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 2007 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 complements, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes. All references in 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, training, educational and support services to various populations with special needs. Our programs include an array of services provided in both residential and non-residential settings for adults and youths with intellectual, cognitive or other developmental disabilities, and youths who have special educational or support needs, are from disadvantaged backgrounds, or have severe emotional disorders, including some who have entered the juvenile justice system. We also offer, through drop-in or live-in services, personal care, meal preparation, housekeeping and transportation to the elderly in their own homes. Additionally, we provide services to welfare recipients, young people and people who have been laid off or have special barriers to employment, to transition into the workforce and become productive employees.

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 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, 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 to individuals with special needs and to older people in their homes. These services are provided on an as-needed basis or hourly basis through our periodic in-home services programs.

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.

Our growing ResCare HomeCare business, also in the Community Services segment, 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. Reimbursement can be through insurance, contracts with hospitals and/or long-term care facilities or private pay from the individuals and their families receiving the care. We are concentrating growth efforts in the home care private pay business to further diversify our revenue streams.

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 domestic 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. 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.

Additionally, we operate international job training and placement agencies that assist disadvantaged job seekers in the U.K., Germany and Netherlands, as well as domestic charter and alternative education schools.

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 of America (U.S. GAAP). The preparation of these financial statements 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.

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 the financial statements was provided in our 2007 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 2008, there were no material changes in the critical accounting policies and assumptions.

Results of Operations



                                 Three Months Ended          Nine Months Ended
                                    September 30                September 30
                                 2008         2007          2008           2007
                                              (Dollars in thousands)

Revenues:
Community Services (1)         $ 282,619    $ 270,354    $   825,219    $   781,856
Job Corps Training Services       39,952       40,074        122,270        122,626
Employment Training Services      55,140       50,904        166,641        147,087
Other (3)                         10,212        3,266         34,570         14,547
Consolidated                   $ 387,923    $ 364,598    $ 1,148,700    $ 1,066,116

Operating income:
Community Services (1) (2)     $  30,185    $  27,674    $    64,709    $    82,164
Job Corps Training Services        2,974        2,896          8,836          8,705
Employment Training Services       5,229        6,001         17,439         13,436
Other (3) (4)                       (685 )       (487 )        1,715            990
Total Operating Expenses (5)     (15,030 )    (13,235 )      (44,443 )      (40,604 )
Consolidated                   $  22,673    $  22,849    $    48,256    $    64,691

Operating margin:
Community Services (1) (2)          10.7 %       10.2 %          7.8 %         10.5 %
Job Corps Training Services          7.4 %        7.2 %          7.2 %          7.1 %
Employment Training Services         9.5 %       11.8 %         10.5 %          9.1 %
Other (3) (4)                       (6.7 )%     (14.9 )%         5.0 %          6.8 %
Total Operating Expenses (5)        (3.9 )%      (3.6 )%        (3.9 )%        (3.8 )%
Consolidated                         5.8 %        6.3 %          4.2 %          6.1 %

(2) Nine months ended September 30, 2008 includes a $24.4 million charge related to the resolution of three separate legal matters and the ongoing proceedings of another case within our CSG segment.

(3) Represents our international job training and placement agencies, as well as our charter and alternative education schools.

(4) Nine months ended September 30, 2007 includes a $0.3 million goodwill impairment charge related to our charter schools.

(5) Represents corporate general and administrative expenses, as well as other operating (income) and expenses related to the corporate office.

Consolidated

Consolidated revenues for the quarter and nine months ended September 30, 2008 increased 6.4% and 7.7%, respectively, over the same periods in 2007. These increases were primarily related to acquisitions in the Community Services and Other segments, as well as new contracts in the Employment Training Services segment. Revenues are more fully described in the segment discussions.

Consolidated operating income for the quarter ended September 30, 2008, was $22.7 million compared to $22.8 million over the same period in 2007. Consolidated operating margins were 5.8% and 6.3% for the quarterly periods in 2008 and 2007, respectively, due primarily to lower operating margins in the Employment Training Services segment, as well as higher corporate general and administrative expenses.

Consolidated operating income for the nine months ended September 30, 2008 was $48.3 million compared to $64.7 million for the same period in 2007. Consolidated operating margins were 4.2% and 6.1% for the nine month periods in 2008 and 2007, respectively. The reductions in 2008 operating income and margins were primarily related to the second quarter 2008 $24.4 million legal charge, but were favorably offset by $1.8 million in lower share-based compensation expense. The legal charge reduced 2008 operating margins by 2.1 percentage points. Operating income is more fully described in the segment discussions.

Net interest expense decreased $0.1 million for the third quarter and $0.4 million for the nine months ended September 30, 2008, compared to the same periods in 2007. The decreases were attributable to lower rates. Our effective income tax rate for the nine months ended September 30, 2008 was 36.0% as compared to 36.7% over the same period in 2007. The decrease in the effective rate was due primarily to the legal charge.

Community Services

Community Services revenues for the quarter and nine months ended September 30, 2008 increased by 4.5% and 5.5%, respectively over the same periods in 2007. These increases were due primarily to acquisition growth, which were partially offset by softness in the HomeCare business. Operating margin increased from 10.2% in the third quarter of 2007 to 10.7% in the same period in 2008 and decreased from 10.5% to 7.8% for the nine months ended September 30, 2007 compared to 2008. The third quarter increase in operating margin was primarily due to $2.3 million in lower insurance costs and the integration of Kelly Home Care Services, which were partially offset by higher fuel and utility costs. The reduction in the year-to-date operating margin was primarily due to the second quarter 2008 $24.4 million legal charge, which was partially offset by expense control. The legal charge reduced operating margin for the nine months ended September 30, 2008 by 3.0 percentage points.

