Subsidiaries			Subsidiaries		Eliminations			Total
Revenues	$	195,154		$	765,513		$	4,383	$	—		$	965,050
Operating expenses	185,700			713,258			3,664		—			902,622
Operating income	9,454			52,255			719		—			62,428
Other (income) expenses:
Interest, net	6,438			6,635			95		—			13,168
Equity in earnings of subsidiaries	(25,852		)	—			—		25,852			—
Total other expenses	(19,414		)	6,635			95		25,852			13,168
Income from continuing operations, before income taxes	28,868			45,620			624		(25,852		)	49,260
Income tax expense	1,162			17,563			240		—			18,965
Income from continuing operations	27,706			28,057			384		(25,852		)	30,295
Loss from discontinued operations, net of tax	—			(2,589		)	—		—			(2,589		)
Net income	$	27,706		$	25,468		$	384	$	(25,852	)	$	27,706

20

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended September 30, 2007

(In thousands)

				Guarantor			Non-Guarantor						Consolidated
	ResCare, Inc.			Subsidiaries			Subsidiaries			Eliminations			Total
Operating activities:
Net income	$	31,695		$	37,656		$	163		$	(37,819	)	$	31,695
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation and amortization	6,908			7,729			17			—			14,654
Impairment charge	—			332			—			—			332
Amortization of discount and deferred debt issuance costs on notes	806			—			—			—			806
Share-based compensation	5,361			—			—			—			5,361
Deferred income tax expense	2,529			—			(1		)	—			2,528
Excess tax benefit from share-based compensation	(1,724		)	—			—			—			(1,724		)
Provision for losses on accounts receivable	—			4,581			—			—			4,581
Loss on sale of assets	—			110			—			—			110
Equity in earnings of subsidiaries	(37,819		)	—			—			37,819			—
Changes in operating assets and liabilities	98,510			(87,198		)	(2,680		)	—			8,632
Cash provided by (used in) operating activities	106,266			(36,790		)	(2,501		)	—			66,975
Investing activities:
Purchases of property and equipment	(8,364		)	(7,846		)	(10		)	—			(16,220		)
Acquisitions of businesses	—			(33,444		)	—			—			(33,444		)
Proceeds from sale of assets	—			534			—			—			534
Cash used in investing activities	(8,364		)	(40,756		)	(10		)	—			(49,130		)
Financing activities:
Long-term debt repayments	(55,918		)	(3,048		)	—			—			(58,966		)
Borrowings of long-term debt	40,000			—			—			—			40,000
Short-term borrowings — three months or less, net	—			—			—			—			—
Payments on obligations under capital leases	—			(174		)	—			—			(174		)
Proceeds from sale and leaseback transactions	—			1,669			—			—			1,669
Net payments relating to intercompany financing	(80,853		)	79,559			1,294			—			—
Excess tax benefit from share-based compensation	1,724			—			—			—			1,724
Proceeds received from exercise of stock options	2,144			—			—			—			2,144
Cash (used in) provided by financing activities	(92,903		)	78,006			1,294			—			(13,603		)
Increase (decrease) in cash and cash equivalents	4,999			460			(1,217		)	—			4,242
Cash and cash equivalents at beginning of period	2,196			26			3,319			—			5,541
Cash and cash equivalents at end of period	$	7,195		$	486		$	2,102		$	—		$	9,783

21

RES-CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended September 30, 2006

(In thousands)

