UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549







FORM
10-Q







(Mark
One)


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




For the
quarterly period ended: September 30, 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)





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 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 by
Rule 12b-2 of the Exchange
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 November 14, 2008 was 1,000.







CRC
HEALTH CORPORATION




INDEX




Page No.Part I.
            Financial
      InformationItem 1.
            Financial
      Statements (Unaudited)Condensed Consolidated Balance Sheets as of September
      30, 2008 and December 31, 2007
            
            
            3Condensed Consolidated Statements of Operations for
      the three and nine months ended September 30, 2008 and
      2007
            
            
            4Condensed Consolidated Statements of Cash Flows for
      the nine months ended September 30, 2008 and 2007
            
            
            5Notes to Condensed Consolidated Financial
      Statements
            
            
            6Item
      2.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            
            
            29Item
      3.
            Quantitative and Qualitative Disclosure About Market
      Risk
            
            
            34Item 4T.
            Controls and Procedures
            
            
            34Part II.
            Other
      InformationItem 1A.
            Risk Factors
            
            
            35Item
      6.
            Exhibits
            
            
            35Signature
            
            
            36Exhibit Index
            
            
            37




Forward-Looking
Statements




This
Quarterly Report on Form 10-Q, including “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” in Item 2 of
Part I of this Quarterly 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; reductions in the availability of governmental and private
financial aid for CRC’s youth treatment programs; CRC’s substantial
indebtedness; changes in applicable regulations or a government investigation or
assertion that CRC has violated applicable regulations; attempts by local
residents to force the closure or relocation of CRC’s facilities; the
potentially difficult, unsuccessful or costly integration of 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
the Company’s Annual Report on Form 10-K for the year ended December 31,
2007 filed on April 7, 2008, and that are otherwise described from time to
time in CRC’s Securities and Exchange Commission filings after this Quarterly
Report. CRC assumes no obligation and does not intend to update these
forward-looking statements.




2


CRC
HEALTH CORPORATION




CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)


SEPTEMBER 30, 2008 AND DECEMBER 31, 2007


(In
thousands, except share amounts)




September
      30,
              2008
            
            
            December
      31,
              2007ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            3,014
            
            
            $
            5,118Accounts
      receivable, net of allowance for doubtful accounts of $5,935 in 2008 and
      $6,901 in 2007
            
            
            31,689
            
            
            
            31,910Prepaid
      expenses
            
            
            6,404
            
            
            
            7,544Other
      current assets
            
            
            1,531
            
            
            
            2,120Income
      taxes receivable
            
            
            ––
            
            
            
            193Deferred
      income taxes
            
            
            6,599
            
            
            
            6,599Total
      current assets
            
            
            49,237
            
            
            
            53,484PROPERTY
      AND EQUIPMENT—Net
            
            
            129,369
            
            
            
            122,937GOODWILL
            
            
            602,854
            
            
            
            730,684INTANGIBLE
      ASSETS—Net
            
            
            361,750
            
            
            
            390,388OTHER
      ASSETS
            
            
            21,831
            
            
            
            24,798TOTAL
      ASSETS
            
            $
            1,165,041
            
            
            $
            1,322,291LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            $
            7,909
            
            
            $
            7,014Accrued
      liabilities
            
            
            29,186
            
            
            
            37,582Current
      portion of long-term debt
            
            
            9,014
            
            
            
            35,603Other
      current liabilities
            
            
            24,582
            
            
            
            29,824Income
      taxes payable
            
            
            6,908
            
            
            
            ––Total
      current liabilities
            
            
            77,599
            
            
            
            110,023LONG-TERM
      DEBT—Less current portion
            
            
            648,910
            
            
            
            612,764OTHER
      LIABILITIES
            
            
            6,039
            
            
            
            7,514DEFERRED
      INCOME TAXES
            
            
            121,585
            
            
            
            145,867Total
      liabilities
            
            
            854,133
            
            
            
            876,168COMMITMENTS
      AND CONTINGENCIES (Note 12)MINORITY
      INTEREST
            
            
            317
            
            
            
            374STOCKHOLDER’S
      EQUITY:Common
      stock, $0.001 par value—1,000 shares authorized; 1,000 shares issued and
      outstanding at September 30, 2008 and December 31, 2007
            
            
            —
            
            
            
            —Additional
      paid-in capital
            
            
            442,150
            
            
            
            438,608(Accumulated
      deficit) retained earnings
            
            
            (130,559
            )
            
            
            7,141Accumulated
      other comprehensive  (loss) income
            
            
            (1,000
            )
            
            
            —Total
      stockholder’s equity
            
            
            310,591
            
            
            
            445,749TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
            
            $
            1,165,041
            
            
            $
            1,322,291




See notes
to unaudited condensed consolidated financial statements.






3


CRC HEALTH CORPORATION
  CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
 (In
thousands)
  Three Months
                Ended
                September
      30,
                2008
              
              
              Three Months
                Ended
                September
      30,
                2007
              
              
              Nine
      Months
                Ended
                September
      30,
                2008
              
              
              Nine
      Months
                Ended
                September
      30,
                2007NET
      REVENUE:Net
      client service revenue
              
              $
              124,278
              
              
              $
              120,623
              
              
              $
              358,646
              
              
              $
              341,489Other revenue
              
              
              2,146
              
              
              
              1,746
              
              
              
              6,126
              
              
              
              4,603Total
      net revenue
              
              
              126,424
              
              
              
              122,369
              
              
              
              364,772
              
              
              
              346,092OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              61,429
              
              
              
              55,443
              
              
              
              183,959
              
              
              
              167,131Supplies,
      facilities and other operating costs
              
              
              36,926
              
              
              
              36,557
              
              
              
              107,582
              
              
              
              100,677Provision
      for doubtful accounts
              
              
              1,715
              
              
              
              2,036
              
              
              
              5,010
              
              
              
              5,064Depreciation
      and amortization
              
              
              5,929
              
              
              
              5,397
              
              
              
              17,343
              
              
              
              16,310Asset
      impairments
              
              
              23,880
              
              
              
              ––
              
              
              
              23,880
              
              
              
              ––Goodwill
      impairment
              
              
              142,238
              
              
              
              ––
              
              
              
              142,238
              
              
              
              ––Total
      operating expenses
              
              
              272,117
              
              
              
              99,433
              
              
              
              480,012
              
              
              
              289,182(LOSS)
      INCOME FROM OPERATIONS
              
              
              (145,693
              )
              
              
              22,936
              
              
              
              (115,240
              )
              
              
              56,910INTEREST
      EXPENSE, NET
              
              
              (13,125
              )
              
              
              (15,169
              )
              
              
              (40,148
              )
              
              
              (44,971
              )OTHER
      (EXPENSE)
              
              
              (37
              )
              
              
              (1,217
              )
              
              
              (69
              )
              
              
              (800
              )(LOSS)
      INCOME BEFORE INCOME TAXES
              
              
              (158,855
              )
              
              
              6,550
              
              
              
              (155,457
              )
              
              
              11,139INCOME
      TAX (BENEFIT) EXPENSE
              
              
              (19,222
              )
              
              
              1,502
              
              
              
              (17,699
              )
              
              
              3,375MINORITY
      INTEREST IN INCOME (LOSS) OF SUBSIDIARIES
              
              
              301
              
              
              
              427
              
              
              
              (57
              )
              
              
              275NET
      (LOSS) INCOME
              
              $
              (139,934
              )
              
              $
              4,621
              
              
              $
              (137,701
              )
              
              $
              7,489


See notes
to unaudited condensed consolidated financial statements.




4


CRC HEALTH CORPORATION




CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007


(In
thousands)




Nine
      Months
              Ended
              September
      30,
              2008
            
            
            Nine
      Months
              Ended
              September
      30,
              2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      (loss) income
            
            $
            (137,701
            )
            
            $
            7,489Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            17,343
            
            
            
            16,310Amortization
      of debt discount and capitalized financing costs
            
            
            3,357
            
            
            
            3,356Loss
      on interest rate swap agreement
            
            
            165
            
            
            
            744Goodwill
      impairment
            
            
            142,238
            
            
            
            ––Asset
      impairments
            
            
            23,880
            
            
            
            ––Gain
      (loss) on disposition of property
            
            
            21
            
            
            
            (10
            )Provision
      for doubtful accounts
            
            
            5,010
            
            
            
            5,064Stock-based
      compensation
            
            
            3,847
            
            
            
            3,203Deferred
      income taxes
            
            
            (26,674
            )
            
            
            3,747Minority
      interest
            
            
            (57
            )
            
            
            275Changes
      in assets and liabilities:Accounts
      receivable
            
            
            (4,789
            )
            
            
            (5,745
            )Income
      taxes receivable
            
            
            193
            
            
            
            (2,605
            )Prepaid
      expenses
            
            
            1,140
            
            
            
            1,929Other
      current assets
            
            
            589
            
            
            
            (296)Accounts
      payable
            
            
            1,740
            
            
            
            (926)Accrued
      liabilities
            
            
            (9,257
            )
            
            
            (10,037
            )Income taxes payable
            
            
            6,908
            
            
            
            ––Other
      current liabilities
            
            
            (6,992
            )
            
            
            (5,211
            )Other
      assets
            
            
            (39
            )
            
            
            357Other
      liabilities
            
            
            168
            
            
            
            475Net
      cash provided by operating activities
            
            
            21,090
            
            
            
            18,119CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
            
            
            (18,587
            )
            
            
            (24,239
            )Proceeds
      from sale of property and equipment
            
            
            101
            
            
            
            67Acquisition
      of business, net of cash acquired
            
            
            (11,567
            )
            
            
            (33,602
            )Acquisition
      adjustments
            
            
            (10
            )
            
            
            979Payments
      made under earnout arrangements
            
            
            (2,947
            )
            
            
            —Net
      cash used in investing activities
            
            
            (33,010
            )
            
            
            (56,795
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Capital 
      (distributed to )/contributed  from Parent
            
            
            (305
            )
            
            
            500Capitalized
      financing costs
            
            
            (187
            )
            
            
            (611
            )Repayment
      of capital lease obligations
            
            
            (17
            )
            
            
            (194
            )Net
      borrowings under revolving line of credit
            
            
            13,500
            
            
            
            41,900Repayments
      of long-term debt
            
            
            (3,175
            )
            
            
            (4,013
            )Net
      cash provided by financing activities
            
            
            9,816
            
            
            
            37,582NET 
      DECREASE  IN CASH AND CASH EQUIVALENTS
            
            
            (2,104
            )
            
            
            (1,094
            )CASH
      AND CASH EQUIVALENTS—Beginning of period
            
            
            5,118
            
            
            
            4,206CASH
      AND CASH EQUIVALENTS—End of period
            
            $
            3,014
            
            
            $
            3,112


SUPPLEMENTAL
      DISCLOSURE OF NONCASH INVESTING ACTIVITIES:Payable
      for contingent consideration
            
            $
            641
            
            
            $
            4,625SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for interest
            
            $
            43,081
            
            
            $
            47,342Cash
      paid for income taxes, net of refunds
            
            $
            1,430
            
            
            $
            2,235






See notes
to unaudited condensed consolidated financial statements.




