UNITED
STATES


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, 2008




or




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the transition period from
             to






Commission
file number 333-135172






CRC
HEALTH CORPORATION


(Exact
name of registrant as specified in its charter)







Delaware
            73-1650429(State or other jurisdiction
      of
              incorporation or organization)
            (I.R.S.
      Employer
              Identification
      No.)20400 Stevens Creek Boulevard,
      Suite 600, Cupertino, California
            95014(Address
      of principal executive offices)
            (Zip
      code)




(877)
272-8668


(Registrant’s
telephone number, including area code)







Securities
registered pursuant to Section 12(b) of the Act: None




Securities
registered pursuant to Section 12(g) of the Act: None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.    Yes   ̈    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
Act.    Yes  x    No   ̈




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   ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) 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, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):




Large accelerated filer   ̈
            Accelerated filer   ̈
            Non-accelerated filer  x
            Smaller reporting company   ̈




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




The
Company is privately held. There is no trading in the common equity and
therefore an aggregate market value based on sales or bid and asked prices is
not determinable.




The total
number of shares of the registrant’s common stock, par value of $0.001 per
share, outstanding as of March 27, 2009 was 1,000.




Documents
incorporated by reference:  exhibits as indicated herein





CRC
HEALTH CORPORATION




INDEX




PagePART
      IItem 1.
            Business
            3Item 1A.
            Risk Factors
            9Item 1B.
            Unresolved Staff Comments
            15Item 2.
            Properties
            17Item 3.
            Legal Proceedings
            18Item 4.
            Submission of Matters to a Vote of Security
      Holders
            18PART
      IIItem 5.
            Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity
Securities
            19Item 6.
            Selected Financial Data
            19Item 7.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            21Item 7A.
            Quantitative and Qualitative Disclosure about Market
      Risk
            28Item 8.
            Financial Statements and Supplementary
      Data
            29Item 9.
            Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosures
            69Item 9A.
            Controls and Procedures
            69Item 9B.
            Other Information
            69PART
      IIIItem 10.
            Directors, Executive Officers and Corporate
      Governance
            70Item 11.
            Executive Compensation
            72Item 12.
            Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
            78Item 13.
            Certain Relationships and Related Transactions, and
      Director Independence
            80Item 14.
            Principal Accountant Fees and
      Services
            81PART
      IVItem 15.
            Exhibits, Financial Statements
      Schedules
            82Signatures
            
            87






























































2








Forward-Looking
Statements




This
Annual Report on Form 10-K, including “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” in Item 7 of Part II
of this Annual Report, includes or may include “forward-looking statements.” All
statements included herein, other than statements of historical fact, may
constitute forward-looking statements. In some cases you can identify
forward-looking statements by terminology such as “may,” “should” or “could.”
Generally, the words “anticipates,” “believes,” “expects,” “intends,”
“estimates,” “projects,” “plans” and similar expressions identify
forward-looking statements. Although CRC Health Corporation (“CRC”) believes
that the expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to be
correct. Important factors that could cause actual results to differ materially
from those expressed or implied by such forward-looking statements include,
among others, the following factors: changes in government reimbursement for
CRC’s services; our substantial indebtedness; changes in applicable regulations
or a government investigation or assertion that CRC has violated applicable
regulation; attempts by local residents to force our closure or relocation; the
potentially difficult, unsuccessful or costly integration of recently acquired
operations and future acquisitions; the potentially difficult, unsuccessful or
costly opening and operating of new treatment programs; the possibility that
commercial payors for CRC’s services may undertake future cost containment
initiatives; the limited number of national suppliers of methadone used in CRC’s
outpatient treatment clinics; the failure to maintain established relationships
or cultivate new relationships with patient referral sources; shortages in
qualified healthcare workers; natural disasters such as hurricanes, earthquakes
and floods; competition that limits CRC’s ability to grow; the potentially
costly implementation of new information systems to comply with federal and
state initiatives relating to patient privacy, security of medical information
and electronic transactions; the potentially costly implementation of accounting
and other management systems and resources in response to financial reporting
and other requirements; the loss of key members of CRC’s management; claims
asserted against CRC or lack of adequate available insurance; and certain
restrictive covenants in CRC’s debt documents and other risks that are described
herein, including but not limited to the items discussed in “Risk Factors” in
Item 1A of Part I of this Annual Report, and that are otherwise
described from time to time in CRC’s Securities and Exchange Commission filings
after this Annual Report. CRC assumes no obligation and does not intend to
update these forward-looking statements.




PART
I




ITEM 1. Business




Overview




We are a
leading provider of substance abuse treatment services and youth treatment
services in the United States. We also provide treatment services for other
addiction diseases and behavioral disorders such as eating disorders. We deliver
our services through our three divisions, the recovery division, the youth
division and the healthy living division. Our recovery division provides our
substance abuse and behavioral disorder treatment services through our
residential treatment facilities and outpatient treatment clinics. Our youth
division provides educational programs for underachieving young people through
residential schools and wilderness programs. Our healthy living division
provides treatment services through its adolescent and adult weight management
programs and its eating disorder facilities. As of December 31, 2008, our
recovery division operated 100 treatment facilities in 24 states and treated
approximately 28,000 patients per day, which we believe makes us the largest and
most geographically diversified for-profit provider of substance abuse
treatment. As of December 31, 2008, our youth division operated programs at 28
facilities, in 10 states and during the 2008 calendar year enrolled
approximately 4,000 students from families from all 50 states of the United
States and from 21 foreign countries. As of December 31, 2008, our healthy
living division operated 16 facilities in 8 states. Since our inception in 1995,
we believe that we have developed a reputation for providing outstanding
services and care and as a result have become a provider of choice throughout
the communities we serve.




All
references in this report to the “Company,” “we,” “our,” and “us” mean, unless
the context indicates otherwise, CRC Health Corporation and its subsidiaries on
a consolidated basis.




Major
Recent Developments





We
initiated a restructuring plan ("the FY08 Plan") in the fourth quarter of 2008
which included certain facility exit activities, facility
consolidations,  as well as workforce reductions, and other
activities. The workforce reduction portion of the FY08 Plan is expected to be
substantially completed  by the end of the first quarter in
2009.  Facility exit activities are expected to be substantially
completed by the end of 2009.  Certain of the facility exit activities
have been classified as discontinued operations in the consolidated income
statements for all periods presented as discontinued operations, facility exits
on the consolidated balances sheets for 2008.




Industry
Overview




Addiction
Disorders




Addiction
is a chronic disease that adversely affects the lives of millions of Americans.
One of the most common and serious addictions is substance abuse, which
encompasses the abuse of alcohol and drugs. Without treatment, substance abuse
can lead to depression, problems at home or work, and in some cases, physical
injury or death. In 2001, expenditures for treatment of substance abuse in the
United States totaled $18.3 billion. In 2004, 23.5 million persons aged 12
or older needed treatment for an alcohol or drug use problem, but only
2.3 million, or 10% of those afflicted, received treatment in inpatient or
outpatient facilities. The prevalence of substance abuse continues to grow as
evidenced by the fact that, in 2004, the number of individuals needing treatment
for substance abuse grew 5.9% over 2003 reported levels. This growth has been
due to several factors including the declining cost of illegal drugs, the
availability of new formulations of existing drugs and the increasing abuse of
prescription painkillers. There is also evidence of increasing alcohol use.
Between 1995 and 2001, the number of binge drinking episodes per person
increased 35%. The Substance Abuse and Mental Health Services Administration
estimated that in 2004 approximately 55 million Americans aged 12 and older
(22.8% of the U.S. population) participated in binge alcohol use, defined as
five or more drinks on one occasion, in the past month. Approximately
16.7 million Americans, or 7.0% of the U.S. population, are considered to
be heavy drinkers, defined as binge drinking five or more times per month.
Furthermore, there is increasing recognition by private and public payors that
failure to deliver early treatment for substance abuse and other behavioral
issues generally results in higher acute-care hospital costs and can compound
the negative effects of these issues over time. Treatment providers for the
large and growing behavioral healthcare market, at both the adult and adolescent
levels, are highly fragmented, with services to the adult population provided by
over 13,000 different facilities of which only 26% are operated by for-profit
organizations, and with services to the adolescent population provided primarily
by single-site competitors and a handful of competitors of significantly lesser
size. Due in part to the regulatory and land use hurdles of opening new
substance abuse treatment facilities, we believe that supply of residential
substance abuse treatment and therapeutic education services is constrained in
the United States as evidenced by high industry-wide utilization
rates.




Addiction
is a complex, neurologically based, life-long disease. While the initial
behavior of addiction manifests itself through conscious choices, such behavior
can develop into a long-term neurological disorder. There is no uniform
treatment protocol for all substance abuse patients. Effective treatment
includes a combination of medical, psychological and social treatment programs.
These programs may be provided in residential and outpatient treatment
facilities.






3


Adolescent
Behavioral Disorders




According
to the National Survey on Drug Use and Health, in 2003, nearly nine million
adolescents or 36% of the population engaged in at least one delinquent behavior
such as drug or alcohol abuse, academic difficulty, violence or stealing, and
approximately 2.2 million adolescents, or 9% of the population had at least
one major depressive episode. While the majority of adolescents successfully
cope with these issues on their own, there are a growing number of adolescents
who need help and support to successfully transition to a productive adulthood.
Other developmental challenges faced by adolescents include learning
disabilities, such as attention deficit hyperactivity disorder and obesity.
According to the National Resource Center on Attention Deficit Hyperactivity
Disorder, this condition affects 3% to 7% of school-age children, who in
relation to their peers have higher rates of psychiatric and behavioral
disorders. The National Health and Nutrition Examination Survey reports that
approximately 16% of the population between the ages of 6 and 19 are
overweight.




Historically,
treatment options for struggling or underachieving youth were limited to
counseling or placement in a highly structured hospital setting. More recently,
however, parents, health professionals and public officials have been
increasingly turning to the preventative care that can be provided by
therapeutic education programs designed to modify adolescent behavior and assist
the transition to a successful and productive adulthood. Therapeutic education
programs offer individualized curricula that combine counseling, education and
therapeutic treatment in residential and outdoor locations that provide a stable
environment for students and provide measurable benefits to adolescents who have
not benefited from counseling alone.




Eating
Disorders




Other
related behavioral disorders that may be effectively treated through a
combination of medical, psychological and social treatment programs include
obesity and eating disorders. Eating disorders, such as anorexia nervosa,
bulimia nervosa, and other forms of disordered eating such as binge eating and
compulsive overeating that may lead to obesity represent large underserved
treatment markets. These segments are highly fragmented with no national
provider.




As many
as 10 million people suffered from an eating disorder such as anorexia or
bulimia in 2005. For females between fifteen to twenty-four years old who suffer
from anorexia nervosa, the mortality rate associated with the illness is twelve
times higher than the death rate of all other causes of death. It is estimated
that 2 million people in the US suffer from an eating disorder (excluding
obesity) at any point in time. Only 10% of those who need treatment receive
treatment and only 35% of those who get treatment receive treatment in an
appropriate program or at the appropriate level of care.




Overweight
and obesity is a significant health issue in the United States. In 2004, the
U.S. Centers for Disease Control and Prevention ranked obesity as the number one
health threat facing America. It is estimated that in 2005 approximately 37% of
the adult population is overweight, 32% of the adult population is obese and
4.8% is morbidly obese. Overweight is defined as having a body mass index (BMI)
of 25.0 to 29.9, obesity is defined as having a BMI of 30 or greater and morbid
or extreme obesity is defined as a BMI of 40 or higher. Obesity increases a
person’s risk for developing several serious obesity-related health conditions
such as cardiovascular disease, hypertension, thyroid disease and
diabetes.




Our
Business




We
deliver our services through our recovery, youth and healthy living divisions.
For purposes of our segment reporting, our healthy living division currently is
not material and therefore is included in the corporate/other division for
segment reporting. Financial information about segment operations appears in
Note 20 to the consolidated financial statements.




Recovery
division




Our
recovery division provides treatment services both on an inpatient and
outpatient basis to patients suffering from chronic addiction diseases and
related behavioral disorders. We operated 30 inpatient facilities and 70
outpatient and comprehensive treatment clinics in 24 states as of December 31,
2008. The majority of our treatment services are provided to patients who abuse
addictive substances such as alcohol, illicit drugs, or opiates, including
prescription drugs. Some of our facilities also treat other addictions and
behavioral disorders such as chronic pain management, sexual compulsivity,
compulsive gambling, mood disorders and emotional trauma.




All of
our treatment facilities and clinics are accredited by either JCAHO or CARF,
making them eligible for reimbursement by third party payors, with the exception
of Bayside Marin, Echo Malibu, Burkwood and portions of Sober Living by the
Sea.  Accreditation is being pursued for Bayside Malibu, Burkwood and
additional Sober Living by the Sea programs.  At this time
accreditation for Echo Malibu is not being sought due to the nature of their
payor profiles, which would not necessarily benefit from
accreditation.


The goal
of the recovery division is to provide the appropriate level of treatment to an
individual no matter where they are in the lifecycle of their disease in order
to restore the individual to a healthier, more productive life, free from
dependence on illicit substances and destructive behaviors. Our treatment
facilities provide a number of different treatment services such as assessment,
detoxification, medication assisted treatment, counseling, education, lectures
and group therapy. We assess and evaluate the medical, psychological and
emotional needs of the patient and address these needs in the treatment process.
Following this assessment, an individualized treatment program is designed to
provide a foundation for a lifelong recovery process. Many modalities are used
in our treatment programs to support the individual, including the twelve step
philosophy, cognitive/behavioral therapies, supportive therapies and continuing
care.




Our
treatment facilities deliver care at various levels of intensity which allows us
to provide the appropriate services depending on the need of the individual. We
treat medically stable adult and adolescent patients. Upon admission, a patient
enters an appropriate stage in our continuum of care depending on the patient’s
diagnosis, the level and acuity of the disease and related treatment
requirements. The patient may enter into one of a number of different levels of
treatment depending on the patient’s needs such as detoxification, inpatient
residential, partial inpatient, day treatment, extended care, or
outpatient.




Inpatient/Residential
Treatment. We operated 30 residential facilities in 12 states. On
average, our residential facilities have been operating for over 19 years. We
have established strong relationships with referral sources and have
longstanding ties to the local community and an extensive network of former
patients and their families. Our residential treatment services are provided in
a peaceful setting that is removed from the pressures, pace and temptations of a
patient’s everyday life. Our inpatient facilities house and care for patients
over an extended period (21 days on average) and typically treat patients from a
broadly defined regional market. As of December 31, 2008, we had 1,910 available
beds in our residential and extended care facilities and treated approximately
1,400 patients per day.




We
provide three basic levels of residential treatment depending on the severity of
the patient’s addiction and/or disorder. Patients with the most debilitating
dependencies are typically placed into inpatient treatment, in which the patient
resides at a treatment facility. If a patient’s condition is less severe, he or
she will be offered day treatment, which allows the patient to return home in
the evening. The least intensive service is where the patient visits the
facility for just a few hours a week to attend counseling/group
sessions.




Following
primary treatment, our extended care programs are typically inpatient facilities
which allow clients to develop healthy and appropriate living skills while
remaining in a safe and nurturing residential environment. Clients are supported
in their recovery by a semi-structured living environment that allows them to
begin the process of employment or to pursue educational goals and to take
personal responsibility for their recovery.The structure of this
treatment phase is monitored by a primary therapist who works with each client
to integrate recovery skills, build a foundation of sobriety, and a strong
support system. Length of stay will vary depending on the clients needs with a
minimum stay of 30 days and could be up to one year if needed.




4


Outpatient and Intensive Outpatient
Services. We provide substance abuse services at 70 treatment clinics in
20 states. Our clinics, which typically range in size from 3,000 to 7,000 square
feet, are generally located within light commercial districts. As of December
31, 2008, our clinics treated on average approximately 25,700 patients on a
daily basis.




During
2008, substantially all of our services were provided to individuals addicted to
heroin and other opiates, including prescription analgesics. In 2008, 35
comprehensive treatment clinics were certified to provide at least one
additional comprehensive outpatient substance abuse treatment service, which we
refer to as our COSAT services.




Substantially
all of our patients addicted to heroin and other opiates are treated with
methadone, but a small percentage of our patients are treated with other
medications such as buprenorphine. Patients usually visit an outpatient
treatment facility once a day in order to receive their medication. During the
beginning of their treatment program, patients receive weekly counseling and as
they successfully progress in the treatment protocol, they continue to receive
counseling each month. This mandatory minimum duration of counseling may vary
from state to state. Following the initial administration of medication,
patients go through an induction phase where medication dosage is systematically
modified until an appropriate dosage is reached. As patients progress with
treatment and meet certain goals in their individualized treatment plan and
certain federal criteria related to time in treatment, they become eligible for
up to 30 days of take-home doses of medication, eliminating the need for daily
visits to the clinic. The length of treatment differs from patient to patient,
but typically ranges from one to three years.




The
recovery division has initiated the development of a broad range of programs and
services for addiction treatment that are administered in our comprehensive
treatment clinics. These services are offered for opiate and other abused
substances in an outpatient setting. Utilizing the platform of our comprehensive
treatment clinics will allow for a broad geographic dissemination of programs
and services. COSAT services broaden the array of services offered at our
clinics and increase our potential patient base by providing services to
individuals with problems with all drugs and alcohol, not just opiates.
Ambulatory detoxification is a program where medication is administered to
counter physical withdrawal symptoms. Patients are monitored daily by nurses and
other medical personnel at the clinic. This program allows patients to remain in
their home environment while going through treatment. Intensive outpatient is a
12-16 week program. An individual treatment plan is developed for each patient
providing manageable goals and objectives to assist in the recovery
process.




Other Services. Several other
related behavioral diseases, in addition to substance abuse, represent large
underserved markets to which our residential treatment services may be provided.
The treatment model used at our residential facilities to treat substance abuse
can also be applied to treat other compulsive behaviors such as trauma and
abuse, chronic pain management, sexual addiction/compulsivity, which a number of
our facilities treat.




Referral Base and Marketing.
We receive a large number of patient referrals generated from our several
thousand referral sources. Patients are referred to our treatment facilities
through a number of different sources, including healthcare practitioners,
public programs, other treatment facilities, managed care organizations, unions,
emergency departments, judicial officials, social workers, police departments
and word of mouth from previously treated patients and their families, among
others. We devote significant resources to establishing strong relationships
with a broad array of potential referral sources at the local and national
level. No single referral source resulted in a significant portion of our
revenues.




We engage
in local marketing, direct-to-consumer internet marketing, coordinate
intra-facility referrals and develop programs and content targeted at key
referral sources on a national basis. Our National Resource Center (“NRC”) is a
centralized call center located at our corporate headquarters that responds to
inquiries from our online marketing efforts and facilitates
cross-referrals.




Payor Mix. We generate our
revenues from three primary sources: self payors, commercial payors such as
managed care organizations and unions, and government programs. We believe our
strong relationships with third party payors and our industry experience allow
us to obtain new contracts for new and acquired facilities which creates an
opportunity to increase the number of patients that we treat.




Staffing and Local Management
Structure. Our residential facilities are managed by an executive
director experienced in substance abuse treatment services. Our executive
directors have on average over 23 years of experience in healthcare and over ten
years tenure at the treatment center they currently manage. The executive
director is supported by a facility staff that consists of physicians, nurses,
counselors, marketing professionals, reimbursement specialists, administrative
and facility maintenance employees. Our comprehensive treatment clinics are
typically run by a clinic director experienced in substance abuse treatment
services. A clinic director is supported by a staff that consists of a medical
director, nurses, counselors and administrative employees.




Youth
division




Our youth
division provides a wide variety of therapeutic and educational programs through
settings and solutions that match individual needs with the appropriate learning
and therapeutic environment. We operated 28 programs in 10 states as of December
31, 2008, with services ranging from short-term intervention programs to
longer-term residential treatment. Our programs are offered in boarding schools,
residential treatment centers, outdoor experiential education programs and
summer camps. These programs exist at the intersection of education and therapy
for adolescents who have demonstrated behavioral or learning challenges that are
interfering with their performance in school and in life such as substance
abuse, academic underachievement, anger and aggressive behavior, family
conflict, special learning needs and depression. Since most of the targeted
customer base for these programs face a wide range of interrelated academic,
emotional, and behavioral disorders, our ability to offer a seamless continuum
of care for a multitude of problems is an important competitive differentiator
for us. Approximately one half of our youth treatment programs are accredited by
an educational accreditation program, such as the Southern Association of
Colleges and Schools (SACS).




Residential programs. We
operated 18 residential programs in 8 states as of December 31, 2008. These
programs are typically operated in traditional boarding school environments
where a unique educational plan is crafted for each student that combines group
therapy, individual counseling and specialized therapeutic experiences, such as
equine therapy, which are designed to build the student’s personal and emotional
skills. Parent seminars and family resolution conferences play an important role
in building mutually respectful and responsible relationships and preparing the
student to face the real world challenges they face upon completion of the
program. Each of our residential programs follows an accredited middle school,
high school or college preparatory curriculum over a length of stay ranging from
three to 24 months with an average duration of approximately ten months.
Admissions are accepted year-round, subject to capacity, and campus sizes range
from 40-160 students at both single gender and co-ed campuses.




•
            Residential
      Treatment Centers. We have six residential treatment centers. These
      programs offer a highly structured environment with 24 hours-per-day
      supervision that emphasizes therapeutic programming and a strong peer
      environment to help students overcome self-defeating behaviors and acquire
      and practice positive behaviors.




•
            Therapeutic
      Boarding Schools. Nine of our residential programs are therapeutic
      boarding schools. These programs focus on educating adolescents who are
      struggling with behavioral, emotional, or academic issues by fostering
      personal growth, healthy self-expression and service to
      others.




•
            Special
      Learning Needs. Three of our residential programs are special learning
      needs programs. These programs are tailored to students with attention
      deficit hyperactivity disorder, learning disabilities or acute emotional
      issues, and offer structured education in an intimate academic environment
      that emphasizes personalized student attention and development of
      organizational and social skills.




5


Outdoor programs. We operated
10 outdoor programs in six states as of December 31, 2008. Outdoor programs
emphasize student exposure to, and interaction with, natural environments and
are based on either a base camp format, where students are housed in fixed
structures between camping expeditions, or a format that utilizes an
expedition-only format. These programs are designed for adolescents who have
typically undergone an acute personal crisis and require immediate intervention
in a short-term, high-impact therapeutic program that emphasizes experiential
learning and individualized counseling as a catalyst for positive behavioral
change. Students enrolled in an outdoor program experience the challenges living
and working together outdoors as a means of identifying and working through
internal conflicts and emotional obstacles that have kept them from responding
to parental efforts, schools and prior treatment. In some cases, academic credit
is offered upon completion of the program.




Payor Mix. Substantially all
of our revenues are from self payors.




Staffing and Local Management
Structure. A typical youth treatment program is managed by an executive
director experienced in education or other clinical areas, and many of our
executive directors hold post-graduate degrees. Our executive directors have on
average over 16 years of experience in education/healthcare and over six years
tenure at the treatment center they currently manage. The executive director is
supported by a staff that consists of therapists, clinical professionals,
teachers, counselors, field staff, admissions, finance and operational personnel
as well as administrative and maintenance employees.




Online Services. As part of a
student’s participation in one of our youth treatment programs, we utilize a
“parent check-in” website that provides parents with updated progress reports,
pictures, and school event information. This website is designed to allow
families to participate in the student’s progress at the program, and assist
with the eventual transition of the student back to home life upon completion of
the program.




Healthy
living division




Our
healthy living division provides treatment services for eating disorders and
obesity, each of which may be effectively treated through a combination of
medical, psychological and social treatment programs.




Eating Disorder Treatment. We
operated three residential eating disorder facilities/programs in three states
as of December 31, 2008. The total number of beds as of December 31, 2008 was
42.  Our residential facilities are located in home-like settings with
scenic and peaceful surroundings and provide individuals with a variety of
treatment options focusing on their individual needs. The full range of services
includes residential inpatient, day program and intensive outpatient treatment
for anorexia nervosa, bulimia nervosa, binge eating and related disorders. All
of our residential facilities are accredited by CARF, making them eligible for
reimbursement by third party payors.




Weight
Management Programs.We operate a number of different types of weight
loss programs for adults and adolescents. Recognizing that weight loss and
management is a complex behavioral and biological struggle, our comprehensive
and intensive weight management programs provide people with the necessary
tools, decision making skills and behavioral strategies to control weight
permanently.




Our
residential weight loss facility for adults, offers a behavioral approach to
weight loss and healthy lifestyle change. As of December 31, 2008, this facility
had 94 available beds. Emphasizing a medically sound approach to healthy living,
Structure House provides individual nutrition counseling, behavioral workshops,
exercise and individual sessions with a psychologist to empower participants and
teach them how to integrate healthy eating principles into their daily
lives.




We
operate one year-round residential weight loss school and twelve summer weight
loss camps in seven states and the United Kingdom for adolescents. These
programs are intended for the growing number of obese adolescents for whom
traditional weight loss methods have been unsuccessful. Our year-round weight
loss school is the nation’s first therapeutic boarding school specifically
designed for obese adolescents, and feature a full academic program in addition
to a therapeutic weight loss program. The residential school, as well as our
summer weight loss camps, employ scientific weight loss methods that are
designed to maximize long-term behavioral change as a catalyst to substantial
and sustained weight loss. These programs include intensive cognitive-behavioral
therapy, a low fat, low energy density diet, high physical activity and an
integrated nutritional and academic educational program. By participating in a
research-based diet and activity management program, and intensive training on
the skill sets and behaviors necessary for weight control, students are returned
to a normal weight and learn to change to a wide range of behaviors, starting
with diet and activity, but including self-esteem, mood, affect and
outlook.




Referral Base and Marketing.
Patients are referred to our eating disorder treatment facilities through a
number of different sources, including healthcare practitioners, public
programs, other treatment facilities, managed care organizations, unions, and
emergency departments. We receive a large number of weight loss patient
referrals generated from our web sites and the public relations efforts of our
marketing staff. We devote significant resources to establishing strong
relationships with a broad array of potential referral sources at the local and
national level. No single referral source resulted in a significant portion of
our revenues.




We engage
in local marketing, direct-to-consumer internet marketing, coordinate
intra-facility referrals and develop programs and content targeted at key
referral sources on a national basis. Our NRC responds to inquiries from our
online marketing efforts and facilitates cross-referrals.




Payor Mix. We generate our
revenues primarily from self payors. We also receive revenues for our eating
disorder services from commercial payors. We believe our strong relationships
with third party payors and our industry experience allow us to obtain and
increase the number of new contracts for our eating disorder business which will
provide us with an opportunity to increase the number of patients that we
treat.




Staffing and Local Management
Structure. A typical eating disorder or adult weight management
residential facility is managed by an executive director experienced in
treatment services. Our executive directors have on average over 10 years of
experience in healthcare. The executive director is supported by a facility
staff that consists of physicians, nurses, counselors, marketing professionals,
reimbursement specialists, administrative and facility maintenance employees.
Our adolescent weight management programs are managed by an executive director
experienced in education or other clinical areas, and many of our executive
directors hold post-graduate degrees. The executive director is supported by a
staff that consists of therapists, clinical professionals, teachers, counselors,
field staff, admissions, finance and operational personnel as well as
administrative and maintenance employees.




6


Competition




Treatment
providers for the large and growing substance abuse treatment market are highly
fragmented, with services being provided by over 13,000 different facilities of
which only 26% are operated by for-profit organizations. The primary competitive
factors in the substance abuse treatment industry include the quality of
programs and services, charges for programs and services, geographic proximity
to the patients served, brand and marketing awareness and the overall
responsiveness to the needs of patients, families and payors. Our recovery
division competes against an array of local competitors, both private and
governmental, hospital-based and free standing and for-profit and non-profit
facilities. Most of our residential facilities compete within local or regional
markets. Sierra Tucson, Life Healing Center and  Bayside
Marin,  three of our residential treatment facilities for addiction
and other behavioral disorders compete in both national and international
markets with other nationally known substance abuse treatment facilities such as
the Betty Ford Clinic and Hazelden.


Providers
of youth treatment services are also highly fragmented with services being
provided by over 500 different facilities. Our youth division competes with a
large number of single-site businesses that lack our name recognition and
management resources, as well as a handful of larger companies who have
divisions that provide youth treatment programs, such as the youth programs of
Universal Health Services, Second Nature and Three Springs.




The
eating disorder market is highly fragmented with no national player that offers
the full continuum of care. Our eating disorder programs for anorexia and
bulimia primarily compete against private and non-profit treatment programs. Our
weight management programs compete primarily against surgical alternatives, such
as bariatric surgery, support programs that offer diet foods and meal
replacement and various weight loss camps.




Technology
Infrastructure




We
utilize computer systems for billing, general ledger and all corporate
accounting. As of December 31, 2008, we expect to invest $2.7 million over the
next 12 months to finalize implementation of a company wide customer
relationship management system, to expand our data centers, and to continue our
investment, initiated in 2007,  for  the implementation of a
comprehensive and fully integrated system encompassing clinical, marketing,
regulatory, financial and management reporting systems. At December 31, 2008 we
had completed deployment of our human resource management systems initiated in
2007.




Regulatory
Matters




Overview




Healthcare
providers are regulated extensively at the federal, state and local levels. In
order to operate our business and obtain reimbursement from third party payors,
we must obtain and maintain a variety of state and federal licenses, permits and
certifications, and accreditations. We must also comply with numerous other laws
and regulations applicable to the conduct of business by healthcare providers.
Our facilities are also subject to periodic on-site inspections by the agencies
that regulate and accredit them in order to determine our compliance with
applicable requirements.




The laws
and regulations that affect healthcare providers are complex, change frequently
and require that we regularly review our organization and operations and make
changes as necessary to comply with the new rules. Significant public attention
has focused in recent years on the healthcare industry, directing attention not
only to the conduct of industry participants but also to the cost of healthcare
services. In recent years, there have been heightened coordinated civil and
criminal enforcement efforts by both federal and state government agencies
relating to the healthcare industry. The ongoing investigations relate to, among
other things, various referral practices, cost reporting, billing practices,
credit balances, physician ownership and joint ventures involving hospitals and
other health care providers. We expect that healthcare costs and other factors
will continue to encourage both the development of new laws and increased
enforcement activity.




Licensure,
Accreditation and Certification




All of
our recovery division treatment facilities must be licensed under applicable
state laws. Licensing requirements typically vary significantly by state and by
the services provided. Licensure requirements generally relate to the provider’s
qualifications, the adequacy of care and other matters, including: its
equipment, personnel, staff-to-patient ratios, operating policies and
procedures, fire prevention, maintenance of adequate records, rate-setting and
compliance with building codes and environmental protection laws. In addition,
all of our facilities that handle and dispense controlled substances are
required to register with the U.S. Drug Enforcement Administration, or the DEA,
and are required to abide by DEA regulations regarding such controlled
substances. The DEA also requires that our comprehensive treatment clinics be
certified by the Substance Abuse and Mental Health Services Administration, or
SAMSHA, in order to provide opiate treatment. In addition, our treatment
facilities that participate in government healthcare payment programs such as
Medicaid must apply to the appropriate government agency and be certified to
participate in the program.




Most of
our residential and comprehensive treatment clinics must obtain and maintain
accreditation from private agencies. JCAHO and CARF are private organizations
that have accreditation programs for a broad spectrum of healthcare facilities.
These accreditation programs are intended generally to improve the quality,
safety, outcomes and value of healthcare services provided by accredited
facilities. CARF accredits behavioral health organizations providing mental
health and alcohol and drug use and addiction services, as well as opiate
treatment programs, and many other types of programs.   JCAHO
accredits a broad variety of healthcare organizations, including hospitals,
behavioral health organizations, nursing and long-term care facilities,
ambulatory care centers, laboratories and managed care networks and others,
including three of our youth treatment programs. Accreditation by JCAHO, CARF or
one of the educational accreditation organizations that recognize our youth
treatment programs requires an initial application and completion of on-site
surveys demonstrating compliance with accreditation requirements. Accreditation
is typically granted for a specified period, typically ranging from one to three
years, and renewals of accreditation generally require completion of a renewal
application and an on-site renewal survey. Accreditation is generally a
requirement for participation in government and private healthcare payment
programs. In addition, certain federal and state licensing agencies require that
providers be accredited.


Both our
youth treatment programs in the youth division and adolescent weight management
programs in the healthy living division must comply with state and local laws
that vary based on the locations in which they operate. A typical youth or
adolescent weight management program will be subject to licensure by the state
department of education or health services, as well as local land use and health
and safety laws. Our eating disorder facilities within the healthy living
division are subject to licensure by the state department of health services. In
addition, the facilities and programs that are accredited must comply with the
guidelines of the applicable accrediting agencies. A number of our youth
programs maintain federal land use permits for their outdoor education and
ranching activities.




We
believe that all of our facilities and programs are in substantial compliance
with current applicable federal, state, local licensure and certification
requirements. In addition, we believe that all are in substantial compliance
with the standards of the agencies, including JCAHO and CARF, which have
accredited them. Periodically, federal, state and accreditation regulatory
organizations conduct surveys of our facilities and may find from time to time
that a facility is out of compliance with certain requirements. Upon receipt of
any such finding, the facility timely submits a plan of correction and corrects
any cited deficiencies.


7


Fraud,
Abuse and Self-Referral Laws




Many of
our facilities in our recovery division must comply with a number of laws and
regulations because such facilities participate in government healthcare payment
programs such as Medicare and Medicaid. The anti-kickback provision of the
Social Security Act, or the anti-kickback statute, prohibits certain offers,
payments or receipt of remuneration in return for referring patients covered by
federal healthcare payment programs or purchasing, leasing, ordering or
arranging for or recommending any services, good, item or facility for which
payment may be made under a federal healthcare program. As a result, dealings by
facilities that participate in such government programs with referring
physicians and other referral sources, including employment contracts,
independent contractor agreements, professional service agreements, joint
venture agreements and medical director agreements, are all subject to the
anti-kickback statute. The anti-kickback statute has been interpreted broadly by
federal regulators and certain courts to prohibit the payment of anything of
value if even one purpose of the payment is to influence the referral of
Medicare or Medicaid business. Violations of the anti-kickback statute may be
punished by criminal or civil penalties, exclusion from federal and state
healthcare programs, imprisonment and damages up to three times the total dollar
amount involved. The Office of Inspector General, or the OIG, of the Department
of Health and Human Services is responsible for identifying fraud and abuse
activities in government programs. The OIG has published regulations describing
activities and business relationships that would be deemed not to violate the
anti-kickback statute, known as “safe harbor” regulations. We use our best
efforts to comply with applicable safe harbors




Sections 1877
and 1903(s) of the Social Security Act, commonly known as the “Stark Law,”
prohibit referrals for designated health services by physicians under the
Medicare and Medicaid programs to any entity in which the physician has an
ownership or compensation arrangement, unless an exception applies, and
prohibits the entity from billing for such services rendered pursuant to any
prohibited referrals. These types of referrals are commonly known as “self
referrals.” There are exceptions for customary financial arrangements between
physicians and facilities, including employment contracts, personal services
agreements, leases and recruitment agreements that meet specific standards. We
use our best efforts to structure our financial arrangements with physicians to
comply with the statutory exceptions included in the Stark Law and related
regulations. Sanctions for violating the Stark Law include required repayment to
governmental payors of amounts received for services resulting from prohibited
referrals, civil monetary penalties, assessments equal to three times the dollar
value of each service rendered for an impermissible referral (in lieu of
repayment) and exclusion from the Medicare and Medicaid programs.




A number
of states have laws comparable to the anti-kickback statute and the Stark Law.
These state laws may be more stringent than the federal rules and apply
regardless of whether the healthcare services involved are paid for under a
federal health care program.




The
Federal False Claims Act




The
federal False Claims Act prohibits healthcare providers from knowingly
submitting false claims for payment under a federal healthcare payment program.
There are many potential bases for liability under the federal False Claims Act,
including claims submitted pursuant to a referral found to violate the Stark Law
or the anti-kickback statute. Although liability under the federal False Claims
Act arises when an entity “knowingly” submits a false claim for reimbursement to
the federal government, the federal False Claims Act defines the term
“knowingly” broadly. Civil liability under the federal False Claims Act can be
up to three times the actual damages sustained by the government plus civil
penalties for each false claim. From time to time, companies in the healthcare
industry, including us, may be subject to actions under the federal False Claims
Act.




Individuals
may also bring an action on behalf of the government under the “whistleblower”
or “qui tam” provisions of the federal False Claims Act. Because qui tam
lawsuits are filed under seal, we could be named in one or more such lawsuits of
which we are not aware. These provisions allow for the private party that
identified the violation to receive a portion of the sums the provider is
required to pay. This whistle-blower structure has encouraged some private
companies to go into the business of detecting and reporting potential fraud and
abuse.




Privacy
and Security Requirements




There are
numerous federal and state regulations addressing patient information privacy
and security concerns. In particular, the federal regulations issued under the
Drug Abuse Prevention, Treatment and the Rehabilitation Act of 1979 and Health
Insurance Portability and Accountability Act of 1996, or HIPAA, contain
provisions that:




•
            protect
      individual privacy by limiting the uses and disclosures of patient
      information;




•
            create
      new rights for patients regarding their health information, such as access
      rights and the right to amend certain aspects of their health
      information;




•
            require
      the implementation of security safeguards to ensure the confidentiality,
      integrity and availability of individually identifiable health information
      in electronic form;




•
            prescribe
      specific transaction formats and data code sets for certain electronic
      healthcare transactions; and




•
            require
      establishment of standard unique health identifiers for individuals,
      employers, health plans and healthcare providers to be used in connection
      with standard electronic transactions no later than May 23,
      2007.




In 2007,
we implemented computer systems to comply with the transaction and code set
requirements to correspond to the requirements of our trading partners. We have
adopted privacy policies in accordance with HIPAA requirements. We believe that
we are in compliance with certain security regulations under HIPAA but have not
yet conducted a full HIPAA audit to ensure compliance. Under HIPAA, a violation
of these regulations could result in civil money penalties of $100 per incident,
up to a maximum of $25,000 per person per year per standard. HIPAA also provides
for criminal penalties of up to $50,000 and one year in prison for knowingly and
improperly obtaining or disclosing protected health information, up to $100,000
and five years in prison for obtaining protected health information under false
pretenses and up to $250,000 and ten years in prison for obtaining or disclosing
protected health information with the intent to sell, transfer or use such
information for commercial advantage, personal gain or malicious
harm.




In
addition, many states impose requirements regarding the confidentiality and
security of healthcare information, as well as regarding the permitted uses of
that information, and many of these state laws are more restrictive than the
federal rules. For example, some states impose laws governing the use and
disclosure of health information pertaining to substance abuse issues that are
more stringent than the rules that apply to healthcare information generally. As
public attention is drawn to the issues of the privacy and security of medical
information, states may revise or expand their laws concerning the use and
disclosure of health information, or may adopt new laws addressing these
subjects. Failure to comply with these laws could expose us to criminal and
civil liability, as well as requiring us to restructure certain of our
operations.




Health
Planning and Certificates of Need




The
construction of new healthcare facilities, the expansion of existing facilities,
the transfer or change of ownership of existing facilities and the addition of
new beds, services or equipment may be subject to state laws that require prior
approval by state regulatory agencies under certificate of need laws. These laws
generally require that a state agency determine the public need for construction
or acquisition of facilities or the addition of new services. Review of
certificates of need and other healthcare planning initiatives may be lengthy
and may require public hearings. Violations of these state laws may result in
the imposition of civil sanctions or revocation of a facility’s license. The
states in which we operate that have certificate of need laws include Indiana,
West Virginia and North Carolina.




8


Local
Land Use and Zoning




Municipal
and other local governments also may regulate our treatment programs. Many of
our facilities must comply with zoning and land use requirements in order to
operate. For example, local zoning authorities regulate not only the physical
properties of a health facility, such as its height and size, but also the
location and activities of the facility. In addition, community or political
objections to the placement of treatment facilities can result in delays in the
land use permit process, and may prevent the operation of facilities in certain
areas.




Corporate
Practice of Medicine and Fee Splitting




Some
states have laws that prohibit business entities, including corporations or
other business organizations that own healthcare facilities, from employing
physicians. Some states also have adopted laws that prohibit direct and indirect
payments or fee-splitting arrangements between physicians and such business
entities. These laws vary from state to state, are often difficult to interpret
and have seldom been interpreted by the courts or regulatory agencies. We use
our best efforts to comply with the relevant state laws. Sanctions for
violations of these restrictions include loss of a physician’s license, civil
and criminal penalties upon both the physician and the business entity and
rescission of business arrangements.




Employees




As of
December 31, 2008, we employed approximately 5,000 people throughout the United
States. Approximately 4,500 of our employees are full-time and the remaining
approximately 500 are part-time employees. There were approximately 3,000
employees in our recovery division, 1,600 employees in our youth division and
300 employees in our healthy living division. The remaining approximately 100
employees are in corporate management, administration and other services. Certain
of our employees are represented by a labor union.  We believe our
relationship with our employees is good.




Available
Information




Our
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a)
and 15(d) of the Securities Exchange Act of 1934, as amended, are available on
our website athttp://www.crchealth.com/investor-sec-filings.asp, as soon as reasonably
practicable after CRC electronically files such reports with, or furnishes those
reports to, the Securities and Exchange Commission.




We
included the certifications of the CEO and the CFO of CRC required by
Section 302 of the Sarbanes-Oxley Act of 2002 and related rules, relating
to the quality of our public disclosure, in this Annual Report on Form 10-K as
Exhibits 31.1 and 31.2.




ITEM 1A. Risk Factors




Set forth
below and elsewhere in this annual report and in other documents we have filed
and will file with the SEC are risks and uncertainties that could cause our
actual results to differ materially from the results contemplated by the
forward-looking statements contained in this Annual Report.




Business
Risks




Unfavorable
economic conditions have, and could continue to, negatively impact our
revenues.




The
economic conditions have negatively impacted our revenues. If the economic
downturn continues or deteriorates further or if other adverse economic
conditions arise, such as inflation, it could have a material adverse effect on
our business. Tightening credit markets, depressed consumer spending and higher
unemployment rates continue to pressure many industries. Substantially all of
the revenue from our youth division and certain residential treatment facilities
such as Sierra Tucson and our extended care facilities is derived from
private-pay funding. In addition, a substantial portion of our revenue from our
comprehensive substance abuse treatment clinics is from self-payors. In 2008, we
experienced a significant decrease in demand for services in our youth division
as a result of declining economic conditions and the inability of families to
access the credit markets to fund tuition. A sustained downturn in the U.S.
economy has, and could continue to, restrain the ability of our patients and the
families of our students to pay for our services in all of our
divisions.  Other risks that we face as a result of general
economic weakness include potential declines in the population covered by health
insurance and patient decisions to postpone care.  Moreover, reduced
revenues as a result of a softening economy may also reduce our working capital
and interfere with our long term business strategy.




Although
inflation has not previously or currently had a material impact on our results
of operations, our industry is very labor intensive and salaries and benefits
are subject to inflationary pressures. Some of our facilities are experiencing
the effects of the tight labor market for certain skilled professionals,
including a shortage of qualified counselors and nurses, which has caused and
may continue to cause an increase in our salaries, wages and benefits expense in
excess of the inflation rate. Our ability to pass on increased costs associated
with providing services to our patients, in some cases, may be
limited.




Our
level of indebtedness could adversely affect our ability to meet our obligations
under our indebtedness, raise additional capital to fund our operations and
limit our ability to react to changes in the economy or our
industry.




We are
highly leveraged. The following chart shows our level of indebtedness as of
December 31, 2008 (in thousands):




Term Loans and Revolving Line of
      Credit(1)
              
              $
              471,341Senior
      Subordinated Notes
              
              
              175,426Other
              
              
              6,385Total
      Debt
              
              $
              653,152Total Stockholder’s Equity
              
              $
              303,222





(1)
            In
      addition, as of December 31, 2008, we had $8.1 million of letters of
      credit outstanding under our revolving line of credit leaving
      approximately $30.4 million available for additional borrowings under our
      revolving credit facility.




In
addition, our parent company has incurred $133.6 million of indebtedness as of
December 31, 2008. During 2008, we incurred $55.0 million in net interest
expense for our indebtedness issued pursuant to our term loans, revolving line
of credit, seller notes, and senior subordinated notes. Our substantial
indebtedness and the indebtedness of our parent company could make it more
difficult for us to satisfy our obligations with respect to our indebtedness,
increase our vulnerability to general adverse economic and industry conditions,
require us to dedicate a substantial portion of our cash flow from operations to
payments on our indebtedness, thereby reducing the availability of our cash flow
to fund working capital, capital expenditures and other general corporate
purposes, limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate, place us at a competitive
disadvantage compared to our competitors that have less debt and limit our
ability to borrow additional funds.




9


Our
ability to make payments, to refinance our indebtedness, and to fund planned
capital expenditures and other general corporate matters will depend on our
ability to generate cash in the future. This, to a certain extent, is subject to
general economic, financial, competitive, legislative, regulatory and other
factors that are beyond our control.




We cannot assure you that our business will generate sufficient cash flow from
operations or that future borrowings will be available to us in an amount
sufficient to enable us to pay our indebtedness or to fund our other liquidity
needs. We may need to refinance all or a portion of our indebtedness on or
before the maturity thereof. We cannot assure you that we will be able to
refinance any of our indebtedness on commercially reasonable terms or at
all.




We
are subject to restrictions that limit our flexibility in operating our business
as a result of our debt financing agreements.
  Our debt
financing agreements contain a number of significant covenants that, among other
things, restrict our ability to incur additional indebtedness, create liens on
our assets, restrict our ability to engage in sale and leaseback transactions,
mergers, acquisitions or asset sales and make investments. Under some
circumstances, these restrictive covenants may not allow us the flexibility we
need to operate our business in an effective and efficient manner and may
prevent us from taking advantage of strategic and financial opportunities that
could benefit our business. In addition, we are required under our senior
secured credit facility to satisfy specified financial ratios and tests. Our
ability to comply with those financial ratios and tests may be affected by
events beyond our control, and we may not be able to meet those ratios and
tests. A breach of any of those covenants could result in a default under our
senior secured credit facility and in our being unable to borrow additional
amounts under our revolving facility.  In an event of default occurs,
the lenders could elect to declare all amounts borrowed under our senior secured
credit facility, together with accrued interest, to be immediately due and
payable and could proceed against the collateral securing that indebtedness.
Substantially all of our assets are pledged as collateral pursuant to the terms
of our senior secured credit facility. In such an event, we could not assure you
that we would have sufficient assets to pay amounts under our secured
indebtedness.
  If we fail to comply with the restrictions in our debt financing agreements, a
default may allow the creditors to accelerate the related indebtedness, as well
as any other indebtedness to which a cross-acceleration or cross-default
provision applies. In addition, lenders may be able to terminate any commitments
they had made to supply us with further funds.
  Our
variable rate indebtedness subjects us to interest rate risk, which could cause
our debt service obligation to increase significantly.
  Certain
of our borrowings, primarily borrowings under our senior secured credit
facility, are at variable rates of interest and expose us to interest rate risk.
If interest rates increase, our debt service obligations on the variable rate
indebtedness would increase even though the amount borrowed remained the same,
and our net income and cash flows would decrease.
  Despite
our current leverage, we may still be able to incur additional indebtedness.
This could further exacerbate the risks that we face.




We may be
able to incur additional indebtedness in the future. Although our senior secured
credit facility and the indenture governing our senior subordinated notes
contain restrictions on the incurrence of additional indebtedness, these
restrictions are subject to a number of important qualifications and exceptions
and the indebtedness incurred in compliance with these restrictions could be
significant. If new debt is added to our existing debt levels, the related risks
that we now face, including those described above, could intensify.




