**SECURITIES
                          AND EXCHANGE COMMISSION**
 **Washington,
                          D.C. 20549**
 
 **Form
                          10-K**
 (Mark
                          One)
 x
                                  **ANNUAL
                                      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                                      SECURITIES EXCHANGE ACT OF
                                      1934 for the fiscal year ended December 31,
                                      2006**
 **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 No. 0-20619**
 
 
 **MATRIA
                          HEALTHCARE, INC.**
 (Exact
                          name of registrant as specified in its charter)
 **Delaware**
                                **20-2091331**(State
                                    or other jurisdiction ofincorporation
                                    or organization)
                                (IRS
                                    Employer Identification No.)
  **1850
                                    Parkway Place**
                                  **Marietta,
                                    Georgia**
                                **30067**(Address
                                    of principal executive offices)
                                (Zip
                                    Code)
  
 **(770)
                          767-4500**
 Registrant's
                          telephone number, including area code
 
 Securities
                                    registered pursuant to Section 12(b) of the Act:
                                Name
                                    of each exchange on which registered:**Common
                                    Stock, par value $0.01 per share**
                                **The
                                    Nasdaq Stock Market, LLC**(Title
                                    of each class)
 
 
 Securities
                          registered pursuant to Section 12(g) of the Act: **None** (Title
                          of class)
 
 Indicate
                          by check mark if the registrant is a well-known seasoned
                          issuer, as defined in
                          Rule 405 of the Securities Act.
 Yes o No x
 
 Indicate
                          by check mark if the registrant is not required to file
                          reports pursuant to
                          Section 13 or Section 15(d) of the Exchange Act.
 Yes o No x
 
 Indicate
                          by check mark whether the registrant: (1) has filed all
                          reports required to be
                          filed by Section 13 or 15(d) of the Securities Exchange
                          Act of 1934 during the
                          preceding 12 months (or for such shorter period that the
                          registrant was required
                          to file such reports), and (2) has been subject to such
                          filing requirements for
                          the past 90 days: Yes x No o
 
 Indicate
                          by check mark if disclosure of delinquent filers pursuant
                          to Item 405 of
                          Regulation S-K is not contained herein and will not be
                          contained, to the best of
                          registrant’s knowledge, in definitive proxy or information statements
                          incorporated by reference in Part III of this Form 10-K
                          or any amendment to this
                          Form 10-K. x
 
 Indicate
                          by check mark whether the registrant is a large accelerated
                          filer, an
                          accelerated filer, or a non-accelerated filer. See definition
                          of “accelerated
                          filer and large accelerated filer” in Rule 12b-2 of the Exchange
                          Act.
 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 Exchange Act).   Yes o No x
 
 
 As
                          of
                          June 30, 2006, the aggregate market value of common stock
                          held by nonaffiliates
                          was approximately $434,488,057, based upon the closing
                          sale price for such date
                          as reported on the Nasdaq Global Select Market. As of March
                          1, 2007, there were
                          21,533,273 shares of our common stock outstanding.
  **DOCUMENTS
                          INCORPORATED BY REFERENCE**
  Portions
                          of the registrant’s definitive Proxy Statement for the 2007 Annual Meeting
                          of
                          Shareholders are incorporated by reference into Part III.
  1
  
 **MATRIA
                          HEALTHCARE, INC.**
 **2006
                          FORM 10-K ANNUAL REPORT**
 **TABLE
                          OF CONTENTS**
 
 
 **PART
                                    I**Item
                                    1.
                                Business
                                3Item
                                    1A.
                                Risk
                                    Factors
                                8Item
                                    1B.
                                Unresolved
                                    Staff Comments
                                13Item
                                    2.
                                Properties
                                13Item
                                    3.
                                Legal
                                    Proceedings
                                13Item
                                    4.
                                Submission
                                    of Matters to a Vote of Security Holders
                                13Special
                                    Item
                                Executive
                                    Officers of the Company
                                14**PART
                                    II**Item
                                    5.
                                Market
                                    for Registrant’s Common Equity, Related Stockholder Matters
                                    and Issuer
                                    Purchases of Equity Securities
                                16Item
                                    6.
                                Selected
                                    Financial Data
                                17Item
                                    7.
                                Management’s
                                    Discussion and Analysis of Financial Condition
                                    Results of
                                    Operations
                                18Item
                                    7A.
                                Quantitative
                                    and Qualitative Disclosures About Market Risk
                                31Item
                                    8.
                                Financial
                                    Statements and Supplementary Data
                                32Item
                                    9.
                                Changes
                                    in and Disagreements with Accountantson
                                    Accounting and Financial Disclosure
                                32Item
                                    9A.
                                Controls
                                    and Procedures
                                32Item
                                    9B.
                                Other
                                    Information
                                33**PART
                                    III**Item
                                    10.
                                Directors,
                                    Executive Officers of the Registrant and Corporate
                                    Governance
                                34Item
                                    11.
                                Executive
                                    Compensation
                                34Item
                                    12.
                                Security
                                    Ownership of Certain Beneficial Owners and ManagementRelated
                                    Stockholder Matters
                                34Item
                                    13.
                                Certain
                                    Relationships and Related Transactions and Director
                                    Independence
                                35Item
                                    14.
                                Principal
                                    Accountant Fees and Services
                                35**PART
                                    IV**Item
                                    15.
                                Exhibits
                                    and Financial Statement Schedules
                                36**SIGNATURES**
                                
                                43
 2
 
 **PART
                          I**
 
 **Item
                          1. Business**
 
 ***General.*** Matria
                          Healthcare, Inc. (“Matria” or the “Company”) provides comprehensive, integrated
                          programs and services focused on wellness, disease and
                          condition management,
                          productivity enhancement and informatics. This suite of
                          services, which we call
“Health Enhancement,” is designed to reduce health-related costs and enhance
                          the
                          health and quality of life of the individuals we serve.
                          Matria provides services
                          to self-insured employers, private and government sponsored
                          health plans,
                          pharmaceutical companies and patients. Our employer clients
                          are primarily
                          Fortune 1000 companies that self-insure the medical benefits
                          provided to their
                          employees, dependents and retirees. Our health plan customers
                          are regional and
                          national health plans, as well as government-sponsored
                          health plans, such as
                          state Medicaid programs.
 
 Our
                          business strategy is described under “Management’s Discussion & Analysis of
                          Financial Condition and Results of Operations” in Item 7 of this
                          Report.
 
 ***Development
                          of our Business*** **.** We were
                          incorporated on December 28, 2004, in connection with our predecessor
                          registrant’s reorganization into a holding company structure. The
                          predecessor
                          registrant was incorporated on October 4, 1995 in connection
                          with the merger of
                          Tokos Medical Corporation and Healthdyne Maternity Management,
                          effective March
                          8, 1996. Through that merger, Matria emerged as the country’s premier provider
                          of high-risk maternity management services. Subsequently,
                          we decided to leverage
                          the experience with patient assessment, education and patient monitoring we
                          gained through our management of high-risk pregnancies
                          by expanding our focus to
                          include management of individuals with chronic diseases.
                          In furtherance of that
                          strategy, we launched our respiratory disease management
                          program in
                          1998.
 
 In
                          1999,
                          we added diabetes disease management to our service offerings
                          through an
                          acquisition. At the same time, we acquired our former pharmacy
                          and supplies
                          business, as well as Facet Technologies, LLC (“Facet”), our diabetes product
                          design, development and assembly business, and our foreign
                          diabetes services
                          business in Germany (“Dia Real”). In 2002, we continued to expand our disease
                          management program offerings through internal development
                          of programs for
                          cardiac disease, depression and chronic pain and through
                          the acquisition of
                          Quality Oncology, Inc. (“Quality Oncology”), the nation’s leading provider of
                          cancer disease management services. In 2003, we launched
                          an initiative to offer
                          disease management services through pharmaceutical companies
                          in support of
                          complex drug therapies and began to offer disease management
                          services for
                          hepatitis C. Through a strategic acquisition in 2004, we
                          expanded our services
                          to include case management. We also divested our domestic
                          pharmacy and supplies
                          business in 2004. In 2005, we furthered our goal of offering
                          the broadest
                          spectrum of services in the industry across the full continuum
                          of care through
                          the acquisitions of Miavita, LLC (“Miavita”), a leading provider of on-line
                          health and wellness programs, and WinningHabits, Inc. (“WinningHabits”), a
                          premier provider of corporate wellness programs. We also
                          launched our
                          commercialized informatics business in 2005, which involves
                          the aggregation and
                          analysis of data to enable our customers to better manage
                          health-related costs
                          and further improve outcomes.
 
 In
                          December 2005, we signed a definitive merger agreement
                          to acquire CorSolutions
                          Medical, Inc. (“CorSolutions”), another leading provider of disease management
                          and related services to employers, health plans and government-sponsored
                          healthcare programs. At the same time, we made the strategic
                          decision to divest
                          Facet and Dia Real. With these strategic initiatives in
                          place, we combined our
                          operations under one reportable segment: Health Enhancement.
                          We completed the
                          acquisition of CorSolutions on January 19, 2006. On September
                          1, 2006, we
                          completed the sale of Facet. We divested Dia Real on October
                          17, 2006. In
                          September 2006, we invested in and formed a strategic alliance
                          with
                          privately-held Secured Independence, Inc. to address the
                          needs of the long-term
                          care insurance industry.
 
 ***Our
                          Business Today***
 
 ***Health
                          Enhancement*** **.** With the
                          completion of the acquisition of CorSolutions in January
                          2006, we have combined
                          two of the leaders in our industry, and we believe that
                          we have created the
                          industry’s
  3
  
 most
                          expansive health enhancement programs, services and capabilities
                          across the full
                          continuum of care. In the merger, we acquired an expanded
                          product line, a
                          significant presence in the health plan market, a talented
                          group of employees,
                          new expertise, valuable customer relationships and several
                          new facilities. We
                          expended substantial effort in 2006 to integrate CorSolutions,
                          Miavita and
                          WinningHabits with our legacy businesses.
 
 Health
                          enhancement involves multiple integrated programs and services
                          that help
                          participants change unhealthy lifestyles that lead to chronic
                          diseases, improve
                          self-care skills and compliance with plans of care and
                          become better educated
                          consumers of healthcare services. Our health enhancement
                          business has 50 service
                          centers that serve participants and patients throughout
                          the United
                          States.
 
 Our
                          on-line, interactive wellness programs address issues such
                          as: smoking
                          cessation, weight loss, exercise, healthier diet, stress
                          relief, healthy aging
                          and productivity enhancement. These programs are designed
                          to help employees and
                          health plan members live healthier and longer lives while
                          reducing their
                          healthcare costs and increasing their productivity.
 
 Our
                          disease and condition management programs focus on the
                          most costly medical
                          conditions, including, without limitation, diabetes, coronary
                          artery disease,
                          congestive heart failure, asthma, chronic obstructive pulmonary
                          disease,
                          depression, chronic pain, hepatitis C, cancer and high-risk
                          pregnancies. With
                          the acquisition of CorSolutions, we expanded our disease
                          management offerings to
                          include many less common chronic conditions. Also, with
                          the acquisition of
                          CorSolutions, we acquired greater expertise in the area
                          of productivity
                          enhancement, including an absence management program and
                          the capability of
                          integrating disease management programs with a customer’s disability carriers.
 
 We
                          emphasize a multidisciplinary approach to care that involves
                          our clinicians
                          working with the physicians that are treating the participants
                          in our programs
                          to oversee adherence to evidenced-based standards of care
                          prescribed by the
                          physician. We focus on the management of participants between
                          visits to their
                          physician, the improvement of participants’ compliance with their physicians’
care plans and the avoidance of controllable and costly
                          events, such as
                          emergency room visits and hospital admissions. We believe
                          that our programs,
                          which were developed in accordance with national clinical
                          standards,
                          demonstrably reduce medical and healthcare-related costs
                          and produce improved
                          outcomes for our participants. Our disease and condition
                          management services
                          include, but are not limited to:
 ·
                                  Sophisticated
                                      data analysis to identify and preliminarily
                                      stratify individuals at risk
                                      for chronic diseases and high cost
                                      conditions;
 
 ·
                                  Administration
                                      of a multi-condition risk assessment, the results
                                      of which we use to build
                                      a detailed medical profile in our proprietary
                                      information
                                      systems;
 
 ·
                                  The
                                      use of predictive modeling to determine the
                                      probability that a given
                                      individual has a chronic condition or is at
                                      risk of a significant health
                                      event that will result in substantial healthcare
                                      costs in the near and
                                      longer-term future;
 
 ·
                                  Development
                                      of risk-specific care plans based on national
                                      clinical
                                      standards;
 
 ·
                                  Ongoing
                                      participant education, motivation and
                                      support;
 
 ·
                                  Monitoring
                                      of the participant’s utilization of medication and supplies, the
                                      frequency
                                      of periodic laboratory testing and adherence
                                      to care plans;
 
 ·
                                  For
                                      some participants, biometric monitoring of
                                      weight, blood glucose, blood
                                      pressure and/or uterine activity;
                                      and
 
 ·
                                  Reporting
                                      of clinical and financial
                                      outcomes.
  4
  
 Our
                          customized educational materials encourage participants
                          to make better lifestyle
                          choices, empower participants through knowledge to make
                          clinically supported
                          decisions about their healthcare and help participants
                          better manage their
                          conditions. The Matria clinicians coach and motivate participants
                          to develop
                          self-care skills to manage their conditions, practice prevention,
                          pursue a
                          health conscious lifestyle, actively seek health and wellness
                          knowledge and
                          understand the financial and health impact of their lifestyle
                          decisions.
 
 People
                          with chronic diseases and high-cost conditions face a myriad
                          of medications,
                          treatments, directives and precautions that are part of
                          a plan of care, and
                          thus, they typically need extra support. Our clinicians ensure this support
                          is readily available and proactively provided. To properly
                          manage one’s chronic
                          disease, the individual must follow clinical parameters
                          defined for the disease.
                          Our nurses, with the aid of the Company’s technology, educate the participant on
                          the management of these critical parameters. By combining
                          the human touch of
                          experienced clinicians with the power of Matria’s technology, the Company’s
                          disease and condition management processes have been demonstrated
                          to improve the
                          participant’s course of treatment.
  All
                          of
                          our programs are built on proprietary, sophisticated and
                          advanced technology
                          that enables us to ingest and analyze data from multiple
                          sources, manage
                          participant care and report clinical and financial outcomes.
                          Increasingly, the
                          market is recognizing the power of data as a tool in managing
                          health care and
                          optimizing clinical and financial outcomes. In 2005, we
                          began to capitalize on
                          our information systems technology and data analysis expertise
                          by offering our
                          informatics services as an adjunct to our wellness and
                          disease and condition
                          management services. We will continue to make substantial
                          investments in our
                          information systems.
 
 ***Customers
                          and Third-Party Payors*** **.** We
                          market
                          our health enhancement services to self-insured employers,
                          health plans (both
                          commercial and governmental), pharmaceutical companies
                          and physicians, through
                          our employee sales force and channel partners. In 2006,
                          revenues from continuing
                          operations were derived from the following types of customers
                          and third-party
                          payors: approximately 57% from health plans, 34% from employers,
                          7% from
                          government payors and 2% from administrative services only
                          (“ASO”) self-insured
                          employer clients.
 
 ***Billing
                          and Revenue Recognition.*** Our
                          services are paid for primarily on the basis of (i) monthly
                          fees for each
                          employee or member enrolled in a health plan, (ii) each
                          member identified with a
                          particular chronic disease or condition under contract,
                          (iii) each member
                          enrolled in our programs, (iv) fee-for-service or (iv)
                          a fixed rate per case.
                          Billings for certain services occur in advance of services
                          being performed. Such
                          amounts are recorded as “Unearned revenues” in the consolidated balance sheets.
                          Such amounts are subsequently recognized as revenue as
                          services are
                          performed.
 
 Some
                          contracts provide that a portion of our fees are at-risk (i.e., refundable)
                          if
                          our programs do not achieve certain financial cost savings
                          and clinical
                          performance criteria. Revenues subject to refund are not
                          recognized if (i)
                          sufficient information is not available to calculate performance
                          measurements;
                          or (ii) interim performance measurements indicate that
                          we are not meeting
                          performance targets. If either of these two conditions
                          exists, we record the
                          amounts as unearned revenue, which is included in “Unearned revenues” in the
                          consolidated balance sheets. These amounts are recognized
                          as revenue when we
                          establish that we have met the performance criteria. Often,
                          recognition of these
                          revenues occurs in periods subsequent to the recognition
                          of the associated
                          costs. Therefore, upon recognition, these revenues increase
                          our operating
                          profits on a dollar-for-dollar basis. If we do not meet
                          performance criteria, we
                          are contractually obligated to refund some or all of the
                          at-risk fees.
                          Historically, such refunds have been immaterial to our
                          financial condition and
                          results of operations.
 
 ***Seasonality*** **.** Our
                          high-risk pregnancy management services revenues tend to
                          be seasonal. Revenues
                          tend to decrease with the onset of the holiday season starting
                          with
                          Thanksgiving. As a result, first and fourth quarter revenues
                          of each year tend
                          to be lower than second and third quarter revenues.
  5
  
 The
                          other
                          aspects of our health enhancement business currently do
                          not reflect any
                          significant degree of seasonality.
 
 ***Competition*** **.** Our
                          health enhancement business is highly competitive. Our
                          competitors and potential
                          competitors include disease management companies, pharmaceutical
                          companies,
                          pharmacy benefit management companies, case management
                          companies, health plans,
                          healthcare providers and other organizations that provide
                          services to health
                          plans and self-insured employers. Certain of our competitors
                          and potential
                          competitors have significantly greater financial and sales
                          resources than we do.
                          We believe that our ability to offer customers an integrated
                          health enhancement
                          solution across a full continuum of care, our demonstrated
                          clinical and
                          financial outcomes capabilities and our highly regarded
                          technology platforms
                          will enable us to compete effectively. However, there can
                          be no assurance that
                          we will not encounter increased or more effective competition
                          in the future,
                          which would limit our ability to maintain or increase our
                          business.
 
 ***Research
                          and Development*** **.** Program
                          development and refinements from the health enhancement
                          operations are a result
                          of the cooperative efforts of the business’s information technology, clinical,
                          operating and marketing staff. The costs of these development
                          activities are
                          charged to earnings when incurred. However, we capitalize
                          development costs
                          incurred for internal use software under the provisions
                          of the AICPA Statement
                          of Position 98-1, *Accounting
                          for the Costs of Computer Software Developed or Obtained
                          for Internal
                          Use.*
 
 ***Governmental
                          Regulation*** **.** The
                          healthcare business is subject to extensive and frequently
                          changing federal,
                          state and local regulations. Changes in applicable laws
                          or any failure to comply
                          with existing or future laws, regulations or standards
                          could have a material
                          adverse effect on our results of operations, financial
                          condition, business and
                          prospects. We believe our current arrangements and practices
                          are in material
                          compliance with applicable laws and regulations. There
                          can be no assurance that
                          we are in compliance with all applicable existing laws
                          and regulations or that
                          we will be able to comply with new laws or regulations.
 
 Certain
                          of our clinicians, such as nurses, must comply with individual
                          licensing
                          requirements. All of our clinicians who are subject to
                          licensing requirements
                          are licensed in the state in which they are physically
                          present, such as the
                          location of the call center from which they operate. In
                          the future, multiple
                          state licensing requirements for healthcare professionals
                          who provide services
                          telephonically over state lines may require us to license
                          some of our clinicians
                          in more than one state. New judicial decisions, agency
                          interpretations or
                          federal or state legislation or regulations could increase
                          the requirement for
                          multi-state licensing of a greater number of our clinical
                          staff, which would
                          increase our administrative costs.
  Certain
                          aspects of our health enhancement business are subject
                          to unique licensing or
                          permit requirements. For example, many states require our
                          subsidiary providing
                          high-risk pregnancy management services to be licensed
                          as a home health agency
                          and to have medical waste disposal permits. Also, many
                          states require Quality
                          Oncology, our cancer disease management subsidiary, to
                          be licensed as a
                          utilization review provider. We may also be required to
                          obtain certification to
                          participate in governmental payment programs, such as state
                          Medicaid programs.
                          Some states have established Certificate of Need ("CON")
                          programs regulating the
                          expansion of healthcare operations. The failure to obtain,
                          renew or maintain any
                          of the required licenses, certifications or CONs could
                          adversely affect our
                          business.
  Some
                          of
                          the monitoring devices used by our subsidiary providing
                          high-risk pregnancy
                          management services in the provision of our services are
                          classified as medical
                          devices under the Federal Food, Drug and Cosmetic Act,
                          or the FDC Act, and are
                          subject to regulation by the Food and Drug Administration,
                          or the FDA. In
                          addition some of our services involve the use of drugs
                          that are regulated by the
                          FDA under the FDC Act. Although medical devices and drugs
                          used by our subsidiary
                          providing high-risk pregnancy management services are labeled
                          for specific
                          indications and cannot be
  6
  
 promoted
                          for any other indications, the FDA allows physicians to
                          prescribe drugs and
                          medical devices for “off-label” indications under the “practice of medicine”
doctrine. Negative publicity concerning the off-label use
                          of drugs and devices
                          may adversely affect the high-risk pregnancy management
                          services component of
                          our business. Our failure to comply with FDA requirements
                          could result in FDA
                          enforcement actions, which could include, but are not limited
                          to, recalls,
                          warning letters, fines, injunctions and criminal prosecution.
                          Any such
                          enforcement actions could have a material adverse effect
                          on our business,
                          financial condition and results of operations.
  The
                          Health Insurance Portability and Accountability Act of
                          1996, or HIPAA, governs
                          electronic healthcare transactions and the privacy and
                          security of medical
                          records and other individually identifiable patient data. Any failure to
                          comply with HIPAA could result in criminal penalties and
                          civil
                          sanctions.
  Although
                          a small component of our business relies on reimbursement
                          by government payors,
                          such as state Medicaid, that business is subject to particularly
                          pervasive
                          regulation by those agencies. These regulations impose
                          stringent requirements
                          for provider participation in those programs and for reimbursement
                          of products
                          and services. Additionally, we are subject to periodic
                          audits or investigations
                          by the Centers for Medicare and Medicaid Services, or CMS
                          and/or its
                          intermediaries, of our compliance with those requirements,
                          and any deficiencies
                          found may be extrapolated to cover a larger number of reimbursement
                          claims.
                          Additionally, many applicable laws and regulations are
                          aimed at curtailing
                          fraudulent and abusive practices in relation to those programs.
                          These rules
                          include the illegal remuneration provisions of the Social
                          Security Act
                          (sometimes referred to as the “Anti-Kickback” statute), which impose criminal
                          and civil sanctions on persons who knowingly and willfully
                          solicit, offer,
                          receive or pay any remuneration, whether directly or indirectly,
                          in return for,
                          or to induce, the referral of a patient covered by a federal healthcare
                          program to a particular provider of healthcare products
                          or services. Related
                          federal laws make it unlawful, in certain circumstances,
                          for a physician to
                          refer patients covered by federal healthcare programs to
                          a healthcare entity
                          with which the physician and/or the physician's family
                          have a financial
                          relationship. Additionally, a large number of states have
                          laws similar to the
                          federal laws aimed at curtailing fraud and abuse and physician
“self-referrals.”
These rules have been interpreted broadly such that any
                          financial arrangement
                          between a provider and potential referral source may be
                          suspect. While we
                          believe our business arrangements are in compliance with
                          these laws and
                          regulations, the government could take a contrary position
                          or could investigate
                          our practices.
  In
                          addition to the laws described above, the Federal False
                          Claims Act imposes civil
                          liability on individuals or entities that submit false
                          or fraudulent claims for
                          payment to the government. HIPAA created two new federal
                          crimes: “Healthcare
                          Fraud” and “False Statements Relating to Healthcare Matters.” The Healthcare
                          Fraud statute prohibits knowingly and willfully executing
                          a scheme or artifice
                          to defraud any healthcare benefit program. The False Statements
                          Relating to
                          Healthcare Matters statute prohibits knowingly and willfully
                          falsifying,
                          concealing or covering up a material fact by any trick,
                          scheme or device or
                          making any materially false, fictitious or fraudulent statement
                          in connection
                          with the delivery of or payment for healthcare benefits,
                          items or services. The
                          Federal False Claims Act allows actions to be brought on
                          the government's behalf
                          by individuals under the Federal False Claims Act’s “ *qui
                          tam”* provision. Violation of these and other applicable rules
                          can result in
                          substantial fines and penalties, required repayment of
                          monies previously
                          recognized as income, as well as exclusion from future
                          participation in
                          government-sponsored healthcare programs.
  There
                          can
                          be no assurance that we will not become the subject of
                          a regulatory or other
                          investigation or proceeding or that our interpretations
                          of applicable laws and
                          regulations will not be challenged. The defense of any
                          such challenge could
                          result in adverse publicity, substantial cost to us and
                          diversion of
                          management's time and attention. Thus, any such challenge
                          could have a material
                          adverse effect on our business, regardless of whether it
                          ultimately is
                          sustained.
  7
  
 The
                          Medicare Prescription Drug Improvement and Modernization
                          Act of 2003 (the “Act”)
                          provided funding for disease management demonstration programs
                          to be implemented
                          in targeted geographic areas across the country, and indicates
                          that if the
                          programs are successful, the programs will be expanded
                          nationwide. The expansion
                          of these programs could represent a significant opportunity
                          for our disease and
                          condition management business.
 
 ***Employees*** **.** As of
                          December 31, 2006, we employed a total of 1,704 regular
                          full-time and 62 regular
                          part-time employees in our continuing operations. Also,
                          the health enhancement
                          business employed an additional 836 part-time clinical
                          employees to provide,
                          among other things, patient training and back-up support on an “as needed”
basis. None of these employees is represented by a union,
                          and we consider our
                          relationship with our employees to be good.
 
 ***Discontinued
                          Operations.*** On
                          June
                          30, 2004, the Company completed the sale of substantially
                          all of the assets,
                          excluding trade and certain other receivables, of our former
                          domestic
                          direct-to-consumer pharmacy and supplies business. As a
                          result of the sale and
                          the discontinuance of the related lab business, the accompanying
                          consolidated
                          financial statements reflect the operations of these divisions
                          as discontinued
                          operations for all periods presented. In December 2005,
                          we announced our
                          strategic plan to divest Facet and Dia Real. As of December
                          31, 2005, we
                          reported the assets and liabilities of Facet and Dia Real
                          as assets held for
                          sale and liabilities related to assets held for sale and
                          other discontinued
                          operations, respectively, and accordingly, reported their
                          results of operations
                          in discontinued operations for all periods presented. We
                          completed the sale of
                          Facet on September 1, 2006, and closed the sale of Dia
                          Real on October 17,
                          2006.
 
 **Available
                          Information** .
 
 The
                          Company’s Annual Report on Form 10-K, quarterly reports on Form
                          10-Q, current
                          reports on Form 8-K, and amendments to those reports filed
                          or furnished pursuant
                          to Section 13(a) or 15(d) of the Securities Exchange Act
                          of 1934, as amended
                          (the “Exchange Act”), will be made available free of charge on or through
                          our
                          website at *www.matria.com* as soon
                          as reasonably practicable after the reports are filed with,
                          or furnished to, the
                          Securities and Exchange Commission (the “SEC” or the “Commission”). Matria’s
                          Corporate Governance Guidelines and Code of Conduct were
                          filed as exhibits to
                          previous Exchange Act reports filed with the SEC and are
                          available on our
                          website. Any waivers of the Guidelines or Code will be
                          disclosed in an SEC
                          filing on Form 8-K.
 
 **Item
                          1A. Risk Factors** ***.***
 
 Our
                          business is subject to certain risks, including the risks
                          described under the
                          headings “Customers and Third-Party Payors,” “Billing and Revenue Recognition,”
“Seasonality,” “Competition,” “Research and Development” and “Governmental
                          Regulation” in Item 1, “Legal Proceedings” in Item 3, and those described below.
                          Readers of this Annual Report on Form 10-K should take
                          such risks into account
                          in evaluating any investment decision involving our common
                          stock. This Item 1A
                          does not describe all risks applicable to our business
                          and is intended only as a
                          summary of certain material factors that affect our operations
                          in the industries
                          in which we operate. More detailed information concerning
                          these and other risks
                          is contained in other sections of this Annual Report on
                          Form 10-K.
 
 **The
                          health enhancement business is an evolving component of
                          the overall healthcare
                          industry.**
 Health
                          enhancement and wellness services are relatively new components
                          of the overall
                          healthcare industry. Accordingly, some of our potential
                          customers have not had
                          significant experience in purchasing, evaluating or monitoring
                          such services,
                          which can result in a lengthy sales cycle. The success
                          of our business plan
                          relative to our disease and condition management and wellness
                          services depends
                          on a number of factors. These factors include:
 
 ·
                                Our
                                    ability to differentiate our products and service
                                    offerings from those of
                                    our competitors;
  8
  
 ·
                                The
                                    extent and timing of the acceptance of our services
                                    as a replacement for,
                                    or supplement to, traditional managed care
                                    offerings;
 
 ·
                                The
                                    effectiveness of our sales and marketing
                                    efforts;
 
 ·
                                Our
                                    ability to implement new and additional services
                                    beneficial to health
                                    plans and employers;
 
 ·
                                Our
                                    ability to effect and sufficiently communicate
                                    cost savings for health
                                    plans and employers through the use of our programs;
                                    and
 
 ·
                                Our
                                    ability to improve patient compliance with the complex drug therapies
                                    offered by our pharmaceutical
                                    customers.
 
 Since
                          the
                          disease and condition management and wellness businesses
                          are continually
                          evolving, we may not be able to anticipate and adapt to
                          the developing market.
                          Moreover, we cannot predict with certainty the future growth
                          rate or the
                          ultimate size of the market.
 
 **We
                          are highly dependent on payments from our customers, which
                          may implement cost
                          reduction measures that adversely affect our business and
                          operations.**
  Healthcare
                          payors continue to face cost reduction pressures that may
                          cause them to curtail
                          their use of or reimbursement for health enhancement services,
                          to negotiate
                          reduced fees or other concessions or to delay payment.
                          These financial pressures
                          could have an adverse impact on our business.
 
 **Government
                          regulations may adversely affect our business.**
 We
                          are
                          subject to extensive and frequently changing federal, state
                          and local
                          regulations. Changes in laws or regulations or new interpretations
                          of existing
                          laws or regulations can have a dramatic effect on operating
                          methods, costs and
                          reimbursement amounts provided by government and third-party
                          payors. There can
                          be no assurance that we are or have been in compliance
                          with all applicable
                          existing laws and regulations or that we will be able to
                          comply with new laws or
                          regulations. Changes in applicable laws or any failure
                          to comply with existing
                          or future laws, regulations or standards could have a material
                          adverse effect on
                          our results of operations, financial condition, business
                          and prospects.
 
 **A
                          portion of our disease management fees are contingent upon
                          performance.**
 Some
                          of
                          our existing disease management agreements contain savings
                          or other guarantees,
                          which typically provide that we will repay all or some
                          of our fees if the
                          payor’s cost savings as a result of our disease management programs
                          do not meet
                          expectations or if other quality performance measures are
                          not met. Some
                          contracts also provide that we will receive bonus compensation
                          by meeting
                          certain performance criteria. There is no guarantee that
                          we will accurately
                          forecast cost savings and clinical outcome improvements
                          under our disease
                          management agreements or meet the performance criteria
                          necessary to receive the
                          designated bonus compensation or to avoid repayment of
                          fees under the
                          agreements. Additionally, untimely, incomplete or inaccurate
                          data from our
                          customers, or flawed analysis of such data, could have
                          a material adverse impact
                          on our ability to recognize revenues.
 
 **Our
                          operating results have fluctuated in the past and could
                          fluctuate in the
                          future.**
  Our
                          operating results have varied in the past and may fluctuate
                          significantly in the
                          future due to a variety of factors, many of which are outside
                          of our control.
                          These factors include, but are not limited to:
 
 ·
                                the
                                    impact of substantial divestitures and
                                    acquisitions;
 
 ·
                                the
                                    loss or addition of customers and referral
                                    sources;
 
 ·
                                investments
                                    required to support growth and
                                    expansion;
 
 ·
                                changes
                                    in the mix of our products and
                                    customers;
 
 ·
                                changes
                                    in healthcare reimbursement policies and
                                    amounts;
 
 ·
                                length
                                    of sales cycle and implementation process for
                                    new disease management
                                    customers;
 
 ·
                                increases
                                    in costs of revenues and operating
                                    expenses;
  9
  
 ·
                                recognition
                                    of deferred revenues and performance
                                    bonuses;
 
 ·
                                incurrence
                                    of performance penalties;
 
 ·
                                increases
                                    in selling, general and administrative
                                    expenses;
 
 ·
                                increased
                                    or more effective competition; and
 
 ·
                                regulatory
                                    changes.
 
 In
                          addition, revenues from our high-risk pregnancy management
                          services are
                          historically lower during the first and fourth calendar
                          quarters than during the
                          second and third calendar quarters. The seasonal variability
                          of demand for these
                          services significantly affects, and we believe will continue
                          to affect, our
                          quarterly operating results.
 