5


CRC
HEALTH CORPORATION




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)




1.
            ORGANIZATION




CRC
Health Corporation (“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 are referred to as the Company’s
recovery division. As of September 30, 2008, the Company operated 109
residential and outpatient treatment facilities in 22 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 are referred to as the Company’s youth division. As of September 30, 2008,
the Company’s youth division operated programs at 29 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
September 30, 2008, the Company’s healthy living division operated 16
facilities in eight states and one facility in the United Kingdom.




2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES




Basis
of Presentation and Principles of Consolidation—These interim, unaudited
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 interim financial information. The Company’s condensed
consolidated financial statements include the accounts of CRC Health Corporation
and its consolidated subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.




In the
opinion of management, these unaudited condensed consolidated financial
statements contain all adjustments, consisting of normal recurring adjustments,
necessary to present fairly the financial position of the Company, its results
of operations, and its cash flows. These unaudited condensed consolidated
financial statements should be read in conjunction with the audited financial
statements and the notes thereto for the year ended December 31,
2007.




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
condensed consolidated financial statements and accompanying notes. Actual
results could differ materially from those estimates.




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 reportable segments
identified in Note 16.  The Company determines the fair value of
its reporting units using a combination of an 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 are paying 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.  At
September 30, 2008, the Company tested its youth division and its
healthy living division for possible impairment based upon year to date results
of operations of the youth division, economic conditions, including the lack of
availability of student loans and other factors.  The Company believes that
there will be a decrease in expected future cash flows, and it has recognized a
non-cash charge of $142.2 million for impairment of goodwill allocated to its
youth division as well as a non-cash charge of $6.0 million related to
intangible assets not subject to amortization for its youth division. Impairment
charges related to goodwill and  intangible assets not subject to
amortization are included in the condensed consolidated statement of
operations under goodwill impairment and asset impairment,
respectively.
  6
  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. 
See Note 6.


Long-Lived
Assets—The
Company tests for impairment of its long-lived assets including property
and equipment and intangible assets subject to amortization in
accordance with Statement of Financial Accounting Standards No. 144, Accounting
for the impairment or Disposal of Long Lived Assets("SFAS
144").  Under
the provisions of SFAS 144, the
Company tests its long lived assets for impairment whenever events and
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.




For
the three and nine months ended September 30, 2008, the Company recognized 
a non-cash charge of  $1.5 million related to impairment of long-lived
assets and a $16.4 million non-cash charge related to impairment of intangible
assets subject to amortization.  These charges are related to the
Company's youth division and are included in the Company's condensed
consolidated statement of operations under asset impairment.  See Note
5 and see Note 6.




Facility
Closures and Restructuring Costs—The Company periodically
reviews its facilities to ensure proper alignment of its operations with its
business strategy.  TheCompany
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"). 
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, the book value of abandoned
property, and other associated costs.  At September 30, 2008, the Company
had not incurred any liabilities related to costs associated with exit
or disposal activities.  See Note
17.




Recent
Accounting Pronouncements— In September 2006, the Financial Accounting
Standards Board (“FASB”) issued Statement of Financial Accounting Standards
No. 157, Fair
Value Measurements (“SFAS 157”). SFAS 157 defines and establishes a
framework for measuring fair value and expands related disclosures, but it does
not require any new fair value measurements.




SFAS 157
is effective for fiscal years beginning after November 15, 2007. However,
effective February 6, 2008, the FASB deferred the effective date of SFAS
157 for one year for non financial assets and non financial liabilities that are
recognized or disclosed at fair value in the financial statements on a
nonrecurring basis.




The
Company adopted the financial asset and liability provisions of SFAS 157 on
January 1, 2008. The Company has not adopted the non-financial asset and
non-financial liability provisions of SFAS 157. See Note 10 for additional
information.






In
February 2007, the FASB issued Statement of Financial Accounting Standards
No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities—Including an
amendment to FASB Statement No. 115 (“SFAS 159”). SFAS 159
expands the use of fair value accounting but does not affect existing standards
which require assets or liabilities to be carried at fair value. Under SFAS 159,
a company may elect to use fair value to measure accounts and loans receivable,
available-for-sale and held-to-maturity securities, equity method investments,
accounts payable, guarantees and issued debt. Other eligible items include firm
commitments for financial instruments that would otherwise not be recognized at
inception and non-cash warranty obligations where a warrantor is permitted to
pay a third party to provide the warranty goods or services. If fair value is
elected, any upfront costs and fees related to the item must be recognized in
earnings and cannot be deferred, e.g., debt issue costs. The fair value election
is irrevocable and may generally be made on an instrument-by-instrument basis,
even if a company hassimilar
instruments that it elects not to measure at fair value. The Company adopted
SFAS 159 on January 1, 2008. Upon adoption and for the nine months ended
September 30, 2008, the Company did not elect any fair value options under the
provisions of SFAS 159.




7






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 natureand
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 2009. The Company is currently evaluating the
potential impact of the adoption of SFAS 141(R) on its financial
statements.




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.




In
March 2008, the FASB issued Statement of Financial Accounting Standards
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 of Financial Accounting Standards No. 133,
Accounting
for Derivative Instruments and Hedging Activities (“SFAS 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, with earlier adoption
allowed. The Company is currently evaluating the potential impact of the
adoption of SFAS 161 on its financial statements.




In April
2008, the FASB issued FSP SFAS 142-3, Determination
of the Useful Life of Intangible Assets(“FSP 142-3”). This guidance is
intended to improve the consistency between the useful life of a recognized
intangible asset under SFAS No. 142, Goodwill
and Other Intangible Assets(“SFAS 142”), and the period of expected cash
flows used to measure the fair value of the asset under SFAS 141R when the
underlying arrangement includes renewal or extension of terms that would require
substantial costs or result in a material modification to the asset upon renewal
or extension. Companies
estimating the useful life of a recognized intangible asset must now consider
their historical experience in renewing or extending similar arrangements or, in
the absence of historical experience, must consider assumptions that market
participants would use about renewal or extension as adjusted for SFAS 142’s
entity-specific factors. FSP 142-3 is effective for the
Company beginning January 1, 2009.  At September 30, 2008, the Company
does not believe that there will be a material impact to its financial
statements as a result of adopting SFAS 142-3.
  On
October 10, 2008, FASB, issued FASB Staff Position, referred to as FSP, No. FAS
157-3, “Determining the Fair Value of a Financial Asset When the Market for That
Asset Is Not Active.” FSP FAS 157-3 clarifies the application of SFAS No. 157,
“Fair Value Measurements,” in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. FSP FAS
157-3 is effective immediately, including prior periods for which financial
statements have not been issued. The Company has adopted FSP FAS 157-3 effective
with the financial statements ended September 30, 2008. The adoption of FSP FAS
157-3 had no impact on the Company’s condensed, consolidated results of
operations, financial position, or cash flows for the three months and nine
months ended September 30, 2008.


8


3.
            ACQUISITIONS 2008
Acquisitions
  In the
nine months ended September 30, 2008, the Company completed two
acquisitions, and paid total cash consideration of approximately $11.6 million,
including acquisition related expenses with an additional  $1.0 million in
earn-out provisions contingent on one of the acquisitions meeting
certain performance benchmarks over two years post 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 of which $11.1 million is expected to be deductible for tax
purposes.
  The acquisitions
were accounted for as purchases in accordance with SFAS No. 141,Business Combinations ("SFAS141").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
unaudited condensed consolidated statements of operations from the date of the
acquisition. Pro forma results of operations have not been presented because the
effects of the acquisitions are not material.
  Prior
Period Acquisitions
  2007
Acquisitions
  In
the nine months ended September 30, 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 $29.7 million of goodwill, of
which $29.7 million is expected to be deductible for tax purposes. Goodwill
assigned to the recovery, youth, and corporate/other divisions was $22.9
million, $2.2 million, and $4.6 million, respectively.
  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 adjusted the allocation of the purchase
consideration as it obtained more information regarding the asset
valuations, liabilities assumed and purchase price adjustments post
acquisition.
  The
Company has included the acquired entities’ results of operations in the
unaudited condensed 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.




4.
            BALANCE
      SHEET COMPONENTS




Balance
sheet components at September 30, 2008 and December 31, 2007 consisted of
the following (in thousands):




September
      30,
              2008
            
            
            December 31,
              2007Accounts
      receivable—gross
            
            $
            37,624
            
            
            $
            38,811Less
      allowance for doubtful accounts
            
            
            (5,935
            )
            
            
            (6,901
            )Accounts
      receivable—net
            
            $
            31,689
            
            
            $
            31,910Other
      assets:Capitalized
      financing costs—net
            
            $
            20,416
            
            
            $
            23,361Deposits
            
            
            935
            
            
            
            874Note
      receivable
            
            
            480
            
            
            
            563Total
      other assets
            
            $
            21,831
            
            
            $
            24,798Accrued
      liabilities:Accrued
      payroll and related expenses
            
            $
            12,096
            
            
            $
            14,923Accrued
      vacation
            
            
            6,227
            
            
            
            5,421Accrued
      interest
            
            
            3,926
            
            
            
            9,647Other
      accrued expenses
            
            
            6,937
            
            
            
            7,591Total
      accrued liabilities
            
            $
            29,186
            
            
            $
            37,582Other
      current liabilities:Deferred
      revenue
            
            $
            12,570
            
            
            $
            13,190Client
      deposits
            
            
            6,338
            
            
            
            8,628Insurance
      premium financing
            
            
            268
            
            
            
            2,653Interest
      rate swap liability
            
            
            2,827
            
            
            
            1,662Other
            
            
            2,579
            
            
            
            3,691Total
      other current liabilities
            
            $
            24,582
            
            
            $
            29,824Income
      taxes payable
            
            $
            6,908
            
            
            $
            ––


9




5.
            PROPERTY
      AND EQUIPMENT




For the
three months and nine months ended September 30, 2008, the Company recognized a
non-cash impairment charge of $1.5 million related to certain long-lived assets
of its youth division. These impairment charges are based on the Company's 
decision to close one of its therapeutic boarding schools within its
youth division and reduce the carrying  value of the fixed assets
of the facility to be closed to their estimated fair value.




Property
and equipment at September 30, 2008 and December 31, 2007 consisted of the
following (in thousands):




September
      30,
              2008
            
            
            December 31,
              2007Land
            
            $
            21,673
            
            
            $
            19,230Building
      and improvements
            
            
            64,960
            
            
            
            63,316Leasehold
      improvements
            
            
            22,179
            
            
            
            19,424Furniture
      and fixtures
            
            
            11,463
            
            
            
            9,571Computer
      equipment
            
            
            9,425
            
            
            
            8,146Computer
      software
            
            
            7,121
            
            
            
            4,291Motor
      vehicles
            
            
            5,436
            
            
            
            4,516Field
      equipment
            
            
            2,806
            
            
            
            2,382Construction
      in progress
            
            
            11,531
            
            
            
            8,792156,594
            
            
            
            139,668Less
      accumulated depreciation
            
            
            (27,225
            )
            
            
            (16,731
            )Property
      and equipment—net
            
            $
            129,369
            
            
            $
            122,937




Depreciation
expense was $3.8 million and $2.7 million for the three months ended September
30, 2008 and 2007, respectively, and $11.1 million and $8.3 million for the nine
months ended September 30, 2008 and 2007, respectively.