Unfavorable
student loan markets and the lack of available credit have and could continue to
negatively impact our revenues in our youth division.
  Many students attending therapeutic boarding school in our youth division obtain
private loans from lenders to finance a portion of their education. In response
to recent tightening in the credit markets, many lenders are no longer making
student loans available or have announced that they will apply more stringent
lending standards for private student loans. In addition, some of the families
of our students in our youth division rely on third-party loans, including
additional home loans, to fund the cost of tuition at our programs. The
unavailability of these loans has and could continue to interfere with the
ability of private-pay customers to afford our programs, and may harm our
operating results.  Continued tightening of the credit markets has and
could continue to result in financing difficulties for those students who rely
on private student loans and the credit markets and could adversely impact our
revenues.


If
federal or state healthcare programs, managed care organizations and other
third-party payors reduce their reimbursement rates for services provided, our
revenue and profitability may decline.




Government
healthcare programs, managed care organizations and other third-party payors pay
for the services we provide to some of our patients. If any of these entities
reduce their reimbursement rates, or elect not to cover some or all of our
services, our revenue and profitability may decline.




For 2008,
we derived approximately 16.4% of our revenue from government programs and 83.6%
of our revenue from non-government payors such as self pay, managed care
organizations, private health insurance programs and labor unions. Government
payors, such as Medicaid and Medicare, generally reimburse us on a
fee-for-service basis based on predetermined reimbursement rate schedules. As a
result, we are limited in the amount we can record as revenue for our services
from these government programs, and if we have a cost increase, we typically
will not be able to recover this increase. In addition, the federal government
and many state governments are operating under significant budgetary pressures,
and they may seek to reduce payments under their Medicaid programs for services
such as those we provide.  They also tend to pay on a slower schedule.
Thus, while 16.4% of our revenue was attributable to governmental payors, such
payors accounted for 36.2% of our accounts receivable as of December 31, 2008.
Therefore, if governmental entities reduce the amounts they will pay for our
services, or if they elect not to continue paying for such services altogether,
our revenue and profitability may decline. In addition, if governmental entities
slow their payment cycles, our cash flow from operations could be negatively
affected.




Commercial
payors such as managed care organizations, private health insurance programs and
labor unions generally reimburse us for the services rendered to insured
patients based upon contractually determined rates. These commercial payors are
under significant pressure to control healthcare costs. In addition to limiting
the amounts they will pay for the services we provide their members, commercial
payors may, among other things, impose prior authorization and concurrent
utilization review programs that may further limit the services for which they
will pay and shift patients to lower levels of care and reimbursement. These
actions may reduce the amount of revenue we derive from commercial
payors.




10


We
derive a significant portion of our revenue from key treatment programs that are
located in Pennsylvania, Utah, California, Arizona, and North Carolina, which
makes us particularly sensitive to regulatory and economic conditions in those
states.




For 2008,
Pennsylvania facilities accounted for approximately 12.3% of our total revenue,
Utah facility accounted for approximately 12.0% of our total revenue, our
California facilities accounted for approximately 11.9% of our total revenue,
our Arizona facilities accounted for approximately 11.6% of our total revenue,
and our North Carolina facilities accounted for approximately 10.2% of our total
revenue. If our treatment facilities in these states are adversely affected by
changes in regulatory and economic conditions, our revenue and profitability may
decline.




We
may have difficulty operating and integrating treatment facilities and youth
treatment programs that we acquire. This may disrupt our business and increase
our costs and harm our operating results.




In 2006,
we acquired six residential facilities, five outpatient treatment clinics and
Aspen Education Group, our largest acquisition to date. In 2007, we acquired one
residential treatment facility, two youth programs and one weight management
facility.  In 2008 we acquired two residential treatment facilities.
Additional acquisitions would expose us to additional business and operating
risk and uncertainties, including risks related to our ability to:




•
            integrate
      operations and personnel at acquired
programs;




•
            retain
      key management and healthcare professional
  personnel;




•
            maintain
      and attract patients and students to acquired
  programs;




•
            manage
      our exposure to unknown or contingent liabilities, including liabilities
      for failure to comply with healthcare laws and regulations;
      and




•
            realize
      our investment return on
acquisitions.




Integration
efforts can require spending substantial resources on projects, such as
implementing consistent billing, payroll and information technology systems,
instituting standard policies and procedures and re-training staff from the
acquired businesses to conform to our service philosophy and internal compliance
procedures. Furthermore, integrating an acquired treatment program may disrupt
our ongoing business and distract our management and other key personnel. If we
are unable to manage our expansion efforts efficiently or effectively, or are
unable to attract and retain additional qualified management and healthcare
professional personnel to run our expanded operations, our business may be
disrupted, our costs may increase and our operating results may be
harmed.




We
may have difficulty opening new treatment facilities and operating them
profitably. We have limited experience in opening new residential treatment
facilities. If we are unable to execute our strategy, our growth may be
restrained and our operating results could be adversely affected.




Our
growth strategy includes developing and opening new treatment facilities and to
date, we have limited experience in opening new treatment facilities. Planning
and opening new treatment facilities in each of the recovery, youth and healthy
living divisions can be complex, and may be delayed and, in some circumstances,
prevented by a variety of forces, including local zoning and land use
regulation, health facility licensing, certificate of need requirements,
community opposition and other political issues. Healthcare laws and other rules
and regulations may also impede or increase the cost of opening new programs. If
we are unable to open new treatment programs on time and on budget, our rate of
growth and operating results may be adversely affected.




Even if
we are able to open new treatment programs, we may not be able to staff them or
integrate them into our organization. In addition, there can be no assurance
that once completed, new treatment programs will achieve sufficient patient
census or student enrollment to generate operating profits. Developing new
programs, particularly residential facilities and programs, involves significant
upfront capital investment and expense and if we are unable to attract patients
and/or students quickly and/or enter into contracts or extend our existing
contracts with third-party payors for these programs, these programs may not be
profitable and our operating results could be adversely affected.





Changes
to federal, state and local regulations could prevent us from operating our
existing facilities or acquiring additional facilities or could result in
additional regulation of our operations which may cause our growth to be
restrained, an increase in our operating expenses and our operating results to
be adversely affected.





Federal, state and local regulations
determine the capacity at which our therapeutic education programs for
adolescents may be operated. Some of our programs in our youth division rely on
federal land-use permits to conduct the hiking, camping and ranching aspects of
these programs. State licensing standards require many of our programs to have
minimum staffing levels, minimum amounts of residential space per student and
adhere to other minimum standards. Local regulations require us to follow land
use guidelines at many of our programs, including those pertaining to fire
safety, sewer capacity and other physical plant matters.





In addition, federal, state and local
regulations may be enacted that impose additional requirements on our
facilities. For example, in 2007, legislators in the states of California and
Indiana introduced bills that would impose new regulations affecting our
operations. In addition, U.S. Representative Miller introduced federal
legislation in April 2008, which, if adopted, would impose an additional layer
of federal regulation on all private residential and outdoor treatment programs
for youth under the age of 18. Adoption of legislation or the creation of new
regulations affecting our facilities could increase our operating costs,
restrain our growth and harm our operating results.







State
and local regulation of the construction, acquisition or expansion of treatment
facilities could prevent us from opening or acquiring additional treatment
facilities or expanding or renovating our existing treatment facilities, which
may cause our growth to be restrained and our operating results to be adversely
affected.




Some
states have enacted laws which require prior approval for the construction,
acquisition or expansion of treatment facilities, or for other capital
expenditures such as the acquisition of certain kinds of equipment used at
treatment facilities. In giving approval, these states consider the need for
additional or expanded treatment facilities or services. In the states of North
Carolina, West Virginia and Indiana in which we currently operate, certificates
of need may be required to be obtained for capital expenditures exceeding a
prescribed amount, changes in capacity or services offered. Other states in
which we now or may in the future operate may also require certificates of need
under certain circumstances not currently applicable to us, or may impose
standards and other health planning requirements upon us.




No
assurance can be given that we will be able to obtain the required approvals or
certificates of need for additional or expanded treatment facilities or services
in the future, which may restrain our growth. If we are unable to obtain
required regulatory, zoning or other required approvals for renovations and
expansions, our growth may be restrained and our operating results may be
adversely affected.




11


If
the Employee Free Choice Act is adopted, it would be easier for our employees to
obtain union representation and our business could be impacted.




Currently,
we only have one facility represented by a union.  If some, or all of
our workforce were to become unionized and the terms of the collective
bargaining agreements were significantly different from our current compensation
arrangements, it could increase our costs and adversely impact our
business.  The Employee Free Choice Act of 2007 (“EFCA”) was passed in
the U.S. House of Representatives last year.  This bill or a variation
of it could be enacted in the future and could have an adverse impact on our
business.




Our
treatment facilities are sometimes subject to attempts by local or regional
governmental authorities and local area residents to force their closure or
relocation.




Property
owners and local authorities have attempted, and may in the future attempt, to
use or enact zoning ordinances to eliminate our ability to operate a given
treatment facility. Local governmental authorities in some cases also have
attempted to use litigation and the threat of prosecution to force the closure
of certain of our clinics. If any of these attempts were to succeed or if their
frequency were to increase, our revenue would be adversely affected and our
operating results might be harmed. In addition, such actions may require us to
litigate which would increase our costs.




A
shortage of qualified workers could adversely affect our ability to identify,
hire and retain qualified personnel. This could increase our operating costs,
restrain our growth and reduce our revenue.




The
success of our business depends on our ability to identify, hire and retain a
professional team of addiction counselors, nurses, psychiatrists, physicians,
licensed counselors and clinical technicians across our network of treatment
facilities. Competition for skilled employees is intense. For example, there are
currently national shortages of qualified addiction counselors and registered
nurses. The process of locating and recruiting skilled employees with the
qualifications and attributes required to treat those suffering from addiction
and other behavioral health illnesses can be lengthy and competition for these
workers could cause the salaries, wages and benefits we must pay to increase
faster than anticipated. Furthermore, many states require specified staff to
patient ratios for residential and outpatient treatment facilities. If we are
unable to identify, hire and retain sufficient numbers of qualified professional
employees, or to continue to offer competitive salaries and benefits, we may be
unable to staff our facilities with the appropriate personnel or to maintain
required staff ratios and may be required to turn away patients. Certain of our
treatment facilities are located in remote geographical areas, far from
population centers, which increase this risk. These factors could increase our
operating costs, restrain our growth and reduce our revenue.




If
we fail to cultivate new or maintain established relationships with referral
sources, our revenue may decline.




Our
ability to grow or even to maintain our existing level of business depends
significantly on our ability to establish and maintain close working
relationships with physicians, managed care companies, insurance companies,
educational consultants and other referral sources. We do not have binding
contracts or commitments with any of these referral sources. We may not be able
to maintain our existing referral source relationships or develop and maintain
new relationships in existing or new markets. If we lose existing relationships
with our referral sources, the number of people to whom we provide services may
decline, which may adversely affect our revenue. If we fail to develop new
referral relationships, our growth may be restrained.




There
are only two significant suppliers of methadone distributed by our outpatient
treatment facilities. If one or both of these vendors does not supply the
methadone we require, we may face increased costs in our outpatient treatment
division, which may adversely affect our operating results and
profitability.




Although
methadone is a generic drug, there are only two significant national suppliers
of methadone. We currently purchase methadone for dispensation in our clinics
from one. If one of these suppliers were to reduce or curtail production of
methadone, we would need to identify other suppliers of methadone. If we are
unable to do so, our cost to purchase methadone may increase which may adversely
affect our operating results and profitability.




A
decline in the revenues or profitability of our Sierra Tucson facility would
likely have a material adverse effect on our revenues and operating
results.




For 2008,
our Sierra Tucson facility represented approximately 9.8% of our total revenue
and approximately 14.8% of our operating income before corporate and divisional
overhead. Historically, our Sierra Tucson facility has had a high occupancy
rate as well as a favorable average length of stay and price of treatment
which made it our most profitable facility for 2008. As discussed above, we rely
primarily on self payor patients at our Sierra Tucson facility. We have
experienced a significant decrease in demand in other divisions as a result of
the inability of patients and students to pay for our services due to tightening
credit markets and the downturn in the US economy. Should Sierra Tucson’s
revenues or profitability decline as a result of the inability or unwillingness
of patients to pay for the services or for other reasons or its operations
be interrupted, our total revenue and profitability would likely decline. For
example, a terrorist act, significant terrorist threat or other disruption to
air travel may reduce the willingness or ability of Sierra Tucson’s national and
international patient base to travel to the facility or a fire or other casualty
loss could interrupt its operations. These events could negatively affect our
consolidated operating results.




Accidents
or other incidents involving the students at our youth treatment facilities, or
those of our competitors, may adversely affect our revenues and operating
results directly or through negative public perception of the
industry.




Accidents
resulting in physical injuries to our students or staff, or incidents that
attract negative attention to the youth treatment industry generally, such as
those involving death or criminal conduct against, or by a student could result
in regulatory action against us, possible legal claims and lost referrals or
student withdrawals. Similar accidents or incidents at programs operated by our
competitors could negatively impact public perception of the therapeutic
education industry and harm our operations as well. No assurance can be given
that accidents or other incidents at our programs or those of our competitors
will not adversely affect our operations.




Natural
disasters such as hurricanes, earthquakes and floods may adversely affect our
revenues and operating results.




Natural
disasters such as hurricanes, earthquakes and floods may adversely affect our
operations. Such natural disasters may result in physical damage to or
destruction of our programs as well as damage to areas where our patients or
referral sources are based. In 2005, hurricanes resulted in property damage and
additional expense to our Florida facilities. In addition, these facilities
experienced a loss of referrals from areas affected by the hurricanes. Such
natural disasters may lead to decreased census, decreased revenues and higher
operating costs.




We
face significant competition from established providers as well as new
entrants.




We
compete directly with a wide variety of non-profit, government and for-profit
treatment providers, and this competition may intensify in the future.
Non-profit and government providers may be able to offer competitive services at
lower prices, which may adversely affect our revenue in regional markets and
service categories. In addition, many for-profit providers are local,
independent operators with strong established reputations within the surrounding
communities, which may adversely affect our ability to attract a sufficiently
large number of patients in markets where we compete with such providers. Our
youth division competes against a small number of multiple-location providers,
such as Universal Health Services, Second Nature and Three Springs, as well as a
number of independent operators. These providers compete with us not only for
referrals, but also for qualified personnel, and in some cases our personnel
have resigned their positions with us to operate programs of their own. We may
also face increasing competition from new operators which may adversely affect
our revenue and operating results in impacted markets.




12


As
a provider of treatment services, we are subject to claims and legal actions by
patients, students, employees and others, which may increase our costs and harm
our business.




We are
subject to medical malpractice and other lawsuits based on the services we
provide. In addition, treatment facilities and programs that we have acquired,
or may acquire in the future, may have unknown or contingent liabilities,
including liabilities related to care and failure to comply with healthcare laws
and regulations, which could result in large claims, significant defense costs
and interruptions to our business. These liabilities may increase our costs and
harm our business. A successful lawsuit or claim that is not covered by, or is
in excess of, our insurance coverage may increase our costs and reduce our
profitability. Furthermore, we maintain a $0.5 million deductible per claim
under our workers compensation insurance, and an increase in workers
compensation claims or average claim size may also increase our costs and reduce
our profitability. Our insurance coverage may not continue to be available at a
reasonable cost, especially given the significant increase in insurance premiums
generally experienced in the healthcare industry.




The
integration of our information systems may be more costly than we anticipate,
may not be completed on time or the integrated systems may not function
properly.




We are
currently introducing new software to consolidate and integrate critical
information systems used in daily operations, including for claims processing,
billing, financial, intake and other clinical functions. The new software is
also intended to streamline internal controls to comply with the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002. We expect to make additional
capital expenditures related to this plan before it is complete. If this
implementation takes longer or is more expensive than anticipated, or if we fail
to successfully complete this implementation or if the software fails to perform
as expected, our operations may be disrupted and we may not comply with the
requirements of Section 404 of the Sarbanes-Oxley Act. This may increase
our costs, reduce our revenue and harm our business.




We
have a limited history of profitability, have incurred net losses in the past
and may incur substantial net losses in the future.




We began
operations in August 2002, and our predecessor organizations began operations in
September 1995. We recorded net losses in 2002, 2003 and 2006 of
approximately $11.5 million, $1.6 million and $35.5 million,
respectively, primarily as a result of transaction costs and the write-off of
capitalized financing costs. For 2007 and 2008, we recorded a net profit of
approximately $1.5 million and a net loss of $141.9 million
respectively.  We cannot assure that we will operate profitably in the
future. In addition, we may experience significant quarter-to-quarter variations
in operating results.




We
depend on our key management personnel.




Our
senior management team has many years of experience addressing the broad range
of concerns and issues relevant to our business. The loss of existing key
management or the inability to attract, retain and motivate sufficient numbers
of qualified management personnel could have an adverse effect on our business
and our ability to execute our growth strategy.




Funds
managed by Bain Capital Partners, LLC control us and may have conflicts of
interest with us.




Investment
funds managed by Bain Capital Partners, LLC which we refer to as Bain Capital,
indirectly own, through their ownership in our parent company, substantially all
of our capital stock. As a result, Bain Capital has control over our decisions
to enter into any corporate transaction regardless of whether our debt holders
believe that any such transaction is in their own best interests. For example,
Bain Capital could cause us to make acquisitions or pay dividends that increase
the amount of indebtedness that is secured or that is senior to our senior
subordinated notes or to sell assets.




Additionally,
Bain Capital is in the business of making investments in companies and may from
time to time acquire and hold interests in businesses that compete directly or
indirectly with us. Bain Capital may also pursue acquisition opportunities that
may be complementary to our business and, as a result, those acquisition
opportunities may not be available to us. So long as investment funds associated
with or designated by Bain Capital continue to indirectly own a significant
amount of the outstanding shares of our common stock, even if such amount is
less than 50%, Bain Capital will continue to be able to strongly influence or
effectively control our decisions.




13


Regulatory
Risks




If
we fail to comply with extensive laws and government regulations, we could
suffer penalties, become ineligible to participate in reimbursement programs, be
the subject of federal and state investigations or be required to make
significant changes to our operations, which may reduce our revenues, increase
our costs and harm our business.




Healthcare
service providers are required to comply with extensive and complex laws and
regulations at the federal, state and local government levels relating to, among
other things:




•
            licensure,
      certification and accreditation;




•
            handling
      of controlled substances;




•
            adequacy
      of care, quality of services, qualifications of professional and support
      personnel;




•
            referrals
      of patients and relationships with
physicians;




•
            inducements
      to use healthcare services that are paid for by governmental
      agencies;




•
            billings
      for reimbursement from commercial and government
  payors;




•
            confidentiality,
      maintenance and security issues associated with health-related information
      and medical records;




•
            physical
      plant planning, construction of new facilities and expansion of existing
      facilities;




•
            state
      and local land use and zoning requirements;
and




•
            corporate
      practice of medicine and fee
splitting.




Failure
to comply with these laws and regulations could result in the imposition of
significant penalties or require us to change our operations, which may harm our
business and operating results. Both federal and state government agencies as
well as commercial payors have heightened and coordinated civil and criminal
enforcement efforts as part of numerous ongoing investigations of healthcare
organizations.




The 2006
Work Plan issued by the OIG includes among the areas that the agency will target
for investigation in 2006 a number of services we offer, including Outpatient
Alcoholism Services and Freestanding Inpatient Alcoholism Providers. Any
investigations of us or our executives or managers could result in significant
liabilities or penalties, including possible exclusion from the Medicare or
Medicaid programs, as well as adverse publicity.




The
following is a discussion of some of the risks relating to specific laws and
regulations that apply to us.




Licensure,
accreditation and certification




In order
to operate our business, our treatment facilities for substance abuse must
obtain the required state and federal licenses and certification as well as in
most cases accreditation from JCAHO or CARF. In addition, such licensure,
certification and accreditation are required to receive reimbursement from most
commercial and government payors. If our programs are unable to maintain such
licensure, certification and accreditation, our revenue may decline, our growth
may be limited and our business may be harmed.




Handling
of controlled substances




All of
our facilities that handle and dispense controlled substances must comply with
especially strict federal and state regulations regarding such controlled
substances. The potential for theft or diversion of such controlled substances
distributed at our facilities for illegal uses has led the federal government as
well as a number of states and localities to adopt stringent regulations not
applicable to many other types of healthcare providers. Compliance with these
regulations is expensive and these costs may increase in the
future.




Referrals
of patients and relationships with physicians




The
federal anti-kickback statute and related regulations prohibit certain offers,
payments or receipt of remuneration in return for referring patients covered by
Medicaid or other federal healthcare programs or purchasing, leasing, ordering
or arranging for or recommending any services, good, item or facility for which
payment may be made under a federal healthcare program. Federal physician
self-referral legislation, known as the Stark Law, generally prohibits a
physician from ordering certain services reimbursable by a federal healthcare
program from an entity with which the physician has a financial relationship,
unless an exception applies, and prohibits the entity from billing for certain
services rendered pursuant to any prohibited referrals. Several of the states in
which we operate have laws that are similar to the federal Stark Law and
anti-kickback laws and that reach services paid for by private payors and
individual patients.




If we
fail to comply with the federal anti-kickback statute and its safe harbors, the
Stark Law or other related state and federal laws and regulations, we could be
subjected to criminal and civil penalties, we could lose our license to operate,
and our residential and outpatient treatment programs could be excluded from
participation in Medicaid and other federal and state healthcare programs and
could be required to repay governmental payors amounts received by our
residential and outpatient treatment programs for services resulting from
prohibited referrals. In lieu of repayment, the OIG may impose civil monetary
assessments of three times the amount of each item or service wrongfully
claimed. In addition, if we do not operate our treatment facilities in
accordance with applicable law, our residential and outpatient treatment
programs may lose their licenses or the ability to participate in third-party
reimbursement programs.




14


Coding
and billing rules




If we
fail to comply with federal and state documentation, coding and billing rules,
we could be subject to criminal and civil penalties, loss of licenses, loss of
payment for past services and exclusion from Medicaid programs, which could harm
us. Approximately 16.4% of our revenue for 2008 consisted of payments from
Medicaid and other government programs. In billing for our services to
government payors, we must follow complex documentation, coding and billing
rules. Failure to follow these rules could result in potential criminal or civil
liability under the federal False Claims Act, under which extensive financial
penalties can be imposed. It could further result in criminal liability under
various federal and state criminal statutes, or in our being ineligible for
reimbursement under Medicaid programs. The rules are complex and we submit a
large number of claims per year for Medicaid and other federal program payments
and we cannot assure you that governmental investigators, commercial insurers or
whistleblowers will not challenge our practices or that there will be no errors.
Any such challenges or errors could result in increased costs and have an
adverse effect on our profitability, and could result in a portion of our
recorded revenue being uncollectible or subject to repayment to governmental
payors.




Privacy
and security requirements




There are
numerous federal and state regulations such as the federal regulations issued
under the Drug Abuse Prevention, Treatment and Rehabilitation Act of 1979 and
the Health Insurance Portability and Accountability Act of 1996, or HIPAA,
addressing patient information privacy and security concerns. Compliance with
these regulations can be costly and requires substantial management time and
resources. Our failure to comply with HIPAA privacy or security requirements
could lead to civil and criminal penalties and our business could be
harmed.




In
addition, many states impose similar, and in some cases more restrictive,
requirements. For example, some states impose laws governing the use and
disclosure of health information pertaining to mental health and/or substance
abuse issues that are more stringent than the rules that apply to healthcare
information generally. As public attention is drawn to the issues of the privacy
and security of medical information, states may revise or expand their laws
concerning the use and disclosure of health information, or may adopt new laws
addressing these subjects. Failure to comply with these laws could expose us to
criminal and civil liability, as well as requiring us to restructure certain of
our operations.




Changes
in state and federal regulation and in the regulatory environment, as well as
different or new interpretations of existing regulations, could adversely affect
our operations and profitability.




Since our
treatment programs and operations are regulated at federal, state and local
levels, we could be affected by different regulatory changes in different
regional markets. Increases in the costs of regulatory compliance and the risks
of noncompliance may increase our operating costs, and we may not be able to
recover these increased costs, which may adversely affect our results of
operations and profitability.




Also,
because many of the current laws and regulations are relatively new, we do not
always have the benefit of significant regulatory or judicial interpretation of
these laws and regulations. In the future, different interpretations or
enforcement of these laws and regulations could subject our current or past
practices to allegations of impropriety or illegality or could require us to
make changes in our treatment facilities, equipment, personnel, services or
capital expenditure programs. A determination that we have violated these laws,
or the public announcement that we are being investigated for possible
violations of these laws, could adversely affect our business and operating
results.




ITEM 1B. Unresolved Staff Comments




Not
applicable.




15


ITEM 2. Properties




Recovery
division. The following tables list our residential treatment facilities,
as of December 31, 2008.




Program
            City
            State
            Owned / LeasedInpatient
      Residential Treatment FacilitiesAzure
      Acres
            Sebastopol
            CA
            OwnedBayside
      Marin (with multiple licensed treatment programs)
            San
      Rafael
            CA
            LeasedBrandywine
            Kennett
      Square
            PA
            OwnedBurkwood
            Hudson
            WI
            OwnedCamp
      Recovery Centers
            Santa
      Cruz
            CA
            OwnedGalax
      Treatment Center
            Galax
            VA
            OwnedKeystone
      Treatment Center
            Canton
            SD
            OwnedLife
      Healing Center
            Santa
      Fe
            NM
            OwnedNew
      Life Lodge
            Burns
            TN
            OwnedSierra
      Tucson
            Tucson
            AZ
            LeasedSober
      Living by the Sea (with multiple licensed treatment programs and sober
      living homes)
            Newport Beach, Riverside
            CA
            LeasedStarlite
      Recovery Center
            Center
      Point
            TX
            OwnedTwelve
      Oaks
            Navarre
            FL
            OwnedWilmington
      Treatment Center
            Wilmington
            NC
            OwnedWhite
      Deer Run (WDR)—Allenwood
            Allenwood
            PA
            OwnedWDR—Blue
      Mountain
            Blue
      Mountain
            PA
            OwnedWDR—Lancaster
            Lancaster
            PA
            LeasedWDR—Lebanon
            Lebanon
            PA
            LeasedWDR—Johnstown
      New Directions
            Johnstown
            PA
            OwnedWDR—Johnstown
      Renewal Center
            Johnstown
            PA
            LeasedWDR—Torrance
            Torrance
            PA
            LeasedWDR—Williamsburg
            Williamburg
            PA
            LeasedWDR—Williamsport
            Williamsport
            PA
            OwnedWDR—York/Adams
            York
            PA
            LeasedWellness
      Resource Center
            Boca
      Raton
            FL
            LeasedOutpatient
      Treatment FacilitiesAzure
            Sacramento
            CA
            LeasedCamp
      San Jose
            San
      Jose
            CA
            LeasedCamp
      Santa Cruz
            Santa
      Cruz
            CA
            LeasedKeystone—Sioux
      Falls
            Sioux
      Falls
            SD
            LeasedSober
      Living—Costa Mesa
            Costa
      Mesa
            CA
            LeasedWilmington—Myrtle
      Beach
            Myrtle
      Beach
            NC
            LeasedWilmington—Wilmington
            Wilmington
            NC
            LeasedWilmington—Shallotte
            Shallotte
            NC
            LeasedWDR—Allentown
            Allentown
            PA
            LeasedWDR—Altoona
            Altoona
            PA
            LeasedWDR—Erie
            Erie
            PA
            LeasedWDR—Harrisburg
            Harrisburg
            PA
            LeasedWDR—Lewisburg
            Lewisburg
            PA
            LeasedWDR—New
      Castle
            New
      Castle
            PA
            LeasedWDR—Pittsburgh
            Pittsburgh
            PA
            Leased




16


Recovery
division.The following table lists our comprehensive treatment clinics
by state and number, as of December 31, 2008. (1)




State
            
            Clinics
            
            Owned
      / LeasedCalifornia
            
            
            12
            
            All clinics leasedColorado
            
            
            1
            
            LeasedDelaware
            
            
            2
            
            All
      clinics leasedGeorgia
            
            
            1
            
            LeasedIndiana
            
            
            5
            
            All
      clinics leasedKansas
            
            
            2
            
            LeasedLouisiana
            
            
            1
            
            LeasedMaryland
            
            
            3
            
            All
      clinics leasedNew
      Mexico
            
            
            1
            
            LeasedNorth
      Carolina
            
            
            3
            
            All
      clinics leasedOregon
            
            
            5
            
            All
      clinics leasedPennsylvania
            
            
            2
            
            All
      clinics leasedTennessee
            
            
            1
            
            LeasedTexas
            
            
            1
            
            LeasedVirginia
            
            
            3
            
            All
      clinics leasedWashington
            
            
            4
            
            All
      clinics leasedWest
      Virginia
            
            
            7
            
            All leased except for one owned propertyWisconsin
            
            
            5
            
            All
      clinics leasedTotal
            
            
            59




(1)
            As
      of December 31, 2008, we operate four comprehensive treatment clinics that
      are held for sale and included in discontinued operations. These
      facilities are located in Texas, New Mexico, Colorado, and
      Kansas.  All are leased
facilities.




Youth
division. The
following table lists our youth treatment programs as of December 31,
2008.




Program
            City
            State
            Owned / LeasedResidential
      Treatment CentersIsland
      View
            Syracuse
            UT
            LeasedAspen
      Ranch
            Loa
            UT
            LeasedAspen
      Institute for Behavioral Assessment
            Loa
            UT
            LeasedYouth
      Care / Pine Ridge Academy
            Draper
            UT
            LeasedSunhawk
      Academy
            St
      George
            UT
            LeasedTurn-About
      Ranch
            Escalante
            UT
            LeasedTherapeutic
      Boarding SchoolsMount
      Bachelor Academy
            Prineville
            OR
            LeasedAcademy
      at Swift River
            Cummington
            MA
            LeasedOakley
      School
            Oakley
            UT
            LeasedCopper
      Canyon Academy
            Rimrock
            AZ
            LeasedBromley
      Brook School
            Manchester
            VT
            LeasedNew
      Leaf Academy
            Bend
            OR
            LeasedNew
      Leaf Academy of North Carolina
            Hendersonville
            NC
            LeasedStone
      Mountain School
            Black Mountain
            NC
            LeasedNorthStar
      Center
            Bend
            OR
            LeasedSpecial
      Learning NeedsCedars
      Academy
            Bridgeville
            DE
            LeasedCamp
      Huntington
            High
      Falls
            NY
            LeasedTalisman
      Summer Camps
            Henderson
            NC
            Leased




17





Program
            City
            State
            Owned / LeasedOutdoor
      ProgramsFour
      Circles Recovery Center
            Horseshoe
            NC
            LeasedSUWS
      of the Carolinas
            Old
      Fort
            NC
            LeasedPassages
      to Recovery
            Loa
            UT
            LeasedAdirondack
      Leadership Expeditions
            Saranac Lake
            NY
            LeasedLone
      Star Expeditions
            Groveton
            TX
            LeasedAspen
      Achievement Academy
            Loa
            UT
            LeasedPhoenix
      Outdoor
            Leicester
            NC
            LeasedSage
      Walk—The Wilderness Program
            Redmond
            OR
            LeasedSUWS
      Seasons
            Old
      Fort
            NC
            LeasedOutback
      Therapeutic Expeditions
            Loa
            UT
            Leased




Healthy living
division. The
following table lists our healthy living programs as of December 31,
2008.




Program
            City
            State
            Owned / LeasedEating
      Disorders FacilitiesMontecatini
            Carlsbad
            CA
            OwnedCenter
      For Hope of the Sierras
            Reno
            NV
            LeasedCarolina
      House
            Durham
            NC
            OwnedResidential
      Weight Management ProgramStructure
      House
            Durham
            NC
            OwnedWeight
      Management CampsAcademy
      of the Sierras NC
            Brevard
            NC
            LeasedAcademy
      of the Sierras CA
            Reedley
            CA
            LeasedCamp
      Wellspring / Wellspring New York
            Paul
      Smiths
            NY
            LeasedWellspring
      Adventure Camp
            Canton
            NC
            LeasedWellspring
      Family Camp
            Village of Pinehurst
            NC
            LeasedWellspring
      Hawaii
            Captain
      Cook
            HI
            LeasedWellspring
      Texas
            San
      Marcos
            TX
            LeasedWellspring
      UK
            Penrith,
      Cumbria
            UK
            LeasedWestern
      Wellspring Adventure Camp CA
            N/A
            CA
            Leased




Our
properties are owned and or leased by our recovery division, youth division and
healthy living division. All owned property is subject to a security interest
under our senior secured credit facility. We believe that our existing
properties are in good condition and are suitable for the conduct of our
business.




ITEM 3. Legal Proceedings




We are
subject to various claims and legal actions that arise in the ordinary course of
our business. In the opinion of management, we are not currently a party to any
proceeding that could have a material adverse effect on our financial condition
or results of operations.




ITEM 4. Submission of Matters to a Vote of Security
Holders




None.




18


PART
II




ITEM 5. Market for the Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities




There is
no established public trading market for our common stock. We are a wholly-owned
subsidiary of CRC Health Group, Inc. which holds all of our outstanding common
stock.




ITEM 6. Selected Financial Data




On
February 6, 2006, investment funds managed by Bain Capital Partners, LLC
(“Bain Capital”) acquired CRC Health Group, Inc. for a total cash consideration
of approximately $742.3 million (including acquisition and financing
transactions related fees and expenses of $28.5 million). As a result of the
acquisition, Bain Capital received control of the Company. We refer to our
acquisition by Bain Capital and the related financings as the
“Transactions.”




Set forth
below is selected historical consolidated financial information at the dates and
for the periods indicated. The summary historical financial information as of
and for the years ended December 31, 2008, 2007, 2006, 2005 and 2004 has been
derived from our audited financial statements. The date of the purchase of our
company by investment funds managed by Bain Capital was February 6, 2006,
but for accounting purposes and to coincide with our normal financial accounting
closing dates, we have utilized February 1, 2006, as the effective date of
the close of the transaction. As a result, we have reported operating results
and financial position for all periods presented prior to February 1, 2006
as those of the Predecessor Company (“Predecessor”) and for all periods from and
after February 1, 2006 as those of the Successor Company (“Successor”) due
to the resulting change in the basis of accounting. For the purpose of
presenting a comparison of our 2006 results to all other years, we have
presented the year ended December 31, 2006 as the mathematical addition of
our operating results for January 2006 to the operating results of the eleven
months ended December 31, 2006. This approach is not consistent with
generally accepted accounting principles and may yield results that are not
strictly comparable on a period-to-period basis primarily due to the impact of
purchase accounting entries recorded as a result of the Transactions. For
purposes of this management’s discussion and analysis of financial condition and
results of operations, however, management believes that it is the most
meaningful way to present our results of operations for the year ended
December 31, 2006.




The
selected historical financial information should be read in conjunction with
Item 7, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and our consolidated financial statements and the
accompanying notes thereto included in Item 8, “Financial Statements and
Supplementary Data,” which are included elsewhere in this Annual Report on Form
10-K. Historical results are not necessarily indicative of results to be
expected for future periods.


Successor
              
              
              PredecessorYear
      Ended
              
              
              Year
      Ended
              
              
              Combined
      Year Ended
              
              
              Eleven Months
      Ended
              
              
              One Month
      Ended
              
              
              Year Ended
      December 31,December 31,
              
              
              December 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006
              
              
              2006
              
              
              2005
              
              
              2004(Dollars
      in thousands)Statement
      of Income Data:Net
      revenue
              
              $
              469,994
              
              
              $
              447,615
              
              
              $
              265,366
              
              
              $
              245,888
              
              
              $
              19,478
              
              
              $
              204,834
              
              
              $
              161,295Operating
      expenses(1)
              
              $
              550,855
              
              
              $
              382,755
              
              
              $
              256,795
              
              
              $
              198,902
              
              
              $
              57,893
              
              
              $
              156,762
              
              
              $
              124,997Operating
      (loss) income
              
              $
              (80,861
              )
              
              $
              64,860
              
              
              $
              8,571
              
              
              $
              46,986
              
              
              $
              (38,415
              )
              
              $
              48,072
              
              
              $
              36,298Interest
      expense, net
              
              
              (54,122
              )
              
              
              (60,262
              )
              
              
              (43,844
              )
              
              
              (41,338
              )
              
              
              (2,506
              )
              
              
              (19,744
              )
              
              
              (13,967
              )Gain
      on debt repurchase and other financing costs(3)
              
              
              8,086
              
              
              
              —
              
              
              
              (10,655
              )
              
              
              —
              
              
              
              (10,655
              )
              
              
              (2,185
              )
              
              
              —Other
      income (expense) (2)
              
              
              1
              
              
              
              (1,770
              )
              
              
              167
              
              
              
              112
              
              
              
              55
              
              
              
              2,232
              
              
              
              —(Loss)
      income from continuing operations before income taxes
              
              $
              (126,896
              )
              
              $
              2,828
              
              
              $
              (45,761
              )
              
              $
              5,760
              
              
              $
              (51,521
              )
              
              $
              28,375
              
              
              $
              22,331Income
      tax (benefit) expense
              
              
              (5,866
              )
              
              
              2,446
              
              
              
              (9,723
              )
              
              
              2,751
              
              
              
              (12,474
              )
              
              
              10,724
              
              
              
              9,684Minority
      interest in (loss) income of a subsidiary
              
              
              (153
              )
              
              
              189
              
              
              
              (38
              )
              
              
              (38
              )
              
              
              —
              
              
              
              —
              
              
              
              —Net
      (loss) income from continuing operations
              
              $
              (120,877
              )
              
              $
              193
              
              
              $
              (36,000
              )
              
              $
              3,047
              
              
              $
              (39,047
              )
              
              $
              17,651
              
              
              $
              12,647(Loss)
      income from discontinued operations, net of tax
              
              
              (21,028
              )
              
              
              1,271
              
              
              
              529
              
              
              
              475
              
              
              
              54
              
              
              
              350
              
              
              
              (1,190
              )Net
      (loss) income
              
              $
              (141,905
              )
              
              $
              1,464
              
              
              $
              (35,471
              )
              
              $
              3,522
              
              
              $
              (38,993
              )
              
              $
              18,001
              
              
              $
              11,457




19


Successor
              
              
              PredecessorYear
      Ended
              
              
              Year
      Ended
              
              
              Eleven Months
      Ended
              
              
              One
      Month Ended
              
              Year
      Ended December 31,December 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006
              
              
              2005
              
              
              2004(Dollars
      in thousands)Balance
      Sheet Data (at period end):Working
      capital(4)
              
              $
              (14,468
              )
              
              $
              (56,539
              )
              
              $
              (18,730
              )
              
              
              
              
              $
              2,284
              
              
              $
              12,493Property
      and equipment, net
              
              
              129,728
              
              
              
              122,937
              
              
              
              94,976
              
              
              
              
              
              
              49,074
              
              
              
              27,809Cash
      and cash equivalents
              
              
              2,540
              
              
              
              5,118
              
              
              
              4,206
              
              
              
              
              
              
              5,077
              
              
              
              10,563Total
      assets
              
              
              1,169,175
              
              
              
              1,322,291
              
              
              
              1,288,788
              
              
              
              
              
              
              424,154
              
              
              
              262,695Total
      debt, including capital leases
              
              
              653,152
              
              
              
              648,367
              
              
              
              626,528
              
              
              
              
              
              
              259,931
              
              
              
              123,343Mandatorily
      redeemable stock
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              
              
              
              115,625
              
              
              
              115,418Shareholders’
      equity (deficit)
              
              
              303,222
              
              
              
              445,749
              
              
              
              437,174
              
              
              
              
              
              
              11,985
              
              
              
              (5,812
              )Other
      Financial Data:Cash
      paid for interest
              
              $
              51,758
              
              
              $
              56,418
              
              
              $
              29,118
              
              
              $
              1,336
              
              
              $
              18,101
              
              
              $
              12,572Depreciation
      and amortization
              
              
              22,362
              
              
              
              21,705
              
              
              
              10,148
              
              
              
              360
              
              
              
              3,850
              
              
              
              3,699Capital
      expenditures
              
              
              25,279
              
              
              
              30,159
              
              
              
              14,189
              
              
              
              411
              
              
              
              11,480
              
              
              
              7,329Cash
      flows from operating activities
              
              
              24,176
              
              
              
              56,420
              
              
              
              (4,486
              )
              
              
              1,201
              
              
              
              23,902
              
              
              
              25,584Cash
      flows from investing activities
              
              
              (39,645
              )
              
              
              (70,947
              )
              
              
              (746,811
              )
              
              
              (315
              )
              
              
              (159,228
              )
              
              
              (22,741
              )Cash
      flows from financing activities
              
              
              12,891
              
              
              
              15,439
              
              
              
              755,080
              
              
              
              (5,540
              )
              
              
              129,840
              
              
              
              599





(1)
            Corporate/other
      expense for the one month ended January 31, 2006 and the twelve
      months ended December 31, 2006 includes $43.7 million in acquisition
      related costs incurred in connection with the purchase of our company by
      Bain Capital. During the year ended December 31, 2008, the Company
      recognized $142.2 million in non-cash, goodwill
      impairment charges related to its youth
      division.


(2)
            Other
      income (expense) for the year ended December 31, 2005 includes $0.6
      million of gain recognized upon termination of our swap agreement in
      connection with the acquisition of Sierra Tucson and refinancing our debt
      in May 2005, $1.6 million of increase in fair value of our new swap on
      December 31, 2005, $0.1 million of gain recognized on the fair value
      of our interest rate swap during the year ended December 31,
      2006,  $1.8 million decrease in fair value of our swap on
      December 31, 2007, and $8.1 million in gains from debt retirement during
      the year ended December 31, 2008.


(3)
            Represents
      the write-off of unamortized capitalized financing costs of $2.2 million
      in the year ended December 31, 2005 and $7.2 million during the one
      month ended January 31, 2006, and $3.5 million during the one month
      ended January 31, 2006, related to the write-off of unamortized debt
      discount.  For the year ended December 31, 2008, this amount
      represents a gain of $8.1 million from the repurchase of senior
      subordinated notes with a par amount of $22.7
  million.


(4)
            We
      define working capital as our current assets (including cash and cash
      equivalents) minus our current liabilities, which includes the current
      portion of long-term debt and accrued interest
  thereon.




20


ITEM 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations




The
following discussion should be read in conjunction with the Consolidated
Financial Statements and the related notes that appear elsewhere in this Annual
Report.




Unless
the context otherwise requires, in this management’s discussion and analysis of
financial condition and results of operations, the terms “our company,” “we,”
“us,” “the Company” and “our” refer (i) for periods prior to the
consummation of the Transactions, to CRC Health Group, Inc. and its consolidated
subsidiaries and (ii) for periods following the consummation of the
Transactions, to CRC Health Corporation and its consolidated subsidiaries
following the mergers described below under “The Transactions.”




OVERVIEW




We are a
leading provider of substance abuse treatment services and youth treatment
services in the United States. We also provide treatment services for other
addiction diseases and behavioral disorders such as eating disorders. We deliver our services
through our three divisions, the recovery division, the youth division and the
healthy living division. Our recovery division provides our substance abuse and
behavioral disorder treatment services through our residential treatment
facilities and outpatient treatment clinics. Our youth division provides
educational programs for underachieving young people through residential schools
and wilderness programs. Our healthy living division provides treatment services
through its adolescent and adult weight management programs and its eating
disorder facilities.




We have
three operating segments: recovery division, youth division, and healthy living
division. However, for the purposes of segment reporting and discussion, we
combine healthy living division with our corporate/other reporting segment
because this segment does not currently meet the quantitative thresholds for
separate disclosure (see Note 20 to the consolidated financial statements). As
of December 31, 2008, our recovery division, which currently operates 30
inpatient and 70 outpatient facilities in 24 states, provides treatment services
to patients suffering from chronic addiction related diseases and related
behavioral disorders. As of December 31, 2008, our recovery division treated
approximately 28,000 patients per day. As of December 31, 2008, our youth
division, which currently operates 28 programs in 10 states and enrolled over
4,000 students during 2008, provides a wide variety of therapeutic and
educational programs for underachieving young people. Our healthy living
division, which operates 16 facilities in 8 states and one facility in the
United Kingdom, provides eating disorder and weight management services. Other
activities classified as “corporate/other” represent revenue and expenses
associated with eGetgoing, an online internet treatment option, and general and
administrative expenses (i.e., expenses associated with our corporate offices in
Cupertino, California, which provides management, financial, human resource and
information system support) and stock option-based compensation expense that are
not allocated to the segments.




We report
in three segments: recovery division, youth division, and corporate/other. The
recovery division includes all inpatient and outpatient drug and alcohol
treatment programs consistent with our long term objective of being a full
spectrum chemical dependency provider that integrates the best of the various
treatment modalities into a seamless web of service. The youth division includes
residential and outdoor programs. Healthy living division is included in
corporate/other because it does not meet the quantitative threshold for separate
segment reporting. Our healthy living division includes eating disorders and
adult weight management facilities (formerly included in the residential
treatment division) and adolescent weight management programs (formerly included
in the youth treatment division).




The
Transactions




On
February 6, 2006, investment funds managed by Bain Capital Partners, LLC
(“Bain Capital”) acquired CRC Health Group, Inc. for a total cash consideration
of approximately $742.3 million (including acquisition and financing
transactions related fees and expenses of $28.5 million). As a result of the
acquisition, Bain Capital received control of our company. We refer to our
acquisition by Bain Capital and the related financings as the
“Transactions.”




Basis
of Presentation




The
accompanying financial data has been prepared by us pursuant to the rules and
regulations of the U.S. Securities and Exchange Commission (“SEC”) and is in
conformity with U.S. generally accepted accounting principles (“GAAP”). Our
fiscal year end is December 31. Unless otherwise stated, all years and
dates refer to our fiscal year.




Management
is responsible for the fair presentation of the accompanying consolidated
financial statements, prepared in accordance with GAAP, and has full
responsibility for their integrity and accuracy. In the opinion of management,
the accompanying consolidated financial statements contain all adjustments
necessary to present fairly our consolidated balance sheet, statement of
operations, statement of cash flows and statement of stockholders’ equity for
all periods presented.




Principles of
consolidation. The consolidated financial statements include the
accounts of the Company and our wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.




As a
result of the Transactions on February 6, 2006, a new basis of accounting
was adopted in fiscal 2006. However, for accounting purposes and to coincide
with our normal financial account closing dates, we have utilized
February 1, 2006 as the effective date of the Transactions. For the purpose
of presenting a comparison of our 2006 operating results to 2005, we have
presented the year ended December 31, 2006 as the mathematical addition of
our operating results for January 2006 (“Predecessor Company”) to the operating
results of the eleven months ended December 31, 2006 (“Successor Company”).
This approach is not consistent with GAAP and may yield results that are not
strictly comparable on a period-to-period basis primarily due to the impact of
purchase accounting entries recorded as a result of the Transactions. For
purposes of this management’s discussion and analysis of financial condition and
results of operations, however, management believes that it is the most
meaningful way to present our results of operations for the year ended December
31, 2006.




Discontinued Operations We
have reflected certain facility closures and disposals as discontinued
operations in our consolidated income statements for all periods presented and
as discontinued operations, facility exits for 2008.




21


Acquisitions




2008
Acquisitions




During
the third quarter of 2008, we closed two acquisitions and paid approximately
$11.6 million in cash. The acquisitions are intended to provide expansion of the
Company’s services within the respective corresponding markets of the acquired
facilities in the United States.




2007
Acquisitions




Our 2007
acquisitions reflect our strategic plan for expanding the services offered by
our three operating divisions. We completed four acquisitions in 2007 and paid
approximately $32.9 million in cash. The acquisitions are intended to expand our
range of services into new geographic regions in the United States.




2006
Acquisitions




In
November 2006, we acquired all of the outstanding capital stock of Aspen
Education Group (“Aspen”) for approximately $279.5 million in total purchase
consideration, including acquisition related expenses of $1.3 million. We
refer to this acquisition as the Aspen Acquisition. We believe Aspen Education
Group is the largest for-profit provider of therapeutic educational programs to
troubled youth. At November 2006, Aspen Education Group operated 32 facilities
in 12 states and one facility in the U.K. and its offerings include boarding
schools, experiential outdoor education programs weight loss residential high
schools and summer weight loss camps. The Aspen Acquisition is intended to
diversify our business into other service offerings and geographic regions. This
acquisition will enhances our overall self payor mix revenue and offers multiple
revenue and cost synergies.