				Guarantor			Non-Guarantor						Consolidated
	ResCare, Inc.			Subsidiaries			Subsidiaries			Eliminations			Total
Operating activities:
Net income	$	27,706		$	25,468		$	392		$	(25,860	)	$	27,706
Adjustments to reconcile net income to cash (used in) provided by operating activities:
Depreciation and amortization	5,352			7,269			22			—			12,643
Impairment charges	—			1,110			—			—			1,110
Amortization of discount and deferred debt issuance costs on notes	736			—			—			—			736
Share-based compensation	1,371			—			—			—			1,371
Deferred income taxes	1,460			—			—			—			1,460
Excess tax benefits from share-based compensation	(2,627		)	—			—			—			(2,627		)
Provision for losses on accounts receivable	—			4,319			—			—			4,319
Loss on sale of assets	—			233			—			—			233
Equity in earnings of subsidiaries	(25,860		)	—			—			25,860			—
Changes in operating assets and liabilities	(46,895		)	22,917			(305		)	—			(24,283		)
Cash (used in) provided by operating activities	(38,757		)	61,316			109			—			22,668
Investing activities:
Purchases of property and equipment	(6,584		)	(5,528		)	366			—			(11,746		)
Acquisitions of businesses	—			(108,430		)	—			—			(108,430		)
Proceeds from sale of assets	—			13			—			—			13
Proceeds from sales and maturities of short-term investments	66,850			—			—			—			66,850
Purchases of short-term investments	(39,200		)	—			—			—			(39,200		)
Cash provided by (used in) investing activities	21,066			(113,945		)	366			—			(92,513		)
Financing activities:
Repayments of long-term debt and capital leases	(78		)	(3,079		)	(393		)	—			(3,550		)
Borrowings of long-term debt	40,000			—			—			—			40,000
Short-term borrowings — three months or less, net	19,500			—			—			—			19,500
Payments on obligations under capital lease, net	—			(891		)	—			—			(891		)
Proceeds from sale and leaseback transactions	—			2,651			—			—			2,651
Debt issuance costs	(468		)	—			—			—			(468		)
Excess tax benefit from share-based compensation	2,627			—			—			—			2,627
Net payments relating to intercompany financing	(54,303		)	53,514			789			—			—
Proceeds received from exercise of stock options	6,734			—			—			—			6,734
Cash provided by financing activities	14,012			52,195			396			—			66,603
(Decrease) increase in cash and cash equivalents	(3,679		)	(434		)	871			—			(3,242		)
Cash and cash equivalents at beginning of period	5,192			1,927			2,775			—			9,894
Cash and cash equivalents at end of period	$	1,513		$	1,493		$	3,646		$	—		$	6,652

22

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

Preliminary Note Regarding Forward-Looking Statements

Statements in this report that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act. In addition, we expect to make such forward-looking statements in future filings with the Securities and Exchange Commission, in press releases, and in oral and written statements made by us or with our approval. These forward-looking statements include, but are not limited to: (1) projections of revenues, income or loss, earnings or loss per share, capital structure and other financial items; (2) statements of plans and objectives of ResCare or our management or Board of Directors; (3) statements of future actions or economic performance, including development activities; (4) statements of assumptions underlying such statements; and (5) statements about the limitations on the effectiveness of controls. Words such as “believes”, “anticipates”, “expects”, “intends”, “plans”, “targeted”, and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Some of the events or circumstances that could cause actual results to differ from those discussed in the forward-looking statements are discussed in the “Risk Factors” section in Part II, Item 1A of this Report and in our 2006 Annual Report on Form 10-K. Such forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date on which such statement is made.

The following Management’s Discussion and Analysis (“MD&A”) section is intended to help the reader understand ResCare’s financial performance and condition. MD&A is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes. All references in this MD&A to “ResCare”, “our company”, “we”, “us”, or “our” mean Res-Care, Inc. and unless the context otherwise requires, its consolidated subsidiaries.

Overview of Our Business

We receive revenues primarily from the delivery of residential, support, training and educational services to various populations with special needs. We have three reportable operating segments: (i) Community Services; (ii) Job Corps Training Services and (iii) Employment Training Services. Management’s discussion and analysis of each segment is included below. Further information regarding our segments is included in Note 8 of the Notes to Condensed Consolidated Financial Statements.