6.
            GOODWILL
      AND INTANGIBLE ASSETS




Changes
to goodwill by reportable segment for the nine months ended September 30, 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
              
              
              —
              
              
              
              (142,238
              )
              
              
              —
              
              
              
              (142,238
              )Goodwill
      related to earnouts
              
              
              —
              
              
              
              641
              
              
              
              —
              
              
              
              641Goodwill
      adjustments
              
              
              685
              
              
              
              1,731
              
              
              
              47
              
              
              
              2,463Goodwill
      September 30, 2008
              
              $
              500,307
              
              
              $
              78,955
              
              
              $
              23,592
              
              
              $
              602,854
 
 
 10
    Goodwill
related to impairment
  At
September 30, 2008, under the provisions of SFAS 142, the Company concluded that
a portion of the youth division goodwill was impaired.  The Company
believes that there will be a significant decrease in expected future cash flows
for the youth division based upon current economic conditions including the lack
of availability of student loans, credit for our clients, and other
factors.  As a result, for the three and nine months ended September 30,
2008, the Company recognized  non-cash impairment charges of $142.2
million for youth division goodwill.  Consistent with the provisions of
SFAS 142, impairment charges for goodwill recognized by the
Company are estimated amounts which are subject to revision as more information
becomes available.
  Goodwill
related to earnouts
  Certain
acquisition agreements related to the purchase of Aspen Education Group
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 nine months ended September 30, 2008,
the youth segment recorded $0.6 million in additional goodwill as a
result of one of the entities meeting the benchmarks.
 Goodwill
adjustments
  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 adjustments also include
 $2.5 million  related to the correction of an error in
determining the estimated deferred tax benefit from deferred
revenues related to an acquisition in 2006. There is no material
effect on the Company's consolidated financial statements related to the above
disclosures.
  Intangible
assets subject to amortization


At
September 30, 2008, the Company tested its indefinite lived intangible
assets  for possible impairment due to events and changes in circumstances
which indicated 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.  For the three and nine months ended September
30, 2008, the Company determined that certain intangible assets subject to
amortization within its youth division  were impaired. Under the provisions
of SFAS 144, the Company recognized a non-cash charge of $16.4 million
which is included in the condensed consolidated statement of operations
under asset impairment.  These impairment charges are based on the
Company's  decision to close one of its therapeutic boarding schools and
reduce the carrying  value of certain of its intangible assets
subject to amortization to their estimated fair
value.




11


Intangible
assets not subject to
amortization




The Company tests
intangible assets not subject to amortization for possible impairment in
accordance with SFAS 142.  Accordingly, due to third quarter changes
in cash flow expectations, market conditions, and other factors, the
Company determined that certain of its  intangible assets not subject
to amortization were impaired due to the Company's  decision to
close one of its therapeutic boarding schools. Subsequently, the Company recognized a non-cash impairment charge of $6.0
million for the three and nine months ended September 30, 2008.Chargesrelated to impairment of the intangible assets are included in the
Company's condensed consolidated statement of operations under asset impairment.




Total intangible
assets at September 30, 2008 and December 31, 2007 consist of the following
(in thousands):
  September
      30, 2008
              
              December 31,
      2007Useful
                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
              
              $
              35,892
              
              
              $
              (3,375
              )
              
              $
              32,517
              
              20 years
              
              $
              45,400
              
              
              $
              (2,554
              )
              
              $
              42,846Accreditations
              20
      years
              
              
              16,118
              
              
              
              (1,521
              )
              
              
              14,597
              
              20
      years
              
              
              24,400
              
              
              
              (1,373
              )
              
              
              23,027Curriculum
              20
      years
              
              
              8,743
              
              
              
              (820
              )
              
              
              7,923
              
              20
      years
              
              
              9,000
              
              
              
              (506
              )
              
              
              8,494Government
      includingMedicaid
      contracts
              15 years
              
              
              35,600
              
              
              
              (6,329
              )
              
              
              29,271
              
              15 years
              
              
              35,600
              
              
              
              (4,548
              )
              
              
              31,052Managed
      care contracts
              10
      years
              
              
              14,400
              
              
              
              (3,840
              )
              
              
              10,560
              
              10
      years
              
              
              14,400
              
              
              
              (2,759
              )
              
              
              11,641Managed
      care contracts
              5
      years
              
              
              100
              
              
              
              (20
              )
              
              
              80
              
              5
      years
              
              
              100
              
              
              
              (5
              )
              
              
              95Core
      developed technology
              5
      years
              
              
              2,704
              
              
              
              (1,446
              )
              
              
              1,258
              
              5
      years
              
              
              2,704
              
              
              
              (1,041
              )
              
              
              1,663Covenants
      not to compete
              3
      years
              
              
              152
              
              
              
              (152
              )
              
              
              —
              
              3
      years
              
              
              152
              
              
              
              (128
              )
              
              
              24Registration
      rights
              2
      years
              
              
              200
              
              
              
              (200
              )
              
              
              —
              
              2
      years
              
              
              200
              
              
              
              (200
              )
              
              
              —Student
      contracts
              1
      year
              
              
              1,772
              
              
              
              (1,751
              )
              
              
              21
              
              1
      year
              
              
              2,241
              
              
              
              (2,241
              )
              
              
              —Total
      intangible assets subject to amortization:
              
              
              $
              115,681
              
              
              $
              (19,454
              )
              
              
              96,227
              
              
              
              $
              134,197
              
              
              $
              (15,355
              )
              
              
              118,842Intangible
      assets not subject to amortization:Trademarks
      and trade names
              
              
              
              
              
              
              
              
              
              
              
              181,463
              
              
              
              
              
              
              
              
              
              
              
              
              183,725Certificates
      of need
              
              
              
              
              
              
              
              
              
              
              
              44,600
              
              
              
              
              
              
              
              
              
              
              
              
              44,600Regulatory
      licenses
              
              
              
              
              
              
              
              
              
              
              
              39,460
              
              
              
              
              
              
              
              
              
              
              
              
              43,221Total
      intangible assets not subject to amortization
              
              
              
              
              
              
              
              
              
              
              
              265,523
              
              
              
              
              
              
              
              
              
              
              
              
              271,546Total
      intangible assets
              
              
              
              
              
              
              
              
              
              
              $
              361,750
              
              
              
              
              
              
              
              
              
              
              
              $
              390,388
  Amortization
expense of intangible assets subject to amortization was $2.1 million and $2.7
million for the three months ended September 30, 2008 and 2007, respectively,
and $6.3 million and $8.1 million for the nine months ended September 30, 2008
and 2007, respectively.
  Estimated
future amortization expense related to the amortizable intangible assets at
September 30, 2008 is as follows (in thousands):
  Fiscal
      Year2008
      (remaining 3 months)
              
              $
              1,8532009
              
              
              7,4122010
              
              
              7,4122011
              
              
              6,9122012
              
              
              6,866Thereafter
              
              
              65,772Total
              
              $
              96,227




12


7.
            INCOME
      TAXES


The Company determines its
income tax expense for interim periods by applying the use of the full years
estimated effective tax rate in financial statements for interim periods. For the three and nine months ended September 30,
2008, the Company recognized an income tax benefit of $19.2 million, and income
tax benefit of $17.7 million respectively, reflecting an effective
tax rate of 12.1% and 11.4%, respectively, including discrete items. The
Company's effective tax rate was 78.21% and 51.37% for the three and nine months ended
September 30, 2008, respectively, without consideration of discrete items.
Impairment charges for goodwill and intangible assets represent the discrete
items.  Of the total impairment charges related to the discrete items,
$62.7 million are deductible for tax purposes.The income tax expense for the three
and nine months ended September 30, 2007 was $1.5 million and $3.4 million,
respectively, reflecting an effective tax rate of 22.9% and 30.3% (there were no discrete
items in 2007). The Company's effective tax rate for the  nine months ended
September 30, 2008 differs from the US federal statutory rate of 35% primarily
because of state taxes and the aforementioned impairments of goodwill and
intangible assets in the third quarter.
  The Company files its income
tax returns in various jurisdictions, including United States federal and state
filings and United Kingdom filings. The Company is currently under
examination by the Internal Revenue Service for the
2006 tax year, as well as by various state jurisdictions. There are different
interpretations of tax laws and regulations and, as a result, significant
disputes may
arise with these tax authorities involving issues of the timing and amount of
deductions and allocations of income among various tax jurisdictions. While the
Company believes its positions comply with
applicable laws, it periodically evaluates its exposures associated with
its tax filing positions.




8.
            LONG-TERM
      DEBT




Long-term
debt at September 30, 2008 and December 31, 2007 consisted of the following
(in thousands):




September 30,
              2008
            
            
            December 31,
              2007Term
      loan
            
            $
            410,890
            
            
            $
            414,034Revolving
      line of credit
            
            
            40,000
            
            
            
            26,500Senior
      subordinated notes, net of discount of $2,184 in 2008 and $2,407 in
      2007
            
            
            197,816
            
            
            
            197,593Seller
      notes
            
            
            8,869
            
            
            
            10,206Lessor
      financing, leasehold improvements
            
            
            331
            
            
            
            ––Capital
      lease obligations
            
            
            18
            
            
            
            34Total
      debt
            
            
            657,924
            
            
            
            648,367Less
      current portion
            
            
            (9,014
            )
            
            
            (35,603
            )Long-term
      debt—less current portion
            
            $
            648,910
            
            
            $
            612,764




Based on
a periodic review of its debt structure, the Company determined that it is
appropriate to classify $40.0 million related to the revolving line of
credit as long-term debt at September 30, 2008.




Interest
expense on total debt was $13.1 million and $15.2 million for the three months
ended September 30, 2008 and 2007, respectively, and $40.1 million and $45.5
million for the nine months ended September 30, 2008 and 2007,
respectively.




9.
            FINANCIAL
      INSTRUMENTS




Derivatives
      -Interest Rate
      Swaps




At
September 30, 2008, the Company had an  interest rate swap agreement which
converted $70.0 million of its floating-rate debt to fixed-rate debt at
4.99%.  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.  In accordance with the
Company’s risk management policy, future changes in the fair value of the
interest rate swap due to hedge effectiveness will be recognized in other
comprehensive income (“OCI”) for the remaining contractual life of the interest
rate swap.  Accumulated ineffectiveness as of the off-market date will
be amortized over the contractual life of the interest rate swap. Any
ineffectiveness in hedging activity related to the interest swap is reclassified
to earnings in the period during which the ineffectiveness is
measured.




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.  The
interest rate swap agreement is designated as a cash flow hedge under SFAS
133.  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% on the
$200.0 million.




The fair
value of the Company’s interest rate swaps and their effects, if any, on the
Company's earnings are
discussed in Note 10.




13




10.
            FAIR
      VALUE MEASUREMENTS




The
Company adopted 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 
September 30, 2008, the aggregate fair value of the Company’s interest rate swap
agreements was a liability of $2.8 million compared to a liability of $1.7
million at December 31, 2007.  For its interest rate swap agreement
executed February 28, 2006 (the "2006 Swap"), the Company recognized a gain of
approximately $0.2 million
for the three and nine months ended September 30, 2008, which is recorded in
OCI. 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 three and nine months ended September 30,
2007, the Company recorded a loss of $1.2 million and $0.7 million respectively
for the 2006 Swap, which were recognized in other (expense) income on
the condensed consolidated statements of operations.   The
Company recognized losses of approximately $0.8 million and $1.2 million for the
three and nine months ended September 30, 2008, respectively, on its interest
rate swap agreement executed on June 30, 2008
(the "2008 Swap") and they are recorded in OCI net of
tax.