 **If
                          our costs of providing products or services increase, we
                          may not be able to pass
                          these cost increases on to our customers.**
  In
                          many
                          of our markets, due to competitive pressures, we have very
                          little control over
                          the price at which we sell our products and services. If
                          our costs increase, we
                          may not be able to increase our prices, which would adversely
                          affect results of
                          operations. Accordingly, any increase in our costs could
                          reduce our overall
                          profit margin.
 
 **Recent
                          and future acquisitions may cause integration problems,
                          disrupt our business and
                          strain our resources.**
  In
                          2005
                          and 2006, we made three strategic business acquisitions,
                          and may continue with
                          such acquisitions in the future. Our success will depend,
                          to a certain extent,
                          on the future performance of these acquired business entities.
                          These
                          acquisitions, either individually or as a whole, could
                          divert management
                          attention from other business concerns and expose us to
                          unforeseen liabilities
                          or risks associated with entering new markets and integrating
                          these new
                          entities. Further, the integration of these entities may
                          cause us to lose key
                          employees or key customers. Integrating newly acquired
                          organizations and
                          technologies could be expensive and time consuming and
                          may strain our resources.
                          Consequently, we may not be successful in integrating these
                          acquired businesses
                          or technologies and may not achieve anticipated revenue
                          and cost
                          benefits.
 
 **We
                          may face costly litigation that could force us to pay damages
                          and harm our
                          reputation.**
 Like
                          other participants in the healthcare market, we are subject
                          to lawsuits alleging
                          negligence, product liability or other similar legal theories,
                          many of which
                          involve large claims and significant defense costs. Any
                          of these claims, whether
                          with or without merit, could result in costly litigation,
                          and divert the time,
                          attention, and resources of our management. Although we
                          currently maintain
                          liability insurance intended to cover such claims, there
                          can be no assurance
                          that the coverage limits of such insurance policies will
                          be adequate or that all
                          such claims will be covered by insurance. In addition,
                          these insurance policies
                          must be renewed annually. Although we have been able to
                          obtain liability
                          insurance, such insurance may not be available in the future
                          on acceptable
                          terms, if at all. A successful claim in excess of the insurance
                          coverage could
                          have a material adverse effect on our results of operations
                          or financial
                          condition.
 
 **If
                          we do not manage our growth successfully, our growth and
                          profitability may slow,
                          decline or stop.**
 If
                          we do
                          not manage our growth successfully, our growth and profitability
                          may slow,
                          decline or stop. We have expanded our operations rapidly
                          and plan to continue to
                          expand. This expansion has created significant demands
                          on our administrative,
                          operational and financial personnel and other resources.
                          Additional expansion in
                          existing or new markets could strain our resources and
                          increase our need for
                          capital. Our personnel, systems, procedures, controls and
                          existing space may not
                          be adequate to support further expansion. In addition,
                          because our business
                          strategy emphasizes growth, the failure to achieve our
                          stated growth objectives
                          or the growth expectations of investors could cause our
                          stock price to
                          decline.
  10
  
 **Our
                          data management and information technology systems are
                          critical to maintaining
                          and growing our business.**
  Our
                          health enhancement services are dependent on the effective
                          use of information
                          technology. Although we believe that our systems provide
                          us with a competitive
                          advantage, we are exposed to technology failure or obsolescence.
                          In addition,
                          data acquisition, data quality control and data analysis,
                          which are a
                          cornerstone of our disease management programs, are intense
                          and complex
                          processes subject to error. Untimely, incomplete or inaccurate
                          data, flawed
                          analysis of such data or our inability to properly integrate,
                          implement and
                          update systems could have a material adverse impact on
                          our business and results
                          of operations.
 
 **We
                          have recorded a significant amount of intangible assets,
                          the value of which
                          could become impaired.**
 Our
                          acquisitions have resulted in the recognition of intangible
                          assets, primarily
                          goodwill. Goodwill, which represents the excess of cost
                          over the fair value of
                          net assets of businesses acquired, and other intangible
                          assets was approximately
                          $556.7 million, net of amortization, at December 31, 2006, representing
                          approximately 78% of our total assets. On an ongoing basis,
                          we will make an
                          evaluation to determine whether events and circumstances
                          indicate that all or a
                          portion of the carrying value of intangible assets may
                          no longer be recoverable,
                          in which case a charge to earnings may be necessary. Any
                          future determinations
                          requiring an asset impairment of a significant portion
                          of intangible assets
                          could materially affect our results of operations for the
                          period in which the
                          adjustment occurs.
 
 **The
                          competition for staff may cause us to restrict growth in
                          certain areas or to
                          realize increased labor costs in existing areas.**
 
 Our
                          operations are dependent on the services provided by qualified
                          management and
                          staff, including nurses and other healthcare professionals,
                          for which we compete
                          with other health care providers. In addition, our opportunities
                          for growth are
                          limited by our ability to attract and retain such personnel.
                          In certain markets,
                          there is a shortage of nurses and other medical providers,
                          thereby increasing
                          competition and requiring us to improve working conditions,
                          including wages and
                          benefits, for such personnel. Our potential inability to
                          maintain and grow an
                          appropriate workforce may inhibit our expansion and could
                          have a material
                          adverse effect on our financial results.
 
 **We
                          derive a significant portion of our revenues from health
                          plan
                          customers.**
  Although
                          no customer accounts for more than 10% of our revenues,
                          the recent expansion of
                          our large health plan customer base in our disease management
                          business has
                          created greater revenue concentration. Consolidation in
                          the health plan industry
                          may cause us to lose business if one of our health plan
                          customers is acquired by
                          another health plan that has its own health enhancement
                          solution. Loss of one or
                          more of these customers or their inability or refusal to
                          pay for our services,
                          whatever the reason, could materially and adversely affect
                          our results of
                          operations, cash flows and financial condition. Additionally,
                          a reduction in the
                          number of covered lives enrolled with our health plan customers
                          or a reduction
                          in the scope of their programs could adversely affect our
                          results of
                          operations.
 
 **Our
                          actual financial results might vary from our publicly disclosed
                          forecasts.**
 Our
                          actual financial results might vary from those anticipated
                          by us, and these
                          variations could be material. Our forecasts reflect numerous
                          assumptions
                          concerning our expected performance, as well as other factors,
                          which are beyond
                          our control, and which might not turn out to have been
                          correct. Although we
                          believe that the assumptions underlying the projections
                          are reasonable, actual
                          results could be materially different. Our financial results
                          are subject to
                          numerous risks and uncertainties, including those identified
                          throughout these
“Risk Factors” and elsewhere in this Annual Report on Form
                          10-K.
  11
  
 **Our
                          substantial leverage could materially adversely impact
                          our financial condition.**
 
 As
                          of
                          December 31, 2006, our total outstanding long-term debt,
                          including current
                          installments, was approximately $280 million, and we had
                          approximately $29
                          million of additional available borrowings under our credit
                          facilities. Our
                          substantial indebtedness could have a material adverse
                          effect on our financial
                          condition by, among other things:
 
 ·
                                increasing
                                    our vulnerability to adverse economic conditions
                                    or increases in
                                    prevailing interest rates, particularly with
                                    respect to any of our
                                    borrowings at variable interest
                                    rates;
 
 ·
                                limiting
                                    our ability to obtain any additional financing
                                    we may need to operate,
                                    develop and expand our business;
 
 ·
                                requiring
                                    us to dedicate a substantial portion of any cash
                                    flow from operations to
                                    service our debt, which reduces the funds available
                                    for operations and
                                    future business opportunities; and
 
 ·
                                potentially
                                    making us more highly leveraged than our competitors,
                                    which could
                                    potentially decrease our ability to compete in
                                    our
                                    industry.
 
 Our
                          ability to make interest payments and pay the principal
                          amounts under our credit
                          facilities will depend upon our future operating performance,
                          which is subject
                          to general economic and competitive conditions, and to
                          financial, business and
                          other factors, many of which we cannot control. If the
                          cash flow from our
                          operating activities is insufficient, we may take actions
                          such as delaying or
                          reducing capital expenditures, attempting to restructure
                          or refinance our debt,
                          selling assets or operations or seeking additional equity
                          capital. In addition,
                          the terms of our credit facilities may limit our ability
                          to take several of
                          these actions. Our failure to undertake any of these actions
                          successfully could
                          have a material adverse effect on our business, results
                          of operations and
                          financial condition.
 
 Additionally,
                          our credit facilities contain a number of affirmative,
                          negative, and financial
                          covenants, which limit our ability to take certain actions
                          and require us to
                          comply with specified financial ratios and other performance
                          covenants. If we
                          are unable to comply with our financial covenants or make
                          required payments in
                          the future, our lenders could pursue their contractual
                          remedies, including
                          requiring the immediate repayment in full of all amounts
                          outstanding, if any.
                          Additionally, we cannot be certain that, if the lenders
                          demanded immediate
                          repayment of any amounts outstanding, we would be able
                          to secure adequate or
                          timely replacement financing on acceptable terms or at
                          all.
 
 ***Forward-Looking
                          Statements*** .
                          This
                          Annual Report on Form 10-K, including the information incorporated
                          by reference
                          herein, contains various forward-looking statements and
                          information that are
                          based on our beliefs and assumptions, as well as information
                          currently available
                          to us. From time to time, the Company and its officers,
                          directors or employees
                          may make other oral or written statements (including statements
                          in press
                          releases or other announcements) that contain forward-looking
                          statements and
                          information. Without limiting the generality of the foregoing,
                          the words
“believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “seek” and
                          similar expressions, when used in this Annual Report on
                          Form 10-K and in such
                          other statements, are intended to identify forward-looking
                          statements, although
                          some statements may use other phrasing. All statements
                          that express expectations
                          and projections with respect to future matters, including,
                          without limitation,
                          statements relating to growth, new lines of business and
                          general optimism about
                          future operating results, are forward-looking statements.
                          All forward-looking
                          statements and information in this Annual Report are forward-looking
                          statements
                          within the meaning of Section 27A of the Securities Act
                          of 1933, as amended, and
                          Section 21E of the Exchange Act, as amended, and are intended
                          to be covered by
                          the safe harbors created thereby. Such forward-looking
                          statements are not
                          guarantees of future performance and are subject to risks,
                          uncertainties and
                          other factors that may cause the actual results, performance
                          or achievements of
                          the Company to differ materially from historical results
                          or from any results
                          expressed or implied by such forward-looking statements.
                          Such factors include,
                          without limitation, the risk factors set forth above under
                          Item 1A, “Risk
                          Factors.” These factors are not intended to be an all-encompassing
                          list of risks
                          and uncertainties that may affect the operations, performance,
                          development and
                          results of our business. Many of such factors are beyond
                          the Company’s ability
                          to control or predict, and readers are cautioned not to
                          put undue
  12
  
 reliance
                          on such forward-looking statements. In providing forward-looking
                          statements, the
                          Company expressly disclaims any obligation to update publicly
                          or otherwise these
                          statements, whether as a result of new information, future
                          events or otherwise
                          except to the extent required by law.
  **Item
                          1B. Unresolved Staff Comments** .
 Not
                          applicable.
 
 
 **Item
                          2. Properties**
 Our
                          principal executive and administrative offices are located
                          at 1850 Parkway
                          Place, Marietta, Georgia, and total approximately 91,000
                          square feet. The
                          facility is leased through February 28, 2010.
 
 In
                          2006,
                          our wellness and disease management businesses had eight
                          locations, with main
                          care centers in Marietta, Georgia and Sunrise, Florida.
                          The eight locations,
                          which include the CorSolutions' locations described herein,
                          total approximately
                          145,700 square feet and have lease terms expiring on various
                          dates through June
                          2011. CorSolutions has four locations with its principal
                          offices located in
                          Rosemont, a suburb of Chicago, Illinois, and three call
                          centers in Florida,
                          Pennsylvania and Arizona. These facilities total approximately
                          77,000 square
                          feet with lease terms expiring on various dates from 2009
                          to 2015. Our high-risk
                          pregnancy management services are provided through a network
                          of 37 patient
                          service centers. These patient service centers are typically
                          located in suburban
                          office parks and range between 250 and 5,800 square feet
                          of space, with an
                          average of approximately 1,500 square feet. Total square
                          footage for these
                          facilities is approximately 54,000 square feet. These facilities
                          are leased for
                          terms expiring on various dates through 2008. Additionally,
                          we lease
                          approximately 10,400 square feet under a lease expiring
                          September 2011 for this
                          business’s customer support center.
 
 These
                          facilities are generally in good condition, and we believe
                          that they are
                          adequate for and suitable to our requirements.
  
 **Item
                          3. Legal Proceedings**
 Pursuant
                          to the merger agreement under which we acquired CorSolutions,
                          we are pursuing a
                          claim before a contractually-designated settlement accountant
                          for certain
                          post-closing adjustments including a $4 million claim relating
                          to a liability
                          resulting from CorSolutions’ pre-closing performance under a customer contract.
                          We are also pursuing a related claim for fraudulent misrepresentation
                          and
                          concealment before the American Arbitration Association
                          in Chicago, Illinois,
                          seeking damages in an unspecified amount exceeding $4 million.
                          There is no
                          assurance that we will prevail in either of these proceedings.
 
 In
                          addition, we are subject to various legal claims and actions
                          incidental to our
                          business and the businesses of our predecessors, including
                          product liability
                          claims and professional liability claims. We maintain insurance,
                          including
                          insurance covering professional and product liability claims,
                          with customary
                          deductible amounts. There can be no assurance, however,
                          that (i) additional
                          suits will not be filed against us in the future, (ii)
                          our prior experience with
                          respect to the disposition of litigation is representative
                          of the results that
                          will occur in pending or future cases or (iii) adequate
                          insurance coverage will
                          be available at acceptable prices for incidents arising
                          or claims made in the
                          future. There are no other pending legal or governmental
                          proceedings to which we
                          are a party that we believe would, if adversely resolved,
                          have a material
                          adverse effect on us.
 
 
 **Item
                          4. Submission of Matters to a Vote of Security Holders**
 Not
                          applicable.
  13
  
 **Special
                          Item. Executive Officers of the Company**
 
 The
                          following sets forth certain information with respect to
                          the executive officers
                          of the Company:
 
 **Name**
                                **Age**
                                **Position
                                    with the Company**Parker
                                    H. Petit
                                67
                                Chairman
                                    of the Board and Chief Executive OfficerRichard
                                    M. Hassett, M.D.
                                51
                                President
                                    and Chief Operating OfficerYvonne
                                    V. Scoggins
                                57
                                Senior
                                    Vice President - Business AnalysisRoberta
                                    L. McCaw
                                51
                                Senior
                                    Vice President, General Counsel and SecretaryThornton
                                    A. Kuntz, Jr.
                                53
                                Senior
                                    Vice President and Chief Administrative OfficerJeffrey
                                    L. Hinton
                                43
                                Senior
                                    Vice President and Chief Financial
                                    Officer
  The
                          executive officers of the Company are elected annually
                          and serve at the pleasure
                          of the Board of Directors.
 
 Mr.
                          Petit
                          has served as Chairman of the Board of the Company since
                          the formation of the
                          Company through the merger of Healthdyne Maternity Management,
                          a division of
                          Healthdyne, Inc. (“Healthdyne”) and Tokos Medical Corporation on March 8, 1996
                          and as Chief Executive Officer since October 5, 2000, and
                          as President and Chief
                          Executive Officer from October 5, 2000, to February 22,
                          2003. Mr. Petit was the
                          founder of Healthdyne and served as its Chairman of the
                          Board of Directors and
                          Chief Executive Officer from 1970 until 1996. Mr. Petit
                          is also a director of
                          Intelligent Systems Corporation and Logility, Inc.
 
 Dr.
                          Hassett has been a member of the Board of Directors since
                          May 31, 2006, and has
                          been President and Chief Operating Officer since November
                          7, 2005. He previously
                          served as Executive Vice President and Chief Strategic
                          Officer of the Company
                          from November 14, 2004 to November 6, 2005. From August
                          2002 to April 2004, Dr.
                          Hassett was Chief Executive Officer and served on the board
                          of Coordinated Care
                          Solutions, a provider of medical care management services,
                          and from September
                          2000 to July 2002, he was President and Chief Executive
                          Officer and served on
                          the board of Vivra Asthma & Allergy, Inc., a specialty disease management
                          company. Dr. Hassett previously held executive positions
                          with Accordant Health
                          Services, a healthcare services and technology company
                          from 1997 to August 2000,
                          last serving as Executive Vice President and Chief Medical
                          Officer and as a
                          member of the board.
 
 Ms.
                          Scoggins has served as Senior Vice President - Business
                          Analysis since October
                          20, 2006, and previously was appointed Senior Vice President
                          - Corporate Finance
                          of the Company from February 22, 2006 to October 20, 2006.
                          She previously served
                          as Vice President - Corporate Finance from July 22, 2004
                          to February 21, 2006.
                          She was Vice President - Financial Planning and Analysis
                          from February 28, 2001,
                          to July 22, 2004, and previously was Vice President, Treasurer
                          and Chief
                          Accounting Officer of the Company from December 15, 1997,
                          to February 28, 2001,
                          and also Vice President and Controller from March 8, 1996,
                          to December 15, 1997.
                          Prior thereto, she was Vice President and Controller of
                          Healthdyne from May 1995
                          to March 8, 1996; Vice President - Planning and Analysis
                          of Healthdyne from May
                          1993 to May 1995; and Vice President and Chief Financial
                          Officer of Home
                          Nutritional Services, Inc., a former majority owned subsidiary
                          of Healthdyne,
                          from February 1990 to April 1993.
 
 Ms.
                          McCaw
                          was appointed Senior Vice President, General Counsel and
                          Secretary of the
                          Company on February 22, 2006. She previously served as
                          Vice President - Legal,
                          General Counsel and Secretary from April 23, 1998 to February
                          21, 2006. She was
                          Assistant General Counsel and Assistant Secretary of the
                          Company from December
                          15, 1997 to April 23, 1998, and Assistant General Counsel
                          from July 1996 to
                          December 1997. Prior thereto, Ms. McCaw was a partner at
                          Tyler, Cooper &
Alcorn, a Connecticut-based law firm, from January 1990
                          to July
                          1996.
 
 Mr.
                          Kuntz
                          was appointed Senior Vice President and Chief Administrative
                          Officer of the
                          Company on February 22, 2006. He previously served as Vice
                          President -
                          Administration from February 24, 1998 to February 21, 2006,
                          and Vice President -
                          Human Resources of the Company from March 8, 1996 to February
  14
  
 24,
                          1998.
                          Prior thereto, he served as Vice President - Administration
                          of Healthdyne from
                          August 1992 to March 1996.
 
 Mr.
                          Hinton was appointed Senior Vice President and Chief Financial
                          Officer of the
                          Company on March 20, 2006. From 2004 to March 2006, Mr.
                          Hinton was Vice
                          President, Internal Controls of HealthSouth Corporation.
                          He was Strategic
                          Financial Consultant for Synavant, Inc. from 2002 to 2003.
                          Mr. Hinton held Chief
                          Financial Officer positions with various public and private
                          companies, including
                          SURGICOE Corporation from 2000 to 2002, Wise Business Forms,
                          Inc. from 1997 to
                          2000, and Notify MD from 1996 to 1997.
  15
  
 **PART
                          II**
 
 **Item
                          5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                          Purchases of Equity Securities**
 
 **(a)
                          Market Information.** Matria’s
                          common stock is listed on the Nasdaq Global Select Market
                          (“NASDAQ”) under the
                          symbol “MATR.”
 
 The
                          following table sets forth, for the calendar quarters indicated,
                          the high and
                          low sales prices of Matria’s common stock as quoted on NASDAQ from January 1,
                          2005, through December 31, 2006, as adjusted to reflect
                          the three-for-two stock
                          split effective February 4, 2005:
  **Quarter**
                                
                                **Low**
                                
                                **High****2005**First
                                
                                $
                                24.31
                                
                                $
                                32.01Second
                                
                                
                                25.23
                                
                                
                                33.00Third
                                
                                
                                31.88
                                
                                
                                39.61Fourth
                                
                                
                                30.23
                                
                                
                                42.16**2006**First
                                
                                $
                                32.70
                                
                                $
                                45.00Second
                                
                                
                                19.77
                                
                                
                                38.21Third
                                
                                
                                21.00
                                
                                
                                27.98Fourth
                                
                                
                                25.10
                                
                                
                                30.41
 
 **(b)
                          Holders.** The
                          approximate number of stockholders of the Company as of
                          March 1, 2007, was 1,750
                          holders of record and approximately 6,900 beneficial holders.
 
 **(c)
                          Dividends.** Matria
                          has not paid any cash dividends with respect to its common
                          stock and does not
                          intend to declare any dividends in the near future. The
                          Company’s credit
                          facilities contain covenants restricting the payment of
                          dividends on and
                          repurchases of the Company’s common stock.
 
 **(d)
                          Purchases of Equity Securities.** During
                          the fourth quarter of 2006, Matria did not repurchase any
                          of its outstanding
                          equity securities. ****
  16
  
 **Item
                          6. Selected Financial Data**
 
 The
                          following table sets forth selected consolidated financial
                          data with respect to
                          the Company’s operations. The data should be read in conjunction with
                          Management’s Discussion and Analysis of Financial Condition and Results
                          of
                          Operations and the consolidated financial statements and
                          related notes thereto.
                          The statement of operations data for each of the five years
                          ended December 31,
                          2006, and the related balance sheet data have been derived
                          from the audited
                          consolidated financial statements (in thousands, except
                          per share
                          data).
  **Years
                                        Ended December 31,****2006**
                                    
                                    **2005**
                                    
                                    **2004**
                                    
                                    
                                    
                                    **2003**
                                    
                                    **2002****Consolidated
                                        statements of operations data:**(1)Revenues
                                        from continuing operations
                                    
                                    $
                                    336,139
                                    
                                    $
                                    179,231
                                    
                                    $
                                    145,087
                                    
                                    
                                    
                                    
                                    $
                                    123,196
                                    
                                    $
                                    106,044Earnings
                                        (loss) from continuing operations
                                    
                                    
                                    18,475
                                    
                                    
                                    4,014
                                    
                                    
                                    (20,077
                                    )
                                    
                                    (2
                                    )
                                    
                                    (8,505
                                    )
                                    
                                    (26,425
                                    )
                                    
                                    (3
                                    )Earnings
                                        (loss) from continuing operations per share:Basic
                                    
                                    $
                                    0.88
                                    
                                    $
                                    0.21
                                    
                                    
                                    ($1.29
                                    )
                                    
                                    
                                    
                                    
                                    ($0.56
                                    )
                                    
                                    ($1.89
                                    )Diluted
                                    
                                    
                                    0.85
                                    
                                    
                                    0.20
                                    
                                    
                                    (1.29
                                    )
                                    
                                    
                                    
                                    
                                    (0.56
                                    )
                                    
                                    (1.89
                                    )**December
                                        31,****2006**
                                    
                                    
                                    **2005**
                                    
                                    
                                    **2004**
                                    
                                    
                                    
                                    
                                    
                                    **2003**
                                    
                                    
                                    **2002****Consolidated
                                        balance sheet data:**Total
                                        assets
                                    
                                    $
                                    711,373
                                    
                                    $
                                    323,207
                                    
                                    $
                                    307,392
                                    
                                    
                                    
                                    
                                    $
                                    333,482
                                    
                                    $
                                    291,407Long-term
                                        debt, excluding current installments
                                    
                                    
                                    275,938
                                    
                                    
                                    2,099
                                    
                                    
                                    85,751
                                    
                                    
                                    
                                    
                                    
                                    121,005
                                    
                                    
                                    118,215
 
 (1)
                          Consolidated statements of operations data includes the
                          results from the
                          following acquisitions: CorSolutions Medical, Inc. effective
                          January 1, 2006;
                          WinningHabits, Inc. effective October 1, 2005; Miavita
                          LLC effective April 1,
                          2005; and Quality Oncology, Inc. effective October 1, 2002.
 (2)
                          Other
                          expense for 2004 included a $22,886 charge resulting from
                          the retirement of $120
                          million in aggregate principal amount of the Company's
                          11% Senior Notes. See
                          Notes to Consolidated Financial Statements included herein.
 (3)
                          In
                          2002, the Company recorded a charge of $14,247 in connection
                          with the
                          termination and restructuring of its split-dollar life
                          insurance plan.
  17
  
 **Item
                          7. Management’s Discussion and Analysis of Financial Condition and Results
                          of
                          Operations**
 
 *The
                          following discussion and analysis should be read in conjunction
                          with the
                          consolidated financial statements and related notes and
                          other financial
                          information appearing elsewhere in this Annual Report.
                          The discussion contains
                          forward-looking statements that involve risks and uncertainties.
                          Actual results
                          could differ materially from those anticipated in the forward-looking
                          statements
                          as a result of a variety of factors, including those discussed
                          in “Risk Factors”
in this Annual Report. The historical results of operations
                          are not necessarily
                          indicative of future results.*
 
 **Executive
                          Overview**
 We
                          are a
                          leading provider of comprehensive, integrated programs
                          and services focused on
                          wellness, disease and condition management, productivity
                          enhancement and
                          informatics. This suite of services, which we call “Health Enhancement,” is
                          designed to reduce health related costs and enhance the
                          health and quality of
                          life of the individuals we serve. We are dedicated to developing
                          better
                          educated, motivated and self-enabled healthcare consumers
                          and supporting
                          clinicians in managing the care of their patients. We provide
                          services to
                          self-insured employers, private and government sponsored
                          health plans,
                          pharmaceutical companies and patients. Our employer clients
                          are primarily
                          Fortune 1000 companies that self-insure the medical benefits
                          provided to their
                          employees, dependents and retirees. Our health plan customers
                          are regional and
                          national health plans, as well as government-sponsored
                          health plans, such as
                          state Medicaid programs.
 
 Our
                          on-line, interactive wellness programs address issues such
                          as: smoking
                          cessation, weight loss, exercise, healthier diet, stress
                          relief, healthy aging,
                          and productivity enhancement. These programs are designed
                          to help employees and
                          health plan members live healthier and longer lives while
                          reducing their
                          healthcare costs and increasing their productivity.
 
 Our
                          disease and condition management programs focus on the
                          most costly medical
                          conditions including, without limitation, diabetes, cardiovascular
                          diseases,
                          respiratory disorders, depression, musculoskeletal and
                          chronic pain, hepatitis
                          C, cancer and high-risk pregnancies. We assist individuals
                          to better manage
                          their conditions by increasing their knowledge about their
                          illnesses or
                          conditions, potential complications and the importance
                          of medication and
                          treatment plan compliance. Depending on acuity, our specialized
                          nurses
                          proactively contact participants to monitor their progress
                          and ensure they are
                          following the plan of care set by their physician.
 
  ***Acquisitions
                          and Dispositions***
 On January 19, 2006, we completed the acquisition of CorSolutions
                          Medical, Inc.
                          (“CorSolutions”), a disease management, health and wellness and productivity
                          enhancement organization. The results of CorSolutions’ operations are included
                          in our results of operations effective January 1, 2006.
 
 On
                          October 1, 2005, we completed the acquisition of WinningHabits,
                          Inc., a premier
                          provider of corporate wellness programs. On April 1, 2005,
                          we completed the
                          acquisition of the business and assets of Miavita LLC,
                          a leading provider of
                          on-line health and wellness programs. Results of operations
                          of these businesses
                          were included in the results of operations from the respective
                          acquisition
                          dates.
 
 During
                          the third and fourth quarters of 2006, we completed the
                          divestitures of Facet
                          Technologies LLC (“Facet”) and our foreign diabetes service operations in
                          Germany (“Dia Real”), respectively. We made the strategic decision to divest
                          Facet and Dia Real in the fourth quarter of 2005. In the
                          accompanying
                          consolidated financial statements, their assets and liabilities
                          were
                          reclassified as “Assets held for sale” and “Liabilities related to assets held
                          for sale and other discontinued operations,” respectively, on the December 31,
                          2005, consolidated balance sheet, and their results of
                          operations are included
                          in discontinued operations for all periods presented.
 
 On
                          June
                          30, 2004, we completed the sale of substantially all of
                          the assets, excluding
                          trade and certain other receivables, of our domestic direct-to-consumer
                          pharmacy
                          and supplies business. As a result of the sale of
  18
  
 the
                          domestic pharmacy and supplies business and the discontinuance
                          of the lab
                          business, the accompanying consolidated financial statements
                          reflect the
                          operations of these divisions as discontinued operations
                          in 2004 and
                          2005.
  ***Financial
                          and Performance Highlights of 2006***
 For
                          the
                          year ended December 31, 2006, we reported $336.1 million
                          in net revenues, a
                          growth of 87.5% over the year ended December 31, 2005.
                          We also reported $18.5
                          million of earnings from continuing operations, compared
                          to earnings from
                          continuing operations of $4.0 million for the year ended
                          December 31, 2005. Our
                          diluted earnings per share from continuing operations increased
                          to $0.85 per
                          common share, compared to $0.20 per common share in 2005.
  During
                          2006, we also had the following financial and performance
                          highlights. These
                          accomplishments should be considered in conjunction with
                          our discussion of
                          operating results, liquidity and capital resources.
  ·
                                Completed
                                    the acquisition of CorSolutions, and integrated
                                    this business’ operations
                                    and the operations of Miavita and WinningHabits,
                                    capturing significant
                                    synergies and operating efficiencies made available
                                    through the
                                    combination of the companies;
 
 ·
                                Completed
                                    the divestitures of our non-core businesses,
                                    Facet and Dia Real,
                                    establishing the Company as a pure play in the
                                    wellness and disease
                                    management market;
 
 ·
                                Accomplished
                                    our goal of reducing acquisition indebtedness
                                    by $175 million, leaving us
                                    with approximately $277 million of acquisition
                                    debt remaining at December
                                    31, 2006;
 
 ·
                                Refinanced
                                    our $65 million Second Lien Credit Facility,
                                    producing interest savings in
                                    2006 and beyond; and
 
 ·
                                Invested
                                    in and formed a strategic alliance with Secured
                                    Independence, Inc. to
                                    address the needs of the long-term care insurance
                                    market for seniors.
 
 ***Business
                          Strategy***
 Our
                          goal
                          is to position ourselves as an industry leader in the health
                          enhancement market.
                          We seek to achieve this goal by pursuing the following
                          strategies:
 
 ***Capitalize
                          on our Position as a Pure Play in the Health Enhancement
                          Market*** *.* We
                          believe our extensive experience, scalable, established
                          infrastructure and
                          demonstrated clinical and financial outcomes will provide
                          us a significant
                          competitive advantage as we seek to capitalize on the growing
                          market for health
                          enhancement. Including our predecessor organizations, we
                          have more than 15 years
                          of experience in providing disease management and related
                          services. Our
                          established infrastructure includes our proprietary informatics
                          technology
                          platform, care center operations located throughout the
                          United States and a
                          national network of skilled multi-disciplinary clinicians.
 
 ***Leverage
                          Our Information Technology.*** ** We
                          will
                          continue to make significant investments in our information
                          technology systems
                          in order to better identify participants for intervention
                          and improve treatment
                          plans for these identified participants by reducing variations
                          in care by
                          consistent applications of national criteria and standards
                          of care. We expect to
                          leverage this technology through the expansion of our informatics
                          business.
  19
  
 ***Further
                          Penetrate All Key Segments of the Growing Health Enhancement
                          Market.*** ** We
                          intend
                          to expand our customer base within the employer, health
                          plan, state and federal
                          governments, and pharmaceutical markets. We believe there
                          is a significant
                          opportunity to expand our health enhancement business by
                          cross-selling other
                          products and services to existing customers as they realize
                          the cost savings and
                          superior clinical outcomes that our programs provide.
 
 **Results
                          of Operations**
 The
                          following table summarizes key components in our financial
                          statements for
                          continuing operations expressed as a percentage of revenues.
  