In 2006,
in addition to the Aspen Acquisition, we completed five other acquisitions for
which we paid approximately $36.6 million in cash, including acquisition related
expenses. These acquisitions are intended to expand our range of treatment
programs into new geographic regions in the United States. In addition, they
contribute to the continued building of a nationwide network of specialized
behavioral care services.




EXECUTIVE
SUMMARY




We
generate revenue by providing substance abuse treatment services and youth
treatment services in the United States. We also generate revenue by providing
treatment services for other specialized behavioral disorders. Revenue is
recognized when rehabilitation and treatment services are provided to a patient.
Client service revenue is reported at the estimated net realizable amounts from
clients, third-party payors and others for services rendered. Revenue under
third-party payor agreements is subject to audit and retroactive adjustment.
Provisions for estimated third-party payor settlements are provided for in the
period the related services are rendered and adjusted in future periods as final
settlements are determined. Revenue for educational services provided to youth
consists primarily of tuition, enrollment fees, alumni services and ancillary
charges. Tuition revenue and ancillary charges are recognized based on
contracted monthly/daily rates as services are rendered. The enrollment fees for
service contracts that are charged upfront are deferred and recognized over the
average student length of stay, approximately ten months. Alumni fees revenue
represents non-refundable upfront fees for post graduation services and these
fees are deferred and recognized systematically over the contracted life, which
is twelve months. During the years ended December 31, 2008 and December 31,
2007, we generated 83.6% and 85.8% of our net revenue from non-governmental
sources, including 68.5% and 71.1% from self payors, respectively, and 15.1% and
14.7% from commercial payors, respectively. Substantially all of our government
program net revenue was received from multiple counties and states under
Medicaid and similar programs.




During
the twelve months ended December 31, 2008 our consolidated same-facility net
revenue decreased by 2.9% compared to an increase of 7.3% for the same period in
2007.  “Same-facility” refers to the comparison of each facility owned
during 2007 with the results for the comparable period in 2008 and
2006.




Our
operating expenses include salaries and benefits, supplies, facilities and other
operating costs, provision for doubtful accounts, depreciation and amortization
and acquisition related costs. Operating expenses for our recovery and youth
divisions exclude corporate level general and administrative costs (i.e.,
expenses associated with our corporate offices in Cupertino, California, which
provide management, financial, human resources and information systems support),
stock option-based compensation expense and expenses associated with
eGetgoing.




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES




General




The
accompanying discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with GAAP. The preparation of these financial statements
requires us to make estimates, assumptions and judgments that affect the
reported amounts of assets, liabilities, net revenue and expenses. We have based
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Our senior management has
reviewed our critical accounting policies and their application in the
preparation of our financial statements and related disclosures and discussed
the development, selection and disclosure of significant estimates. To the
extent that actual results differ from those estimates, our future results of
operations may be affected. The following describe the estimates considered most
critical to our operating performance and involve the most subjective and
complex assumptions and assessments.




Revenue
Recognition




Revenue
is recognized when rehabilitation and treatment services are provided to a
patient. Client service revenue is reported at the estimated net realizable
amounts from clients, third-party payors and others for services rendered.
Revenue under third-party payor agreements is subject to audit and retroactive
adjustment. Provisions for estimated third-party payor settlements are provided
for in the period the related services are rendered and adjusted in future
periods as final settlements are determined. Revenue for educational services
provided to youth consists primarily of tuition, enrollment fees, alumni
services and ancillary charges. Tuition revenue and ancillary charges are
recognized based on contracted monthly/daily rates as services are rendered. The
enrollment fees for service contracts that are charged upfront are deferred and
recognized over the average student length of stay, approximately ten months.
Alumni fees revenue represents non-refundable upfront fees for post graduation
services and these fees are deferred and recognized systematically over the
contracted life, which is twelve months.




Allowance
for Doubtful Accounts




We
maintain allowances for doubtful accounts for estimated losses resulting from
non-payment of accounts receivables from patients and students and third party
billings and notes receivable from payors. We record bad debt expense monthly
based on an analysis of age and collectability of outstanding accounts
receivable that reflects our historical experience. In evaluating the
collectability of accounts receivable, we consider a number of factors,
including the age of the accounts, changes in collection trends, the composition
of patient accounts by payor, the status of ongoing disputes with third party
payors and general industry conditions. If the financial condition of our payors
were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required. If, at December 31, 2008, we
were to recognize an increase of 10% in the allowance for our doubtful accounts,
our total current assets would decrease by $0.5 million, or 0.9%.




22


Evaluation
of Goodwill and Purchased Intangible Assets




Goodwill
is measured as the excess of the cost of acquisition over sum of the amounts
assigned to tangible and identifiable intangible assets acquired less
liabilities assumed. We review goodwill and indefinite-lived intangible assets
for impairment at least annually at the beginning of the fourth quarter or
whenever changes in events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable in accordance with Statement
of Financial Accounting Standards No. 142,Goodwill and Other Intangible
Assets (“SFAS 142”). Applying the provisions of SFAS 142, we perform a
two-step impairment test for goodwill. In the first step, we compare the fair
value of each reporting unit to its carrying value. Our reporting units are
consistent with our reportable segments. We determine the fair value of the
reporting units based on weighted values of discounted cash flow, market value
based on guideline public companies, and market value based on guideline
transactions method. If the fair value of the reporting unit exceeds the
carrying value of the net assets assigned to the reporting unit, goodwill is not
impaired and no further testing is performed. If the carrying value of the net
assets assigned to the reporting unit exceeds the fair value of the reporting
unit, then we must perform the second step of the impairment test in order to
determine the implied fair value of goodwill. In the second step, the fair value
of the reporting unit (determined in the first step) is allocated to all the
assets and liabilities of that unit as if the reporting unit had been acquired
in a business combination and the fair value of the reporting unit was the
purchase price. The fair value of goodwill resulting from the purchase price
allocation is the implied fair value of goodwill. The implied fair value of
goodwill is compared to the carrying amount to determine how much goodwill is
impaired. If the implied fair value of goodwill is less than the carrying amount
of goodwill, then an impairment loss is recorded for the difference. SFAS 142
also requires that the fair value of the indefinite-lived intangible assets be
estimated and compared to the carrying value annually. We estimate the fair
value of these intangible assets using the income approach at the beginning of
the fourth quarter or more frequently if impairment indicators exist. We
recognize an impairment loss when the fair value of the indefinite-lived
purchased intangible asset is less than the carrying value. Determining the fair
value of a reporting unit or an indefinite-lived intangible asset is judgmental
in nature and involves the use of significant estimates and assumptions,
including revenue growth rates and operating margins. We base our fair value
estimates on assumptions we believe are reasonable.





The most significant types of assumptions employed by us in determining the fair
value of goodwill and indefinite-lived intangible assets are as
follows:





o
            Future
      cash flows are based on a five-year projection of revenue and expenses,
      capital expenditures, and working capital requirements.  These
      projections were prepared by management, excluding
      acquisitions.


o
            After
      the projection period, we utilized a perpetuity growth rate for revenue
      and margins for the purpose of discounted cash
  flow.


o
            We
      selected comparable companies for use in estimating EBITDA
      multiples.


o
            We
      selected a discount rate based upon a weighted average cost of capital
      utilizing after-tax cost of debt and cost of common
  equity.





These assumptions and estimates will likely differ from future actual results
and it is possible that these differences could be material.  In addition,
future events could cause us to conclude that impairment indicators exist and
that asset values are impaired.  If the actual results differ from our
estimates and assumptions, we may be required to record impairment on goodwill
and indefinite-lived purchased intangible assets.




For the year ended December 31, 2008, we recorded $142.8 million in impairment
charges related to the carrying value of goodwill and $10.9 million for
impairment charges related to indefinite-lived purchased intangible assets,
respectively.  We did not record any impairment charges relating to
the carrying value of goodwill or indefinite-lived purchased intangible assets
during the years ended December 31, 2007 and 2006.




Intangibles
assets with finite lives are amortized on a straight-line basis over the
estimated economic useful lives of the assets, ranging from one to 20 years. We
review the intangible assets with finite lives for impairment whenever events or
changes in circumstances indicate the carrying value of the asset may not be
recoverable in accordance with Statement of Financial Accounting Standards
No. 144,Accounting for
the Impairment or Disposal of Long-Lived Assets.For the Year ended
December 31, 2008, we recorded impairment charges of $16.9 million related to
the carrying value of finite lived intangible assets.  We did not
record any impairment charges relating to the carrying value of finite lived
intangible assets during the years ended December 31, 2007 and
2006.




Income
Taxes




As part
of our process for preparing our consolidated financial statements, management
is required to compute income taxes in each of the jurisdictions in which we
operate. This process involves estimating the current tax benefit or expense of
future deductible and taxable temporary differences. The future deductible and
taxable temporary differences are recorded as deferred tax assets and
liabilities which are components of our balance sheet. Management then assesses
our ability to realize the deferred tax assets based on reversals of deferred
tax liabilities and, if necessary, estimates of future taxable income. A
valuation allowance for deferred tax assets is established when we believe that
it is more likely than not that the deferred tax asset will not be realized.
Management must also assess the impact of our acquisitions on the realization of
deferred tax assets subject to a valuation allowance to determine if all or a
portion of the valuation allowance will be offset by reversing taxable
differences or future taxable income of the acquired entity. To the extent the
valuation allowance can be reversed due to the estimated future taxable income
of an acquired entity, then our valuation allowance is reduced accordingly as an
adjustment to purchase price.




In June
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”).
This statement clarifies the criteria that an individual tax position must
satisfy for some or all of the benefits of that position to be recognized in a
company’s financial statements.




The
Company adopted FIN 48 on January 1, 2007. The effect of adopting FIN 48 was a
decrease in tax reserves and an increase of $2.2 million to the January 1, 2007
retained earnings balance. Upon adoption, the liability for income taxes
associated with uncertain tax positions at January 1, 2007 was $1.9
million.   At December 31, 2008, the Company’s total unrecognized
tax benefits were approximately $1.1 million exclusive of interest and
penalties. Included in this amount is approximately $1.0 million of unrecognized
tax benefits that, if recognized, would favorably affect the effective tax rate
in a future period.




Stock
Options




We
adopted the provisions of Statement of Financial Standards No. 123 (revised
2004),Share-Based
Payment (“SFAS 123(R)”) using the prospective transition method on
January 1, 2006 and therefore have not restated results for prior periods.
During 2008 and 2007, we recognized stock option compensation expense of
approximately $6.0 million and $3.9 million respectively. During the eleven
months ended December 31, 2006, we recorded stock option-based compensation
expense of $3.5 million in accordance with SFAS 123(R). On February 6,
2006, after the consummation of the Transactions, our parent company (CRC Health
Group, Inc, the “Group”) adopted the 2006 Management Incentive Plan (the
“Management Plan”) and the 2006 Executive Incentive Plan (the “Executive Plan”)
and in September 2007, the Group adopted the 2007 Incentive Plan (the “2007
Plan”), collectively referenced as the “Plans”. The current period stock-based
compensation recognized is based on the amortization of the fair value of stock
options in accordance with SFAS 123(R).




Valuation
of our stock option expense is done in accordance with SFAS 123(R). Our
valuation approach for our stock options utilizes the Black Scholes model as
well as a binomial model. For the binomial model, we utilized statistical
simulation, known as the “Monte Carlo” simulation, to derive the calculations
and results for valuation of our stock options. Additionally, individual stock
options awards comprise several groups or “tranches” of options with differing
vesting conditions which in effect are each valued separately using either the
Black Scholes model or the binomial model. The assumptions utilized in our
models are based on historical data, related to grantee stock option activity,
macroeconomic data, as well independent analysis performed by experts in the
field.




The
assumptions used in calculating the fair value of share-based payment awards
represent management’s best estimates, but these estimates involve inherent
uncertainties and the application of management judgment. As a result, if
factors change and we use different assumptions, our stock-based compensation
expense could be materially different in the future.




23


Restructuring
and Asset Impairment




We
initiated the FY08 Plan in the fourth quarter of 2008 which included certain
facility exit activities as well as workforce reductions, and other activities.
Workforce reductions included the elimination of approximately 100 full time
positions.  The workforce reduction portion of the Plan is expected to
be substantially completed by the end of the first quarter in
2009.  Restructuring activities are also expected to be substantially
completed by the end of 2009 but we will continue to make lease payments on some
of our excess facility space for approximately the next five
years.  Activities related to our restructuring plan are accounted for
in accordance with SFAS 146 and SFAS 144.   As of December 31,
2008, the Company had recognized approximately $3.3 million in liabilities
related to obligations under the FY08 Plan and the Company expects to incur
additional expenses of approximately $0.7 million for future actions under the
FY08 Plan.





Discontinued
Operations




In the fourth quarter ended December
31, 2008, the Company executed an asset sale agreement for the salefour
clinics within its recovery division.  Additionally, in the
fourth quarter of 2008, the Company announced its intention to sell, dispose, or
cease operations of additional facilities across each of its business
divisions.  At December 31, 2008, the Company had classified a total
of ten facilities as discontinued operations.   Facilities which
have been closed, held for sale, or otherwise disposed as of December 31, 2008
are accounted in accordance with SFAS 146 and SFAS 144 and they are reflected as
discontinued operations in the Company’s consolidated income statements for all
periods presented and as discontinued operations, facility exits on the
consolidated balance sheets for 2008.




RECENT
ACCOUNTING PRONOUNCEMENTS




See
Note 2 to our consolidated financial statements in Part II,
Item 8 for a description of recent accounting pronouncements, including our
expected adoption dates and estimated effects on our results of operations,
financial condition, and cash flows.




RESULTS
OF OPERATIONS




The
following table presents our results of operations by reportable segments for
the years ended December 31, 2008, 2007 and 2006 (dollars in thousands, except
for percentages; percentages are calculated as percentage of total net
revenue).




Years
      Ended December 31,Statement
      of Income Data:
            
            2008
            
            
            %
            
            
            2007
            
            
            %
            
            
            2006(1)
            
            
            %Net
      revenue:Recovery
      division
            
            $
            309,545
            
            
            
            65.9
            %
            
            $
            286,097
            
            
            
            63.9
            %
            
            $
            247,256
            
            
            
            93.2
            %Youth
      division
            
            
            132,726
            
            
            
            28.2
            %
            
            
            138,983
            
            
            
            31.1
            %
            
            
            13,261
            
            
            
            5.0
            %Corporate / other(2)
            
            
            27,723
            
            
            
            5.9
            %
            
            
            22,535
            
            
            
            5.0
            %
            
            
            4,849
            
            
            
            1.8
            %Total
      net revenue
            
            
            469,994
            
            
            
            100.0
            %
            
            
            447,615
            
            
            
            100.0
            %
            
            
            265,366
            
            
            
            100.0
            %Operating
      expenses:Recovery
      division
            
            
            224,748
            
            
            
            47.8
            %
            
            
            206,262
            
            
            
            46.1
            %
            
            
            175,420
            
            
            
            66.1
            %Youth
      division
            
            
            269,602
            
            
            
            57.4
            %
            
            
            130,155
            
            
            
            29.1
            %
            
            
            14,531
            
            
            
            5.5
            %Corporate / other(2)
            
            
            56,505
            
            
            
            12.0
            %
            
            
            46,338
            
            
            
            10.3
            %
            
            
            66,844
            
            
            
            25.2
            %Total
      operating expenses
            
            
            550,855
            
            
            
            117.2
            
            
            
            382,755
            
            
            
            85.5
            %
            
            
            256,795
            
            
            
            96.8
            %Operating
      income (loss):Recovery
      division
            
            
            84,797
            
            
            
            18.0
            %
            
            
            79,835
            
            
            
            17.8
            %
            
            
            71,836
            
            
            
            27.1
            %Youth
      division
            
            
            (136,876
            )
            
            
            (29.1
            )%
            
            
            8,828
            
            
            
            2.0
            %
            
            
            (1,270
            )
            
            
            (0.5
            )%Corporate / other(2)
            
            
            (28,782
            )
            
            
            (6.1
            )%
            
            
            (23,803
            )
            
            
            (5.3
            )%
            
            
            (61,995
            )
            
            
            (23.4
            )%Operating
      (loss) income
            
            
            (80,861
            )
            
            
            (17.2
            )%
            
            
            64,860
            
            
            
            14.5
            %
            
            
            8,571
            
            
            
            3.2
            %Interest
      expense, net
            
            
            (54,122
            )
            
            
            
            
            
            
            (60,262
            )
            
            
            
            
            
            
            (43,844
            )Gain
      on debt repurchase and other financing costs
            
            
            8,086
            
            
            
            
            
            
            
            —
            
            
            
            
            
            
            
            (10,655
            )Other  income
      (expense)
            
            
            1
            
            
            
            
            
            
            
            (1,770
            )
            
            
            
            
            
            
            167(Loss)
      income from continuing operations before income taxes
            
            
            (126,896
            )
            
            
            
            
            
            
            2,828
            
            
            
            
            
            
            
            (45,761
            )Income
      tax (benefit) expense
            
            
            (5,866
            )
            
            
            
            
            
            
            2,446
            
            
            
            
            
            
            
            (9,723
            )Minority
      interest in (loss) income of a subsidiary
            
            
            (153
            )
            
            
            
            
            
            
            189
            
            
            
            
            
            
            
            (38
            )(Loss)
      income from continuing operations
            
            
            (120,877
            )
            
            
            
            
            
            
            193
            
            
            
            
            
            
            
            (36,000
            )(Loss)
      income from discontinued operations, net of tax
            
            
            (21,028
            )
            
            
            
            
            
            
            1,271
            
            
            
            
            
            
            
            529Net
      (loss) income
            
            $
            (141,905
            )
            
            
            
            
            
            $
            1,464
            
            
            
            
            
            
            $
            (35,471
            )




(1)
              For
      the year ended December 31, 2006, operating results is the
      mathematical addition of the operating results for January 2006,
      ("Predecessor Company") to the operating results of the eleven months
      ended December 31, 2006 ("Predecessor
Company").


(2)
            Includes
      our healthy living division




Continuing
Operations, Year Ended December 31, 2008 Compared to Continuing Operations Year
Ended December 31, 2007




Consolidated net revenue increased $22.4 million, or 5.0%, to $470.0 million in
2008 from $447.6 million in 2007. Of the
total net revenue increase, the recovery division contributed
$23.4 million, representing 8.2% growth for the division, with the
remaining net revenue growth driven by an increase of $5.2 million, or 23.0% in
corporate/other.  Total net revenue growth was partially offset by a
net revenue decrease in the youth division of $6.3 million, or 4.5%.
The $6.3 million decrease in youth division revenue, is attributable to the
outdoor camps that was offset by a $0.1 million revenue increases from
residential boarding schools. There has been a significant lessening in demand
for youth division services as a result of declining economic conditions and the
inability of families to access the credit markets and student loan markets to
fund the tuition. Our youth division same–facility net revenue decreased $12.0
million, or 8.7%, due primarily to a $10.1 million decrease in same facility
residential boarding schools and a $1.9 million decrease in outdoor
camps.  Revenue growth in the recovery division was primarily due to
same-facility growth of $16.4 million, or 5.8%. Of the remaining $7.0 million
net revenue increase in recovery division, $5.0 million increase was
due to acquisitions completed in the quarters ended September 30, 2007 and
2008 respectively. The remaining $2.0 million increase was due to increases in
census as well as start-ups.  The $5.2 million net revenue increase in
corporate/other is primarily attributed to $5.1 million net revenue growth in
eating disorders.




24


Consolidated
operating expenses increased $168.1 million, or 43.9%, to $550.9 million
from $382.8 million in the same period of 2007. Of the $168.1 million
increase in operating expenses, the recovery division incurred an increase of
$18.5 million, or 9.0%, corporate/other incurred an increase of
$10.2 million, or 22.0%, and our youth division incurred a
net increase of $139.4 million, or 107.1%. The increase in
operations expenses within the youth division was primarily due to a
$142.2 million non-cash impairment charge for goodwill partially
offset by reductions in general and administrative
expenses.  Excluding the combined $142.2 million in youth
division impairment charges, youth division operating expenses decreased $2.8
million or 2.2% compared to the same period in the prior year. For our recovery
division, same-facility increase in operating expenses was $15.1 million, or
8.4% of which $4.5 million was related to non-cash asset impairment charges for
one of our residential facilities.  Recovery division
acquisition-related increases of $4.7 million, and startup related increases of
approximately $0.7 million contributed to the increases in operating expenses
year over year. Corporate/other same-facility growth in operating expenses
increased $0.7 million or 4.3% year over year for the twelve months ended
December 31, 2008.





Our consolidated operating margin was -17.2% in 2008 compared to 14.5% in
2007.  Excluding youth division non-cash impairment charges of $142.2
million, consolidated operating margin was 13.0% for the twelve months
ended December 31, 2008.   On a same-facility basis, our consolidated
operating margin decreased to 28.5% in 2008 compared to 31.7% in
2007.   Recovery division same-facility operating margin
decreased to 34.9% in 2008 compared to 36.4 % in 2007. Youth division
same-facility operating margin decreased to 15.5% in 2008 compared to 24.0% in
2007. The significant decrease in our youth division operating margin is
primarily due to the $12.0 million decrease of revenue in the youth division as
a result of a significant lessening in demand for youth division services as a
result of declining economic conditions and the inability of families to access
the credit markets and student loan markets to fund the tuition. Corporate/other
same-facility operating margin decreased to 16.2% in 2008 compared to 20.0% in
2007 primarily due to increases in operating expenses at a greater rate than
revenue.




For the
twelve months ended December 31, 2008, consolidated net income decreased by
$143.4 million compared to the same period in 2007. The decrease in net income
in 2008 is primarily attributable to a $142.2 million non-cash goodwill
impairment charge within the youth division as well as by reduced revenues
in the youth division offset by net revenue increases in the recovery and in
corporate/other divisions. Other income increased by $1.8 million in 2008 due to
decreased losses related to interest rate swaps. Additionally, the Company
recognized a $8.1 million gain due to debt retirement activities. Income tax
expense decreased $8.3 million in 2008 resulting in an income tax benefit of
$5.9 million in 2008 compared to a $2.4 million income tax expense in 2007. The
effective tax rate in 2008 was 4.6% compared to 65.5% in 2007. The effective tax
rate decrease relates primarily to decreases in the state tax effective rates
due to the benefit of 2008 tax rates of deductible losses.




Continuing
Operations Year Ended December 31, 2007 Compared to Continuing Operations
Year Ended December 31, 2006




Consolidated
net revenue increased $182.2 million, or 68.7%, to $447.6 million in 2007 from
$265.4 million in 2006. Of the $182.2 million revenue increase, the youth
division contributed $125.7 million and the remaining net revenue growth was
driven by net revenue increases of $38.8 million or 15.7%, and $17.7 million in
our recovery division and corporate/other, respectively. Of the $38.8 million
and $17.7 million net revenue increases in the recovery division and
corporate/other, respectively, $23.6 million and $16.5 million, respectively,
was contributed by acquisitions and start-ups that were not fully included in
both 2006 and 2007 results of operations. In addition, same-facility revenue
growth in recovery division and corporate/other of $14.9 million, or 6.1%, and
$3.3 million, or 106.5%, respectively, contributed to the net revenue growth.
Our same-facility recovery division growth was driven in part by a 5.4% increase
in patient census and a 0.9% increase in revenue per patient day. Our
same-facility corporate/other growth was driven in part by a 43.2% increase in
patient census and a 2.8% decrease in revenue per patient day.




Consolidated
operating expenses increased $126.0 million, or 49.1%, to $382.8 million in 2007
from $256.8 million in 2006. Of the $126.0 million increase in operating
expenses, the youth division incurred $115.6 million in expenses that are mainly
attributable to salaries and wages and other general operating expenses
associated with the Aspen Acquisition. The operating expense changes in our
recovery division and corporate/other was an increase of $30.8 million, or
17.6%, and a decrease of $20.5 million, or 30.7%, respectively. The increase in
recovery division operating expenses was mainly attributable to $18.0 million in
expenses related to the 2006 and 2007 acquisitions and start-ups and partially
attributable to a $10.2 million, or 6.7%, same-facility increase in operating
expenses. The decrease in corporate/other operating expenses was mainly
attributable to $13.6 million in expenses related to the 2006 and 2007
acquisitions and start-ups partially offset by a $2.5 million, or 92.6 %,
same-facility increase in operating expenses due to same facility increases in
salaries and other operating costs.




Our
consolidated operating margins increased to 14.5% in 2007 from 3.2% in 2006, due
primarily to the reduction from 2006 to 2007 in one-time expenses that had
occurred in 2006. In 2006, related to the Transactions, we incurred one-time
expenses of $43.7 million. Partially offsetting this improvement in margins, our
consolidated margins in 2007 were negatively impacted relative to 2006 due to
our youth division (acquired in 2006 as part of Aspen Education Group) which has
lower margins than our other divisions. Our operating margins in our recovery
division decreased to 27.9% in 2007 from 29.1% in 2006. On a same-facility
basis, our consolidated operating margin decreased to 37.3% in 2007, as compared
to 37.8% in 2006.




Consolidated
net income increased by $36.9 million in 2007 compared to 2006. The increase in
net income in 2007 was primarily attributable to the increase in operating
income of $10.1 million driven by the acquisition of Aspen in the youth
division, an increase in operating income of $8.0 million in our recovery
division and an increase in operating income of $38.2 million in the
corporate/other division. The increase in operating income in the
corporate/other division was primarily due to a decrease in transaction related
costs compared to 2006. Other income decreased by $1.9 million in 2007 due
primarily to a loss on an interest rate swap agreement of $1.8 million. Income
tax expense increased $12.2 million in 2007 resulting in an expense of $2.4
million in 2007 compared to a $9.7 million benefit in 2006. The effective tax
rate in 2007 was 65.5% compared to 20.9% in 2006. The effective tax rate
increase relates primarily to an increase in the state tax effective rate due to
separate filing states that have taxable income and to the benefit of 2006 tax
rate of deductible acquisition costs.




25


Restructuring
Activities and Discontinued Operations





During
the year ended on December 31, 2008, based on a combination of factors, 
including significantlyl lower demand for the services of our youth division as
a result of the challenging economic environment and a detailed review of 
our financial results, we initiated restructuring activities under the FY08
Plan. Restructuring activities under the FY08 Plan include facility exits and
consolidations as well as the elimination of approximately 100 full-time
positions. Both facility consolidations and workforce reductions under the FY08
plan are expected to be completed by the end of the first quarter of
2009.  Under the FY08 plan, the Company has classified  ten
facilities as discontinued operations, and  it expects to consolidate the
youth division corporate headquarters into other locations.   All
activities under the FY08 Plan  are expected to be substantially
completed by the end of 2009.





As
of December 31, 2008, in accordance with the provisions of SFAS 146, the Company
had incurred approximately $3.3 million in future liabilities under the FY08
Plan which relate primarily to severance benefits, facility exit costs, and
other costs.  Remaining restructuring actions under the FY08 Plan may
include further division consolidations and facility exit actions in future
periods based on management’s periodic review of its operations. The
Company anticipates recording additional charges related to its workforce and
facility reductions over future periods. While the Company expects to incur
additional expenses of approximately $0.7 million related to future actions
under the FY08 Plan, the total amount and timing of these charges will depend
upon the nature, timing and extent of these future actions.





Under
the provisions of SFAS 142 and SFAS 144 as well as a result of its restructuring
activities under the FY08 Plan, we performed impairment testing across its
divisions. Upon completion of its impairment testing, we recorded non-cash
impairment charges of $10.9 million for intangible assets not subject to
amortization, $16.9 million for intangible assets subject to amortization,
$142.8 million for goodwill and $3.0 million for asset impairment on property
and equipment.   Impairment charges resulting
from our impairment testing and attributable to those facilities
recognized as discontinued operations totaled $26.3 million and $0.6 million for
asset impairments and goodwill impairment respectively for the twelve months
ended December 31, 2008.





Charges
related to impairment of intangible assets and fixed assets are included
in our consolidated statement of operations under both asset impairments
and results from discontinued operations. Charges related to impairment of
goodwill are included in the Company’s consolidated statement of operations
under both impairment of goodwill and in results from discontinued operations.
Both asset impairment and goodwill impairment charges represent our best
estimate of the impairment losses for the year ended December 31,
2008.  We did not have restructuring activities in 2007 or in
2006.





LIQUIDITY
AND CAPITAL RESOURCES




Our
principal sources of liquidity for operating activities are payments from self
pay patients, students, commercial payors and government programs for treatment
services. We receive most of our cash from self payors in advance or upon
completion of treatment. Cash revenue from commercial payors and government
programs is typically received upon the collection of accounts receivable, which
are generated upon delivery of treatment services.




Working
Capital




Working
capital is defined as total current assets, including cash and cash equivalents,
less total current liabilities, including the current portion of long-term
debt.




We had
negative working capital of $14.5 million at December 31, 2008, compared to
negative working capital of $56.5 million at December 31, 2007. The
increase in working capital from December 31, 2007 to December 31, 2008 was
primarily attributable to changes in the Company's intent regarding
repayment of approximately $61.5 million of current debt related to its
revolving line of credit.  Additionally the reclassification of all
long term assets of discontinued operations to short term assets of discontinued
operations further contributed to the decrease in negative working
capital.




Sources
and Uses of Cash




Years
      Ended December 31,2008
              
              
              2007
              
              
              2006(In
      thousands)Net
      cash provided by (used in) operating activities
              
              $
              24,176
              
              
              $
              56,420
              
              
              $
              (3,285
              )Net
      cash (used in) investing activities
              
              
              (39,645
              )
              
              
              (70,947
              )
              
              
              (747,126
              )Net
      cash provided by financing activities
              
              
              12,891
              
              
              
              15,439
              
              
              
              749,540Net
      (decrease) increase in cash
              
              $
              (2,578
              )
              
              $
              912
              
              
              $
              (871
              )


Year
Ended December 31, 2008 Compared to Year Ended December 31,
2007




Cash
provided from operating activities was $24.2 million in 2008 and $56.4 million
in 2007. The $32.2 million decrease in cash flows from operating activities in
fiscal 2008 is due to net losses incurred by the Company for 2008 compared to
2007 reduced by non-cash impairments, other non-cash items, and changes in
assets and liabilities.  Additionally, a decrease of $11.7 million in
income tax receivable further contributed to the decrease in cash from operating
activities.




Cash used
in investing activities was $39.6 million in 2008, compared to $70.9 million in
2007. The decrease in the cash used for investing activities during 2008 was due
to decreases in acquisition related activity compared to 2007 as well as to a
decrease of $4.9 million in purchases of property and equipment and a decrease
of  $5.7 million in payments made under earnout
arrangements.




Cash
provided by financing activities was $12.9 million in 2008, compared to $15.4
million in 2007.  The decrease of $2.5 million was due primarily to a
net increase in borrowings of $11.4 million offset by debt retirement of $13.6
million and capital contributed to Parent of $0.6 million.




26


Year
Ended December 31, 2007 Compared to Year Ended December 31,
2006




Cash
provided from operating activities was $56.4 million in 2007, compared to cash
used in operating activities of $3.3 million in 2006. The increase in cash flows
from operating activities in fiscal 2007 is due to decreases in transaction
related costs compared to fiscal 2006. Additionally, the cash used in operating
activities for the year ended December 31, 2006 was primarily due to the
net loss in the January 2006 Predecessor Company statement of operations
resulting from the payment of non-recurring acquisition related expenses
incurred in connection with the Transactions.




Cash used
in investing activities was $70.9 million in 2007, compared to $747.1 million in
2006. The decrease in the cash used for investing activities during 2007 was due
to reductions in acquisition activity in 2007 compared to 2006. In 2006, we made
payments to former shareholders in connection with the Transactions and also
acquired Aspen Education Group.




Cash
provided by financing activities was $15.4 million in 2007, compared to $749.5
million in 2006. The decrease of $734.1 million was due primarily to
non-recurring fiscal 2006 activity, which was primarily an equity contribution
of $330.7 million from investment funds managed by Bain Capital Partners in
connection with the Transactions and Aspen Acquisition, and an equity
contribution of $99.5 million from the Group resulting from proceeds net of
financing costs of a PIK loan in connection with the Aspen Acquisition. In
addition, the net increase in net issuances of long-term debt of $354.8 million
in 2006 contributed to the overall decrease.




Financing
and Liquidity




We intend
to fund our ongoing operations through cash generated by operations, funds
available under the revolving portion of our senior secured credit facility and
existing cash and cash equivalents. As of December 31, 2008, senior secured
credit facility was comprised of a $409.8 million senior secured term loan
facility and a $100.0 million revolving credit facility. At December 31, 2008,
$61.5 million of the revolving line of credit facility was outstanding and
classified on our balance sheet as long term debt. In addition, the revolving
line of credit facility had approximately $8.1 million of letters of credit
issued and outstanding. As part of the Transactions, we issued $200.0 million in
aggregate principal amount of senior subordinated notes of which $177.3 million,
excluding discount,  remained outstanding at December 31, 2008. We
anticipate that cash generated by current operations, the remaining funds
available under the revolving portion of our senior secured credit facility and
existing cash and cash equivalents will be sufficient to meet working capital
requirements, service our debt and finance capital expenditures over the next 12
months.




In
addition, we may expand existing recovery and youth treatment facilities and
build or acquire new facilities. Management continually assesses our capital
needs and may seek additional financing, including debt or equity, to fund
potential acquisitions or for other corporate purposes. We had historically and
currently intend to make payments to reduce borrowing under the revolving line
of credit from operating cash flow. In addition, we expect that future
financings will serve not only to partially fund acquisitions but also to repay
all or part of any outstanding revolving line of credit balances then
outstanding. In negotiating such financing, there can be no assurance that we
will be able to raise additional capital on terms satisfactory to us. Failure to
obtain additional financing on reasonable terms could have a negative effect on
our plans to acquire additional treatment facilities. We expect to spend
approximately $6.3 million for maintenance related expenditures and an
additional $5.7 million over the next 12 months for expansion projects,
systems upgrades and other related initiatives.




Under the
terms of our borrowing arrangements, we are required to comply with various
covenants, including the maintenance of certain financial ratios. As of December
31, 2008, we were in compliance with all such covenants. A breach of these could
result in a default under our credit facilities and in our being unable to
borrow additional amounts under our revolving credit facility. If an event of
default occurs, the lenders could elect to declare all amounts borrowed under
our credit facilities to be immediately due and payable and the lenders under
our term loans and revolving credit facility could proceed against the
collateral securing the indebtedness.




Effective
April 16, 2007, we entered into an amendment to our senior secured credit
agreement dated November 17, 2006. Per the agreement, the term loan
interest is payable quarterly at 90 day LIBOR plus 2.25% per annum;
provided that on and after such time our corporate rating from Moody’s is at
least B1 then the interest is payable quarterly at 90 day LIBOR plus 2% per
annum.




27


Funding
Commitments




In
connection with an acquisition which closed in October 2005, we were obligated
to make certain payments in the amount of up to $1.8 million in the first year
and up to $2.0 million in the second year if the entity satisfied certain
performance milestones. In the third quarter of 2006, the entity met the first
year performance milestones and as a result we made a payment of $1.8 million in
the fourth quarter of 2006. During the third quarter of 2007, the entity had
achieved the second year performance milestones and additional goodwill and
liability of $2.0 million, respectively, was recognized. The $2.0 million
related to performance milestones was paid in the fourth quarter of 2007. We
have no subsequent performance payment liability or obligation related to the
October 2005 acquisition.




Certain
agreements acquired in the Aspen Acquisition contain contingent earnout
provisions that provide for additional payments in the amount of up to $6.0
million if the acquisitions meet performance milestones as specified in the
agreements. During the year ended December 31, 2008, the Company made payments
of $2.9 million related to earn out provisions. The Company is not subject to
any future earn-out repayment commitments as of December 31, 2008.




Off
Balance Sheet Obligations




As of
December 31, 2008, we did not have any off-balance sheet obligations other than
$8.1 million of letters of credit.




Obligations
and Commitments




The
following table sets forth our contractual obligations as of December 31, 2008
(dollars in millions):




Total
              
              
              Less Than
      1 Year
              
              
              1-3 Years
              
              
              4-5 Years
              
              
              ThereafterTerm loans, including
      interest(i)
              
              $
              473.4
              
              
              $
              19.4
              
              
              $
              38.3
              
              
              $
              415.7
              
              
              $
              —Senior subordinated notes,
      including interest(ii)
              
              
              320.2
              
              
              
              19.1
              
              
              
              38.1
              
              
              
              38.1
              
              
              
              224.9Revolving line of credit,
      including interest(iii)
              
              
              66.9
              
              
              
              1.8
              
              
              
              3.6
              
              
              
              61.5
              
              
              
              —Seller
      notes, including interest
              
              
              8.6
              
              
              
              2.8
              
              
              
              5.2
              
              
              
              0.6
              
              
              
              —Operating
      leases
              
              
              126.8
              
              
              
              18.6
              
              
              
              28.1
              
              
              
              19.4
              
              
              
              60.7Consulting
      agreements
              
              
              0.6
              
              
              
              0.3
              
              
              
              0.3
              
              
              
              —
              
              
              
              —Liability
      for income taxes associated with uncertain tax positions
              
              
              1.1
              
              
              
              0.4
              
              
              
              0.7
              
              
              
              —
              
              
              
              —Total
      obligations
              
              $
              997.6
              
              
              $
              62.4
              
              
              $
              114.3
              
              
              $
              535.3
              
              
              $
              285.6





(i)
            Interest
      rate is calculated using published three month LIBOR at December 31, 2008,
      plus 2.25%, which equals 3.675%.


(ii)
            Stated
      interest rate of 10.75% per the
indenture.


(iii)
            Interest
      rate is calculated using published one month LIBOR at December 31, 2008,
      plus 2.50%, which equals 2.94%.




ITEM 7A. Quantitative and Qualitative Disclosure about Market
Risk




Interest
rate risk




We are
subject to interest rate risk in connection with our long-term debt. Our
principal interest rate exposure relates to the term loans outstanding under our
amended and restated senior secured credit facility. As of December 31, 2008 we
have $409.8 million in term loans outstanding, bearing interest at variable
rates. A hypothetical quarter point increase or decrease in market interest
rates compared to the interest rates at December 31, 2008 would result in a $1.0
million change in annual interest expense on our term loans. We also have a
revolving credit facility, which provides for borrowings of up to $100.0
million, which bears interest at variable rates. Assuming the revolving line of
credit is fully drawn, each quarter point change in interest rates compared to
the interest rates at December 31, 2008 would result in an immaterial change in
the annual interest expense on our revolving credit facility. In conjunction
with our term loans, we entered into an interest rate swap agreement on
February 28, 2006 in the amount of $115.0 million as provided under our
credit agreement and retained in our amended and restated credit agreement to
exchange floating for fixed interest rate payments to reduce interest rate
volatility. The effective date of the swap agreement was March 31, 2006 and
has a maturity date of March 31, 2011. At December 31, 2008, the
outstanding amount of this interest rate swap was $60.0 million.  On
June 30, 2008, as provided for in the Credit Agreement and retained in the
Amended and Restated Credit Agreement and Amendment No. 2, the Company entered
into an interest rate swap agreement to provide for interest rate protection for
an aggregate notional amount of $200.0 million. The effective date of the
agreement is June 30, 2008 and has a maturity date of July 1,
2011.  At December 31, 2008, the outstanding amount of this interest
rate swap was $200 million.




28


ITEM 8. Financial Statements and Supplementary
Data




TABLE
OF CONTENTS




Report of Independent Registered Public Accounting
      Firm
            30Consolidated Balance Sheets as of December 31, 2008
      (Successor) and 2007 (Successor)
            31Consolidated Statements of Operations for the years ended
      December 31, 2008 (Successor) and 2007 (Successor), the eleven- month
      period ended December 31, 2006 (Successor) and the one-month period
      ended January 31, 2006 (Predecessor)
            32Consolidated Statements of Mandatorily Redeemable
      Stock and Stockholder’s Equity for the years ended December 31, 2008
      (Successor) and 2007 (Successor), the eleven-month period ended
      December 31, 2006 (Successor) and the one-month period ended
      January 31, 2006 (Predecessor)
            33Consolidated Statements of Cash Flows for the years ended
      December 31, 2008 (Successor) and 2007 (Successor), the eleven- month
      period ended December 31, 2006 (Successor), the one-month period
      ended January 31, 2006 (Predecessor)
            35Notes to Consolidated Financial
    Statements
            37




29


REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING
FIRM




To the
Board of Directors and Stockholders of


CRC
Health Corporation:







We have
audited the accompanying consolidated balance sheets of CRC Health Corporation
and subsidiaries, (the “Company”), (a wholly owned subsidiary of CRC Health
Group, Inc.) as of December 31, 2008 (Successor) and 2007 (Successor), and the
related consolidated statements of operations, mandatorily redeemable stock and
stockholder’s equity (deficit), and cash flows for the years ended December 31,
2008 (Successor) and 2007 (Successor), the eleven-month period ended
December 31, 2006 (Successor), and the one-month period ended
January 31, 2006 (Predecessor). These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these 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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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, such consolidated financial statements present fairly, in all material
respects, the financial position of CRC Health Corporation and subsidiaries as
of December 31, 2008 (Successor) and 2007 (Successor), and the results of their
operations and their cash flows for the years ended December 31, 2008
(Successor), and 2007 (Successor),  the eleven-month period ended
December 31, 2006 (Successor), and the one-month period ended
January 31, 2006 (Predecessor) in conformity with accounting principles
generally accepted in the United States of America.




As
discussed in Note 2 to the consolidated financial statements, on January 1,
2007, the Company adopted Financial Accounting Standards Board Interpretation
No. 48, Accounting for
Uncertainties in Income Taxes – an interpretation of FASB Statement No.
109.




/s/    DELOITTE &
TOUCHE LLP




San
Francisco, California


March 25,
2009








30


CRC
HEALTH CORPORATION




CONSOLIDATED BALANCE SHEETS


(In
thousands, except share amounts)





December 31,
            
            
            December 31,2008
            
            
            2007(Successor)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            2,540
            
            
            $
            5,118Accounts
      receivable, net of allowance for doubtful accounts of $5,409 in 2008 and
      $6,901 in 2007
            
            
            30,826
            
            
            
            31,910Prepaid
      expenses
            
            
            7,703
            
            
            
            7,544Other
      current assets
            
            
            1,618
            
            
            
            2,120Income
      taxes receivable
            
            
            —
            
            
            
            193Deferred
      income taxes
            
            
            4,029
            
            
            
            6,599Current
      assets of discontinued operations, facility exits
            
            
            14,125
            
            
            
            —Total
      current assets
            
            
            60,841
            
            
            
            53,484PROPERTY
      AND EQUIPMENT—Net
            
            
            129,728
            
            
            
            122,937GOODWILL
            
            
            604,078
            
            
            
            730,684INTANGIBLE
      ASSETS—Net
            
            
            354,463
            
            
            
            390,388OTHER
      ASSETS
            
            
            20,065
            
            
            
            24,798TOTAL
      ASSETS
            
            $
            1,169,175
            
            
            $
            1,322,291LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            $
            6,165
            
            
            $
            7,014Accrued
      liabilities
            
            
            29,061
            
            
            
            37,582Income
      taxes payable
            
            
            1,201
            
            
            
            —Current
      portion of long-term debt
            
            
            6,522
            
            
            
            35,603Other
      current liabilities
            
            
            31,657
            
            
            
            29,824Current
      liabilities of discontinued operations, facility exits
            
            
            703
            
            
            
            —Total
      current liabilities
            
            
            75,309
            
            
            
            110,023LONG-TERM
      DEBT—Less current portion
            
            
            646,630
            
            
            
            612,764OTHER
      LONG-TERM LIABILITIES
            
            
            7,553
            
            
            
            7,514OTHER
      LONG-TERM LIABILITIES OF DISCONTINUED OPERATIONS, FACILITY
      EXITS
            
            
            1,909
            
            
            
            —DEFERRED
      INCOME TAXES
            
            
            134,331
            
            
            
            145,867Total
      liabilities
            
            
            865,732
            
            
            
            876,168COMMITMENTS
      AND CONTINGENCIES (Note 12)MINORITY
      INTEREST
            
            
            221
            
            
            
            374STOCKHOLDER’S
      EQUITY:Common
      stock, $0.001 par value—1,000 shares authorized; 1,000 shares issued and
      outstanding
            
            
            —
            
            
            
            —Additional
      paid-in capital
            
            
            444,275
            
            
            
            438,608Accumulated
      (deficit) retained earnings
            
            
            (134,764
            )
            
            
            7,141Accumulated
      other comprehensive (loss)
            
            
            (6,289
            )
            
            
            —Total
      stockholder’s equity
            
            
            303,222
            
            
            
            445,749TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
            
            $
            1,169,175
            
            
            $
            1,322,291






See notes
to consolidated financial statements.