Revenues for our Community Services operations are derived primarily from state Medicaid programs, other government agencies, commercial insurance companies and from management contracts with private operators. Private operators are generally not-for-profit providers, who contract with state government agencies and are also reimbursed under the Medicaid program. Our services include social, functional and vocational skills training, supported employment and emotional and psychological counseling for individuals with intellectual or other disabilities. We also provide respite, therapeutic and other services on an as-needed or hourly basis reimbursed by unit-of-service.

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Reimbursement varies by state and service type, and may be based on a variety of methods including flat-rate, cost-based reimbursement, per person per diem, or unit-of-service basis. Generally, rates are adjusted annually based upon historical costs experienced by us and by other service providers, or economic conditions and their impact on state budgets. At facilities and programs where we are the provider of record, we are directly reimbursed under state Medicaid programs for services we provide and such revenues are affected by occupancy levels. At most facilities and programs that we operate pursuant to management contracts, the management fee is negotiated with the provider of record.

Also in the Community Services segment, ResCare has a growing business through ResCare HomeCare, which offers personalized services to seniors and individuals of all ages, physical conditions and cognitive abilities recovering from illness, injury, surgery, living with a chronic disability or dealing with the natural process of aging. We provide professional nursing, personal care and support, homemaking, respite and other services in the home, the hospital or long-term care facilities to augment the institutional care. Pay can be through insurance, contracts with hospitals, long-term care facilities or private pay from individuals and their families receiving the care.

We operate vocational training centers under the federal Job Corps program administered by the Department of Labor (DOL) through our Job Corps Training Services operations. Under Job Corps contracts, we are reimbursed for direct facility and program costs related to Job Corps center operations, allowable indirect costs for general and administrative costs, plus a predetermined management fee. The management fee takes the form of a fixed contractual amount plus a computed amount based on certain performance criteria. All of such amounts are reflected as revenue, and all such direct costs are reflected as facility and program costs. Final determination of amounts due under Job Corps contracts is subject to audit and review by the DOL, and renewals and extension of Job Corps contracts are based in part on performance reviews.

We operate job training and placement programs that assist disadvantaged job seekers in finding employment and improving their career prospects through our Employment Training Services operations. These programs are administered under contracts with local and state governments. We are typically reimbursed for direct facility and program costs related to the job training centers, allowable indirect costs plus a fee for profit. All of such amounts are reflected as revenue, and all such direct costs are reflected as facility and program costs. The fee can take the form of a fixed contractual amount (rate or price) or be computed based on certain performance criteria. The contracts are funded by federal agencies, including the DOL and Department of Health and Human Services.

Application of Critical Accounting Policies

Our discussion and analysis of the financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts and related disclosures of commitments and contingencies. We rely on historical experience and on various other assumptions that we believe to be reasonable under the circumstances to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.

We continually review our accounting policies and financial information disclosures. A summary of our more significant accounting policies that require the use of estimates and judgments in preparing

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the financial statements was provided in our 2006 Annual Report on Form 10-K. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2007, there were no material changes in the accounting policies and assumptions.

Results of Operations

	Three Months Ended September 30						Nine Months Ended September 30
	2007			2006			2007			2006
	(Dollars in thousands)
Revenues:
Community Services (1)	$	270,354		$	238,618		$	781,856		$	672,406
Job Corps Training Services	40,074			39,404			122,626			118,733
Employment Training Services	50,904			48,344			147,087			158,848
Other	3,266			4,017			14,547			15,063
Consolidated	$	364,598		$	330,383		$	1,066,116		$	965,050
Operating income (loss):
Community Services (1)	$	28,355		$	28,017		$	83,094		$	77,552
Job Corps Training Services	3,891			4,350			12,001			12,732
Employment Training Services	6,001			3,393			13,436			12,254
Other (2)	(487		)	(483		)	990			1,325
Total Operating Expenses (3)	(15,035		)	(13,857		)	(45,137		)	(41,435		)
Consolidated	$	22,725		$	21,420		$	64,384		$	62,428
Operating margin:
Community Services (1)	10.5		%	11.7		%	10.6		%	11.5		%
Job Corps Training Services	9.7		%	11.0		%	9.8		%	10.7		%
Employment Training Services	11.8		%	7.0		%	9.1		%	7.7		%
Other (2)	(14.9		%)	(12.0		%)	6.8		%	8.8		%
Total Operating Expenses	(4.1		%)	(4.2		%)	(4.2		%)	(4.3		%)
Consolidated	6.2		%	6.5		%	6.0		%	6.5		%