 **Years
                                    Ended December 31,****2006**
                                
                                **2005**
                                
                                **2004**Revenues
                                
                                
                                100.0
                                %
                                
                                100.0
                                %
                                
                                100.0
                                %Cost
                                    of revenues
                                
                                
                                32.7
                                %
                                
                                40.7
                                %
                                
                                44.8
                                %Gross
                                    margin
                                
                                
                                67.3
                                %
                                
                                59.3
                                %
                                
                                55.2
                                %Selling
                                    and administrative expenses
                                
                                
                                47.3
                                %
                                
                                52.6
                                %
                                
                                54.7
                                %Provision
                                    for doubtful accounts
                                
                                
                                1.2
                                %
                                
                                1.9
                                %
                                
                                1.7
                                %Amortization
                                    of intangible assets
                                
                                
                                2.1
                                %
                                
                                0.2
                                %
                                
                                0.0
                                %Operating
                                    earnings (loss)
                                
                                
                                16.6
                                %
                                
                                4.5
                                %
                                
                                -1.1
                                %Interest
                                    expense, net
                                
                                
                                7.7
                                %
                                
                                0.9
                                %
                                
                                6.6
                                %Other
                                    income, net
                                
                                
                                0.4
                                %
                                
                                0.1
                                %
                                
                                0.5
                                %Loss
                                    on retirement of Senior Notes
                                
                                
                                0.0
                                %
                                
                                0.0
                                %
                                
                                15.8
                                %Earnings
                                    (loss) from continuing operations before income
                                    taxes
                                
                                
                                9.3
                                %
                                
                                3.8
                                %
                                
                                -23.0
                                %Income
                                    tax expense (benefit)
                                
                                
                                3.8
                                %
                                
                                1.5
                                %
                                
                                -9.2
                                %Earnings
                                    (loss) from continuing operations
                                
                                
                                5.5
                                %
                                
                                2.2
                                %
                                
                                -13.8
                                %
  
 ***2006
                          Compared to 2005***
  Revenues
                          from continuing operations increased by $156.9 million,
                          or 87.5%, to $336.1
                          million for the year ended December 31, 2006, from $179.2
                          million in 2005. This
                          increase was due primarily to our acquisitions of CorSolutions
                          effective January
                          1, 2006, Winning Habits on October 1, 2005, and Miavita
                          on April 1, 2005.
                          Revenues from these acquired businesses contributed $135.9
                          million, or 86.6%, to
                          the 2006 increase. Also contributing to the revenue growth
                          was the addition of
                          new and expanded accounts that were implemented in 2005
                          and 2006. Excluding
                          maternity management program revenues, disease and condition
                          management program
                          revenues, including wellness program revenues, increased
                          $151.2 million, or
                          195.4%, to $228.6 million for the year ended December 31,
                          2006. Wellness program
                          revenues were $19.4 million for the year ended December
                          31, 2006, compared to
                          $4.9 million in 2005. Maternity management program revenues
                          increased $5.7
                          million, or 5.6%, to $107.5 million for the year ended
                          December 31, 2006. This
                          increase was due to an increase in the days of service
                          and an increase in the
                          portion of our maternity management programs generating
                          revenues as a result of
                          electronic identification of potential patients.
  Cost
                          of
                          revenues consists primarily of clinical labor and supplies
                          related to the
                          provision of services. Cost of revenues as a percentage
                          of revenues decreased to
                          32.7% for the year ended December 31, 2006, from 40.7%
                          in 2005. This decrease
                          was primarily due to the growth in the disease management
                          and wellness program
                          revenues and improved margins from these programs resulting
                          from the leveraging
                          impact of higher revenues.
 
 Selling
                          and administrative expenses increased $64.7 million to
                          $159.0 million for the
                          year ended December 31, 2006, compared to $94.3 million
                          in 2005. We incurred
                          increased costs as a result of our 2005 and 2006 acquisitions,
                          primarily for
                          salaries and other personnel-related expenses and increased
                          depreciation and
                          amortization expenses related to our technology investments.
                          Also included in
                          our 2006 expense is approximately $7.0 million of share-based
                          compensation
                          associated with the adoption of Statement of Financial
                          Accounting Standards
                          Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R), *Share-Based
                          Payment* (“SFAS
                          123(R)”). As a percentage of revenues, selling and administrative
                          expenses
                          decreased to 47.3% in 2006, compared to 52.6% in 2005,
                          primarily due to the
                          leveraging impact of higher revenues and the synergies
                          realized from the
                          integration of the CorSolutions acquisition in 2006.
  20
  
 The
                          provision for doubtful accounts as a percentage of revenues
                          was 1.2% in 2006
                          compared to 1.9% in 2005. The provision, which is recorded
                          primarily for our
                          maternity management program revenues, is adjusted periodically
                          based upon our
                          quarterly evaluation of historical collection experience,
                          recoveries of amounts
                          previously provided, industry reimbursement trends and
                          other relevant factors.
                          The percentage decrease results from an increase in the
                          portion of revenues from
                          our non-maternity management program sources.
 
 We
                          recorded $7.1 million and $365,000 of expense in 2006 and
                          2005, respectively,
                          from the amortization of intangible assets. The increase
                          in amortization expense
                          resulted primarily from our 2006 acquisition of CorSolutions.
 
 Interest
                          expense, net, increased to $26.0 million in 2006 from $1.6
                          million in 2005. This
                          increase was primarily the result of the new credit facilities
                          we entered into
                          in January 2006 in conjunction with our acquisition of
                          CorSolutions (discussed
                          below under “Liquidity and Capital Resources - Financing Activities”). In 2006,
                          we allocated $9.8 million of interest expense and amortization
                          expense of
                          deferred financing fees related to the new credit facilities
                          to discontinued
                          operations in accordance with Emerging Issues Task Force
                          (“EITF”) Issue 87-24, *Allocation
                          of Interest to Discontinued Operations* .
                          EITF
                          Issue 87-24 states that interest on debt that must be repaid
                          when the disposal
                          of discontinued operations occurs should be allocated to
                          discontinued
                          operations. In accordance with the terms of the new credit
                          facilities, we used
                          the net proceeds from the sales of Facet in the third quarter
                          of 2006 and Dia
                          Real in the fourth quarter of 2006 to repay a portion of
                          the outstanding
                          indebtedness. The weighted average interest rates, including
                          amortization of
                          debt discount and expense and net gains from interest rate
                          swap transactions, on
                          all outstanding indebtedness were 9.29% and 6.80% for years
                          ended December 31,
                          2006 and 2005, respectively.
 
 Other
                          income (expense), net, increased to $1.3 million in 2006
                          from $226,000 in 2005.
                          In 2006, we recorded a $741,000 gain from the settlement
                          of the forward exchange
                          agreement we entered into with a bank to eliminate the
                          potential impact of
                          foreign exchange fluctuations on the U.S. dollar equivalent
                          of the expected euro
                          proceeds from the sale of Dia Real. Under the terms of
                          the agreement, we sold
€26.0 million at the forward rate and received approximately
                          $33.4 million on
                          the settlement date. We reported the forward exchange agreement
                          at fair value
                          until settled in October 2006. Other income also includes
                          collections of notes
                          and receivables that were previously written-off, royalties
                          and other
                          miscellaneous items in both periods and favorable currency
                          adjustments on a
                          euro-denominated receivable in 2005.
 
 Income
                          tax expense for the years ended December 31, 2006, reflects
                          a higher effective
                          tax rate than the statutory federal tax rate due to state
                          income taxes and
                          certain non-deductible expenses for tax purposes. Cash
                          outflows for income taxes
                          for continuing and discontinued operations in 2006 and
                          2005 were $6.7 million
                          and $4.0 million, respectively, comprised of foreign, federal
                          alternative
                          minimum taxes and state income taxes. As of December 31,
                          2006, our remaining net
                          operating loss carryforwards of $67.0 million, the tax
                          effect of which is
                          reflected on the balance sheet as a deferred tax asset,
                          will be available to
                          offset future taxable income.
 
 On
                          September 1, 2006, we completed the sale of Facet for net
                          cash proceeds of
                          $121.9 million and recorded a gain on the sale of $26.6
                          million, or $23.9
                          million, net of income taxes. We wrote-off $76.2 million
                          of goodwill and
                          recorded $541,000 for unamortized share-based compensation
                          expense resulting
                          from the accelerated vesting of options granted to the
                          Facet employees. On
                          October 17, 2006, we completed the sale of Dia Real for
                          net cash proceeds of
                          $33.3 million. The gain on the sale was $9.1 million, or
                          $5.0 million net of
                          income taxes, and included charges of $3.6 million for
                          net goodwill and
                          intangibles and $67,000 for unamortized share-based compensation.
                          The net
                          proceeds from these sales were used to repay a portion
                          of the outstanding
                          indebtedness under our First Lien Credit Facility (see
                          below).
 
 Earnings
                          from discontinued operations include the operations of
                          Facet, Dia Real
                          and our domestic direct to consumer pharmacy and supplies business
                          (sold on
                          June 30, 2004). Earnings from discontinued operations were
                          $5.3 million, net of
                          tax, in 2006 compared to $9.9 million in 2005. Discontinued
                          operations in 2006
                          include a pre-tax expense of $9.8 million for the allocation
                          of interest and
                          deferred financing fees to Facet and Dia Real related to
                          the new credit
                          facilities as described above; $1.1 million of this amount
                          was charged
                          to
  21
  
 the
                          gain
                          on disposal of discontinued operations. In 2005, we recorded
                          a $10 million
                          pre-tax charge for the settlement of the *qui
                          tam* claims
                          related to our pharmacy and supplies business. The purchaser
                          of the pharmacy and
                          supplies business did not assume the liability for these
                          claims. Our earnings
                          from discontinued operations in 2005 also include a $2
                          million charge for the
                          write-off of the remaining accounts receivable of our pharmacy
                          and supplies
                          business, which we retained after the sale. The collection
                          efforts for these
                          receivables were outsourced to a third party in the first
                          quarter of 2005.
 
 
 ***2005
                          Compared to 2004***
  Revenues
                          from continuing operations increased by $34.1 million,
                          or 23.5%, to $179.2
                          million for the year ended December 31, 2005, from $145.1
                          million in 2004.
                          Disease and condition management program revenues, excluding
                          maternity
                          management program revenues, and wellness program revenues
                          increased $25.0
                          million, or 47.7%, to $77.4 million for the year ended
                          December 31, 2005.
                          Revenues from disease management and wellness programs
                          increased due to new and
                          expanded accounts implemented in 2004 and 2005. In 2005,
                          we added wellness
                          programs to our health enhancement services through the
                          acquisition of Miavita
                          on April 1, 2005, and Winning Habits on October 1, 2005.
                          Revenue from these
                          wellness programs were $4.9 million for the year ended
                          December 31, 2005.
                          Maternity management program revenues increased $9.1 million,
                          or 9.8%, to $101.8
                          million for the year ended December 31, 2005. This increase
                          was due to an
                          increase in the days of service, the addition of new programs
                          that are beginning
                          to generate revenue growth, as well as a shift in mix of
                          services offered to
                          therapies with a higher average revenue amount per day.
  Cost
                          of
                          revenues as a percentage of revenues decreased to 40.7%
                          for the year ended
                          December 31, 2005, from 44.8% in 2004. This decrease was
                          primarily due to the
                          growth in the disease and condition management and wellness
                          program revenues and
                          improved margins from these programs resulting from the
                          leveraging impact of
                          higher revenues.
 
 Selling
                          and administrative expenses increased $15.0 million to
                          $94.3 million in 2005,
                          compared to $79.3 million in 2004. We incurred increased
                          costs for salaries and
                          other personnel related expenses and increased depreciation
                          and amortization
                          expenses related to our technology investments. As a percentage
                          of revenues,
                          selling and administrative expenses decreased to 52.6%
                          in 2005, compared to
                          54.7% in 2004. The decrease in this percentage was primarily
                          due to higher
                          revenues in 2005.
 
 The
                          provision for doubtful accounts as a percentage of revenues
                          was 1.9% for the
                          year ended December 31, 2005, compared to 1.7% for the
                          year ended December 31,
                          2004. The provision is adjusted periodically based upon
                          our quarterly evaluation
                          of historical collection experience, recoveries of amounts
                          previously provided,
                          industry reimbursement trends, audit activity and other
                          relevant factors.
 
 Interest
                          expense, net, decreased by $8.0 million, or 83.5%, in 2005,
                          compared to 2004.
                          This decrease was primarily the result of the retirement
                          of substantially all of
                          the 11% Senior Notes in June 2004 (discussed below under
“Liquidity and Capital
                          Resources - Financing Activities”) partially offset by interest due to the
                          issuance of the 4.875% convertible senior subordinated
                          notes in May 2004. In May
                          2005, all of the Company’s 4.875% convertible senior subordinated notes were
                          converted into common stock of the Company. The weighted
                          average interest rates,
                          including amortization of debt discount and expense and
                          net gains from
                          terminated interest rate swap transactions, on all outstanding
                          indebtedness were
                          6.80% and 8.62% for the years ended December 31, 2005 and
                          2004, respectively.
 
 Other
                          income, net, included income of $226,000 for 2005, compared
                          to $681,000 for
                          2004. Other income includes collections of notes and receivables
                          that were
                          previously written-off, royalties and other miscellaneous
                          items and favorable
                          currency adjustments on a euro-denominated receivable in
                          2005.
 
 On
                          March
                          29, 2004, we commenced a tender offer for all of our unsecured
                          11% Senior Notes,
                          which had an aggregate principal amount of $122 million.
                          We received valid
                          tenders from holders of $120 million in aggregate principal
                          amount of the 11%
                          Senior Notes. On June 30, 2004, we completed the repurchase
                          of the 11% Senior
                          Notes tendered in the tender offer with proceeds from the
                          issuance of our 4.875%
                          convertible
  22
  
 senior
                          subordinated notes and with the proceeds from the sale
                          of assets of the pharmacy
                          and supplies business. The repurchase of substantially
                          all of the 11% Senior
                          Notes resulted in a loss of $22.9 million, or $14.1 million,
                          net of taxes.
 
 Income
                          tax expense for the year ended December 31, 2005, reflected
                          a higher effective
                          tax rate than the statutory federal tax rate due to state
                          and foreign income
                          taxes and certain non-deductible expenses for tax purposes.
                          Cash outflows for
                          income taxes in 2005 and 2004, were $4.0 million and $7.7
                          million, respectively,
                          comprised of foreign, federal alternative minimum taxes
                          and state income taxes.
 
 Earnings
                          from discontinued operations of $9.9 million, net of tax,
                          in 2005 includes a $10
                          million pre-tax charge for the settlement of the *qui
                          tam* claims
                          and a $2 million pre-tax charge for the write-off of the
                          remaining accounts
                          receivable of the pharmacy and supplies business described
                          above. In 2004, we
                          recorded a gain on the sale of the pharmacy and supplies
                          business of $30.9
                          million, net of income taxes of $20.9 million. Goodwill
                          of $16.3 million was
                          charged against the gain. Also in connection with the sale,
                          in 2004 we increased
                          the allowance for doubtful accounts for the retained receivables
                          by $11.9
                          million to provide for the estimated effects of the sale
                          of the business and
                          2005 outsourcing of the collection effort to a third party
                          could have on
                          collections.
 
 **Liquidity
                          and Capital Resources**
 ***Operating
                          Activities***
  As
                          of
                          December 31, 2006, we had cash and cash equivalents of
                          $19.8 million. Net cash
                          provided by (used in) continuing operations was $27.4 million
                          in 2006 compared
                          to $5.0 million in 2005 and $(3.6) million in 2004. This
                          increase in cash from
                          operations was due primarily to an increase in earnings
                          from continuing
                          operations and increases in non-cash charges for depreciation
                          and amortization,
                          deferred income taxes and share-based compensation. The
                          increase in 2006 was
                          partially offset by decreases in accounts payable and in
                          accrued and other
                          liabilities relating primarily to the payment of transaction-related
                          expenses
                          incurred in the CorSolutions acquisition.
 
 Cash
                          flows from discontinued operations were $(3.1) million,
                          $20.0 million and $13.7
                          million for the years ended December 31, 2006, 2005 and
                          2004, respectively. In
                          2006, cash flows used in discontinued operations included
                          a $10.0 million
                          settlement payment, net of $150,000 insurance reimbursement,
                          for the two *qui
                          tam* actions
                          filed against the Company and its former subsidiary, Diabetes
                          Self Care, Inc.
                          This charge was included in earnings from discontinued
                          operations for the year
                          ended December 31, 2005. The 2006 period also reflects
                          the allocation of $9.8
                          million in interest expense (before taxes) discussed above.
 
 Our
                          accounts receivable days’ sales outstanding, or DSO, were 54 days and 63 days at
                          December 31, 2006 and 2005, respectively. The decrease
                          is due to a lower DSO
                          from our disease management and wellness businesses.
 
 ***Investing
                          Activities***
  Net
                          cash
                          provided by (used in) investing activities totaled $(299.4)
                          million in 2006,
                          $(28.9) million in 2005, and $67.8 million in 2004. The
                          increase in net cash
                          used in investing activities is driven primarily by our
                          acquisition and
                          divestiture activities. The results of operations of our
                          acquired businesses
                          have been included in our consolidated statements of operations
                          since their
                          respective acquisition dates.
 
 On
                          January 19, 2006, we completed the acquisition of CorSolutions
                          for a cash
                          payment of $434.7 million, net of cash acquired. Also in
                          2006, we successfully
                          completed the divestitures of Facet on September 1, 2006,
                          for cash proceeds of
                          $119.8 million, net of transaction costs, and Dia Real
                          on October 19, 2006, for
                          cash proceeds of $30.5 million, net of transaction costs.
 
 In
                          2005,
                          cash used in investing activities included $19.7 million
                          for the acquisition of
                          two businesses. On April 1, 2005, we acquired the business
                          and assets of Miavita
                          for a net cash payment of $4.8 million, with
  23
  
 additional
                          amounts to be paid in 2006 and 2007 under an earn-out agreement.
                          In May 2006, we
                          paid $1.7 million of additional consideration for the first
                          earn-out period of
                          this acquisition as a result of certain operating milestones
                          being achieved. The
                          payment was recorded as additional goodwill. On October
                          1, 2005, we acquired the
                          business of WinningHabits for a net cash payment of $14.9
                          million, with
                          additional amounts to be paid in 2007 under an earn-out
                          agreement. As of
                          December 31, 2006,  the estimated additional earn-out consideration to be
                          paid under these agreements was approximately $54.2 million.
 
 Continuing
                          operations’ capital expenditures of $13.1 million in 2006, $11.1 million
                          in
                          2005, and $8.6 million in 2004 relate primarily to the
                          replacement and
                          enhancement of computer information systems and to the
                          replacement of medical
                          devices used in our maternity management programs. Discontinued
                          operations’
capital expenditures of $379,000 in 2006, $1.5 million
                          in 2005, and $1.6 million
                          in 2004 relate primarily to purchases of machinery and
                          equipment and computer
                          information systems.
 
 On
                          June
                          30, 2004, we completed the sale of substantially all of
                          the assets, excluding
                          trade and certain other receivables, of our direct-to-consumer
                          pharmacy and
                          supplies business. At the closing, we received cash proceeds,
                          net of transaction
                          costs, of approximately $101.1 million. We used approximately
                          $20.5 million of
                          the proceeds received from the sale to satisfy the earn-out
                          payment owed to the
                          sellers of Quality Oncology and approximately $53 million
                          to complete the
                          funding of our tender offer for our 11% Senior Notes.
 
 Restricted
                          cash increased to $1.4 million in 2006 from $550,000 in
                          2005. We have restricted
                          funds for amounts held in escrow related to customer contracts
                          and as collateral
                          for insurance policies. Generally, such funds are held
                          in interest-bearing
                          investment accounts or certificates of deposit.
 
 ***Financing
                          Activities***
  Net
                          cash
                          provided by (used in) financing activities was $271.7 million,
                          $(8.2) million
                          and $(49.1) million for 2006, 2005 and 2004, respectively.
 
 On
                          January 19, 2006, we funded the acquisition of CorSolutions
                          with the proceeds
                          from term loans and revolving credit loans pursuant to
                          a credit agreement and a
                          second lien term loan facility with Bank of America, N.A.,
                          as administrative and
                          collateral agent (the “New Credit Facilities”). The New Credit Facilities, as
                          amended, provide for borrowings of up to an aggregate of
                          $485 million and were
                          divided between a First Lien Credit Facility and a Second
                          Lien Credit Facility.
                          The New Credit Facilities replaced our previous revolving
                          credit facility, which
                          was terminated on January 13, 2006. There were no amounts
                          outstanding under the
                          revolving credit facility at the time of termination.
 
 At
                          December 31, 2006, the New Credit Facilities consisted
                          of the
                          following:
 
 
 **Loan**
                                
                                **Outstanding
                                    Balance at December 31, 2006**
                                
                                **Interest**
                                
                                **Variable
                                    Interest Rate at December 31, 2006**
                                
                                **Maturity
                                    Date****First
                                    Lien Credit Facility**Term
                                    Loan B Facility
                                
                                $
                                277.2
                                    million
                                
                                
                                LIBOR
                                    plus 2.00
                                %
                                
                                7.36%
                                    to 7.37
                                %
                                
                                January
                                    19, 2012Term
                                    Loan C Facility (a)
                                
                                $
                                --
                                
                                
                                -
                                
                                
                                -
                                
                                
                                January
                                    19, 2007Revolving
                                    Credit Facility
                                
                                $
                                --
                                
                                
                                -
                                
                                
                                -
                                
                                
                                January
                                    19, 2011**Second
                                    Lien Credit Facility**Term
                                    Loan Facility (b)
                                
                                $
                                --
                                
                                
                                LIBOR
                                    plus 6.75
                                %
                                
                                -
                                
                                
                                January
                                    19, 2012
 
 (a)  We
                          used
                          the net proceeds from the sales of Facet and Dia Real and
                          operating cash flows
                          to prepay the outstanding indebtedness under the Term Loan
                          C
                          Facility.
 (b)  On
                          November 6, 2006, we amended the terms of the New Credit
                          Facilities and prepaid
                          the Second Lien Credit Facility with proceeds from the
                          First Lien Credit
                          Facility.
 
 Amounts
                          borrowed under the Term Loan B Facility and the Term Loan
                          C Facility accrue
                          interest at a variable spread over LIBOR, with the applicable
                          spread determined
                          by the Company’s consolidated leverage
  24
  
 ratio,
                          as
                          described in the applicable credit agreement. Interest
                          rates for these
                          facilities, as well as for the Term Loan Facility, are
                          reset quarterly. Amounts
                          borrowed under the New Credit Facilities are fully and
                          unconditionally
                          guaranteed on a joint and several basis by substantially
                          all of our
                          subsidiaries. Amounts borrowed under the First Lien Credit
                          Facility are secured
                          by a first priority lien on substantially all of our assets
                          and the assets of
                          our subsidiary guarantors.
 
 The
                          New
                          Credit Facilities also provide for a Revolving Credit Facility.
                          Amounts borrowed
                          under the Revolving Credit Facility accrue interest at
                          a variable spread over
                          LIBOR or the prime rate, at our option, with the applicable
                          spread determined by
                          reference to our consolidated leverage ratio, as described
                          in the credit
                          agreement. At December 31, 2006, there were no amounts
                          outstanding under the
                          Revolving Credit Facility, and the available balance was
                          $28.5 million.
 
 In
                          November 2006, we amended the terms of the New Credit Facilities.
                          Under the
                          amended agreement, the First Lien Credit Facility was increased
                          by $65.0
                          million, the proceeds of which were used to prepay the
                          Second Lien Credit
                          Facility. Borrowings under the First Lien Credit Facility
                          bore interest at LIBOR
                          plus 2.00%, a 475 basis point reduction from the Second
                          Lien Credit Facility.
                          All the other terms and conditions of the Credit Agreement
                          (other than those
                          relating to the increased amount of the First Lien Credit
                          Facility and those
                          that are no longer applicable because they relate solely
                          to the Second Lien
                          Credit Facility) remain unchanged. We incurred fees and
                          expenses of
                          approximately $1.7 million, which were recorded as deferred
                          financing costs and
                          are being amortized over the term of the First Lien Credit
                          Facility (January
                          2012). On February 23, 2007, we entered into a third amendment
                          to the New Credit
                          Facilities, the terms of which increased our borrowing
                          capacity under the
                          Revolving Credit Facility from $30.0 million to $50.0 million.
                          All other terms
                          of the New Credit Facilities, as amended, remain unchanged.
 
 The
                          New
                          Credit Facilities contain, among other things, various
                          representations,
                          warranties and affirmative, negative and financial covenants
                          customary for
                          financings of this type. The negative covenants include,
                          without limitation,
                          certain limitations on transactions with affiliates, liens,
                          making investments,
                          the incurrence of debt, sales of assets, and changes in
                          business. The financial
                          covenants contained in the New Credit Facilities include
                          a consolidated leverage
                          ratio and a consolidated fixed charges coverage ratio.
                          At December 31, 2006, we
                          were in compliance with all covenants of the New Credit
                          Facilities.
 
 During
                          the third and fourth quarters of 2006, we made prepayments
                          of $175.0 million
                          toward the reduction of the First Lien Credit Facility.
                          Of this amount, $115.0
                          million and $30.0 million were paid from proceeds from
                          the Facet and Dia Real
                          divestitures, respectively, and $30.0 million was paid
                          from our operating cash
                          flows. As of December 31, 2006, the outstanding balance
                          under the New Credit
                          Facilities was $277.2 million.
 
 In
                          February and May 2006, we entered into two interest rate
                          swap agreements
                          totaling $200 million notional amount to hedge our exposure
                          to fluctuations in
                          interest rates related to the New Credit Facilities. The
                          swap agreements had the
                          economic effect of converting $200 million of our floating
                          rate debt under the
                          New Credit Facilities to fixed rate debt. Under the terms
                          of the agreements, we
                          will pay the bank fixed base rates of 5.065% and 5.350%,
                          respectively, and the
                          bank will pay us floating rates based on three-month LIBOR
                          (5.371% and 5.364%,
                          respectively, at December 31, 2006). We reflected the interest
                          rate swap
                          agreements on the consolidated balance sheet at a fair
                          value of $62,000 at
                          December 31, 2006, which was based upon the estimated amount
                          we would pay upon
                          settlement of the agreements, taking into account interest
                          rates at December 31,
                          2006. For the year ended December 31, 2006, we recognized
                          a net gain of $79,000
                          from the cash flow hedges, which is included in “Interest expense” in the
                          consolidated statements of operations.
 
 In
                          September 2006, we entered into a forward exchange agreement
                          with a bank to
                          eliminate the potential impact of foreign exchange fluctuations
                          on the U.S.
                          dollar equivalent of the expected euro proceeds from the
                          sale of Dia Real. Under
                          the terms of the agreement, we agreed to sell €26.0 million at the forward rate
                          (1.2837) and receive approximately $33.4 million on the
                          settlement date. We
                          reported the forward exchange agreement at fair value on
                          our consolidated
                          balance sheet until it was settled in October 2006.
  25
  
 In
                          2004,
                          we completed the sale of $86.3 million in aggregate principal
                          amount of 4.875%
                          convertible senior subordinated notes due 2024. We received
                          proceeds, net of
                          discount, of $83.2 million from the issuance of the convertible
                          senior
                          subordinated notes. We used the proceeds and proceeds from
                          the sale of
                          substantially all of the assets of our direct-to-consumer
                          pharmacy and supplies
                          business to fund the repurchase of $120 million in aggregate
                          principal amount of
                          11% Senior Notes, which had an aggregate principal amount
                          of $122 million,
                          tendered in a tender offer. This repurchase resulted in
                          a net cash payment of
                          $136.5 million. In June 2004, we recorded a charge of $22.9
                          million, or $14.1
                          million, net of taxes, related to the repurchase of substantially
                          all of the 11%
                          Senior Notes.
 
 On
                          April
                          27, 2005, we issued a notice of our intention to redeem
                          our $86.3 million in
                          aggregate principal amount of 4.875% convertible senior
                          subordinated notes on
                          May 27, 2005. In response to the redemption notice, all
                          noteholders converted
                          their notes into shares of the Company’s common stock prior to the redemption
                          date, and the Company issued approximately 4.4 million
                          shares of common stock
                          ($19.61 per share). In addition, the redemption also required
                          us to make a
“make-whole payment” equal to the present value, as of the redemption date,
                          of
                          all remaining scheduled interest payments on the notes
                          through May 1, 2009. We
                          paid the noteholders the “make-whole payment” totaling $15.5 million ($3.52 per
                          share), which included $294,000 of accrued but unpaid interest.
                          The “make-whole
                          payment,” excluding the accrued but unpaid interest, was accounted
                          for in
                          accordance with SFAS No. 84, *Induced
                          Conversion of Convertible Debt* .
                          Since
                          the conversion was pursuant to the original conversion
                          terms and no inducement
                          was made to the noteholders, no loss was recognized with
                          respect to the
“make-whole payment,” excluding the accrued but unpaid interest, or the shares
                          issued.
 
 Proceeds
                          received from participants under our stock purchase and
                          stock option plans
                          totaled $6.0 million, $7.3 million, and $6.6 million in
                          2006, 2005 and 2004,
                          respectively.
  We
                          believe that our cash, other liquid assets, operating cash
                          flows and New Credit
                          Facilities, taken together, will provide adequate resources
                          to fund ongoing
                          operating requirements, planned capital expenditures and
                          contractual obligations
                          through the remainder of 2007.
 
 **Contractual
                          Obligations, Commitments and Off-Balance Sheet
                          Arrangements**
 
 We
                          have
                          various contractual obligations that are appropriately
                          recorded as liabilities
                          in our consolidated financial statements. Certain other items, such as
                          operating
                          lease obligations, are not recognized as liabilities in
                          our consolidated
                          financial statements but are required to be disclosed.
                          The following sets forth
                          our future minimum payments required under contractual
                          obligations as of
                          December 31, 2006 (in thousands):
 
 
 **Payments
                                    Due by Year****Total**
                                
                                **2007**
                                
                                **2008-2009**
                                
                                **2010-2011**
                                
                                **Thereafter**Long-term
                                    debt obligations(1)
                                
                                $
                                279,957
                                
                                $
                                4,069
                                
                                $
                                8,600
                                
                                $
                                238,791
                                
                                $
                                28,497Capital
                                    lease obligations
                                
                                
                                144
                                
                                
                                127
                                
                                
                                17
                                
                                
                                -
                                
                                
                                -Operating
                                    lease obligations
                                
                                
                                31,450
                                
                                
                                8,539
                                
                                
                                14,427
                                
                                
                                5,011
                                
                                
                                3,473Other
                                    long-term obligations
                                
                                
                                6,981
                                
                                
                                3,343
                                
                                
                                2,606
                                
                                
                                1,032
                                
                                
                                -Acquisition
                                    obligations(2)
                                
                                
                                54,223
                                
                                
                                54,223
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -$
                                372,755
                                
                                $
                                70,301
                                
                                $
                                25,650
                                
                                $
                                244,834
                                
                                $
                                31,970
 
 (1)
                                Does
                                    not include the interest expense associated with
                                    the long-term debt
                                    obligations.
 (2)
                                Discussed
                                    above under “Liquidity and Capital Resources - Investing Activities” and
                                    below under “Other Factors Affecting
                                    Liquidity.”
 
 Principal
                          and interest payments of $3.3 million and $21.9 million,
                          respectively, under the
                          New Credit Facilities are payable in 2007. Capital expenditures
                          of approximately
                          $19 million are estimated in 2007 as we continue to enhance
                          our computer
                          information systems.
 
 We
                          have
                          restricted funds of $1.4 million as of December 31, 2006,
                          which represent
                          amounts held in escrow related to customer contracts. Funds
                          are held in
                          interest-bearing investment accounts.
  26
  
 As
                          of
                          December 31, 2006, we did not have any significant off-balance
                          sheet
                          arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation
                          S-K, except for
                          our indemnification obligations related to potential breaches
                          of the
                          representations and warranties contained in the definitive
                          agreements to sell
                          Facet and Dia Real, which obligations are capped at $12.5
                          million and $9.9
                          million, respectively.
 
 ***Other
                          Factors Affecting Liquidity***
 In
                          connection with our acquisitions of WinningHabits and Miavita,
                          we are required
                          to pay additional consideration in future periods, based
                          upon the attainment of
                          defined operating objectives of these businesses. In accordance
                          with SFAS No.
                          141, *Business
                          Combinations* ,
                          we
                          accrue contingent consideration obligations upon attainment
                          of the objectives.
                          Additionally, any such payments result in increases in
                          goodwill.
 
 We
                          currently estimate that the additional consideration pursuant
                          to the terms of
                          our earn-out agreement for the WinningHabits acquisition
                          is $32.2
                          million. ****** The
                          estimated additional consideration, which is included in
“Acquisition contingent
                          consideration” on the consolidated balance sheet, is based on the attainment
                          of
                          the operating objectives for the year ended December 31,
                          2006, and is subject to
                          final audit. The final amount for WinningHabits will be
                          payable in 2007.
 
 Also
                          included in “Acquisition contingent consideration" is $22.0 million
                          of earn-out
                          consideration for the second earn-out period ending March
                          31, 2007, for the
                          Miavita acquisition. On November 6, 2006, we entered into
                          a Settlement Agreement
                          and Release with the seller that effectively amends the
                          terms of the original
                          acquisition agreement to fix the amount payable for the
                          second earn-out period
                          at $20 million plus 3.575 times net revenues from certain
                          new customers between
                          November 6, 2006, and March 31, 2007, provided that no
                          payment is payable in
                          respect of the second earn-out period unless payments received
                          from such new
                          customers between November 6, 2006, and May 1, 2007, are
                          at least $500,000.
 
 Goodwill
                          was increased by $55.9 million at December 31, 2006, for
                          the consideration paid
                          during 2006 and the estimated additional consideration payable under the
                          earn-out agreements described above.
 
 ***Uncertainties***
  Pursuant
                          to the merger agreement under which we acquired CorSolutions,
                          we are pursuing a
                          claim before a contractually-designated settlement accountant
                          for certain
                          post-closing adjustments including a $4 million claim relating
                          to a liability
                          resulting from CorSolutions’ pre-closing performance under a customer contract.
                          We are also pursuing a related claim for fraudulent misrepresentation
                          and
                          concealment before the American Arbitration Association
                          in Chicago, Illinois,
                          seeking damages in an unspecified amount exceeding $4 million.
                          There is no
                          assurance that we will prevail in either of these proceedings.
 