31











CRC
HEALTH CORPORATION




CONSOLIDATED STATEMENTS OF OPERATIONS


(In
thousands)


Successor
              
              
              PredecessorEleven Months
              
              
              One
      MonthYear Ended
              
              
              Year Ended
              
              
              Ended
              
              
              EndedDecember 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006NET
      REVENUE:Net
      client service revenue
              
              $
              461,851
              
              
              $
              441,228
              
              
              $
              241,439
              
              
              $
              18,988Other
      revenue
              
              
              8,143
              
              
              
              6,387
              
              
              
              4,449
              
              
              
              490Total
      net revenue
              
              
              469,994
              
              
              
              447,615
              
              
              
              245,888
              
              
              
              19,478OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              236,006
              
              
              
              220,406
              
              
              
              116,106
              
              
              
              9,079Supplies,
      facilities and other operating costs
              
              
              139,232
              
              
              
              133,768
              
              
              
              67,620
              
              
              
              4,459Provision
      for doubtful accounts
              
              
              6,492
              
              
              
              6,876
              
              
              
              5,028
              
              
              
              285Depreciation
      and amortization
              
              
              22,362
              
              
              
              21,705
              
              
              
              10,148
              
              
              
              360Asset
      impairment
              
              
              4,525
              
              
              
              —
              
              
              
              —
              
              
              
              —Goodwill
      impairment
              
              
              142,238
              
              
              
              —
              
              
              
              —
              
              
              
              —Acquisition
      related costs
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              43,710Total
      operating expenses
              
              
              550,855
              
              
              
              382,755
              
              
              
              198,902
              
              
              
              57,893OPERATING
      (LOSS) INCOME
              
              
              (80,861
              )
              
              
              64,860
              
              
              
              46,986
              
              
              
              (38,415
              )INTEREST
      EXPENSE, NET
              
              
              (54,122
              )
              
              
              (60,262
              )
              
              
              (41,338
              )
              
              
              (2,506
              )GAIN
      ON DEBT REPURCHASE AND OTHER FINANCING COSTS
              
              
              8,086
              
              
              
              —
              
              
              
              —
              
              
              
              (10,655
              )OTHER
      INCOME (EXPENSE)
              
              
              1
              
              
              
              (1,770
              )
              
              
              112
              
              
              
              55(LOSS)
      INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
              
              
              (126,896
              )
              
              
              2,828
              
              
              
              5,760
              
              
              
              (51,521
              )INCOME
      TAX (BENEFIT) EXPENSE
              
              
              (5,866
              )
              
              
              2,446
              
              
              
              2,751
              
              
              
              (12,474
              )MINORITY
      INTEREST IN (LOSS) INCOME OF SUBSIDIARIES
              
              
              (153
              )
              
              
              189
              
              
              
              (38
              )
              
              
              —(LOSS)
      INCOME FROM CONTINUING OPERATIONS
              
              
              (120,877
              )
              
              
              193
              
              
              
              3,047
              
              
              
              (39,047
              )(LOSS)
      INCOME FROM DISCONTINUED OPERATIONS (net of tax (benefit) expense of
      $(11,265) in 2008, $697 in 2007, $260 and $30 for 11 months and 1 month in
      2006, respectively)
              
              
              (21,028
              )
              
              
              1,271
              
              
              
              475
              
              
              
              54NET
      (LOSS) INCOME
              
              $
              (141,905
              )
              
              $
              1,464
              
              
              $
              3,522
              
              
              $
              (38,993
              )




See notes
to consolidated financial statements




32


CRC
HEALTH CORPORATION




CONSOLIDATED
STATEMENTS OF MANDATORILY REDEEMABLE STOCK AND STOCKHOLDER’S
EQUITY


(In
thousands, except share amounts)




Redeemable
      Convertible
              
              
              
              
              
              
              
              
              
              
              
              Retained
              
              
              
              
              
              TotalPreferred
      and A-1
              
              
              Series
      A
              
              
              Additional
              
              
              Earnings
              
              
              Accumulated
              
              
              Stockholders’Common
      Stock
              
              
              Common
      Stock
              
              
              Paid-in
              
              
              (Accumulated
              
              
              Other
              
              
              Equity
              
              
              ComprehensiveShares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Deficit)
              
              
              Comprehensive
      Loss
              
              
              (Deficit)
              
              
              Income
      (Loss)BALANCE—December
      31, 2005 (Predecessor)
              
              
              262,399,056
              
              
              $
              115,625
              
              
              
              8,652,429
              
              
              $
              —
              
              
              $
              215
              
              
              $
              11,770
              
              
              $
              —
              
              
              $
              11,985
              
              
              $
              —Exercise
      of options
              
              
              
              
              
              
              
              
              
              
              72,968
              
              
              
              
              
              
              
              7
              
              
              
              
              
              
              
              
              
              
              
              7Net
      loss for the one month ended January 31, 2006
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (38,993
              )
              
              
              —
              
              
              
              (38,993
              )
              
              
              (38,993
              )BALANCE—January
      31, 2006 (Predecessor)
              
              
              262,399,056
              
              
              $
              115,625
              
              
              
              8,725,397
              
              
              $
              —
              
              
              $
              222
              
              
              $
              (27,223
              )
              
              $
              —
              
              
              $
              (27,001
              )
              
              $
              (38,993
              )Merger
      with CRCA Merger Corporation:Repurchase
      and retirement of CRC Health Group, Inc. preferred and common stock and
      Series A common stock
              
              
              (262,399,056
              )
              
              
              (115,625
              )
              
              
              (8,725,397
              )
              
              
              
              
              
              
              (222
              )
              
              
              27,223
              
              
              
              
              
              
              
              27,001Issuance
      of CRC Health Corporation common stock
              
              
              
              
              
              
              
              
              
              
              1,000
              
              
              
              
              
              
              
              294,475
              
              
              
              
              
              
              
              
              
              
              
              294,475Capital
      contributed by Parent
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              139,177
              
              
              
              
              
              
              
              
              
              
              
              139,177Net
      income for the eleven months ended December 31,
    2006
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,522
              
              
              
              
              
              
              
              3,522
              
              
              
              3,522BALANCE—December
      31, 2006 (Successor)
              
              
              —
              
              
              $
              —
              
              
              
              1,000
              
              
              $
              —
              
              
              $
              433,652
              
              
              $
              3,522
              
              
              $
              —
              
              
              $
              437,174
              
              
              $
              3,522








(continued)




See notes
to consolidated financial statements.




33


CRC
HEALTH CORPORATION




CONSOLIDATED
STATEMENTS OF MANDATORILY REDEEMABLE STOCK AND STOCKHOLDER’S
EQUITY—(Continued)


(In
thousands, except share amounts)




Redeemable
      Convertible
              
              
              
              
              
              
              
              
              
              
              
              Retained
              
              
              
              
              
              TotalPreferred
      and A-1
              
              
              Series
      A
              
              
              Additional
              
              
              Earnings
              
              
              Accumulated
              
              
              Stockholders’Common
      Stock
              
              
              Common
      Stock
              
              
              Paid-in
              
              
              (Accumulated
              
              
              Other
              
              
              Equity
              
              
              ComprehensiveShares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Deficit)
              
              
              Comprehensive
      Loss
              
              
              (Deficit)
              
              
              Income
      (Loss)BALANCE—December
      31, 2006 (Successor)
              
              
              —
              
              
              $
              —
              
              
              
              1,000
              
              
              $
              —
              
              
              $
              433,652
              
              
              $
              3,522
              
              
              $
              —
              
              
              $
              437,174
              
              
              $
              3,522Cumulative
      effect of adoption of FIN48
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,155
              
              
              
              
              
              
              
              2,155Capital
      contributed by Parent, net
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,956
              
              
              
              
              
              
              
              
              
              
              
              4,956Net
      income for the year ended December 31, 2007
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,464
              
              
              
              
              
              
              
              1,464
              
              
              
              1,464BALANCE—December
      31, 2007 (Successor)
              
              
              —
              
              
              $
              —
              
              
              
              1,000
              
              
              $
              —
              
              
              $
              438,608
              
              
              $
              7,141
              
              
              $
              —
              
              
              $
              445,749
              
              
              $
              1,464Capital
      contributed by Parent, net
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              5,667
              
              
              
              
              
              
              
              
              
              
              
              5,667Net
      (loss) for the year ended December 31, 2008
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (141,905
              )
              
              
              
              
              
              
              (141,905
              )
              
              
              (141,905
              )Other
      comprehensive (loss)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (6,289
              )
              
              
              
              
              
              
              (6,289
              )BALANCE—December
      31, 2008 (Successor)
              
              
              —
              
              
              $
              —
              
              
              
              1,000
              
              
              $
              —
              
              
              $
              444,275
              
              
              $
              (134,764
              )
              
              $
              (6,289
              )
              
              $
              303,222
              
              
              $
              (148,194
              )








(concluded)




See notes
to consolidated financial statements




34


CRC
HEALTH CORPORATION




CONSOLIDATED
STATEMENTS OF CASH FLOWS


(In
thousands)




Successor
              
              
              PredecessorEleven Months
              
              
              One
      MonthYear Ended
              
              
              Year Ended
              
              
              Ended
              
              
              EndedDecember 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      (loss) income
              
              $
              (141,905
              )
              
              $
              1,464
              
              
              $
              3,522
              
              
              $
              (38,993
              )Adjustments
      to reconcile net (loss) income to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
              
              
              22,811
              
              
              
              22,015
              
              
              
              10,193
              
              
              
              361Write-off
      of debt discount and capitalized financing costs
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              10,655Amortization
      of debt discount and capitalized financing costs
              
              
              4,536
              
              
              
              4,476
              
              
              
              2,906
              
              
              
              162Goodwill
      impairment
              
              
              142,862
              
              
              
              —
              
              
              
              —
              
              
              
              —Asset
      impairment
              
              
              30,836
              
              
              
              —
              
              
              
              —
              
              
              
              —Gain
      on debt repurchase
              
              
              (8,086
              )
              
              
              —
              
              
              
              —
              
              
              
              —(Gain)/
      loss on interest rate swap agreement
              
              
              (1
              )
              
              
              1,771
              
              
              
              (109
              )
              
              
              (55
              )(Gain)/
      loss on sale of property and equipment
              
              
              68
              
              
              
              218
              
              
              
              (41
              )
              
              
              (1
              )Provision
      for doubtful accounts
              
              
              6,561
              
              
              
              6,857
              
              
              
              5,106
              
              
              
              285Stock-based
      compensation
              
              
              6,026
              
              
              
              3,909
              
              
              
              3,469
              
              
              
              17,666Deferred
      income taxes
              
              
              (19,756
              )
              
              
              1,306
              
              
              
              (85
              )
              
              
              —Minority
      interest
              
              
              (153
              )
              
              
              189
              
              
              
              (38
              )
              
              
              —Changes
      in assets and liabilities:Accounts
      receivable
              
              
              (5,655
              ))
              
              
              (4,962
              )
              
              
              (9,216
              )
              
              
              (1,271
              )Income
      taxes receivable
              
              
              193
              
              
              
              11,899
              
              
              
              2,931
              
              
              
              (9,041
              )Prepaid
      expenses
              
              
              (164
              )
              
              
              216
              
              
              
              (2,069
              )
              
              
              317Other
      current assets
              
              
              494
              
              
              
              56
              
              
              
              3,500
              
              
              
              40Accounts
      payable
              
              
              (803
              )
              
              
              300
              
              
              
              (838
              )
              
              
              (2,997
              )Accrued
      liabilities
              
              
              (8,381
              )
              
              
              (2,877
              )
              
              
              (29,543
              )
              
              
              25,641Other
      current liabilities
              
              
              (6,288
              )
              
              
              2,710
              
              
              
              6,097
              
              
              
              485Income
      taxes payable
              
              
              1,202
              
              
              
              —
              
              
              
              —
              
              
              
              (3,384
              )Other
      long-term assets
              
              
              (19
              )
              
              
              840
              
              
              
              (534
              )
              
              
              1,302Other
      long-term liabilities
              
              
              (202
              )
              
              
              6,033
              
              
              
              263
              
              
              
              29Net
      cash provided by (used in) operating activities
              
              
              24,176
              
              
              
              56,420
              
              
              
              (4,486
              )
              
              
              1,201CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (25,279
              )
              
              
              (30,159
              )
              
              
              (12,786
              )
              
              
              (316
              )Proceeds
      from sale of property and equipment
              
              
              188
              
              
              
              90
              
              
              
              41
              
              
              
              1Acquisition
      of businesses, net of cash acquired
              
              
              (11,597
              )
              
              
              (32,912
              )
              
              
              (304,861
              )
              
              
              —Acquisition
      adjustments
              
              
              (10
              )
              
              
              779
              
              
              
              (14
              )
              
              
              —Payment
      of purchase price to former shareholders
              
              
              —
              
              
              
              —
              
              
              
              (429,191
              )
              
              
              —Payments
      made under earnout arrangements
              
              
              (2,947
              )
              
              
              (8,645
              )
              
              
              —
              
              
              
              —Purchase
      of intangible asset
              
              
              —
              
              
              
              (100
              )
              
              
              —
              
              
              
              —Net
      cash (used in) investing activities
              
              
              (39,645
              )
              
              
              (70,947
              )
              
              
              (746,811
              )
              
              
              (315
              )
 (continued)






35












CRC
HEALTH CORPORATION




CONSOLIDATED
STATEMENTS OF CASH FLOWS—(Continued)


Successor
              
              
              PredecessorEleven Months
              
              
              One
      MonthYear Ended
              
              
              Year Ended
              
              
              Ended
              
              
              EndedDecember 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006CASH
      FLOWS FROM FINANCING ACTIVITIES:Equity
      contribution from Bain Capital
              
              
              —
              
              
              
              —
              
              
              
              294,475
              
              
              
              —Capital
      (distributed to) contributed by Parent
              
              
              (359
              )
              
              
              252
              
              
              
              135,711
              
              
              
              —Payment
      of Bain Merger costs
              
              
              —
              
              
              
              —
              
              
              
              (5,354
              )
              
              
              —Stock
      options exercised
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              7Capitalized
      financing costs
              
              
              (338
              )
              
              
              (640
              )
              
              
              (29,527
              )
              
              
              (547
              )Repayments
      of capital lease obligations
              
              
              (22
              )
              
              
              (259
              )
              
              
              (43
              )
              
              
              —Repurchase
      of long term debt
              
              
              (13,607
              )
              
              
              —
              
              
              
              —
              
              
              
              —Net
      borrowings (repayments) under revolving line of credit
              
              
              35,000
              
              
              
              22,900
              
              
              
              (900
              )
              
              
              (5,000
              )Proceeds
      from issuances of long-term debt
              
              
              —
              
              
              
              —
              
              
              
              617,522
              
              
              
              —Repayment
      of long-term debt
              
              
              (7,783
              )
              
              
              (6,814
              )
              
              
              (256,804
              )
              
              
              —Net
      cash provided by (used in) financing activities
              
              
              12,891
              
              
              
              15,439
              
              
              
              755,080
              
              
              
              (5,540
              )NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              (2,578
              )
              
              
              912
              
              
              
              3,783
              
              
              
              (4,654
              )CASH
      AND CASH EQUIVALENTS—Beginning of period
              
              
              5,118
              
              
              
              4,206
              
              
              
              423
              
              
              
              5,077CASH
      AND CASH EQUIVALENTS—End of period
              
              $
              2,540
              
              
              $
              5,118
              
              
              $
              4,206
              
              
              $
              423SUPPLEMENTAL
      DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:Payable
      in conjunction with the addition of property and equipment
              
              $
              —
              
              
              $
              —
              
              
              $
              1,403
              
              
              $
              95Assets
      acquired under capital lease
              
              $
              ––
              
              
              $
              33
              
              
              $
              ––
              
              
              $
              —Notes
      payable issued in connection with earnout arrangements
              
              $
              897
              
              
              $
              5,681
              
              
              $
              —
              
              
              $
              —Lessor
      financing of leasehold improvements
              
              $
              374
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —Payable
      in conjunction with contingent acquisition consideration
              
              $
              —
              
              
              $
              3,204
              
              
              $
              268
              
              
              $
              —SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for interest
              
              $
              51,758
              
              
              $
              56,418
              
              
              $
              29,118
              
              
              $
              1,336Cash
      paid (received) for income taxes, net of refunds
              
              $
              1,128
              
              
              $
              (10,062
              )
              
              $
              593
              
              
              $
              —




(concluded)




See notes
to consolidated financial statements.




36


CRC
HEALTH CORPORATION




NOTESTO CONSOLIDATED FINANCIAL STATEMENTS




1.
            ORGANIZATION




CRC
Health Group, Inc. (“Health Group”) was incorporated as a Delaware corporation
on January 31, 2002 for the purpose of holding all of the securities of CRC
Health Corporation (the “Predecessor Company”) and eGetgoing, Inc.
(“eGetgoing”), each a Delaware corporation that primarily provides chemical
dependency treatment services.




On
February 6, 2006, investment funds managed by Bain Capital Partners, LLC
(“Bain Capital”) acquired Health Group for approximately $742.3 million (see
Note 3). This transaction (the “Bain Merger”) was structured as a merger in
which CRCA Merger Corporation, a newly-organized Delaware corporation and an
indirect wholly owned subsidiary of CRCA Holdings, Inc., a newly-organized
Delaware corporation controlled by Bain Capital, merged with and into Health
Group with Health Group remaining as the surviving corporation. Immediately
after the merger, CRC Health Corporation and eGetgoing merged with and into
Health Group with Health Group as the surviving entity. CRCA Holdings Inc. was
renamed to CRC Health Group, Inc. and Health Group was renamed CRC Health
Corporation (the “Company”). As a result, the Company is a wholly owned
subsidiary of CRC Health Group, Inc. referred to as (the “Group”) or (the
“Parent”).




The
Company is headquartered in Cupertino, California and through its wholly owned
subsidiaries provides substance abuse treatment services and youth treatment
services in the United States. The Company also provides treatment services for
other addiction diseases and behavioral disorders such as eating disorders. The Company delivers its
substance abuse and addiction disease treatment services through residential and
outpatient treatment facilities, which is referred to as the Company’s recovery
division. As of December 31, 2008, the Company operated 100 residential and
outpatient treatment facilities in 24 states and treated approximately 28,000
patients per day. The Company delivers its youth treatment services through its
residential schools, wilderness programs and summer camps, which is referred to
as the Company’s youth division. As of December 31, 2008, the Company’s youth
division operated programs at 28 facilities in 10 states. The Company’s healthy
living division provides treatment services for eating disorders and obesity,
each of which may be effectively treated through a combination of medical,
psychological and social treatment programs. As of December 31, 2008, the
Company’s healthy living division operated 16 facilities in 8
states.




2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES




Basis of
Presentation and Principles of Consolidation—The date of the Bain Merger
was February 6, 2006 but for accounting purposes and to coincide with its
normal financial closing, the Company has utilized February 1, 2006 as the
effective date. As a result, the Company has reported operating results
of the period presented prior to February 1, 2006 as those of the
Predecessor Company and for all periods from and subsequent to February 1,
2006 as those of the Successor Company due to the resulting change in the basis
of accounting.




These
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States of America
(“GAAP”) and pursuant to the rules and regulations of the Securities and
Exchange Commission (the “SEC”) applicable for annual financial information. The
Company’s consolidated financial statements include the accounts of CRC Health
Corporation and its consolidated subsidiaries, and, for the periods through
January 31, 2006, CRC Health Group, Inc. and its consolidated subsidiaries.
All significant intercompany accounts and transactions have been eliminated in
consolidation.




Use of
Estimates—Preparation of financial
statements in accordance with GAAP requires management to make estimates and
assumptions that affect the amounts reported in the Company’s consolidated
financial statements and accompanying notes. Actual results could differ
materially from those estimates.




Cash and Cash
Equivalents—Cash
includes amounts in demand accounts. At December 31, 2008 and 2007 substantially
all cash was on deposit with financial institutions. Cash equivalents are
short-term investments with original maturities of three months or less.
Interest income for the years ended December 31, 2008 and 2007, the eleven
months ended December 31, 2006 and the one month ended January 31,
2006 was approximately $0.1 million, $0.7 million, $0.1 million and $0.0
million, respectively, and is recorded in interest expense, net, on the
consolidated statements of operations.




Property and
Equipment—Property and equipment are
stated at cost less accumulated depreciation. Depreciation expense is computed
on a straight-line basis over the estimated useful lives of the assets,
generally three to seven years, except for buildings, which are depreciated over
thirty years. Leasehold improvements and assets held under capital leases are
amortized using the straight-line method over the life of the lease, or the
estimated useful life of the asset, whichever is shorter. Maintenance and
repairs are charged to operations as incurred.




Long-Lived
Assets— In accordance with Statement of Financial Accounting Standards
No. 144,Accounting for the
Impairment or Disposal of Long Lived Assets  ("SFAS 144"),
 the Company tests its long lived assets and intangible assets
subject to amortization for impairment whenever events or changes in
circumstances indicate that the carrying value of certain of its assets may not
be recoverable.  According to SFAS 144, if the undiscounted future
cash flows from the asset tested are less than the carrying value, a loss
equal to the difference between the carrying value and the fair market value of
the asset is recorded.




The
Company's analysis of its undiscounted cash flows requires judgment with
respect to many factors, including future cash flows, success at
executing its business strategy, and future revenue and expense growth
rates. It is possible that the Company's estimates of undiscounted cash flows
may change in the future resulting in the need to reassess the carrying value of
its long-lived assets for impairment.




During
the year ended December 31, 2008, the Company recognized a non-cash charge
of $3.0 million related to the impairment of property and equipment and a $16.9
million non-cash charge related to the impairment of intangible assets subject
to amortization.  These charges are recorded in the Company's
divisions and are included in the Company's consolidated statement of
operations within discontinued operations. See Note 5, Note 6, and Note
18.




Goodwill and
Other Intangible Assets—In accordance with Statement
of Financial Accounting Standards No. 142,Goodwill and Other Intangible
Assets ("SFAS 142"), the Company tests goodwill and indefinite lived
intangible assets for impairment annually, at the beginning of its fourth
quarter or more frequently if evidence of possible impairment
arises.




The
provisions of SFAS 142 require that a two-step impairment test be performed on
goodwill. In the first step, the Company compares the fair value of the
reporting unit being tested to its carrying value. The
Company's reporting units are consistent with the operating segments
identified in Note 20.  The Company determines the fair value of
its reporting units using a combination of income approach and
a market approach. Under the income approach, the Company calculates
the fair value of a reporting unit based on the present value of estimated
future cash flows. Under the market approach, the Company estimates fair value
based on what investors have paid for similar interests in comparable companies
through the development of ratios of market prices to various earnings
indications of comparable companies taking into consideration adjustments for
growth prospects, debt levels and overall size. If the fair value of the
reporting unit exceeds the carrying value of the net assets assigned to that
unit, goodwill is not impaired and the Company is not required to
perform further testing. If the carrying value of the net assets assigned to the
reporting unit exceeds the fair value of the reporting unit, then the
Company must perform the second step of the impairment test in order to
determine the implied fair value of the reporting unit’s goodwill. If the
carrying value of a reporting unit’s goodwill exceeds its implied fair value,
then the Company records an impairment loss equal to the
difference.




37


The
process of evaluating the potential impairment of goodwill is subjective and
requires significant estimates and assumptions at many points during the
analysis.  The Company's estimated future cash flows are based on
assumptions that are consistent with its annual planning process and
include estimates for revenue and operating margins and future economic and
market conditions. Actual future results may differ from those
estimates. The Company bases its fair value estimates on
assumptions it believes to be reasonable at the time, but that are
unpredictable and inherently uncertain. In addition, the Company makes
certain judgments and assumptions in allocating shared assets and liabilities to
determine the carrying values for each of its reporting units tested.




In the
third quarter of 2008, the Company tested its youth reporting unit in
advance of the annual goodwill impairment test date, as there was a
more-likely-than-not expectation that a significant portion of the reporting
unit would be disposed of. Additionally, during the third quarter of 2008, the
healthy living reporting unit was tested for possible impairment due to
decreases in operating income and deteriorating economic conditions. As a result
of these impairment tests, the Company has recognized a non-cash goodwill
impairment charge of $142.2 million within its youth division. At the beginning
of the fourth quarter, the Company tested the recovery reporting unit in
accordance with the Company’s annual testing policy. See Note 6.





During
2008, the Company also recognized non-cash impairment charges of $4.5 million
and $6.4 million related to intangible assets not subject to amortization within
its youth and recovery divisions, respectively. Impairment charges related to
goodwill and intangible assets not subject to amortization are
included in the consolidated statement of operations under goodwill
impairment, asset impairment, and discontinued operations. See Note
6.




Capitalized
Financing Costs—Costs related to
obtaining financing and long-term debt are capitalized and amortized using the
effective interest method.  As of December 31, 2008 and 2007, other
long-term assets, net includes capitalized financing costs of $18.7 million, and
$23.4 million, respectively. Amortization expense for the years ended December
31, 2008 and 2007, the eleven months ended December 31, 2006, and the one
month ended January 31, 2006 was $4.2 million, $4.2 million, $2.6 million,
and $0.1 million, respectively and are included in the Company’s consolidated
statement of operations under interest expense, net.




Revenue
Recognition—Revenue is recognized when
rehabilitation and treatment services are provided to a patient. Client service
revenue is reported at the estimated net realizable amounts from clients,
third-party payors and others for services rendered. Revenue under third-party
payor agreements is subject to audit and retroactive adjustment. Provisions for
estimated third-party payor settlements are provided for in the period the
related services are rendered and adjusted in future periods as final
settlements are determined. Revenue for educational services provided by the
Company’s youth division consists primarily of tuition, enrollment fees, alumni
services and ancillary charges. Tuition revenue and ancillary charges are
recognized based on contracted monthly/daily rates as services are rendered. The
enrollment fees for service contracts that are charged upfront are deferred and
recognized over the average student length of stay, approximately eleven months.
Alumni fees revenue represents non-refundable upfront fees for post graduation
services and these fees are deferred and recognized systematically over the
contracted life, which is twelve months. The Company, from time to time, may
provide charity care to a limited number of clients. The Company does not record
revenues or receivables for charity care provided. Advance billings for client
services are deferred and recognized as the related services are
performed.




Advertising
Costs—Advertising costs, included in supplies and facilities costs, are
expensed as incurred. Advertising costs for the years ended December 31, 2008
and 2007, the eleven months ended December 31, 2006, and the one month
ended January 31, 2006 were approximately $4.1 million, $2.9 million, $1.3
million, and $0.07 million, respectively.




Stock-Based
Compensation—On January 1, 2006, the Predecessor Company adopted
Statement of Financial Accounting Standards No. 123R,Share-Based Payment (“SFAS
123(R)”), which requires the measurement and recognition of compensation expense
for all share-based payment awards, including employee stock options, granted
after January 1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123(R). Prior to the adoption of SFAS
123(R), the Predecessor Company recognized stock-based compensation expense in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (“APB 25”), and related interpretations, as permitted by
Statement of Financial Accounting Standards No. 123,Accounting for Stock Based
Compensation(“SFAS 123”). In March 2005, the SEC issued Staff Accounting
Bulletin No. 107, Valuation of Share-Based Payment
Arrangements for Public Companies (“SAB 107”) relating to SFAS 123R and
the Predecessor Company has applied the provisions of SAB 107 in its adoption of
SFAS 123R. The Predecessor Company adopted SFAS 123R using the prospective
transition method, which requires the application of the accounting standard to
awards granted, modified or settled after the date of adoption.




Gain on Debt
Repurchase and Other Financing Costs— During the year ended
December 31, 2008 the Company retired senior subordinated notes with a par
amount of $22.7 million. Excluding immaterial transaction related costs, the
Company realized a gain of $8.1 million from debt retirement
activities.  The Company did not have any debt retirement activities
in 2007, the eleven months ended December 31, 2006, or the one month ended
January 31, 2006.




Other
financing costs written off in the one month ended January 31, 2006 include
charges associated with the early extinguishment of borrowings, including
amounts paid for prepayment premiums and additional interest, and capitalized
financing costs and debt discounts associated with the retired debt that were
written off.  For the years ended December 31, 2008 and 2007, and for
the eleven months ended December 31, 2006, the Company did not incur any
other financing costs.




Minority
Interest—The Company through the acquisition of Aspen acquired a
seventy-five percent interest in certain weight loss
programs.  Additionally, a former employee acquired a 10% interest in
two youth division programs as a result of a prior agreement in place from the
Aspen acquisition. The Company consolidates its investment for financial
reporting purposes. Losses are allocated based upon the “at risk” capital of
each limited liability partner member. Losses in excess of the “at risk” capital
are allocated to the Company without regard to the percentage of ownership. The
Company retains an option to buy-out the minority interest at a price to be
calculated pursuant to the terms and conditions of the operating
agreement.




Income
Taxes—The
Company accounts for income taxes under an asset and liability method. Under
this method, deferred income tax assets and liabilities are determined based
upon the difference between the financial statement carrying amounts and tax
bases of assets and liabilities using tax rates in effect when the differences
are expected to reverse. A valuation allowance is established when necessary to
reduce deferred tax assets to the amounts expected to be realized. For U.S.
federal tax return purposes, the Company is part of a consolidated tax return
with its Parent, CRC Health Group, Inc. However, the Company’s provision for
income taxes is prepared on a stand-alone basis.




In June
2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation
No. 48, “Accounting for
Uncertainty in Income Taxes — an interpretation of FASB Statement
No. 109” (“FIN 48”). This statement clarifies the criteria that
an individual tax position must satisfy for some or all of the benefits of that
position to be recognized in a company’s financial statements. The
Company adopted FIN 48 on January 1, 2007. The effect of adopting
FIN 48 was a decrease in tax reserves and an increase of $2.2 million to
the January 1, 2007 retained earnings balance. Upon adoption, the liability for
income taxes associated with uncertain tax positions at January 1, 2007 was $1.9
million.  At December 31, 2008, the Company’s total unrecognized tax
benefits were approximately $1.1 million exclusive of interest and penalties.
Included in this amount is approximately $1.0 million of unrecognized tax
benefits that, if recognized, would favorably affect the effective tax rate in a
future period. See Note 7.




38


Restructuring and
Discontinued Operations—  The Company
accounts for facility closures and restructuring costs in accordance with
Statement of Financial Accounting Standards No.146, Accounting for Costs Associated with
Exit or Disposal Activities ("SFAS 146") and  SFAS
144.  The Company records as an obligation, the present value of
estimated costs that will not be recovered. These costs include employment
termination benefits, lease contract termination costs, and other
associated costs. At December 31, 2008, the Company had incurred
liabilities of approximately $3.3 million related to costs associated with exit
or disposal activities.




Additionally,
upon review of facility closures and disposals, the Company assesses the
classification of such facilities as discontinued operations in accordance with
SFAS 144. Should the Company classify certain facility closures and disposals as
discontinued operations under the provisions of SFAS 144, the facility
operations related to closures and disposals are classified as discontinued
operations on the consolidated statements of operations for all periods
presented. Assets and liabilities of discontinued operations are classified
under assets and liabilities of discontinued operations, facility exits on the
consolidated balance sheet for 2008. See Note 19.




Concentration of
Credit Risk—Financial
instruments that potentially subject the Company to a concentration of credit
risk consist primarily of cash and accounts receivable. The Company’s cash
accounts are maintained with financial institutions in the United States of
America. At times, deposits in these institutions may exceed federally insured
limits. The Company’s accounts receivable are primarily derived from methadone
treatment, detoxification, psychological evaluations, counseling, education,
weight loss management, and other related rehabilitation services provided to
clients. As of December 31, 2008 and 2007, approximately 36.2% and 26.0% of
gross accounts receivable and approximately 16.4% and 14.2%  for the
years ended December 31, 2008 and 2007, respectively, and 19.9% for the eleven
months ended December 31, 2006 and 26.0% for the one month ended
January 31, 2006 of net client service revenue, respectively, was derived
from county, state and federal contracts under Medicaid and other programs. In
the event of cancellation or curtailment of these programs or default on these
accounts receivable, the Company’s operating results and financial position
would be adversely affected. The Company performs ongoing credit evaluations of
its third-party insurance payors’ financial condition and generally requires
advance payment from its clients who do not have verifiable insurance coverage.
The Company maintains an allowance for doubtful accounts to cover potential
credit losses based upon the estimated collectability of accounts
receivable.  Fair Value of
Financial Instruments—The carrying value of cash, accounts receivable,
accounts payable and accrued liabilities approximate their fair values due to
their short maturities. Based upon the borrowing rates currently available to
the Company for loans with similar terms and the anticipated payment of its term
loans per the amended and restated credit agreement (see Note 8) the carrying
value of the term loans approximates fair value. At December 31, 2008 and 2007
the carrying value and fair value of the senior subordinated notes was $175.4
million and $106.8 million and $197.6 million and $205.0 million,
respectively.


Interest Rate
Swaps—Interest rate swaps are used principally in the management of the
Company’s interest rate exposures and are recorded on the balance sheet at fair
value. As part of its hedging strategy, the Company has designated its
interest rate swaps as cash flow hedges under the provisions of Statement of
Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (“SFAS 133”).





The fair
value of the interest rate swaps are estimated based upon terminal value models.
If the swaps are designated as a cash flow hedge, the effective portions of
changes in the fair value of the swap are recorded in other comprehensive
income. Ineffective portions of changes in the fair value of cash flow hedges
are recognized in earnings. Additionally, changes in the fair value of effective
cash flow hedges, related to accumulated ineffectiveness of off-market interest
rate swaps, are recognized as interest expense, net on the consolidated
statement of operations.  If the swaps are not designated as a cash
flow hedges, the changes in the fair value of the swaps are recorded in other
income (expense) on the consolidated statement of operations. See Notes 9 and
11.





Other
Comprehensive Income—Other comprehensive income (“OCI”) includes income,
expenses, gains and losses that bypass the income statement and are reported
directly as a separate component of equity. For the year ended December 31,
2008, the Company recognized a pre-tax loss of $10.5 million in OCI related to
the effective portion of changes in fair value of its interest rate swaps
designated as cash flow hedges.  For the year ended December 31, 2007,
the eleven months ended December 31, 2006, and the one month ended January 31,
2006, the Company’s interest rate swap was not designated as a hedge;
therefore, changes in its fair value were recorded in other income
(expense) in the consolidated statements of operations. See Note
10.




Business
Segments—Performance of the Company’s two reportable segments (recovery
division and youth division) is evaluated based on profit or loss from
operations before depreciation and amortization, gain on sale of assets, special
charges or benefits, income taxes and minority interest (“segment profit”).
Management uses segment profit information for internal reporting and control
purposes and considers it important in making decisions regarding the allocation
of capital and other resources, risk assessment and employee compensation, among
other matters. Intersegment sales and transfers are insignificant. See Note
20.





Recent Accounting
Pronouncements—In December 2007, the FASB issued Statement of Financial
Accounting Standards No. 141 (revised 2007), Business Combinations
(“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. SFAS 141(R) also
establishes disclosure requirements to enable the evaluation of the nature and
financial effects of the business combination. SFAS 141(R) is effective for
fiscal years beginning after December 15, 2008, and will be adopted by the
Company in the first quarter of fiscal 2009. The provisions of SFAS 141(R) will
be applied to future acquisitions made by the Company.




In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 160, Noncontrolling
Interests in Consolidated Financial Statements—an amendment of Accounting
Research Bulletin No. 51 (“SFAS 160”). SFAS 160
establishes accounting and reporting standards for ownership interests in
subsidiaries held by parties other than the parent, the amount of consolidated
net income attributable to the parent and to the noncontrolling interest,
changes in a parent’s ownership interest, and the valuation of retained
noncontrolling equity investments when a subsidiary is deconsolidated.
SFAS 160 also establishes disclosure requirements that clearly identify and
distinguish between the interests of the parent and the interests of the
noncontrolling owners inclusive of requiring retroactive adoption of the
presentation and disclosure requirements for existing minority interests. All
other requirements shall be applied prospectively. SFAS 160 is effective
for fiscal years beginning after December 15, 2008. The Company is
currently evaluating the potential impact of the adoption of SFAS 160 on
its financial statements.




On
March 19, 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No.
133 (“SFAS 161”). SFAS 161 requires enhanced disclosures about
an entity’s derivative and hedging activities. These enhanced disclosures will
discuss (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years beginning after November 15, 2008
(January 1, 2009, for the Company), with earlier adoption allowed. The
Company has not completed the process of evaluating the impact on its results of
operations or financial condition that will result from adopting
SFAS 161.




39


3.
            ACQUISITIONS




2008
Acquisitions




For the
year ended December 31, 2008, the Company completed two acquisitions, and
paid total cash consideration of approximately $11.6 million, including
acquisition related expenses. Additional contingent consideration of $1.0
million may be paid subject to the acquired entity meeting certain performance
benchmarks over the two year period subsequent to the
acquisition.  The acquisitions are intended to provide expansion of
the Company’s services within the respective corresponding markets of the
acquired facilities in the United States. The Company recorded $11.3 million of
goodwill for its recovery division, all of which is expected to be
deductible for tax purposes.




The
acquisitions were accounted for as a purchase in accordance with SFAS 141.
Under purchase accounting the purchase price for each acquisition was allocated
to the assets acquired and liabilities assumed based on their respective fair
values. The purchase price was allocated using the information currently
available. As a result, the Company may adjust the allocation of the purchase
consideration as it obtains more information regarding the asset valuations,
liabilities assumed and purchase price adjustments. The Company has included the
acquired entities’ results of operations in the consolidated statements of
operations from the date of the acquisition. Pro forma results of operations
have not been presented because the effect of the acquisitions was not
material.




2007
Acquisitions




During
the year ended December 31, 2007, the Company completed four acquisitions and
paid total cash consideration of approximately $32.9 million, including
acquisition related expenses. The acquisitions expanded its recovery, youth, and
corporate/other services into new geographic regions within the United
States. The Company recorded $29.1 million of goodwill, of which $28.6
million is expected to be deductible for tax purposes. Goodwill assigned to the
recovery, youth, and corporate/other divisions was $22.9 million, $1.6 million,
and $4.6 million, respectively.




The
acquisitions were accounted for as a purchase in accordance with Statement of
Financial Accounting Standards No. 141,Business Combinations
(“SFAS 141”). Under purchase accounting the purchase price for each
acquisition was allocated to the assets acquired and liabilities assumed based
on their respective fair values. The Company has included the acquired
entities’ results of operations in the consolidated statements of operations
from the date of the acquisition. Pro forma results of operations have not been
presented because the effect of the acquisitions was not material.




2006
Acquisitions




Aspen
Acquisition—On November 17, 2006, the Company acquired all the
outstanding capital stock of Aspen Education Group, Inc., a California
corporation (“Aspen”) for approximately $273.9 million in cash purchase
consideration, the assumption of approximately $20.6 million of indebtedness as
defined per the merger agreement (includes the buy-out of minority interest of
$4.2 million), and the payment of costs associated with the acquisition and
related financing of approximately $1.3 million and $10.8 million, respectively.
Aspen provides educational services to youth who have demonstrated behavioral
issues that have interfered with their performance in school and life. Aspen
offers its programs through its boarding schools, outdoor education programs and
weight management programs for children and teenagers. Among other benefits, the
Aspen Acquisition offers multiple revenue and cost synergies. The Aspen
Acquisition further enhances the Company’s private pay mix and business
diversification, thereby reducing business risk from any one aspect of the
Company’s operations. In addition, the Company is expected to benefit from
increased cross-referral opportunities. Subsequent to the acquisition, in the
third quarter of fiscal 2007, the healthy living part of Aspen together with
certain parts of the recovery division, were transformed into the healthy living
division which is reported under corporate/other for segment reporting. The
remaining legacy facilities from the Aspen acquisition are included in the youth
division.




The Aspen
Acquisition and associated transactions and expenses were financed by the
issuance of an additional $175.5 million of senior secured term loan (by
amending and restating the Company’s existing $243.8 million senior secured term
loan facility), and capital contributions of $135.7 million from the Group,
which was treated as equity. The Group funded such capital contributions by a
combination of $36.2 million resulting from the sale of its equity
securities to certain of the Group’s equity holders and by the issuance of a
payment in kind (“PIK”) loan of $105.0 million issued at 1% original issue
discount for net proceeds of $103.9 million. The Group incurred $4.5 million of
financing costs in connection with the PIK loan which was treated as a reduction
in the capital contribution. The interest payable per annum for the PIK loan is
180 day LIBOR plus 7.0% for the first year, 180 day LIBOR plus 7.5% for the
second year and 180 day LIBOR plus 8.0% for the years thereafter until the
maturity date. Per the PIK loan agreement, the interest is accrued through an
increase in the principal amount. The aggregate principal amount inclusive of
the accrued interest matures on November 17, 2013. This senior unsecured
PIK loan is not guaranteed by the Company or any of its
subsidiaries.




The
acquisition was accounted for as a purchase in accordance with SFAS 141. Under
purchase accounting, the purchase consideration was allocated to the assets and
liabilities based on their relative fair values. The consideration remaining was
allocated to the Company’s intangibles with finite lives and is being amortized
over that life, as well as to goodwill and identifiable intangibles with
indefinite lives, which will be evaluated on at least an annual basis to
determine impairment and adjusted accordingly. Goodwill was assigned a value of
$226.3 million of which $58.5 million is expected to be deductible for tax
purposes.




A summary
of the acquisition purchase consideration is as follows (in
thousands):




Cash
            
            $
            273,988Acquisition
      related expenses
            
            
            1,308Buyout
      of minority interests and other agreement(a)
            
            
            4,189Total
      purchase consideration
            
            $
            279,485





(a)
            Represents
      the purchase of a 10% minority interest for $3.7 million in SUWS of the
      Carolinas, a 10% interest for $0.2 million in the Eating Disorder Venture
      owned by Niton, LLC and a $0.3 million payment related to the termination
      of a consulting agreement.


40




Allocation
of the aggregate purchase price to the assets and liabilities based on estimated
fair value is as follows (in thousands):




Cash
            
            
            
            
            $
            11,251Accounts
      receivable
            
            
            
            
            
            4,534Prepaid
      expenses
            
            
            
            
            
            1,399Other
      current assets
            
            
            
            
            
            1,354Income
      taxes receivable
            
            
            
            
            
            554Deferred
      income tax assets
            
            
            
            
            
            1,179Property
      and equipment
            
            
            
            
            
            19,007Other
      assets
            
            
            
            
            
            1,178Goodwill
            
            
            
            
            
            226,347Intangible
      assets:Curriculum
            
            
            9,000Accreditation
            
            
            24,400Referral
      network
            
            
            45,400Student
      contracts
            
            
            2,241Regulatory
      licenses
            
            
            16,300Trademark
      and trade name
            
            
            10,800Total
      intangible assets
            
            
            
            
            
            
            108,141Accounts
      payable
            
            
            
            
            
            
            (4,070
            )Accrued
      expenses
            
            
            
            
            
            
            (20,454
            )Current
      portion of long—term debt
            
            
            
            
            
            
            (2,990
            )Other
      current liabilities
            
            
            
            
            
            
            (17,865
            )Long
      term debt—Less current portion
            
            
            
            
            
            
            (5,015
            )Other
      long-term liabilities
            
            
            
            
            
            
            (4,943
            )Deferred
      income tax liabilities
            
            
            
            
            
            
            (39,836
            )Minority
      Interest
            
            
            
            
            
            
            (286
            )Total
      purchase price
            
            
            
            
            
            $
            279,485




Intangible
assets determined to have finite lives are being amortized over that life and
consist of curriculum, accreditation, referral network and student contracts.
Intangible assets determined to have an indefinite life are the regulatory
licenses and trademarks and trade names and, accordingly, are not being
amortized by the Company.




Pro-forma
Financial Information—The unaudited pro-forma financial information
presented below sets forth the Company’s historical consolidated statements of
operations for the period indicated and gives effect to the Aspen Acquisition as
if it took place at the beginning of the period presented below. Such
information is presented for comparative purposes only and is not intended to
represent what the Company’s results of operations would actually have been
had these transactions occurred at the beginning of the period presented
(in thousands).


For
      the Year EndedDecember 31,2006(a)(unaudited)Net
      revenue
              
              $
              401,152(Loss)
      income from operations before income taxes
              
              $
              (63,794
              )Net
      (loss) income
              
              $
              (48,208
              )





(a)
            The
      unaudited pro forma consolidated statement of operations for the year
      ended December 31, 2006 includes certain nonrecurring charges that
      were incurred by Aspen in connection with the Aspen Acquisition:
      (i) stock option compensation expenses of $9.6 million, recognized
      upon settlement of the options and (ii) various accounting, other
      professional fees and other transaction related fees of $7.1 million,
      of which tax deductible transaction fees are $5.2 million. The tax effect
      of these nonrecurring items at Aspen Education Group’s historical
      effective tax rate of 41.6% is $6.1 million. In addition, the year ended
      December 31, 2006 pro forma consolidated statement of operations
      includes $54.4 million of certain nonrecurring charges incurred by the
      Company, net of tax benefit of $13.1
million.




Bain
Merger—On February 6, 2006, investment funds managed by Bain Capital
acquired Health Group in a merger in which CRCA Merger Corporation, a
newly-organized Delaware corporation and an indirect wholly owned subsidiary of
CRCA Holdings, Inc., a newly-organized Delaware corporation controlled by Bain
Capital, merged with and into Health Group with Health Group remaining as the
surviving corporation. In connection with the Bain Merger, certain members of
management elected to rollover options to exchange, or roll, a portion of their
pre-merger equity for an interest in CRCA Holdings, Inc. Immediately after the
merger, CRC Health Corporation (the “Predecessor Company”) and eGetgoing merged
with and into Health Group with Health Group continuing as the surviving entity.
Immediately thereafter, CRCA Holdings Inc. was renamed CRC Health Group, Inc.
and the Predecessor Company was renamed CRC Health Corporation (the “Company”).
Total cash contributed was approximately $742.3 million (including
acquisition and financing transactions related fees and expenses of
$27.0 million incurred by CRCA Merger Corporation. Subsequent to the
closing of the acquisition an additional $1.5 million of financing related fees
and expenses were recorded for a total acquisition and financing transaction
related fees and expenses of $28.5 million). The proceeds were used to repay
existing balances on the revolving line of credit of $4.5 million,
long-term debt of $254.0 million, accrued interest of $1.4 million and
acquisition and financing related expense of $24.4 million incurred by the
Company that were expensed in the Predecessor Company financial statements and
are included in acquisition related costs on the consolidated statement of
operations. The proceeds were also used to pay $0.3 million related to the
February and March management fees per the management agreement with an
affiliate of Bain Capital (see Note 16) which was recorded in the eleven months
ended December 31, 2006 consolidated statement of operations. In addition,
as part of the transactions, the Company’s former stockholders, including
mandatorily redeemable common and preferred stockholders, were paid
$429.2 million as per the merger agreement.




41


The
aggregate purchase price of $722.9 million plus expenses of $28.5 million
incurred by CRCA Merger Corporation was financed with the senior secured term
loans of $245.0 million dated February 6, 2006, the issuance of senior
subordinated notes of $197.0 million ($200.0 million aggregate principal
amount, less $3.0 million of original issue discount), a borrowing under
the revolving credit facility of $4.3 million, an equity investments
by investment funds managed by Bain Capital of $294.5 million, rollover equity
investments by certain members of the Company’s management of $9.1 million
and $1.5 million from the Company’s cash flow from operations.




As a
result of the acquisition, Bain Capital received unilateral control of the
Company. The acquisition was accounted for as a complete change in accounting
basis in a successor company (CRC Health Corporation). Equity rollover of
$9.1 million from certain members of the Company’s management was recorded
at the stockholder’s predecessor basis, which is zero for accounting purposes,
in accordance with Financial Accounting Standards Board Emerging Issues Task
Force (“EITF”) Issue No. 88-16,Basis in Leveraged Buyout
Transactions.




The
acquisition was accounted for as a purchase in accordance with SFAS 141.
Under purchase accounting, the purchase consideration was allocated to the
assets and liabilities based on their relative fair values. The consideration
remaining was allocated to the Company’s intangibles with finite lives and is
being amortized over that life, as well as to goodwill and identifiable
intangibles with indefinite lives, which will be evaluated on at least an annual
basis to determine impairment and adjusted accordingly. Goodwill was assigned a
value of $445.4 million of which $121.6 million is expected to be
deductible for tax purposes.




A summary
of the acquisition purchase consideration is as follows (in
thousands):




Total purchase price
            
            $
            722,856Less—management rollover equity (zero basis)
            
            
            (9,075
            )Add—Total costs incurred by CRCA Merger Corporation(a)
            
            
            28,494Total cash contributed
            
            $
            742,275





(a)
            Total
      costs incurred by CRCA Merger Corporation include acquisition related
      expenses of $5.4 million that were included as part of the purchase price
      and financing related costs of $23.1 million that were capitalized on the
      successor balance sheet. These fees and expenses were primarily comprised
      of accounting and professional fees, financial advisory and investment
      banking fees and fees paid to other service
  providers.




Allocation
of the aggregate purchase price to the assets and liabilities based on fair
value as determined by independent valuations (for intangibles) is as follows
(in thousands):




Cash
            
            
            
            
            $
            423Accounts
      receivable
            
            
            
            
            
            24,404Prepaid
      expenses
            
            
            
            
            
            4,216Other
      current assets
            
            
            
            
            
            16,152Property
      and equipment
            
            
            
            
            
            64,382Other
      assets and capitalized financing costs
            
            
            
            
            
            24,105Goodwill
            
            
            
            
            
            445,375Intangible
      assets:Government,
      including Medicaid, contracts
            
            
            35,600Managed
      care contracts
            
            
            14,400Covenants
      not to compete
            
            
            152Registration
      rights
            
            
            200Core
      developed technology
            
            
            2,484Certificates
      of need
            
            
            44,600Licenses
            
            
            25,200Trademark
      and trade name
            
            
            163,700Total
      intangible assets
            
            
            
            
            
            
            286,336Other
      liabilities assumed
            
            
            
            
            
            
            (18,987
            )Deferred
      income tax liabilities
            
            
            
            
            
            
            (104,131
            )Total
      purchase price
            
            
            
            
            
            $
            742,275




42


Pro-forma
Financial Information—The unaudited pro-forma financial information
presented below sets forth the Company’s historical consolidated statements of
operations for the period indicated and gives effect to the Bain Merger as if it
took place at the beginning of the period presented below. Such information
is presented for comparative purposes only and is not intended to represent what
the Company’s results of operations (in thousands) would actually have been had
these transactions occurred at the beginning of the period
presented.