11.
            OTHER
      COMPREHENSIVE INCOME





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


Comprehensive
income for the three and nine months ended September 30, 2008 and 2007 are
comprised of the following (in thousands):





Three Months
              Ended
              September
      30,
              2008
            
            
            Three Months
              Ended
              September
      30,
              2007
            
            
            Nine
      Months
              Ended
              September
      30,
              2008
            
            
            Nine
      Months
              Ended
              September
      30,
              2007Net
      income
            
            $
            (139,934
            )
            
            $
            4,621
            
            
            $
            (137,701
            )
            
            $
            7,489Other
      comprehensive incomeNet change in
      unrealized losses on cash flow hedges (net of tax)
            
            
            (647
            )
            
            —
            
            
            
            (1,000
            )
            
            —Total
      Comprehensive Income
            
            $
            (140,581
            )
            
            $
            4,621
            
            
            $
            (138,701
            )
            
            $
            7,489




14




12.
            COMMITMENTS
      AND CONTINGENCIES




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.




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.




Earnouts—
Certain acquisition agreements acquired in the purchase of Aspen Education Group
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. Additionally, future acquisitions may contain
earnout provisions which would require the Company to pay amounts beyond the
original purchase consideration upon satisfaction of defined performance
benchmarks. The Company’s policy is to accrue the earnouts as they are earned
and issue periodic payments on the earnouts through a combination of notes and
cash payments.




13.
            STOCK-BASED
      COMPENSATION




Description
of Share-Based Plans





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





On
February 6, 2006, 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 September 30, 2008, only non-incentive options (non-qualified under Internal
Revenue Code Section 422) have been awarded under the Plans. Options
granted under the Plans represent the right to purchase units of Group shares.
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 with a term 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 Executive and Incentive
plans; tranche 2 options vest and become exercisable upon achievement of 
market conditions, 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 certain performance
conditions and a market condition, as defined in the Executive and Incentive
plans. Tranche 1 options represent 50% of an option grant under the Executive
and Incentive plans and tranches 2 and 3 options each represent 25% of the
options granted under the Executive and Incentive plans.





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.





In
September 2007, the Group amended the Executive Plan to provide that any
unvested tranche 3 options—options that vest over a five year period upon
the Company’s earnings before interest, taxes, depreciation and amortization
(“EBITDA”) reaching certain levels—would vest upon the first anniversary of an
initial public offering, each six month anniversary thereafter or the date of a
sale transaction if the value per unit (nine shares of Class A and one
share of Class L) equals or exceeds $360 on such date. In conjunction with
this modification the Company evaluated the impact on modified awards and
determined that the incremental compensation cost was immaterial.





15


During
the nine months ended September 30, 2008, the Group’s board of directors
increased the number of share units available under the Plans by 20,000 units.
Consequently, at September 30, 2008, a maximum of 5,734,054 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 connection with rolled over options at the time of the acquisition of
the Company by investment funds managed by Bain Capital Partners, LLC in
February 2006 and the acquisition of Aspen Education Group by the Company in
November 2006.




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
and 3 Executive Plan grants, and tranche 1 Incentive Plan grants. The Company
uses the Monte Carlo simulation approach to a binomial model to determine the
fair value of tranche 2 and 3 Incentive Plan grants and tranche 2 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 three months ended
September 30, 2008 and 2007 were $53.53 and $54.52 per unit, respectively. For
the  nine months ended September 30, 2008 and 2007 the average grant date
fair value of units granted was $53.72 and $54.91 per unit
respectively.




The
following assumptions were used to calculate the weighted average grant date
fair values of employee stock options for the periods presented
below:





Three Months
              Ended
              September
      30,
              2008
            
            
            Three Months
              Ended
              September
      30,
              2007Black
      ScholesExpected
      term (in years)
            
            
            6.27
            
            
            
            6.22Expected
      volatility
            
            
            39.90
            %
            
            
            45.30
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.40
            %
            
            
            4.18
            %Binomial
      (Monte Carlo simulation)Expected
      volatility
            
            
            51.32
            %
            
            
            54.34
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.94
            %
            
            
            4.42
            %





Nine
      Months
              Ended
              September
      30,
              2008
            
            
            Nine
      Months
              Ended
              September
      30,
              2007Black
      ScholesExpected
      term (in years)
            
            
            6.30
            
            
            
            6.26Expected
      volatility
            
            
            39.37
            %
            
            
            47.10
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.22
            %
            
            
            4.62
            %Binomial
      (Monte Carlo simulation)Expected
      volatility
            
            
            51.30
            %
            
            
            54.72
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.80
            %
            
            
            4.78
            %










•
            
            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 during the period 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.







16


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 condensed consolidated financial statements, as substantially all
grants have been made to employees of the Company. Under the provisions of
Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based
Payment  (“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. Stock option compensation
expense related to employee stock options granted under the Plans was $1.5
million and $1.1 million for the three months ended September 30, 2008 and 2007,
respectively, and $3.8 million and $3.2 million for the nine months ended
September 30, 2008 and 2007, respectively.  Stock-based compensation
expense is recorded within salaries and benefits on the condensed consolidated
statements of operations. The total income tax benefit recognized in the
condensed consolidated statement of operations for stock option-based
compensation expense was $0.5 million and $0.4 million for the three months
ended September 30, 2008 and 2007, respectively, and $1.5 million and $1.3
million for the nine months ended September 30, 2008 and 2007,
respectively.





As of
September 30, 2008, $13.1 million of total unrecognized compensation, net of
estimated forfeitures of $0.7 million, is expected to be recognized over a
weighted-average period of 2.84 years if all performance conditions are met
under the provisions of the plans.
During the three and nine months ended September 30, 2008, 281,925 and 591,576
shares vested with an aggregate grant date fair value of $1.5 million and $3.2
million, respectively.





Stock
Option Activity under the Plans





During
the nine months ended September 30, 2008, the Group granted units, which
represent option shares to purchase Class A common stock of the Group and
option shares to purchase Class L common stock of the Group. Activity under
the Plans for the nine months ended September 30, 2008 is summarized
below:




Option Shares
            
            
            Weighted-
              Average
              Exercise
              Price
              Per Share
            
            
            Weighted-
              Average
              Remaining
              Contractual Term
              (In
      Years)Balance
      at December 31, 2007
            
            
            7,251,136
            
            
            $
            7.76
            
            
            
            8.33Granted
            
            
            481,616
            
            
            
            11.23
            
            
            
            9.68Exercised
            
            
            (38,793
            )
            
            
            2.98Forfeited/cancelled/expired
            
            
            (275,302
            )
            
            
            9.62Outstanding—September
      30, 2008
            
            
            7,418,657
            
            
            $
            7.94
            
            
            
            7.70Exercisable—September
      30, 2008
            
            
            2,799,371
            
            
            $
            5.42
            
            
            
            7.47Exercisable
      and expected to be exercisable
            
            
            7,047,724
            
            
            $
            7.94





As of
September 30, 2008, the aggregate intrinsic value of share options outstanding,
exercisable, and outstanding and expected to be exercisable was $24.4 million,
$16.3 million and $23.2 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 September 30, 2008.





The Group
recorded an immaterial amount of cash received for options exercised by certain
non-director employees who terminated their employment with the Company. All
cash received and paid related to the option exercise and Class A and L
Common Stock retirement is reflected within the Company’s financial statements
as Capital Contribution from Parent. The aggregate intrinsic value of share
options exercised under equity compensation plans for the three months ended
September 30, 2008 was immaterial. For the nine months ended September 30, 2008,
the aggregate intrinsic value of share options exercised under equity
compensation plans was $0.3 million.





The
following table presents the composition of options outstanding and exercisable
as of September 30, 2008:




Options
      Outstanding
            
            
            Options
      ExercisableRange of Exercise
      Prices
            
            
            Number
      of
              Shares
            
            
            Weighted Average
              Remaining Contractual
              Term
      (Years)
            
            
            Weighted Average
              Exercise
      Price
            
            
            Number
      of
              Shares
            
            
            Weighted Average
              Exercise
      Price$0.03 - $ 0.32
            
            
            
            1,129,132
            
            
            
            7.44
            
            
            $
            0.10
            
            
            
            1,129,132
            
            
            $
            0.10$1.00 - $ 3.30
            
            
            
            5,558,498
            
            
            
            7.75
            
            
            
            1.15
            
            
            
            1,401,233
            
            
            
            1.08$7.89 - $17.62
            
            
            
            114,616
            
            
            
            7.37
            
            
            
            8.07
            
            
            
            114,616
            
            
            
            8.07$81.00 - $98.16
            
            
            
            616,411
            
            
            
            7.75
            
            
            
            83.50
            
            
            
            154,390
            
            
            
            81.76Total
            
            
            
            7,418,657
            
            
            
            7.70
            
            
            $
            7.94
            
            
            
            2,799,371
            
            
            $
            5.42





17


14.
            RELATED
      PARTY TRANSACTIONS




In
connection with the 2006 acquisition of the Company by investment funds managed
by Bain Capital Partners, LLC (“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 directors
are employees of Bain Capital Partners, LLC, the Parent’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 provide management services. Pursuant to such agreement, an
affiliate of Bain Capital Partners, LLC receives 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. The
Company under this agreement paid management fees approximating $0.5 million
during each of the three months ended September 30, 2008 and 2007 and
approximately $1.6 million and $1.5 million  for the nine months ended
September 30, 2008 and 2007, respectively, which is included in supplies,
facilities and other operating costs.




The
Company leases buildings from certain employees. Such related party leases
are due and payable on a monthly basis on similar terms and conditions as the
Company’s other leasing arrangements.




Two
directors receive compensation for their services to the Company as consultants.
During 2007, one director was granted options to purchase 13,435 shares of
Class A common stock of the Group and options to purchase 1,492 shares of
Class L common stock of the Group 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.




15.
            CONDENSED
      CONSOLIDATING FINANCIAL INFORMATION




As of
September 30, 2008, the Company had $200.0 million aggregate principal amount of
the 10.75% Senior Subordinated Notes due 2016 (“the Notes”) outstanding. The
Notes are fully and unconditionally guaranteed, jointly and severally on an
unsecured senior subordinated basis, by the Company’s wholly owned
subsidiaries.




The
following supplemental tables present condensed consolidating balance sheets for
the Company and its subsidiary guarantors as of September 30, 2008 and
December 31, 2007, the condensed consolidating statements of operations for
the three and nine months ended September 30, 2008 and 2007, and the condensed
consolidating statements of cash flows for the nine months ended September 30,
2008 and 2007.




For the
year 2007, management determined that allocations including income tax accounts
and intercompany management fee revenue should be allocated to the parent and
the investment in the Company’s subsidiaries should be presented using the
equity method in the parent column of the consolidating financial statements. As
a result, the consolidating balance sheet for the year ended December 31, 2007
and the consolidating statement of operations and consolidating statement of
cash flows for the three and nine months ended September 30, 2007 have been
restated from previously reported amounts to reflect the allocations and
the investment in subsidiaries using the equity method instead of the cost basis
method. There is no impact on the Company’s condensed consolidated financial
statements as the allocations and investment in subsidiaries are eliminated in
consolidation.