 We
                          are
                          subject to various legal claims and actions incidental
                          to our business and the
                          businesses of our predecessors, including product liability
                          claims and
                          professional liability claims. We maintain insurance, including
                          insurance
                          covering professional and product liability claims, with
                          customary deductible
                          amounts. There can be no assurance, however, that (i) lawsuits
                          will not be filed
                          against us in the future, (ii) our prior experience with
                          respect to the
                          disposition of litigation is representative of the results
                          that will occur in
                          pending or future cases or (iii) adequate insurance coverage
                          will be available
                          at acceptable prices, if at all, for incidents arising
                          or claims made in the
                          future. There are no pending legal or governmental proceedings
                          to which we are a
                          party that we believe would, if adversely resolved, have
                          a material adverse
                          effect on us. For a discussion of other risks and uncertainties
                          that may affect
                          our business, see “Risk Factors” in Item 1A of this Annual Report on Form
                          10-K.
  27
  
 **Critical
                          Accounting Policies and Estimates**
  Critical
                          accounting policies are those policies that require management
                          to make the most
                          challenging, subjective or complex judgments, often because
                          they must estimate
                          the effect of matters that are inherently uncertain and
                          may change in subsequent
                          periods. Critical accounting policies involve judgments
                          and uncertainties that
                          are sufficiently sensitive to result in materially different
                          results under
                          different assumptions and conditions. We believe our most
                          critical accounting
                          policies are described below.
 
 ***Revenue
                          Recognition and Allowances for Uncollectible Accounts.*** Our
                          services are provided telephonically and, in some cases,
                          in a patient’s home
                          from care centers located throughout the United States.
                          In addition, our
                          services are provided through access to our online health
                          and wellness based
                          tools. Revenues are recognized as the related services
                          are rendered and are net
                          of contractual allowances and related discounts.
 
 Our
                          services are paid for primarily on the basis of (i) monthly
                          fees for each
                          employee or member enrolled in a health plan, (ii) each
                          member identified with a
                          particular chronic disease or condition under contract,
                          (iii) each member
                          enrolled in our programs, (iv) fee-for-service, or (v)
                          a fixed rate per case.
                          Billings for certain services occur in advance of services
                          being performed. Such
                          amounts are recorded as “Unearned revenues” in the consolidated balance sheets.
                          Such amounts are subsequently recognized as revenue as
                          services are
                          performed.
 
 Some
                          contracts provide that a portion of our fees are at-risk
                          (i.e., refundable) if
                          our programs do not achieve certain financial cost savings
                          and clinical
                          performance criteria. Revenues subject to refund are not
                          recognized if (i)
                          sufficient information is not available to calculate performance
                          measurements,
                          or (ii) interim performance measurements indicate that
                          we are not meeting
                          performance targets. If either of these two conditions
                          exists, we record the
                          amounts as “Unearned revenues” in the consolidated balance sheets. If we do not
                          meet performance levels by the end of the operations period
                          under the contract,
                          we are contractually obligated to refund some or all of
                          the at-risk fees.
 
 In
                          2006,
                          revenues from continuing operations were derived from the
                          following types of
                          customers and third-party payors: approximately 57% from
                          health plans, 34% from
                          employers, 7% from government payors and 2% from administrative
                          services only
                          (“ASO”) self-insured employer clients.
 
 A
                          significant portion of our revenues is billed to third-party
                          reimbursement
                          sources. Therefore, the collectibility of all of our accounts
                          receivable varies
                          based on payor mix, general economic conditions and other
                          factors. A provision
                          for doubtful accounts is made for revenues estimated to
                          be uncollectible and is
                          adjusted periodically based upon our evaluation of current
                          industry conditions,
                          historical collection experience, recoveries of amounts
                          previously provided,
                          industry reimbursement trends and other relevant factors
                          which, in the opinion
                          of management, deserve recognition in estimating the allowance
                          for uncollectible
                          accounts. The evaluation is performed at each reporting
                          period for each
                          operating unit with an overall assessment at the consolidated
                          level. While
                          estimates and judgments are involved and factors impacting
                          collectibility may
                          change, management believes adequate provision has been
                          made for any adjustments
                          that may result from final determination of amounts to
                          be
                          collected.
 
 ***Goodwill
                          and Identifiable Intangible Assets*** **.** Goodwill
                          represents the excess of cost over fair value of identifiable
                          net assets
                          acquired. Goodwill arising from business combinations is
                          accounted for under the
                          provision of SFAS No. 141, *Business
                          Combinations* ,
                          and
                          SFAS No. 142, *Goodwill
                          and Other Intangible Assets* ,
                          and is
                          not amortized. Our identifiable intangible assets are amortized
                          over their
                          respective estimated useful lives. As of December 31, 2006,
                          we reported goodwill
                          and identifiable intangible assets at net carrying amounts
                          of $500.8 million and
                          $55.9 million, respectively. The total of $556.7 million
                          represents
                          approximately 78% of our total assets as of December 31,
                          2006.
  We
                          review
                          goodwill and identifiable intangibles for impairment annually
                          as of December 31
                          and whenever events or changes in circumstances indicate
                          that the carrying value
                          may not be recoverable. In testing
  28
  
 for
                          impairment, we compare the book value of net assets to
                          the fair value of the
                          related reporting units that have goodwill and indefinite
                          life intangibles
                          assigned to them. If the fair value is determined to be
                          less than book value, a
                          second step is performed to compute the amount of impairment.
                          We estimate the
                          fair values of the reporting units based upon earnings
                          multiples for similar
                          precedent transactions as well as the present value of
                          estimated future free
                          cash flows. The approach utilized is dependent on a number
                          of factors, including
                          estimates of future revenues and operating costs, appropriate
                          discount rates and
                          other variables. We base our estimates on assumptions that
                          we believe to be
                          reasonable, but which are unpredictable and inherently
                          uncertain. Therefore,
                          future impairments could result if actual results differ
                          from those estimates.
                          Based on our evaluation, we concluded that no impairment
                          of recorded goodwill
                          and intangibles existed at December 31, 2006.
  ***Accounting
                          for Income Taxes.*** We
                          account for income taxes using an asset and liability approach.
                          Deferred income
                          taxes are recognized for the tax consequences of “temporary differences” by
                          applying enacted statutory tax rates applicable to future
                          years to differences
                          between the financial statement carrying amounts and the
                          tax bases of existing
                          assets and liabilities and net operating loss and tax credit
                          carryforwards.
                          Additionally, the effect on deferred taxes of a change
                          in tax rates is
                          recognized in earnings in the period that includes the
                          enactment
                          date.
 
 The
                          income tax expense (benefit) for continuing operations
                          was $12.8 million, $2.7
                          million, and $(13.3) million for the years ended December
                          31, 2006, 2005 and
                          2004, respectively. Reflected in each year were various
                          non-deductible permanent
                          differences between tax and financial reporting. As of
                          December 31, 2006, our
                          remaining net operating loss carryforwards of $67.0 million,
                          the tax effect of
                          which is reflected as an asset on the balance sheet in
                          the “Deferred income
                          taxes,” will be available to offset future taxable income liabilities.
                          Based on
                          projections of taxable income in 2007 and future years,
                          we believe that it is
                          more likely than not that we will fully realize the value
                          of the recorded
                          deferred income tax assets. The amount of the deferred
                          tax asset considered
                          realizable, however, could be reduced if estimates of future
                          taxable income
                          during the carryforward period are reduced.
 
 ***Share-Based
                          Compensation.*** On
                          January 1, 2006, we adopted Statement of Financial Accounting Standards
                          No. 123 (revised 2004), *Share-Based
                          Payment* (“SFAS 123(R)”). SFAS 123(R) establishes standards for the accounting
                          for
                          share-based payment transactions in which an enterprise
                          receives employee
                          services in exchange for either equity instruments of the
                          enterprise or
                          liabilities that are based on the fair value of the enterprise’s equity
                          instruments or that may be settled by the issuance of such
                          equity instruments.
                          SFAS 123(R) eliminates the ability to account for share-based
                          compensation
                          transactions, as we formerly did, using the intrinsic value
                          method as prescribed
                          by Accounting Principles Board, (“APB”), Opinion No. 25, *Accounting
                          for Stock Issued to Employees* ,
                          and
                          generally requires that such transactions be accounted
                          for using a
                          fair-value-based method. Changes in assumptions as to the
                          employee forfeitures
                          assumptions, exercise dates and volatility could have a
                          significant impact on
                          the stock compensation fair value determinations.
 
 The
                          above
                          listing is not intended to be a comprehensive list of all
                          of our accounting
                          policies. In many cases, the accounting treatment of a
                          particular transaction is
                          specifically dictated by generally accepted accounting
                          principles, with no need
                          for management’s judgment in their application. There are also areas in
                          which
                          management’s judgment in selecting any available alternative would
                          not produce a
                          materially different result. See the Notes to Consolidated
                          Financial Statements
                          in this Annual Report on Form 10-K, which contain additional
                          accounting policies
                          and other disclosures required by generally accepted accounting
                          principles.
 
 Our
                          senior management has discussed the development and selection
                          of our critical
                          accounting estimates, and this disclosure, with the Audit
                          Committee of our Board
                          of Directors.
 
 **Recently
                          Issued and Recently Adopted Accounting Standards**
  ***Accounting
                          for Uncertainty in Income Taxes.*** In
                          June
                          2006, the FASB published Interpretation No. 48, Accounting
                          for Uncertainty in
                          Income Taxes, an interpretation of FASB Statement No. 109
                          (“FIN 48”). FIN 48
                          prescribes a recognition threshold and measurement attribute
                          for the financial
                          statement recognition and
  29
  
 measurement
                          of a tax position taken or expected to be taken in a tax
                          return. FIN 48 also
                          provides guidance on derecognition, classification, interest
                          and penalties,
                          accounting in interim periods, disclosure and transition.
                          The effective date of
                          this interpretation is January 1, 2007, the first fiscal
                          year beginning after
                          December 15, 2006. We are currently evaluating the provisions
                          of FIN 48 to
                          determine its impact, if any, on our financial statements
                          but presently
                          anticipate that its adoption will not have a material impact
                          on our results of
                          operations and financial position.
 
 ***Fair
                          Value Measurements*** **.** In
                          September 2006, the FASB issued SFAS No. 157, *Fair
                          Value Measurements* (“SFAS
                          157”), which defines fair value, establishes framework for
                          measuring fair value
                          in GAAP and expands disclosures about fair value measurements.
                          SFAS 157 will be
                          effective for financial statements issued for fiscal years
                          beginning after
                          November 15, 2007, and interim periods within those fiscal
                          years. We are
                          currently evaluating the requirements of this new standard
                          and have not
                          concluded our analysis on the impact, if any, on our results
                          of operations and
                          financial position.
 
 ***Prior
                          Year Misstatements*** .
                          In
                          September 2006, the Securities and Exchange Commission
                          (“SEC”) issued Staff
                          Accounting Bulletin No. 108, *Considering
                          the Effects of Prior Year Misstatements when Quantifying
                          Misstatements in
                          Current Year Financial Statements* (“SAB
                          No.
                          108”). SAB No. 108 addresses quantifying the financial statement
                          effects of
                          misstatements, specifically, how the effects of prior year
                          uncorrected errors
                          must be considered in quantifying misstatements in current
                          year financials.
                          Under the provisions of SAB No. 108, a reporting entity
                          must quantify and
                          evaluate errors using a balance sheet approach and an income
                          statement approach.
                          After considering all relevant quantitative and qualitative
                          factors, if either
                          approach results in a misstatement that is material, a
                          reporting entity’s
                          financial statements must be adjusted. SAB No. 108 is effective
                          for fiscal years
                          ending after November 15, 2006.
 
 We
                          adopted the provisions of SAB No. 108 in the fourth quarter
                          of 2006 and recorded
                          a cumulative effect adjustment of $813,000, net of income
                          taxes of $518,000, to
                          our January 1, 2006 consolidated balance sheet. We identified
                          two uncorrected
                          misstatements for consideration under SAB 108, each of
                          which was considered
                          immaterial to our results of operations in any reporting
                          period when using only
                          the income statement approach we historically used to assess
                          the materiality of
                          unrecorded errors:
 
 1.
                                An
                                    unrecorded liability for drugs and supplies from
                                    a major vendor, which is
                                    included in “Accounts payable” on the consolidated balance sheets,
                                    resulted from an accumulation of unrecorded costs
                                    over several periods
                                    prior to 2003. This misstatement was identified
                                    in 2003 The amount
                                    required at January 1, 2006, to correct the liability
                                    balance would result
                                    in a $600,000 charge to our results of operations
                                    in
                                    2006.
 
 2.
                                During
                                    2006, we discovered that our medical device inventory,
                                    which is included
                                    in “Property and equipment” on the consolidated balance sheets, was
                                    overstated due to improper recording of disposed
                                    and lost medical devices
                                    and the related depreciation expense. The misstatement
                                    originated in 2003
                                    and accumulated over subsequent periods. The
                                    amount required to correct
                                    the medical device inventory balance at January
                                    1, 2006, would result in a
                                    $731,000 charge to our results of operations
                                    in
                                    2006.
 
 Under
                          the
                          balance sheet approach and the income statement approach,
                          or the dual approach,
                          we determined that correcting the above misstatements would
                          be material to our
                          2006 financial statements and recorded a cumulative effect
                          adjustment to our
                          January 1, 2006, consolidated balance sheet upon our initial
                          application of SAB
                          108.
  30
  
 **Item
                          7A. Quantitative and Qualitative Disclosure about Market
                          Risk**
 
 We
                          are
                          exposed to market risk from changes in interest rates on
                          long-term debt.
 
 Our
                          primary interest rate risk relates to the New Credit Facilities
                          and our interest
                          rate swap facilities. In February 2006 and May 2006, we
                          entered into interest
                          rate swap agreements with notional amounts totaling $200
                          million with a bank
                          under which we will pay the bank fixed base rates of interest
                          of 5.065% and
                          5.350%, respectively, and the bank will pay us floating
                          rates based on
                          three-month LIBOR (5.371% and 5.364%, respectively, at
                          December 31, 2006). The
                          agreements, which have a two-year term, have the economic
                          effect of converting a
                          portion of our floating rate debt to fixed rate debt. Based
                          upon the total
                          amount outstanding at December 31, 2006, not covered by
                          interest rate swaps, a
                          hypothetical two percentage point increase in the interest
                          rates for a duration
                          of one year would result in additional interest expense
                          of approximately $2
                          million.
  31
  
 **Item
                          8. Financial Statements and Supplementary Data**
 
 Our
                          consolidated financial statements are included as pages
                          F-1 through F-30 of this
                          Annual Report on Form 10-K:
 
 **PAGE**Report
                                    of Independent Registered Public Accounting Firm
                                    on Consolidated Financial
                                    Statements
                                F-1Report
                                    of Independent Registered Public Accounting Firm
                                    on Management’s
                                    Assessment of Internal Controls
                                F-2Management’s
                                    Report on Internal Controls Over Financial Reporting
                                F-3Consolidated
                                    Balance Sheets - December 31, 2006 and 2005
                                F-4Consolidated
                                    Statements of Operations - Years Ended December
                                    31, 2006, 2005 and
                                    2004
                                F-5Consolidated
                                    Statements of Shareholders’ Equity and Comprehensive Earnings (Loss) -
                                    Years Ended December 31, 2006, 2005 and 2004
                                F-6Consolidated
                                    Statements of Cash Flows - Years Ended December
                                    31, 2006, 2005 and
                                    2004
                                F-7Notes
                                    to Consolidated Financial Statements
                                F-8
 
 
 **Item
                          9. Changes in and Disagreements with Accountants on Accounting
                          and Financial
                          Disclosure**
 None.
 
 **Item
                          9A. Controls and Procedures**
 
 ***Evaluation
                          of Disclosure Controls and Procedures***
  The
                          Chief
                          Executive Officer and Chief Financial Officer have evaluated
                          the effectiveness
                          of the design and operation of our disclosure controls
                          and procedures (as such
                          term is defined in Rules 13a-15(e) and 15d-15(e) under
                          the Securities Exchange
                          Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2006. No
                          process, no matter how well designed and operated, can
                          provide absolute
                          assurance that the objectives of the process are met in
                          all cases. However, our
                          disclosure controls and procedures are designed to provide
                          reasonable assurance
                          that the certifying officers will be alerted on a timely
                          basis to material
                          information relating to the Company (including the Company’s consolidated
                          subsidiaries) required to be included in our reports filed
                          or submitted under
                          the Exchange Act.
  Based
                          on
                          such evaluation, such officers have concluded that our
                          disclosure controls and
                          procedures were effective as of December 31, 2006, to provide
                          reasonable
                          assurance that the objectives of the disclosure controls
                          and procedures were
                          met.
  32
  
 ***Management’s
                          Report on Internal Control Over Financial Reporting and
                          Report of Independent
                          Registered Public Accounting Firm***
 
 “Report
                          of Independent Registered Public Accounting Firm” on management’s assessment of
                          internal controls and “Management’s Report on Internal Control Over Financial
                          Reporting” are included on pages F-2 and F-3 of this Annual Report
                          on Form 10-K.
 
 ***Changes
                          in Internal Control over Financial Reporting***
 On
                          January 19, 2006, the Company completed the acquisition
                          of CorSolutions Medical,
                          Inc. The Company is now in the process of integrating the
                          CorSolutions
                          operations. The Company has extended its Section 404 compliance
                          program under
                          the Sarbanes-Oxley Act of 2002 and the applicable rules
                          and regulations under
                          such Act to include CorSolutions. See Note 2 to the Notes
                          to Consolidated
                          Financial Statements included on page F-8 of this Annual
                          Report on Form 10-K for
                          a discussion of the acquisition and related financial data.
 
 Except
                          for the CorSolutions acquisition, Messrs. Petit and Hinton
                          have concluded that
                          there have been no significant changes in the Company’s internal control over
                          financial reporting during the period ended December 31,
                          2006, that have
                          materially affected, or are reasonably likely to materially
                          affect, the
                          Company’s internal control over financial reporting.
 
 **Item
                          9B. Other Information**
 None.
  33
  
 **PART
                          III**
 
 **Item
                          10. Directors, Executive Officers of the Registrant and
                          Corporate
                          Governance.**
 Except
                          as
                          set forth below, information required by this item will
                          be included under the
                          captions “Election of Directors,” “Corporate Governance and Nominating
                          Committee,” “Board Committees, Attendance and Communications with Board
                          of
                          Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the
                          Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders
                          to be held
                          on June 5, 2007, to be filed with the Commission and incorporated
                          by reference
                          herein. Additional information relating to the executive
                          officers of the Company
                          is included as a Special Item in Part I of this Annual
                          Report on Form
                          10-K.
 
 Information
                          relating to the Company’s Corporate Governance Guidelines and Code of Conduct is
                          included under the caption “Available Information” in Part I, Item 1 of this
                          Annual Report on Form 10-K.
  **Item
                          11. Executive Compensation.**
 Information
                          required by this item will be contained under the captions
“Compensation
                          Committee Interlocks and Insider Participation,” “Executive Compensation” and
“Compensation Committee Report” in the Company’s Proxy Statement for the 2007
                          Annual Meeting of Stockholders to be held on June 5, 2007,
                          to be filed with the
                          Commission and incorporated by reference herein.
 
 **Item
                          12. Security Ownership of Certain Beneficial Owners and
                          Management and Related
                          Stockholder Matters.**
 
 Except
                          as
                          set forth below, information required by this item will
                          be contained under the
                          caption “Security Ownership of Certain Beneficial Owners and Management” in the
                          Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders
                          to be held
                          on June 5, 2007, to be filed with the Commission and incorporated
                          by reference
                          herein.
 
 For
                          purposes of determining the aggregate market value of the
                          Company’s common stock
                          held by non-affiliates as shown on the cover page of this
                          report, shares held by
                          all directors and executive officers of the Company have
                          been excluded. The
                          exclusion of such shares is not intended to, and shall
                          not, constitute a
                          determination as to which persons may be “affiliates” of the Company as defined
                          by the rules of the Commission.
 
 **Equity
                          Compensation Plan Information.** The
                          following table gives information about the Company’s common stock that may be
                          issued upon the exercise of options, warrants and rights
                          under all existing
                          equity compensation plans as of December 31, 2006:
 
 **Plan
                                    Category**
                                
                                **Number
                                    of Securities to be Issued Upon Exercise of Outstanding
                                    Options, Warrants
                                    and Rights**
                                
                                **Weighted-Average
                                    Exercise Price of Outstanding Options, Warrants
                                    and
                                    Rights**
                                
                                **Number
                                    of Securities Remaining Available for Future
                                    Issuance Under Equity
                                    Compensation Plans (1)**Equity
                                    compensation plans approved by security holders
                                
                                
                                2,462,384
                                
                                $
                                22.33
                                
                                
                                512,722
                                
                                
                                (2
                                )Equity
                                    compensation plans not approved by security holders
                                    (3)
                                
                                
                                24,619
                                
                                $
                                15.79
                                
                                
                                --Total
                                
                                
                                2,487,003
                                
                                $
                                22.26
                                
                                
                                512,722
 
 (1)
                                Excluding
                                    securities reflected in first
                                    column.
 (2)
                                Includes
                                    securities available for future issuance under
                                    shareholder-approved
                                    compensation plans as follows: 284,572 shares
                                    under the Long-Term Stock
                                    Incentive Plan, 16,350 shares under the 2002
                                    Stock Incentive Plan, 597
                                    shares under the 2001 Stock Incentive Plan, 90,687
                                    shares under the 2005
                                    Directors’ Non-qualified Stock Option Plan, 4,478 shares
                                    under the 2000
                                    Stock Incentive Plan,
  34
  
 and
                          5,500
                          shares under the 2000 Directors Non-qualified Stock Option
                          Plan. Also includes
                          110,538 shares that remain available for purchase under
                          the 2005 Stock Purchase
                          Plan.
 
 (3)
                                This
                                    total includes options for: (a) 12,940 shares
                                    granted to certain key
                                    employees (other than executive officers) on
                                    October 20, 1997 and 7,500
                                    shares granted to non-employee members of the
                                    Company’s Board of Directors
                                    on February 24, 1998. All of these options were
                                    granted at exercise prices
                                    equal to the fair market value of a share of
                                    the Company’s stock on the
                                    date of grant and all expire ten years from the
                                    date of the grant. The
                                    October 20, 1997 grants vested and became fully
                                    exercisable on October 20,
                                    2000. The February 24, 1998 grants vested on
                                    February 24, 1999; (b) 4,179
                                    shares assumed by the Company in connection with
                                    the acquisition of
                                    MarketRing on June 14, 2002, which options were
                                    granted by MarketRing
                                    under the MarketRing 1999 Stock Option and Stock
                                    Appreciation Rights Plan
                                    prior to the acquisition. The exercise price
                                    for these options, originally
                                    set by MarketRing, has been determined by reference
                                    to the exchange ratio
                                    prescribed for converting shares of MarketRing
                                    common stock into shares of
                                    the Company’s common stock pursuant to the acquisition. The
                                    assumed
                                    options generally vest in increments of 25% annually,
                                    and will be fully
                                    vested on June 14, 2007, with such options expiring
                                    five to ten years from
                                    the date of grant or upon termination of
                                    employment.
 
 **Item
                          13. Certain Relationships and Related Transactions and
                          Director
                          Independence.**
 Information
                          required by this item will be contained under the captions
“Certain
                          Relationships and Related Transactions” and “Corporate Governance” in the
                          Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders
                          to be held
                          on June 5, 2007, to be filed with the Commission and incorporated
                          by reference
                          herein.
 
 **Item
                          14. Principal Accountant Fees and Services**
 Information
                          required by this item will be contained under the caption
“Audit Fees” in the
                          Company’s Proxy Statement for the 2007 Annual Meeting of Stockholders
                          to be held
                          on June 5, 2007, to be filed with the Commission and incorporated
                          by reference
                          herein.
  35
  
 **PART
                          IV**
 
 **Item
                          15. Exhibits and Financial Statement Schedules**
 
 **(a)(1)**  **Financial
                          Statements**
 See
                          Part
                          II, Item 8 for an index to our financial statements and
                          supplementary
                          data.
 
 **(a)(2)** The
                          following supporting financial statement schedule and report
                          of independent
                          registered public accounting firm thereon are included
                          as part of this Annual
                          Report on Form 10-K:
 
 **PAGE**Report
                                    of Independent Registered Public Accounting Firm
                                45Schedule
                                    II - Valuation and Qualifying Accounts
                                46
 
 All
                          other
                          Schedules are omitted because the required information
                          is inapplicable or
                          information is presented in the Consolidated Financial
                          Statements or related
                          notes.
 
 **(a)(3)
                          Exhibits**
 
 The
                          following exhibits are incorporated by reference herein
                          as part of this Report
                          as indicated:
 
 2.1
                                Asset
                                    Purchase Agreement, dated June 22, 2004, by and
                                    among Matria Healthcare,
                                    Inc., Diabetes Management Solutions, Inc., Diabetes
                                    Self Care, Inc. and
                                    DEGC Enterprises (U.S.), Inc. (incorporated by
                                    reference to Exhibit 2.1 to
                                    the Company’s Current Report on Form 8-K filed July 15, 2004).2.1.1
                                Amendment
                                    No. 1 to Asset Purchase Agreement, dated June
                                    30, 2004, by and among
                                    Matria Healthcare, Inc., Diabetes Management
                                    Solutions, Inc., Diabetes
                                    Self Care, Inc. and DEGC Enterprises (U.S.),
                                    Inc. (incorporated by
                                    reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed
                                    July 15, 2004).2.2
                                Asset
                                    Purchase Agreement dated March 9, 2005, by and
                                    between Miavita LLC and
                                    Matria Healthcare, Inc. (incorporated by reference
                                    to Exhibit 99.1 to the
                                    Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended March 31,
                                    2005).2.3
                                Agreement
                                    and Plan of Merger by and among Matria Healthcare,
                                    Inc., WHI Acquisition
                                    Corp. and WinningHabits, Inc., dated September
                                    19, 2005 (incorporated by
                                    reference to Exhibit 2.3 to the Company’s Quarterly Report on Form 10-Q
                                    for the quarter ended September 30, 2005).2.4
                                Agreement
                                    and Plan of Merger dated as of December 14, 2005,
                                    by and among
                                    CorSolutions Medical, Inc., Matria Healthcare,
                                    Inc. and Coral Acquisition
                                    Corp. (incorporated by reference to Exhibit 2.5
                                    to the Company’s Annual
                                    Report on Form 10-K for the year ended December
                                    31,
                                    2005).2.5
                                Membership
                                    Interest Purchase Agreement dated July 26, 2006
                                    by and among Matria
                                    Healthcare, Inc., Facet Technologies, LLC and
                                    Facet Acquisition, LLC
                                    (incorporated by reference to Exhibit 2.1 to
                                    the Company’s Current Report
                                    on Form 8-K filed July 31, 2006).2.6
                                Sale
                                    and Purchase Agreement dated September 22, 2006,
                                    by and among Matria
                                    Healthcare, Inc., Diabetes Acquisition, Inc.,
                                    OPG Holding GmbH and OPG
                                    Groep N.V. (incorporated by reference to Exhibit
                                    2.1 to the Company’s
                                    Current Report on Form 8-K filed September 27,
                                    2006).3.1
                                Certificate
                                    of Incorporation of Matria Holding Company, Inc.,
                                    dated as of December 28,
                                    2004 (incorporated by reference to Exhibit 3.1
                                    to the Company’s Current
                                    Report on Form 8-K filed January 6,
                                    2005).
  36
  
 3.2
                                Certificate
                                    of Ownership and Merger merging Matria Mergeco,
                                    Inc. with and into Matria
                                    Holding Company, Inc., dated December 31, 2004
                                    (incorporated by reference
                                    to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed January
                                    6, 2004).3.3
                                Amended
                                    and Restated Bylaws of Matria Healthcare, Inc.
                                    (incorporated by reference
                                    to the Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended June
                                    30, 2006).4.1
                                Indenture,
                                    dated as of July 9, 2001, by and among Matria
                                    Healthcare, Inc., the
                                    Guarantors named therein and Wells Fargo Minnesota,
                                    National Association
                                    as Trustee, relating to the Company’s 11% Senior Notes due 2008
                                    (incorporated by reference to Exhibit 99.2 to
                                    the Company’s Current Report
                                    on Form 8-K filed July 19, 2001).4.2
                                Supplemental
                                    Indenture, dated June 21, 2002, between the Company
                                    and Wells Fargo Bank
                                    Minnesota, N.A. (Incorporated by reference to
                                    Exhibit 4.10 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).4.3
                                Supplemental
                                    Indenture, dated August 1, 2002, between the
                                    Company and Wells Fargo Bank
                                    Minnesota, N.A. (Incorporated by reference to
                                    Exhibit 4.11 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).4.4
                                Supplemental
                                    Indenture, dated October 4, 2002, between the
                                    Company and Wells Fargo Bank
                                    Minnesota, N.A. (Incorporated by reference to
                                    Exhibit 4.12 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).4.5
                                Supplemental
                                    Indenture, dated April 19, 2004, by and among
                                    Matria Healthcare, Inc., the
                                    Company’s subsidiary guarantors listed therein and Wells
                                    Fargo Bank, N.A.
                                    (incorporated by reference to Exhibit 4.2 to
                                    the Company’s Quarterly
                                    Report on Form 10-Q for the quarter ended June
                                    30,
                                    2004).4.6
                                Supplemental
                                    Indenture, dated December 31, 2004 among Matria
                                    Healthcare, Inc., Matria
                                    Holding Company, Inc., the subsidiary guarantors
                                    listed therein and Wells
                                    Fargo Bank, N.A., as Trustee, amending the Indenture,
                                    dated July 9, 2001
                                    by and among Matria Healthcare, Inc., the subsidiary
                                    guarantors listed
                                    therein and Wells Fargo Bank, N.A., as Trustee
                                    (incorporated by reference
                                    to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed January
                                    6, 2005).*10.1
                                1996
                                    Stock Incentive Plan (incorporated by reference
                                    to Appendix F-1 to the
                                    Joint Proxy Statement/Prospectus filed as a part
                                    of the Company’s
                                    Registration Statement No. 333-781 on Form S-4
                                    filed on February 7,
                                    1996).*10.2
                                1996
                                    Directors’ Non-Qualified Stock Option Plan (incorporated
                                    by reference to
                                    Appendix F-11 to the Joint Proxy Statement/Prospectus
                                    filed as a part of
                                    the Company’s Registration Statement No. 333-781 on Form
                                    S-4 filed on
                                    February 7, 1996).*10.3
                                2002
                                    Employee Stock Purchase Plan (incorporated by
                                    reference to Appendix D to
                                    the Proxy Statement/Prospectus/Solicitation Statement
                                    filed as a part of
                                    the Company’s Registration Statement No. 333-90944 on Form
                                    S-4 filed June
                                    30, 2002).*10.4
                                1997
                                    Stock Incentive Plan (incorporated by reference
                                    to Exhibit A to the
                                    Company’s Definitive Proxy Statement filed with the Commission
                                    on April
                                    16, 1998).*10.5
                                2000
                                    Stock Incentive Plan (incorporated by reference
                                    to Exhibit A to the
                                    Company’s Definitive Proxy Statement filed with the Commission
                                    on April
                                    14, 2000).*10.6
                                2000
                                    Director’s Non-Qualified Stock Option Plan (incorporated
                                    by reference to
                                    the Company’s Definitive Proxy Statement filed with the Commission
                                    on
                                    April 14, 2000).
  37
  