For
      the Year EndedDecember 31,2006(a)(unaudited)Net
      revenue
              
              $
              271,178Loss
      from operations before income taxes
              
              $
              (46,543
              )Net
      (loss) income
              
              $
              (36,416
              )





(a)
            The
      predecessor consolidated statement of operations for the one month ended
      January 31, 2006 includes certain material nonrecurring charges that
      are directly attributable to the Bain Merger and such charges were not
      excluded from the year ended December 31 2006 pro-forma financial
      information. The charges and their related tax effects are as follows (in
      thousands):




Stock
      option-based compensation expense related to the settlement of stock
      options
            
            $
            17,666Fees
      to financial advisors
            
            
            9,635Fees
      to former lead investors
            
            
            9,437Management
      bonuses and related payroll taxes
            
            
            3,530Legal,
      accounting and other professional fees
            
            
            3,442Capitalized
      financing costs written-off
            
            
            7,164Unamortized
      debt discount
            
            
            3,491Income
      tax benefit(i)
            
            
            (13,058
            )Total
      nonrecurring items—net of tax
            
            $
            41,307







(i)
            Income
      tax benefit at 41% tax rate is as follows (in
  thousands):


Pre-tax
              
              
              TaxAmount
              
              
              EffectStock
      option-based compensation expense related to the settlement of stock
      options
              
              $
              17,666
              
              
              $
              7,243Management
      bonuses and related payroll taxes
              
              
              3,530
              
              
              
              1,447Capitalized
      financing costs written-off
              
              
              7,164
              
              
              
              2,937Unamortized
      debt discount
              
              
              3,491
              
              
              
              1,431Total
      income tax benefit
              
              
              
              
              
              $
              13,058




2006
Other Acquisitions




In 2006,
the Company completed five other acquisitions and paid total cash consideration
of approximately $36.6 million, including acquisition related expenses. These
acquisitions expand the range of services offered by the Company and extend the
services into new geographic regions in the United States. They contribute to
the continued building of a nationwide network of specialized behavioral care
services by the Company. The Company recorded $28.5 million of goodwill, of
which $16.4 million is expected to be deductible for tax purposes. The goodwill
was assigned to its recovery segment. The Company also recorded $11.2 million of
purchased intangibles in connection with these acquisitions.




The
acquisitions were accounted for as a purchase and, accordingly, the purchase
price was allocated to the assets acquired and liabilities assumed based on
their respective fair values. The Company has included the results of operations
in the consolidated statements of operations from the respective dates of the
acquisitions. Pro forma results of operations have not been presented because
the effects of these acquisitions are not material either on an individual or an
aggregate basis.




43


4.
            BALANCE
      SHEET COMPONENTS




Balance
sheet components at December 31, 2008 and 2007 consist of the following
(in thousands):




2008
              
              
              2007(Successor)Accounts
      receivable—gross
              
              $
              36,235
              
              
              $
              38,811Less
      allowance for doubtful accounts
              
              
              (5,409
              )
              
              
              (6,901
              )Accounts
      receivable—net
              
              $
              30,826
              
              
              $
              31,910Other
      assets:Capitalized
      financing costs—net
              
              $
              18,688
              
              
              $
              23,361Deposits
              
              
              912
              
              
              
              874Note
      receivable
              
              
              465
              
              
              
              563Total
      other assets
              
              $
              20,065
              
              
              $
              24,798Accrued
      liabilities:Accrued
      payroll and related expenses
              
              $
              7,864
              
              
              $
              14,923Accrued
      vacation
              
              
              5,613
              
              
              
              5,421Accrued
      interest
              
              
              8,289
              
              
              
              9,647Accrued
      expenses
              
              
              7,295
              
              
              
              7,591Total
      accrued liabilities
              
              $
              29,061
              
              
              $
              37,582Other
      current liabilities:Deferred
      revenue
              
              $
              10,249
              
              
              $
              13,190Client
      deposits
              
              
              5,114
              
              
              
              8,628Insurance
      premium financing
              
              
              2,226
              
              
              
              2,653Interest
      rate swap liability
              
              
              12,110
              
              
              
              1,662Other
      liabilities
              
              
              1,958
              
              
              
              3,691Total
      other current liabilities
              
              $
              31,657
              
              
              $
              29,824




The
following schedule reflects activity associated with the Company’s allowance for
doubtful accounts for the years ended December 31, 2008, 2007 and 2006 (in
thousands):


2008
              
              
              2007
              
              
              2006
      (2)(Successor)Allowance
      for Doubtful AccountsBalance—beginning
      of the period(1)
              
              $
              6,849
              
              
              $
              8,235
              
              
              $
              4,459Provision for doubtful
      accounts(2)
              
              
              6,492
              
              
              
              6,857
              
              
              
              5,391Write-off of uncollectible
      accounts(2)
              
              
              (7,932
              )
              
              
              (8,191
              )
              
              
              (1,615
              )Balance—end
      of the period
              
              $
              5,409
              
              
              $
              6,901
              
              
              $
              8,235




(1)
            Beginning
      balance for the year ended December 31, 2008 has been adjusted to exclude
      accounts receivable related to discontinued operations.(2)
            2006
      amounts include provision and write-offs recorded during the one month
      ended January 31, 2006
(Predecessor).




44




5.
            PROPERTY
      AND EQUIPMENT




Property
and equipment at December 31, 2008 and 2007 consists of the following
(in thousands):


2008
              
              
              2007Land
              
              $
              21,373
              
              
              $
              19,230Building
      and improvements
              
              
              65,733
              
              
              
              63,316Leasehold
      improvements
              
              
              22,147
              
              
              
              19,424Furniture
      and fixtures
              
              
              11,556
              
              
              
              9,571Computer
      equipment
              
              
              9,474
              
              
              
              8,146Computer
      software
              
              
              9,495
              
              
              
              4,291Motor
      vehicles
              
              
              5,568
              
              
              
              4,516Field
      equipment
              
              
              2,901
              
              
              
              2,382Construction
      in progress
              
              
              12,013
              
              
              
              8,792160,260
              
              
              
              139,668Less
      accumulated depreciation
              
              
              (30,532
              )
              
              
              (16,731
              )Property
      and equipment—net
              
              $
              129,728
              
              
              $
              122,937




Depreciation
expense was $14.2 million, $11.3 million, $5.2 million, and $0.3 million for the
years ended December 31, 2008 and 2007, eleven months ended December 31,
2006, and one month ended January 31, 2006, respectively. For the year
ended December 31, 2008, the Company recognized non-cash charges of $3.0 million
for impairment of property and equipment consisting of $1.4 million related to
its youth division assets and $1.6 million related to its recovery division
assets.  Property and equipment impairment charges are recorded in the
Company’s consolidated statement of operations under discontinued
operations.  See Notes 18 and 19.






6.
            GOODWILL
      AND INTANGIBLE ASSETS





Changes
to goodwill by reportable segment for the year ended December 31, 2008 are
as follows (in thousands):


Recovery
      (restated)
            
            
            Youth
              (restated)
            
            
            Corporate/
              Other
            
            
            TotalGoodwill December 31, 2007
            
            $
            488,318
            
            
            $
            218,821
            
            
            $
            23,545
            
            
            $
            730,684Goodwill additions
            
            
            11,304
            
            
            
            —
            
            
            
            —
            
            
            
            11,304Goodwill impairment
            
            
            (624
            )
            
            
            (142,238
            )
            
            
            —
            
            
            
            (142,862
            )Goodwill related to earnouts
            
            
            —
            
            
            
            641
            
            
            
            —
            
            
            
            641Goodwill adjustments
            
            
            2,533
            
            
            
            1,731
            
            
            
            47
            
            
            
            4,311Goodwill December 31, 2008
            
            $
            501,531
            
            
            $
            78,955
            
            
            $
            23,592
            
            
            $
            604,078





Subsequent
to the issuance of the 2007 financial statements, the Company determined
that errors were made in the allocation of goodwill attributable to the
Company's segments.  Goodwill as of December 31, 2007 has been reduced
by $3.9 million for the Company's recovery division and has been increased
by $3.9 million for the youth division from amounts previously
reported.





Goodwill
additions





Goodwill
additions consist primarily of additions related to acquisitions during the
periods reported.  For the year ended December 31, 2008, additions to
goodwill were $11.3 million attributable to two acquisitions completed during
the third quarter.





Goodwill
impairment





In the
third quarter of 2008, the Company tested its youth and healthy living divisions
for impairment, in advance of the annual test date, based upon restructuring
activity and deteriorating economic conditions. The Company recorded a non-cash
impairment charge of $142.2 million related to its youth division, which is
reflected as goodwill impairment in continuing operations on the consolidated
statement of operations.





As of
December 31, 2008, certain facilities within the Company’s recovery division
were classified as held for sale. A portion of the recovery division goodwill
was allocated to these assets held for sale on a relative fair value
basis.  At December 31, 2008, the Company determined that the carrying
value of the assets held for sale exceeded the fair
value.  Accordingly, the Company recognized $0.6 million goodwill
impairment charge which is recorded within discontinued operations on the
consolidated statement of operations.





Goodwill related
to earnouts




Certain
acquisition agreements contain contingent earnout provisions that provide for
additional consideration to be paid to the sellers if the results of the
acquired entity's operations exceed negotiated benchmarks. During the year ended
December 31, 2008, the youth segment recorded $0.6 million
in additional goodwill as a result of one of the entities meeting the
benchmarks.




Goodwill
adjustments




Goodwill
adjustments include a $1.8 million correction related to an above
market lease from an acquisition completed in 2007 and a $2.5 million
correction of estimated deferred tax benefits related to acquisitions occurring
in 2006.





45


Intangible assets at December 31, 2008 and 2007 consist of the following (in
thousands):





December  31,
      2008 (Successor)
            
            December 31,
      2007 (Successor)Useful
              Life
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Carrying
              Amount
            
            Useful
              Life
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Carrying
              AmountIntangible
      assets
              subject
      to amortization:Referral
      network
            20 years
            
            $
            35,914
            
            
            $
            (3,823
            )
            
            $
            32,091
            
            20 years
            
            $
            45,400
            
            
            $
            (2,554
            )
            
            $
            42,846Accreditations
            20
      years
            
            
            16,118
            
            
            
            (1,722
            )
            
            
            14,396
            
            20
      years
            
            
            24,400
            
            
            
            (1,373
            )
            
            
            23,027Curriculum
            20
      years
            
            
            8,743
            
            
            
            (929
            )
            
            
            7,814
            
            20
      years
            
            
            9,000
            
            
            
            (506
            )
            
            
            8,494Government
              includingMedicaid
      contracts
            15 years
            
            
            34,979
            
            
            
            (6,806
            )
            
            
            28,173
            
            15 years
            
            
            35,600
            
            
            
            (4,548
            )
            
            
            31,052Managed
      care
              contracts
            10
      years
            
            
            14,400
            
            
            
            (4,200
            )
            
            
            10,200
            
            10
      years
            
            
            14,400
            
            
            
            (2,759
            )
            
            
            11,641Managed
      care
              contracts
            5
      years
            
            
            100
            
            
            
            (25
            )
            
            
            75
            
            5
      years
            
            
            100
            
            
            
            (5
            )
            
            
            95Core
      developed
              technology
            5
      years
            
            
            2,704
            
            
            
            (1,582
            )
            
            
            1,122
            
            5
      years
            
            
            2,704
            
            
            
            (1,041
            )
            
            
            1,663Covenants
      not to
              compete
            3
      years
            
            
            152
            
            
            
            (152
            )
            
            
            —
            
            3
      years
            
            
            152
            
            
            
            (128
            )
            
            
            24Total
      intangible assets
              subject
      to amortization:
            
            
            $
            113,110
            
            
            $
            (19,239
            )
            
            
            93,871
            
            
            
            $
            131,756
            
            
            $
            (12,914
            )
            
            
            118,842Intangible
      assets not
              subject
      to amortization:Trademarks and
              trade
      names
            
            
            
            
            
            
            
            
            
            
            
            176,587
            
            
            
            
            
            
            
            
            
            
            
            
            183,725Certificates
      of need
            
            
            
            
            
            
            
            
            
            
            
            44,600
            
            
            
            
            
            
            
            
            
            
            
            
            44,600Regulatory
              licenses
            
            
            
            
            
            
            
            
            
            
            
            39,405
            
            
            
            
            
            
            
            
            
            
            
            
            43,221Total
      intangible assets
              not
      subject to
              amortization
            
            
            
            
            
            
            
            
            
            
            
            260,592
            
            
            
            
            
            
            
            
            
            
            
            
            271,546Total
      intangible assets
            
            
            
            
            
            
            
            
            
            
            $
            354,463
            
            
            
            
            
            
            
            
            
            
            
            $
            390,388








Amortization
expense related to intangible assets subject to amortization
was   $8.1 million, $10.4 million, 4.9 million, and $0.02 million
for the years ended December 31, 2008 and 2007, the eleven months ended December
31, 2006, and the one month ended January 31, 2006 respectively. As a result of
impairment testing during the year, the Company recognized non-cash impairment
charges of $16.9 million related to intangibles subject to amortization and
$10.9 million related to intangible assets not subject to
amortization.  Of the total impairment charges, $4.5 million of
charges related to intangible assets not subject to amortization are recognized
in continuing operations on the Company’s consolidated statement of operations
under asset impairment. The remaining impairment charges are recognized in
discontinued operations.




Estimated
future amortization expense related to the amortizable intangible assets at
December 31, 2008 is as follows (in thousands):




Fiscal
      Year2009
            
            $
            7,3712010
            
            
            7,3712011
            
            
            6,8712012
            
            
            6,8252013
            
            
            6,810Thereafter
            
            
            58,623Total
            
            $
            93,871


46


7.
            INCOME
      TAXES







The
provision for income taxes from continuing operations for the year ended
December 31, 2008 and 2007, the eleven months ended December 31, 2006 and
the one month ended January 31, 2006 consists of the following
(in thousands):


Eleven Months
              
              
              One
      MonthYear
      Ended
              
              
              Year
      Ended
              
              
              Ended
              
              
              EndedDecember 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006(Successor)
              
              
              (Predecessor)Current:Federal
              
              $
              269
              
              
              $
              (854
              )
              $
              
              (9,178
              )
              
              $
              —State
      and local
              
              
              2,353
              
              
              
              2,690
              
              
              
              297
              
              
              
              —Total
      current
              
              
              2,622
              
              
              
              1,836
              
              
              
              (8,881
              )
              
              
              —Deferred:Federal
              
              
              (7,876
              )
              
              
              538
              
              
              
              2,719
              
              
              
              (12,329
              )State
      and local
              
              
              (612
              )
              
              
              72
              
              
              
              8,913
              
              
              
              (145
              )Total
      deferred
              
              
              (8,488
              )
              
              
              610
              
              
              
              11,632
              
              
              
              (12,474
              )Income
      tax (benefit) expense
              
              $
              (5,866
              )
              
              $
              2,446
              
              $
              
              2,751
              
              
              $
              (12,474
              )
  The
Company's overall tax benefits amount to $17.1 million, representing an
effective tax rate of 10.8% on all operations as of December 31, 2008. Out of
these $17.1 million tax benefits, $5.9 million are related to continuing
operations, representing an effective tax rate of 4.6% on continuing operations.
The remaining $11.2 million are related to discontinued operations, representing
an effective tax rate of 34.7% for discontinued operations.




Income
Tax on Goodwill Impairment





During
the year ended December 31, 2008, the Company recognized a total of $173.7
million in impairments related to both tangible and intangible assets. Of the
$173.7 million in impairment, $170.7 million is related to impairment of
goodwill and other intangibles. The remaining $3.0 million is related to
fixed asset impairments.





Of the
$170.7 million in impairments related to goodwill and other intangibles, $102.9
million represents goodwill that is non-deductible for income tax purposes,
resulting in an increase to federal income tax expense by $36.0 million. The
$36.0 million increase in income tax expense reduced the income tax benefit to
the Company’s total effective tax rate by 22.7%. Of the $36 million income tax
expense, $35.8 million is related to continuing operations and $0.2 million is
related to discontinued operations, representing an effective income tax rate
change of 28.3% and 0.7%, respectively.





Of the
total impairments, $67.7 million impairment generated approximately $27.0
million of income tax benefits in the form of future tax deductions. The $67.7
million of impairments relate to goodwill and other intangible assets which the
Company acquired through prior years acquisitions.





Income
Tax from Discontinued Operations





The
effective tax rate for discontinued operations is 34.7% for the year ended
December 31, 2008, which is different from the discontinued operations blended
statutory tax rate of 35.4%. This is primarily due to the effects of goodwill
impairment representing a 0.7% favorable impact on effective tax
rate.




The
following table summarizes the differences between the federal statutory tax
rate and the Company’s effective tax rate on income from continuing operations
for financial statement purposes:




Eleven Months
              
              
              One
      MonthYear
      Ended
              
              
              Year
      Ended
              
              
              Ended
              
              
              EndedDecember 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
              
              
              2006(Successor)
              
              
              (Predecessor)Statutory
      federal rate
              
              
              35.0
              %
              
              
              35.0
              %
              
              
              35.0
              %
              
              
              35.0
              %State
      taxes—net of federal tax benefit
              
              
              (0.7
              )
              
              
              77.1
              
              
              
              20.9
              
              
              
              2.4Change
      in valuation allowance
              
              
              (1.0
              )
              
              
              —
              
              
              
              —
              
              
              
              —Acquisition
      costs
              
              
              —
              
              
              
              —
              
              
              
              13.5
              
              
              
              (14.1
              )Non
      deductible expenses
              
              
              (0.2
              )
              
              
              7.3
              
              
              
              0.1
              
              
              
              —Prior
      year provision true-ups
              
              
              (0.3
              )
              
              
              4.4
              
              
              
              —
              
              
              
              —Release
      of tax reserve
              
              
              —
              
              
              
              (44.1
              )
              
              
              (25.4
              )
              
              
              —Goodwill
      impairment
              
              
              (28.3
              )
              
              
              —
              
              
              
              —
              
              
              
              —Other
              
              
              0.1
              
              
              
              6.8
              
              
              
              3.7
              
              
              
              0.9Effective
      tax rate
              
              
              4.6
              %
              
              
              86.5
              %
              
              
              47.8
              %
              
              
              24.2
              %




47


Deferred
Taxes





Deferred
taxes arise because of different timing treatment between financial statement
accounting and tax accounting, known as “temporary differences.” We record the
tax effect of these temporary differences as “deferred tax assets” (generally
items that can be used as a tax deduction or credit in future periods) or
“deferred tax liabilities” (generally items for which we received a tax
deduction, but that have not yet been recorded in the consolidated statement of
operations).





The tax
effect of the major items recorded as deferred tax assets and liabilities at
December 31, 2008 (continuing operations only) and 2007 is as follows
(in thousands):





2008
            
            
            2007(Successor)Deferred
      tax assets:Reserves
      and allowances
            
            $
            4,006
            
            
            $
            6,540Net
      operating loss carryforwards
            
            
            1,277
            
            
            
            7,186Research
      credits
            
            
            1,295
            
            
            
            1,969Acquisition
      costs
            
            
            3,184
            
            
            
            3,151Flow
      through entity
            
            
            204
            
            
            
            —Stock
      based compensation
            
            
            5,637
            
            
            
            3,211Charitable
      contributions
            
            
            97
            
            
            
            75State
      taxes
            
            
            8
            
            
            
            59Interest
      rate swap
            
            
            5,356
            
            
            
            453Gross
      deferred tax assets
            
            
            21,064
            
            
            
            22.644Valuation
      allowance
            
            
            (8,127
            )
            
            
            (5,124
            )Total
      deferred tax assets
            
            
            12,937
            
            
            
            17,520Deferred
      tax liabilities:Acquired
      intangible assets
            
            
            (142,999
            )
            
            
            (142,768
            )Depreciation
      and amortization
            
            
            (240
            )
            
            
            (13,729
            )Flow
      through entity
            
            
            —
            
            
            
            (291
            )Total
      deferred tax liabilities
            
            
            (143,239
            )
            
            
            (156,788
            )Total
      net deferred tax liabilities
            
            $
            (130,302
            )
            
            $
            (139,268
            )


The
deferred tax assets (liabilities) are contained in the following tax accounts on
the consolidated balance sheet as of December 31, 2008 for continuing and
discontinued operations separately:


Continuing
      Operations
              
              
              Discontinued
      Operations
              
              
              Total
      Deferred Tax Assets (Liabilities)Current
      deferred tax asset
              
              $
              4,029
              
              
              $
              —
              
              
              $
              4,029Current
      assets of discontinued operations, facility exits
              
              $
              —
              
              
              $
              12,558
              
              
              $
              12,558Noncurrent
      deferred tax liability
              
              $
              (134,331
              )
              
              $
              —
              
              
              $
              (134,331
              )
  At
December 31, 2008, the Company had $4.9 million and $57.9 million of U.S.
federal and state net operating loss carry forwards, respectively, available to
offset future taxable incomes, which expire in varying amounts beginning in 2027
and 2012 respectively, if not utilized. Under the Tax Reform Act of 1986, the
amounts of and benefits from net operating loss carry forwards may be impaired
or limited in certain circumstances. Events which cause limitations in the
amount of net operating losses that the company may utilize in any one year
include, but are not limited to, a cumulative ownership change of more than 50%,
as defined, over a three-year period. At December 31, 2008, the Company's net
operating loss and credit carry forwards may be subject to such
limitations.




At
December 31, 2008, the Company had approximately $0.5 million and $0.3 million
of federal and state research and development credit carry forwards,
respectively. Federal credits will expire in varying amounts beginning in 2022,
if not utilized. The state credits carry forward indefinitely.




As of
December 31, 2008, the Company also had $0.9 million of federal alternative
minimum tax credit that can be carried forward indefinitely to offset the future
federal regular tax liability.




The
Company has established a valuation allowance against certain deferred tax
assets due to uncertainty surrounding the realization of such assets. At
December 31, 2008, the valuation allowance applied to certain deferred tax
assets was $8.1 million, which increased by $3.0 million from December 31,
2007.  Management evaluates on a periodic basis the recoverability of
these deferred tax assets. At such time as is determined that it is more likely
than not that these deferred tax assets are realizable; the valuation allowance
will be reduced.




Our
income tax returns are audited by federal and various states tax authorities. We
are currently under examination by the Internal Revenue Service for the tax year
2006 and by various state jurisdictions for various tax years. We periodically
evaluate our exposures associated with our tax filing
positions.




Unrecognized
tax benefit




At
December 31, 2008, the Company’s total unrecognized tax benefits were
approximately $1.1 million exclusive of interest and penalties described below.
Included in this amount is approximately $1.0 million of unrecognized tax
benefits that, if recognized, would favorably affect the effective tax rate in a
future period. The Company does not expect that the unrecognized tax benefits
will significantly increase or decrease within the next twelve
months.




The
Company’s practice is to recognize interest and/or penalties related to
unrecognized tax benefits in income tax expense. At December 31, 2008 and 2007,
the Company had $0.1 million and $0.1 million accrued for estimated
interest.




48


The
Company is no longer subject to U.S. federal, state and local income tax audits
by taxing authorities for years prior to 2004. The tax years 2004
through 2007 remain open to examination by major taxing jurisdictions to which
the Company is subject, in the United States. In addition, the Company has net
operating losses in certain states for which the statute of limitations relative
to the net operating loss carryovers is open from 2001.




A
reconciliation of the beginning and ending gross unrecognized tax benefits for
the years ended December 31, 2008 and 2007 (in thousands) is as
follows:




2008
              
              
              2007Balance
      at the beginning of
              
              $
              1,075
              
              
              $
              1,918Tax
      positions related to current year:AdditionsReductionsTax
      positions related to prior years:Additions
              
              
              112
              
              
              
              464ReductionsSettlementsLapse
      of statute of limitations
              
              
              (90
              )
              
              
              (1,307
              )Balance
      at December 31
              
              $
              1,097
              
              
              $
              1,075


8.
            LONG-TERM
      DEBT


Long-term
debt at December 31, 2008 and 2007 consists of the following (in
thousands):


2008
              
              
              2007Term
      loan
              
              $
              409,841
              
              
              $
              414,034Revolving
      line of credit
              
              
              61,500
              
              
              
              26,500Senior
      subordinated notes, net of discount of $1,870 in 2008 and $2,407 in
      2007
              
              
              175,426
              
              
              
              197,593Seller
      notes
              
              
              6,216
              
              
              
              10,206Lessor
      financing, leasehold improvement
              
              
              157
              
              
              
              —Capital
      lease obligations
              
              
              12
              
              
              
              34Total
      debt
              
              
              653,152
              
              
              
              648,367Less
      current portion
              
              
              (6,522
              )
              
              
              (35,603
              )Long-term
      debt—less current portion
              
              $
              646,630
              
              
              $
              612,764




Term Loan and
Revolving Line of Credit— On February 6, 2006, concurrent with the Bain
Merger, the Company entered into a Credit Agreement (the “Credit Agreement”)
with a syndicate of institutional lenders and financial institutions. The Credit
Agreement provided for financing of $245.0 million in senior secured term loans
and $100.0 million of revolving line of credit. On November 17, 2006,
concurrent with the Aspen Acquisition, the Company amended and restated the
Credit Agreement (the “Amended and Restated Credit Agreement”) entered into
during the Bain Merger. The Amended and Restated Credit Agreement provides for
financing of $419.3 million in senior secured term loans (“Term Loan”) and
$100.0 million of revolving line of credit. The Company borrowed $175.5 million
in senior secured term loans upon execution of the amendment. Effective
April 16, 2007, the Company entered into Amendment No. 2 (“Amendment
No. 2”) that amends the Company’s Amended and Restated Credit Agreement.
Under Amendment No. 2, the Term Loan interest is payable quarterly at 90
day LIBOR plus 2.25% per annum (previously 2.50% per annum); provided
that on and after such time if the Company’s corporate rating from Moody’s is at
least B1 then the interest is payable quarterly at 90 day LIBOR plus
2.0% per annum.




Term
Loan—Aggregate commitment of $419.3 million matures on February 6,
2013. The Term Loan is payable in quarterly principal installments of $1.05
million per quarter through December 31, 2012, and the remainder on
February 6, 2013. Interest is payable quarterly at 90 day London Interbank
Offered Rate (“LIBOR”) plus 2.25% (3.675% at December 31, 2008). Under the
Amendment No. 2, the Company must comply with certain restrictive financial
covenants that limit the amount of capital expenditures the Company may make on
an annual basis and require the Company to maintain certain levels of liquidity,
debt to income ratios and interest coverage ratios. The Company was in
compliance with all such covenants as of December 31, 2008. The principal
balance outstanding at December 31, 2008 was $409.8 million.




Revolving Line of
Credit—Maximum borrowings are not to exceed $100.0 million. At the
Company’s option, interest is currently payable at LIBOR plus 2.50% or monthly
at the Base Rate (defined as the higher of (a) the prime rate or
(b) the overnight federal funds rate plus 50 basis points) plus
1.50% per annum. Principal is payable at the Company’s discretion based on
available operating cash balances. The revolving line of credit commitment
expires on February 6, 2012. At December 31, 2008, the outstanding balance
under the revolving line of credit was $61.5 million. Based on periodic review
of its debt structure, the Company determined it appropriate to classify $61.5
million related to the revolving line of credit as long-term debt as the company
does not intend to repay such amount in 2009. From time to time the revolving
line of credit may include one or more swing line loans at the Base Rate or one
or more letters of credit (“LCs”). At December 31, 2008, there was no
outstanding balance on the swing line loans. LCs outstanding at December 31,
2008 and 2007 were $8.1 million and $6.3 million, respectively, with interest
payable quarterly at LIBOR plus 2.50% per annum. The LCs secure various
liability and workers’ compensation policies in place for the Company and its
subsidiaries. The Company has historically and currently intends to make
payments to reduce borrowing under the revolving line of credit from operating
cash flow. In addition, the Company expects that future financings will serve
not only to partially fund acquisitions but also to repay all or part of any
outstanding revolving line of credit balances then outstanding.




Senior
Subordinated Notes—Concurrent with the Bain Merger, the Company issued
$200.0 million aggregate principal amount of 10 3/4% Senior Subordinated Notes
(the “Notes”) due February 1, 2016 (see Note 3). Interest is payable
semiannually beginning August 1, 2006. The Notes were issued at a price of
98.511%, resulting in $3.0 million of original issue discount. The Company may
redeem some or all of the Notes on or prior to February 1, 2011 at a
redemption price equal to 100% of the principal amount of the Notes redeemed
plus a “make-whole” premium or at the redemption prices set forth in the
indenture governing the Notes. The Company may also redeem up to 35% of the
aggregate principal amount of the Notes using the proceeds of one or more equity
offerings completed before February 1, 2009. If there is a change of
control as specified in the indenture, the Company must offer to repurchase the
Notes. The Notes are subordinated to all of the Company’s existing and future
senior indebtedness, rank equally with all of the Company’s existing and future
senior subordinated indebtedness and rank senior to all of the Company’s
existing and future subordinated indebtedness. The Notes are guaranteed on an
unsecured senior subordinated basis by all the Company’s wholly owned
subsidiaries.




During
the fourth quarter ended December 31, 2008 the Company retired senior
subordinated notes with a par amount of $22.7 million. Excluding immaterial
transaction related costs, the Company realized a gain of $8.1 million related
to debt retirement activities, which is included in gain on debt repurchase
and other financing costs on the Company’s consolidated statement of
operations.


49


Seller
Notes—Represents notes payable for amounts owed by the Company arising
out of achievement of certain earn out obligations per the terms of the
underlying purchase agreements and to fund acquisitions made by Aspen Education
Group prior to the acquisition of Aspen Education Group by the Company. Interest
rates on these notes range from 6.75% to 10.25%. Principal and interest are
payable quarterly through January 2012.




Lessor
Financing— Leasehold improvements at two facilities leased by the Company
were financed by the lessor. Such amounts are due and payable in the aggregate
amount of approximately $0.3 million.




Capital
Leases—Principal and interest are payable monthly at various dates
through December 2009. Interest rates range from 5.00% to 12.20%.




Interest
expense on total debt was $55.0 million for the year ended December 31, 2008
inclusive of $0.8 million of capitalized interest, $61.0 million for the year
ended December 31, 2007, $41.5 million in the eleven months ended
December 31, 2006, and $2.5 million in the one month ended January 31,
2006.




At
December 31, 2008, currently scheduled principal payments of total long-term
debt, excluding discount on senior subordinated notes, are as follows (in
thousands):




Total2009
            
            $
            6,4872010
            
            
            5,9082011
            
            
            7,1052012
            
            
            66,1172013
            
            
            393,250Thereafter
            
            
            177,296Total
            
            $
            656,163






9.
            FAIR
      VALUE MEASUREMENTS




The
Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements(“SFAS 157”) on
January 1, 2008. SFAS 157 applies to all assets and liabilities that are
being measured and reported on a fair value basis. As defined in SFAS 157, fair
value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. SFAS 157 also establishes a fair value hierarchy that
prioritizes the inputs to valuation techniques used to measure fair value. The
fair value hierarchy, under the provisions of SFAS 157, also requires an entity
to maximize the use of quoted market prices and minimize the use of unobservable
inputs. An asset or liability’s level is based on the lowest level of input that
is significant to the fair value measurement. The statement requires that assets
and liabilities carried at fair value be classified and disclosed in one of the
following three categories:




Level 1:
            Quoted
      prices (unadjusted) in active markets for identical assets or
      liabilities;Level 2:
            Inputs
      other than quoted prices included within Level 1 that are either directly
      or indirectly observable;Level 3:
            Unobservable
      inputs in which little or no market activity exists, therefore requiring
      an entity to develop its own assumptions about the assumptions that market
      participants would use in pricing.




The
Company values its interest rate swaps using terminal values which are derived
using proprietary models based upon well recognized financial principles and
reasonable estimates about relevant future market conditions. These instruments
are allocated to the Level 2 on the SFAS 157 fair value hierarchy because the
critical inputs into these models, including the relevant yield curves and the
known contractual terms of the instrument, are readily available. As
of December 31, 2008, the aggregate fair value of the Company’s interest
rate swap agreements was a liability of $12.1million compared to a liability of
$1.7 million at December 31, 2007.




10.
            OTHER
      COMPREHENSIVE INCOME




Other
comprehensive income includes other gains and losses affecting equity that are
excluded from net income. The components of other comprehensive (loss) income
consist of changes in the fair value of derivative financial
instruments.




Comprehensive
(loss) income for the year ended December 31, 2008 and 2007 are comprised of the
following (in thousands):


2008
              
              
              2007Net
      (loss) income
              
              $
              (141,905
              )
              
              $
              1,464Other
      comprehensive (loss), net of taxNet
      change in unrealized losses on cash flow hedges, net of tax benefit of
      $4,160
              
              
              (6,289
              )
              
              
              —Total
      comprehensive (loss) income
              
              $
              (148,194
              )
              
              $
              1,464


11.
            FINANCIAL
      INSTRUMENTS




Derivatives
–Interest Rate
Swaps





At
December 31, 2008, the Company had an interest rate swap agreement (the " 2006
swap") which converted $60.0 million of its floating-rate debt to fixed-rate
debt at 4.99%.  The effective date of the agreement is March 31, 2006
and has a maturity date of March 31, 2011.  At June 30, 2008, the
interest rate swap had not been designated as a qualifying hedge under the
provisions of SFAS 133. On July 1, 2008 (the “off-market” date) the Company
designated the interest rate swap as a qualifying SFAS 133 cash
flow hedge.




On June
30, 2008, the Company entered into an interest rate swap agreement (the
"2008 swap") to provide for interest rate protection for an aggregate notional
amount of $200.0 million. The effective date of the agreement is June 30, 2008
and has a maturity date of July 1, 2011. Under the interest rate swap, the
Company receives an interest rate equal to 3-month LIBOR and in exchange pays a
fixed rate of 3.875%. The interest rate swap agreement is designated as a cash
flow hedge under SFAS 133.




50


For the
2006 swap, the Company recorded  an unrealized loss of approximately
$0.4 million during the year ended December 31, 2008, which is recorded in
OCI net of tax. Additionally, the Company recognized $0.3 million in cumulative
hedge ineffectiveness related to the embedded financing element of the 2006 swap
which is recorded in interest expense, net on the Company’s consolidated
statement of operations.  For the six months ended June 30, 2008, and
prior to the off-market date, the Company recognized an
immaterial loss for the 2006 swap which is recorded in other (expense)
income.  For the year ended December 31, 2007 and the eleven months ended
December 31, 2006, the Company recorded a loss of $1.8 million and a gain
of $0.1 million respectively for the 2006 swap, which were
recognized in other (expense) income on the Company’s consolidated
statements of operations.   The Company recorded unrealized
losses of approximately $5.9 million for the year ended December 31,
2008 related to the 2008 swap which is recorded in OCI net of tax.  As of
December 31, 2008, the Company does not anticipate reclassification of any
amounts, related to its interest rate swap hedging activities, from accumulated
OCI to earnings within the next twelve months.


12.
            COMMITMENTS AND
      CONTINGENCIES




Operating
Leases—The Company leases various office space, clinic offices,
facilities and equipment under non cancelable operating leases throughout the
United States with various expiration dates through November 2026. Rent expense
was $22.1 million, $19.7 million, $8.5 million and $0.3 million for the years
ended December 31, 2008, and 2007, the eleven months ended December 31,
2006 and the one month ended January 31, 2006, respectively. The Company
earned $0.5 million in sublease rental income for the year ended December 31,
2008, $0.4 million for the year ended December 31, 2007 and $0.3 million for the
eleven months ended December 31, 2006, but did not earn any sublease rental
income for the one month ended January 31, 2006. The terms of certain
facility leases provide for annual scheduled increases in cost adjustments and
rental payments on a graduated scale. Related party leases arise as a result of
the Company’s acquisitions (see Note 16). Such related party leases are due and
payable on a monthly basis on similar terms and conditions as the Company’s
other leasing arrangements. In addition, the Company is also responsible for
certain expenses including property tax, insurance and maintenance costs
associated with some of the clinic offices and facility leases.




Future
minimum lease payments under all non cancelable operating leases at December 31,
2008 are as follows (in thousands):




Third Party
              Operating
              Lease
              Payments
            
            
            Related Party
              Operating
              Lease
              Payments
            
            
            Total
              Operating
              Lease
              Payments2009
            
            $
            16,371
            
            
            $
            2,207
            
            
            $
            18,5782010
            
            
            13,701
            
            
            
            1,951
            
            
            
            15,6522011
            
            
            10,608
            
            
            
            1,860
            
            
            
            12,4682012
            
            
            8,847
            
            
            
            1,835
            
            
            
            10,6822013
            
            
            7,137
            
            
            
            1,614
            
            
            
            8,751Thereafter
            
            
            51,370
            
            
            
            9,347
            
            
            
            60,717Total
      minimum lease payments
            
            $
            108,034
            
            
            $
            18,814
            
            
            $
            126,848




Indemnifications—The
Company provides for indemnification of directors, officers and other persons in
accordance with limited liability agreements, certificates of incorporation,
bylaws, articles of association or similar organizational documents, as the case
may be. The Company maintains directors’ and officers’ insurance which should
enable the Company to recover a portion of any future amounts paid.




In
addition to the above, from time to time the Company provides standard
representations and warranties to counterparties in contracts in connection with
business dispositions and acquisitions and also provide indemnities that protect
the counterparties to these contracts in the event they suffer damages as a
result of a breach of such representations and warranties or in certain other
circumstances relating to such sales or acquisitions.




While the
Company’s future obligations under certain agreements may contain limitations on
liability for indemnification, other agreements do not contain such limitations
and under such agreements it is not possible to predict the maximum potential
amount of future payments due to the conditional nature of the Company’s
obligations and the unique facts and circumstances involved in each particular
agreement. Historically, no payments have been made under any of these
indemnities.




Consulting
Agreements—The Company has entered into consulting agreements with
certain professionals who require annual consulting fee payments which range
from $0.1 million to $0.2 million per annum. Typically such professionals are
valuation experts, actuaries, business advisory services, and behavioral health
experts. The consulting agreements range from a period of one to seven years. In
the event that such consulting agreements are terminated without cause, the
Company may be contractually obligated to pay the remaining balance due on the
consulting agreements. In addition, two Directors receive compensation of
$10,000 and $5,000 per month in connection with consulting services provided to
the Company.




The
following is a schedule of the Company’s future minimum annual payments under
such consulting agreements as of December 31, 2008 (in thousands):




2009
            
            $
            3462010
            
            
            2062011
            
            
            782012
            
            
            —2013
            
            
            —Thereafter
            
            
            —Total
            
            $
            630




Self Insurance
Plans—Effective May 2004, the Company established a self-insurance
program for workers’ compensation benefits for employees. Self-insurance
reserves are based on past claims experience and projected losses for incurred
claims and include an estimate of costs for claims incurred but not reported at
the balance sheet date. The Company obtains an independent actuarial valuation
of the estimated costs of claims reported but not settled, and claims incurred
but not reported and may adjust the reserves based on the results of the
valuations. Insurance coverage, in excess of the per occurrence self-insurance
retention, has been secured with insurers for specified amounts. The reserve for
self-insured workers’ compensation claims was $3.2 million and $2.2 million at
December 31, 2008 and 2007, respectively, and is included in accrued liabilities
on the consolidated balance sheet.




The
Company is self insured for the cost of the Aspen employee group health
insurance. Insurance coverage, in excess of the per occurrence self-insurance
retention, has been secured with insurers for specified amounts. Self-insurance
reserves are based on projected costs for incurred claims and include an
estimate of costs of claims incurred but not reported at the balance sheet date.
The reserve for self-insured health insurance claims totaled $0.7 million at
December 31, 2008 and 2007, respectively, and is included in accrued
liabilities on the consolidated balance sheet.




Litigation—The
Company is involved in litigation and regulatory investigations arising in the
course of business. After consultation with legal counsel, management estimates
that these matters will be resolved without material adverse effect on the
Company’s future financial position or results from operations and cash
flows.


51


13.
            MANDATORILY REDEEMABLE STOCK
      AND STOCKHOLDER’S EQUITY




Predecessor
Company




On
February 6, 2006 (February 1, for accounting purposes) the holders of
mandatorily redeemable stock and common stock in the Predecessor Company
liquidated their equity interest in connection with the Bain Merger (see Note
3). Concurrent with the Bain Merger and the related transactions, certain
mandatorily redeemable stock holders received a payout of their liquidation
preference of $99.4 million. Subsequent to the payout of the liquidation
preference, all redeemable convertible preferred and redeemable common stock,
was converted into Series A common stock of the Predecessor Company. The Series
A common stock holders and the common stock option holders received a
distribution in the amount of $338.9 million (includes $9.1 million of
management equity roll over). Upon consummation of the Bain Merger all the
outstanding mandatorily redeemable shares of 262,399,056 and Series A common
shares of 8,725,397 of the Predecessor Company were eliminated.




Successor
Company




Common
Stock




The
Company’s Amended and Restated Certificate of Incorporation authorizes the
Company to issue 1,000 shares of $0.001 par value common stock, all of which are
issued and outstanding as of December 31, 2008 and are held by the
Group.




Voting—Each
share of common stock is entitled, on all matters submitted for a vote or the
consent of the holders of shares of common stock, to one vote.




Capital
Contributed by Parent




As
discussed in Note 1, the Company is a wholly owned subsidiary of the
Group. Contributions to and distributions from the
Group are reflected as capital contributed by Parent,
net on the Company’s statement of stockholder’s equity. During the years
ended December 31, 2008 and 2007, the Company recorded capital contributions
from the Parent of $5.7 million and $5.0 million, respectively.




The
Company is included in the consolidated income tax returns of the Parent.
Settlements of intercompany tax receivable and payable amounts between the
Company and the Group are reflected as capital contributions or distributions on
the statement of stockholders’ equity.  During the year ended December
31, 2007, the Company received $0.8 million from the Parent representing
payment by the Group of the Company's tax liability.


The
Company recognizes stock-based compensation in conjunction with stock options
issued by the Group. Stock-based
compensation is primarily related to employees of the Company who have received
options to purchase Group stock. Stock based compensation expense associated
with these grants is recorded as a capital contribution from the
Parent.  For the year ended December 31, 2008 and 2007, the Company
recognized $6.0 million and $3.9 million in non-cash capital contribution from
the Parent.


Druing
the year ended December 31, 2008, the Company received $0.1
million in cash realted to stock
options exercised.  Additionally, during 2008 amd 2007,  the
Company paid approximately $0.4 million and $0.3 million in cash to
repurchase Group common stock as a result of stock options exercised. The
cash payment related to Group stock repurchase and retirement is recorded
as a capital distribution to the Parent.




During
the third quarter of 2007, the Company received a capital contribution of
$0.5 million from the Group. The Group funded the capital contribution with the
proceeds from the sale of Group equity securities.




In
November 2006, the Company received a capital contribution of $135.7 million
from the Group to fund the Aspen Acquisition (see Note 3). The Group funded such
capital contributions by a combination of $36.2 million resulting from the
sale of its equity securities to certain of the Group’s equity holders and by
the issuance of a PIK loan of $105.0 million issued at 1% original issue
discount for net proceeds of $103.9 million. The Group incurred $4.5 million of
financing costs in connection with the issuance of the PIK loan which was
treated as a reduction in the capital contribution. The interest payable per
annum for the PIK loan is 180 day LIBOR plus 7.0% per annum for the first
year, 180 day LIBOR plus 7.5% per annum for the second year and 180 day
LIBOR plus 8.0% for the years thereafter until the maturity date. Per the PIK
loan agreement, the interest is accrued through an increase in the principal
amount. The aggregate principal amount inclusive of the accrued interest matures
on November 17, 2013. This senior unsecured PIK loan is not guaranteed by
the Company or any of its subsidiaries. The PIK loan balance was $133.6 million
and $119.5 million including interest of $14.0 million and $13.9 million at
December 31, 2008 and 2007, respectively and is reflected as long term debt on
the Group's financial statements.




14.
            STOCK-BASED
      COMPENSATION




Description
of Share-Based Plans




2006
Executive Incentive Plan, 2006 Management Incentive Plan and 2007 Incentive
Plan




On
February 6, 2006, following the Bain Merger, the Group adopted the 2006
Executive Incentive Plan (the “Executive Plan”) and the 2006 Management
Incentive Plan (the “Management Plan”) and on September 7, 2007, the Group
adopted the 2007 Incentive Plan (the “Incentive Plan”). The Company refers to
the Executive Plan, Management Plan and Incentive Plan collectively as the
“Plans”. The Plans provide for options to purchase Group stock by the Company’s
key employees, directors, consultants and advisors. Options granted under the
Plans may be either incentive or non-incentive stock options. As of December 31,
2008, only non-incentive options (non-qualified under Internal Revenue Code 422)
have been awarded under the Plans. Options granted under the Plans represent
units. One unit consists of nine shares of class A and one share of class L
common stock of the Group.




Options
under the Plans may be granted for periods of up to ten years at an exercise
price generally not less than fair market value of the shares subject to the
award, determined as of the award date. In the case that the incentive stock
options are granted to a 10% shareholder, an exercise price shall not be less
than 110% of the fair market value of the shares subject to the award at the
grant date. All options granted under the Plans generally expire ten years from
the date of grant.




Options
granted under the Executive Plan and Incentive Plan vest in three tranches as
follows: tranche 1 options vest and become exercisable at the rate of 20% in one
year from the date of grant and 10% on each six-month period thereafter or, if
earlier, 100% on a change of control as defined in the plans; tranche 2 options
vest and become exercisable upon achievement of a market condition, as defined
in the Executive and Incentive plans; tranche 3 options vest and become
exercisable over a five-year period upon achievement of performance conditions
or alternatively upon achievement of a market condition, as defined in the
Executive and Incentive plans. Tranche 1 options represent 50% of an option
grant under the Executive Plan and Incentive plans and tranches 2 and 3 options
each represent 25% of the options granted under the Executive and Incentive
plans.




52


Options
granted under the Management Plan vest and become exercisable over five years as
follows: 20% in one year from the date of grant and 10% on each six-month period
thereafter or, if earlier, 100% on a change of control, as defined in the
Management Plan.




A maximum
of 5,734,053 shares of Class A common stock of the Group and 637,117 shares
of Class L common stock of the Group may be granted under the
Plans. Additional fully vested options under the Executive Plan of
1,184,809 shares of Class A common stock of the Group and 131,647 shares of
Class L common stock of the Group were issued in




Adoption
of SFAS 123(R)




On
January 1, 2006, the Company adopted SFAS 123(R), which requires the
measurement and recognition of compensation expense for all share-based payment
awards, including employee stock options, granted after January 1, 2006,
based on the grant-date fair value estimated in accordance with the provisions
of SFAS 123(R).




SFAS 123(R)
requires management to estimate the fair value of share-based payment awards on
the date of grant using an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as expense over the
requisite service periods in the consolidated statement of operations. The
Company attributes the fair value of stock option-based compensation to expense
on a straight-line, single option method. In addition, for the options that vest
upon the achievement of performance conditions, the Company recognizes
compensation expense only if the probability of achievement of such performance
conditions is assured.  Such expense is recognized starting from the
service inception date.




As stock
option-based compensation expense recognized in the consolidated statement of
operations for the years ended December 31, 2008 and 2007 and for the eleven
months 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 date of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. The
estimated forfeiture rate at December 31, 2008, 2007, and 2006 is 5% per
year. The Company previously accounted for forfeitures as they
occurred.




Prior to
the adoption of SFAS 123(R), the Predecessor Company presented all tax benefits
of deductions resulting from the exercise of stock options as operating cash
flows in the consolidated statement of cash flows. SFAS 123(R) requires the cash
flows resulting from the tax benefits resulting from tax deductions in excess of
the compensation cost recognized for those options to be classified as financing
cash flows.




SFAS
123(R) did not change the accounting guidance for share-based payment
transactions with parties other than employees and, accordingly, the Company
continues to account for stock options issued to non-employees in accordance
with the provisions of SFAS 123 as originally issued and EITF Issue
No. 96-18, Accounting for
Equity Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with, Selling Goods or Services.