Job Corps Training Services

Job Corps Training Services revenues remained consistent for the quarter and nine months ended September 30, 2008 and 2007. Operating margin increased from 7.2% in the third quarter of 2007 to 7.4% in the same period in 2008 and increased from 7.1% in the nine months ended September 30, 2007 to 7.2% for the same period in 2008.

Employment Training Services

Employment Training Services revenues increased 8.3% in the quarter and 13.3% in the nine months ended September 30, 2008 over the same periods in 2007, due primarily to the ramping up of the Arizona and Indiana contracts and new contracts in Texas, Arkansas and South Carolina, which were partially offset by lost contracts in Florida due to the state taking services in-house. Operating margin decreased from 11.8% in the third quarter of 2007 to 9.5% in the same period in 2008, due primarily to the timing of performance incentives. Operating margin increased from 9.1% in the nine months ended September 30, 2007 to 10.5% for the first nine months of 2008, due primarily to improvements in performance in the New York City Back to Work contract, incentives received in certain programs, and the ramping up of the Arizona and Indiana contracts, which were partially offset by lost contracts in Florida.

Other

Included in Other is our international job training and placement agencies, as well as a portion of our business dedicated to operating domestic charter and alternative education schools. Revenues increased from $3.3 million in the 2007 third quarter to $10.2 million in the same period in 2008 and from $14.5 million for the nine month period ended September 30, 2007 to $34.6 million in the same period in 2008. This increase was primarily related to the late 2007 acquisitions in international job training and placement agency business. International revenues related to these acquisitions were approximately $6.1 million and $20.3 million for the quarter and nine months ended September 30, 2008, respectively. Operating margin improved from (14.9%) in the third quarter ended September 30, 2007 to (6.7%) in the comparable period in 2008, and decreased from 6.8% in the nine months ended September 30, 2007 to 5.0% in the 2008 nine month period. The lower margin for the nine months ended September 30, 2008 reporting period is due primarily to the low operating income in the international business, which is caused by slower than anticipated revenue growth and higher than anticipated integration costs.

Total Operating Expenses

Total operating expenses represent corporate general and administrative expenses, as well as other operating income and expenses. Total operating expenses increased 13.6% and 9.5% for the quarter and nine months ended September 30, 2008, respectively, compared to the same periods in 2007. These increases were due primarily to higher information technology department costs, as well as increases associated with revenue growth, which were partially offset by lower share-based compensation expense.

Financial Condition, Liquidity and Capital Resources

Total assets increased 6.8% in 2008 over balances at December 31, 2007. This increase was primarily due to growth from acquisitions. Goodwill and other intangible assets increased $35.6 million from December 31, 2007, primarily as a result of the acquisitions completed during the first nine months of 2008.

Cash and cash equivalents were $14.3 million at September 30, 2008, as compared to $10.8 million at December 31, 2007. The increase in cash and cash equivalents is primarily related to proceeds from short-term borrowings needed for working capital purposes. Cash provided from operations for the nine months ended September 30, 2008 was $47.3 million compared to $67.0 million for the nine months ended September 30, 2007. The decrease in cash provided from operations was primarily related to lower net income due principally to the $24.4 million legal charge from the second quarter 2008.

Net accounts receivable at September 30, 2008 increased to $220.2 million, compared to $206.5 million at December 31, 2007 due primarily to acquisition-related growth. Days of revenue in net accounts receivable were 50.4 days at September 30, 2008 compared with 49.0 days at December 31, 2007.

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 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 flows and borrowings under our revolving credit facility.

The capital markets remain under duress due to the ongoing financial crisis and may impede our ability to expand and grow our business if credit conditions remain tight or our access to these markets becomes limited. State budgetary pressures from the financial crisis may put further pressure on reimbursement rates and limit our ability to receive rate increases. We expect to begin negotiating new renewal terms for our $250 million senior secured revolving credit facility during the second half of 2009 and may face significant rate and pricing increases as well as more restrictive debt covenants over the terms in place currently. Some members of our bank lending group, due to pressure from the financial crisis, may have limitations in providing capital and we may see a significant change in lender participation as a result.

Capital expenditures were consistent with our historical experience. We invested $14.2 million during the first nine months of 2008 on purchases of property and equipment. We also used $39.0 million on acquisitions.

Our financing activities included a net borrowing on the revolver of $10.0 million, offset by payments of debt and capital lease obligations of $1.6 million for the first nine months of 2008. This compares to net borrowings on the revolver of $40.0 million, offset by payments of debt and capital lease obligations of $59.0 million for the same period in 2007. Stock option exercise activity resulted in $1.3 million in proceeds for the 2008 period versus $2.1 million in 2007.

The 2007 amendment to our senior secured revolving credit facility increased our borrowing capacity by $50 million to a total of $250 million. Additional capacity of $50 million remains in place, subject to certain limitations in our $150 million 7.75% Senior Notes due 2013, which allows us to expand our total borrowing capacity to $300 million. 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, 2008, we had $116.5 million available under the revolver with an outstanding balance of $79.3 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, 2008, the weighted average interest rate was 4.71%. As of September 30, 2008, we had irrevocable standby letters of credit in the principal amount of $54.2 million issued primarily in connection with our insurance programs. Letters of credit had a borrowing rate of 1.38% as of September 30, 2008. 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, 2008 and although the $24.4 million legal charge recorded in the second quarter 2008 negatively impacted the calculation of certain bank covenants, we believe we will continue to be in compliance with our debt covenants over the next twelve months. 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 60% through Medicaid reimbursement, 11% from the DOL and 29% 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 2008 or 2007.

Impact of Recently Issued Accounting Pronouncements

See Note 11 of the Notes to Condensed Consolidated Financial Statements.