 *10.7
                                Amendment
                                    to the 1996 Directors’ Non-Qualified Stock Option Plan approved by the
                                    Company’s stockholders on May 18, 1998 (incorporated
                                    by reference to
                                    Exhibit 10.23 to the Company’s Form 10-K for the year ended December 31,
                                    2000).*10.8
                                Amendment
                                    to the 2000 Directors’ Non-Qualified Stock Option Plan, approved by
                                    the
                                    Company’s stockholders on May 24, 2001 (incorporated
                                    by reference to the
                                    Company’s Definitive Proxy Statement filed with the Commission
                                    April 26,
                                    2001).*10.9
                                2001
                                    Stock Incentive Plan (incorporated by reference
                                    to the Company’s
                                    Definitive Proxy Statement filed with the Commission
                                    April 26,
                                    2001).*10.10
                                2002
                                    Stock Incentive Plan (incorporated by reference
                                    to Appendix C to the
                                    Prospectus/Proxy Statement/Solicitation Statement
                                    filed as part of the
                                    Company’s Registration Statement No. 333-90944 on Form
                                    S-4 filed June 21,
                                    2002).*10.11
                                MarketRing.com,
                                    Inc. 1999 Stock Option and Stock Appreciation
                                    Rights Plan, effective
                                    September 30, 1999, assumed by the Company (incorporated
                                    by reference to
                                    Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the
                                    quarter ended June 30, 2002).*10.12
                                MarketRing.com,
                                    Inc. Amendment No. 1 to 1999 Stock Option and
                                    Stock Appreciation Rights
                                    Plan, dated July 14, 2000, assumed by the Company
                                    (incorporated by
                                    reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q
                                    for the quarter ended June 30, 2002).*10.13
                                2005
                                    Stock Purchase Plan (incorporated by reference
                                    to Appendix A to the
                                    Company’s Definitive Proxy Statement filed with the Commission
                                    on April
                                    25, 2005).*10.14
                                Long-Term
                                    Stock Incentive Plan (incorporated by reference
                                    to Appendix B to the
                                    Company’s Definitive Proxy Statement filed with the Commission
                                    on April
                                    25, 2005).*10.15
                                2005
                                    Directors’ Non-Qualified Stock Option Plan (incorporated
                                    by reference to
                                    Appendix C to the Company’s Definitive Proxy Statement filed with the
                                    Commission on April 25, 2005).10.16
                                NewMarket
                                    Building Lease Agreement, dated September 4,
                                    2002, between Matria
                                    Healthcare, Inc. and Trizec Realty, Inc. (incorporated
                                    by reference to
                                    Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the
                                    quarter ended September 30, 2002).10.17
                                One
                                    Parkway Center Lease Agreement, dated November
                                    8, 2002, between Matria
                                    Healthcare, Inc. and Atlanta Parkway Investment
                                    Group, Inc. (incorporated
                                    by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form
                                    10-Q for the quarter ended September 30, 2002).*10.18
                                Split
                                    Dollar Termination Agreement between the Company
                                    and Roberta L. McCaw,
                                    dated January 1, 2003 (incorporated by reference
                                    to Exhibit 10.27 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).*10.19
                                Split
                                    Dollar Termination Agreement between the Company
                                    and Thornton A. Kuntz,
                                    Jr., dated January 1, 2003 (incorporated by reference
                                    to Exhibit 10.28 to
                                    the Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).*10.20
                                Split
                                    Dollar Termination Agreement between the Company
                                    and Parker H. Petit,
                                    dated January 1, 2003 (incorporated by reference
                                    to Exhibit 10.29 to the
                                    Company’s Annual Report on Form 10-K for the year ended December 31,
                                    2002).
  38
  
 *10.21
                                Split
                                    Dollar Termination Agreement between the Company
                                    and Yvonne V. Scoggins,
                                    dated January 1, 2003 (incorporated by reference
                                    to Exhibit 10.30 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).*10.22
                                Supplemental
                                    Executive Retirement Plan between the Company
                                    and Roberta L. McCaw, dated
                                    January 1, 2003 (incorporated by reference to
                                    Exhibit 10.31 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).*10.23
                                Supplemental
                                    Executive Retirement Plan between the Company
                                    and Thornton A. Kuntz, Jr.,
                                    dated January 1, 2003 (incorporated by reference
                                    to Exhibit 10.32 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).*10.24
                                Trust
                                    Under the Matria Healthcare, Inc. Supplemental
                                    Executive Retirement Plan,
                                    dated February 4, 2003 (incorporated by reference
                                    to Exhibit 10.37 to the
                                    Company’s Annual Report on Form 10-K for the year ended
                                    December 31,
                                    2002).*10.25
                                First
                                    Amendment to the Trust under the Matria Healthcare,
                                    Inc. Supplemental
                                    Retirement Plan effective February 4, 2003 (incorporated
                                    by reference to
                                    Exhibit 10 to the Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended March 31, 2003.)10.26
                                First
                                    Amendment of Lease, dated May 9, 2003, to the
                                    New Market Building Lease
                                    Agreement between Matria Healthcare, Inc. and
                                    Trizec Realty, Inc.
                                    (incorporated by reference to Exhibit 10 to the
                                    Company’s Quarterly Report
                                    on Form 10-Q for the quarter ended June 30, 2003).10.27
                                First
                                    Amendment to Lease Agreement dated December 11,
                                    2003, by and between
                                    Atlanta Parkway Investment Group, Inc., and Matria
                                    Healthcare, Inc.
                                    (incorporated by reference to Exhibit 10.34 to
                                    the Company’s Annual Report
                                    on Form 10-K for the year ended December 31,
                                    2003).10.28
                                Second
                                    Amendment to Lease Agreement dated December 11,
                                    2003, between Atlanta
                                    Parkway Investment Group, Inc., and Matria Healthcare,
                                    Inc. (incorporated
                                    by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K
                                    for the year ended December 31, 2003).10.29
                                Second
                                    Amendment of Lease, dated February 3, 2004, to
                                    the New Market Building
                                    Lease between Matria Healthcare, Inc., and Trizec
                                    Realty, Inc.,
                                    (incorporated by reference to Exhibit 10.43 to
                                    the Company’s Annual Report
                                    on Form 10-K for the year ended December 31,
                                    2003).*10.30
                                Amendment
                                    to the Matria Healthcare, Inc. 2000 Directors’ Non-Qualified Stock Option
                                    Plan (incorporated by reference to Exhibit 10.3
                                    to the Company’s Quarterly
                                    Report on Form 10-Q for the quarter ended June
                                    30,
                                    2004).10.31
                                Third
                                    Amendment of Lease, dated March 30, 2004, to
                                    the New Market Building Lease
                                    between the Company and Trizec Realty, Inc. (incorporated
                                    by reference to
                                    Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the
                                    quarter ended June 30, 2004).10.32
                                Matria
                                    Healthcare, Inc. Form of Stock Option Agreement
                                    (incorporated by reference
                                    to Exhibit 10 to the Company’s Quarterly Report on Form 10-Q for the
                                    quarter ended September 30, 2004).*10.33
                                Letter
                                    Agreement dated as of November 7, 2005, by and
                                    between Matria Healthcare,
                                    Inc. and Richard M. Hassett, M.D. (incorporated
                                    by reference to Exhibit
                                    10.1 to the Company’s Current Report on Form 8-K filed November 10,
                                    2005).
  39
  
 10.34
                                Credit
                                    Agreement, dated January 19, 2006, by and among
                                    Matria, certain of its
                                    domestic subsidiaries, as guarantors and Bank
                                    of America, N.A. as issuing
                                    bank swing lender, administrative agent and collateral
                                    agent (incorporated
                                    by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
                                    filed January 25 2006).10.35
                                Term
                                    Loan Agreement, dated January 19, 2006, by and
                                    among Matria, certain of
                                    its domestic subsidiaries, as guarantors and
                                    Bank of America, N.A. as
                                    administrative agent and collateral agent (incorporated
                                    by reference to
                                    Exhibit 10.2 to the Company’s Current Report on Form 8-K filed January 25,
                                    2006).10.36
                                First
                                    Amendment to Credit Agreement, dated February
                                    2, 2006, by and among
                                    Matria, certain of its domestic subsidiaries,
                                    as guarantors and Bank of
                                    America, N.A., as issuing bank, swingline lender,
                                    administrative agent and
                                    collateral agent (incorporated by reference to
                                    Exhibit 10.1 to the
                                    Company’s Current Report on Form 8-K filed February 7,
                                    2006).10.37
                                First
                                    Amendment to Term Loan Agreement, dated February
                                    2, 2006, by and among
                                    Matria, certain of its domestic subsidiaries,
                                    as guarantors and Bank of
                                    America, N.A. as administrative agent and collateral
                                    agent (incorporated
                                    by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K
                                    filed February 7, 2006).*10.38
                                Letter
                                    Agreement dated as of March 8, 2006, by and between
                                    Matria Healthcare,
                                    Inc. and Jeffrey L. Hinton (incorporated by reference
                                    to Exhibit 10.1 to
                                    the Company’s Current Report on Form 8-K filed March 8,
                                    2006).10.39
                                Form
                                    of Restricted Stock Agreement to be issued under
                                    the Long-Term Stock
                                    Incentive Plan prior to 2007 (incorporated by
                                    reference to the Company’s
                                    Current Report on Form 8-K filed April 26, 2006).10.40
                                Second
                                    Amendment to the Credit Agreement and Consent,
                                    effective November 2, 2006,
                                    by and among Matria, certain of its domestic
                                    subsidiaries, as guarantors
                                    and Bank of America, N.A., as administrative
                                    agent and collateral agent
                                    (incorporated by reference to the Company’s Quarterly Report on Form 10-Q
                                    for the quarter ended September 30, 2006).10.41
                                Settlement
                                    Agreement and Release dated November 6, 2006,
                                    between Matria and MAJ
                                    Industries LLC (fka Miavita LLC) (incorporated
                                    by reference to the
                                    Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended September
                                    30, 2006).*10.42
                                Severance
                                    Compensation and Restrictive Covenant Agreement
                                    between Matria and Yvonne
                                    V. Scoggins dated November 6, 2006 (incorporated
                                    by reference to the
                                    Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended September
                                    30, 2006).*10.43
                                Severance
                                    Compensation and Restrictive Covenant Agreement
                                    between Matria and Richard
                                    M. Hassett, M.D. dated April 26, 2006 (incorporated
                                    by reference to the
                                    Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended September
                                    30, 2006).*10.44
                                Change-in-Control
                                    Severance Compensation and Restrictive Covenant
                                    Agreement between Matria
                                    and Richard M. Hassett, M.D. dated April 26,
                                    2006 (incorporated by
                                    reference to the Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended September 30, 2006).*10.45
                                Severance
                                    Compensation and Restrictive Covenant Agreement
                                    between Matria and Jeffrey
                                    L. Hinton dated April 26, 2006 (incorporated
                                    by reference to the Company’s
                                    Quarterly Report on Form 10-Q for the quarter
                                    ended September 30,
                                    2006).
  40
  
 *10.46
                                Change-in-Control
                                    Severance Compensation and Restrictive Covenant
                                    Agreement between Matria
                                    and Jeffrey L. Hinton dated April 26, 2006 (incorporated
                                    by reference to
                                    the Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended
                                    September 30, 2006).*10.47
                                Severance
                                    Compensation and Restrictive Covenant Agreement
                                    between Matria and Roberta
                                    L. McCaw dated April 26, 2006 (incorporated by
                                    reference to the Company’s
                                    Quarterly Report on Form 10-Q for the quarter
                                    ended September 30,
                                    2006).*10.48
                                Change-in-Control
                                    Severance Compensation and Restrictive Covenant
                                    Agreement between Matria
                                    and Roberta L. McCaw dated April 26, 2006 (incorporated
                                    by reference to
                                    the Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended
                                    September 30, 2006).*10.49
                                Severance
                                    Compensation and Restrictive Covenant Agreement
                                    between Matria and Parker
                                    H. Petit dated April 26, 2006 (incorporated by
                                    reference to the Company’s
                                    Quarterly Report on Form 10-Q for the quarter
                                    ended September 30,
                                    2006).*10.50
                                Change-in-Control
                                    Severance Compensation and Restrictive Covenant
                                    Agreement between Matria
                                    and Parker H. Petit dated April 26, 2006 (incorporated
                                    by reference to the
                                    Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended September
                                    30, 2006).*10.51
                                Change-in-Control
                                    Severance Compensation and Restrictive Covenant
                                    Agreement between Matria
                                    and Yvonne V. Scoggins dated April 26, 2006 (incorporated
                                    by reference to
                                    the Company’s Quarterly Report on Form 10-Q for the quarter
                                    ended
                                    September 30, 2006).10.52
                                Matria
                                    Healthcare, Inc. Board of Directors’ Charter of Corporate Governance and
                                    Nominating Committee (incorporated by reference
                                    to the Company’s Quarterly
                                    Report on Form 10-Q for the quarter ended September
                                    30,
                                    2006).*10.53
                                2006
                                    Management Incentive Plan (incorporated by reference
                                    to the Company’s
                                    Current Report on Form 8-K filed February 22,
                                    2006).10.54
                                Third
                                    Amendment to the Credit Agreement dated February
                                    25, 2007, by and among
                                    Matria, certain of its domestic subsidiaries,
                                    as guarantors, and Bank of
                                    America, N.A., as administrative agent and collateral
                                    agent (incorporated
                                    by reference to the Company’s Current Report on Form 8-K filed February
                                    28, 2007).14
                                Code
                                    of Conduct of Matria Healthcare, Inc., as amended
                                    October 19, 2004
                                    (incorporated by reference to Exhibit 14 to the
                                    Company’s Current Report
                                    on Form 8-K filed October 25,
                                    2004).
 
 The
                          following exhibits are filed as part of this Report:
 
 10.55
                                Matria’s
                                    Charter of the Audit Committee, as amended December
                                    14,
                                    2006.*10.56
                                Severance
                                    Compensation and Restrictive Covenant Agreement
                                    between Matria and
                                    Thornton A. Kuntz, Jr. dated April 26, 2006.*10.57
                                Change-in-Control
                                    Severance Compensation and Restrictive Covenant
                                    Agreement between Matria
                                    and Thornton A. Kuntz, Jr. dated April 26, 2006.*10.58
                                Form
                                    of Restricted Stock Agreement to be issued under
                                    the Company’s Stock
                                    Incentive Plans for Performance-Based
                                    Awards.
  41
   *10.58.1
                                Form
                                    of Restricted Stock Agreement to be issued under
                                    the Company’s Stock
                                    Incentive Plans for Time-Based Awards.*+10.59
                                2007
                                    Management Incentive Plan.21
                                List
                                    of Subsidiaries23
                                Consent
                                    of Independent Registered Public Accounting Firm24
                                Power
                                    of Attorney (included in signature page to this
                                    report)31.1
                                Rule
                                    13a-14(a)/15d-14(a) Certification by Parker H.
                                    Petit31.2
                                Rule
                                    13a-14(a)/15d-14(a) Certification by Jeffrey
                                    L. Hinton32.1
                                Section
                                    1350 Certification by Parker H. Petit32.2
                                Section
                                    1350 Certification by Jeffrey L. Hinton
 
 *Management
                          contract or compensatory plan or arrangement
 +Confidential
                          treatment pursuant to Rule 24b-2 under the Securities Exchange
                          Act has been
                          requested regarding certain portions of the indicated Exhibit,
                          which portions
                          have been filed separately
                          with the Commission.
 42
   **SIGNATURES**
  
 Pursuant
                          to the requirements of Section 13 or 15(d) 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.
 
 MATRIA
                                    HEALTHCARE, INC.March
                                      20, 2007
                                  By:
                                  /s/
                                      Parker H. PetitParker
                                      H. PetitChairman
                                      of the Board andChief
                                      Executive Officer(Principal
                                      Executive Officer)/s/
                                      Jeffrey L. HintonJeffrey
                                      L. Hinton, Senior Vice President  and Chief Financial Officer(Principal
                                      Financial Officer)/s/
                                      Joseph A. BlankenshipJoseph
                                      A. BlankenshipVice
                                      President - Corporate Controller(Principal
                                      Accounting Officer)
 
 
 
 KNOW
                          ALL
                          MEN BY THESE PRESENTS, that each person whose signature
                          appears below
                          constitutes and appoints Parker H. Petit as his or her
                          true and lawful
                          attorney-in-fact and agent, with full power of substitution
                          and re-substitution,
                          for and in his or her name, place and stead, in any and
                          all capacities, to sign
                          any and all amendments to this Annual Report on Form 10-K,
                          and to file the same,
                          with all exhibits thereto, and other documents in connection
                          therewith with the
                          Securities and Exchange Commission, granting unto said
                          attorney-in-fact and
                          agent full power and authority to do and to perform each
                          and every act and thing
                          requisite and necessary to be done in and about the premises,
                          as fully and to
                          all intents and purposes as he or she might or would do
                          in person, hereby
                          ratifying and confirming all that said attorney-in-fact
                          and agent, or his
                          substitute or substitutes, may lawfully do or cause to
                          be done by virtue
                          hereof.
 
 Pursuant
                          to the requirements of the Securities Exchange Act of 1934,
                          this report has been
                          signed below by the following persons on behalf of the
                          registrant and in the
                          capacities and on the dates indicated.
  
 Signature
                                
                                Title
                                Date/s/
                                    Parker H. Petit
                                
                                Chairman
                                    of the Board
                                March
                                    16, 2007Parker
                                    H. Petit
                                
                                and
                                    Chief Executive Officer/s/
                                    Richard M. Hassett, M.D.
                                
                                President,
                                    Chief Operating Officer
                                March
                                    16, 2007Richard
                                    M. Hassett, M.D.
                                
                                and
                                    Director/s/
                                    Joseph G. Bleser
                                
                                Director
                                March
                                    13, 2007Joseph
                                    G. Bleser
  43
  
 /s/
                                    J. Terry Dewberry
                                
                                Director
                                March
                                    13, 2007J.
                                    Terry Dewberry/s/
                                    Donald J. Lothrop
                                
                                Director
                                March
                                    13, 2007Donald
                                    J. Lothrop./s/
                                    Myldred H. Mangum
                                
                                Director
                                March
                                    13, 2007Myldred
                                    H. Mangum/s/
                                    Guy W. Millner
                                
                                Director
                                March
                                    13, 2007Guy
                                    W. Millner/s/
                                    Kaaren J. Street
                                
                                Director
                                March
                                    13, 2007Kaaren
                                    J. Street/s/
                                    Thomas S. Stribling
                                
                                Director
                                March
                                    14, 2007Thomas
                                    S. Stribling/s/
                                    Wayne P. Yetter
                                
                                Director
                                March
                                    13, 2007Wayne
                                    P. Yetter
  44
  
 **Report
                          of Independent Registered Public Accounting Firm**
 
 
 ***The
                          Board of Directors and Shareholders***
 ***Matria
                          Healthcare, Inc.:***
 
 Under
                          date of March 20, 2007, we reported on the consolidated
                          balance sheets of Matria
                          Healthcare, Inc. and subsidiaries (the "Company") as of
                          December 31, 2006 and
                          2005, and the related consolidated statements of operations,
                          shareholders’
equity and comprehensive earnings (loss) and cash flows
                          for each of the years in
                          the three-year period ended December 31, 2006, as contained
                          in the 2006 annual
                          report to shareholders. These consolidated financial statements
                          and our report
                          thereon are included in the annual report on Form 10-K
                          for the year 2006. In
                          connection with our audits of the aforementioned consolidated
                          financial
                          statements, we also audited the related financial statement
                          schedule as listed
                          in the accompanying index. This financial statement schedule
                          is the
                          responsibility of the Company’s management. Our responsibility is to express an
                          opinion on this financial statement schedule based on our
                          audits.
 
 In
                          our
                          opinion, such financial statement schedule, when considered
                          in relation to the
                          basic consolidated financial statements taken as a whole,
                          presents fairly, in
                          all material respects, the information set forth therein.
 
 As
                          discussed in note 1 to the consolidated financial statements,
                          the Company
                          adopted the provisions of Staff Accounting Bulletin No.
                          108, *Considering
                          the Effects of Prior Year Misstatements when Quantifying
                          Misstatements in
                          Current Year Financial Statements* ,
                          as of
                          January 1, 2006. Additionally, as discussed in notes 1
                          and 9 to the consolidated
                          financial statements, the Company adopted Statements of
                          Financial Accounting
                          Standards No. 123R, *Share
                          Based Payment* ,
                          as of
                          January 1, 2006.
 
 
 /s/ **KPMG
                          LLP**
 
 Atlanta,
                          Georgia
 March
                          20,
                          2007
  45
  
 **Matria
                          Healthcare, Inc. and Subsidiaries**
 **Schedule
                          II**
 **Valuation
                          and Qualifying Accounts**
 (Amounts
                          in thousands)
 
 
 **Additions****Balance
                                    at**
                                
                                **Charges
                                    to**
                                
                                **Charges
                                    to**
                                
                                
                                
                                
                                
                                **Balance
                                    at****Beginning**
                                
                                **Costs
                                    and**
                                
                                **Other**
                                
                                
                                
                                
                                
                                **End
                                    of****Description**
                                
                                **of
                                    Period**
                                
                                **Expenses**
                                
                                **Accounts**
                                
                                
                                
                                **Deductions**
                                
                                **Period**Year
                                    ended December 31, 2004
                                
                                $
                                2,940
                                
                                
                                2,412
                                
                                
                                -
                                
                                
                                
                                
                                
                                (3,060
                                )
                                $
                                2,292Year
                                    ended December 31, 2005
                                
                                $
                                2,292
                                
                                
                                3,493
                                
                                
                                15
                                
                                
                                1
                                
                                
                                (1,914
                                )
                                $
                                3,886Year
                                    ended December 31, 2006
                                
                                $
                                3,886
                                
                                
                                4,093
                                
                                
                                50
                                
                                
                                2
                                
                                
                                (3,632
                                )
                                $
                                4,397
 
 
 1 Represents
                          beginning balances in allowance for doubtful accounts of
                          acquired companies
                          (WinningHabits)
 2 Represents
                          beginning balances in allowance for doubtful accounts of
                          acquired companies
                          (CorSolutions)
 
 
 *See
                          accompanying report of Independent Registered Public Accounting
                          Firm.*
  46
  
 **Report
                          of Independent Registered Public Accounting Firm**
  
 
 ***The
                          Board of Directors and Shareholders***
 ***Matria
                          Healthcare, Inc.*** **:**
 
 We
                          have
                          audited the accompanying consolidated balance sheets of
                          Matria Healthcare, Inc.
                          and subsidiaries (the "Company") as of December 31, 2006
                          and 2005, and the
                          related consolidated statements of operations, shareholders’ equity and
                          comprehensive earnings (loss), and cash flows for each
                          of the years in the
                          three-year period ended December 31, 2006. These consolidated
                          financial
                          statements are the responsibility of the Company’s management. Our
                          responsibility is to express an opinion on these consolidated
                          financial
                          statements based on our audits.
 
 We
                          conducted our audits in accordance with the standards of
                          the Public Company
                          Accounting Oversight Board (United States). Those standards
                          require that we plan
                          and perform the audit to obtain reasonable assurance about
                          whether the financial
                          statements are free of material misstatement. An audit
                          includes examining, on a
                          test basis, evidence supporting the amounts and disclosures
                          in the financial
                          statements. An audit also includes assessing the accounting
                          principles used and
                          significant estimates made by management, as well as evaluating
                          the overall
                          financial statement presentation. We believe that our audits
                          provide a
                          reasonable basis for our opinion.
 
 In
                          our
                          opinion, the consolidated financial statements referred
                          to above present fairly,
                          in all material respects, the financial position of Matria
                          Healthcare, Inc. and
                          subsidiaries as of December 31, 2006 and 2005, and the
                          results of their
                          operations and their cash flows for each of the years in
                          the three-year period
                          ended December 31, 2006, in conformity with U.S. generally
                          accepted accounting
                          principles.
 
 As
                          discussed in note 1 to the consolidated financial statements,
                          the Company
                          adopted the provisions of Staff Accounting Bulletin No.
                          108, *Considering
                          the Effects of Prior Year Misstatements when Quantifying
                          Misstatements in
                          Current Year Financial Statements* ,
                          as of
                          January 1, 2006. Additionally, as discussed in notes 1
                          and 9 to the consolidated
                          financial statements, the Company adopted Statement of
                          Financial Accounting
                          Standards No. 123R, *Share
                          Based Payment* ,
                          as of
                          January 1, 2006.
 
 We
                          have
                          also audited, in accordance with the standards of the Public
                          Company Accounting
                          Oversight Board (United Sates), the effectiveness of Matria
                          Heatlhcare, Inc. and
                          subsidiaries' internal control over financial reporting
                          as of December 31, 2006,
                          based on criteria established in *Internal Control - Integrated
                          Framework* issued by the Committee of Sponsoring Organizations
                          of the
                          Treadway  Commission (COSO), and our report dated March 20, 2007,
                          expressed
                          an unqualified opinion on management's assessment of, and
                          the effective
                          operation of, internal control over financial reporting.
  **/s/
                          KPMG LLP**
 
 Atlanta,
                          Georgia
 March
                          20,
                          2007
  F-1
  
 **Report
                          of Independent Registered Public Accounting Firm**
  ***The
                          Board of Directors and Shareholders***
 ***Matria
                          Healthcare, Inc.:***
 
 We
                          have
                          audited management's assessment, included in the accompanying
                          Management’s
                          Report on Internal Control Over Financial Reporting, that
                          Matria Healthcare,
                          Inc. and subsidiaries  (the "Company") maintained effective internal
                          control over financial reporting as of December 31, 2006,
                          based on criteria
                          established in *Internal Control—Integrated Framework* issued
                          by
                          the Committee of Sponsoring Organizations of the Treadway
                          Commission (COSO). The
                          Company's management is responsible for maintaining effective
                          internal control
                          over financial reporting and for its assessment of the
                          effectiveness of internal
                          control over financial reporting. Our responsibility is
                          to express an opinion on
                          management's assessment and an opinion on the effectiveness
                          of the Company’s
                          internal control over financial reporting based on our
                          audit.
 
 We
                          conducted our audit in accordance with the standards of
                          the Public Company
                          Accounting Oversight Board (United States). Those standards
                          require that we plan
                          and perform the audit to obtain reasonable assurance about
                          whether effective
                          internal control over financial reporting was maintained
                          in all material
                          respects. Our audit included obtaining an understanding
                          of internal control over
                          financial reporting, evaluating management's assessment,
                          testing and evaluating
                          the design and operating effectiveness of internal control,
                          and performing such
                          other procedures as we considered necessary in the circumstances.
                          We believe
                          that our audit provides a reasonable basis for our opinion.
 
 A
                          company's internal control over financial reporting is
                          a process designed 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. A company's
                          internal control over
                          financial reporting includes those policies and procedures
                          that (1) pertain to
                          the maintenance of records that, in reasonable detail,
                          accurately and fairly
                          reflect the transactions and dispositions of the assets
                          of the company; (2)
                          provide reasonable assurance that transactions are recorded
                          as necessary to
                          permit preparation of financial statements in accordance
                          with generally accepted
                          accounting principles, and that receipts and expenditures
                          of the company are
                          being made only in accordance with authorizations of management
                          and directors of
                          the company; and (3) provide reasonable assurance regarding
                          prevention or timely
                          detection of unauthorized acquisition, use, or disposition
                          of the company’s
                          assets that could have a material effect on the financial
                          statements.
 
 Because
                          of its inherent limitations, internal control over financial
                          reporting may not
                          prevent or detect misstatements. Also, projections of any
                          evaluation of
                          effectiveness to future periods are subject to the risk
                          that controls may become
                          inadequate because of changes in conditions, or that the
                          degree of compliance
                          with the policies or procedures may deteriorate.
 
 In
                          our
                          opinion, management's assessment that Matria Healthcare,
                          Inc. and subsidiaries
                          maintained effective internal control over financial reporting
                          as of December
                          31, 2006, is fairly stated, in all material respects, based
                          on criteria
                          established in *Internal Control—Integrated Framework* issued
                          by
                          the Committee of Sponsoring Organizations of the Treadway
                          Commission (COSO).
                          Also, in our opinion, Matria Healthcare, Inc. and subsidiaries
                          maintained, in
                          all material respects, effective internal control over
                          financial reporting as of
                          December 31, 2006, based on criteria established in *Internal
                          Control—Integrated Framework* issued
                          by
                          the Committee of Sponsoring Organizations of the Treadway
                          Commission
                          (COSO).
 
 We
                          also
                          have audited, in accordance with the standards of the Public
                          Company Accounting
                          Oversight Board (United States), the consolidated balance
                          sheets of Matria
                          Healthcare, Inc. and subsidiaries as of December 31, 2006
                          and 2005, and the
                          related consolidated statements of operations, shareholders’ equity and
                          comprehensive earnings (loss), and cash flows for each
                          of the years in the
                          three-year period ended December 31, 2006, and our report
                          dated March 20,
                          2007, ** expressed
                          an unqualified opinion on those consolidated financial
                          statements, with an
                          explanatory paragraph as the Company adopted the provisions
                          of Staff Accounting
                          Bulletin No. 108, *Considering the Effects of Prior Year Misstatements
                          when
                          Quantifying Misstatements in Current Year Financial Statements*, and
                          Statement of Financial Accounting Standards No. 123R, *Share Based
                          Payment*, in 2006.
 
 **/s/
                          KPMG LLP**
 Atlanta,
                          Georgia
 March
                          20,
                          2007
  F-2
  
 **Management’s
                          Report on Internal Control Over Financial Reporting**
  The
                          management of Matria Healthcare, Inc. (the “Company”) is responsible for
                          establishing and maintaining adequate internal control
                          over financial reporting
                          as defined in Rule 13a-15(f) under the Securities Exchange
                          Act of 1934. The
                          Company maintains accounting and internal control systems
                          which are intended to
                          provide reasonable assurance that assets are safeguarded
                          against loss from
                          unauthorized use or disposition, transactions are executed
                          in accordance with
                          management’s authorization and accounting records are reliable for
                          preparing
                          financial statements in accordance with accounting principles
                          generally accepted
                          in the United States of America.
  Internal
                          control over financial reporting cannot provide absolute
                          assurance of achieving
                          financial reporting objectives because of its inherent
                          limitations. Internal
                          control over financial reporting is a process that involves
                          human diligence and
                          compliance and is subject to lapses in judgment and breakdowns
                          resulting from
                          human failures. Internal control over financial reporting
                          also can be
                          circumvented by collusion or improper management override.
                          Because of such
                          limitations, there is a risk that material misstatements
                          may not be prevented or
                          detected on a timely basis by internal control over financial
                          reporting.
                          However, these inherent limitations are known features
                          of the financial
                          reporting process. Therefore, it is possible to design
                          into the process
                          safeguards to reduce, though not eliminate, risk.
  The
                          Company’s management assessed the effectiveness of the Company’s internal
                          control over financial reporting as of December 31, 2006.
                          In making this
                          assessment, management used the criteria set forth by the
                          Committee of
                          Sponsoring Organizations (COSO) of the Treadway Commission
                          in *Internal
                          Control - Integrated Framework.*
  Based
                          on
                          our assessment management believes that, as of December
                          31, 2006, the Company’s
                          internal control over financial reporting is effective
                          based on those criteria.
  Management’s
                          assessment of the effectiveness of internal control over
                          financial reporting as
                          of December 31, 2006, has been audited by KPMG LLP, the
                          independent registered
                          public accounting firm who also audited the Company’s consolidated financial
                          statements. KPMG LLP’s attestation report on management’s assessment of the
                          Company’s internal control over financial reporting appears on
                          page F-2
                          hereof.
  