Valuation
of Stock-Based Awards




The
Company estimates the fair value of stock options granted using the
Black-Scholes option valuation model for Management Plan grants, tranche 1
Executive Plan grants, and tranche 1 Incentive Plan grants. The Company uses the
Monte Carlo simulation approach to determine the fair value of tranche 2 and 3
Incentive Plan grants and tranche 2 and 3 Executive Plan grants. The estimated
fair value of awards granted is based upon certain assumptions, including
probability of achievement of market conditions for certain Executive Plan and
Incentive Plan awards, stock price, expected term, expected volatility, dividend
yield, and a risk-free interest rate. The weighted average grant date fair value
of units granted during the years  ended December 31, 2008 and 2007,
and the eleven months ended December 31, 2006 were $53.72, $56.31 and
$53.50 per unit, respectively. The fair value of share-based payment awards was
estimated using following assumptions.




Year
      Ended
              
              
              Year
      Ended
              
              
              Eleven
      Months EndedDecember 31,
              
              
              December 31,
              
              
              December 31,2008
              
              
              2007
              
              
              2006Black
      ScholesExpected
      term (in years)
              
              
              6.22
      - 6.40
              
              
              
              5.97
      - 6.47
              
              
              
              6.28
      -6.40Expected
      volatility
              
              
              38.7
      - 39.90
              %
              
              
              40.50 - 48.90
              %
              
              
              56.00
      – 57.00
              %Dividend
      yield
              
              
              0
              %
              
              
              0
              %
              
              
              0
              %Risk-free
      interest rate
              
              
              2.87
      - 3.40
              %
              
              
              3.50
      - 5.06
              %
              
              
              4.52
      – 5.14
              %Binomial
      (Monte Carlo simulation)Expected
      volatility
              
              
              50.80%
      -51.78
              %
              
              
              51.05 - 55.09
              %
              
              
              55.02
      – 57.00
              %Dividend
      yield
              
              
              0
              %
              
              
              0
              %
              
              
              0
              %Risk-free
      interest rate
              
              
              3.53
      - 3.94
              %
              
              
              3.94
      - 5.14
              %
              
              
              4.55
      – 5.14
              %




•
            Expected
      term used in the Black Scholes valuation model represents the period that
      the Company’s stock options are expected to be outstanding and is
      determined based on historical experience of similar awards, giving
      consideration to the contractual terms of the stock options, vesting
      schedules and expectation of future employee behavior as influenced by
      changes to the terms of its stock option
grants.




•
            Expected
      volatility utilized for the units granted is based on the historical
      volatility of comparable public companies for periods corresponding to
      expected term of the awards.




•
            No
      dividends are expected to be paid over the option
  term.




•
            The
      risk-free rate used for options granted is based on the implied yield on
      U.S. Treasury constant maturities issued with a term equal to the expected
      term of the options.




Stock-Based
Compensation Expense




Options
granted under the Plans are for the purchase of Group stock by the Company’s key
employees, directors, consultants and advisors. Stock based compensation expense
related to the stock options granted by the Group is being recorded on the
Company’s consolidated financial statements, as substantially all grants have
been made to employees of the Company. Under the provision of SFAS 123(R), the
Company recognizes stock based compensation costs net of an estimated forfeiture
rate and recognizes the compensation costs for only those shares expected to
vest on a straight-line basis over the requisite service period of the award.
For the years ended December 31, 2008 and 2007, the Company recognized
stock-based compensation expense of $6.0 million and $3.9 million respectively.
For the eleven months ended December 31, 2006, the Company recognized
stock-based compensation expense of $3.5 million. Stock-based compensation
expense is recorded within salaries and benefits on the consolidated statements
of operations. The total income tax benefit recognized in the consolidated
statement of operations for stock option-based compensation expense was $2.4
million, $1.5 million, and $1.6 million for the years ended December 31, 2008
and 2007, and the eleven months ended 2006, respectively.




53


The
Predecessor Company recognized share-based compensation expense of $17.7 million
and tax benefit of $7.3 million in consolidated statement of operations for the
one month ended January 31, 2006 related to the accelerated vesting of
Predecessor Company options. Such amount is included in the
acquisition related costs on the consolidated statement of
operations.




As of
December 31, 2008, $11.3 million of total unrecognized compensation, net of
estimated forfeitures of $0.6 million, is expected to be recognized over a
weighted-average period of 2.6 years if all performance conditions are met under
the provisions of the option plans.  During the years ended December
31, 2008 and 2007, 570,719 shares and 958,255 shares vested with an aggregate
grant date fair value of  $3.1 million and $5.1 million respectively.
For the eleven months ended December 31, 2006 no grants under the Plans
vested.




Stock
Option Activity under the Plans




During
the year ended December 31, 2008, the Group granted 48,162 units, which
represent 433,454 option shares to purchase Class A common stock of the
Group and 48,162 option shares to purchase Class L common stock of the
Group. Activity under the Plans for the year ended December 31, 2008 is
summarized below:




Weighted-
              
              
              Weighted-Average
              
              
              AverageExercise
              
              
              RemainingPrice
              
              
              Contractual TermOption Shares
              
              
              Per Share
              
              
              (In
      Years)Balance
      at December 31, 2007
              
              
              7,251,136
              
              
              $
              7.76
              
              
              
              8.33Granted
              
              
              481,616
              
              
              
              11.23
              
              
              
              9.43Exercised
              
              
              (81,698
              )
              
              
              1.50Forfeited/cancelled/expired
              
              
              (340,181
              )
              
              
              9.60Outstanding—December
      31, 2008
              
              
              7,310,873
              
              
              $
              7.97
              
              
              
              7.44Exercisable—December
      31, 2008
              
              
              2,794,053
              
              
              $
              5.57
              
              
              
              7.22Exercisable
      and expected to be exercisable
              
              
              6,945,329
              
              
              $
              7.97
  As of
December 31, 2008, the aggregate intrinsic value of share options outstanding,
exercisable, and outstanding and expected to be exercisable was $6.7 million,
$6.7 million and $6.4 million, respectively. The aggregate intrinsic value is
calculated as the difference between the exercise price of the underlying awards
and the fair value of the Group’s shares as of December 31, 2008.




The
aggregate intrinsic value of share options exercised under equity compensation
plans was $0.8 million and $0.3 million for the years ended December 31, 2008
and 2007 respectively.  There were no option exercises for the
Successor Company in 2006.




The
following table presents the composition of options outstanding and exercisable
as of December 31, 2008.




Options
      Outstanding
              
              
              Options
      ExercisableWeighted AverageRange of Exercise
              
              
              Number
      of
              
              
              Remaining Contractual
              
              
              Weighted Average
              
              
              Number
      of
              
              
              Weighted AveragePrices
              
              
              Shares
              
              
              Term
      (years)
              
              
              Exercise
      Price
              
              
              Shares
              
              
              Exercise
      Price$
      0.03 - $ 0.32
              
              
              
              1,090,517
              
              
              
              7.16
              
              
              $
              0.10
              
              
              
              1,090,519
              
              
              $
              0.10$
      1.00 - $ 3.30
              
              
              
              5,495,817
              
              
              
              7.50
              
              
              
              1.15
              
              
              
              1,430,654
              
              
              
              1.09$
      7.89 - $17.62
              
              
              
              114,616
              
              
              
              7.12
              
              
              
              8.07
              
              
              
              114,616
              
              
              
              8.07$
      81.00 - $98.16
              
              
              
              609,923
              
              
              
              7.50
              
              
              
              83.49
              
              
              
              158,264
              
              
              
              81.95Total
              
              
              
              7,310,873
              
              
              
              7.44
              
              
              $
              7.97
              
              
              
              2,794,053
              
              
              $
              5.57




15.
            EMPLOYEE
      BENEFITS




Defined
Contribution Plans







The
Company has a qualified 401(k) plan (the “401 K Plan”). The 401 K Plan is a
defined contribution plans, available to all eligible employees and allow
participants to contribute up to the legal maximum of their eligible
compensation, not to exceed the maximum tax-deferred amount allowed by the
Internal Revenue Service. The 401 K Plan also allows the Company to make
discretionary matching contributions. The Company’s defined contribution plan
expense was approximately $0.7 million, $0.8 million, and $0.4 million, and
$0.02 million the years ended December 31, 2008 and 2007, the eleven months
ended December 31, 2006, and the one month ended January 31, 2006,
respectively.




54






16.
            RELATED
      PARTY TRANSACTIONS




In
connection with the Bain Merger, the Company and its security holders entered
into a stockholders agreement. The stockholders agreement contains agreements
among the parties with respect to the election of the Company’s directors and
the directors of the Parent,  restrictions on the issuance or transfer
of shares, including tag-along rights and drag-along rights, other special
corporate governance provisions (including the right to approve various
corporate actions), registration rights (including customary indemnification
provisions) and call options. Three of the Company’s five directors are
employees of Bain Capital, the Company’s principal shareholder.




Upon the
consummation of the Bain Merger, the Company entered into a management agreement
with an affiliate of Bain Capital Partners, LLC pursuant to which such entity or
its affiliates will provide management services. Pursuant to such agreement, an
affiliate of Bain Capital Partners, LLC will receive an aggregate annual
management fee of $2.0 million and reimbursement for out-of-pocket expenses
incurred in connection with the Bain Merger prior to the closing of the Bain
Merger and in connection with the provision of services pursuant to the
agreement. In addition, pursuant to such agreement, an affiliate of Bain Capital
Partners, LLC also received aggregate transaction fees of approximately
$7.2 million in connection with services provided by such entity related to
the Bain Merger. Of the $7.2 million, approximately $2.9 million were for
acquisition related expenses and $4.3 million were for financing related
expenses which are capitalized and recorded in other assets. The management
agreement has a five year, evergreen term, however, in certain circumstances,
such as an initial public offering or change of control of the Group, the
Company may terminate the management agreement and buy out its remaining
obligations under the agreement to Bain Capital Partners, LLC and affiliates. In
addition, the management agreement provides that an affiliate of Bain Capital
Partners, LLC may receive fees in connection with certain subsequent financing
and acquisition transactions. The management agreement includes customary
indemnification provisions in favor of Bain Capital Partners, LLC and its
affiliates. The Company under this agreement paid management fees of $2.2
million, $2.0 million and $1.8 million during the years ended December 31, 2008
and 2007, and the eleven months ended December 31, 2006, respectively,
which is included in supplies, facilities and other operating costs. In
connection with the Aspen Acquisition and the associated financing transactions,
the Company paid an affiliate of Bain Capital an aggregate transaction fee of
$3.2 million. Of the $3.2 million, approximately $1.8 million is related to the
Company entering into the Amended and Restated Credit Agreement (see Note 8),
which is capitalized and is recorded in other assets in the Company’s
consolidated balance sheet at December 31, 2006 and $0.3 million is
included in the Aspen Acquisition related expenses (see Note 3) and was included
in the purchase price. In addition, $1.1 million is related to the Group’s PIK
loan financing costs, which is treated as a reduction in the capital
contribution.




In
addition, under a separate management agreement with two of the former
stockholders of the Predecessor Company, the Predecessor Company paid management
fees of $0.1 million and $1.2 million during the one month ended
January 31, 2006 which is included in supplies, facilities and other
operating costs. This agreement was terminated as part of the Bain
Merger.




In
connection with the closing of the Bain Merger on February 6, 2006, and
pursuant to a rollover and subscription agreement, certain members of the
Company’s management converted options with an aggregate value of $9.1 million
to purchase stock of the Predecessor Company into options to purchase stock of
the Group.




The
Company has acquired operating leases with certain employees resulting primarily
from Aspen Education Group’s historic acquisitions. Such related party leases
are due and payable on a monthly basis on similar terms and conditions as the
Company’s other leasing arrangements (see Note 12).




In
connection with the closing of the Aspen Acquisition on November 17, 2006
and pursuant to a rollover and subscription agreement, certain employees of
Aspen Education Group, Inc. converted options to purchase stock of Aspen
Education Group, Inc. into options to purchase stock of the Group with an
aggregate value of approximately $1.8 million. Included in the $1.8 million,
approximately $0.6 million relates to the options converted by one of the
Company’s directors.




Two
Directors receive compensation for their services to the Company as consultants.
One Director was granted options to purchase 13,435 shares of Class A
common stock and 1,492 shares of Class L common stock and receives a salary of
$10,000 per month in consideration for his services to the Company as a
consultant. The other Director receives a salary of $5,000 per month for
consulting services rendered to the Company. Additionally, he retains an
aggregate of 49,885 options for Class A common shares and 5,543 options for
Class L common shares, with 24,942 options for Class A common shares and
2,771 options for Class L common shares in consideration for his services as a
member of the Board of Directors and 24,942 options for Class A common
shares and 2,771 options for Class L common shares in consideration for his
services as a consultant.




17.
            CONDENSED
      CONSOLIDATING FINANCIAL INFORMATION




As of December 31, 2008,
the Company had outstanding $177.0 million aggregate principal amount of Notes
due 2016. The Notes are fully and unconditionally guaranteed, jointly and
severally on an unsecured senior subordinated basis, by all of the
Company’s wholly owned subsidiaries.




The
following supplemental tables present condensed consolidating balance sheets for
the Company and its subsidiary guarantors as of December 31, 2008 and 2007, and
the condensed consolidating statements of operations for the years ended
December 31, 2008 (Successor Company) and 2007 (Successor Company), the eleven
months ended December 31, 2006 (Successor Company), and one month ended
January 31, 2006 (Predecessor Company), and the condensed consolidating
statements of cash flows for the years ended December 31, 2008 (Successor
Company) and 2007 (Successor Company), the eleven months ended December 31,
2006 (Successor Company), and one month ended January 31, 2006 (Predecessor
Company).










55


Condensed
Consolidating Balance Sheet as of December 31, 2008 (Successor)


(In
thousands)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              —
              
              
              $
              2,180
              
              
              $
              360
              
              
              $
              —
              
              
              $
              2,540Accounts
      receivable—net of allowance for doubtful accounts
              
              
              2
              
              
              
              30,390
              
              
              
              434
              
              
              
              —
              
              
              
              30,826Prepaid
      expenses
              
              
              4,420
              
              
              
              3,204
              
              
              
              79
              
              
              
              —
              
              
              
              7,703Other
      current assets
              
              
              31
              
              
              
              1,543
              
              
              
              44
              
              
              
              —
              
              
              
              1,618Deferred
      income taxes
              
              
              4,029
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,029Current
      assets of discontinued operations, facility exits
              
              
              —
              
              
              
              14,125
              
              
              
              —
              
              
              
              —
              
              
              
              14,125Total
      current assets
              
              
              8,482
              
              
              
              51,442
              
              
              
              917
              
              
              
              —
              
              
              
              60,841PROPERTY
      AND EQUIPMENT—Net
              
              
              8,712
              
              
              
              118,358
              
              
              
              2,658
              
              
              
              —
              
              
              
              129,728GOODWILL
              
              
              —
              
              
              
              592,280
              
              
              
              11,798
              
              
              
              —
              
              
              
              604,078INTANGIBLE
      ASSETS—Net
              
              
              —
              
              
              
              354,463
              
              
              
              —
              
              
              
              —
              
              
              
              354,463OTHER
      ASSETS
              
              
              18,778
              
              
              
              1,266
              
              
              
              21
              
              
              
              —
              
              
              
              20,065INVESTMENT
      IN SUBSIDIARIES
              
              
              1,082,757
              
              
              
              —
              
              
              
              —
              
              
              
              (1,082,757
              )
              
              
              —TOTAL
      ASSETS
              
              $
              1,118,729
              
              
              $
              1,117,809
              
              
              $
              15,394
              
              
              $
              (1,082,757
              )
              
              $
              1,169,175LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
              
              $
              3,636
              
              
              $
              2,424
              
              
              $
              105
              
              
              $
              —
              
              
              $
              6,165Accrued
      liabilities
              
              
              14,819
              
              
              
              13,514
              
              
              
              728
              
              
              
              —
              
              
              
              29,061Income
      taxes payable
              
              
              1,201
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1,201Current
      portion of long-term debt
              
              
              4,193
              
              
              
              2,329
              
              
              
              —
              
              
              
              —
              
              
              
              6,522Other
      current liabilities
              
              
              14,603
              
              
              
              16,354
              
              
              
              700
              
              
              
              —
              
              
              
              31,657Current
      liabilities of discontinued operations, facility exits
              
              
              —
              
              
              
              703
              
              
              
              —
              
              
              
              —
              
              
              
              703Total
      current liabilities
              
              
              38,452
              
              
              
              35,324
              
              
              
              1,533
              
              
              
              —
              
              
              
              75,309LONG-TERM
      DEBT—Less current portion
              
              
              642,575
              
              
              
              4,055
              
              
              
              —
              
              
              
              —
              
              
              
              646,630OTHER
      LONG-TERM LIABILITIES
              
              
              149
              
              
              
              7,378
              
              
              
              26
              
              
              
              —
              
              
              
              7,553OTHER
      LONG-TERM LIABILITIES OF DISCONTINUED OPERATIONS, FACILITY
      EXITS
              
              
              —
              
              
              
              1,909
              
              
              
              —
              
              
              
              —
              
              
              
              1,909DEFERRED
      INCOME TAXES
              
              
              134,331
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              134,331Total
      liabilities
              
              
              815,507
              
              
              
              48,666
              
              
              
              1,559
              
              
              
              —
              
              
              
              865,732MINORITY
      INTEREST
              
              
              —
              
              
              
              —
              
              
              
              221
              
              
              
              —
              
              
              
              221STOCKHOLDER’S
      EQUITY
              
              
              303,222
              
              
              
              1,069,143
              
              
              
              13,614
              
              
              
              (1,082,757
              )
              
              
              303,222TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
              
              $
              1,118,729
              
              
              $
              1,117,809
              
              
              $
              15,394
              
              
              $
              (1,082,757
              )
              
              $
              1,169,175






56


Condensed
Consolidating Balance Sheet as of December 31, 2007 (Successor)


(In
thousands) (Restated)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              —
              
              
              $
              4,929
              
              
              $
              189
              
              
              $
              —
              
              
              $
              5,118Accounts
      receivable—net of allowance for doubtful accounts
              
              
              —
              
              
              
              31,203
              
              
              
              707
              
              
              
              —
              
              
              
              31,910Prepaid
      expenses
              
              
              4,315
              
              
              
              3,162
              
              
              
              67
              
              
              
              —
              
              
              
              7,544Other
      current assets
              
              
              19
              
              
              
              2,099
              
              
              
              2
              
              
              
              —
              
              
              
              2,120Income
      taxes receivable
              
              
              193
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              193Deferred
      income taxes
              
              
              6,599
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              6,599Total
      current assets
              
              
              11,126
              
              
              
              41,393
              
              
              
              965
              
              
              
              —
              
              
              
              53,484PROPERTY
      AND EQUIPMENT—Net
              
              
              5,629
              
              
              
              115,392
              
              
              
              1,916
              
              
              
              —
              
              
              
              122,937GOODWILL
              
              
              —
              
              
              
              718,886
              
              
              
              11,798
              
              
              
              —
              
              
              
              730,684INTANGIBLE
      ASSETS—Net
              
              
              —
              
              
              
              390,388
              
              
              
              —
              
              
              
              —
              
              
              
              390,388OTHER
      ASSETS
              
              
              23,436
              
              
              
              1,347
              
              
              
              15
              
              
              
              —
              
              
              
              24,798INVESTMENT
      IN SUBSIDIARIES
              
              
              1,215,413
              
              
              
              —
              
              
              
              —
              
              
              
              (1,215,413
              )
              
              
              —TOTAL
      ASSETS
              
              $
              1,255,604
              
              
              $
              1,267,406
              
              
              $
              14,694
              
              
              $
              (1,215,413
              )
              
              $
              1,322,291LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
              
              $
              4,240
              
              
              $
              2,741
              
              
              $
              33
              
              
              $
              —
              
              
              $
              7,014Accrued
      liabilities
              
              
              17,075
              
              
              
              19,495
              
              
              
              1,012
              
              
              
              —
              
              
              
              37,582Current
      portion of long-term debt
              
              
              30,693
              
              
              
              4,910
              
              
              
              —
              
              
              
              —
              
              
              
              35,603Other
      current liabilities
              
              
              4,381
              
              
              
              24,843
              
              
              
              600
              
              
              
              —
              
              
              
              29,824Total
      current liabilities
              
              
              56,389
              
              
              
              51,989
              
              
              
              1,645
              
              
              
              —
              
              
              
              110,023LONG-TERM
      DEBT—Less current portion
              
              
              607,434
              
              
              
              5,330
              
              
              
              —
              
              
              
              —
              
              
              
              612,764OTHER
      LONG-TERM LIABILITIES
              
              
              165
              
              
              
              7,349
              
              
              
              —
              
              
              
              —
              
              
              
              7,514DEFERRED
      INCOME TAXES
              
              
              145,867
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              145,867Total
      liabilities
              
              
              809,855
              
              
              
              64,668
              
              
              
              1,645
              
              
              
              —
              
              
              
              876,168MINORITY
      INTEREST
              
              
              —
              
              
              
              —
              
              
              
              374
              
              
              
              —
              
              
              
              374STOCKHOLDER’S
      EQUITY
              
              
              445,749
              
              
              
              1,202,738
              
              
              
              12,675
              
              
              
              (1,215,413
              )
              
              
              445,749TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
              
              $
              1,255,604
              
              
              $
              1,267,406
              
              
              $
              14,694
              
              
              $
              (1,215,413
              )
              
              $
              1,322,291
  57






Condensed
Consolidating Statements of Operations


For
the Year Ended December 31, 2008 (Successor)


(In
thousands)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedNET
      REVENUE:Net
      client service revenue
              
              $
              24
              
              
              $
              439,029
              
              
              $
              22,798
              
              
              $
              —
              
              
              $
              461,851Other
      revenue
              
              
              11
              
              
              
              8,131
              
              
              
              1
              
              
              
              —
              
              
              
              8,143Management
      fee revenue
              
              
              74,315
              
              
              
              —
              
              
              
              —
              
              
              
              (74,315
              )
              
              
              —Total
      net revenue
              
              
              74,350
              
              
              
              447,160
              
              
              
              22,799
              
              
              
              (74,315
              )
              
              
              469,994OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              17,565
              
              
              
              208,340
              
              
              
              10,101
              
              
              
              —
              
              
              
              236,006Supplies,
      facilities and other operating costs
              
              
              9,151
              
              
              
              118,372
              
              
              
              11,709
              
              
              
              —
              
              
              
              139,232Provision
      for doubtful accounts
              
              
              8
              
              
              
              6,290
              
              
              
              194
              
              
              
              —
              
              
              
              6,492Depreciation
      and amortization
              
              
              2,390
              
              
              
              19,194
              
              
              
              778
              
              
              
              —
              
              
              
              22,362Asset
      impairment
              
              
              —
              
              
              
              4,525
              
              
              
              —
              
              
              
              —
              
              
              
              4,525Goodwill
      impairment
              
              
              —
              
              
              
              142,238
              
              
              
              —
              
              
              
              —
              
              
              
              142,238Management
      fee expense
              
              
              —
              
              
              
              70,251
              
              
              
              4,064
              
              
              
              (74,315
              )
              
              
              —Total
      operating expenses
              
              
              29,114
              
              
              
              569,210
              
              
              
              26,846
              
              
              
              (74,315
              )
              
              
              550,855OPERATING
      INCOME (LOSS)
              
              
              45,236
              
              
              
              (122,050
              )
              
              
              (4,047
              )
              
              
              —
              
              
              
              (80,861
              )INTEREST
      EXPENSE, NET
              
              
              (53,388
              )
              
              
              (732
              )
              
              
              (2
              )
              
              
              —
              
              
              
              (54,122
              )GAIN
      ON DEBT REPURCHASE
              
              
              8,086
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              8,086OTHER
      INCOME (EXPENSE)
              
              
              1
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              1(LOSS)
      FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
              
              
              (65
              )
              
              
              (122,782
              )
              
              
              (4,049
              )
              
              
              —
              
              
              
              (126,896
              )INCOME
      TAX (BENEFIT)
              
              
              (3
              )
              
              
              (5,676
              )
              
              
              (187
              )
              
              
              —
              
              
              
              (5,866
              )MINORITY
      INTEREST IN (LOSS) OF A SUBSIDIARY
              
              
              —
              
              
              
              —
              
              
              
              (153
              )
              
              
              —
              
              
              
              (153
              )(LOSS)
      FROM CONTINUING OPERATIONS
              
              
              (62
              )
              
              
              (117,106
              )
              
              
              (3,709
              )
              
              
              —
              
              
              
              (120,877
              )(LOSS)
      FROM DISCONTINUED OPERATIONS, NET OF TAX BENEFIT OF
    ($11,265)
              
              
              —
              
              
              
              (21,028
              )
              
              
              —
              
              
              
              —
              
              
              
              (21,028
              )EQUITY
      IN (LOSS) INCOME OF SUBSIDIARIES, NET OF TAX
              
              
              (141,843
              )
              
              
              —
              
              
              
              —
              
              
              
              141,843
              
              
              
              —NET
      (LOSS) INCOME
              
              $
              (141,905
              )
              
              $
              (138,134
              )
              
              $
              (3,709
              )
              
              $
              141,843
              
              
              $
              (141,905
              )






58


Condensed
Consolidating Statements of Operations


For
the Year Ended December 31, 2007 (Successor)


(In
thousands) (Restated)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedNET
      REVENUE:Net
      client service revenue
              
              $
              24
              
              
              $
              425,237
              
              
              $
              15,967
              
              
              $
              —
              
              
              $
              441,228Other
      revenue
              
              
              10
              
              
              
              6,377
              
              
              
              —
              
              
              
              
              
              
              
              6,387Management
      fee revenue
              
              
              80,369
              
              
              
              —
              
              
              
              —
              
              
              
              (80,369
              )
              
              
              —Total
      net revenue
              
              
              80,403
              
              
              
              431,614
              
              
              
              15,967
              
              
              
              (80,369
              )
              
              
              447,615OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              13,981
              
              
              
              200,506
              
              
              
              5,919
              
              
              
              —
              
              
              
              220,406Supplies,
      facilities and other operating costs
              
              
              10,509
              
              
              
              114,286
              
              
              
              8,973
              
              
              
              —
              
              
              
              133,768Provision
      for doubtful accounts
              
              
              —
              
              
              
              6,822
              
              
              
              54
              
              
              
              —
              
              
              
              6,876Depreciation
      and amortization
              
              
              1,631
              
              
              
              19,772
              
              
              
              302
              
              
              
              —
              
              
              
              21,705Management
      fee expense
              
              
              —
              
              
              
              76,730
              
              
              
              3,639
              
              
              
              (80,369
              )
              
              
              —Total
      operating expenses
              
              
              26,121
              
              
              
              418,116
              
              
              
              18,887
              
              
              
              (80,369
              )
              
              
              382,755OPERATING
      INCOME (LOSS)
              
              
              54,282
              
              
              
              13,498
              
              
              
              (2,920
              )
              
              
              —
              
              
              
              64,860INTEREST
      EXPENSE, NET
              
              
              (59,442
              )
              
              
              (819
              )
              
              
              (1
              )
              
              
              
              
              
              
              (60,262
              )OTHER
      (EXPENSE) INCOME
              
              
              (1,771
              )
              
              
              4
              
              
              
              (3
              )
              
              
              
              
              
              
              (1,770
              )(LOSS)
      INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
              
              
              (6,931
              )
              
              
              12,683
              
              
              
              (2,924
              )
              
              
              —
              
              
              
              2,828INCOME
      TAX (BENEFIT) EXPENSE
              
              
              (4,542
              )
              
              
              8,904
              
              
              
              (1,916
              )
              
              
              —
              
              
              
              2,446MINORITY
      INTEREST IN INCOME OF A SUBSIDIARY
              
              
              —
              
              
              
              —
              
              
              
              189
              
              
              
              —
              
              
              
              189(LOSS)
      INCOME FROM CONTINUING OPERATIONS
              
              
              (2,389
              )
              
              
              3,779
              
              
              
              (1,197
              )
              
              
              —
              
              
              
              193INCOME
      FROM DISCONTINUED OPERATIONS, NET OF TAX OF $697
              
              
              —
              
              
              
              1,271
              
              
              
              —
              
              
              
              —
              
              
              
              1,271EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
              
              
              3,853
              
              
              
              —
              
              
              
              —
              
              
              
              (3,853
              )
              
              
              —NET
      INCOME (LOSS)
              
              $
              1,464
              
              
              $
              5,050
              
              
              $
              (1,197
              )
              
              $
              (3,853
              )
              
              $
              1,464
  59


Condensed
Consolidating Statements of Operations


For
the Eleven Months Ended December 31, 2006 (Successor)


(In
thousands)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedNET
      REVENUE:Net
      client service revenue
              
              $
              33
              
              
              $
              240,338
              
              
              $
              1,068
              
              
              $
              —
              
              
              $
              241,439Other
      revenue
              
              
              11
              
              
              
              4,430
              
              
              
              8
              
              
              
              
              
              
              
              4,449Management
      fee revenue
              
              
              52,786
              
              
              
              —
              
              
              
              —
              
              
              
              (52,786
              )
              
              
              —Total
      net revenue
              
              
              52,830
              
              
              
              244,768
              
              
              
              1,076
              
              
              
              (52,786
              )
              
              
              245,888OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              10,842
              
              
              
              104,818
              
              
              
              446
              
              
              
              —
              
              
              
              116,106Supplies,
      facilities and other operating costs
              
              
              6,114
              
              
              
              60,757
              
              
              
              749
              
              
              
              —
              
              
              
              67,620Provision
      for doubtful accounts
              
              
              1
              
              
              
              5,020
              
              
              
              7
              
              
              
              —
              
              
              
              5,028Depreciation
      and amortization
              
              
              784
              
              
              
              9,347
              
              
              
              17
              
              
              
              —
              
              
              
              10,148Management
      fee expense
              
              
              —
              
              
              
              52,786
              
              
              
              —
              
              
              
              (52,786
              )
              
              
              —Total
      operating expenses
              
              
              17,741
              
              
              
              232,728
              
              
              
              1,219
              
              
              
              (52,786
              )
              
              
              198,902OPERATING
      INCOME (LOSS)
              
              
              35,089
              
              
              
              12,040
              
              
              
              (143
              )
              
              
              —
              
              
              
              46,986INTEREST
      EXPENSE, NET
              
              
              (41,295
              )
              
              
              (44
              )
              
              
              1
              
              
              
              
              
              
              
              (41,338
              )OTHER
      INCOME
              
              
              89
              
              
              
              23
              
              
              
              —
              
              
              
              
              
              
              
              112(LOSS)
      INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
              
              
              (6,117
              )
              
              
              12,019
              
              
              
              (142
              )
              
              
              —
              
              
              
              5,760INCOME
      TAX EXPENSE
              
              
              (2,921
              )
              
              
              5,740
              
              
              
              (68
              )
              
              
              —
              
              
              
              2,751MINORITY
      INTEREST IN LOSS OF A SUBSIDIARY
              
              
              —
              
              
              
              —
              
              
              
              (38
              )
              
              
              
              
              
              
              (38
              )(LOSS)
      INCOME FROM CONTINUING OPERATIONS
              
              
              (3,196
              )
              
              
              6,279
              
              
              
              (36
              )
              
              
              —
              
              
              
              3,047(LOSS)
      INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX OF $260
              
              
              —
              
              
              
              475
              
              
              
              —
              
              
              
              —
              
              
              
              475EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
              
              
              6,718
              
              
              
              —
              
              
              
              —
              
              
              
              (6,718
              )
              
              
              —NET
      (LOSS) INCOME
              
              $
              3,522
              
              
              $
              6,754
              
              
              $
              (36
              )
              
              $
              (6,718
              )
              
              $
              3,522




60


Condensed
Consolidating Statements of Operations


For
the One Month Ended January 31, 2006 (Predecessor)


(In
thousands)


CRC
      Health
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Eliminations
              
              
              ConsolidatedNET
      REVENUE:Net
      client service revenue
              
              $
              5
              
              
              $
              18,983
              
              
              $
              —
              
              
              $
              18,988Other
      revenue
              
              
              1
              
              
              
              489
              
              
              
              —
              
              
              
              490Management
      fee revenue
              
              
              1,110
              
              
              
              —
              
              
              
              (1,110
              )
              
              
              —Total
      net revenue
              
              
              1,116
              
              
              
              19,472
              
              
              
              (1,110
              )
              
              
              19,478OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              666
              
              
              
              8,413
              
              
              
              —
              
              
              
              9,079Supplies,
      facilities and other operating costs
              
              
              324
              
              
              
              4,135
              
              
              
              —
              
              
              
              4,459Provision
      for doubtful accounts
              
              
              —
              
              
              
              285
              
              
              
              —
              
              
              
              285Depreciation
      and amortization
              
              
              40
              
              
              
              320
              
              
              
              —
              
              
              
              360Acquisition
      related costs
              
              
              43,710
              
              
              
              —
              
              
              
              —
              
              
              
              43,710Management
      fee expense
              
              
              —
              
              
              
              1,110
              
              
              
              (1,110
              )
              
              
              —Total
      operating expenses
              
              
              44,740
              
              
              
              14,263
              
              
              
              (1,110
              )
              
              
              57,893OPERATING
      (LOSS) INCOME
              
              
              (43,624
              )
              
              
              5,209
              
              
              
              —
              
              
              
              (38,415
              )INTEREST
      EXPENSE, NET
              
              
              (2,506
              )
              
              
              —
              
              
              
              —
              
              
              
              (2,506
              )OTHER
      FINANCING COSTS
              
              
              (10,655
              )
              
              
              —
              
              
              
              —
              
              
              
              (10,655
              )OTHER
      INCOME
              
              
              55
              
              
              
              —
              
              
              
              —
              
              
              
              55(LOSS)
      INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
              
              
              (56,730
              )
              
              
              5,209
              
              
              
              —
              
              
              
              (51,521
              )INCOME
      TAX (BENEFIT)
              
              
              (13,735
              )
              
              
              1,261
              
              
              
              —
              
              
              
              (12,474
              )(LOSS)
      INCOME FROM CONTINUING OPERATIONS
              
              
              (42,995
              )
              
              
              3,948
              
              
              
              —
              
              
              
              (39,047
              )INCOME
      FROM DISCONTINUED OPERATIONS, NET OF TAX OF $30
              
              
              —
              
              
              
              54
              
              
              
              —
              
              
              
              54EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
              
              
              4,002
              
              
              
              —
              
              
              
              (4,002
              )
              
              
              —NET
      (LOSS) INCOME
              
              $
              (38,993
              )
              
              $
              4,002
              
              
              $
              (4,002
              )
              
              $
              (38,993
              )






61


Condensed
Consolidating Statements of Cash Flows


For
the Year Ended December 31, 2008 (Successor)


(In
thousands)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash provided (used in) by operating activities
              
              $
              (6,644
              )
              
              $
              33,771
              
              
              $
              (2,951
              )
              
              $
              —
              
              
              $
              24,176CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (5,509
              )
              
              
              (13,385
              )
              
              
              (6,385
              )
              
              
              —
              
              
              
              (25,279
              )Proceeds
      from sale of property and equipment
              
              
              —
              
              
              
              188
              
              
              
              —
              
              
              
              —
              
              
              
              188Acquisition
      of businesses, net of cash acquired
              
              
              (11,597
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (11,597
              )Acquisition
      adjustments
              
              
              —
              
              
              
              (10
              )
              
              
              —
              
              
              
              —
              
              
              
              (10
              )Payments
      made under earnout arrangements
              
              
              (2,947
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (2,947
              )Net
      cash (used in) investing activities
              
              
              (20,053
              )
              
              
              (13,207
              )
              
              
              (6,385
              )
              
              
              —
              
              
              
              (39,645
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              13,784
              
              
              
              (23,291
              )
              
              
              9,507
              
              
              
              —
              
              
              
              —Capital
      distributed to parent
              
              
              (359
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (359
              )Capitalized
      financing costs
              
              
              (338
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (338
              )Repayment
      of capital lease obligations
              
              
              —
              
              
              
              (22
              )
              
              
              —
              
              
              
              —
              
              
              
              (22
              )Repurchase
      of long-term debt
              
              
              (13,607
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (13,607
              )Net
      borrowings under revolving line of credit
              
              
              35,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              35,000Repayment
      of long-term debt
              
              
              (7,783
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (7,783
              )Net
      cash provided by (used in) financing activities
              
              
              26,697
              
              
              
              (23,313
              )
              
              
              9,507
              
              
              
              —
              
              
              
              12,891NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              (2,749
              )
              
              
              171
              
              
              
              —
              
              
              
              (2,578
              )CASH
      AND CASH EQUIVALENTS—Beginning of period
              
              
              —
              
              
              
              4,929
              
              
              
              189
              
              
              
              —
              
              
              
              5,118CASH
      AND CASH EQUIVALENTS—End of period
              
              $
              —
              
              
              $
              2,180
              
              
              $
              360
              
              
              $
              —
              
              
              $
              2,540






62


Condensed
Consolidating Statements of Cash Flows


For
the Year Ended December 31, 2007 (Successor)


(In
thousands) (Restated)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash provided (used in) by operating activities
              
              $
              28,694
              
              
              $
              28,718
              
              
              $
              (992
              )
              
              $
              —
              
              
              $
              56,420CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (3,002
              )
              
              
              (25,820
              )
              
              
              (1,337
              )
              
              
              —
              
              
              
              (30,159
              )Proceeds
      from sale of property and equipment
              
              
              —
              
              
              
              90
              
              
              
              —
              
              
              
              —
              
              
              
              90Acquisition
      of businesses, net of cash acquired
              
              
              (32,912
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (32,912
              )Acquisition
      adjustments
              
              
              —
              
              
              
              779
              
              
              
              —
              
              
              
              —
              
              
              
              779Payments
      made under earnout arrangements
              
              
              (8,645
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (8,645
              )Purchase
      of intangible asset
              
              
              (100
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (100
              )Net
      cash (used in) investing activities
              
              
              (44,659
              )
              
              
              (24,951
              )
              
              
              (1,337
              )
              
              
              —
              
              
              
              (70,947
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              267
              
              
              
              (2,746
              )
              
              
              2,479
              
              
              
              —
              
              
              
              —Capital
      contributed by parent
              
              
              252
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              252Capitalized
      financing costs
              
              
              (640
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (640
              )Repayment
      of capital lease obligations
              
              
              —
              
              
              
              (259
              )
              
              
              —
              
              
              
              —
              
              
              
              (259
              )Net
      borrowings under revolving line of credit
              
              
              22,900
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              22,900Repayment
      of long-term debt
              
              
              (6,814
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (6,814
              )Net
      cash provided by (used in) financing activities
              
              
              15,965
              
              
              
              (3,005
              )
              
              
              2,479
              
              
              
              —
              
              
              
              15,439NET
      INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              762
              
              
              
              150
              
              
              
              —
              
              
              
              912CASH
      AND CASH EQUIVALENTS—Beginning of period
              
              
              —
              
              
              
              4,167
              
              
              
              39
              
              
              
              —
              
              
              
              4,206CASH
      AND CASH EQUIVALENTS—End of period
              
              $
              —
              
              
              $
              4,929
              
              
              $
              189
              
              
              $
              —
              
              
              $
              5,118








63


Condensed
Consolidating Statements of Cash Flows


For
the Eleven Months Ended December 31, 2006 (Successor)


(In
thousands)


CRC
      Health
              
              
              Subsidiary
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash (used in) provided by operating activities
              
              $
              (24,928
              )
              
              $
              21,040
              
              
              $
              (598
              )
              
              $
              —
              
              
              $
              (4,486
              )CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (1,707
              )
              
              
              (11,052
              )
              
              
              (27
              )
              
              
              —
              
              
              
              (12,786
              )Proceeds
      from sale of property and equipment
              
              
              —
              
              
              
              41
              
              
              
              —
              
              
              
              —
              
              
              
              41Acquisition
      of businesses, net of cash acquired
              
              
              (304,861
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (304,861
              )Acquisition
      adjustments
              
              
              (14
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (14
              )Payment
      of purchase price to former shareholders
              
              
              (429,191
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (429,191
              )Net
      cash (used in) investing activities
              
              
              (735,773
              )
              
              
              (11,011
              )
              
              
              (27
              )
              
              
              —
              
              
              
              (746,811
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              5,022
              
              
              
              (5,652
              )
              
              
              630
              
              
              
              —
              
              
              
              —Equity
      contribution from Bain Capital
              
              
              294,475
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              294,475Capital
      contributed by parent
              
              
              135,711
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              135,711Payment
      of transaction related costs
              
              
              (5,354
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (5,354
              )Capitalized
      financing costs
              
              
              (29,527
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (29,527
              )Repayment
      of capital lease obligations
              
              
              —
              
              
              
              (43
              )
              
              
              —
              
              
              
              —
              
              
              
              (43
              )Net
      repayments under revolving line of credit
              
              
              (900
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (900
              )Proceeds
      from issuances of long-term debt
              
              
              617,522
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              617,522Repayment
      of long-term debt
              
              
              (256,248
              )
              
              
              (556
              )
              
              
              —
              
              
              
              —
              
              
              
              (256,804
              )Net
      cash provided by (used in) financing activities
              
              
              760,701
              
              
              
              (6,251
              )
              
              
              630
              
              
              
              —
              
              
              
              755,080NET
      INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              3,778
              
              
              
              5
              
              
              
              —
              
              
              
              3,783CASH
      AND CASH EQUIVALENTS—Beginning of period
              
              
              —
              
              
              
              389
              
              
              
              34
              
              
              
              —
              
              
              
              423CASH
      AND CASH EQUIVALENTS—End of period
              
              $
              —
              
              
              $
              4,167
              
              
              $
              39
              
              
              $
              —
              
              
              $
              4,206






64


Condensed
Consolidating Statements of Cash Flows


For
the One Month Ended January 31, 2006 (Predecessor)


(In
thousands)




CRC
      Health
              
              
              SubsidiaryCorporation
              
              
              Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash (used in) provided by operating activities
              
              $
              (3,563
              )
              
              $
              4,764
              
              
              $
              —
              
              
              $
              1,201CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (30
              )
              
              
              (286
              )
              
              
              —
              
              
              
              (316
              )Proceeds
      from sale of property and equipment
              
              
              —
              
              
              
              1
              
              
              
              —
              
              
              
              1Net
      cash (used in) investing activities
              
              
              (30
              )
              
              
              (285
              )
              
              
              —
              
              
              
              (315
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              4,187
              
              
              
              (4,187
              )
              
              
              —
              
              
              
              —Stock
      options exercised
              
              
              7
              
              
              
              —
              
              
              
              —
              
              
              
              7Capitalized
      financing costs
              
              
              (547
              )
              
              
              —
              
              
              
              —
              
              
              
              (547
              )Net
      repayment under revolving line of credit
              
              
              (5,000
              )
              
              
              —
              
              
              
              —
              
              
              
              (5,000
              )Net
      cash used in financing activities
              
              
              (1,353
              )
              
              
              (4,187
              )
              
              
              —
              
              
              
              (5,540
              )NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              (4,946
              )
              
              
              292
              
              
              
              —
              
              
              
              (4,654
              )CASH
      AND CASH EQUIVALENTS—Beginning of period
              
              
              4,946
              
              
              
              131
              
              
              
              —
              
              
              
              5,077CASH
      AND CASH EQUIVALENTS—End of period
              
              $
              —
              
              
              $
              423
              
              
              $
              —
              
              
              $
              423






65





18.
            RESTRUCTURING





In the
second half of fiscal 2008, management initiated a restructuring plan (the “FY08
Plan”) to further align the Company’s resources with its strategic business plan
through facility consolidations, facility exit actions, and certain workforce
reductions.   Actions under the FY08 Plan are focused on those
facilities which have been negatively impacted by the economic crisis and the
depressed credit markets. Facility exit actions include the closure, sale, or
disposal of certain facilities across all divisions and are expected to be
substantially complete by the end of 2009.  The Company has recognized
approximately $2.9 million in lease obligations, net of sublease
income, related to minimum operating lease payments over the next five
years for facility exits. Lease obligations related to minimum operating lease
payments are recorded on the Company’s consolidated balance sheets under accrued
liabilities. Facility consolidations include consolidating administrative
activities within the youth division headquarters in Southern California, into
other locations. Workforce reductions include the elimination of approximately
100 full-time positions throughout the divisions. The workforce reduction
component of the FY08 Plan is expected to be substantially complete by the end
of the first quarter in 2009. The FY08 Plan also includes sale or disposal of
certain facilities as discontinued operations. Remaining
restructuring actions may include further division consolidations and facility
exit actions in future periods. Under the FY08 Plan, the Company anticipates
recording additional charges of $0.7 million related primarily to future
workforce and facility reductions within its youth division. The total amount,
nature, and timing of the Company’s restructuring charges under the FY08 Plan
will depend upon the nature, timing and extent of future actions. A summary of
total restructuring activity, including those classified as discontinued
operations, is shown in the table below:





Workforce
      Reduction
              
              
              Consolidation
      and Exit of Excess Facilities
              
              
              Total(in
      thousands)Restructuring
      reserve as of December 31, 2007
              
              $
              —
              
              
              $
              —
              
              
              $
              —Expenses
              
              
              369
              
              
              
              3,225
              
              
              
              3,594Cash
      (payments) receipts, net
              
              
              (193
              )
              
              
              (121
              )
              
              
              (314
              )Restructuring
      reserve as of December 31, 2008
              
              $
              176
              
              
              $
              3,104
              
              
              
              3,280


Under the
FY08 Plan, the Company recorded non-cash impairment charges of $10.9 million for
intangible assets not subject to amortization, $16.9 million for intangible
assets subject to amortization, and $3.0 million for impairment on property and
equipment.  Total restructuring related asset impairment charges for
the Company’s recovery, youth, and corporate/other segments were $8.1 million,
$22.2 million, and $0.5 million, respectively, for the year ended December 31,
2008.





Restructuring
related impairment charges related to continuing operations totaled $4.5 million
in asset impairments for the Company’s recovery
division.   Restructuring related impairment charges attributable
to those facilities recognized as discontinued operations under the FY08 Plan
totaled $26.3 million for the year ended December 31, 2008. Excluding asset
impairment charges, the Company recognized restructuring charges of
approximately $1.3 million and $2.2 million in its youth and recovery
divisions, respectively.





19.
            DISCONTINUED
      OPERATIONS





As part
of the FY08 Plan, the Company’s executive management team executed purchase
agreements for the sale of four facilities within its recovery
segment. During the fourth quarter of 2008, the Company announced its
intention to sell, dispose, or cease operations at certain of its facilities
across each of its business divisions. The facilities include one
therapeutic boarding school in the Company’s youth division, one eating disorder
start-up in its healthy living division, and eight outpatient treatment clinics
in its recovery division.  As of December 31, 2008, the Company had
classified these facilities as discontinued
operations.  Facilities which have been held for sale, or otherwise
disposed as of December 31, 2008 are reflected as discontinued
operations.  The income tax effects related to discontinued operations
are summarized in Note 7.





Activities
related to discontinued operations are recognized in the Company’s
consolidated statement of operations under discontinued operations for
all periods presented.




The
results of operations for those facilities classified as discontinued operations
are summarized below (in thousands):




For
      the Year Ended December 31,2008
              
              
              2007
              
              
              2006(1)Net
      revenue
              
              $
              6,089
              
              
              $
              12,390
              
              
              $
              5,813Operating
      expenses
              
              
              11,374
              
              
              
              10,422
              
              
              
              4,992Asset
      impairment
              
              
              26,311
              
              
              
              —
              
              
              
              —Goodwill
      impairment
              
              
              623
              
              
              
              —
              
              
              
              —Loss
      (gain) on disposals
              
              
              74
              
              
              
              —
              
              
              
              2(Loss)
      income before income taxes
              
              
              (32,293
              )
              
              
              1,968
              
              
              
              819Tax
      ( benefit) expense
              
              
              (11,265
              )
              
              
              697
              
              
              
              290(Loss)
      income from discontinued operations
              
              $
              (21,028
              )
              
              $
              1,271
              
              
              $
              529
  (1)
              For
      the year ended December 31, 2006, operating results are the
      mathematical addition of the operating results for January 2006,
      ("Predecessor Company") to the operating results of the eleven months
      ended December 31, 2006 ("Predecessor
Company").