18


Condensed
Consolidating Balance Sheet as of September 30, 2008


(In
thousands) (Unaudited)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            —
            
            
            $
            2,678
            
            
            $
            336
            
            
            $
            —
            
            
            $
            3,014Accounts
      receivable—net of allowance
            
            
            ––
            
            
            
            30,998
            
            
            
            691
            
            
            
            
            
            
            
            31,689Prepaid
      expenses
            
            
            2,843
            
            
            
            3,398
            
            
            
            163
            
            
            
            
            
            
            
            6,404Other
      current assets
            
            
            20
            
            
            
            1,463
            
            
            
            48
            
            
            
            
            
            
            
            1,531Deferred
      income taxes
            
            
            6,599
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            6,599Total
      current assets
            
            
            9,462
            
            
            
            38,537
            
            
            
            1,238
            
            
            
            —
            
            
            
            49,237PROPERTY
      AND EQUIPMENT—Net
            
            
            8,095
            
            
            
            118,624
            
            
            
            2,650
            
            
            
            
            
            
            
            129,369GOODWILL
            
            
            —
            
            
            
            591,056
            
            
            
            11,798
            
            
            
            
            
            
            
            602,854INTANGIBLE
      ASSETS—Net
            
            
            —
            
            
            
            361,750
            
            
            
            —
            
            
            
            
            
            
            
            361,750OTHER
      ASSETS
            
            
            20,506
            
            
            
            1,304
            
            
            
            21
            
            
            
            
            
            
            
            21,831INVESTMENT
      IN SUBSIDIARIES
            
            
            1,068,889
            
            
            
            —
            
            
            
            —
            
            
            
            (1,068,889
            )
            
            
            —TOTAL
      ASSETS
            
            $
            1,106,952
            
            
            $
            1,111,271
            
            
            $
            15,707
            
            
            $
            (1,068,889
            )
            
            $
            1,165,041LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            $
            5,400
            
            
            $
            2,387
            
            
            $
            122
            
            
            $
            —
            
            
            $
            7,909Accrued
      liabilities
            
            
            10,421
            
            
            
            17,364
            
            
            
            1,401
            
            
            
            
            
            
            
            29,186Current
      portion of long-term debt
            
            
            4,193
            
            
            
            4,821
            
            
            
            —
            
            
            
            
            
            
            
            9,014Other
      current liabilities
            
            
            3,180
            
            
            
            20,054
            
            
            
            1,348
            
            
            
            
            
            
            
            24,582Income
      taxes payable
            
            
            6,908
            
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            6,908Total
      current liabilities
            
            
            30,102
            
            
            
            44,626
            
            
            
            2,871
            
            
            
            —
            
            
            
            77,599LONG-TERM
      DEBT—Less current portion
            
            
            644,513
            
            
            
            4,397
            
            
            
            —
            
            
            
            
            
            
            
            648,910OTHER
      LIABILITIES
            
            
            161
            
            
            
            5,858
            
            
            
            20
            
            
            
            
            
            
            
            6,039DEFERRED
      INCOME TAXES
            
            
            121,585
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            121,585Total
      liabilities
            
            
            796,361
            
            
            
            54,881
            
            
            
            2,891
            
            
            
            —
            
            
            
            854,133MINORITY
      INTEREST
            
            
            —
            
            
            
            —
            
            
            
            317
            
            
            
            —
            
            
            
            317STOCKHOLDER’S
      EQUITY
            
            
            310,591
            
            
            
            1,056,390
            
            
            
            12,499
            
            
            
            (1,068,889
            )
            
            
            310,591TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
            
            $
            1,106,952
            
            
            $
            1,111,271
            
            
            $
            15,707
            
            
            $
            (1,068,889
            )
            
            $
            1,165,041




19


Condensed
Consolidating Balance Sheet as of December 31, 2007


(In
thousands) (Unaudited) (Restated)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            —
            
            
            $
            4,929
            
            
            $
            189
            
            
            $
            —
            
            
            $
            5,118Accounts
      receivable—net of allowance
            
            
            —
            
            
            
            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
      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




20


Condensed Consolidating Statements of
Operations


For
the Three Months Ended September 30, 2008


(In
thousands) (Unaudited)


CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            8
            
            
            $
            115,169
            
            
            $
            9,101
            
            
            $
            —
            
            
            $
            124,278Other
      revenue
            
            
            2
            
            
            
            2,143
            
            
            
            1
            
            
            
            
            
            
            
            2,146Management
      fee revenue
            
            
            20,096
            
            
            
            —
            
            
            
            —
            
            
            
            (20,096
            )
            
            
            —Total
      net revenue
            
            
            20,106
            
            
            
            117,312
            
            
            
            9,102
            
            
            
            (20,096
            )
            
            
            126,424OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            4,661
            
            
            
            53,859
            
            
            
            2,909
            
            
            
            
            
            
            
            61,429Supplies,
      facilities and other operating costs
            
            
            1,926
            
            
            
            29,621
            
            
            
            5,379
            
            
            
            
            
            
            
            36,926Provision
      for doubtful accounts
            
            
            1
            
            
            
            1,694
            
            
            
            20
            
            
            
            
            
            
            
            1,715Depreciation
      and amortization
            
            
            630
            
            
            
            5,127
            
            
            
            172
            
            
            
            
            
            
            
            5,929Asset impairments
            
            
            ––
            
            
            
            23,880
            
            
            
            ––
            
            
            
            
            
            
            
            23,880Goodwill impairment
            
            
            ––
            
            
            
            142,238
            
            
            
            ––
            
            
            
            
            
            
            
            142,238Management
      fee expense
            
            
            —
            
            
            
            19,462
            
            
            
            634
            
            
            
            (20,096
            )
            
            
            —Total
      operating expenses
            
            
            7,218
            
            
            
            275,881
            
            
            
            9,114
            
            
            
            (20,096
            )
            
            
            272,117INCOME
      (LOSS) FROM OPERATIONS
            
            
            12,888
            
            
            
            (158,569
            )
            
            
            (12
            )
            
            
            —
            
            
            
            (145,693
            )INTEREST
      EXPENSE, NET
            
            
            (12,930
            )
            
            
            (193
            )
            
            
            (2
            )
            
            
            
            
            
            
            (13,125
            )OTHER
      EXPENSE
            
            
            (2
            )
            
            
            —
            
            
            
            (35
            )
            
            
            
            
            
            
            (37
            )(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (44
            )
            
            
            (158,762
            )
            
            
            (49
            )
            
            
            —
            
            
            
            (158,855
            )INCOME
      TAX EXPENSE (BENEFIT)
            
            
            420
            
            
            
            (20,640
            )
            
            
            998
            
            
            
            
            
            
            
            (19,222
            )MINORITY
      INTEREST IN INCOME (LOSS) OF  SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            301
            
            
            
            
            
            
            
            301EQUITY
      IN LOSS OF SUBSIDIARIES, NET OF TAX
            
            
            (139,470
            )
            
            
            —
            
            
            
            —
            
            
            
            139,470
            
            
            
            —NET
      LOSS
            
            $
            (139,934
            )
            
            $
            (138,122
            )
            
            $
            (1,348
            )
            
            $
            139,470
            
            
            $
            (139,934
            )






21


Condensed Consolidating Statements of
Operations


For
the Three Months Ended September 30, 2007


(In
thousands) (Unaudited) (Restated)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            6
            
            
            $
            113,874
            
            
            $
            6,743
            
            
            $
            —
            
            
            $
            120,623Other
      revenue
            
            
            3
            
            
            
            1,528
            
            
            
            215
            
            
            
            
            
            
            
            1,746Management
      fee revenue
            
            
            19,427
            
            
            
            —
            
            
            
            —
            
            
            
            (19,427
            )
            
            
            —Total
      net revenue
            
            
            19,436
            
            
            
            115,402
            
            
            
            6,958
            
            
            
            (19,427
            )
            
            
            122,369OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            3,079
            
            
            
            50,453
            
            
            
            1,911
            
            
            
            
            
            
            
            55,443Supplies,
      facilities and other operating costs
            
            
            2,221
            
            
            
            31,092
            
            
            
            3,244
            
            
            
            
            
            
            
            36,557Provision
      for doubtful accounts
            
            
            —
            
            
            
            2,017
            
            
            
            19
            
            
            
            
            
            
            
            2,036Depreciation
      and amortization
            
            
            130
            
            
            
            5,179
            
            
            
            88
            
            
            
            
            
            
            
            5,397Asset impairments
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            
            
            
            
            ––Goodwill impairment
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            
            
            
            
            ––Management
      fee expense
            
            
            —
            
            
            
            17,880
            
            
            
            1,547
            
            
            
            (19,427
            )
            
            
            —Total
      operating expenses
            
            
            5,430
            
            
            
            106,621
            
            
            
            6,809
            
            
            
            (19,427
            )
            
            
            99,433INCOME
      (LOSS) FROM OPERATIONS
            
            
            14,006
            
            
            
            8,781
            
            
            
            149
            
            
            
            
            
            
            
            22,936INTEREST
      EXPENSE, NET
            
            
            (14,947
            )
            
            
            (222
            )
            
            
            —
            
            
            
            
            
            
            
            (15,169
            )OTHER 
      (EXPENSE) INCOME
            
            
            (1,220
            )
            
            
            ––
            
            
            
            3
            
            
            
            
            
            
            
            (1,217
            )(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (2,161
            )
            
            
            8,559
            
            
            
            152
            
            
            
            
            
            
            
            6,550INCOME
      TAX (BENEFIT) EXPENSE
            
            
            (496
            )
            
            
            1,963
            
            
            
            35
            
            
            
            
            
            
            
            1,502MINORITY
      INTEREST IN INCOME OF  SUBSIDIARIES
            
            
            ––
            
            
            
            —
            
            
            
            427
            
            
            
            
            
            
            
            427EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
            
            
            6,286
            
            
            
            —
            
            
            
            —
            
            
            
            (6,286
            )
            
            
            —NET
      INCOME (LOSS)
            
            $
            4,621
            
            
            $
            6,596
            
            
            $
            (310
            )
            
            $
            (6,286
            )
            
            $
            4,621




22


Condensed Consolidating Statements of
Operations


For
the Nine Months Ended September 30, 2008


(In
thousands) (Unaudited)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            20
            
            
            $
            340,971
            
            
            $
            17,655
            
            
            $
            —
            
            
            $
            358,646Other
      revenue
            
            
            8
            
            
            
            6,117
            
            
            
            1
            
            
            
            
            
            
            
            6,126Management
      fee revenue
            
            
            58,777
            
            
            
            —
            
            
            
            —
            
            
            
            (58,777
            )
            
            
            —Total
      net revenue
            
            
            58,805
            
            
            
            347,088
            
            
            
            17,656
            
            
            
            (58,777
            )
            
            
            364,772OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            12,837
            
            
            
            163,719
            
            
            
            7,403
            
            
            
            
            
            
            
            183,959Supplies,
      facilities and other operating costs
            
            
            5,910
            
            
            
            91,016
            
            
            
            10,656
            
            
            
            
            
            
            