 
 /s/ Parker
                                    H. Petit
                                
                                
                                /s/ Jeffrey
                                    L. HintonParker
                                    H. Petit
                                  Chairman
                                    of the Board and
                                  Chief
                                    Executive Officer
                                
                                
                                Jeffrey
                                    L. Hinton
                                  Senior
                                    Vice President and
                                  Chief
                                    Financial Officer
  F-3
  
 **MATRIA
                          HEALTHCARE, INC. AND SUBSIDIARIES**
 **Consolidated
                          Balance Sheets**
 (Amounts
                          in thousands, except per share amounts)
 
 
 **December
                                    31,****ASSETS**
                                
                                **2006**
                                
                                **2005**Current
                                    assets:Cash
                                    and cash equivalents
                                
                                $
                                19,839
                                
                                $
                                22,758Restricted
                                    cash
                                
                                
                                1,372
                                
                                
                                550Trade
                                    accounts receivable, less allowances of $4,397
                                    and$3,886
                                    at December 31, 2006 and 2005, respectively
                                
                                
                                52,985
                                
                                
                                33,996Assets
                                    held for sale
                                
                                
                                -
                                
                                
                                132,455Prepaid
                                    expenses and other current assets
                                
                                
                                14,234
                                
                                
                                6,588Deferred
                                    income taxes
                                
                                
                                8,087
                                
                                
                                8,629Total
                                    current assets
                                
                                
                                96,517
                                
                                
                                204,976Property
                                    and equipment, net
                                
                                
                                38,950
                                
                                
                                26,430Goodwill,
                                    net
                                
                                
                                500,830
                                
                                
                                69,248Other
                                    intangibles, net
                                
                                
                                55,891
                                
                                
                                6,935Deferred
                                    income taxes
                                
                                
                                5,564
                                
                                
                                10,666Other
                                    assets
                                
                                
                                13,621
                                
                                
                                4,952$
                                711,373
                                
                                $
                                323,207**LIABILITIES
                                    AND SHAREHOLDERS' EQUITY**Current
                                    liabilities:Accounts
                                    payable, principally trade
                                
                                $
                                13,846
                                
                                $
                                10,702Current
                                    installments of long-term debt
                                
                                
                                4,197
                                
                                
                                1,021Liabilities
                                    related to assets held for sale and other discontinued
                                    operations
                                
                                
                                -
                                
                                
                                31,042Unearned
                                    revenues
                                
                                
                                13,493
                                
                                
                                7,205Acquisition
                                    contingent consideration
                                
                                
                                54,223
                                
                                
                                -Accrued
                                    liabilities
                                
                                
                                22,661
                                
                                
                                13,412Total
                                    current liabilities
                                
                                
                                108,420
                                
                                
                                63,382Long-term
                                    debt, excluding current installments
                                
                                
                                275,938
                                
                                
                                2,099Other
                                    long-term liabilities
                                
                                
                                8,039
                                
                                
                                5,788Total
                                    liabilities
                                
                                
                                392,397
                                
                                
                                71,269Shareholders'
                                    equity:Preferred
                                    stock, $.01 par value. Authorized 50,000 shares;none
                                    outstanding at December 31, 2006 and 2005
                                
                                
                                -
                                
                                
                                -Common
                                    stock, $.01 par value. Authorized 50,000 shares;issued
                                    and outstanding 21,255 and 20,832 at December
                                    31, 2006and
                                    2005, respectively
                                
                                
                                213
                                
                                
                                208Additional
                                    paid-in capital
                                
                                
                                415,950
                                
                                
                                400,488Accumulated
                                    deficit
                                
                                
                                (97,149
                                )
                                
                                (149,026
                                )Accumulated
                                    other comprehensive earnings
                                
                                
                                (38
                                )
                                
                                268Total
                                    shareholders' equity
                                
                                
                                318,976
                                
                                
                                251,938$
                                711,373
                                
                                $
                                323,207
   *See
                          accompanying notes to consolidated financial statements* .
  F-4
  
 **MATRIA
                          HEALTHCARE, INC. AND SUBSIDIARIES**
 **Consolidated
                          Statements of Operations**
 (Amounts
                          in thousands, except per share amounts)
 
 
 **Years
                                    ended December 31,****2006**
                                
                                **2005**
                                
                                **2004**Revenues
                                
                                $
                                336,139
                                
                                $
                                179,231
                                
                                $
                                145,087Cost
                                    of revenues
                                
                                
                                109,924
                                
                                
                                72,972
                                
                                
                                64,938Selling
                                    and administrative expenses
                                
                                
                                159,021
                                
                                
                                94,291
                                
                                
                                79,309Provision
                                    for doubtful accounts
                                
                                
                                4,093
                                
                                
                                3,493
                                
                                
                                2,412Amortization
                                    of intangible assets
                                
                                
                                7,144
                                
                                
                                365
                                
                                
                                -Total
                                    costs and operating expenses
                                
                                
                                280,182
                                
                                
                                171,121
                                
                                
                                146,659Operating
                                    earnings (loss) from continuing operations
                                
                                
                                55,957
                                
                                
                                8,110
                                
                                
                                (1,572
                                )Interest
                                    income
                                
                                
                                1,548
                                
                                
                                829
                                
                                
                                498Interest
                                    expense
                                
                                
                                (27,591
                                )
                                
                                (2,418
                                )
                                
                                (10,127
                                )Other
                                    income, net
                                
                                
                                1,329
                                
                                
                                226
                                
                                
                                681Loss
                                    on retirement of 11% Senior Notes
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (22,886
                                )Earnings
                                    (loss) from continuing operations before income
                                    taxes
                                
                                
                                31,243
                                
                                
                                6,747
                                
                                
                                (33,406
                                )Income
                                    tax benefit (expense)
                                
                                
                                (12,768
                                )
                                
                                (2,733
                                )
                                
                                13,329Earnings
                                    (loss) from continuing operations
                                
                                
                                18,475
                                
                                
                                4,014
                                
                                
                                (20,077
                                )Discontinued
                                    Operations:Earnings
                                    from discontinued operations, net of income taxes
                                
                                
                                5,293
                                
                                
                                9,949
                                
                                
                                16,205Gain
                                    on disposal of discontinued operations, net of
                                    income
                                    taxes
                                
                                
                                28,922
                                
                                
                                -
                                
                                
                                30,938Earnings
                                    from discontinued operations
                                
                                
                                34,215
                                
                                
                                9,949
                                
                                
                                47,143Net
                                    earnings
                                
                                $
                                52,690
                                
                                $
                                13,963
                                
                                $
                                27,066Net
                                    earnings (loss) per common share:Basic:Continuing
                                    operations
                                
                                $
                                0.88
                                
                                $
                                0.21
                                
                                $
                                (1.29
                                )Discontinued
                                    operations
                                
                                
                                1.63
                                
                                
                                0.53
                                
                                
                                3.03$
                                2.51
                                
                                $
                                0.74
                                
                                $
                                1.74Diluted:Continuing
                                    operations
                                
                                $
                                0.85
                                
                                $
                                0.20
                                
                                $
                                (1.29
                                )Discontinued
                                    operations
                                
                                
                                1.58
                                
                                
                                0.50
                                
                                
                                3.03$
                                2.43
                                
                                $
                                0.70
                                
                                $
                                1.74Weighted
                                    average shares outstanding:Basic
                                
                                
                                21,025
                                
                                
                                18,795
                                
                                
                                15,520Diluted
                                
                                
                                21,665
                                
                                
                                19,874
                                
                                
                                15,520
 
 
 *See
                          accompanying notes to consolidated financial statements.*
  F-5
  
 **MATRIA
                          HEALTHCARE, INC. AND SUBSIDIARIES**
 **Consolidated
                          Statements of Shareholders’ Equity and Comprehensive Earnings
                          (Loss)**
 (Amounts
                          in thousands)
 
 
 **Additional**
                                
                                
                                
                                **Other**
                                
                                **Total****Common
                                    stock**
                                
                                **Paid-in**
                                
                                **Accumulated**
                                
                                **Comprehensive**
                                
                                **Shareholders'****Shares**
                                
                                **Amount**
                                
                                **Capital**
                                
                                **Deficit**
                                
                                **Earnings
                                    (loss)**
                                
                                **Equity****Balance,
                                    January 1, 2004**
                                
                                
                                15,284
                                
                                $
                                153
                                
                                $
                                313,047
                                
                                $
                                (190,055
                                )
                                $
                                402
                                
                                $
                                123,547Issuance
                                    of common stock:Exercise of employee stock options
                                
                                
                                527
                                
                                
                                5
                                
                                
                                6,014
                                
                                
                                -
                                
                                
                                -
                                
                                
                                6,019Employee stock purchase plan
                                
                                
                                49
                                
                                
                                1
                                
                                
                                588
                                
                                
                                -
                                
                                
                                -
                                
                                
                                589Tax
                                    benefit from exercise of employee stock options
                                
                                
                                -
                                
                                
                                -
                                
                                
                                1,532
                                
                                
                                -
                                
                                
                                -
                                
                                
                                1,532Net
                                    earnings
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                27,066
                                
                                
                                -
                                
                                
                                27,066Change
                                    in foreign currency translation adjustment
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                907
                                
                                
                                907Comprehensive
                                    earnings
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                27,066
                                
                                
                                907
                                
                                
                                27,973**Balance,
                                    December 31, 2004**
                                
                                
                                15,860
                                
                                
                                159
                                
                                
                                321,181
                                
                                
                                (162,989
                                )
                                
                                1,309
                                
                                
                                159,660Issuance
                                    of common stock:Exercise of employee stock options
                                
                                
                                553
                                
                                
                                5
                                
                                
                                6,433
                                
                                
                                -
                                
                                
                                -
                                
                                
                                6,438Employee stock purchase plan
                                
                                
                                31
                                
                                
                                -
                                
                                
                                814
                                
                                
                                -
                                
                                
                                -
                                
                                
                                814Conversion of 4.875% notes
                                
                                
                                4,388
                                
                                
                                44
                                
                                
                                68,005
                                
                                
                                -
                                
                                
                                -
                                
                                
                                68,049Exercise of warrant
                                
                                
                                -
                                
                                
                                -
                                
                                
                                3
                                
                                
                                -
                                
                                
                                -
                                
                                
                                3Tax
                                    benefit from exercise of employee stock options
                                
                                
                                -
                                
                                
                                -
                                
                                
                                4,052
                                
                                
                                -
                                
                                
                                -
                                
                                
                                4,052Net
                                    earnings
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                13,963
                                
                                
                                -
                                
                                
                                13,963Change
                                    in foreign currency translation adjustment, net
                                    tax
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (1,041
                                )
                                
                                (1,041
                                )Comprehensive
                                    earnings
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                13,963
                                
                                
                                (1,041
                                )
                                
                                12,922**Balance,
                                    December 31, 2005**
                                
                                
                                20,832
                                
                                
                                208
                                
                                
                                400,488
                                
                                
                                (149,026
                                )
                                
                                268
                                
                                
                                251,938Cumulative
                                    effects of adjustments resulting from adoptionSAB 108, net of tax
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (813
                                )
                                
                                -
                                
                                
                                (813
                                )Issuance
                                    of common stock:Exercise of employee stock options
                                
                                
                                359
                                
                                
                                4
                                
                                
                                4,531
                                
                                
                                -
                                
                                
                                -
                                
                                
                                4,535Employee stock purchase plan
                                
                                
                                64
                                
                                
                                1
                                
                                
                                1,452
                                
                                
                                -
                                
                                
                                -
                                
                                
                                1,453Tax benefit from exercise of employee stock options
                                
                                
                                -
                                
                                
                                -
                                
                                
                                1,885
                                
                                
                                -
                                
                                
                                -
                                
                                
                                1,885Share-based
                                    compensation
                                
                                
                                -
                                
                                
                                -
                                
                                
                                6,986
                                
                                
                                -
                                
                                
                                -
                                
                                
                                6,986Share-based
                                    compensation-discontinued operations
                                
                                
                                -
                                
                                
                                -
                                
                                
                                608
                                
                                
                                -
                                
                                
                                -
                                
                                
                                608Change
                                    in fair value of interest rate swap
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (62
                                )
                                
                                (62
                                )Net
                                    earnings
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                52,690
                                
                                
                                -
                                
                                
                                52,690Change
                                    in foreign currency translation adjustment, net
                                    of tax
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (244
                                )
                                
                                (244
                                )Comprehensive
                                    earnings
                                
                                
                                -
                                
                                
                                -
                                
                                
                                -
                                
                                
                                52,690
                                
                                
                                (244
                                )
                                
                                52,446**Balance,
                                    December 31, 2006**
                                
                                
                                21,255
                                
                                $
                                213
                                
                                $
                                415,950
                                
                                $
                                (97,149
                                )
                                $
                                (38
                                )
                                $
                                318,976
 
  
 *See
                          accompanying notes to consolidated financial statements.*
  F-6
  
 **MATRIA
                          HEALTHCARE, INC. AND SUBSIDIARIES**
 **Consolidated
                          Statements of Cash Flows**
 (Amounts
                          in thousands)
 
 **Years
                                    ended December 31,****2006**
                                
                                **2005**
                                
                                **2004**Net
                                    earnings
                                
                                $
                                52,690
                                
                                $
                                13,963
                                
                                $
                                27,066Less
                                    earnings from discontinued operations, net of
                                    income taxes
                                
                                
                                (34,215
                                )
                                
                                (9,949
                                )
                                
                                (47,143
                                )Earnings
                                    (loss) from continuing operations
                                
                                
                                18,475
                                
                                
                                4,014
                                
                                
                                (20,077
                                )Adjustments
                                    to reconcile earnings (loss) from continuing
                                    operations tonet
                                    cash provided by operating activities:Depreciation
                                    and amortization (including debt discount and
                                    expenses)
                                
                                
                                20,777
                                
                                
                                6,657
                                
                                
                                5,545Provision
                                    for doubtful accounts
                                
                                
                                4,093
                                
                                
                                3,493
                                
                                
                                2,412Deferred
                                    income taxes
                                
                                
                                11,713
                                
                                
                                1,925
                                
                                
                                (14,240
                                )Share-based
                                    compensation
                                
                                
                                6,986
                                
                                
                                -
                                
                                
                                -Excess
                                    tax benefits from share-based compensation arrangements
                                
                                
                                (1,386
                                )
                                
                                -
                                
                                
                                -Imputed
                                    interest on acquisition consideration
                                
                                
                                1,747
                                
                                
                                -
                                
                                
                                -Loss
                                    on retirement of 11% Senior Notes
                                
                                
                                -
                                
                                
                                -
                                
                                
                                22,886Payment
                                    for termination of interest rate swap agreements
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (993
                                )Other
                                
                                
                                -
                                
                                
                                294
                                
                                
                                -Changes
                                    in assets and liabilities:Trade
                                    accounts receivable
                                
                                
                                (7,885
                                )
                                
                                (8,083
                                )
                                
                                (4,251
                                )Prepaid
                                    expenses and other current assets
                                
                                
                                3,822
                                
                                
                                (451
                                )
                                
                                6Other
                                    noncurrent assets
                                
                                
                                (482
                                )
                                
                                (971
                                )
                                
                                (1,919
                                )Accounts
                                    payable
                                
                                
                                (880
                                )
                                
                                766
                                
                                
                                6,219Accrued
                                    and other liabilities
                                
                                
                                (29,571
                                )
                                
                                (2,644
                                )
                                
                                810Net
                                    cash provided by (used in) continuing operations
                                
                                
                                27,409
                                
                                
                                5,000
                                
                                
                                (3,602
                                )Net
                                    cash provided by (used in) discontinued operations
                                
                                
                                (3,114
                                )
                                
                                19,954
                                
                                
                                13,735Net
                                    cash provided by operating activities
                                
                                
                                24,295
                                
                                
                                24,954
                                
                                
                                10,133Purchases
                                    of property and equipment
                                
                                
                                (13,139
                                )
                                
                                (11,072
                                )
                                
                                (8,563
                                )Purchases
                                    of property and equipment related to discontinued
                                    operations
                                
                                
                                (379
                                )
                                
                                (1,452
                                )
                                
                                (1,602
                                )Acquisition
                                    of businesses, net of cash received
                                
                                
                                (434,727
                                )
                                
                                (19,678
                                )
                                
                                (200
                                )Proceeds
                                    from the sale of businesses, net of transaction
                                    costs
                                
                                
                                150,315
                                
                                
                                -
                                
                                
                                101,055Payment
                                    of acquisition obligation
                                
                                
                                (1,677
                                )
                                
                                -
                                
                                
                                (20,480
                                )Decrease
                                    (increase) in restricted cash
                                
                                
                                233
                                
                                
                                3,273
                                
                                
                                (3,368
                                )Net
                                    proceeds from investments
                                
                                
                                -
                                
                                
                                -
                                
                                
                                927Net
                                    cash provided by (used in) investing activities
                                
                                
                                (299,374
                                )
                                
                                (28,929
                                )
                                
                                67,769Proceeds
                                    from the issuance of long-term debt, net of transaction
                                    costs
                                
                                
                                446,533
                                
                                
                                2,083
                                
                                
                                2,446Payment
                                    of debt refinancing fees
                                
                                
                                (1,733
                                )
                                
                                -
                                
                                
                                -Principal
                                    repayments of long-term debt
                                
                                
                                (180,519
                                )
                                
                                (2,224
                                )
                                
                                (2,475
                                )Proceeds
                                    from issuance of common stock
                                
                                
                                5,989
                                
                                
                                7,252
                                
                                
                                6,608Excess
                                    tax benefits from share-based compensation arrangements
                                
                                
                                1,386
                                
                                
                                -
                                
                                
                                -Net
                                    payment for conversion of 4.875% convertible
                                    senior notes and related
                                    transaction costs
                                
                                
                                -
                                
                                
                                (15,332
                                )
                                
                                -Proceeds
                                    from issuance of convertible senior debt, net
                                    of issuance
                                    costs
                                
                                
                                -
                                
                                
                                -
                                
                                
                                83,210Net
                                    payment for the retirement of 11% Senior Notes
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (136,518
                                )Net
                                    repayments under credit agreement
                                
                                
                                -
                                
                                
                                -
                                
                                
                                (2,418
                                )Net
                                    cash provided by (used in) financing activities
                                
                                
                                271,656
                                
                                
                                (8,221
                                )
                                
                                (49,147
                                )504
                                
                                
                                (363
                                )
                                
                                907Net
                                    increase (decrease) in cash and cash equivalents
                                
                                
                                (2,919
                                )
                                
                                (12,559
                                )
                                
                                29,66222,758
                                
                                
                                35,317
                                
                                
                                5,655$
                                19,839
                                
                                $
                                22,758
                                
                                $
                                35,317Interest
                                
                                $
                                30,746
                                
                                $
                                3,234
                                
                                $
                                11,642Income
                                    taxes
                                
                                $
                                6,716
                                
                                $
                                4,047
                                
                                $
                                7,727Conversion
                                    of debt to equity
                                
                                $
                                -
                                
                                $
                                83,381
                                
                                $
                                -
 
 
 *See
                          accompanying notes to consolidated financial statements.*
  F-7
  
 **MATRIA
                          HEALTHCARE, INC. AND SUBSIDIARIES**
 **Notes
                          to Consolidated Financial Statements**
 **December
                          31, 2006, 2005 and 2004**
 
 
 
 **(1)**  **Summary
                          of Significant Accounting Policies**
 ***(a)***  ***Business***
 Matria
                          Healthcare, Inc. (“Matria,” “the Company” or “we”) provides comprehensive,
                          integrated programs and services focused on wellness, disease
                          and condition
                          management, productivity enhancement and informatics. We
                          call this suite of
                          services “Health Enhancement.” These services are designed to reduce
                          health-related costs and enhance the health and quality
                          of life of the
                          individuals we serve. We provide services to self-insured
                          employers, private and
                          government sponsored health plans, pharmaceutical companies,
                          administrative
                          services only customers, and patients. Our employer clients
                          are primarily
                          Fortune 1000 companies that self-insure the medical benefits
                          provided to their
                          employees, dependents and retirees. Our health plan customers
                          are regional and
                          national health plans, as well as government-sponsored
                          health plans, such as
                          state Medicaid programs. Our service offerings include
                          wellness programs,
                          disease and condition management programs and informatics.
 
 Our
                          wellness programs address issues such as: smoking cessation,
                          weight loss,
                          exercise, healthy diet, stress relief, healthy aging, and
                          productivity
                          enhancement. These programs help employees and health plan
                          members live better
                          and longer while reducing their healthcare costs and increasing
                          their
                          productivity.
 
 The
                          disease and condition management programs assist individuals
                          to better manage
                          their conditions by increasing their knowledge about their
                          illnesses or
                          condition, potential complications and the importance of
                          medication and
                          treatment plan compliance. Our specialized nurses proactively
                          contact patients to monitor their progress and ensure they are
                          following
                          the plan of care set by their physician. The chronic and
                          episodic disease and
                          condition management programs include programs for diabetes,
                          cardiovascular
                          diseases, respiratory disorders, end-stage renal disorder,
                          depression, chronic
                          pain, hepatitis C, cancer and high-risk pregnancies.
 
 On
                          January 19, 2006, we completed the acquisition of CorSolutions
                          Medical, Inc.
                          (“CorSolutions”), a disease management, health and wellness and productivity
                          enhancement organization. The results of CorSolutions are
                          included in our
                          results of operations effective January 1, 2006.
 
 In
                          September 2006, to address the needs of the long-term care
                          insurance industry,
                          we invested in and formed a strategic alliance with Secured
                          Independence, Inc.
                          (“Secured Independence”), a privately-held company. The assets, liabilities and
                          results of operations of Secured Independence are included
                          in our consolidated
                          financial statements effective September 30, 2006.
 
 On
                          April
                          1, 2005, we acquired the business and assets of Miavita
                          LLC for a net cash
                          payment of $4.8 million, with potential additional amounts
                          to be paid under an
                          earn-out agreement, of which $1.7 million was paid during
                          2006 and additional
                          amounts are expected to be payable in 2007. On October
                          1, 2005, we acquired of
                          business of WinningHabits, Inc. for a net cash payment
                          of $14.9 million, with
                          additional potential amounts to be paid under an earn-out
                          agreement. Results of
                          operations of these businesses have been included in our
                          consolidated results of
                          operations since their respective acquisition dates.
  F-8
  
 On
                          September 1, 2006, we completed the sale of Facet Technologies,
                          LLC (“Facet”) to
                          a private equity firm in a cash transaction valued at approximately
                          $122
                          million. On October 17, 2006, we completed the sale of
                          our foreign diabetes
                          service operations in Germany (“Dia Real”) for approximately $33.3 million. At
                          December 31, 2005, the assets and liabilities of these
                          business units were
                          reclassified as “Assets held for sale” and “Liabilities related to assets held
                          for sale and other discontinued operations,” respectively, and their results of
                          operations are included in discontinued operations for
                          all periods presented.
 
 ***(b)***  ***Basis
                          of Financial Statement Presentation and*** **Principles
                          of Consolidation**
 The
                          consolidated financial statements have been prepared in
                          conformity with
                          accounting principles generally accepted in the United
                          States. Our consolidated
                          financial statements include the accounts of the Company
                          and its majority owned
                          subsidiaries and partnerships. All significant intercompany
                          balances and
                          transactions have been eliminated in consolidation.
 
 **(c)**  **Use
                          of Estimates**
 In
                          preparing financial statements, it is necessary for management
                          to make
                          assumptions and estimates affecting the amounts reported
                          in the consolidated
                          financial statements and related notes. These estimates
                          and assumptions are
                          developed based upon all information available. Actual
                          results could materially
                          differ from estimated amounts under different assumptions
                          or conditions. In the
                          opinion of management, all adjustments, consisting of normal
                          recurring accruals,
                          necessary for fair presentation of the consolidated financial
                          position and
                          results of operations for the periods presented have been
                          included.
 
 ***(d*** **)**  **Cash
                          and Cash Equivalents**
 Cash
                          and
                          cash equivalents consist of cash and interest-bearing deposits.
                          We consider all
                          highly liquid debt instruments with maturities of three
                          months or less when
                          purchased to be cash equivalents, other than those amounts
                          designated for other
                          than current operations.
 
 ***(e)***  ***Restricted
                          Cash***
 Restricted
                          cash consists of funds designated for a particular use
                          and not available for
                          current operations. We had $1.4 million and $550,000 of
                          restricted funds at
                          December 31, 2006 and 2005, respectively, for amounts held
                          in escrow related to
                          customer contracts and as collateral for insurance policies.
                          Funds are held in
                          interest-bearing investment accounts or in certificates
                          of deposit with maturity
                          dates that coincide with insurance policy termination dates.
 
 ***(f)***  ***Revenue
                          Recognition and Allowances for Uncollectible Accounts***
 Our
                          services are provided telephonically and, in some cases,
                          in a patient's home
                          from home care centers located throughout the United States. In addition,
                          our services are provided through access to our online
                          health and wellness based
                          tools. Revenues are recognized as the related services
                          are rendered and are net
                          of contractual allowances and related discounts.
 
 Our
                          services are paid for primarily on the basis of (i) monthly
                          fees for each
                          employee or member enrolled in a health plan, (ii) each
                          member identified with a
                          particular chronic disease or condition under contract,
                          (iii) each member
                          enrolled in our programs, (iv) fee-for-service, or (v)
                          a fixed rate per case.
                          Billings for certain services occur in advance of services
                          being performed. Such
                          amounts are recorded as “Unearned revenues” in the consolidated balance sheets.
                          Such amounts are subsequently recognized as revenue as
                          services are
                          performed.
 
 Some
                          contracts provide that a portion of our fees are at-risk
                          (i.e., refundable) if
                          our programs do not achieve certain financial cost savings
                          and clinical
                          performance criteria. Revenues subject to refund are not
                          recognized if (i)
                          sufficient information is not available to calculate performance
  F-9
  
 measurements,
                          or (ii) interim performance measurements indicate that
                          we are not meeting
                          performance targets. If either of these two conditions
                          exists, we record the
                          amounts as “Unearned revenues” in the consolidated balance sheets. If we do not
                          meet performance levels by the end of the operations period
                          under the contract,
                          we are contractually obligated to refund some or all of
                          the at-risk
                          fees.
 
 A
                          significant portion of our revenues is billed to third-party
                          reimbursement
                          sources. Therefore, the collectibility of all of our accounts
                          receivable varies
                          based on payor mix, general economic conditions and other
                          factors. A provision
                          for doubtful accounts is made for revenues estimated to
                          be uncollectible and is
                          adjusted periodically based upon our evaluation of current
                          industry conditions,
                          historical collection experience, recoveries of amounts
                          previously provided,
                          industry reimbursement trends and other relevant factors
                          which, in the opinion
                          of management, deserve recognition in estimating the allowance
                          for uncollectible
                          accounts. The evaluation is performed at each reporting
                          period for each
                          operating unit with an overall assessment at the consolidated
                          level. While
                          estimates and judgments are involved and factors impacting
                          collectibility may
                          change, management believes adequate provision has been
                          made for any adjustments
                          that may result from final determination of amounts to
                          be
                          collected.
 
 ***(g)***  ***Concentrations
                          of Credit Risk***
 Financial
                          instruments, which potentially expose us to concentrations
                          of credit risk,
                          consist primarily of accounts receivable from third-party
                          payors. The
                          collectibility of accounts receivable from third-party
                          payors is directly
                          affected by conditions and changes in the insurance industry
                          and governmental
                          programs, which we take into account in computing and evaluating
                          our allowances
                          for uncollectible accounts. At December 31, 2006 and 2005,
                          no single customer
                          exceeded 10% of our consolidated trade accounts receivable.
 
 ***(h)***  ***Property
                          and Equipment***
 Property
                          and equipment are stated at cost, less accumulated depreciation
                          and
                          amortization. Depreciation for property and equipment is
                          provided primarily on
                          the straight-line method over the estimated useful lives
                          of the related assets,
                          which generally ranges from three to ten years. Amortization
                          of leasehold
                          improvements and leased equipment is recorded over the
                          shorter of the lives of
                          the related assets or the lease terms.
 
 Property
                          and equipment includes amounts capitalized for the development
                          of software for
                          internal use. Capitalized costs include external costs
                          of materials and services
                          and payroll costs of employees devoted to the specific
                          software development.
                          These costs are capitalized based upon Statement of Position
                          98-1, *Accounting
                          for the Costs of Computer Software Development or Obtained
                          for Internal
                          Use* .
                          Internal-use software development costs are capitalized
                          once (i) the preliminary
                          project stage is completed, (ii) management authorizes
                          and commits to funding a
                          computer software project, and (iii) it is probable that
                          the project will be
                          completed, and the software will be used to perform the
                          function intended. Costs
                          incurred prior to meeting these qualifications are expensed
                          as incurred.
                          Capitalization of costs ceases when the project is substantially
                          complete and
                          ready for its intended use. Internal-use software development
                          costs are
                          amortized using on the straight-line basis over estimated
                          useful lives of the
                          underlying software, which generally ranges from three
                          to ten years. The
                          capitalization and ongoing assessment of recoverability
                          of development costs
                          requires considerable judgment by us with respect to certain
                          external factors,
                          including, but not limited to, technological and economic
                          feasibility, and
                          estimated economic life. For the years ended December 31,
                          2006, 2005 and 2004,
                          we capitalized software development costs of $4.9 million,
                          $3.1 million and $1.8
                          million, respectively. As of December 31, 2006 and 2005,
                          net capitalized
                          software costs totaled $12.2 million and $8.7 million,
                          respectively.
  F-10
  
 ***(i)***  ***Goodwill
                          and Other*** **Intangible
                          Assets**
 Goodwill
                          represents the excess purchase price over the estimated
                          fair value of
                          identifiable net assets acquired in our business combinations.
                          Intangible assets
                          consist of trade names, content, customer relationships,
                          current technology and
                          covenants not to compete. Intangible assets are amortized
                          on a straight-line
                          basis over periods ranging from five to ten years.
 
 We
                          account for goodwill and other intangible assets in accordance
                          with Statement of
                          Financial Accounting Standards (“SFAS”) No. 142 *,
                          Goodwill and Other Intangible Assets* (“SFAS
                          142”). SFAS 142 requires that goodwill and intangible assets
                          with indefinite
                          useful lives no longer be amortized, but instead be tested
                          for impairment at
                          least annually at the reporting unit level. The Company
                          evaluated the fair
                          values of its reporting units as of December 31, 2006 and
                          2005 and concluded
                          that no impairment of recorded goodwill exists. As a result,
                          no impairment of
                          goodwill was identified during any of the periods presented.
 
 SFAS
                          142
                          also requires that intangible assets with estimable useful
                          lives be amortized
                          over their respective estimated useful lives to their estimated
                          residual values,
                          and that such assets be reviewed for impairment in accordance
                          with
                          SFAS 144 *,
                          Accounting for the Impairment or Disposal of Long-Lived
                          Assets* (“SFAS
                          144”) *.* We
                          reassessed the useful lives, residual values and classification
                          of its
                          identifiable intangible assets and determined that they
                          continue to be
                          appropriate.
 
 ***(j)***  ***Impairment
                          of Long-lived Asse*** **ts**
 We
                          account for long-lived assets, other than goodwill with
                          an indefinite useful
                          life, in accordance with SFAS No. 144. We review long-lived
                          assets, such as
                          property and equipment and intangibles subject to amortization,
                          including
                          contract acquisition costs and certain computer software,
                          for impairment
                          whenever events or changes in circumstances indicate that
                          the carrying amount of
                          an asset may not be recoverable. Recoverability of assets
                          to be held and used is
                          measured by a comparison of the carrying amount of an asset
                          to estimated
                          undiscounted operating cash flows expected to be generated
                          by the asset. If the
                          carrying amount of an asset exceeds its estimated future
                          cash flows, an
                          impairment charge is recognized by the amount by which
                          the carrying amount of an
                          asset exceeds the fair value of the asset.
 
 Assets
                          to
                          be disposed of are separately presented in the balance
                          sheet and reported at the
                          lower of the carrying amount or fair value less costs to
                          sell, and are no longer
                          depreciated. The assets and liabilities of a disposal group
                          classified as held
                          for sale are presented separately in the appropriate asset
                          and liability
                          sections of the balance sheets.
 
 As
                          of
                          December 31, 2006 or 2005, there was no impairment of our
                          long-lived
                          assets.
 
 ***(k)***  ***Derivative
                          Financial Instruments***
 We
                          use
                          derivative financial instruments to manage our risk associated
                          with fluctuations
                          in interest rates and foreign currency exchange rates.
                          We account for derivative
                          instruments in accordance with SFAS No. 133, “ *Accounting
                          for Derivative Instruments and Hedging Activities* ,”
which
                          requires that all derivative instruments be recorded on
                          the balance sheet at
                          their respective fair values. We do not use derivative
                          financial instruments for
                          trading or speculative purposes.
 
 ***(l)***  ***Fair
                          Value Disclosure of Financial Instruments***
 We
                          estimate that the fair values of cash and cash equivalents,
                          accounts and notes
                          receivable, accounts payable and accrued liabilities approximate
                          their carrying
                          value due to the short-term maturities of these assets
                          and liabilities. We
                          estimate that the fair value of our long-term debt approximates
                          its carrying
                          value because these debt instruments bear interest at a
                          variable rate which
                          resets quarterly based on the then current market rate.
  F-11
  
 **(m)**  **Unearned
                          Revenues**
 Unearned
                          revenues represent billings in advance of services being
                          performed and at-risk
                          revenues.
 
 ***(n)***  ***Income
                          Taxes***
 We
                          account for income taxes in accordance with SFAS No. 109, *Accounting
                          for Income Taxes* ,
                          using
                          an asset and liability approach. Deferred income taxes
                          are recognized for the
                          tax consequences of “temporary differences” by applying enacted statutory tax
                          rates applicable to future years to differences between
                          the financial statement
                          carrying amounts and the tax bases of existing assets and
                          liabilities and net
                          operating loss and tax credit carryforwards. Additionally,
                          the effect on
                          deferred taxes of a change in tax rates is recognized in
                          earnings in the period
                          that includes the enactment date.
 
 ***(*** **o)**  **Share-based
                          Compensation**
 On
                          January 1, 2006, we adopted SFAS No. 123 (revised 2004), *Share-Based
                          Payment* (“SFAS
                          123(R)”), which requires us to measure and recognize compensation
                          expense for
                          all share-based payment awards based on estimated fair
                          values at the date of
                          grant. SFAS 123(R) establishes standards for the accounting
                          for share-based
                          payment transactions in which an enterprise receives employee
                          services in
                          exchange for either equity instruments of the enterprise
                          or liabilities that are
                          based on the fair value of the enterprise’s equity instruments or that may be
                          settled by the issuance of such equity instruments. SFAS
                          123(R) eliminates the
                          ability to account for share-based compensation transactions,
                          as we formerly
                          did, using the intrinsic value method as prescribed by
                          Accounting Principles
                          Board, (“APB”), Opinion No. 25, *Accounting
                          for Stock Issued to Employees* ,
                          and
                          generally requires that such transactions be accounted
                          for using a
                          fair-value-based method.
 
 Share-based
                          compensation expense recognized during the period is based
                          on the value of the
                          portion of share-based payment awards that is ultimately
                          expected to vest.
                          Share-based compensation expense recognized in the consolidated
                          statement of
                          operations during the period ended December 31, 2006, included
                          compensation
                          expense for share-based payment awards granted prior to,
                          but not yet vested, as
                          of December 31, 2005, based on the grant date fair value
                          estimated in accordance
                          with the pro forma provisions of SFAS 148, *Accounting
                          for Stock-Based Compensation-Transition and Disclosure* ,
                          and
                          compensation expense for the share-based payment awards
                          granted subsequent to
                          December 31, 2005, based on the grant date fair value estimated
                          in accordance
                          with SFAS 123(R). Since share-based compensation expense
                          recognized in the
                          consolidated statement of operations for the period ended
                          December 31, 2006, is
                          based on awards ultimately expected to vest, it has been
                          reduced for estimated
                          forfeitures. SFAS 123(R) requires forfeitures to be estimated
                          at the time of
                          grant and, if necessary, revised in subsequent periods
                          if actual forfeitures
                          differ from those estimates. In the pro forma information
                          required under SFAS
                          148 for the periods prior to 2006, we estimated forfeitures
                          at the time of grant
                          and, if necessary, revised the estimates in subsequent
                          periods if actual
                          forfeitures differed from those estimates.
 