66





20.
            SEGMENT
      INFORMATION




In
accordance with the criteria of Statement of Financial Accounting Standards No.
131, Disclosures about
Segments of an Enterprise and Related Information (“SFAS 131”), the
Company has three identified operating segments under its organizational
structure: recovery division, youth division, and healthy living division. For
segment reporting purposes, the Company has identified two reportable segments:
recovery and youth. The Company evaluated the healthy living division for
segment reporting under the provisions of SFAS 131 and determined that this
segment does not meet the quantitative thresholds for separate disclosure and
therefore is not a reportable segment. The healthy living division is combined
with corporate/other for the purposes of segment reporting.




Reportable
segments are based upon the Company’s internal organizational structure, the
manner in which the operations are managed and on the level at which the
Company’s chief operating decision-maker allocates resources. The Company’s
chief operating decision-maker is its Chief Executive Officer. The financial
information used by the Company’s chief operating decision-maker includes net
revenue, operating expenses, income (loss) from operations and capital
expenditures.




A summary
of the Company’s reportable segments are as follows:




Recovery—The
recovery segment specializes in the treatment of chemical dependency and other
behavioral health disorders both on an inpatient residential basis and on an
outpatient basis. Services offered in this segment include:
inpatient/residential care, partial/day treatment, intensive outpatient groups,
therapeutic living/half-way house environments, aftercare centers and
detoxification. As of December 31, 2008, the recovery segment provided substance
abuse and behavioral health services to patients at 100 facilities located in 24
states.




Youth—The
youth segment provides a wide variety of therapeutic programs through settings
and solutions that match individual needs with the appropriate learning and
therapeutic environment. As of December 31, 2008, the youth segment operated 28
educational facilities in 10 states and its offerings include boarding schools,
experiential outdoor education programs, and summer camps.




Corporate/Other—In
addition to the two reportable segments as described above, the Company has
activities classified as corporate/other which represent revenue and expenses
associated with eGetgoing, an online internet treatment option, certain
corporate-level operating general and administrative costs (i.e., expenses
associated with the corporate offices in Cupertino, California, which provides
management, financial, human resources and information system support), stock
option-based compensation expense that are not allocated to the segments, and
the healthy living division.




The
healthy living division provides treatment services for eating disorders and
obesity, each a related behavioral disorder that may be effectively treated
through a combination of medical, psychological and social treatment programs.
As of December 31, 2008, our healthy living division operated 16 facilities
in 8 states.




Major
Customers—No single customer represented 10% or more of the Company’s
total net revenue in any period presented.




Geographic
Information—The Company’s business operations are primarily in the United
States.




Selected
segment financial information for the Company’s reportable segments was as
follows (in thousands):


Successor
              
              
              PredecessorEleven Months
              
              
              One
      MonthYear Ended
              
              
              Year Ended
              
              
              Ended
              
              
              EndedDecember 31,
              
              
              December 31,
              
              
              December 31,
              
              
              January 31,2008
              
              
              2007
              
              
              2006
      (Revised)
              
              
              2006
      (Revised)Net
      revenue:Recovery
      division
              
              $
              309,545
              
              
              $
              286,097
              
              
              $
              227,958
              
              
              $
              19,298Youth
      division
              
              
              132,726
              
              
              
              138,983
              
              
              
              13,261
              
              
              
              —Corporate/other
              
              
              27,723
              
              
              
              22,535
              
              
              
              4,669
              
              
              
              180Total
      consolidated net revenue
              
              $
              469,994
              
              
              $
              447,615
              
              
              $
              245,888
              
              
              $
              19,478Operating
      expenses:Recovery
      division
              
              $
              224,748
              
              
              $
              206,262
              
              
              $
              162,243
              
              
              $
              13,177Youth
      division
              
              
              269,602
              
              
              
              130,155
              
              
              
              14,531
              
              
              
              —Corporate/other
              
              
              56,505
              
              
              
              46,338
              
              
              
              22,128
              
              
              
              44,716Total
      consolidated operating expenses
              
              $
              550,855
              
              
              $
              382,755
              
              
              $
              198,902
              
              
              $
              57,893Operating
      income (loss):Recovery
      division
              
              $
              84,797
              
              
              $
              79,835
              
              
              $
              65,715
              
              
              $
              6,121Youth
      division
              
              
              (136,876
              )
              
              
              8,828
              
              
              
              (1,270
              )
              
              
              —Corporate/other
              
              
              (28,782
              )
              
              
              (23,803
              )
              
              
              (17,459
              )
              
              
              (44,536
              )Total
      consolidated operating (loss) income
              
              $
              (80,861
              )
              
              $
              64,860
              
              
              $
              46,986
              
              
              $
              (38,415
              )Operating
      income (loss):Total
      consolidated operating (loss) income
              
              $
              (80,861
              )
              
              $
              64,860
              
              
              $
              46,986
              
              
              $
              (38,415
              )Interest
      expense, net
              
              
              (54,122
              )
              
              
              (60,262
              )
              
              
              (41,338
              )
              
              
              (2,506
              )Gain
      on debt repurchase and other financing costs
              
              
              8,086
              
              
              
              —
              
              
              
              —
              
              
              
              (10,655
              )Other
      income (expense)
              
              
              1
              
              
              
              (1,770
              )
              
              
              112
              
              
              
              55Total
      consolidated income (loss) from continuing operations before income
      taxes
              
              $
              (126,896
              )
              
              $
              2,828
              
              
              $
              5,760
              
              
              $
              (51,521
              )Capital
      expenditures(1)
      :Recovery
      division
              
              $
              12,525
              
              
              $
              18,309
              
              
              $
              8,351
              
              
              $
              381Youth
      division
              
              
              4,863
              
              
              
              5,709
              
              
              
              1,471
              
              
              
              —Corporate/other
              
              
              7,891
              
              
              
              6,141
              
              
              
              4,367
              
              
              
              30Total
      consolidated capital expenditures
              
              $
              25,279
              
              
              $
              30,159
              
              
              $
              14,189
              
              
              $
              411
 67


December 31,
              
              
              December 31,2008
              
              
              2007(Successor)Total assets(1)Recovery
      division
              
              $
              899,399
              
              
              $
              895,506Youth
      division
              
              
              179,467
              
              
              
              344,274Corporate/other
              
              
              90,309
              
              
              
              82,511Total
      consolidated assets
              
              $
              1,169,175
              
              
              $
              1,322,291




(1)
Includes amounts related to discontinued operations







21.
            QUARTERLY
      SUMMARY (Unaudited)




Quarter
      EndedMarch 31
              
              
              June 30
              
              
              September 30
              
              
              December 31(in
      thousands)2008Net
      revenue
              
              $
              114,575
              
              
              $
              120,760
              
              
              $
              124,765
              
              
              $
              109,894(Loss)
      income from continuing operations, net of tax
              
              
              (792
              )
              
              
              4,459
              
              
              
              (123,902
              )
              
              
              (642
              )(Loss)
      income from discontinued operations, net of tax
              
              
              (732
              )
              
              
              (702
              )
              
              
              (16,032
              )
              
              
              (3,562
              )Net
      (loss) income
              
              
              (1,524
              )
              
              
              3,757
              
              
              
              (139,934
              )
              
              
              (4,204
              )2007Net
      revenue
              
              $
              104,137
              
              
              $
              112,012
              
              
              $
              119,506
              
              
              $
              111,960(Loss)
      income from continuing operations, net of tax
              
              
              (813
              )
              
              
              2,084
              
              
              
              4,423
              
              
              
              (5,501
              )Income
      (loss) from discontinued operations, net of tax
              
              
              767
              
              
              
              830
              
              
              
              198
              
              
              
              (524
              )Net
      (loss) income
              
              
              (46
              )
              
              
              2,914
              
              
              
              4,621
              
              
              
              (6,025
              )


68




ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure




None




ITEM 9A. Controls and Procedures




(a)
Evaluation of disclosure controls and procedures.




We
conducted an evaluation under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end
of the period covered by this Annual Report. Based upon this evaluation, our
principal executive officer and principal financial officer concluded that our
disclosure controls and procedures are effective to ensure that material
information required to be disclosed by us in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules and forms
and is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.




(b)
Changes in internal control over financial reporting.




We
regularly review our system of internal control over financial reporting and
make changes to our processes and systems to improve controls and increase
efficiency, while ensuring that we maintain an effective internal control
environment. Changes may include such activities as implementing new, more
efficient systems, consolidating activities, and migrating processes. No change
in our internal control over financial reporting (as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) occurred during the period covered by this
Annual Report that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




(c)
Management’s report on internal control over financial reporting.




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as defined in Exchange Act
Rule 13a-15(f). Management conducted an evaluation of the effectiveness of
our internal control over financial reporting based on the framework in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Based on this evaluation, management concluded that
our internal control over financial reporting was effective as of December 31,
2008. Management reviewed the results of their assessment with our Audit
Committee.




This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by the company’s public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit the Company to provide only management’s report in this
Annual Report.




Inherent
Limitations on Effectiveness of Controls




The
Company’s management, including the CEO and CFO, does not expect that our
Disclosure Controls or our internal control over financial reporting will
prevent or detect all error and all fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the control system’s objectives will be met. The design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Further, because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not
occur or that all control issues and instances of fraud, if any, within the
company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over time,
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with policies or procedures.




ITEM 9B. Other Information




Not
applicable




69


PART
III




ITEM 10. Directors, Executive Officers and Corporate
Governance




All of
our directors serve until a successor is duly elected and qualified or until the
earlier of his death, resignation or removal. Our executive officers are
appointed and serve at the discretion of our board of directors. There are no
family relationships between any of our directors or executive
officers.




Executive
Officers and Directors




The
following table sets forth information with respect to our directors and
executive officers:




Name
            Age
            PositionDr. Barry W.
      Karlin
            54
            Chairman
      and Chief Executive OfficerJames
      Hudak
            61
            Chief
      Administrative Officer, Vice PresidentKevin
      Hogge
            51
            Chief
      Financial Officer, Vice President and TreasurerPhilip
      L. Herschman
            61
            President,
      Healthy Living DivisionJerome
      E. Rhodes
            51
            President,
      Recovery DivisionJames
      Dredge
            58
            President,
      Youth DivisionKathleen
      Sylvia
            63
            Executive
      Vice President of Business DevelopmentDr. Thomas J.
      Brady
            56
            Chief
      Medical OfficerPamela
      B. Burke
            41
            Vice
      President, General Counsel and SecretarySteven
      Barnes
            48
            DirectorJohn
      Connaughton
            43
            DirectorChris
      Gordon
            36
            DirectorGeneral
      Barry R. McCaffrey (ret.)
            66
            DirectorElliot
      Sainer
            63
            Director




The
following biographies describe the business experience of our executive officers
and directors:




Dr. Barry W. Karlin,
Chairman and Chief Executive Officer. Dr. Karlin has served as our
chairman and chief executive officer since January 2002. From January 2002 to
June 2003, Dr. Karlin also served as our secretary, treasurer and chief
financial officer. Before our formation in January 2002, Dr. Karlin was the
chairman and chief executive officer of eGetgoing, Inc. and CRC Health
Corporation from May 2000 and November 2000, respectively, to January 2002.
Dr. Karlin also served as chairman and chief executive officer of CRC
Recovery, Inc., the general partner of The Camp Recovery Centers, L.P. from July
1995 to January 2001. From 1993 to 1995, Dr. Karlin acted as an independent
consultant providing strategic consulting services to Fortune 100 companies.
From 1992 to 1993, Dr. Karlin served as chairman and chief executive
officer of Karlin and Collins, Inc., an emerging growth high-technology company
which he founded. In 1990, Dr. Karlin joined Corporate Technology Partners,
a venture capital firm specializing in the wireless communications industry,
where he served as a general partner until 1992. From 1984 to 1990,
Dr. Karlin served as chairman and chief executive officer of Navigation
Technologies, Inc., a provider of maps for vehicle navigation. Dr. Karlin
began his career as a strategy management consultant in 1981, first with
Strategic Decisions Group and subsequently with Decision Processes, Inc.
Dr. Karlin holds Ph.D. and M.S. degrees from Stanford University in the
department of engineering economic systems, specializing in decision analysis,
and a B.S. in electrical engineering from University of Witwatersrand in South
Africa.




James Hudak, Chief
Administrative Officer. Mr. Hudak has served as our chief
administrative officer since July 2008. From 2006 to 2008, Mr. Hudak served as
Chairman of the Board of Directors of MedAvant, Inc. From 2003 to 2006, Mr.
Hudak served as chief operating officer and then as chief executive officer of
United Behavioral Health. From 2000 to 2003, he served as Executive VP and chief
executive officer of United Health Technologies. From 1980 to 2000, Mr. Hudak
worked at Accenture (formerly Andersen consulting) where he worked as a manager
and then served as Global Managing Partner to the health services division. Mr.
Hudak holds a B.A. from Yale University and a Master of Public Policy from the
University of Michigan.




Kevin Hogge, Chief Financial
Officer, Vice President and Treasurer. Mr. Hogge has served as our
chief financial officer since June 2003. From September 1999 to June 2003,
Mr. Hogge was the chief financial officer for Epoch Senior Living, Inc., an
assisted living and skilled nursing company. From April 1996 to January 1999, he
served as controller of the hospital division of Horizon/CMS Healthcare
Corporation, a provider of specialty healthcare services, maintaining his
position following the acquisition of this division by Regency Health Services,
Inc. and the subsequent acquisition of Regency Health Services, Inc. by Sun
Healthcare Group, Inc. From October 1992 to April 1996, Mr. Hogge worked as
vice president of planning for Tenet Healthcare Corporation, an owner and
operator of acute care hospitals and related healthcare services. Prior to
working in healthcare, Mr. Hogge was a certified public accountant with
Ernst & Whinney. Mr. Hogge holds a B.S. in accounting from
Virginia Polytechnic Institute.







Philip L. Herschman, President,
Health Living Division. Mr. Herschman has served as the president of
our healthy living division since September 2007. From May 2002 to September
2007, Mr. Herschman served as president of our outpatient treatment
division. From August 1993 to May 2002, Mr. Herschman served as chief
executive officer of Behavioral Health Concepts, a national mental health
management company which he founded in 1993. From 1984 to 1992,
Mr. Herschman worked in operations and business development for Republic
Health Corporation, a healthcare company, where he was responsible for
implementing the company’s strategy of joint venturing its acute care hospitals
with physician groups. During this time, Mr. Herschman was also responsible
for the operations of three acute care hospitals with over 500 beds for OrNda
Health Corp. Prior to OrNda/Republic, Mr. Herschman was a regional vice
president of operations with Horizon Health Corporation, a multi-unit
psychiatric management company. Mr. Herschman holds a Ph.D. in psychology
from the University of California, Irvine and a B.A. from the University of
California, San Diego.




Jerome E. Rhodes, President,
Recovery Division. Mr. Rhodes has served as the president of our
recovery division since September 2007. From January 2004 to September 2007,
Mr. Rhodes served as president of our residential treatment division. From
August 2003 to January 2004, he was president of our eastern division. From
September 1993 to February 2003, Mr. Rhodes served as chief executive
officer of Comprehensive Addiction Programs, Inc., a behavioral healthcare
treatment company. We acquired Comprehensive Addiction Programs, Inc. in
February 2003. From 1991 to 1993, Mr. Rhodes was the senior vice president
of operations and from 1987 to 1991 he served as the senior vice president of
acquisitions and development for Comprehensive Addiction Programs, Inc. From
1982 to 1987, Mr. Rhodes was the director of development for Beverly
Enterprises, Inc., a publicly held nursing home company. From 1980 to 1982,
Mr. Rhodes was the chief development consultant at Wilmot Bower and
Associates, an architectural and development firm specializing in healthcare
facilities. From 1978 to 1980, Mr. Rhodes was a project coordinator and
analyst with Manor Care, Inc., a publicly held nursing home company.
Mr. Rhodes holds a B.A. in business administration from Columbia Union
College.




70


James Dredge, President, Youth
Division. Mr. Dredge has served as the President of our youth
division since October 1, 2007. From November 2006 through September 2007,
Mr. Dredge served as chief operating officer of the youth division. From
April 2004 through November 2006, Mr. Dredge served as chief operating
officer of Aspen Education Group, Inc. We acquired Aspen Education Group, Inc.
in November 2006. Mr. Dredge has spent most of his career building and
running education software companies. He previously served as President and CEO
for Academic Systems, a wholly owned subsidiary of Lightspan, Inc. He is a magna
cum laude graduate from the University of Minnesota with a Master Degree in
Public Administration from the University of Minnesota.




Kathleen Sylvia, Executive Vice
President of Business Development. Ms. Sylvia has served as our
executive vice president of business development since June 2003. From May 1995
to June 2003, Ms. Sylvia served as our chief operating officer. From
January 1993 to May 1995, Ms. Sylvia was the executive director of The Camp
Recovery Centers, L.P. From 1988 to 1993, Ms. Sylvia was the assistant
administrator at National Medical Enterprise Hospitals and Community Psychiatric
Centers. Ms. Sylvia holds a nursing degree from the University of
California, Los Angeles, Harbor College, School of Nursing, a B.A. in sociology
and anthropology from Old Dominion University and a master of public
administration from the University of Oklahoma.




Dr. Thomas J. Brady, Chief
Medical Officer. Dr. Brady has served as our chief medical officer
since October 2004. From June 1997 to October 2004, Dr. Brady held various
positions with MHN, Inc., a mental and behavioral health services company,
including acting corporate medical director from June 2003 through September
2003, and regional medical director from June 1997 to October 2004. From 1988 to
1999, Dr. Brady held various positions at St. Mary’s Medical Center in San
Francisco, including chair of the department of psychiatry and medical director
of Child and Adolescent Psychiatric Services, the Children’s Psychiatric
Inpatient Unit and the Adolescent Day Treatment Center. Dr. Brady conducted
a private practice in psychiatry from 1986 to 2004, treating thousands of
outpatient and inpatient mentally ill and addiction patients during that time.
Dr. Brady holds an M.B.A. from Golden Gate University, an M.D. from the
University of Alabama, Birmingham School of Medicine, a B.S. in biology from the
University of Alabama and a B.A. in psychology from the University of
California, Berkeley. Dr. Brady is American Society of Addiction Medicine
certified and board certified in General, Child and Adolescent and Forensic
Psychiatry.




Pamela B. Burke, Vice President,
General Counsel and Secretary. Ms. Burke has served as our vice
president, general counsel and secretary since February 2005. Prior to joining
us in February 2005, Ms. Burke was a partner at the law firm DLA Piper
Rudnick Gray Cary US LLP, which she joined in September 1996. From September
1993 to April 1996, Ms. Burke worked for Ernst & Young in its
National Tax Office. Ms. Burke received her B.A. in government from Cornell
University and her J.D. from George Washington University.




Steven Barnes, Director.Steven Barnes,
Director.  Mr. Barnes has served as a director since February
2006.  Mr. Barnes has been associated with Bain Capital since 1988 and
has been a Managing Director since 2000.  In addition to working for
Bain Capital, he also held senior operating roles of several Bain Capital
portfolio companies including chief executive officer of Dade Behring, Inc.,
president of Executone Business Systems, Inc. and president of Holson Burnes
Group, Inc.  Mr. Barnes currently serves on several boards including
Ideal Standard and Clear Channel Communications, Inc.  He also
volunteers on several charitable organizations, serving as a member of the board
of Make-A-Wish Foundation of Massachusetts, Project Health, Syracuse University
and Children’s Hospital Board of Trustees.  Mr. Barnes received a B.S.
from Syracuse University.


John Connaughton, Director.
Mr. Connaughton has served as a director since February 2006.
Mr. Connaughton has been a Managing Director of Bain Capital Partners, LLC
since 1997 and a member of the firm since 1989. He has played a leading role in
transactions in the medical, technology and media industries. Prior to joining
Bain Capital, Mr. Connaughton was a consultant at Bain & Company,
Inc., where he worked in the consumer products and business services industries.
Mr. Connaughton currently serves as a director of Hospital Corporation of
America (HCA), M/C Communications (PriMed), Warner Chilcott (WCRX-NASDAQ),
Quintiles Transnational Corp, Sungard Data Systems, Warner Music Group
(NYSE-WMG), AMC Theatres, Clear Channel Communications Inc. and The Boston
Celtics. He also volunteers for a variety of charitable organizations, serving
as a member of Children’s Hospital Board of Overseers, The Berklee College of
Music Board of Trustees and UVa McIntire Foundation Board of Trustees.
Mr. Connaughton received a B.S. in commerce from the University of Virginia
and an M.B.A. from Harvard Business School.




Chris Gordon, Director.
Mr. Gordon has served as director since February 2006. Mr. Gordon is a
managing director of Bain Capital and joined the firm in 1997. Prior to joining
Bain Capital, Mr. Gordon was a consultant at Bain & Company, Inc.
and currently serves as a director of Hospital Corporation of America and of
Accellent, Inc. He also volunteers for a variety of charitable organizations,
currently serving on the Children’s Hospital Board of Overseers and the Boston
Public Library Foundation Board of Directors.Mr. Gordon received an
M.B.A. from Harvard Business School where he was a Baker Scholar and graduated
magna cum laude with an A.B. in economics from Harvard College.




General Barry R. McCaffrey (ret),
Director. General McCaffrey has served as a director since August 2002.
From March 2001 to the present, General McCaffrey has served as president of BR
McCaffrey Associates, LLC, an international consulting firm. General McCaffrey
served as the Director of the White House Office of National Drug Control Policy
from March 1996 to March 2001, and as the Bradley Distinguished Professor of
National Security Studies at the U.S. Military Academy from March 2001 to June
2005. General McCaffrey has also served as an analyst for NBC News since
September 2001. During his time at the White House, General McCaffrey was a
member of both the President’s Cabinet and the National Security Council for
drug-related issues. General
McCaffrey also serves on the board of directors of DynCorp International, LLC,
McNeil Technologies, Global Linguist Solutions and HNTB Corporation.General McCaffrey graduated from the U.S. Military Academy at West Point.
He holds an M.A. in civil government from American University and attended the
Harvard University National Security Program as well as the Business School
Executive Education Program.




Elliot Sainer, Director.
Mr. Sainer has served as a director since November 2006. From November 2006
through September 31, 2007, Mr. Sainer served as the president of our
youth division. From 1998 to 2006, he served as chief executive officer of
Aspen Education Group, Inc. We acquired Aspen Education Group, Inc. in
November 2006. From 1991 to 1998, Mr. Sainer was Chief Executive
Officer of College Health Enterprises.  Mr.
Sainer serves as a director of Acadia Healthcare, LLC, Knowledge Delivery
Systems, Inc. and StarPoint LLC Healthcare Group.  He also serves as a
member of the board of Alzheimers Association of Greater Los Angeles and Union
Station Homeless Services.Mr. Sainer holds an M.B.A. in
health care administration from George Washington University and a B.A. in
Political Science from the University of Pittsburgh.




Code
of Conduct




The CRC
Health Corporation Code of Business Conduct and Ethics is our code of ethics
applicable to all employees, including all officers and directors with regard to
company related activities.  The code incorporates our policy to
conduct our business affairs honestly and in an ethical manner.  It
also incorporates our expectations of all employees to provide accurate and
timely disclosures in our filings with the SEC.  A copy of our code is
available on our website at www.crchealth.com
under “Press Releases”, “Investor Relations,” SEC Filings.”  We will
post any amendments to our code, or waivers of the code for our executive
officers, on our website at www.crchealth.com
under “Press Releases,” “About CRC Health Group,” “Code of
Conduct.”




We
also maintain a Compliance Manual and Code of Conduct that focuses on our
responsibilities to our patients and the high standards of ethics that we
require from all employees. This Code of Conduct is compliant with the
requirements of our accrediting bodies.




Section 16(a)
Compliance




There is
no established public trading market for our common stock. We are a wholly-owned
subsidiary of CRC Health Group, Inc. which holds all of our outstanding common
stock. CRC Health Group, Inc. is a privately held corporation.




71


Audit
Committee




The audit
committee selects the independent auditors to be nominated for election by the
stockholders and reviews the independence of such auditors, approves the scope
of the annual audit activities of the independent auditors, approves the audit
fee payable to the independent auditors and reviews such audit results with the
independent auditors. The audit committee is currently composed of Steven
Barnes, Chris Gordon and Elliot Sainer. Chris Gordon serves as our “audit
committee financial expert” as defined in Item 407(d)(5) of
Regulation S-K.




ITEM 11. Executive Compensation




Compensation
Discussion and Analysis




This
section discusses the principles underlying our executive compensation policies
and decisions. In this section, we address the members and role of our
compensation committee, our compensation setting process, our compensation
philosophy and policies regarding executive compensation, the components of our
executive compensation program and our compensation decisions for 2008. We
address the compensation paid or awarded during 2008 to our chief executive
officer, our chief financial officer and the three other most highly compensated
executive officers in fiscal year 2008. We refer to these five executive
officers as our named executive officers.




On
February 6, 2006, we were acquired by investments funds managed by Bain
Capital (the “Bain Merger”). We refer to Bain Capital Partners as our “Sponsor.”
As discussed in more detail below, various aspects of the compensation of our
named executive officers was negotiated and determined at the time of the Bain
Merger. There is no established public trading market for our common stock. We
are a wholly-owned subsidiary of CRC Health Group, Inc. which holds all of our
outstanding common stock. CRC Health Group, Inc. is a privately held
corporation. Our parent company’s outstanding capital stock consists of
Class A common stock and Class L common stock. All references to options
herein refer to options to purchase Class A common stock and Class L common
stock of our parent company.




The
Compensation Committee and Compensation Setting Practice




The
compensation committee operates under a written charter adopted by our Board of
Directors and has responsibility for discharging the responsibilities of the
Board of Directors relating to the compensation of our executive officers and
related duties. Compensation decisions are designed to promote our fundamental
business objectives and strategy and align the interests of management with the
interests of our stakeholders. Our chief executive officer works with senior
management to evaluate employee performance, establish business performance
targets and objectives and recommend salary levels and then presents cash and
equity compensation recommendations to the Compensation Committee for its
consideration and approval. We have not engaged a compensation consultant or
benchmarked our compensation against other companies to date but may consider
doing so in the future. The Compensation Committee reviews these proposals and
makes all final compensation decisions for the executive officers by exercising
its discretion in accepting, modifying or rejecting any management
recommendations.




The Board
of Directors created a compensation committee in January 2007.  The
current members of the compensation committee are John Connaughton, Steven
Barnes and Barry Karlin.




Our
Compensation Philosophy




Compensation
decisions are designed to promote our fundamental business objectives and
strategy and align the interests of management with the interests of our
stakeholders. We believe that compensation should focus management on achieving
strong short-term (annual) performance in a manner that supports and ensures out
long-term success and profitability. We also believe that pay should be directly
linked to performance and that pay should be at competitive levels necessary to
attract and retain exceptional leadership talent. This philosophy has guided
many compensation related decisions:




•
            A
      substantial portion of executive officer compensation is contingent on
      achievement of objective corporate, division and individual performance
      objectives.


•
            Our
      annual incentive bonus program and equity incentive bonus program
      emphasize performance-based compensation that promotes the achievement of
      short-term and long-term business objectives which are aligned with our
      long term strategic plan.


•
            Total
      compensation is higher for individuals with greater responsibility and
      greater ability to influence our achievement of targeted results and
      strategy; further, as position and responsibility increases, a greater
      portion of the executive officer’s total compensation is performance based
      pay and equity based pay, making a significant portion of their total
      compensation dependent on the achievement of performance
      objectives.




Components
of Executive Compensation Plan




In 2008,
the principal elements of annual compensation for our named executive officers
consisted of base salary and performance based incentive bonuses, long term
equity incentive compensation and benefits.




Base Salary. Base pay is a
critical element of executive compensation because it provides executives with a
base level of monthly income. In determining base salaries, we consider the
executive’s qualification and experience, scope of responsibilities and future
potential, the goals and objectives established for the executive, the
executive’s past performance and competitive salary practices. Further, for our
most senior executives, we establish base salaries at a level so that a
significant portion of the total compensation that such executives can earn is
performance based pay. Dr. Barry Karlin’s base salary was determined in his
employment agreement which was negotiated at the time of the Bain Merger and is
reviewed annually by the Compensation Committee. For all of our other named
executive officers, base salary increases are at the discretion of the
Compensation Committee. Base salary is reviewed annually at the beginning of the
year and any increases are based on our overall performance and the executive’s
individual performance during the preceding year. At its February 2009 meeting,
the Compensation Committee reviewed recommendations for salary adjustments for
all executive officers and determined that because of the economic environment
and need to reduce operating expense that base salaries for our named executives
would not increase in 2009.




2008 Incentive Bonus Plan.
Our 2008 Incentive Bonus Plan is designed to reward our employees for the
achievement of 2008 EBITDA goals related to the business. EBITDA represents
actual earnings before interest, taxes, depreciation and amortization and
certain other adjustments as agreed upon with Bain Capital. The bonus payment
for our Chief Executive Officer is governed by his employment agreement and is
wholly dependent on the achievement of certain EBITDA targets. Pursuant to his
employment agreement, our target annual incentive bonus for our Chief Executive
Officer is 100% of his base salary in the event that our actual EBITDA is 100%
of our budgeted EBITDA; he may earn an annual incentive bonus of up to a maximum
150% of his base salary in the event that our actual EBITDA is 110% of our
budgeted EBITDA but also may earn nothing in the event that financial milestones
are not achieved. The bonus plan for Kevin Hogge, Philip Herschman, Jerome
Rhodes and James Hudak is based on our overall achievement of our EBITDA targets
(target bonus assumes our actual EBITDA is 100% of budgeted EBITDA and the
maximum bonus assumes that our actual EBITDA is 110% or greater than budgeted
EBITDA) and individual contributions. These officers have a target annual
incentive bonus of 50% of base salary; they may earn a maximum annual incentive
bonus of up to 75% of base salary but may also earn nothing in the event our
financial milestones are not achieved. The bonus is paid after completion of our
annual audit and the officer must be an employee at such time to receive a bonus
payment.




72


If our
actual EBITDA is less than 90% of our budgeted EBITDA, then the bonus pool is
zero provided that the Compensation Committee may authorize bonuses in their
sole discretion. In the event that our actual EBITDA for the year is less than
100% of our budgeted EBITDA but greater than 90% then the bonus pool will be
prorated and all bonus payment amounts are in the discretion of the Compensation
Committee. Consistent with our focus on pay for performance, additional amounts
can be earned when actual EBITDA exceeds our budgeted EBITDA. Actual EBITDA was
less than 90% of budgeted EBITDA and, accordingly, bonus amounts were in the
discretion of the Compensation Committee. The Compensation Committee determined
that discretionary bonuses would be provided to reward and provide future
motivation for employees who had achieved or partially achieved their goals and
for individual performance. The Compensation Committee approved an aggregate
year end bonus pool of $1,150,000 (excluding special retention bonuses, sales
commissions etc.) to be allocated and distributed based on performance by the
CEO.




Equity Based Compensation. We
believe that equity compensation is a critical tool in aligning the interests of
our stockholders and executive officers in building share value and in retaining
key executives. We have designed an equity plan that promotes the achievement of
both short-term and long-term business objectives which are aligned with our
strategic plan. We have elected to use stock options as the equity compensation
vehicle.




Upon
consummation of the Bain Merger, our parent company established the 2006
Executive Incentive Plan and the 2006 Management Incentive Plan. Options issued
pursuant to the 2006 Executive Incentive Plan vest based, in part, on the
passage of time and in part on the achievement of performance objectives. At the
time of the Bain Merger, state securities laws restricted our use of performance
based option plans. As a result, our parent company adopted the 2006 Management
Incentive Plan pursuant to which options vest over a five year period. In 2007,
the state securities laws were amended to allow for broader use of performance
based plans. Our parent company established the 2007 Incentive Plan in September
2007. This plan is identical to our 2006 Executive Incentive Plan. These plans
provide for the granting of either incentive stock options or nonincentive stock
options to our key employees, directors, consultants and advisors. In
determining the number of options to be granted to employees, we take into
account the individual’s position, scope of responsibility, ability to affect
profits and shareholder value and the individual’s historic and recent
performance and the value of the stock options in relation to other elements of
total compensation. All of our executive officers and generally any employee
with profit and loss responsibility received options under the 2006 Executive
Incentive Plan. All current options are granted under the 2007 Incentive Plan.
Each option is an option to purchase a unit which consists of nine shares of
Class A Stock and one share of Class L Stock. The options are exercisable
only for whole units and cannot be separately exercised for the individual
classes of stock. The grant date of the stock options is always the date of
approval of the grants.




All stock
options under our plans have the following features: the term of grant does not
exceed 10 years, the grant price is not less than the fair market value on the
date of grant, repricing of options is prohibited, unless approved by the
shareholders, vesting is generally over a five year period and options
generally will remain exercisable for three months following the participant’s
termination of service other than for cause, except that if service terminates
as a result of the participant’s death or disability, the option generally will
remain exercisable for twelve months, but in any event not beyond the expiration
of its term. In general, options granted under the Executive Plan and 2007
Incentive Plan vest and become exercisable at the rate of 10% on the one year
anniversary of the date of grant and 5% on each six-month anniversary thereafter
until 50% of the options granted are vested. An additional 25% shall vest upon
our stock price reaching a certain level during a sale event or at certain times
after an initial public offering. An additional 25% shall vest over a five year
time horizon upon our EBITDA reaching certain levels or in the event that our
stock price reaches a certain level during a sale event or at certain times
after an initial public offering. In general, options granted under the
Management Plan vest and become exercisable at the rate of 20% on the one year
anniversary of the date of grant and 10% on each six-month anniversary
thereafter until 100% of the options granted are vested.




Our
parent company does not have a formal policy requiring stock ownership by
management. However, our senior executives, including our named executive
officers, have committed significant personal capital to CRC. In connection with
the closing of the Bain Merger and the acquisition of Aspen Education Group, and
pursuant to a rollover and subscription agreement, certain members of our
management, including all of the named executive officers, converted options to
purchase stock of our predecessor company into options to purchase stock of
Holdings with an aggregate value of approximately $9.9 million.




Other Compensation
Information. We provide employees, including our named executive
officers, with a variety of other benefits, including medical, dental and vision
plans, life insurance and holidays and vacation. These benefits are generally
provided to employees on a company-wide basis. We do not offer any retirement
plans to our directors or executive officers, other than the 401(k) plan
generally available to employees. In accordance with the terms of the our 401(k)
plan, in 2008 we matched, in cash, 25% of amounts contributed to that plan by
each plan participant, up to 6% of eligible pay. The matching contribution made
by us is subject to vesting, based on continued employment, with 25% scheduled
to vest on each of the four anniversaries of the employee’s date of
hire.




In
connection with the Aspen Acquisition, we acquired a non-qualified Insured
Security Option Plan (the “ISOP”) which was available to certain key employees
of Aspen Education Group, our youth division. This plan was available to
Mr. Elliot Sainer and Mr. James Dredge. The ISOP permits these
employees to defer on an after-tax basis a portion of their salary or bonus each
calendar year. Under the ISOP, we could make discretionary contributions to
these employee accounts, up to $6,000 per employee. Additionally, we may also
make additional discretionary contributions to these employee accounts to
simulate the pre-tax benefits of our 401(k) plan. We discontinued these
discretionary contributions for employee contributions made after the 2007 plan
year.




Accounting
and Tax Implications




The
accounting and tax treatment of particular forms of compensation do not
materially affect the Compensation Committee’s compensation decisions. However,
we evaluate the effect of such accounting and tax treatment on an ongoing basis
and will make appropriate modifications to compensation policies where
appropriate.




Compensation
Committee Report




The
following report of the Compensation Committee is included in accordance with
the rules and regulations of the Securities and Exchange Commission. It is not
incorporated by reference into any of our registration statements under the
Securities Act of 1933, as amended.




Compensation
Committee Report




The
Committee has reviewed and discussed the Compensation Discussion and Analysis
(CD&A) with management. Based upon the review and discussions, the Committee
recommended to the Board of Directors, and the Board approved, that the CD&A
be included in the Form 10-K for the year ended December 31, 2008.




Respectfully
submitted on March  27, 2009 by the members of the Compensation
Committee of the Board of Directors:




Dr. Barry
      Karlin


John
      Connaughton


Steven
      Barnes




73


Summary
Compensation Table




The
following table summarizes the compensation paid to our Chief Executive Officer,
Chief Financial Officer and our three other most highly compensated executive
officers, whom we refer to as our “named executive officers,” for the years
ended December 31, 2008, December 31, 2007 and December 31,
2006.


Change
      inPension
      ValueandNonqualifiedOption
              
              
              Non-equity
              
              
              Deferred
              
              
              All
      otherSalary
              
              
              Bonus
              
              
              Stock
              
              
              Awards
              
              
              Incentive
      Plan
              
              
              Compensation
              
              
              Compensation
              
              
              TotalName and Principal
      Position
              Year
              
              ($)
              
              
              ($)(2)
              
              
              Awards
              
              
              ($)(3)
              
              
              Compensation
              
              
              Earnings
              
              
              ($)
              
              
              ($)Dr. Barry W.
      Karlin
              2008
              
              
              616,515
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              39,077
              (10)
              
              
              655,592Chairman
      and Chief Executive Officer
              2007
              
              
              595,346
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              175,000
              (5)
              
              
              —
              
              
              
              38,580
              (6)
              
              
              808,9262006
              
              
              549,038
              (1)
              
              
              1,400,000
              
              
              
              —
              
              
              
              9,320,563
              
              
              
              430,446
              (4)
              
              
              —
              
              
              
              29,818
              (7)
              
              
              11,729,865James
      Hudak
              2008
              
              
              124,097
              
              
              
              —
              
              
              
              —
              
              
              
              1,071,400
              
              
              
              —
              
              
              
              —
              
              
              
              3,796
              (11)
              
              
              1,199,293Chief
      Administrative Office
              2007
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —2006
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Philip
      L. Herschman
              2008
              
              
              294,855
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,852
              (13)
              
              
              297,707President,
      Healthy Living Division
              2007
              
              
              284,730
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              55,591
              (5)
              
              
              —
              
              
              
              2,500
              (8)
              
              
              342,8212006
              
              
              270,961
              (1)
              
              
              450,000
              
              
              
              —
              
              
              
              2,342,409
              
              
              
              73,431
              (4)
              
              
              —
              
              
              
              2,752
              (8)
              
              
              3,139,554Jerome
      E. Rhodes
              2008
              
              
              294,855
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              27,000
              (12)
              
              
              —
              
              
              
              13,308
              (9)
              
              
              335,163President,
      Recovery Division
              2007
              
              
              284,730
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              60,591
              (5)
              
              
              —
              
              
              
              13,118
              (9)
              
              
              358,4402006
              
              
              270,961
              (1)
              
              
              450,000
              
              
              
              —
              
              
              
              2,342,409
              
              
              
              120,849
              (4)
              
              
              —
              
              
              
              13,150
              (9)
              
              
              3,202,152Kevin
      Hogge
              2008
              
              
              294,855
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              9,004
              (14)
              
              
              303,859Chief
      Financial Officer, Vice President and Treasurer
              2007
              
              
              284,730
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              55,591
              (5)
              
              
              —
              
              
              
              2,500
              (8)
              
              
              342,8212006
              
              
              270,961
              (1)
              
              
              300,000
              
              
              
              —
              
              
              
              2,342,409
              
              
              
              103,372
              (4)
              
              
              —
              
              
              
              1,822
              (8)
              
              
              3,202,152


(1)
            Salaries
      reflect amounts earned in 2006. Salaries were negotiated at the time of
      the Bain Merger and were effective as of February 6, 2006. The
      salaries for our named executive officers are: (1) Dr. Barry
      Karlin—$575,000, (ii) Philip Herschman—$275,000, (iv) Jerome
      Rhodes—$275,000, and Kevin
Hogge—$275,000.




(2)
            Amounts
      listed under this column reflect one time performance bonuses made in
      connection with the Bain Merger.




(3)
            The
      amounts included in this column reflect the compensation costs associated
      with stock option awards recognized as expense in our financial statements
      in accordance with SFAS 123(R). These costs relate to option awards
      granted in February 2006 under the 2006 Executive Incentive Plan. Under
      SFAS 123(R), the full grant date fair value of the February 2006 option
      awards is recognized over a five year period. For a discussion of the
      assumptions made in the valuation, please see Note 12 to our Consolidated
      Financial Statements.




(4)
            2006
      annual incentive bonus plan which was paid in April 2007 upon completion
      of our 2006 audit. Bonuses paid pursuant to the 2006 Incentive Bonus Plan
      are accrued in the year earned and paid in the following
    year.




(5)
            2007
      annual incentive bonus paid in March 2007. Bonuses paid pursuant to the
      2007 Incentive Bonus Plan are accrued in the year earned and paid in the
      following year.




(6)
            Represents
      $12,650 for premium costs on a life insurance policy for which the
      beneficiaries are his family, $22,680 in medical, dental and vision
      contributions, and $3,250 in company contributions pursuant to our 401(k)
      Plan for 2007.




(7)
            Represents
      $12,500 for premium costs on a life insurance policy for which the
      beneficiaries are his family, $14,123 in medical, dental and vision
      contributions, and $3,195 in company contributions pursuant to our 401(k)
      Plan for 2006.




(8)
            Represents
      company contributions pursuant to our 401(k)
  Plan.




(9)
            Represents
      $10,400 in car allowance during 2008, 2007, and 2006. In addition,
      represents $2,836, $2,718, and $2,750 in company contributions pursuant to
      our 401(k) Plan for 2008, 2007, and 2006
  respectively.




(10)
            Represents
      $12,000 for premium costs on a life insurance policy for which the
      beneficiaries are his family, $23,630 in medical, dental and vision
      contributions, and $3,375 in company contributions pursuant to our 401(k)
      Plan for 2008.




(11)
            Represents
      $3,796 in medical, dental and vision
  contributions.




(12)
            2008
      annual incentive bonus paid in March 2008. Bonuses paid pursuant to the
      2008 Incentive Bonus Plan are accrued in the year earned and paid in the
      following year.




(13)
            Represents
      $2,779 in company contributions pursuant to our 401(k) Plan for
      2008.




(14)
            Represents
      $5,345 in medical, dental and vision contributions and $3,586 in company
      contributions pursuant to our 401(k) Plan for
  2008.




74




Grants
of Plan-Based Awards in 2008




The
following table contains information concerning grants of plan-based awards to
our named executive officers during 2008:


Estimated Possible Payouts Under
              
              
              Estimated Future Payouts UnderNon-Equity Incentive Plan Awards(1)
              
              
              Equity
      Incentive Plan Awards(2)All Other
      Stock Awards:
              
              
              All
      Other Option Awards:Number
      of Shares
              
              
              Number of
      Securities
              
              
              Exercise
      or Base
              
              
              Grant
      Date Fair ValueGrant
              
              Threshold
              
              
              Target
              
              
              Maximum
              
              
              Threshold
              
              
              Target
              
              
              Maximum
              
              
              of
      Stock or Units
              
              
              Underlying
      Options
              
              
              Price of
      Option Awards
              
              
              of
      Stock and Option AwardsName
              Date(2)
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              
              (#)
              
              
              
              (#)
              
              
              
              (#)
              
              
              
              (#)
              
              
              
              (#)
              
              
              ($/Sh)
              
              
              ($)Dr. Barry
      Karlin
              1/1/08
              
              
              0
              
              
              
              618,930
              
              
              
              928,935
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Philip
      Herschman
              1/1/08
              
              
              0
              
              
              
              147,428
              
              
              
              221,141
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Jerome
      Rhodes
              1/1/08
              
              
              0
              
              
              
              147,428
              
              
              
              221,141
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Kevin
      Hogge
              1/1/08
              
              
              0
              
              
              
              147,428
              
              
              
              221,141
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —James
      Hudak
              1/1/08
              
              
              0
              
              
              
              147,428
              
              
              
              221,141
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —




NOTES TO
TABLE:




(1)
            Amounts
      reflect cash awards pursuant to our 2008 Incentive Bonus Plan to which our
      named executive officers are eligible.  Pursuant to our 2008
      Incentive Bonus Plan, the amounts are based on the achievement of the
      EBITDA targets for the period January 1, 2008 through December 31,
      2008. The Target amount equals 100% of achievement of the target and the
      Maximum amount assumes that our actual EBITDA exceeded 110% of budgeted
      EBITDA. The threshold amount equals 90% of achievement of the target;
      provided however, that they Compensation Committee, in their discretion,
      may award bonuses if there is 90% or less achievement of the targets. For
      the year ended December 31, 2008 Actual EBITDA was less than 90% of
      budgeted EBITDA and, accordingly, bonus amounts were in the discretion of
      the Compensation Committee. See the Summary Compensation Table for bonuses
      received by our named executive
officers




(2)
            The
      grant date provided is the date that the plan year began for the 2008
      Incentive Bonus Plan.




The
material terms of our stock option awards, 2008 Incentive Bonus Plan and our
employment agreement with Dr. Barry Karlin are described in Compensation
Discussion and Analysis.




75


Outstanding
Equity Awards at Fiscal Year-End 2008




The
following table sets forth certain information with respect to the value of all
unexercised options and unvested stock awards previously awarded to our named
executive officers as of December 31, 2008.


Option
      Awards(1)
              
              Stock
      AwardsEquityEquity Incentive
              
              
              
              
              
              
              
              
              
              
              
              
              Incentive Plan
              
              
              Equity IncentivePlan Awards:
              
              
              
              
              
              
              
              
              
              Market
              
              
              Awards:
              
              
              Plan Awards:Number of
              
              
              
              
              
              
              Number
              
              
              Value of
              
              
              Number
      of
              
              
              Market or PayoutNumber
      of
              
              
              Number of
              
              
              Securities
              
              
              
              
              
              
              of Shares
              
              
              Shares
      or
              
              
              Unearned
              
              
              Value of unearnedSecurities
              
              
              Securities
              
              
              Underlying
              
              
              
              
              
              
              or Units
              
              
              Units
              
              
              Shares, Units
              
              
              Shares, Units orUnderlying
              
              
              Underlying
              
              
              Unexercised
              
              
              Option
              
              
              
              of Stock
              
              
              of Stock
              
              
              or Other Rights
              
              
              Other
      RightsUnexercised
              
              
              Unexercised
              
              
              Unearned
              
              
              Exercise
              
              Option
              
              That Have
              
              
              That Have
              
              
              That Have
              
              
              That Have NotOptions
              
              
              Options
              
              
              Options
              
              
              Price
              
              Expiration
              
              Not Vested
              
              
              Not Vested
              
              
              Not
      Vested
              
              
              VestedName
              
              Exercisable(#)
              
              
              Unexercisable(#)
              
              
              
              (#)
              
              
              ($)
              
              Date
              
              
              (#)
              
              
              ($)
              
              
              
              (#)
              
              
              ($)Dr. Barry Karlin
              
              
              48,231
              (2)(3)
              
              
              120,941
              (2)
              
              
              —
              
              
              
              90.00
              
              2/6/16
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —61,554
              (4)
              
              
              —
              
              
              
              —
              
              
              
              8.77
              
              12/14/14
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Philip Herschman
              
              
              12,121
              (2)(3)
              
              
              30,393
              (2)
              
              
              —
              
              
              
              90.00
              
              2/6/16
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —11,079
              (4)
              
              
              —
              
              
              
              —
              
              
              
              8.77
              
              12/14/14
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Jerome Rhodes
              
              
              12,121
              (2)(3)
              
              
              30,393
              (2)
              
              
              —
              
              
              
              90.00
              
              2/6/16
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —11,079
              (4)
              
              
              —
              
              
              
              —
              
              
              
              8.77
              
              12/14/14
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Kevin
      Hogge
              
              
              12,121
              (2)(3)
              
              
              30,393
              (2)
              
              
              —
              
              
              
              90.00
              
              2/6/16
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —11,079
              (4)
              
              
              —
              
              
              
              —
              
              
              
              8.77
              
              12/14/14
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —James
      Hudak
              
              
              —
              
              
              
              20,000
              
              
              
              —
              
              
              
              112.287
              
              09/11/17
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
  NOTES TO
TABLE:




(1)
            All
      information in this table relates to nonqualified stock options. We have
      not granted any incentive stock options or stock appreciation rights. Each
      option is an option to purchase one Unit consisting of 9 shares of
      Class A Common Stock and one share of Class L Common
      Stock.