            107,582Provision
      for doubtful accounts
            
            
            9
            
            
            
            4,899
            
            
            
            102
            
            
            
            
            
            
            
            5,010Depreciation
      and amortization
            
            
            1,754
            
            
            
            15,089
            
            
            
            500
            
            
            
            
            
            
            
            17,343Asset impairments
            
            
            ––
            
            
            
            23,880
            
            
            
            ––
            
            
            
            
            
            
            
            23,880Goodwill impairment
            
            
            ––
            
            
            
            142,238
            
            
            
            ––
            
            
            
            
            
            
            
            142,238Management
      fee expense
            
            
            —
            
            
            
            56,769
            
            
            
            2,008
            
            
            
            (58,777
            )
            
            
            —Total
      operating expenses
            
            
            20,510
            
            
            
            497,610
            
            
            
            20,669
            
            
            
            (58,777
            )
            
            
            480,012INCOME
      (LOSS) FROM OPERATIONS
            
            
            38,295
            
            
            
            (150,522
            )
            
            
            (3,013
            )
            
            
            —
            
            
            
            (115,240
            )INTEREST
      EXPENSE, NET
            
            
            (39,578
            )
            
            
            (568
            )
            
            
            (2
            )
            
            
            
            
            
            
            (40,148
            )OTHER
      EXPENSE
            
            
            (34
            )
            
            
            —
            
            
            
            (35
            )
            
            
            
            
            
            
            (69
            )(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (1,317
            )
            
            
            (151,090
            )
            
            
            (3,050
            )
            
            
            —
            
            
            
            (155,457
            )INCOME
      TAX BENEFIT
            
            
            (150
            )
            
            
            (17,202
            )
            
            
            (347
            )
            
            
            
            
            
            
            (17,699
            )MINORITY
      INTEREST IN (LOSS) OF SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            (57
            )
            
            
            
            
            
            
            (57
            )EQUITY
      IN (LOSS) OF SUBSIDIARIES, NET OF TAX
            
            
            (136,534
            )
            
            
            —
            
            
            
            —
            
            
            
            136,534
            
            
            
            —NET
      LOSS
            
            $
            (137,701
            )
            
            $
            (133,888
            )
            
            $
            (2,646
            )
            
            $
            136,534
            
            
            $
            (137,701
            )




23


Condensed Consolidating Statements of
Operations


For
the Nine Months Ended September 30, 2007


(In
thousands) (Unaudited) (Restated)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            21
            
            
            $
            328,756
            
            
            $
            12,712
            
            
            $
            —
            
            
            $
            341,489Other
      revenue
            
            
            8
            
            
            
            4,363
            
            
            
            232
            
            
            
            
            
            
            
            4,603Management
      fee revenue
            
            
            58,565
            
            
            
            —
            
            
            
            —
            
            
            
            (58,565
            )
            
            
            —Total
      net revenue
            
            
            58,594
            
            
            
            333,119
            
            
            
            12,944
            
            
            
            (58,565
            )
            
            
            346,092OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            9,901
            
            
            
            152,637
            
            
            
            4,593
            
            
            
            
            
            
            
            167,131Supplies,
      facilities and other operating costs
            
            
            6,466
            
            
            
            87,159
            
            
            
            7,052
            
            
            
            
            
            
            
            100,677Provision
      for doubtful accounts
            
            
            ––
            
            
            
            5,034
            
            
            
            30
            
            
            
            
            
            
            
            5,064Depreciation
      and amortization
            
            
            1,217
            
            
            
            14,891
            
            
            
            202
            
            
            
            
            
            
            
            16,310Asset impairments
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            
            
            
            
            ––Goodwill impairment
            
            
            ––
            
            
            
            ––
            
            
            
            ––
            
            
            
            
            
            
            
            ––Management
      fee expense
            
            
            ––
            
            
            
            55,622
            
            
            
            2,943
            
            
            
            (58,565
            )
            
            
            —Total
      operating expenses
            
            
            17,584
            
            
            
            315,343
            
            
            
            14,820
            
            
            
            (58,565
            )
            
            
            289,182INCOME
      (LOSS) FROM OPERATIONS
            
            
            41,010
            
            
            
            17,776
            
            
            
            (1,876
            )
            
            
            —
            
            
            
            56,910INTEREST
      EXPENSE, NET
            
            
            (44,345
            )
            
            
            (625
            )
            
            
            (1
            )
            
            
            
            
            
            
            (44,971
            )OTHER
      (EXPENSE) INCOME
            
            
            (789
            )
            
            
            (13
            )
            
            
            2
            
            
            
            
            
            
            
            (800
            )(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (4,124
            )
            
            
            17,138
            
            
            
            (1,875
            )
            
            
            —
            
            
            
            11,139INCOME
      TAX (BENEFIT) EXPENSE
            
            
            (1,250
            )
            
            
            5,193
            
            
            
            (568
            )
            
            
            
            
            
            
            3,375MINORITY
      INTEREST IN INCOME OF SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            275
            
            
            
            
            
            
            
            275EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
            
            
            10,363
            
            
            
            —
            
            
            
            —
            
            
            
            (10,363
            )
            
            
            —NET
      INCOME (LOSS)
            
            $
            7,489
            
            
            $
            11,945
            
            
            $
            (1,582
            )
            
            $
            (10,363
            )
            
            $
            7,489






24


Condensed Consolidating Statements of Cash
Flows
 For
the Nine Months Ended September 30, 2008
 (In
thousands) (Unaudited)
  CRC
      Health
                Corporation
              
              
              Subsidiary
                Guarantors
              
              
              Subsidiary
                Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash (used in) provided by operating activities
              
              $
              (17,485
              )
              
              $
              39,659
              
              
              $
              (1,084
              )
              
              $
              
              
              
              $
              21,090CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (4,257
              )
              
              
              (13,893
              )
              
              
              (437
              )
              
              
              
              
              
              
              (18,587
              )Proceeds
      from sale of property and equipment
              
              
              ––
              
              
              
              101
              
              
              
              ––
              
              
              
              
              
              
              
              101Acquisition
      of business, net of cash acquired
              
              
              (11,567
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (11,567
              )Acquisition
      adjustments
              
              
              ––
              
              
              
              (10
              )
              
              
              ––
              
              
              
              
              
              
              
              (10
              )Payments
      made under earnout arrangements
              
              
              (2,947
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (2,947
              )Net
      cash used in investing activities
              
              
              (18,771
              )
              
              
              (13,802
              )
              
              
              (437
              )
              
              
              —
              
              
              
              (33,010
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              26,423
              
              
              
              (28,091
              )
              
              
              1,668
              
              
              
              
              
              
              
              —Capital
      distributed to Parent
              
              
              (305
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (305
              )Capitalizedfinancing
      costs
              
              
              (187
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (187
              )Repayments
      of capital lease obligations
              
              
              ––
              
              
              
              (17
              )
              
              
              ––
              
              
              
              
              
              
              
              (17
              )Net
      borrowings under revolving line of credit
              
              
              13,500
              
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              13,500Repayments
      of long-term debt
              
              
              (3,175
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (3,175
              )Net
      cash provided by (used in) financing activities
              
              
              36,256
              
              
              
              (28,108
              )
              
              
              1,668
              
              
              
              
              
              
              
              9,816(DECREASE)
      INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              (2,251
              )
              
              
              147
              
              
              
              —
              
              
              
              (2,104
              )CASH
      AND CASH EQUIVALENTS Beginning of period
              
              
              —
              
              
              
              4,929
              
              
              
              189
              
              
              
              —
              
              
              
              5,118CASH
      AND CASH EQUIVALENTS End of period
              
              $
              —
              
              
              $
              2,678
              
              
              $
              336
              
              
              $
              —
              
              
              $
              3,014
  25




Condensed Consolidating Statements of Cash
Flows
 For
the Nine Months Ended September 30, 2007
 (In
thousands) (Unaudited) (Restated)
  CRC
      Health
                Corporation
              
              
              Subsidiary
                Guarantors
              
              
              Subsidiary
                Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash provided by operating activities
              
              $
              4,021
              
              
              $
              14,062
              
              
              $
              36
              
              
              $
              —
              
              
              $
              18,119CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (2,247
              )
              
              
              (20,776
              )
              
              
              (1,216
              )
              
              
              
              
              
              
              (24,239
              )Proceeds
      from sale of property and equipment
              
              
              ––
              
              
              
              67
              
              
              
              ––
              
              
              
              
              
              
              
              67Acquisition
      of businesses, net of cash acquired
              
              
              (33,602
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (33,602
              )Acquisition
      adjustments
              
              
              ––
              
              
              
              979
              
              
              
              ––
              
              
              
              
              
              
              
              979Net
      cash (used in) investing activities
              
              
              (35,849
              )
              
              
              (19,730
              )
              
              
              (1,216
              )
              
              
              —
              
              
              
              (56,795
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              (5,948
              )
              
              
              4,419
              
              
              
              1,529
              
              
              
              
              
              
              
              —Capitalized
      contributed by parent
              
              
              500
              
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              500Repayments of capital lease obligations
              
              
              ––
              
              
              
              (194
              )
              
              
              ––
              
              
              
              
              
              
              
              (194
              )Capitalized
      financing costs
              
              
              (611
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (611
              )Net
      borrowingsunder
      revolver line of credit
              
              
              41,900
              
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              41,900Repayments
      of long-term debt
              
              
              (4,013
              )
              
              
              ––
              
              
              
              ––
              
              
              
              
              
              
              
              (4,013
              )Net
      cash provided by financing activities
              
              
              31,828
              
              
              
              4,225
              
              
              
              1,529
              
              
              
              ––
              
              
              
              37,582NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              (1,443
              )
              
              
              349
              
              
              
              —
              
              
              
              (1,094
              )CASH
      AND CASH EQUIVALENTS Beginning of period
              
              
              —
              
              
              
              4,167
              
              
              
              39
              
              
              
              —
              
              
              
              4,206CASH
      AND CASH EQUIVALENTS End of period
              
              $
              —
              
              
              $
              2,724
              
              
              $
              388
              
              
              $
              —
              
              
              $
              3,112
  26




16.
            SEGMENT
      INFORMATION




Effective
October 1, 2007, the Company realigned its operations and internal
organizational structure. In accordance with the criteria of SFAS 131, the
Company has three identified operating segments under the new 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. All periods
presented have been restated to give effect to the change in reportable
segments.




Reportable
segments are based upon the Company’s internal organizational structure, the
manner in which 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, total assets and
capital expenditures.




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 September 30, 2008, the recovery segment provided
substance abuse and behavioral health services to patients at 109
facilities located in 22 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 September 30, 2008, the youth segment operated 29
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 expenses 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 September 30, 2008, the healthy living division operated 16
facilities in eight states and one facility in the United Kingdom.




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.




As
discussed in Note 6, there were goodwill adjustments for prior acquisitions that
relate primarily to revisions of the original estimates, which affected goodwill
allocation between the recovery division and youth division segments. These
adjustments affect the segments’ total assets as of December 31, 2007. There is
no effect on the Company’s consolidated balance sheet, statement of operations,
or statement of cash flows for 2007 or for 2008.