(1)	Excludes results for Washington, D.C. and New Mexico, which were reclassified to discontinued operations for all periods presented.
(2)	Nine months ended September 30, 2007 includes a $0.3 million goodwill impairment charge related to our charter schools reporting unit.
(3)	Represents corporate general and administrative expenses, other operating (income) and expenses.

Consolidated

Consolidated revenues for the quarter ended September 30, 2007 increased 10.4% over the 2006 quarter. This increase was primarily related to acquisitions and organic growth in the Community Services segment, as well as new contracts in the Employment Training Services segment. Consolidated revenues for the nine months ended September 30, 2007 increased 10.5% over the same period in 2006. The increase is primarily related to acquisitions and organic growth in the Community Services segment, which were partially offset by 2006 Employment Training Services contract non-renewals and

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unfavorable modifications to existing contracts, generally effective July 1, 2006. Revenues are more fully described in the segment discussions.

Consolidated operating income for the quarter ended September 30, 2007 increased 6.1% over the same period in 2006, primarily due to revenue increases. Operating margin decreased to 6.2% for the 2007 quarter compared to 6.5% for the 2006 quarter. The decrease in operating margin was primarily attributed to higher share-based compensation and insurance related costs and low margins on the ramp up and integration of our Kelly Home Care Services acquisition in March 2007.

Consolidated operating income for the nine months ended September 30, 2007 increased 3.1% over the same period in 2006, while operating margin decreased to 6.0% for the 2007 nine month period compared to 6.5% for the nine months of 2006. The margin decrease was primarily attributed to incremental share-based compensation expense of $4.0 million, higher insurance-related costs of $1.1 million, a $0.3 million goodwill impairment charge in the quarter ended March 31, 2007 related to our charter schools, and the lower overall margins associated with our Kelly Home Care Services acquisition. Included in consolidated operating income are total operating expenses, which represent corporate general and administrative expenses, other operating income and expenses. As a percentage of total revenue, the expenses were 4.1% and 4.2% in the quarter and nine months ended September 30, 2007, respectively, and 4.2% and 4.3% for the same periods in 2006.

Net interest expense was $4.5 million for the quarters ended September 30, 2007 and 2006. Net interest expense increased $0.6 million for the nine months ended September 30, 2007, compared to the same period in 2006. The increase for the nine month period in 2007 was primarily attributable to increased average borrowing levels due to acquisitions.

Our effective income tax rate for the quarter and nine months ended September 30, 2007 is 36.7%, as compared to 36.6% and 38.5% for the quarter and nine months ended September 30, 2006, respectively. The 2006 effective rates were primarily higher due to the reenactment of the Work Opportunity Tax Credit in December 2006, which was not included in the quarterly or nine month 2006 tax rates. The 2006 effective tax rates were partially reduced for the reversal of certain income tax reserves upon the expiration of the applicable statute of limitations for certain tax filing positions, which was recorded in the third quarter of 2006.

Community Services

Community Services revenues for the quarter and nine months ended September 30, 2007 increased by 13.3% and 16.3%, respectively, over the same periods in 2006. These increases were due primarily to acquisitions in 2006 and 2007. Operating margin decreased from 11.7% in the third quarter of 2006 to 10.5% in the same period in 2007 and from 11.5% to 10.6% for the nine months ended September 30, 2007, over the comparable period in 2006. The decreased margin percentages were primarily due to incremental share-based compensation expense of $0.4 million in the quarter and $2.0 million in the nine month period. Also, higher insurance related costs of $2.3 million in the quarter and $4.6 million in the nine month period, as well as the lower overall margins associated with our Kelly Home Care Services acquisition and pharmacy business contributed to the lower 2007 margin.