 ***(p)***  ***Net
                          Earnings (Loss) Per Share of Common Stock***
 Basic
                          net
                          earnings (loss) per common share is based on the weighted
                          average number of
                          common shares outstanding. Diluted net earnings (loss)
                          per common share is based
                          on the weighted average number of common shares outstanding
                          and dilutive
                          potential common shares, such as dilutive stock options
                          and restricted stock
                          awards, determined using the treasury stock method, and
                          dilutive contingent
                          convertible debt, determined using the if-converted method.
  F-12
  
 ***(q)***  ***Comprehensive
                          Earnings (Loss)***
 Comprehensive
                          earnings (loss) generally include all changes in equity
                          during a period except
                          those resulting from investments by owners and distributions
                          to owners.
                          Comprehensive earnings (loss) consist of net earnings (loss),
                          foreign currency
                          translation adjustments (net of income taxes) and changes
                          in the fair value of
                          derivative financial instruments (net of income taxes).
 
 ***(r)***  ***Interest
                          Allocated to Discontinued Operations***
 We
                          allocated interest expense to discontinued operations in
                          accordance with
                          Emerging Issues Task Force (“EITF”) Issue 87-24, *Allocation
                          of Interest to Discontinued Operations* .
                          Under
                          EITF Issue 87-24, interest on debt that must be repaid
                          upon disposal of
                          discontinued operations must be allocated to discontinued
                          operations. In
                          accordance with the terms of the New Credit Facilities,
                          we used the net proceeds
                          from the sale of Facet and Dia Real to repay a portion
                          of the outstanding
                          indebtedness.
 
 ***(s)***  ***Recently
                          Issued or Adopted Accounting Standards***
 ***Accounting
                          for Uncertainty in Income Taxes*** .
                          In June
                          2006, the FASB published Interpretation No. 48, *Accounting
                          for Uncertainty in Income Taxes* ,
                          an
                          interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a
                          recognition threshold and measurement attribute for the
                          financial statement
                          recognition and measurement of a tax position taken or
                          expected to be taken in a
                          tax return. FIN 48 also provides guidance on derecognition,
                          classification,
                          interest and penalties, accounting in interim periods,
                          disclosure and
                          transition. The effective date of this interpretation is
                          January 1, 2007, the
                          first fiscal year beginning after December 15, 2006. We
                          are currently evaluating
                          the provisions of FIN 48 to determine its impact, if any,
                          on our financial
                          statements.
 
 ***Fair
                          Value Measurements*** .
                          In
                          September 2006, the FASB issued SFAS No. 157, *Fair
                          Value Measurements* (“SFAS
                          157”), which defines fair value, establishes a framework for
                          measuring fair
                          value in GAAP and expands disclosures about fair value
                          measurements. SFAS 157
                          will be effective for financial statements issued for fiscal
                          years beginning
                          after November 15, 2007, and interim periods within those
                          fiscal years. We are
                          currently evaluating the requirements of this new standard
                          and have not
                          concluded its analysis on the impact, if any, to its results
                          of operations and
                          financial position.
 
 ***Prior
                          Year Misstatements.*** In
                          September 2006, the Securities and Exchange Commission
                          (“SEC”) issued Staff
                          Accounting Bulletin No. 108, *Considering
                          the Effects of Prior Year Misstatements when Quantifying
                          Misstatements in
                          Current Year Financial Statements* (“SAB
                          No. 108”). SAB No. 108 addresses quantifying the financial statement
                          effects of
                          misstatements, specifically, how the effects of prior year
                          uncorrected errors
                          must be considered in quantifying misstatements in current
                          year financials.
                          Under the provisions of SAB No. 108, a reporting entity
                          must quantify and
                          evaluate errors using a balance sheet approach and an income
                          statement approach.
                          After considering all relevant quantitative and qualitative
                          factors, if either
                          approach results in a misstatement that is material, a
                          reporting entity’s
                          financial statements must be adjusted. SAB No. 108 is effective
                          for fiscal years
                          ending after November 15, 2006.
 
 We
                          adopted the provisions of SAB No. 108 in the fourth quarter
                          of 2006 and recorded
                          a cumulative effect adjustment of $813,000, net of income
                          taxes of $518,000, to
                          our January 1, 2006 consolidated balance sheet. We identified
                          two uncorrected
                          misstatements for consideration under SAB 108, each of
                          which was considered
                          immaterial to our results of operations in any reporting
                          period when using only
                          the income statement approach we historically used to assess
                          the materiality of
                          unrecorded errors:
  1.
                                An
                                    unrecorded liability for drugs and supplies from
                                    a major vendor, which is
                                    included in “Accounts payable” on the consolidated balance sheets,
                                    resulted from anaccumulation
                                    of
  F-13
  
 unrecorded
                          costs over several periods prior to 2003. This misstatement
                          was identified in
                          2003. The final amount required to correct the liability
                          balance at
                          January 1, 2006,  would
                          result in a $600,000 charge to our results of operations
                          in 2006.
 
 2.
                                During
                                    2006, we discovered that our medical device inventory,
                                    which is included
                                    in “Property and equipment” on the consolidated balance sheets, was
                                    overstated due to improper recording of disposed
                                    and lost medical devices
                                    and the related depreciation expense. The misstatement
                                    originated in 2003
                                    and accumulated over subsequent periods. The
                                    amount required to correct
                                    the medical device inventory at January 1, 2006,
                                    would result in a
                                    $731,000 charge to our results of operations
                                    in
                                    2006.
 
 Under
                          the
                          balance sheet approach and the income statement approach,
                          or the dual approach,
                          we determined that correcting the above misstatements would
                          be material to our
                          2006 financial statements and recorded the cumulative effect
                          adjustment to our
                          January 1, 2006, consolidated balance sheet upon our initial
                          application of SAB
                          108.
 
 **(2)**
                                **Acquisitions**
 ***CorSolutions
                          Medical, Inc.*** On
                          January 19, 2006, we completed the acquisition of CorSolutions
                          Medical, Inc., a
                          Delaware corporation (“CorSolutions”), pursuant to the Agreement and Plan of
                          Merger (the “Merger Agreement”), dated as of December 14, 2005, by and among
                          Matria, Coral Acquisition Corp. (“Merger Sub”), an indirect wholly owned
                          subsidiary of Matria, and CorSolutions. CorSolutions is
                          a leading provider of
                          disease management services to employers, health plans
                          and government-sponsored
                          healthcare programs. The effective date of the acquisition
                          for accounting
                          purposes was January 1, 2006. Accordingly, the results
                          of CorSolutions are
                          included in the consolidated financial statements from
                          January 1,
                          2006.
 
 Pursuant
                          to the Merger Agreement, Merger Sub merged with and into
                          CorSolutions (the
“Merger”), with CorSolutions continuing as the surviving corporation
                          and an
                          indirect wholly owned subsidiary of Matria. In the Merger,
                          all outstanding
                          capital stock, together with options and warrants to purchase
                          capital stock of
                          CorSolutions, were converted into the right to receive
                          a pro rata portion of the
                          initial merger consideration, which approximated $470.8
                          million, subject to
                          adjustment.
 
 We funded
                          the Merger with the proceeds of term loans and revolving
                          credit loans pursuant
                          to a credit agreement with Bank of America, N.A., as administrative
                          and
                          collateral agent, as amended, (the “First Lien Credit Facility”), and with the
                          proceeds of a second lien term loan facility pursuant to
                          a term loan agreement,
                          with Bank of America, N.A., as administrative agent and
                          collateral agent (the
“Second Lien Credit Facility” and, together with the First Lien Credit Facility,
                          the “New Credit Facilities”).
 
 The
                          total
                          preliminary purchase price, excluding cash acquired, was
                          $433.0 million, which
                          was determined as follows (in thousands):
 
 Purchase
                                    price consideration, excluding cash acquired
                                
                                $
                                429,473Acquisition-related
                                    transaction costs
                                
                                
                                5,254Imputed
                                    interest from January 1, 2006 through January
                                    19, 2006
                                
                                
                                (1,747
                                )Total
                                    preliminary purchase price
                                
                                $
                                432,980
 
 In
                          accordance with SFAS No. 141, *Business
                          Combinations* ,
                          the
                          Company increased interest expense and reduced the cost
                          of CorSolutions by
                          approximately $1.7 million. As the operations of CorSolutions
                          are included in
                          the consolidated statements of operations effective January
                          1, 2006, and the
                          consideration was not delivered until January 19, 2006,
                          this adjustment
                          represents the amount of interest on the debt imputed during
                          the interim period.
  F-14
  
 Under
                          business combination accounting, the total purchase price
                          is allocated to
                          CorSolutions’ net tangible and identifiable intangible assets based on
                          their
                          estimated fair values. The excess of the purchase price
                          over the net tangible
                          and identifiable intangible assets is recorded as goodwill.
                          The allocation of
                          the purchase price used in the consolidated financial statements
                          is based upon a
                          valuation. The estimated fair values of certain assets
                          and liabilities have been
                          determined with the assistance of an independent third-party
                          valuation firm.
 
 The
                          following table represents the allocation of the acquisition
                          cost to the assets
                          acquired and liabilities assumed, based on their fair values
                          (in thousands):
 
 Accounts
                                    receivable, net
                                
                                $
                                14,160Other
                                    current assets
                                
                                
                                7,433Property
                                    and equipment
                                
                                
                                10,400Other
                                    long-term assets
                                
                                
                                198Net
                                    deferred tax asset
                                
                                
                                12,824Amortizable
                                    intangible assets
                                
                                
                                56,100Goodwill
                                
                                
                                375,682Accounts
                                    payable
                                
                                
                                (3,450
                                )Other
                                    accrued expenses
                                
                                
                                (36,880
                                )Unearned
                                    revenue
                                
                                
                                (3,487
                                )Total
                                    purchase price allocation
                                
                                $
                                432,980
 
 The
                          components of the amortizable intangible assets are as
                          follows (in
                          thousands):
 
 **Useful****Fair**
                                
                                **Life****Value**
                                
                                **(Years)**Customer
                                    contracts
                                
                                $
                                46,900
                                
                                
                                10Developed
                                    technology
                                
                                
                                7,700
                                
                                
                                7Tradename
                                
                                
                                1,500
                                
                                
                                7$
                                56,100
 
 The
                          following unaudited pro forma consolidated results of operations
                          have been
                          prepared as if the acquisition of CorSolutions had occurred
                          at January 1, 2005
                          (in thousands, except per share amounts):
 
 **Years
                                    Ended December 31,****2006**
                                
                                **2005**Revenues
                                
                                $
                                336,139
                                
                                $
                                303,503Operating
                                    earnings from continuing operations
                                
                                $
                                55,957
                                
                                $
                                33,079
                                
                                
                                (a)(b
                                )Net
                                    earnings from continuing operations
                                
                                $
                                18,475
                                
                                $
                                3,208
                                
                                
                                (a)(b)(c)(d
                                )Net
                                    earnings from continuing operations per share:Basic
                                
                                $
                                0.88
                                
                                $
                                0.17Diluted
                                
                                $
                                0.85
                                
                                $
                                0.16
 
  (a)
                                Adjusted
                                    to decrease the depreciation expense resulting
                                    from the difference between
                                    the preliminary estimate of the fair value and
                                    the historical amount of
                                    CorSolutions’ property and
                                    equipment.
 
 (b)
                                Adjusted
                                    to reflect the increase in amortization expense
                                    resulting from the
                                    preliminary estimate of the fair value of amortizable
                                    intangible
                                    assets.
 
 (c)
                                Adjusted
                                    to reflect the interest and amortization expense
                                    resulting from the
                                    issuance of debt and related underwriting
                                    fees.
 
 (d)
                                Adjusted
                                    to include the tax benefit on pro forma adjustments
                                    noted
                                    above.
 
 We
                          are
                          pursuing a claim before a contractually-designated settlement
                          accountant for
                          certain post-closing adjustments including a $4 million
                          claim relating to a
                          liability resulting from CorSolutions’ pre-closing
  F-15
  
 performance
                          under a customer contract. We are also pursuing a related
                          claim for fraudulent
                          misrepresentation and concealment before the American Arbitration
                          Association in
                          Chicago, Illinois, seeking damages in an unspecified amount
                          exceeding $4
                          million. There is no assurance that we will prevail in
                          either of these
                          proceedings. See Note 12.
 
 ***Other
                          Acquisitions.*** On
                          April
                          1, 2005, we acquired the business and assets of Miavita,
                          a leading provider of
                          on-line wellness programs, for total consideration including
                          transaction costs
                          of $4.8 million, net of cash received. Our December 31,
                          2005, balance sheet
                          reflects the assets acquired and liabilities assumed in
                          this transaction,
                          including goodwill and intangible assets resulting from
                          the purchase price
                          allocation of $3.1 million and $1.6 million, respectively.
                          The intangible assets
                          are being amortized on a straight-line basis over ten years.
                          On October 1, 2005,
                          we acquired the business and assets of WinningHabits, Inc.,
                          a leading provider
                          of corporate wellness programs, for total consideration
                          including transaction
                          costs of $14.9 million, net of cash received. The transaction
                          resulted in
                          goodwill and intangible assets from the purchase price
                          allocation of $11.5
                          million and $5.7 million, respectively. The intangible
                          assets are being
                          amortized on a straight-line basis over five to seven years.
 
 ****** In
                          connection with our acquisition of WinningHabits, we are
                          required to pay
                          additional consideration in future periods, based upon
                          the financial performance
                          of this business. We currently estimate that the additional
                          consideration
                          pursuant to the terms of our earn-out agreement for the
                          WinningHabits
                          acquisition is $32.2 million. The estimated additional
                          consideration, which is
                          included in “Acquisition contingent consideration” on the consolidated balance
                          sheet, is based on the attainment of the operating objectives
                          for the year ended
                          December 31, 2006, and is subject to final audit. The final
                          amount for
                          WinningHabits will be payable in 2007.
  Also included in “Acquisition contingent consideration" on the consolidated
                          balance sheet is $22.0 million of earn-out consideration
                          for the second earn-out
                          period ending March 31,  2007,
                          for
                          the Miavita acquisition. On November 6, 2006, the Company
                          and the seller entered
                          into a Settlement Agreement and Release that effectively
                          amends the terms of the
                          original acquisition agreement to fix the amount payable
                          for the second earn-out
                          period at $20.0 million plus 3.575 times net revenues from
                          certain new customers
                          between November 6, 2006, and March 31, 2007, provided
                          that no payment is
                          payable in respect of the second earn-out period unless
                          payments received from
                          such new customers between November 6, 2006, and May 1,
                          2007, are at least
                          $500,000. During the second quarter of 2006, the Company
                          paid $1.7 million for
                          the additional consideration earned for the first earn-out
                          period ended March
                          31, 2006, for the Miavita acquisition.
  Goodwill
                          was increased by $55.9 million at December 31, 2006, for
                          the consideration paid
                          and the additional estimated consideration payable under
                          the earn-out agreements
                          described above.
  **(3)**  **Property
                          and Equipment**
 Property
                          and equipment at December 31, 2006 and 2005 consisted of
                          the following (in
                          thousands):
 
 
 **December
                                    31,****2006**
                                
                                **2005**Computer
                                    hardware and software
                                
                                $
                                45,335
                                
                                $
                                30,138Medical
                                    equipment
                                
                                
                                8,027
                                
                                
                                7,887Machinery,
                                    office equipment and fixtures
                                
                                
                                8,061
                                
                                
                                4,384Leasehold
                                    improvements
                                
                                
                                4,821
                                
                                
                                2,15766,244
                                
                                
                                44,566Less
                                    accumulated depreciation and amortization
                                
                                
                                27,294
                                
                                
                                18,136$
                                38,950
                                
                                $
                                26,430
 F-16
 Depreciation
                          and amortization expense for property and equipment was
                          $10.3 million, $5.3
                          million and $4.3 million for the years ended December 31,
                          2006, 2005 and 2004,
                          respectively.
  **(4)**  **Goodwill
                          and Intangible Assets**
 Changes
                          in the carrying amount of goodwill at December 31, 2006
                          and 2005 are as follows
                          (in thousands):
 
 **December
                                    31,****2006**
                                
                                **2005**Carrying
                                    value at January 1,
                                
                                $
                                69,248
                                
                                $
                                54,665Additional
                                    goodwill from acquisitions (Note 2)
                                
                                
                                375,682
                                
                                
                                14,583Acquisition
                                    contingent consideration
                                
                                
                                55,900
                                
                                
                                -Carrying
                                    value at December 31,
                                
                                $
                                500,830
                                
                                $
                                69,248
  The
                          components of identifiable intangible assets, which resulted
                          from our 2006 and
                          2005 acquisitions, were as follows (in thousands):
 
 **December
                                    31,****2006**
                                
                                **2005**Gross
                                    carrying amounts:Customer
                                    relationships
                                
                                $
                                49,100
                                
                                $
                                2,200Current
                                    technology
                                
                                
                                10,500
                                
                                
                                2,800Content
                                
                                
                                1,600
                                
                                
                                1,600Covenants
                                    not-to-compete
                                
                                
                                700
                                
                                
                                700Trade
                                    names
                                
                                
                                1,500
                                
                                
                                -Total
                                
                                
                                63,400
                                
                                
                                7,300Accumulated
                                    amortization
                                
                                
                                (7,509
                                )
                                
                                (365
                                )$
                                55,891
                                
                                $
                                6,935
 
 Amortization
                          expense for the years ended December 31, 2006, 2005 and
                          2004 was $7.1 million,
                          $365,000 and $0, respectively. Estimated amortization expense
                          for the next five
                          years and thereafter is as follows (in thousands):
 
 2007
                                
                                $
                                7,1442008
                                
                                
                                7,1442009
                                
                                
                                7,1442010
                                
                                
                                6,9992011
                                
                                
                                6,565Thereafter
                                
                                
                                20,895$
                                55,891
 **(5)**  **Accrued
                          Liabilities**
 Significant
                          components of accrued liabilities at December 31, 2006
                          and 2005 are summarized
                          as follows (in thousands):
 
 **December
                                    31,****2006**
                                
                                **2005**Accrued
                                    compensation and related liabilities
                                
                                $
                                12,379
                                
                                $
                                10,293Other
                                    accrued expenses
                                
                                
                                10,282
                                
                                
                                3,119$
                                22,661
                                
                                $
                                13,412
  F-17
   **(6)**  **Long-Term
                          Debt**
 Our
                          long-term debt balances at December 31, 2006 and 2005 consisted
                          of the following
                          (in thousands):
 
 **December
                                    31,****2006**
                                
                                **2005**Term
                                    Loan B Facility, accrues interest at LIBOR plus
                                    2.0%, interest rate
                                    ranging between 7.36% to 7.37% at December 31,
                                    2006; interest payable
                                    quarterly; interest rate reset quarterly, maturing
                                    January 2012, including
                                    $62 of fair value of interest rate swap
                                
                                $
                                212,412
                                
                                $
                                -Term
                                    Loan B-2 Facility, accrues interest at LIBOR
                                    plus 2.0%, interest rate of
                                    7.36% at December 31, 2006; interest payable
                                    quarterly; interest rate
                                    reset quarterly, maturing January 2012
                                
                                
                                64,838
                                
                                
                                -Unsecured
                                    11% Senior Notes, net of unamortized discount
                                    of $34 and $57 at December
                                    31, 2006 and 2005, respectively, plus unamortized
                                    deferred gains resulting
                                    from termination of interest rate swaps of $6
                                    and $10 at December 31, 2006
                                    and 2005, respectively
                                
                                
                                1,972
                                
                                
                                1,953Capital
                                    lease obligations; interest ranging from approximately
                                    6% to 10.8% with
                                    various monthly payments and maturing at various
                                    dates through July
                                    2008
                                
                                
                                144
                                
                                
                                395Other
                                    debt; interest rate 5.91%; payable in monthly
                                    installments through May
                                    2007
                                
                                
                                769
                                
                                
                                772Total
                                    long-term debt
                                
                                
                                280,135
                                
                                
                                3,120Less
                                    current installments
                                
                                
                                4,197
                                
                                
                                1,021Long-term
                                    debt, excluding current installments
                                
                                $
                                275,938
                                
                                $
                                2,099
 
 Approximate
                          aggregate minimum annual payments due on long-term debt,
                          excluding the
                          unamortized discount and deferred gains on interest rate
                          swaps, for the five
                          years subsequent to December 31, 2006 and thereafter are
                          as follows (in
                          thousands):
  2007
                                
                                $
                                4,1972008
                                
                                
                                5,3502009
                                
                                
                                3,3002010
                                
                                
                                3,3002011
                                
                                
                                235,491Thereafter
                                
                                
                                28,497$
                                280,135
 
 ***New
                          Credit Facilities*** .
                          On
                          January 19, 2006, in connection with the acquisition of
                          CorSolutions, we entered
                          into the New Credit Facilities with Bank of America, N.A.,
                          as administrative and
                          collateral agent. The New Credit Facilities, as amended,
                          provided for borrowings
                          of up to an aggregate of $485.0 million and are structured
                          to include both term
                          loans and a revolving credit facility. The New Credit Facilities
                          were divided
                          between a First Lien Credit Facility and a Second Lien
                          Credit Facility and
                          replaced the Company’s previous revolving credit facility, which was terminated
                          on January 13, 2006. There were no amounts outstanding
                          under the revolving
                          credit facility at the time of termination.
 
 Amounts
                          borrowed under the New Credit Facilities are fully and
                          unconditionally
                          guaranteed on a joint and several basis by substantially
                          all of
                          the subsidiaries of the Company. Amounts borrowed under the
                          First Lien
                          Credit Facility are secured by a first priority lien on
                          substantially all of the
                          assets of the Company and the subsidiary guarantors.
 
 The
                          New
                          Credit Facilities contain, among other things, various
                          representations,
                          warranties and affirmative, negative and financial covenants
                          customary for
                          financings of this type. The negative covenants include,
                          without limitation,
                          certain limitations on transactions with affiliates, liens,
                          making
  F-18
  
 investments,
                          the incurrence of debt, sales of assets, and changes in
                          business. The financial
                          covenants contained in both of the credit agreements include
                          a consolidated
                          leverage ratio and a consolidated fixed charges coverage
                          ratio. At December 31,
                          2006, we were in compliance with all covenants of the New
                          Credit Facilities.
 
 The
                          proceeds from the New Credit Facilities used to fund the
                          CorSolutions
                          acquisition were $444.0 million, net of debt issuance costs
                          of $11.1 million.
                          During the third and fourth quarters of 2006, prepayments
                          of $175.0 million were
                          made toward the reduction of the First Lien Credit Facility.
                          Of this amount,
                          $115.0 million and $30.0 million were paid from the net
                          proceeds from the Facet
                          and Dia Real divestitures, respectively, and $30.0 million
                          was paid from our
                          operating cash flows.
  The
                          New
                          Credit Facilities also provide for a Revolving Credit Facility.
                          Amounts borrowed
                          under the Revolving Credit Facility accrue interest at
                          a variable spread over
                          LIBOR or the prime rate, at our option, with the applicable
                          spread determined by
                          reference to our consolidated leverage ratio, as described
                          in the credit
                          agreement. At December 31, 2006, there were no amounts
                          outstanding under the
                          Revolving Credit Facility, and the available balance was
                          $28.5 million.
 
 In
                          November 2006, we amended the terms of the New Credit Facilities.
                          Under the
                          amended agreement, the First Lien Credit Facility was increased
                          by $65.0
                          million, the proceeds of which were used to prepay the
                          Second Lien Credit
                          Facility. Borrowings under the First Lien Credit Facility
                          bore interest at LIBOR
                          plus 2.00%, a 475 basis point reduction from the Second
                          Lien Credit Facility.
                          All the other terms and conditions of the Credit Agreement
                          (other than those
                          relating to the increased amount of the First Lien Credit
                          Facility and those
                          that are no longer applicable because they relate solely
                          to the Second Lien
                          Credit Facility) remain unchanged. We incurred fees and
                          expenses of
                          approximately $1.7 million, which were recorded as deferred
                          financing costs and
                          are being amortized over the term of the First Lien Credit
                          Facility (January
                          2012).  On February 23, 2007, we entered into a third amendment
                          to the New
                          Credit Facilities, the terms of which increased our borrowing
                          capacity under the
                          Revolving Credit Facility from $30.0 million to $50.0 million.
                          All other terms
                          of the New Credit Facilities, as amended, remain unchanged.
  **(7)**  **Derivative
                          Financial Instruments**
 In
                          February and May 2006, we entered into two interest rate
                          swap agreements, each
                          with a notional amount of $100.0 million, to hedge exposure
                          to fluctuations in
                          interest rates related to the New Credit Facilities. The
                          agreements, which have
                          two-year terms, have the economic effect of converting
                          $200.0 million of
                          floating rate debt under the New Credit Facilities to fixed
                          rate debt. Under the
                          terms of the agreements, we will pay the bank fixed base
                          rates of 5.065% and
                          5.350%, respectively, and the bank will pay us floating
                          rates based on
                          three-month LIBOR (5.371% and 5.364%, respectively, at
                          December 31, 2006). The
                          variable rates are reset quarterly.
 
 On
                          the
                          dates the interest rate swap derivative contracts were
                          entered into, we
                          designated the derivatives as hedges of the variability
                          of cash flow to be paid
                          (“cash flow” hedge). Under cash flow hedge accounting, changes in the
                          fair value
                          of a derivative that is qualified, designated and highly
                          effective as a cash
                          flow hedge are recorded in other comprehensive income until
                          earnings are
                          affected by the variability of cash flows. We reflected
                          the interest rate swap
                          agreements on the consolidated balance sheet at fair value
                          ($62,000 at December
                          31, 2006), which was based upon the estimated amount we
                          would pay upon
                          settlement of the agreements taking into account interest
                          rates at December 31,
                          2006. For the year ended December 31, 2006, we recognized
                          a net gain of $79,000
                          from the cash flow hedges, which is included in “Interest expense” in the
                          consolidated statements of operations.
 
 In
                          September 2006, we entered into a forward exchange agreement
                          with a bank to
                          eliminate the potential
  F-19
  
 impact
                          of
                          foreign exchange fluctuations on the U.S. dollar equivalent
                          of the expected euro
                          proceeds from the sale of Dia Real. Under the terms of
                          the agreement, we sold
€26.0 million at the forward rate and received approximately
                          $33.4 million on
                          the settlement date, resulting in a net gain of $741,000.
                          We reported the
                          forward exchange agreement at fair value until its termination
                          in October
                          2006.
 
 **(8)**  **Income
                          Taxes**
 The
                          components of the income tax expense (benefit) from continuing
                          operations
                          consisted of (in thousands):
 
 **Years
                                    ended December 31,****2006**
                                
                                **2005**
                                
                                **2004**Current
                                    tax expense:U.S.
                                    federal
                                
                                $
                                679
                                
                                $
                                -
                                
                                $
                                788State
                                    and local
                                
                                
                                376
                                
                                
                                808
                                
                                
                                123Total
                                    current tax expense
                                
                                
                                1,055
                                
                                
                                808
                                
                                
                                911Deferred
                                    tax expense (benefit):U.S.
                                    federal
                                
                                
                                10,517
                                
                                
                                2,518
                                
                                
                                (11,475
                                )State
                                    and local
                                
                                
                                1,196
                                
                                
                                (593
                                )
                                
                                (2,765
                                )Total
                                    deferred tax expense (benefit)
                                
                                
                                11,713
                                
                                
                                1,925
                                
                                
                                (14,240
                                )Total
                                    income tax expense (benefit)
                                
                                $
                                12,768
                                
                                $
                                2,733
                                
                                $
                                (13,329
                                )
 
 
 Below
                          is
                          a reconciliation of the expected income tax expense (benefit)
                          from continuing
                          operations (based on the U.S. federal statutory income
                          tax rate of 35%) to the
                          actual income tax expense (benefit) (in thousands):
 
 **Years
                                    ended December 31,****2006**
                                
                                **2005**
                                
                                **2004**Computed
                                    expected income tax expense (benefit)
                                
                                $
                                10,935
                                
                                $
                                2,361
                                
                                $
                                (11,692
                                )Effect
                                    of:State
                                    and local income taxes, net of federal effect
                                
                                
                                1,089
                                
                                
                                140
                                
                                
                                (1,717
                                )Nondeductible
                                    share-based compensation
                                
                                
                                515
                                
                                
                                -
                                
                                
                                -Other
                                    nondeductible expenses
                                
                                
                                405
                                
                                
                                273
                                
                                
                                425Nontaxable
                                    income of captive insurance subsidiary
                                
                                
                                (347
                                )
                                
                                (142
                                )
                                
                                (270
                                )Valuation
                                    allowance
                                
                                
                                97
                                
                                
                                -
                                
                                
                                -Other,
                                    net
                                
                                
                                74
                                
                                
                                101
                                
                                
                                (75
                                )Income
                                    tax expense (benefit)
                                
                                $
                                12,768
                                
                                $
                                2,733
                                
                                $
                                (13,329
                                )
 F-20
 At
                          December 31, 2006 and 2005, the deferred income tax assets consist
                          of
                          future tax benefits attributable to (in thousands):
 
 **December
                                    31,****2006**
                                
                                **2005**Deferred
                                    income tax assets (liabilities)Current:Allowance
                                    for doubtful accounts and other receivables
                                
                                $
                                1,304
                                
                                $
                                1,284Accruals
                                    and reserves not deducted for tax purposes
                                
                                
                                4,142
                                
                                
                                6,240Deferred
                                    revenues
                                
                                
                                2,642
                                
                                
                                1,110Other
                                
                                
                                (1
                                )
                                
                                (5
                                )8,087
                                
                                
                                8,629Non-current:Depreciation
                                    and amortization
                                
                                
                                (29,267
                                )
                                
                                (16,043
                                )Accruals
                                    and reserves not deducted for tax purposes
                                
                                
                                1,033
                                
                                
                                -Supplemental
                                    executive retirement plan
                                
                                
                                1,801
                                
                                
                                1,645Share-based
                                    compensation
                                
                                
                                2,290
                                
                                
                                -Net
                                    operating loss carryforwards
                                
                                
                                27,074
                                
                                
                                21,436Credit
                                    carryforwards
                                
                                
                                7,705
                                
                                
                                3,064Valuation
                                    allowance
                                
                                
                                (5,052
                                )
                                
                                -Other
                                
                                
                                (20
                                )
                                
                                5645,564
                                
                                
                                10,666Total
                                    deferred income tax assets
                                
                                $
                                13,651
                                
                                $
                                19,295
 
 As
                          of
                          December 31, 2005, we had approximately $56.5 million of
                          federal net operating
                          losses (NOL’s). We added approximately $81.2 million of federal NOL’s through
                          the acquisition of CorSolutions, which are limited, by
                          the Internal Revenue Code
                          Section 382, to approximately $19.4 million per year. We
                          utilized approximately
                          $70.7 million of federal NOL’s to offset taxable income in 2006. At
                          December 31, 2006, we had the following estimated operating loss
                          carryforwards available for federal income tax reporting
                          purposes to be applied
                          against future taxable income with the corresponding tax
                          year of expiration (in
                          thousands):
 
 
 2019
                                
                                $
                                1,1622020
                                
                                
                                1,6352021
                                
                                
                                7822022
                                
                                
                                4162024
                                
                                
                                1272025
                                
                                
                                62,883$
                                67,005
 
 We
                          also
                          have available alternative minimum tax (“AMT”) credit carryforwards of
                          approximately $3.7 million available to offset regular
                          income tax, if any, in
                          future years. The AMT credit carryforwards do not expire.
                          The AMT net operating
                          loss carryforward is approximately $70.3 million as of
                          December 31,
                          2006.
 
 We
                          reduced our federal income taxes payable by utilizing approximately
                          $10.6
                          million of foreign tax credits in 2006 related to the disposition
                          of Dia Real.
                          In addition, we realized a tax benefit from exercises of
                          employee stock options
                          of approximately $1.9 million which were recorded as an
                          increase to
                          shareholder’s equity.
 
 As
                          of
                          December 31, 2006, we had a valuation allowance of $5.1
                          million. The valuation
                          allowance is related to $4.0 million of foreign tax credits,
                          related to the
                          disposition of Dia Real, and $1.1 million of state NOL’s, which primarily relate
                          to the acquisition of CorSolutions. We believe that it
                          is more likely than not
                          that we will not realize these benefits.
  F-21
  
 Based
                          on
                          projections of taxable income in 2007 and future years,
                          management believes that
                          it is more likely than not that the Company will fully
                          realize the net value of
                          the recorded deferred income tax assets. The amount of
                          the deferred tax asset
                          considered realizable, however, could be reduced if estimates
                          of future taxable
                          income during the carryforward period are reduced.
 
 We
                          undergo audits of our various tax returns from time to
                          time. We record refunds
                          from audits when receipt is assured and assessments when
                          the loss is probable.
 