27







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




Three
              Months Ended
              September
      30,
              2008
            
            
            Three
              Months Ended
              September
      30,
              2007
            
            
            Nine
              Months
      Ended
              September
      30,
              2008
            
            
            Nine
              Months Ended
              September
      30,
              2007Net
      revenue:Recovery
      division
            
            $
            79,979
            
            
            $
            73,713
            
            
            $
            235,994
            
            
            $
            216,176Youth
      division
            
            
            36,713
            
            
            
            40,224
            
            
            
            105,795
            
            
            
            112,693Corporate/other
            
            
            9,732
            
            
            
            8,432
            
            
            
            22,983
            
            
            
            17,223Total
      consolidated net revenue
            
            $
            126,424
            
            
            $
            122,369
            
            
            $
            364,772
            
            
            $
            346,092Operating
      expenses:Recovery
      division
            
            $
            56,246
            
            
            $
            52,728
            
            
            $
            169,035
            
            
            $
            154,589Youth
      division (1)
            
            
            200,219
            
            
            
            35,163
            
            
            
            267,559
            
            
            
            102,686Corporate/other
            
            
            15,652
            
            
            
            11,542
            
            
            
            43,418
            
            
            
            31,907Total
      consolidated operating expenses
            
            $
            272,117
            
            
            $
            99,433
            
            
            $
            480,012
            
            
            $
            289,182Income
      (loss) from operations:Recovery
      division
            
            $
            23,733
            
            
            $
            20,985
            
            
            $
            66,959
            
            
            $
            61,587Youth
      division
            
            
            (163,506
            )
            
            
            5,061
            
            
            
            (161,764
            )
            
            
            10,007Corporate/other
            
            
            (5,920
            )
            
            
            (3,110
            )
            
            
            (20,435
            )
            
            
            (14,684
            )Total
      consolidated (loss) income from operations
            
            $
            (145,693
            )
            
            $
            22,936
            
            
            $
            (115,240
            )
            
            $
            56,910Income
      (loss) from operations before income taxes:Total
      consolidated (loss) income from operations
            
            $
            (145,693
            )
            
            $
            22,936
            
            
            $
            (115,240
            )
            
            $
            56,910Interest
      expense, net
            
            
            (13,125
            )
            
            
            (15,169
            )
            
            
            (40,148
            )
            
            
            (44,971
            )Other
      (expense)
            
            
            (37
            )
            
            
            (1,217
            )
            
            
            (69
            )
            
            
            (800
            )Total
      consolidated (loss) income before income taxes
            
            $
            (158,855
            )
            
            $
            6,550
            
            
            $
            (155,457
            )
            
            $
            11,139Capital
      expenditures:Recovery
      division
            
            $
            3,175
            
            
            $
            5,542
            
            
            $
            8.890
            
            
            $
            14,814Youth
      division
            
            
            1,228
            
            
            
            1,669
            
            
            
            3,973
            
            
            
            4,588Corporate/other
            
            
            1,699
            
            
            
            2,060
            
            
            
            5,724
            
            
            
            4,837Total
      consolidated capital expenditures
            
            $
            6,102
            
            
            $
            9,271
            
            
            $
            18,587
            
            
            $
            24,239September
      30,
              2008
            
            
            December 31,
              2007(Restated)Total
      assets:Recovery
      division
            
            
            
            
            
            
            
            
            
            $
            904,738
            
            
            $
            891,556Youth
      division
            
            
            
            
            
            
            
            
            
            
            179,313
            
            
            
            348,224Corporate/other
            
            
            
            
            
            
            
            
            
            
            80,990
            
            
            
            82,511Total
      consolidated assets
            
            
            
            
            
            
            
            
            
            $
            1,165,041
            
            
            $
            1,322,291


(1) Includes
$23.9 million of asset impairments and $142.2 million of goodwill
impairment
  17.
              SUBSEQUENT
      EVENTS
  Subsequent
September 30, 2008, and prior to issuance of the interim financial
statements, the Company's executive management team conducted a review of 
facility operations across its divisions. As a result, the Company's
executive management team decided to discontinue operations at certain of the
Company's facilities.  As of November 14, 2008, the Company had not
incurred any liabilities associated with such closures subsequent to September
30, 2008.  The Company's executive management team expects to more fully
develop a plan for closure of such facilities before December 31, 2008.
 28


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




The following discussion should be read in conjunction with the
Unaudited Condensed Consolidated Financial Statements and the related notes that
appear elsewhere in this Quarterly 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 to CRC Health Corporation and its
consolidated subsidiaries.




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 the healthy living division does not currently meet the quantitative
thresholds for separate disclosure (see Note 16 to the condensed consolidated
financial statements). As of September 30, 2008, our recovery division, which
operates the 30 inpatient and 79 outpatient facilities in 22 states,
provides treatment services to patients suffering from chronic addiction related
diseases and related behavioral disorders. As of September 30, 2008, our
recovery division treated approximately 28,000 patients per day. As of September
30, 2008, our youth division, which operates 29 programs in 10 states, provides
a wide variety of therapeutic and educational programs for underachieving young
people. Our healthy living division, which operates 16 facilities in eight
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.




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 ends on December 31 and our third fiscal quarter ends
on September 30. Unless otherwise stated, all year and quarterly dates
refer to our fiscal year or our third fiscal quarter, respectively.




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




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




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 such as eating
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 three months ended September
30, 2008 and 2007,we generated 84.1% and 85.7% of our net revenue from
non-governmental sources, including 69.5% and 71.2% from self payors,
respectively, and 14.6% and 14.5% from commercial payors, respectively. During
the nine months ended September 30, 2008 and 2007, we generated 84.0% and
86.1%




29


of our
net revenue from non-governmental sources, including 68.7% and 71.2% from self
payors, respectively, and 15.2% and 14.9% 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 three months ended September 30, 2008, our consolidated same-facility net
revenue decreased by $0.1 million or 0.1% when compared to the comparable
period in 2007.  For the nine months ended September 30, 2008, our
consolidated, same-facility revenue increased $2.3 million or 0.7% when compared
to the comparable period in 2007.  “Same-facility” means a comparison over
the comparable period of the financial performance of a facility we have
operated for at least one year.




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-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 unaudited condensed 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. We believe that
there have not been any significant changes during the nine months ended
September 30, 2008 to the items that we have previously reported in our critical
accounting policies in management’s discussion and analysis of financial
condition and results of operations for the year ended December 31, 2007 in
our Annual Report on Form 10-K.




RECENT
ACCOUNTING PRONOUNCEMENTS




See
Note 2 to our condensed consolidated financial statements in Part I,
Item 1 for a description of recent accounting pronouncements, including our
expected adoption dates and estimated effects, if any, on our results of
operations, financial condition and cash flows.




30


RESULTS
OF OPERATIONS




The
following table presents our results of operations by segment for the three and
nine months ended September 30, 2008 and 2007 (dollars in thousands, except for
percentages; percentages are calculated as percentage of total net
revenue).




Three
      Months Ended September 30,
            
            
            Nine
      Months Ended September 30,Statement
      of Income Data:
            
            2008
            
            
            %
            
            
            2007
            
            
            %
            
            
            2008
            
            
            %
            
            
            2007
            
            
            %Net
      revenue:Recovery
      division
            
            $
            79,979
            
            
            
            63.3
            %
            
            $
            73,713
            
            
            
            60.2
            %
            
            $
            235,994
            
            
            
            64.7
            %
            
            $
            216,176
            
            
            
            62.5
            %Youth
      division
            
            
            36,713
            
            
            
            29.0
            %
            
            
            40,224
            
            
            
            32.9
            %
            
            
            105,795
            
            
            
            29.0
            %
            
            
            112,693
            
            
            
            32.5
            %Corporate
      / other(1)
            
            
            9,732
            
            
            
            7.7
            %
            
            
            8,432
            
            
            
            6.9
            %
            
            
            22,983
            
            
            
            6.3
            %
            
            
            17,223
            
            
            
            5.0
            %Total
      net revenue
            
            
            126,424
            
            
            
            100.0
            %
            
            
            122,369
            
            
            
            100.0
            %
            
            
            364,772
            
            
            
            100.0
            %
            
            
            346,092
            
            
            
            100.0
            %Operating
      expenses:Recovery
      division
            
            
            56,246
            
            
            
            44.5
            %
            
            
            52,728
            
            
            
            43.1
            %
            
            
            169,035
            
            
            
            46.3
            %
            
            
            154,589
            
            
            
            44.7
            %Youth
      division (2)
            
            
            200,219
            
            
            
            158.3
            %
            
            
            35,163
            
            
            
            28.7
            %
            
            
            267,559
            
            
            
            73.3
            %
            
            
            102,686
            
            
            
            29.7
            %Corporate
      / other(1)
            
            
            15,652
            
            
            
            12.4
            %
            
            
            11,542
            
            
            
            9.5
            %
            
            
            43,418
            
            
            
            11.9
            %
            
            
            31,907
            
            
            
            9.2
            %Total
      operating expenses
            
            
            272,117
            
            
            
            215.2
            %
            
            
            99,433
            
            
            
            81.3
            %
            
            
            480,012
            
            
            
            131.5
            %
            
            
            289,182
            
            
            
            83.6
            %Income
      (loss) from operations:Recovery
      division
            
            
            23,733
            
            
            
            18.8
            %
            
            
            20,985
            
            
            
            17.1
            %
            
            
            66,959
            
            
            
            18.4
            %
            
            
            61,587
            
            
            
            17.8
            %Youth
      division
            
            
            (163,506
            )
            
            
            (129.3
            )%
            
            
            5,061
            
            
            
            4.1
            %
            
            
            (161,764
            )
            
            
            (44.3
            )%
            
            
            10,007
            
            
            
            2.9
            %Corporate
      / other(1)
            
            
            (5,920
            )
            
            
            (4.7
            )%
            
            
            (3,110
            )
            
            
            (2.5
            )%
            
            
            (20,435
            )
            
            
            (5.6
            )%
            
            
            (14,684
            )
            
            
            (4.3
            )%(Loss)
      income from operations
            
            
            (145,693
            )
            
            
            (115.2
            )%
            
            
            22,936
            
            
            
            18.7
            %
            
            
            (115,240
            )
            
            
            (31.5
            )%
            
            
            56,910
            
            
            
            16.4
            %Interest
      expense, net
            
            
            (13,125
            )
            
            
            
            
            
            
            (15,169
            )
            
            
            
            
            
            
            (40,148
            )
            
            
            
            
            
            
            (44,971
            )Other
      (expense)
            
            
            (37
            )
            
            
            
            
            
            
            (1,217
            )
            
            
            
            
            
            
            (69
            )
            
            
            
            
            
            
            (800
            )Income
      before income taxes
            
            
            (158,855
            )
            
            
            
            
            
            
            6,550
            
            
            
            
            
            
            
            (155,457
            )
            
            
            
            
            
            
            11,139Income
      tax (benefit) expense
            
            
            (19,222
            )
            
            
            
            
            
            
            1,502
            
            
            
            
            
            
            
            (17,699
            )
            
            
            
            
            
            
            3,375Minority
      interest in income (loss)of a subsidiary
            
            
            301
            
            
            
            
            
            
            
            427
            
            
            
            
            
            
            
            (57
            )
            
            
            
            
            
            
            275Net
      (loss) income
            
            $
            (139,934
            )
            
            
            
            
            
            $
            4,621
            
            
            
            
            
            
            $
            (137,701
            )
            
            
            
            
            
            $
            7,489






(1)
              (2)
            Includes
      our healthy living division.
              Youth
      division operating expenses include $23.9 million of asset impairments and
      $142.2 million of goodwill
impairment.