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Job Corps Training Services

Job Corps Training Services revenues increased 1.7% and 3.3%, respectively, for the quarter and nine months ended September 30, 2007, over the same periods in 2006 due principally to contractual and spending increases. Operating margin decreased from 11.0% in the third quarter of 2006 to 9.7% in the same period in 2007 and from 10.7% to 9.8% for the nine months ended September 30, 2007, over the comparable period in 2006. These decreases were primarily due to higher administration costs being allocated in 2007 versus 2006, which were included in corporate general and administrative expenses in the prior year.

Employment Training Services

Employment Training Services revenues increased 5.3% in the quarter ended September 30, 2007 over the same period in 2006, due primarily to new 2007 contracts in Arizona and Indiana, coupled with 2006 contract non-renewals and concessions in modifications to existing contracts, which were generally effective July 1, 2006. Revenues for the nine months ended September 30, 2007 decreased 7.4% from the same period in 2006 due primarily to the higher 2006 revenues prior to the effective dates of contract non-renewals and concessions in modifications to existing contracts. Operating margin increased from 7.0% in the third quarter of 2006 to 11.8% in the same period in 2007, due primarily to performance incentives on certain projects, as well as lower than expected start-up costs for certain contracts. Operating margin increased from 7.7% in the nine months ended September 20, 2006 to 9.1% in the same period in 2007. This increase was primarily related to the factors noted above for the quarter ended September 30, 2007, partially offset by increased share-based compensation expense.

Other

Our Other segment reflects activity for operating schools and international job training and placement agencies. Revenues from the segment decreased 18.7% and 3.4% for the quarter and nine months ended September 30, 2007 compared to the same periods in 2006, due primarily to a lost contract in Florida, which was effective July 1, 2007. Operating income was flat for the quarter ended September 30, 2007, versus the same period in 2006. Operating income decreased $0.3 million, or 25.3% in the nine months ended September 30, 2007 versus the same period in 2006, due primarily to a $0.3 million goodwill impairment charge related to our charter schools, which was recorded in March 2007.

Corporate General and Administrative Expenses

Corporate general and administrative expenses for the quarter ended September 30, 2007 were $15.0 million, or 4.1% of total revenues, compared to $13.9 million, or 4.2% of total revenues, for the same period in 2006. The increase in expenses for the third quarter of 2007 was primarily related to corporate office relocation expenses of $0.5 million and higher compensation accruals. Expenses for the nine months ended September 30, 2007 were $45.1 million, or 4.2% of total revenues, compared to $41.4 million, or 4.3% of total revenues, for the same period in 2006. The 2007 dollar increase resulted primarily from $1.6 million of incremental share-based compensation expense, $1.0 million of corporate office relocation expenses, as well as higher compensation related accruals.

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Discontinued Operations

The discontinued operations relate to the Community Services segment’s exit from the District of Columbia and the state of New Mexico, which were effective on March 31, 2006 and October 31, 2006, respectively.

Net loss from discontinued operations was $0.1 million in the third quarter of 2007 and $0.4 million for the nine months ended September 30, 2007, compared to $0.1 million and $2.6 million for the same periods a year ago. The net loss from discontinued operations for the nine months ended September 30, 2007 includes pretax operational losses of $0.7 million, offset by favorable adjustments of $0.1 million to our exit cost accrual, and a tax benefit of $0.2 million.

The net loss from discontinued operations for the nine months ended September 30, 2006, includes pretax operational losses of $2.0 million, a pretax charge of $1.6 million for an exit cost accrual, and $0.6 million impairment charge for impaired leaseholds and furniture, offset by a tax benefit of $1.6 million.