 **(9)**  **Shareholders’
                          Equity**
 ***Stock
                          Option Plans***
 During
                          2005, the Board of Directors of the Company adopted the
                          2005 Directors’
Non-Qualified Stock Option Plan, which provides for the
                          issuance of
                          non-qualified stock options to the Company’s non-employee directors. Under the
                          terms of this plan, a total of 165,000 shares of common
                          stock were reserved for
                          issuance. The options are granted with an exercise price
                          equal to the fair
                          market value of the Company’s common stock on the date of grant and vest monthly
                          over 12 months from the date of grant. The term of each
                          option is ten years from
                          the date of grant.
 
 During
                          2005, the Board of Directors of the Company amended and
                          restated the 2004 Stock
                          Incentive Plan to increase the number of shares available
                          for issuance to 1.6
                          million. The plan was also renamed the Long-Term Stock
                          Incentive Plan and is
                          available for employees, officers, independent contractors
                          and consultants of
                          the Company. The Long-Term Incentive Plan has three components:
                          a stock option
                          component, a stock bonus/stock purchase component and a
                          stock appreciation
                          rights component. The Long-Term Stock Incentive Plan contains
                          a $100,000
                          limitation on the aggregate fair market value of incentive
                          stock options which
                          first become exercisable by an optionee in any calendar
                          year. Also, the maximum
                          number of shares of stock with respect to which stock appreciation
                          rights or
                          options to acquire stock may be granted, or sales or bonus
                          grants of stock may
                          be made, to any individual per calendar year shall not
                          exceed 150,000 shares.
                          The maximum term of each stock option is ten years from
                          the date of grant, and
                          five years in the case of an incentive stock option granted
                          to a person owning
                          more than ten percent of the combined voting power of the
                          Company or an
                          affiliate. Options  vest over a period of years (generally three to five),
                          subject to eligibility status as specified in the individual
                          option agreement.
                          Restricted stock vests over a period of years (generally
                          three), subject to
                          eligibility status and satisfactory achievement of performance
                          goals, in each
                          case as specified in the individual restricted stock agreement.
 
 During
                          2002, the Board of Directors of the Company adopted the
                          2002 Stock Incentive
                          Plan for employees, officers, independent contractors and
                          consultants of the
                          Company. The 2002 Stock Incentive Plan also has three components:
                          a stock option
                          component, a stock bonus/stock purchase component and a
                          stock appreciation
                          rights component. Options, stock bonuses and rights to
                          purchase the Company’s
                          common stock may be granted to exercise or purchase an
                          aggregate of not more
                          than 375,000 shares of the Company’s common stock. The 2002 Stock Incentive Plan
                          contains a $100,000 limitation on the aggregate fair market
                          value of incentive
                          stock options which first become exercisable by an optionee
                          in any calendar
                          year. Also, the maximum number of shares of stock with
                          respect to which stock
                          appreciation rights or options to acquire stock may be
                          granted, or sales or
                          bonus grants of stock may be made, to any individual per
                          calendar year shall not
                          exceed 100,000 shares. The term of each option is ten years
                          from the date of
                          grant. Options vest over a period of years (generally three to five),
                          subject to eligibility status as specified in the individual
                          stock option
                          agreement.
 
 The
                          Company also has options and shares available for grant
                          under the 2001 Stock
                          Incentive Plan, the 2000 Stock Incentive Plan and the 2000
                          Board of Directors
                          Plan, the provisions of which are similar to the plans
                          described above. Due to
                          forfeitures of previously issued grants, at December 31,
                          2006, there were
                          approximately 11,000 options and shares available for grant
                          under these
                          plans.
  F-22
  
 ***Employee
                          Stock Purchase Plan***
 The
                          Company maintains an Employee Stock Purchase Plan (the
“Purchase Plan”) to
                          encourage ownership of its common stock by employees. The
                          Purchase Plan provides
                          for the purchase of up to 187,500 shares of the Company’s common stock by
                          eligible employees of the Company and its subsidiaries.
                          In 2005, the Company
                          established the 2005 Employee Stock Purchase Plan to provide
                          for an additional
                          150,000 shares of common stock to be available for purchase
                          by employees. Under
                          both plans, the Company may conduct an offering each fiscal
                          quarter of its
                          common stock to eligible employees. The participants in
                          the plans can elect to
                          purchase common stock at the lower of 85% of the fair market
                          value per share on
                          either the first or last business day of the quarter, limited
                          to a maximum of
                          the lesser of 10% of the employee’s compensation or 375 shares of common stock
                          per quarter. A participant immediately ceases to be a participant
                          in the plans
                          upon termination of his or her employment for any reason.
                          During 2006, 2005 and
                          2004, approximately 64,000, 31,000 and 49,000 shares of
                          common stock,
                          respectively, were issued under the Purchase Plan.
 
 ***Implementation
                          of SFAS 123(R)***
 Prior
                          to
                          January 1, 2006, we accounted for stock compensation arrangements
                          using the
                          intrinsic value method, which followed the recognition
                          and measurement
                          principles of APB Opinion No. 25, *Accounting*  *for
                          Stock Issued to Employees* ,
                          and the
                          related Interpretations.
 
 Beginning
                          January 1, 2006, we adopted SFAS 123(R) using the modified
                          prospective
                          transition method. Accordingly, in 2006, we recorded share-based
                          compensation
                          expense for awards granted prior to, but not yet vested,
                          as of December 31,
                          2005, as if the estimated grant date fair value method
                          required for pro forma
                          disclosure under SFAS 123 (the Black-Scholes option-pricing
                          model) were in
                          effect for expense recognition purposes, as adjusted for
                          estimated forfeitures.
                          For share-based awards granted after December 31, 2005,
                          we recognized
                          compensation expense based on the estimated grant date
                          fair value method using
                          the Black-Scholes option-pricing model and used a straight-line
                          amortization
                          method.
 
 For
                          the
                          year ended December 31, 2006, the impact on our results
                          of operations of
                          recording share-based compensation was $7.0 million ($4.8
                          million net of income
                          tax), of which $447,000 was from the Employee Stock Purchase
                          Plan. This expense
                          is included in “Selling and administrative expenses” on the consolidated
                          statement of operations. We did not capitalize any share-based
                          compensation
                          costs. The impact on both basic and diluted earnings per
                          share for the period
                          was $0.23.
 
 Cash
                          received from option exercises under all share-based payment
                          arrangements for
                          the years ended December 31, 2006, 2005 and 2004 were $6.0
                          million, $7.3 million
                          and $6.6 million, respectively.
 
 SFAS
                          123(R) requires us to calculate an initial “pool” of excess tax benefits
                          available at the adoption to absorb any tax deficiencies
                          that may be recognized
                          under SFAS 123(R). The pool includes the net excess tax
                          benefits that would have
                          been recognized if we had adopted SFAS 123 for recognition
                          purposes on its
                          effective date. In accordance with SFAS 123(R), tax benefits
                          from the exercise
                          of stock options are classified as financing cash flows
                          rather than operating
                          cash flows.
  F-23
  
 ***Valuation
                          Assumptions***
 We
                          calculated the fair value of each option award on the date
                          of grant using the
                          Black-Scholes option-pricing model. The following assumptions
                          were used for each
                          respective period:
 
 **2006**
                                
                                **2005**
                                
                                **2004**Risk-free
                                    interest rates
                                
                                
                                4.75
                                %
                                
                                4.02
                                %
                                
                                3.43
                                %Expected
                                    lives (in years)
                                
                                
                                4
                                
                                
                                5
                                
                                
                                5Dividend
                                    yield
                                
                                
                                NA
                                
                                
                                NA
                                
                                
                                NAExpected
                                    volatility
                                
                                
                                53
                                %
                                
                                68
                                %
                                
                                67
                                %
 
 Our
                          computation of expected volatility for grants awarded in
                          2006 was based on
                          historical daily volatility. Prior to 2006, our computation
                          of expected
                          volatility was based on historical monthly volatility.
                          The computations of
                          expected lives were determined based on historical experience
                          of similar awards,
                          giving consideration to the contractual terms of the share-based
                          awards, vesting
                          schedules and expectations of future employee behavior.
                          The risk-free interest
                          rate is based on the U.S. Treasury yield in effect at the
                          time of grant. The
                          weighted average fair value of the options granted during
                          2006, 2005 and 2004
                          was $14.26, 18.03 and $10.53, respectively, on the date
                          of grant.
 
 The
                          following table summarizes our stock option activity during
                          the years ended
                          December 31, 2006, 2005 and 2004 (shares in thousands):
 
 
 **2006**
                                
                                **2005**
                                
                                **2004****Exercise**
                                
                                
                                
                                **Exercise**
                                
                                
                                
                                **Exercise****Shares**
                                
                                **Price**
                                
                                **Shares**
                                
                                **Price**
                                
                                **Shares**
                                
                                **Price**Outstanding
                                    at beginning of year
                                
                                
                                2,790
                                
                                $
                                20.19
                                
                                
                                2,498
                                
                                $
                                12.62
                                
                                
                                2,584
                                
                                $
                                10.81Granted
                                
                                
                                364
                                
                                $
                                31.07
                                
                                
                                1,096
                                
                                $
                                31.81
                                
                                
                                678
                                
                                $
                                17.88Exercised
                                
                                
                                (359
                                )
                                $
                                12.63
                                
                                
                                (553
                                )
                                $
                                11.64
                                
                                
                                (527
                                )
                                $
                                11.42Forfeited/expired/cancelled
                                
                                
                                (308
                                )
                                $
                                25.03
                                
                                
                                (251
                                )
                                $
                                14.89
                                
                                
                                (237
                                )
                                $
                                8.90Outstanding
                                    at the end of year
                                
                                
                                2,487
                                
                                $
                                22.26
                                
                                
                                2,790
                                
                                $
                                20.19
                                
                                
                                2,498
                                
                                $
                                12.62Options
                                    exercisable at end of year
                                
                                
                                1,214
                                
                                $
                                19.00
                                
                                
                                1,043
                                
                                $
                                12.53
                                
                                
                                885
                                
                                $
                                12.29
 
 The
                          total
                          aggregate intrinsic value of options exercised during the
                          years ended December
                          31, 2006, 2005 and 2004 was $6.3 million, $12.3 million
                          and $4.4 million,
                          respectively.
 
 The
                          following table summarizes our options outstanding and options exercisable
                          as of December 31, 2006 (shares in thousands):
 
 **Outstanding**
                                
                                **Exercisable****Range
                                    of Exercise Prices**
                                
                                **Shares
                                    Outstanding**
                                
                                **Weighted
                                    Average Remaining Contractual Life (years)**
                                
                                **Weighted
                                    Average Exercise Price**
                                
                                **Shares
                                    Exercisable**
                                
                                **Weighted
                                    Average Remaining Contractual Life (years)**
                                
                                **Weighted
                                    Average Exercise Price**$
                                    4.57 - $10.00
                                
                                
                                235
                                
                                
                                5.4
                                
                                $
                                7.28
                                
                                
                                169
                                
                                
                                5.1
                                
                                $
                                7.79$10.01
                                    - $20.00
                                
                                
                                926
                                
                                
                                5.4
                                
                                $
                                13.38
                                
                                
                                719
                                
                                
                                4.9
                                
                                $
                                16.32$20.01
                                    - $30.00
                                
                                
                                786
                                
                                
                                8.7
                                
                                $
                                28.26
                                
                                
                                188
                                
                                
                                8.4
                                
                                $
                                28.08$30.01
                                    - $40.33
                                
                                
                                540
                                
                                
                                8.8
                                
                                $
                                35.28
                                
                                
                                138
                                
                                
                                8.8
                                
                                $
                                34.432,487
                                
                                
                                7.2
                                
                                $
                                22.26
                                
                                
                                1,214
                                
                                
                                5.9
                                
                                $
                                19.00
 
 The
                          aggregate intrinsic value of options outstanding and options
                          exercisable as of
                          December 31, 2006, was $20.0 million and $15.3 million,
                          respectively.
 
 At
                          December 31, 2006, the total compensation cost related
                          to unvested share-based
                          awards granted to
  F-24
  
 employees
                          under stock option plans but not yet recognized was approximately
                          $19.5 million,
                          after estimating forfeitures and before income taxes. Of
                          this amount,
                          approximately $3.7 million relates to shares of unvested
                          restricted stock that
                          we issued in 2006 (discussed below). The cost of all unvested
                          share-based awards
                          is expected to be recognized over an estimated weighted
                          average period of 2.9
                          years.
 
 During
                          2006, we recorded a charge of $608,000 to “Gain on disposal of discontinued
                          operations” for unamortized share-based compensation expense related
                          to the
                          accelerated vesting of options granted to the Facet and
                          Dia Real employees. We
                          completed the sales of Facet on September 1, 2006, and
                          Dia Real on October 17,
                          2006.
 
 ***Restricted
                          Stock***
 During
                          2006, we issued shares of unvested restricted stock. The
                          following table
                          summarizes our restricted stock award activity for the
                          year ended December 31,
                          2006 (shares in thousands):
 
 
 **Weighted****Average****Grant
                                    Date****Fair
                                    Value****Shares**
                                
                                **Per
                                    Share**Nonvested
                                    at January 1, 2006
                                
                                
                                -
                                
                                $
                                -Granted
                                
                                
                                233
                                
                                
                                28.10Vested
                                
                                
                                -
                                
                                
                                -Forfeited
                                
                                
                                (12
                                )
                                
                                28.16Nonvested
                                    at December 31, 2006
                                
                                
                                221
                                
                                $
                                28.10
  During
                          2006, we recognized compensation expense totaling $1.1
                          million related to our
                          restricted stock awards. As of December 31, 2006, we had
                          approximately $3.7
                          million of unrecognized compensation expense related to
                          restricted stock awards,
                          which we expect to recognize over a weighted average period
                          of 1.9 years.
 
 ***Pro
                          forma Information for Periods Prior to the Adoption of
                          SFAS
                          123(R)***
 Share-based
                          compensation for the years ended December 31, 2005 and
                          2004 was determined using
                          the intrinsic value method under APB Opinion No. 25. The
                          following table
                          illustrates the effect on net income and earnings per share
                          if the Company had
                          applied the fair value recognition provisions of SFAS No.
                          123 to share-based
                          compensation for the years ended December 31, 2005 and
                          2004 (in thousands,
                          except per share data):
 
 **Years
                                    Ended December 31,****2005**
                                
                                **2004**Earnings
                                    (loss) from continuing operations, as reported
                                
                                $
                                4,014
                                
                                $
                                (20,077
                                )Deduct:
                                    Share-based compensation, net of tax effects
                                
                                
                                (2,616
                                )
                                
                                (1,408
                                )Pro
                                    forma earnings (loss) from continuing operations
                                
                                $
                                1,398
                                
                                $
                                (21,485
                                )Earnings
                                    (loss) per share from continuing operations:Basic
                                    - as reported
                                
                                $
                                0.21
                                
                                $
                                (1.29
                                )Basic
                                    - pro forma
                                
                                $
                                0.07
                                
                                $
                                (1.38
                                )Diluted
                                    - as reported
                                
                                $
                                0.20
                                
                                $
                                (1.29
                                )Diluted
                                    - pro forma
                                
                                $
                                0.07
                                
                                $
                                (1.38
                                )
   **(10)**  **Employee
                          Benefit Plans**
 We
                          maintain a 401(k) defined contribution plan for the benefit
                          of our employees.
                          Our obligation for
  F-25
  
 contributions
                          under the 401(k) plan is limited to each participant’s contribution but not more
                          than 3% of the participant’s compensation. Discretionary Company contributions
                          are allowed under the plan. Contributions to the plan in
                          the years ended
                          December 31, 2006, 2005 and 2004 were approximately $1.4 million,
                          $1.3
                          million and $1.2 million, respectively.
 
 We
                          maintain a Supplemental Executive Retirement Plan (“SERP”) for certain executive
                          employees. Benefits vest under the SERP based on age and
                          years of service with
                          100% vesting obtained at age 55 and 15 years of service.
                          Earlier vesting may
                          occur upon a change in control or other events as defined
                          in the agreement.
                          During 2006, 2005 and 2004, $175,000, $172,000 and $162,000,
                          respectively, were
                          expensed related to the SERP and an additional $338,000
                          is expected to be
                          expensed over the next four years of expected service by
                          the respective current
                          employees. The liability under the SERP plan as of December
                          31, 2006 and 2005
                          was $4.7 million and $4.2 million, respectively, and is
                          recorded in “Other
                          long-term liabilities” on the consolidated balance sheets. The fair value of the
                          assets in the SERP of $3.9 million and $3.6 million at
                          December 31, 2006 and
                          2005, respectively, is recorded in “Other assets” in the consolidated balance
                          sheets.
 
 **(11)**  **Commitments**
 We
                          are
                          committed under noncancelable lease agreements for facilities
                          and equipment.
                          Future minimum operating lease payments and the present
                          value of the future
                          minimum capital lease payments as of December 31, 2006
                          are as follows (in
                          thousands):
 
 **Years
                                    ending December 31,**
                                
                                **Operating
                                    Leases**
                                
                                **Capital
                                    Leases**2007
                                
                                $
                                8,539
                                
                                $
                                1322008
                                
                                
                                8,099
                                
                                
                                172009
                                
                                
                                6,328
                                
                                
                                -2010
                                
                                
                                3,138
                                
                                
                                -2011
                                
                                
                                1,873
                                
                                
                                -Thereafter
                                
                                
                                3,473
                                
                                
                                -$
                                31,450
                                
                                
                                149Less
                                    interest
                                
                                
                                
                                
                                
                                (5
                                )Present
                                    value of future minimum capital lease payments
                                
                                
                                
                                
                                $
                                144
  Amortization
                          of capital leased assets is included in depreciation expense.
                          Rental expense for
                          cancelable and noncancelable leases was approximately $9.0
                          million, $5.0
                          million, and $4.5 million for the years ended December
                          31, 2006, 2005 and 2004,
                          respectively.
 
 
 **(12)**  **Contingencies
                          and Concentrations**
 Pursuant
                          to the CorSolutions Merger Agreement, we are pursuing a
                          claim before a
                          contractually-designated settlement accountant for certain
                          post-closing
                          adjustments including a $4 million claim relating to a
                          liability resulting from
                          CorSolutions’ pre-closing performance under a customer contract. We are
                          also
                          pursuing a related claim for fraudulent misrepresentation
                          and concealment before
                          the American Arbitration Association in Chicago, Illinois,
                          seeking damages in an
                          unspecified amount exceeding $4 million. There is no assurance
                          that we will
                          prevail in either of these proceedings.
  The
                          Company and its subsidiaries are involved in various claims
                          and legal actions
                          arising in the ordinary course of business. In the opinion
                          of management, based
                          in part on the advice of counsel, the ultimate disposition
                          of these matters will
                          not have a material adverse effect on the Company’s consolidated balance sheet,
                          results of operations or liquidity.
  F-26
  
 **(13)
                          Divestitures**
 During
                          the fourth quarter of 2005, we made the strategic decision
                          to divest the
                          operations of Facet and Dia Real. As a result, the accompanying
                          consolidated
                          financial statements reflect the operations of these divisions
                          as discontinued
                          operations for all periods presented. Also, the assets
                          and liabilities of these
                          businesses have been reclassified as “Assets held for sale” and “Liabilities
                          related to assets held for sale and other discontinued
                          operations” in the
                          consolidated balance sheets at December 31, 2005.
 
 On
                          September 1, 2006, the Company completed the sale of Facet
                          for net cash proceeds
                          of $121.9 million. The sale resulted in a gain of $26.6
                          million, or $23.9
                          million net of income taxes. The assets sold consisted
                          primarily of accounts
                          receivable, inventories, property and equipment and other
                          assets, and the buyer
                          assumed certain accrued liabilities. Goodwill of $76.2
                          million was charged
                          against the gain. In connection with the sale, the Company
                          recorded
                          transaction-related costs of $4.1 million, of which $2.4
                          million related to cash
                          transactions paid during 2006, $541,000 related to unamortized
                          share-based
                          compensation expense for the accelerated vesting of options
                          granted to Facet
                          employees, and $1.2 million was accrued for other liabilities
                          related to the
                          sale.
 
 On
                          October 17, 2006, we completed the sale of Dia Real for
                          net cash proceeds of
                          $33.3 million, resulting in a gain of $9.1 million, or
                          $5.0 million net of
                          income taxes. Accounts receivable, inventories, property
                          and equipment and other
                          assets, as well as certain accrued liabilities, were acquired
                          by the purchaser.
                          Goodwill and intangibles totaling $3.6 million were charged
                          against the gain.
                          Also, we recorded transaction-related costs of $3.0 million,
                          of which $2.9
                          million related to cash transactions paid during 2006,
                          $67,000 related to
                          unamortized share-based compensation expense for the accelerated
                          vesting of
                          options granted to Dia Real employees, and $71,000 was
                          accrued for other
                          liabilities related to the sale.
 
 On
                          June
                          30, 2004, we discontinued the operations of our direct-to-consumer
                          laboratory
                          business and completed the sale of substantially all of
                          the assets of our
                          direct-to-consumer pharmacy and supplies business. The
                          accounts receivable of
                          the business and certain other assets and liabilities were
                          excluded from the
                          sale and retained by us. In December 2005, we recorded
                          a liability of $10.0
                          million for the settlement of the *qui
                          tam* claim
                          filed against us and this business, which was paid in April
                          2006. The purchaser
                          did not assume liability for the *qui
                          tam* claim.
                          Liabilities related to the sale are reflected in “Liabilities related to assets
                          held for sale and other discontinued operations” on the consolidated balance
                          sheet at December 31, 2005. There were no remaining liabilities
                          related to this
                          sale as of December 31, 2006.
 
 A
                          reconciliation of the accrued liability balance for all
                          discontinued operations
                          is as follows (in thousands):
 
 **Type
                                    of Charge**
                                
                                **Employee
                                    Termination Benefits**
                                
                                **Contractual
                                    Obligations**
                                
                                ***Qui
                                    tam*****Settlement Costs**
                                
                                **Other
                                    Accruals**
                                
                                **Total**Balance
                                    January 1, 2005
                                
                                $
                                330
                                
                                $
                                330
                                
                                $
                                -
                                
                                $
                                258
                                
                                $
                                918Charges
                                
                                
                                -
                                
                                
                                304
                                
                                
                                10,000
                                
                                
                                -
                                
                                
                                10,304Payments
                                
                                
                                (309
                                )
                                
                                (113
                                )
                                
                                -
                                
                                
                                (16
                                )
                                
                                (438
                                )Adjustments
                                
                                
                                (21
                                )
                                
                                (21
                                )
                                
                                -
                                
                                
                                (192
                                )
                                
                                (234
                                )Balance
                                    at December 31, 2005
                                
                                
                                -
                                
                                
                                500
                                
                                
                                10,000
                                
                                
                                50
                                
                                
                                10,550Charges
                                
                                
                                290
                                
                                
                                872
                                
                                
                                -
                                
                                
                                124
                                
                                
                                1,286Payments
                                
                                
                                -
                                
                                
                                (487
                                )
                                
                                (10,000
                                )
                                
                                (8
                                )
                                
                                (10,495
                                )Adjustments
                                
                                
                                -
                                
                                
                                (13
                                )
                                
                                -
                                
                                
                                (42
                                )
                                
                                (55
                                )Balance
                                    at December 31, 2006
                                
                                $
                                290
                                
                                $
                                872
                                
                                $
                                -
                                
                                $
                                124
                                
                                $
                                1,286
  F-27
  
 The
                          $1.3
                          million of charges to the accrued liability balance in
                          2006 relates to the Facet
                          and Dia Real divestitures. Of this amount, $629,000 is
                          included in “Accrued
                          liabilities,” and the remaining $657,000 is included in “Other long-term
                          liabilities” on the consolidated balance sheet at December 31, 2006.
 
 The
                          operating results of discontinued operations are as follows
                          (in
                          thousands):
 
 **Year
                                    Ended December 31,****2006**
                                
                                **2005**
                                
                                **2004**Revenues
                                
                                $
                                    102,610
                                
                                $
                                    152,395
                                
                                $190,476Earnings
                                    from discontinued operations, net of income tax
                                    expense of $3,347, $7,221
                                    and $10,091 in 2006, 2005 and 2004, respectively
                                
                                $
                                5,293
                                
                                $
                                9,949
                                
                                $
                                16,205Gain
                                    on disposal of discontinued operations, net of
                                    income tax expense of
                                    $6,797 and $20,874 in 2006 and 2004, respectively
                                
                                
                                28,922
                                
                                
                                -
                                
                                
                                30,938Earnings
                                    from discontinued operations, net of tax
                                
                                $
                                34,215
                                
                                $
                                9,949
                                
                                $
                                47,143
 
 “Earnings
                          from discontinued operations” for the year ended December 31, 2006, include a
                          charge of $8.7 million for interest expense and deferred
                          financing fees related
                          to the New Credit Facilities. “Gain on disposal of discontinued operations” for
                          the year ended December 31, 2006, includes $1.1 million
                          for the pro rata share
                          of deferred financing fees written off as a result of the
                          prepayment of debt
                          using the net proceeds from the Facet and Dia Real divestitures.
                          These amounts
                          were allocated in accordance with Emerging Issues Task
                          Force (“EITF”) Issue
                          87-24, Allocation of Interest to Discontinued Operations.
                          Under EITF Issue
                          87-24, interest on debt that must be repaid upon disposal
                          of discontinued
                          operations must be allocated to discontinued operations.
                          The terms of the New
                          Credit Facilities required that we use the net proceeds
                          from the sale of Facet
                          and Dia Real to repay a portion of the outstanding indebtedness.
 
 The
                          components of “Assets held for sale” and “Liabilities related to assets held for
                          sale and other discontinued operations” at December 31, 2005, are as follows (in
                          thousands):
 
 
 **December
                                    31,****2005**Cash
                                    and cash equivalents
                                
                                $
                                2,716Accounts
                                    receivable, net
                                
                                
                                22,575Inventories
                                
                                
                                22,395Property
                                    and equipment, net
                                
                                
                                3,259Goodwill
                                    and intangible assets, net
                                
                                
                                80,248Other
                                
                                
                                1,262Assets
                                    held for sale
                                
                                $
                                132,455Accounts
                                    payable
                                
                                $
                                17,013*Qui
                                    tam*settlement cost and other contractual obligations
                                
                                
                                10,550Accrued
                                    and other liabilities
                                
                                
                                3,479Liabilities
                                    related to assets held for sale and other discontinued
                                    operations
                                
                                $
                                31,042
 F-28
 **(14)**  **Earnings
                          (Loss) Per Share**
 The
                          computations for basic and diluted net earnings (loss)
                          per common share are as
                          follows (in thousands, except per share amounts):
 
 **Year
                                    Ended December 31,****2006**
                                
                                **2005**
                                
                                **2004****Net
                                    earnings (loss) - basic and diluted:**Continuing
                                    operations
                                
                                $
                                18,475
                                
                                $
                                4,014
                                
                                $
                                (20,077
                                )Discontinued
                                    operations
                                
                                
                                34,215
                                
                                
                                9,949
                                
                                
                                47,143Net
                                    earnings available to common shareholders
                                
                                $
                                52,690
                                
                                $
                                13,963
                                
                                $
                                27,066**Shares:**Weighted
                                    average common shares outstanding - basic
                                
                                
                                21,025
                                
                                
                                18,795
                                
                                
                                15,520Dilutive
                                    effect of:Stock
                                    options and employee stock purchase plan
                                
                                
                                488
                                
                                
                                1,079
                                
                                
                                -Unvested
                                    restricted stock awards
                                
                                
                                152
                                
                                
                                -
                                
                                
                                -Weighted
                                    average common shares outstanding - diluted
                                
                                
                                21,665
                                
                                
                                19,874
                                
                                
                                15,520**Basic:**Continuing
                                    operations
                                
                                $
                                0.88
                                
                                $
                                0.21
                                
                                $
                                (1.29
                                )Discontinued
                                    operations
                                
                                
                                1.63
                                
                                
                                0.53
                                
                                
                                3.03$
                                2.51
                                
                                $
                                0.74
                                
                                $
                                1.74**Diluted:**Continuing
                                    operations
                                
                                $
                                0.85
                                
                                $
                                0.20
                                
                                $
                                (1.29
                                )Discontinued
                                    operations
                                
                                
                                1.58
                                
                                
                                0.50
                                
                                
                                3.03$
                                2.43
                                
                                $
                                0.70
                                
                                $
                                1.74
 
 The
                          calculation of diluted earnings (loss) per share excludes
                          1.3 million, 482,500
                          and 2.5 million shares in the years ended December 31,
                          2006, 2005 and 2004,
                          respectively, since the effect of assumed exercise of the
                          related options would
                          be antidilutive. In 2006, the computation excludes the
                          antidilutive effect of
                          69,000 unvested restricted stock awards. In 2005 and 2004,
                          the diluted earnings
                          (loss) per share also excludes 1.8 million and 4.4 million
                          shares, respectively,
                          from the assumed conversion of the 4.875% convertible senior
                          subordinated notes,
                          since the effect would be antidilutive.
  F-29
  
 **(15)**  **Quarterly
                          Financial Information - Unaudited**
 Presented
                          below is a summary of the unaudited consolidated quarterly
                          financial information
                          for the years ended December 31, 2006 and 2005 (in thousands,
                          except per share
                          amounts).
 
 
 **2006:**
                                
                                **Quarter****Fourth**
                                
                                **Third**
                                
                                **Second**
                                
                                **First**(as
                                    restated)Revenues
                                
                                $
                                88,420
                                
                                $
                                84,186
                                
                                $
                                82,627
                                
                                $
                                80,906Net
                                    earningsContinuing
                                    operations
                                
                                $
                                5,693
                                
                                $
                                4,532
                                
                                $
                                4,834
                                
                                $
                                3,416Discontinued
                                    operations
                                
                                
                                4,812
                                
                                
                                25,505
                                
                                
                                2,391
                                
                                
                                1,507$
                                10,505
                                
                                $
                                30,037
                                
                                $
                                7,225
                                
                                $
                                4,923Net
                                    earnings per diluted common shareContinuing
                                    operations
                                
                                $
                                0.26
                                
                                $
                                0.21
                                
                                $
                                0.22
                                
                                $
                                0.16Discontinued
                                    operations
                                
                                
                                0.22
                                
                                
                                1.18
                                
                                
                                0.11
                                
                                
                                0.07Total
                                
                                $
                                0.48
                                
                                $
                                1.39
                                
                                $
                                0.33
                                
                                $
                                0.23**2005:**
                                
                                **Quarter****Fourth**
                                
                                
                                **Third**
                                
                                
                                **Second**
                                
                                
                                **First**Revenues
                                
                                $
                                48,580
                                
                                $
                                46,266
                                
                                $
                                44,762
                                
                                $
                                39,623Net
                                    earnings (loss)Continuing
                                    operations
                                
                                $
                                1,510
                                
                                $
                                1,602
                                
                                $
                                756
                                
                                $
                                146Discontinued
                                    operations
                                
                                
                                (2,864
                                )
                                
                                4,835
                                
                                
                                4,318
                                
                                
                                3,660$
                                (1,354
                                )
                                $
                                6,437
                                
                                $
                                5,074
                                
                                $
                                3,806Net
                                    earnings (loss) per diluted common shareContinuing
                                    operations
                                
                                $
                                0.07
                                
                                $
                                0.07
                                
                                $
                                0.04
                                
                                $
                                0.01Discontinued
                                    operations
                                
                                
                                (0.13
                                )
                                
                                0.23
                                
                                
                                0.23
                                
                                
                                0.21Total
                                
                                $
                                (0.06
                                )
                                $
                                0.30
                                
                                $
                                0.27
                                
                                $
                                0.22
 
 
 **Restatement** .
 In
                          connection with the preparation of this Annual Report on
                          Form 10-K, we
                          determined that an error had been made in calculating income
                          tax expense for the
                          disposition of Facet. Effective January 1, 1999, we acquired
                          substantially all
                          of the assets of Gainor Medical Management, LLC (“Gainor Medical”), which
                          included Facet, for approximately $147.8 million. In connection
                          with the
                          purchase of Gainor, we incorrectly calculated the purchase
                          price allocation made
                          for tax purposes. Because the original purchase price allocation
                          made in 1999
                          was incorrect when we disposed of Facet in September 2006,
                          the calculation of
                          the after-tax gain on the disposition also was incorrect.  As a result, our
                          income tax expense on the gain on disposal of Facet was
                          overstated by
                          approximately $7.3 million.  The corrected financial statements for the
                          three and nine months ended September 30, 2006, reflect
                          an increase of $5.5
                          million in the long-term portion of deferred tax assets,
                          a decrease of $1.8
                          million in income taxes payable, and a corresponding decrease
                          of $7.3 million in
                          income tax expense.  The net result is an increase in the gain on the
                          disposal of Facet, net of income taxes, and an increase
                          in diluted earnings per
                          share from discontinued operations of $7.3 million and
                          $0.34, respectively, for
                          the three and nine months ended September 30, 2006.  These adjustments did
                          not affect our earnings from continuing operations for
                          these periods as
                          previously reported.
  In
                          addition, we recorded adjustments to eliminate the
                          contingent consideration liability for the acquisition of WinningHabits, as
                          the contingency was not resolved and additional consideration
                          was not issuable
                          as of September 30, 2006.  The effects of these adjustments on the
                          consolidated balance sheet as of September 30, 2006, were
                          decreases of $23.3
                          million in Goodwill and Accrued liabilities.
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