(2)
            Option
      issued pursuant to the 2006 Executive Incentive Plan. The exercisable
      options include all options that have vested. All unexercisable options
      have not yet vested. Pursuant to such plan, options vest as follows:
      (i) 50% of the option (the Tranche 1 Options) is time based and vests
      over five years with 20% vesting on February 6, 2007, one year from
      the date of grant, and 10% of the remaining balance vesting every 6 months
      thereafter, (ii) 25% of the option is performance based and vests
      based on the attainment of a certain value of the Company (the Tranche 2
      Options), as discussed in the Compensation Discussion and Analysis and
      (iii) the remaining 25% (the Tranche 3 Options) of the option is
      performance based and vests on the attainment of certain annual goals for
      the Company during the 5 year period beginning January 1, 2006, as
      discussed in the Compensation Discussion and
  Analysis.


(3)
            Vested
      options represents 50% of the Tranche 1 Options vesting based on time and
      14.04% of the Tranche 3 Options vesting based on achievement of EBITDA
      milestones.


(4)
            Rollover
      options are fully vested. To the extent that outstanding options were not
      cancelled in the Bain Merger, such options converted into fully vested
      options to purchase equity units in our parent company. Each rollover
      option is an option to purchase one Unit consisting of 9 shares of
      Class A Common Stock and 1 share of Class L Common
    Stock.




Option
Exercises and Stock Vested in 2008




The
following table sets forth information about stock options exercised by the
named executives in fiscal year 2008 and stock awards that vested or were paid
in fiscal year 2008 to the named executives.




Option
      Awards
              
              
              
              
              
              Stock
      AwardsNumber of Shares
              
              
              Value Realized
              
              
              Number of Shares
              
              
              Value RealizedAcquired on Exercise
              
              
              on Exercise
              
              
              Acquired on Vesting
              
              
              on VestingName
              
              
              (#)
              
              
              ($)
              
              
              
              (#)
              
              
              ($)Dr. Barry
      Karlin
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Philip
      Herschman
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Jerome
      Rhodes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Kevin
      Hogge
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —James
      Hudak
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
  Pension
Benefits




None of
the Named Executive Officers receive nonqualified deferred compensation
benefits.




Potential
Payments Upon Termination or a Change in Control




Employment
Agreement




Pursuant
to our employment agreement with Dr. Karlin, in the event of
Dr. Karlin’s termination without cause or his resignation for good reason
(both defined in his employment agreement), we must pay Dr. Karlin a lump
sum equal to his base salary for a period of 36 months and provided further that
if Dr. Karlin signs a general release of all claims, we shall also pay to
Dr. Karlin for a period of 18 months all premiums due for COBRA premiums
for Dr. Karlin and his insured dependents, all premiums relating to our
group disability plan and all premiums relating to his life insurance policy, an
aggregate amount of approximately $1.912 million calculated as of December 31,
2008. In the event of a termination due to death, disability or cause or if
Dr. Karlin resigns without good reason, we must pay Dr. Karlin any
base salary earned but not paid through the date of termination, any vacation
time accrued but not used through the date of termination, any bonus
compensation earned but unpaid on the date of termination and any business
expenses incurred but un-reimbursed on the date of termination.




We have
no employment agreements with Kevin Hogge, James Hudak, Philip Herschman or
Jerome Rhodes.




76


2008
Incentive Bonus Plan




An
employee is only eligible to receive a bonus pursuant to the 2008 Annual
Incentive Bonus plan if such employee is an employee of CRC or a subsidiary of
CRC at the time of completion of our annual audit (typically in early
April).




Stock
Options




In
general, option grants under the Executive Plan and 2007 Incentive Plan
stipulate that in the event of a change in control of our parent company in
which Bain Capital achieves liquidity, up to 100% of the options will vest;
provided however, that options that did not vest in years prior to the change of
control because of the failure to attain the EBITDA targets do not vest upon the
change of control unless the stock price reaches $360 per unit in a change of
control transaction. In general, option grants under the Management Plan
stipulate that in the event of a change in control of our parent company in
which Bain Capital achieves liquidity, up to 100% of the options will vest. In
the event of a change of control in which Bain Capital does not achieve
liquidation, options issued to our executive officers will fully vest in the
event that there is a termination or constructive termination of employment of
the executive within 12 months after the change in control.




The
successor entity may assume or continue in effect options outstanding under the
Executive Plan or Management Plan or substitute substantially equivalent options
for the successor’s stock. Any options which are not assumed or continued in
connection with a change in control or exercised prior to the change in control
will terminate effective as of the time of the change in control. The Executive
Plan and Management Plan also authorize the administrator to treat as satisfied
any vesting condition in the event of a change of control.




Restrictions
Upon Termination or a Change of Control




During
the course of employment and for a period of 18 months following the end of
employment, Dr. Karlin may not participate in any other chemical or alcohol
dependency business or any behavioral health business in a field in which we
have plans to become engaged. For the same period, Dr. Karlin may also not
solicit any of our employees, customers, referral sources or
suppliers.




Director
Compensation




None of
our directors except General Barry McCaffrey and Elliot Sainer receive
compensation for serving as a director. The members of our board of directors
are not separately compensated for their services as directors, other than
reimbursement for out-of-pocket expenses incurred in connection with rendering
such services.




Effective
September 30, 2007, Elliot Sainer retired as President of our youth
division. As a result of Mr. Sainer’s retirement, the employment provisions
of the employment agreement between the Company and Elliot Sainer terminated as
of September 30, 2007. Mr. Sainer will receive $0.7 million in payment
to be paid over the 18 month period following his termination as defined in his
employment agreement. Of the 166,284 options for Class A common shares and
18,476 options for Class L common shares held by Mr. Sainer during his
employment, 116,399 options for Class A common shares and 12,933 options
for Class L common shares were cancelled, which had an aggregate weighted
average fair value of $769,525. Mr. Sainer will continue to serve as a
member of the Board of Directors of the Company. Additionally, as of the
effective date of his retirement, the Company retained Mr. Sainer in the
capacity as a consultant. The following table contains compensation
received by General Barry McCaffrey and Elliot Sainer during the year ended
December 31, 2008 for serving as a director of, and providing consulting
services to, CRC and Holdings.





Change inPension
      Valueand NonqualifiedNon-Equity
              
              
              DeferredFees Earned or
              
              
              Stock
              
              
              
              
              
              Incentive
      Plan
              
              
              Compensation
              
              
              All
      OtherPaid in Cash
              
              
              Awards
              
              
              Option Awards
              
              
              Compensation
              
              
              Earnings
              
              
              Compensation
              
              
              TotalName
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              ($)General Barry McCaffrey
              
              
              120,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              120,000Elliot
      Sainer
              
              
              60,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              467,244
              
              
              
              60,000
  NOTES TO
TABLE:




(1)
            General
      McCaffrey receives a salary of $10,000 per month for consulting services
      rendered to us. He does not receive cash payments for attendance at board
      meetings.




(2)
            Following
      his retirement as President of our youth division, Elliot Sainer received
      a consulting fee of $5,000 per month for consulting services rendered to
      us. Items under “All Other Compensation” consist of payments made to Mr.
      Sainer in 2008 pursuant to his Employment Agreement as well as $12,791 in
      life and disability insurance benefits. He does not receive cash payments
      for attendance at board meetings.




Compensation
Committee Interlocks and Insider Participation




Our
Compensation Committee is currently comprised of Messrs. Connaughton, Barnes and
Karlin. Dr. Barry Karlin is the chief executive officer of CRC and the
Group. Messrs. Connaughton and Barnes have not been at any time an officer or
employee of CRC or an affiliate of CRC. During 2008, we had no compensation
committee “interlocks”—meaning that it was not the case that an executive
officer of ours served as a director or member of the compensation committee of
another entity and an executive officer of the other entity served as a director
or member of our Compensation Committee.




77


ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters




Beneficial
Ownership




All of
our outstanding common stock is held by our parent company. Our parent company’s
outstanding capital stock consists of Class A common shares and Class L
common shares.




The table
below sets forth, as of March 1, 2008, the number and percentage of shares
of our parent company’s common stock beneficially owned by (i) each person
known by us to beneficially own more than 5% of the outstanding shares of common
stock of our parent company, (ii) each of our directors, (iii) each of
our named executive officers and (iv) all our directors and executive
officers as a group.




Notwithstanding
the beneficial ownership of common stock presented below, our stockholders
agreement governs the stockholders exercise of their voting rights with respect
to election of directors and certain other material events. The parties to our
stockholders agreement have agreed to vote their shares to elect the board of
directors as set forth therein. In addition, our stockholders agreement governs
certain stockholders’ exercise of voting rights with respect to effecting a
change of control transaction. See “Certain Relationships and Related Party
Transactions.”




The
amounts and percentages of shares beneficially owned are reported on the basis
of SEC regulations governing the determination of beneficial ownership of
securities. Under SEC rules, a person is deemed to be a “beneficial owner” of a
security if that person has or shares voting power or investment power, which
includes the power to dispose of or to direct the disposition of such security.
A person is also deemed to be a beneficial owner of any securities of which that
person has a right to acquire beneficial ownership within 60 days. Securities
that can be so acquired are deemed to be outstanding for purposes of computing
such person’s ownership percentage, but not for purposes of computing any other
person’s percentage. Under these rules, more than one person may be deemed to be
a beneficial owner of the same securities and a person may be deemed to be a
beneficial owner of securities as to which such person has no economic
interest.


78


Except as
described in the agreements mentioned above or as otherwise indicated in a
footnote, each of the beneficial owners listed has, to our knowledge, sole
voting and investment power with respect to the indicated shares of common
stock. Unless otherwise indicated in a footnote, the address for each individual
listed below is c/o CRC Health Corporation, 20400 Stevens Creek Boulevard, Suite
600, Cupertino, California 95014.


Shares
      of
              
              
              Percent of
              
              
              Shares
      of
              
              
              Percent ofClass A
              
              
              Class A
              
              
              Class L
              
              
              Class LCommon
              
              
              Common
              
              
              Common
              
              
              CommonName
      and Address
              
              Stock
              
              
              Stock
              
              
              Stock
              
              
              StockBain Capital Partners VIII, L.P.
      and Related Funds(1)
              
              
              32,547,498
              
              
              
              95.0
              %
              
              
              3,616,388
              
              
              
              95.0
              %Dr. Barry W.
      Karlin(2)
              
              
              1,064,202
              
              
              
              2.7
              %
              
              
              118,243
              
              
              
              2.7
              %James
      Hudak
              
              
              —
              
              
              
              *
              
              
              
              —
              
              
              
              *Philip L. Herschman(3)
              
              
              227,943
              
              
              
              *
              
              
              
              25,326
              
              
              
              *Jerome E. Rhodes(4)
              
              
              227,943
              
              
              
              *
              
              
              
              25,326
              
              
              
              *Kevin Hogge(5)
              
              
              227,943
              
              
              
              *
              
              
              
              25,326
              
              
              
              *Barry R. McCaffrey(6)
              
              
              4,502
              
              
              
              *
              
              
              
              500
              
              
              
              *Elliot Sainer(7)
              
              
              64,764
              
              
              
              *
              
              
              
              7,195
              
              
              
              *Steven Barnes(8)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —John Connaughton(8)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Chris Gordon(8)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —All
      directors and executive officers as a group
              
              
              2,004,485
              
              
              
              5.8
              %
              
              
              222,274
              
              
              
              5.7
              %





*
            indicates
      less than 1% of common stock


(1)
            Represents
      shares owned by the following groups of investment funds affiliated with
      Bain Capital Partners, LLC: (i) 27,861,389.88 shares of Class A
      common stock and 3,095,709.94 shares of Class L common stock owned by Bain
      Capital Fund VIII, LLC, a Delaware limited liability company (“BCF VIII”),
      whose sole member is Bain Capital Fund VIII, L.P., a Cayman Islands
      exempted limited partnership (“BCF VIII Cayman”), whose sole general
      partner is Bain Capital Partners VIII, L.P., a Cayman Islands exempted
      limited partnership (“BCP VIII”), whose sole general partner is Bain
      Capital Investors, LLC, a Delaware limited liability company (“BCI”);
      (ii) 3,666,862.04 shares of Class A common stock and 407,429.12
      shares of Class L common stock owned by Bain Capital VIII Coinvestment
      Fund, LLC, a Delaware limited liability company (“BC VIII Coinvest”),
      whose sole member is Bain Capital VIII Coinvestment Fund, L.P., a Cayman
      Islands exempted limited partnership (“BC VIII Coinvest Cayman”), whose
      sole general partner is BCP VIII; (iii) 10,287.59 shares of
      Class A common stock and 1,143.08 shares of Class L common stock
      owned by BCIP Associates-G (`BCIP-G”), whose managing partner is BCI;
      (iv) 787,645.94 shares of Class A common stock and 69,256.98
      shares of Class L common stock owned by BCIP Associates III, LLC, a
      Delaware limited liability company (“BCIP IIP”), whose sole member is BCIP
      Associates III, a Cayman Islands partnership (“BCIP III Cayman”), whose
      managing partner is BCI; (v) 118,584 shares of Class A common
      stock and 31,435.32 shares of Class L common stock owned by BCIP T
      Associates III, LLC a Delaware limited liability company (“BCIP T III”),
      whose sole member is BCIP Trust Associates III, a Cayman Islands
      partnership (“BCIP T III Cayman”), whose managing partner is BCI;
      (vi) 65,975.32 shares of Class A common stock and 9,482.95
      shares of Class L common stock owned by BCIP Associates III-B, LLC, a
      Delaware limited liability company (`BCIP III-B”), whose sole member is
      BCIP Associates III-B, a Cayman Islands partnership (“BCIP III-B Cayman”),
      whose managing partner is BCI and (vii) 36,754 shares of Class A
      common stock and 1,931.37 shares of Class L common stock owned by BCIP T
      Associates III-B, LLC, a Delaware limited liability company (“BCIP T
      III-B” and together with BCF VIII, BC VIII Coinvest, BCIP-G, BCIP III,
      BCIP T III and BCIP III-B, the “Bain Funds”), whose sole member is BCIP
      Trust Associates III-B, a Cayman Islands partnership (“BCIP T III-B
      Cayman”), whose sole general partner is
BCI.




BCF VIII
Cayman, BCP VIII and BCI, by virtue of the relationships described above, may be
deemed to beneficially own the shares held by BCF VIII. BCF VIII Cayman, BCP
VIII and BCI disclaim beneficial ownership of such shares except to the extent
of their pecuniary interest therein.




BCF VIII
Coinvest Cayman, BCP VIII and BCI, by virtue of the relationships described
above, may be deemed to beneficially own the shares held by BCP VIII Coinvest.
BCF VIII Coinvest Cayman, BCP VIII and BCI disclaim beneficial ownership of such
shares except to the extent of their pecuniary interest therein.




BCI, by
virtue of the relationships described above, may be deemed to beneficially own
the shares held by BCIP-G. BCI disclaims beneficial ownership of such shares
except to the extent of their pecuniary interest therein.




BCIP III
Cayman and BCI, by virtue of the relationships described above, may be deemed to
beneficially own the shares held by BCIP III. BCIP III Cayman and BCI disclaim
beneficial ownership of such shares except to the extent of their pecuniary
interest therein.




BCIP T III
Cayman and BCI, by virtue of the relationships described above, may be deemed to
beneficially own the shares held by BCIP T III. BCIP T III Cayman and BCI
disclaim


beneficial
ownership of such shares except to the extent of their pecuniary interest
therein.




BCIP III-B
Cayman and BCI, by virtue of the relationships described above, may be deemed to
beneficially own the shares held by BCIP III-B. BCIP III-B Cayman and BCI
disclaim


beneficial
ownership of such shares except to the extent of their pecuniary interest
therein.




BCIP T
III-B Cayman and BCI, by virtue of the relationships described above, may be
deemed to beneficially own the shares held by BCIP T III-B. BCIP T II1-B Cayman
and BCI disclaim beneficial ownership of such shares except to the extent of
their pecuniary interest therein.




(2)
            Represents
      options to purchase 118,243 Units consisting of 1,064,202 shares of
      Class A common stock issuable pursuant to options exercisable within
      60 days and 118,243 shares of Class L common stock issuable pursuant to
      options exercisable within 60 days.




(3)
            Represents
      options to purchase 25,326 Units consisting of 227,943 shares of
      Class A common stock issuable pursuant to options exercisable within
      60 days and 25,326 shares of Class L common stock issuable pursuant to
      options exercisable within 60 days.




(4)
            Represents
      options to purchase 25,326 Units consisting of 227,943 shares of
      Class A common stock issuable pursuant to options exercisable within
      60 days and 25,326 shares of Class L common stock issuable pursuant to
      options exercisable within 60 days.




(5)
            Represents
      options to purchase 25,326 Units consisting of 227,943 shares of
      Class A common stock issuable pursuant to options exercisable within
      60 days and 25,326 shares of Class L common stock issuable pursuant to
      options exercisable within 60 days.




79


(6)
            Represents
      options to purchase 500 Units consisting of 4,502 shares of Class A
      common stock issuable pursuant to options exercisable within 60 days and
      500 shares of Class L common stock issuable pursuant to options
      exercisable within 60 days.




(7)
            Represents
      options to purchase 7,195 Units consisting of 64,764 shares of
      Class A common stock issuable pursuant to options exercisable within
      60 days and 7,195 shares of Class L common stock issuable pursuant to
      options exercisable within 60 days.




(8)
            Mr. Barnes,
      Mr. Connaughton and Mr. Gordon are each a managing director of
      Bain Capital Partners, LLC. They disclaim any beneficial ownership of any
      shares beneficially owned by any entity affiliated with Bain Capital
      Partners, LLC in which they do not have a pecuniary interest.
      Mr. Barnes, Mr. Connaughton and Mr. Gordon each have an
      address c/o Bain Capital Partners, LLC, 111 Huntington Avenue, Boston,
      Massachusetts 02199.




Securities
Authorized for Issuance Under Equity Compensation Plans




The
following table summarizes the securities authorized for issuance as of December
31, 2007 under our 2006 Executive Incentive Plan, our 2006 Management Incentive
Plan, and our 2007 Incentive Plan, the number of shares of our Class A
common stock and Class L common stock issuable upon the exercise of outstanding
options, the weighted average exercise price of such options and the number of
additional shares of our common stock still authorized for issuance under such
plans. Each of the 2006 Executive Incentive Plan, our 2006 Management Incentive
Plan and our 2007 Incentive Plan have been approved by our
shareholders.




(a)
            
            
            (b)
            
            
            (c)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
      (excluding securities
              reflected in
      column (a))Class A
              common
              stock
            
            
            Class L
              common
              stock
            
            
            Class A
              common
              stock
            
            
            Class
      L
              common
              stock
            
            
            Class A
              common
              stock
            
            
            Class
      L
              common
              stock2006
      Executive Incentive Plan
            
            
            5,416,016
            (1)
            
            
            601,778
            (1)
            
            $
            0.88
            
            
            $
            66.71
            
            
            
            (2)
            
            
            
            (2)2006
      Management Incentive Plan
            
            
            481,874
            
            
            
            53,541
            
            
            $
            1.22
            
            
            $
            83.67
            
            
            
            (2)
            
            
            
            (2)2007
      Incentive Plan
            
            
            681,891
            
            
            
            75,770
            
            
            $
            1.58
            
            
            $
            88.10
            
            
            
            (2)
            
            
            
            (2)Equity
      compensation plans not approved by security holders
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —





(1)
            This
      amount consists of 1,090,518 shares of Class A common stock and
      121,168 shares of Class L common stock that were issued in connection with
      rolled over options at the time of the Bain Merger and Aspen Acquisition.
      It also includes 4,325,498 shares of Class A common stock and 480,610
      shares of Class L common stock issued pursuant to the 2006 Executive
      Incentive Plan.


(2)
            The
      number of securities remaining available for future issuance under either
      the 2007 Incentive Plan, 2006 Executive Incentive Plan or the 2006
      Management Incentive Plan is an aggregate of 244,790 shares of
      Class A common stock and 27,196 shares of Class L common
      stock.




ITEM 13. Certain Relationships and Related Transactions and
Director Independence




Pursuant
to our Code, all employees and directors (including our named executive
officers) who have, or whose immediate family members have, any financial
interests in other entities where such involvement is or may appear to cause a
conflict of interest situation are required to report to us the conflict. If the
conflict involves a director or executive officer or is considered material, the
situation will be reviewed by the Audit Committee. The Audit Committee will
determine whether a conflict exists or will exist, and if so, what action should
be taken to resolve the conflict or potential conflict.




Arrangements
with Our Investors




On
February 6, 2006, investment funds managed by Bain Capital Partners, LLC
and certain members of our management entered into a stockholders agreement
related to the purchase of shares of capital stock of Holdings. The stockholders
agreement contains agreements among the parties with respect to the election of
our directors and the directors of our direct parent company, restrictions on
the issuance or transfer of shares, including tag-along rights and drag-along
rights, other special corporate governance provisions (including the right to
approve various corporate actions), registration rights (including customary
indemnification provisions) and call options. Three of our directors, Steven
Barnes, John Connaughton and Chris Gordon hold the position of managing director
or principal with Bain Capital Partners, LLC.




Rollover
of Certain Management Equity Interests




In
connection with the closing of the Bain Merger on February 6, 2006, and
pursuant to a rollover and subscription agreement, certain members of our
management converted options to purchase stock of our predecessor company into
options to purchase stock of Holdings with an aggregate value of approximately
$9.1 million. Dr. Barry W. Karlin, Jerome E. Rhodes, Kevin Hogge,
Philip L. Herschman, Kathleen Sylvia, Dr. Thomas J. Brady and Pamela
B. Burke converted options with a value of $5.0 million, $0.9 million, $0.9
million, $0.9 million, $0.5 million, $185,000 and $125,000,
respectively.




In
connection with the closing of the Aspen Acquisition on November 17, 2006
and pursuant to a rollover and subscription agreement, certain employees of
Aspen Education Group, Inc. converted options to purchase stock of Aspen
Education Group, Inc. into options to purchase stock of the Group with an
aggregate value of approximately $1.8 million. Mr. Elliot Sainer converted
options with a value of $0.6 million.




80


Management
Agreement




Upon the
consummation of the Bain Merger, we and our parent companies entered into a
management agreement with an affiliate of Bain Capital Partners, LLC pursuant to
which such entity or its affiliates will provide management services. Pursuant
to such agreement, an affiliate of Bain Capital Partners, LLC will receive an
aggregate annual management fee of $2.0 million, and reimbursement for
out-of-pocket expenses incurred in connection with the Transactions prior to the
closing of the Transactions and in connection with the provision of services
pursuant to the agreement. In addition, pursuant to such agreement, an affiliate
of Bain Capital Partners, LLC also received aggregate transaction fees of
approximately $7.2 million in connection with services provided by such entity
related to the Transactions. The management agreement has a five year, evergreen
term, however, in certain circumstances, such as an initial public offering or
change of control of Holdings, we may terminate the management agreement and buy
out our remaining obligations under the agreement to Bain Capital Partners, LLC
and its affiliates. In addition, the management agreement provides that an
affiliate of Bain Capital Partners, LLC may receive fees in connection with
certain subsequent financing and acquisition transactions. In connection with
the Aspen Acquisition and the related amending and restating of our then
existing senior secured credit facility, an affiliate of Bain Capital Partners,
LLC received aggregate transaction fees of $3,200,000. The management agreement
includes customary indemnification provisions in favor of Bain Capital Partners,
LLC and its affiliates.




Director
Independence




CRC is a
privately held corporation. None of our directors meet the standards for
“independent directors” of a national stock exchange.




ITEM 14. Principal Accountant Fees and
Services




For the
fiscal years ended December 31, 2008 and December 31, 2007,
Deloitte & Touche LLP, and its affiliates, the Company’s independent
registered public accounting firm and principal accountant, billed the fees set
forth below (in thousands).


Year
      Ended
              
              
              Year
      EndedDecember 31,
              
              
              December 31,2008
              
              
              2007Audit Fees(1)
              
              $
              1,577
              
              
              $
              2,146Audit-Related Fees(2)
              
              
              —
              
              
              
              30Tax Fees(3)
              
              
              —
              
              
              
              —All Other Fees(4)
              
              
              —
              
              
              
              —Total
      Fees
              
              $
              1,577
              
              
              $
              2,176


(1)
            Audit
      Fees billed in the fiscal years ended December 31, 2008 and 2007
      represented fees for the following services: the audit of the Company’s
      annual financial statements, reviews of the Company’s quarterly financial
      statements, and other services normally provided in connection with
      statutory and regulatory filings. The 2007 amounts have been revised from
      amounts previously reported.


(2)
            Audit-Related
      Fees billed in the fiscal years ended December 31, 2007 represented fees
      for the following services: due diligence related to mergers and
      acquisitions and financial accounting and reporting
      consultations.


(3)
            The
      Company did not incur any Tax Fees for the years ended December 31, 2008
      and 2007 with its principal independent registered accounting
      firm.


(4)
            The
      Company did not incur any “All Other Fees” in the fiscal years ended
      December 31, 2008 and 2007 with its principal independent registered
      accounting firm.




The audit
committee was formed in May 2006. All audit and non-audit services performed
after such date have been pre-approved by the audit committee.




81


PART
IV




ITEM 15. Exhibits and Financial Statement
Schedules




(a)
Financial Statements




The
financial statements are filed as part of this Annual Report on Form 10-K under
Item 8 – “Financial Statements and Supplementary Data.”




(b)
Financial Statement Schedules




Financial
statement schedules have been omitted since they are either not required, not
applicable, or the information is presented in the consolidated financial
statements and the notes thereto in Item 8 above.




(c)
Exhibit Index




2.1
                Agreement
      and Plan of Merger among CRCA Holdings, Inc., CRCA Merger Corporation and
      CRC Health Group, Inc. dated as of October 8, 2005 (incorporated by
      reference to Exhibit 2.1 of Form S-4 (File No. 333-1351712) filed
      June 21, 2006)2.1a
                Agreement
      and Plan of Merger dated as of September 22, 2006, by and among Aspen
      Education Group, Inc., Frazier Healthcare II, L.P., as Shareholders’
      Representative, Madrid Merger Corporation and CRC Health Corporation
      (incorporated by reference to Exhibit 2.1 of Form 8-K (File
      No. 333-135172) filed September 28, 2006)3.1
                Certificate
      of Incorporation of CRC Health Corporation, with amendments (incorporated
      by reference to Exhibit 3.1 of Form S-4 (File No. 333-1351712) filed
      June 21, 2006)3.2
                By-Laws
      of CRC Health Corporation (incorporated by reference to Exhibit 3.3 of
      Form S-4 (File No. 333-1351712) filed June 21,
    2006)4.1
                Indenture,
      dated as of February 6, 2006, by and among CRCA Merger Corporation, CRC
      Health Corporation, the Guarantors named therein and U.S. Bank National
      Association, as Trustee, with respect to the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form S-4 (File
      No. 333-135172) filed June 21, 2006)4.1a
                First
      Supplemental Indenture dated as of July 7, 2006, by and among CRC Health
      Corporation, the Guarantors named therein, the New Guarantors named
      therein and U.S. Bank National Association, as Trustee, with respect to
      the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.4 of Form S-4 (File
      No. 333-1351712) filed June 21, 2006)4.1b
                Second
      Supplemental Indenture dated as of September 28, 2006, by and among
      CRC Health Corporation, the Guarantors named therein, the New Guarantors
      named therein and U.S. Bank National Association, as Trustee, with respect
      to the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form 10-Q
      filed November 14, 2006)4.1c
                Third
      Supplemental Indenture dated as of October 24, 2006, by and among CRC
      Health Corporation, the Guarantors named therein, the New Guarantors named
      therein and U.S. Bank National Association, as Trustee, with respect to
      the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form 10-Q
      filed November 14, 2006)4.1d
                Fourth
      Supplemental Indenture dated as of November 17, 2006 among CRC Health
      Corporation, a Delaware corporation (the “Company”), the Guarantors, the New
      Guarantors named therein and U.S. Bank National Association, as trustee
      with respect to the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form 10-K
      filed April 2, 2007)
  82
 4.1e
                Fifth
      Supplemental Indenture dated as of April 27, 2007 among CRC Health
      Corporation, a Delaware corporation (the “Company”), the Guarantors, the New
      Guarantors named therein and U.S. Bank National Association, as trustee
      with respect to the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form 10-Q
      filed May 15, 2007)4.1f
                Sixth
      Supplemental Indenture dated as of July 26, 2007 among CRC Health
      Corporation, a Delaware corporation (the “Company”), the Guarantors, the New
      Guarantors named therein and U.S. Bank National Association, as trustee
      with respect to the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form 10-Q
      filed November 13, 2007)4.1g
                Seventh
      Supplemental Indenture dated as of May 23, 2008 among CRC Health
      Corporation, a Delaware corporation (the “Company”), the Guarantors, the New
      Guarantors named therein and U.S. Bank National Association, as trustee
      with respect to the 103/4% Senior Subordinated
      Notes due 2016 (incorporated by reference to Exhibit 4.1 of Form 10-Q
      filed August 13, 2008)4.1h
                Release
      of Guarantee dated as of July 25, 2008 by and among US Bank National
      Association, as Trustee, CRC Health Corporation, Adirondack Leadership
      Expeditions, LLC and LoneStar Expeditions, Inc. (incorporated by reference
      to 4.1 of Form 10-Q filed November 14, 2008).4.1i
                Eighth
      Supplemental Indenture dated as of November ___, 2008 among CRC Health
      Corporation, a Delaware corporation (the “Company”), the Guarantors, CRC Holdings,
      LLC, a Delaware limited liability company (the “New Guarantor”) and U.S. Bank National
      Association, as trustee with respect to the 103/4% Senior Subordinated
      Notes due 2016.4.2
                Registration
      Rights Agreement, dated as of February 6, 2006, by and among CRCA
      Merger Corporation, CRC Health Corporation, the Guarantors named therein
      and the Initial Purchasers named therein (incorporated by reference to
      Exhibit 4.2 of Form S-4 (File No. 333-135172) filed June 21,
      2006)4.3
                Form
      of 103⁄4%
      Senior Subordinated Notes due 2016 (contained in Exhibit 4.1)
      (incorporated by reference to Exhibit 4.3 of Form S-4 (File
      No. 333-135172) filed June 21, 2006)10.1
                Credit
      Agreement, dated as of February 6, 2006, by and among CRC Health Group,
      Inc. (to be renamed CRC Health Corporation), CRC Intermediate Holdings,
      Inc., Citibank, N.A., the other lenders party thereto, JPMorgan Chase
      Bank, N.A., as syndication agent and Merrill Lynch, Pierce, Fenner &
      Smith Incorporated and Credit Suisse as co-documentation agents and
      Citigroup Global Markets Inc. and J.P. Morgan Securities Inc. as co-lead
      arrangers and joint bookrunners (incorporated by reference to Exhibit 10.1
      of Form S-4 (File No. 333-1351712) filed June 21,
      2006)10.1a
                Amendment
      No. 1 to Credit Agreement, dated as of May 19, 2006 among CRC Intermediate
      Holdings, Inc., CRC Health Corporation and Citibank, N.A. in its capacity
      as administrative agent for the Lenders and as collateral agent for the
      Secured Parties (incorporated by reference to Exhibit 10.15 of Form S-4
      (File No. 333-1351712) filed June 21, 2006)10.1b
                AMENDMENT
      AGREEMENT, dated as of November 17, 2006 among CRC Health Group, Inc., CRC
      Health Corporation, the Subsidiary Guarantors, as defined therein, and
      Citibank, N.A., in its capacity as administrative agent for the Lenders
      and as collateral agent for the Secured Parties, and the lenders party
      hereto and under the Credit Agreement dated as of
      February 6, 2006 (incorporated by reference to Exhibit 4.1 of
      Form 10-K filed April 2, 2007)10.1c
                AMENDED
      AND RESTATED CREDIT AGREEMENT (“Agreement”) entered into as of
      November 17, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, Citibank, N.A., as administrative agent, collateral agent,
      swing line lender and L/C issuer, each lender from time to time party
      thereto, JPMorgan, Chase Bank, N.A., as Syndication Agent, and Merrill
      Lynch, Pierce, Fenner & Smith Incorporated, as documentation agent
      (incorporated by reference to Exhibit 4.1 of Form 10-K filed April 2,
      2007)10.1d
                AMENDMENT
      NO. 2 to Credit Agreement dated as of April 16, 2007, among CRC HEALTH
      GROUP, INC., a Delaware corporation (“Holdings”), CRC HEALTH
      CORPORATION, a Delaware corporation (the “Borrower”), CITIBANK,
      N.A., in its capacity as administrative agent for the Lenders and as
      collateral agent for the Secured Parties (incorporated by reference to
      Exhibit 10.1 of Form 10-Q filed May 15, 2007)10.2
                Security
      Agreement, dated as of February 6, 2006, between CRC Health Group, Inc.
      (to be renamed CRC Health Corporation), CRC Intermediate Holdings, Inc.,
      the Subsidiaries identified therein and Citibank, N.A., as administrative
      agent (incorporated by reference to Exhibit 10.2 of Form S-4 (File
      No. 333-1351712) filed June 21, 2006)10.2a
                Form
      of SUPPLEMENT NO. 1 dated as of June 22, 2006, to the Security Agreement
      dated as of February 6, 2006 among CRC Health Corporation (f/k/a CRC
      Health Group, Inc.), CRC Intermediate Holdings, Inc., and the Subsidiaries
      of the Borrower identified therein and Citibank, N.A., as Collateral Agent
      for the Secured Parties as defined
therein.
  83
 10.2b
                Form
      of SUPPLEMENT NO. 2 dated as of June 22, 2006, to the Security Agreement
      dated as of February 6, 2006 among CRC Health Corporation (f/k/a CRC
      Health Group, Inc.), CRC Intermediate Holdings, Inc., and the Subsidiaries
      of the Borrower identified therein and Citibank, N.A., as Collateral Agent
      for the Secured Parties as defined therein (incorporated by reference to
      Exhibit 4.1 of Form 10-K filed April 2, 2007)10.2c
                Form
      of SUPPLEMENT NO. 3 dated as of September 27, 2006, to the Security
      Agreement dated as of February 6, 2006 among CRC Health Corporation (f/k/a
      CRC Health Group, Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings,
      Inc.) and the Subsidiaries of the Borrower identified therein and
      Citibank, N.A., as Collateral Agent for the Secured Parties as defined
      therein (incorporated by reference to Exhibit 4.1 of Form 10-K filed April
      2, 2007)10.2d
                Form
      of SUPPLEMENT NO. 4 dated as of October 18, 2006, to the Security
      Agreement dated as of February 6, 2006 among CRC Health Corporation (f/k/a
      CRC Health Group, Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings,
      Inc.) and the Subsidiaries of the Borrower identified therein and
      Citibank, N.A., as Collateral Agent for the Secured Parties as defined
      therein (incorporated by reference to Exhibit 4.1 of Form 10-K filed April
      2, 2007)10.2e
                SUPPLEMENT
      NO. 5 dated as of November 17, 2006, to the Security Agreement dated
      as of February 6, 2006 among CRC Health Corporation (f/k/a CRC Health
      Group, Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings, Inc.), and the
      Subsidiaries of the Borrower identified therein and Citibank, N.A., as
      collateral Agent for the Secured Parties, as defined therein (incorporated
      by reference to Exhibit 4.1 of Form 10-K filed April 2,
      2007)10.2f
                SUPPLEMENT
      NO. 6 dated as of April 27, 2007, to the Security Agreement dated as of
      February 6, 2006 among CRC Health Corporation (f/k/a CRC Health Group,
      Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings, Inc.), and the
      Subsidiaries of the Borrower identified therein and Citibank, N.A., as
      collateral Agent for the Secured Parties, as defined therein (incorporated
      by reference to Exhibit 10.2 of Form 10-Q filed May 15,
    2007)10.2g
                SUPPLEMENT
      NO. 7 dated as of July 26, 2007, to the Security Agreement dated as of
      February 6, 2006 among CRC Health Corporation (f/k/a CRC Health Group,
      Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings, Inc.), and the
      Subsidiaries of the Borrower identified therein and Citibank, N.A., as
      collateral Agent for the Secured Parties, as defined therein (incorporated
      by reference to Exhibit 10.2 of Form 10-Q filed November 13,
      2007)10.2h
                SUPPLEMENT
      NO. 8 dated as of May 23, 2008, to the Security Agreement dated as of
      February 6, 2006 among CRC Health Corporation (f/k/a CRC Health Group,
      Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings, Inc.), and the
      Subsidiaries of the Borrower identified therein and Citibank, N.A., as
      collateral Agent for the Secured Parties, as defined therein (incorporated
      by reference to Exhibit 10.2 of Form 10-Q filed August 13,
      2008)10.2i
                SUPPLEMENT
      NO. 9 dated as of November __, 2008, to the Security Agreement dated as of
      February 6, 2006 among CRC Health Corporation (f/k/a CRC Health Group,
      Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings, Inc.), and the
      Subsidiaries of the Borrower identified therein and Citibank, N.A., as
      collateral Agent for the Secured Parties, as defined
    therein10.3
                Guarantee
      Agreement, dated as of February 6, 2006, among CRC Health Group, Inc.
      (to be renamed CRC Health Corporation), CRC Intermediate Holdings, Inc.,
      the Subsidiaries named therein and Citibank, N.A. as administrative agent
      (incorporated by reference to Exhibit 10.3 of Form S-4 (File
      No. 333-1351712) filed June 21, 2006)10.3a
                Form
      of SUPPLEMENT NO. 1 dated as of June 22, 2006, to the Guarantee Agreement
      dated as of February 6, 2006, among CRC Intermediate Holdings, Inc., CRC
      Health Corporation, the Subsidiaries of the Borrower identified therein
      and Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 4.1 of Form 10-K filed April 2, 2007)10.3b
                Form
      of SUPPLEMENT NO. 2 dated as of June 22, 2006, to the Guarantee Agreement
      dated as of February 6, 2006, among CRC Intermediate Holdings, Inc., CRC
      Health Corporation, the Subsidiaries of the Borrower identified therein
      and Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 4.1 of Form 10-K filed April 2, 2007)10.3c
                Form
      of SUPPLEMENT NO. 3 dated as of September 27, 2006, to the Guarantee
      Agreement dated as of February 6, 2006, among CRC Health Group, Inc., CRC
      Health Corporation, the Subsidiaries of the Borrower identified therein
      and Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 4.1 of Form 10-K filed April 2,
2007)
  84
 10.3d
                Form
      of SUPPLEMENT NO. 4 dated as of October 18, 2006, to the Guarantee
      Agreement dated as of February 6, 2006, among CRC Health Group, Inc., CRC
      Health Corporation, the Subsidiaries of the Borrower identified therein
      and Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 4.1 of Form 10-K filed April 2, 2007)10.3e
                SUPPLEMENT
      NO. 5 dated as of November 17, 2006, to the Guarantee Agreement dated as
      of February 6, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, the Subsidiaries of the Borrower, as defined herein and
      Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 4.1 of Form 10-K filed April 2, 2007)10.3f
                SUPPLEMENT
      NO. 6 dated as of April 27, 2007, to the Guarantee Agreement dated as of
      February 6, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, the Subsidiaries of the Borrower, as defined herein and
      Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 10.2 of Form 10-Q filed May 15, 2007)10.3g
                SUPPLEMENT
      NO. 7 dated as of July 26, 2007, to the Guarantee Agreement dated as of
      February 6, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, the Subsidiaries of the Borrower, as defined herein and
      Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 10.2 of Form 10-Q filed November 13, 2007)10.3h
                SUPPLEMENT
      NO. 8 dated as of May 23, 2008, to the Guarantee Agreement dated as of
      February 6, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, the Subsidiaries of the Borrower, as defined herein and
      Citibank, N.A., as Administrative Agent (incorporated by reference to
      Exhibit 10.2 of Form 10-Q filed August 13, 2008)10.3i
                SUPPLEMENT
      NO. 9 dated as of November __, 2008, to the Guarantee Agreement dated as
      of February 6, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, the Subsidiaries of the Borrower, as defined herein and
      Citibank, N.A., as Administrative Agent10.3i
                Release
      of Guarantee and Collateral Dated as of July 25, 2008 by and mong
      Citibank, NA, as Administrative Agent and Collateral Agent , CRC Health
      Corporation, Adirondack Leadership Expeditions, LLC and LoneStar
      Expeditions, Inc. (incorporated by reference to Exhibit 10.3i of Form 10-Q
      filed August 13, 2008).10.4
                Management
      Agreement dated as of February 6, 2006, by and among CRCA Holdings, Inc.
      (to be renamed CRC Health Group, Inc.), CRC Intermediate Holdings, Inc.,
      CRCA Merger Corporation and Bain Capital Partners, LLC (incorporated by
      reference to Exhibit 10.4 of Form S-4 (File No. 333-1351712)
      filed June 21, 2006)10.5
                Employment
      Agreement between Dr. Barry W. Karlin, CRC Health Group, Inc. and CRC
      Health Corporation, dated February 6, 2006 (incorporated by reference to
      Exhibit 10.5 of Form S-4 (File No. 333-1351712) filed June 21,
      2006)*10.6
                Stockholders
      Agreement among CRC Health Group, Inc. (f/k/a CRCA Holdings, Inc.), CRC
      Intermediate Holdings, Inc., CRC Health Corporation (f/k/a CRC Health
      Group, Inc.), the Investors, Other Investors, and Managers named therein,
      dated as of February 6, 2006 (incorporated by reference to Exhibit 10.6 of
      Form S-4 (File No. 333-1351712) filed June 21,
    2006)10.6a
                Amended
      and Restated Stockholders Agreement among CRC Health Group, Inc. (f/k/a
      CRCA Holdings, Inc.), CRC Intermediate Holdings, Inc., CRC Health
      Corporation (f/k/a CRC Health Group, Inc.), the Investors, Other
      Investors, and Managers named therein, dated as of February 6, 2006 and as
      amended and restated on August 13, 2008.10.7
                Form
      of Executive Letter Agreement re: Fair Market Value Determination of
      Shares dated February 6, 2006 (incorporated by reference to Exhibit
      10.7 of Form S-4 (File No. 333-1351712) filed June 21,
      2006)*10.8
                2006
      Executive Incentive Plan of CRC Health Group, Inc. (incorporated by
      reference to Exhibit 10.8 of Form S-4 (File No. 333-1351712) filed
      June 21, 2006)*10.8a
                2006
      Executive Incentive Plan of CRC Health Group, Inc., as amended
      (incorporated by reference to Exhibit 4.1 of Form 10-K filed April 2,
      2007)*10.9
                2006
      Management Incentive Plan of CRC Health Group, Inc. (incorporated by
      reference to Exhibit 10.9 of Form S-4 (File No. 333-1351712)
      filed June 21, 2006)*10.9a
                2006
      Management Incentive Plan of CRC Health Group, Inc., as amended
      (incorporated by reference to Exhibit 4.1 of Form 10-K filed April 2,
      2007)*10.10
                Form
      of Senior Executive Option Certificate (incorporated by reference to
      Exhibit 10.10 of Form S-4 (File No. 333-1351712) filed June 21,
      2006)*10.10a
                Form
      of 2007 Senior Executive Option Certificate, as amended (incorporated by
      reference to Exhibit 4.1 of Form 10-K filed April 2,
      2007)*10.11
                Form
      of Executive Option Certificate (incorporated by reference to Exhibit
      10.11 of Form S-4 (File No. 333-1351712) filed June 21,
      2006)*10.11a
                Form
      of 2007 Executive Option Certificate, as amended (incorporated by
      reference to Exhibit 4.1 of Form 10-K filed April 2,
  2007)*10.11b
                Form
      of Amended and Restated 2007 Executive Option Certificate (incorporated by
      reference to Exhibit 10.2 of Form 10-Q filed November 13,
      2007)*10.11c
                Form
      of Amended and Restated Executive Option Certificate (incorporated by
      reference to Exhibit 10.2 of Form 10-Q filed November 13,
      2007)*10.12
                Form
      of Management Time Vesting Option Certificate (incorporated by reference
      to Exhibit 10.12 of Form S-4 (File No. 333-1351712) filed
      June 21, 2006)*
  85
 10.13
                Form
      of Substitute Option Certificate (incorporated by reference to Exhibit
      10.13 of Form S-4 (File No. 333-1351712) filed June 21,
      2006)*10.14
                Rollover
      and Subscription Agreement, dated as of February 6, 2006, between CRCA
      Holdings, Inc. and the investors in CRC Health Group, Inc. listed therein
      (incorporated by reference to Exhibit 10.14 of Form S-4 (File
      No. 333-1351712) filed June 21, 2006)*10.15
                EMPLOYMENT
      AGREEMENT dated as of February 1, 2004, between Aspen Education Group,
      Inc. and Elliot A. Sainer (incorporated by reference to Exhibit 4.1 of
      Form 10-K filed April 2, 2007)*10.16
                FIRST
      AMENDMENT TO EMPLOYMENT AGREEMENT, dated as of November 17, 2006, made and
      entered into by and between Aspen Education Group, Inc. and Elliot A
      Sainer (incorporated by reference to Exhibit 4.1 of Form 10-K filed April
      2, 2007)*10.17
                2007
      Incentive Plan of CRC Health Group, Inc. (incorporated by reference to
      Exhibit 10.2 of Form 10-Q filed November 13, 2007)*10.18
                Form
      of 2007 Incentive Plan Option Certificate (incorporated by reference to
      Exhibit 10.2 of Form 10-Q filed November 13, 2007)*10.18a
                Form
      of 2008 Incentive Plan Option Certificate ‡*10.19
                Agreement
      dated as of September 20, 2007 between Elliot A. Sainer, CRC Health Group,
      Inc., CRC Health Corporation and Aspen Education Group (incorporated by
      reference to Exhibit 10.2 of Form 10-Q filed November 13,
      2007)*12
                Statement
      of Computation of Ratio of Earnings to Fixed Charges ‡21
                Subsidiaries
      of CRC Health Corporation‡31.1
                Rule
      13a-14(a)/15d-14(a) Certification of Principal Executive Officer
      ‡31.2
                Rule
      13a-14(a)/15d-14(a) Certification of Principal Financial Officer and
      Principal Accounting Officer ‡32.1
                Section 1350
      Certification of Principal Executive Officer †32.2
                Section 1350
      Certification of Principal Financial Officer and Principal Accounting
      Officer †


‡
            Filed
      herewith.


†
            Furnished
      herewith.


*
            Management
      contract or compensatory plan or
arrangement.




86


SIGNATURE




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




Date:
March 27, 2009




CRC
      HEALTH CORPORATION(Registrant)By
            /s/    KEVIN HOGGEKevin
      Hogge,
              Chief
      Financial Officer
              (Principal Financial Officer and Principal Accounting
              Officer
      and duly authorized signatory)




Pursuant
to the requirements of Section 13 or Section 15(d) of the Securities
Exchange Act of 1934, this report has been signed by the following persons in
the capacities indicated on March 27, 2009




Signature
            TitlePrincipal
      Executive Officer:
              
              /s/    DR. BARRY W. KARLIN
              
              Dr. Barry W.
      Karlin
            Chairman
      and Chief Executive OfficerPrincipal
      Financial and Accounting Officer:
              
              /s/    KEVIN HOGGEKevin
      Hogge
            Chief
      Financial Officer/s/    STEVEN BARNES
              
              Steven
      Barnes
            Director/s/    JOHN CONNAUGHTON
              
              John
      Connaughton
            Director/s/    CHRIS GORDON
              
              Chris
      Gordon
            Director/s/    BARRY R. MCCAFFREY
              
              Barry
      R. McCaffrey
            Director/s/    ELLIOT SAINER
              
              Elliot
      Sainer
            Director






87