Financial Condition, Liquidity and Capital Resources

Total assets increased 7.1% in 2007 over balances at December 31, 2006. This increase was primarily due to growth from prior year and current year acquisitions. Goodwill and other intangible assets increased $29.2 million and $5.7 million, respectively, from December 31, 2006, as a result of the acquisitions completed during the first nine months of 2007.

Cash and cash equivalents were $9.8 million at September 30, 2007, as compared to $5.5 million at December 31, 2006. Cash provided from operations for the nine months ended September 30, 2007 was $67.0 million compared to $22.7 million for the nine months ended September 30, 2006. The increase in 2007 from 2006 was primarily the result of the 2006 funding of the accounts receivable and other working capital requirements for the January 3, 2006 Workforce Services acquisition, as well as increases in net income, depreciation and share-based compensation.

Net accounts receivable at September 30, 2007 increased to $201.0 million, compared to $197.7 million at December 31, 2006 due to the organic growth and acquisitions in the Community Services segment. Days revenue in net accounts receivable were 49.5 days at September 30, 2007 compared with 51.9 days at December 31, 2006. The decrease in the number of days is attributable to higher collections in our Employment Training Services and Community Services segments.

Capital expenditures were higher than our historical experience due primarily to increased leasehold improvements related to the relocation of our corporate office. We invested $16.2 million in the first nine months of 2007 on purchases of property and equipment compared to $11.7 million in the same period in 2006. We also used $33.4 million on acquisitions.

Our financing activities during the first nine months of 2007 included net payments on the revolver of $15.0 million, as well as net payments of debt and capital lease obligations of $0.4 million. This compares to net borrowings on the revolver in the same period for 2006 of $59.5 million, primarily due to the Workforce Services acquisition. Stock option exercise activity resulted in $2.1 million in proceeds for the 2007 period versus $6.7 million in 2006.

Our capital requirements relate primarily to our plans to expand through selective acquisitions and the development of new facilities and programs, and our need for sufficient working capital for

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general corporate purposes. Since most of our facilities and programs are operating at or near capacity, and budgetary pressures and other forces are expected to limit increases in reimbursement rates we receive, our ability to continue to grow at the current rate depends directly on our acquisition and development activity. We have historically satisfied our working capital requirements, capital expenditures and scheduled debt payments from our operating cash flow and utilization of our credit facility.

As of September 30, 2007, we had irrevocable standby letters of credit in the principal amount of $55.8 million issued primarily in connection with our insurance programs.

We have a $200 million revolving credit facility, which can be increased to $250 million at our option. The credit facility expires on October 3, 2010 and will be used primarily for working capital purposes, letters of credit required under our insurance programs and for acquisitions. The credit facility is secured by a lien on all of our assets and, through secured guarantees, on all of our domestic subsidiaries’ assets.

As of September 30, 2007, we had $104.2 million available under the revolver with an outstanding balance of $40.0 million. Outstanding balances bear interest at 1.38% over the London Interbank Offered Rate (LIBOR) or other bank developed rates at our option. As of September 30, 2007, the weighted average interest rate was 7.14%. Letters of credit had a borrowing rate of 1.38% as of September 30, 2007. The commitment fee on the unused balance was 0.3%. The margin over LIBOR and the commitment fee are determined quarterly based on our leverage ratio, as defined by the revolving credit facility.

The credit facility contains various financial covenants relating to net worth, capital expenditures and rentals and requires us to maintain specified ratios with respect to our interest and leverage. We are in compliance with our debt covenants as of September 30, 2007. Our ability to achieve the thresholds provided for in the financial covenants largely depends upon the maintenance of continued profitability and/or reductions of amounts borrowed under the facility, and continued cash collections.

Operating funding sources are approximately 62% through Medicaid reimbursement, 12% from the DOL and 26% from other payors. We believe our sources of funds through operations and available through the credit facility described above will be sufficient to meet our working capital, planned capital expenditure and scheduled debt repayment requirements for the next twelve months.

We had no significant off-balance sheet transactions or interests in 2007.

Impact of Recently Issued Accounting Pronouncements

See Note 12 of the Notes to Condensed Consolidated Financial Statements.

Item 3.            Quantitative and Qualitative Disclosures about Market Risk

                While we are exposed to changes in interest rates as a result of any outstanding variable rate debt, we do not currently utilize any derivative financial instruments related to our interest rate exposure. Our senior secured credit facility, which has an interest rate based on margins over LIBOR or prime, tiered based upon leverage calculations, had an outstanding balance of $40.0 million and $55.0 million as of September 30, 2007 and December 31, 2006, respectively. A 100 basis point movement in

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the interest rate would result in an approximate $0.4 million annualized effect on interest expense and cash flows.

Item 4.            Controls and Procedures

Evaluation of Disclosure Controls and Procedures

ResCare’s management, under the supervision and with the participation of the Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2007. Based on that evaluation, the CEO and CFO concluded that ResCare’s disclosure controls and procedures are effective in timely making known to them material information required to be disclosed in the reports filed or submitted under the Securities Exchange Act. There were no changes in ResCare’s internal controls over financial reporting during the quarter ended September 30, 2007 that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

Limitations on the Effectiveness of Controls

A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, with our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, that breakdowns can occur because of simple errors or mistakes, and that controls can be circumvented by the acts of individuals or groups. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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PART II.                OTHER INFORMATION

Item 1.            Legal Proceedings

Information regarding the legal proceedings is described in Note 10 to the condensed consolidated financial statements set forth in Part I of this report and incorporated by reference into this Part II, Item 1.

Item 1A.         Risk Factors

There have been no material changes from the risk factors previously disclosed in our 2006 Annual Report on Form 10-K and our 2007 Quarterly Reports on Form 10-Q.

Item 2.            Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities	None
Issuer Repurchases of Securities	None

Item 5.            Other Information

                From time to time executive officers and directors of ResCare may adopt non-discretionary, written trading plans that comply with SEC Rule 10b5-1, which provides executives with a method to monetize their equity-based compensation in an automatic and non-discretionary manner over time. The trading plans adopted by our executives must comply with our compensation and trading policies, and applicable laws and regulations. Consistent with ResCare’s philosophy of open communication with our shareholders, we post information about any trading plans of our executive officers and directors in effect from time to time on our corporate website.

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Item 6.            Exhibits

(a) Exhibits

31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended.
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended.
32.	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		RES-CARE, INC.
		Registrant
Date:	November 6, 2007	By:	/s/ Ralph G. Gronefeld, Jr.
			Ralph G. Gronefeld, Jr.
			President and Chief Executive Officer
Date:	November 6, 2007	By:	/s/ David W. Miles
			David W. Miles
			Executive Vice President and
			Chief Financial Officer

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EX-31.1

EXHIBIT 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT

I, Ralph G. Gronefeld, Jr., certify that:

1.I have reviewed this report on Form 10-Q of Res-Care, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of  the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	November 6, 2007	By:	/s/ Ralph G. Gronefeld, Jr.
			Ralph G. Gronefeld, Jr.
			President and Chief Executive Officer

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EX-31.2

EXHIBIT 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT

I, David W. Miles, certify that:

1.I have reviewed this report on Form 10-Q of Res-Care, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of  the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	November 6, 2007	By:	/s/ David W. Miles
			David W. Miles
			Executive Vice President and
			Chief Financial Officer

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EX-32

EXHIBIT 32

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350

(AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002)

In connection with the Quarterly Report of Res-Care, Inc. (the “Company”) on Form 10-Q for the period ended September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”),  the undersigned, the Chief Executive Officer and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, that:

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:	November 6, 2007	By:	/s/ Ralph G. Gronefeld, Jr.
			Ralph G. Gronefeld, Jr.
			President and Chief Executive Officer
Date:	November 6, 2007	By:	/s/ David W. Miles
			David W. Miles
			Executive Vice President and
			Chief Financial Officer

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

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