Three
Months Ended September 30, 2008 Compared to Three Months Ended September 30,
2007




Consolidated
net revenue increased $4.1 million, or 3.3%, to $126.4 million in 2008 from
$122.4 million in 2007. Of the total net revenue increase, the recovery division
contributed $6.3 million, representing 8.5%growth
for the division, with the remaining net revenue growth driven by an
increase of $1.3 million, or 15.4% in corporate/other.  Total net
revenue growth was partially offset by a net revenue decrease in the youth
division of $3.5million,
or 8.7%.Of
the $3.5 million decrease in youth division revenue, $1.1 million is attributed
to a single therapeutic boarding school that experienced a significant increase
in student graduation rates without a commensurate increase in
enrollments beginning the quarter ended September 30, 2007. We believe, in
addition to the impact of this boarding school, that there has been a slight
lessening in demand as aresult
of the soft economy and the inability of families to access the credit markets
and student loan markets to fund the tuition. Additionally, our youth division
same–facility net revenue decreased $4.4 million, or 11.5%, due in part from the
impact of the aforementioned boarding
school.The
remaining decrease was due to lower census in both our residential and outdoor
programs. Revenue growth in the recovery division was due to same-facility
growthof
$4.7 million, or 6.5%. Of theremaining
$1.6 million net revenue increase in recovery division,
$1.1 million increase was due to an acquisition completed in the
quarter ended September 30, 2007 and the rest was fromstartups.  The $1.3 million
net revenue increase in corporate/other was
contributed by start-ups and  acquisitions completed in the three months
ended September 30,
2007.




Consolidated
operating expenses increased $172.7 million, or 173.7%, to $272.1 million
for the three months ended September 30, 2008 from $99.4 million in the same
period of 2007. Of the $172.7 million increase in operating expenses, the
recovery division incurred an increase of $3.5 million, or 6.7%, corporate/other
incurred an increase of $4.1 million, or 35.6%, and our youth division
incurred a net increase of $165.1million,
or 469.4%. The increase in operations expenses within the youth division
was primarily due to a $142.2 million non-cash  impairment charge
for goodwill as well as for a  $23.9 million non-cash impairment charge
related to asset impairments partially offset by reductions in general
and administrative expenses.  Excluding the combined $166.1 million
in youth division impairment charges, youth division operating expenses
decreased $1.0 million compared to the same period in the prior year. For our
recovery division, same-facility
increase in operating expenses was $1.8 million, or 3.8%, acquisition-related
increase was $1.1 million, and startup related increase was $0.7 million.
Corporate/other
same-facility growth in operating expenses was flat year over year for
the three months ended September 30,
2008.







31


Our consolidated operating margin was -115.2% in the quarter ended September 30,
2008 compared to 18.7% in the quarter ended September 30, 2007.  Excluding
youth division non-cash impairment charges of $166.1 million, consolidated
operating margin was 16.2% for the three months ended September 30,
2008.   On a same-facility basis, our consolidated operating margin
decreased to -109.4% in the quarter ended September 30, 2008 compared to 32.7%
in the quarter ended September 30, 2007. Recovery division same-facility
operating margin increased to 37.7% in the quarter ended September 30, 2008
compared to 36.2% in the quarter ended September 30, 2007. Youth division
same-facility operating margin decreased to -475.3% in the quarter ended
September 30, 2008 compared to 26.0% in the quarter ended September 30,
2007. The
significant decrease in our youth division operating margin is in primarily due
to the non-cash goodwill and asset impairment charges as well as to a
decrease of $1.1 million in revenue from one single therapeutic boarding school,
and the remaining decline is generally attributable to lower student census in
the remaining youth division programs.Corporate/other
same-facility operating margin decreased to 29.9% in the quarter ended September
30, 2008 compared to 33.1% in the quarter ended September 30,
2007.




For the
three months ended September 30, 2008, consolidated net income decreased by
$144.6 million compared to the same period in 2007. The decrease in net income
in 2008 is primarily attributable to goodwill and asset
impairments within the youth division in the amounts of $142.2
million and $23.9 million respectively offset by reductions in general and
administrative expenses.




Nine
Months Ended September 30, 2008 Compared to Nine Months Ended September 30,
2007




Consolidated
net revenue increased $18.7 million, or 5.4%, to $364.8 million in 2008 from
$346.1 million in 2007. Of the $18.7 million increase, the recovery division
contributed $19.8 million, representing 9.2% growth for the division, and the
remaining net revenue growth was driven by a net revenue increase of $5.8
million, or 33.4% in corporate/other. Our youth division had a net revenue
decrease of $6.9 million, or 6.1%. Of the $6.9 million decrease in youth division
revenue, $5.1 million is attributed to a single therapeutic boarding school that
experienced a significant increase in student graduations beginning in the
quarter ended September 30, 2007 without a commensurate increase in new
enrollments. Additionally, our youth division same-facility net
revenue decreased $12.6  million, or 11.2% due inpart from the
impact from the aforementioned boarding school. The remaining
decrease was due to lower census in both our residential and outdoor programs.
Revenue growth in the recovery division was due to same-facility growth of $14.2
million, or 6.7%. Of the remaining 5.6 million net revenue increase in recovery
division, $3.9 million increase resulted from an acquisition, completed in the
quarter ended September 30, 2007 and the rest was from
startups.  Of the $5.8 million net revenue increase in
corporate/other, $0.7 million or 4.6% was due to same facility growth and $5.1
million was
contributed by start-ups and by an acquisition completed in the three months
ended September 30, 2007.





Consolidated
operating expenses increased $190.8 million, or 66.0%, to
$480.0 million in 2008 from $289.2 million in 2007. Of the
$190.8 million increase in operating expenses, the recovery division
incurred an increase of $14.5 million, or 9.3%, corporate/other incurred an
increase of $11.5 million, or 36.1%, and our youth division incurred an
increase of $164.8 million, or 160.6% due to impairment charges of $142.2
million for goodwill and $23.9 million for long-lived assets. 
Excluding the non-cash impairment charges of $166.1 million, youth division
operating expenses decreased $1.2 million or approximately 1.2% due to lower
general and administrative expenses.   For our recovery division,
same-facility increase in operating expenses was $9.9 million, or 7.4%,
and acquisition and startup-related increase
was $4.5 million. For corporate/other, same-facility increase in
operating expenses was $1.2 million, or 9.9%. Of the remaining increase, $10.3
million was related to an acquisition completed in the quarter ended September
30, 2007 and start-ups.




Our consolidated operating margin was -31.6% for the
nine months ended September 30, 2008 compared to 16.4% for the nine months ended
September 30, 2007. Excluding youth division non-cash, combined impairment
charges $166.1 million, consolidated operating margins were $13.9% for the
nine months ended September 30, 2008.   On a same-facility basis,
our consolidated operating margin decreased to -18.9% for the nine months ended
September 30, 2008 as compared to 32.5% for the nine months ended September 30,
2007. Excluding youth division impairments of $166.1 million, same facility
margins were 29.3% for the nine months ended September 30, 2008. 
 Recovery division same-facility operating margin decreased to 36.4% for
the nine months ended September 30, 2008 as compared to 36.8% for the nine
months ended September 30, 2007. Youth division same-facility operating margin
decreased to -151.4% for the nine months ended September 30, 2008 as compared to
25.7% for the nine months ended September 30, 2007.The significant decrease in our youth division
operating margin is due to the $166.1 million in non-cash impairment charges
recognized during the third quarter. The remainder is due to a decrease of $5.1
million in revenue from one single therapeutic boarding school as well
as to lower census in the remaining youth division programs. 
Excluding the $166.1 million non-cash impairment charges, same-facility youth
division margins for the  nine months ended September 30, 2008 were
14.9%.Corporate/other
same-facility operating margin decreased to 19.5% for the nine months
ended September 30, 2008 as compared to 23.4% for the nine months ended
September 30,
2007.




For the
nine months ended September 30, 2008, consolidated net income decreased by
$145.2 million compared to the same period in 2007. The decrease in net income
in 2008 is primarily attributable to goodwill and asset impairments
within the youth division in the amounts of $142.2 million and $23.9
million respectively.




32


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 $28.4 million at September 30, 2008, compared to
negative working capital of $56.5 million at December 31, 2007. The
increase in working capital from September 30, 2008 compared to 
December 31, 2007 was primarily attributable to a reclassification of
$40.0 million, related to the revolver loan from short-term to long term
debt.






Sources
and Uses of Cash
  Nine
      Months Ended
                September
      30,2008
              
              
              2007(In
      thousands)Net
      cash provided by operating activities
              
              $
              21,090
              
              
              $
              18,119Net
      cash used in investing activities
              
              
              (33,010
              )
              
              
              (56,795
              )Net
      cash provided by financing activities
              
              
              9,816
              
              
              
              37,582Net
      increase (decrease) in cash
              
              $
              (2,104
              )
              
              $
              (1,094)
   Cash used
provided by operating activities was $21.1 million
for the nine months ended September 30, 2008 compared to cash provided in
operating activities of $18.1 million during the same period in
2007.
  Cash used
in investing activities was $33.0 million
in for the nine months ended September 30, 2008 compared to $56.8 million in the
same period of 2007.  The decrease in cash used in investing activity
primarily relates to a decrease in the additions of plant, property and
equipment and in acquisitions.
  Cash
provided by financing activities was $9.8 million for the nine months ended
September 30, 2008 compared to $37.6 million for the same period in 2007. The
decrease in cash provided by financing activities is primarily due to a net
decrease in borrowing under the revolving line of
credit.




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 September 30, 2008, our senior secured
credit facility was comprised of a $410.9 million senior secured term loan
facility and a $100.0 million revolving credit facility. At September 30, 2008,
the revolving credit facility had $52.8 million available for borrowing, $40.0
million outstanding and classified on our balance sheet as long term debt, and
$7.2 million of letters of credit issued and outstanding. As part of the
acquisition of the Company by investment funds managed by Bain Capital Partners,
LLC, we issued $200.0 million in aggregate principal amount of 10.75% senior
subordinated notes due 2016 of which $200.0 million, less original issue
discount, remained outstanding at September 30, 2008. We anticipate that cash
generated by 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 made
and currently intend to make payments to reduce borrowing under the revolving
line of credit from operating cash flow. In addition, if future financings are
executed, we expect that such 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 $8.2 million for maintenance
related expenditures and an additional $21.2 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
September 30, 2008, we were in compliance with all such covenants.




33


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.  Our interest rate swaps have effectively fixed the interest
rate on a substantial portion of the term loan.  Our existing swaps
have fixed $70 million of the term loan at 4.990% and $200 million of the term
loan at 3.875%.








Funding
Commitments




Certain
agreements acquired in our acquisition of Aspen Education Group (the
"Acquisition") contain contingent earnout provisions that provide for additional
payments if the acquisitions meet performance milestones as specified in the
agreements. For the nine months ended September 30, 2008, we incurred
liabilities of $0.6 million associated with earnout obligations and made
payments of $2.9 million. We have no future obligations for additional
liabilities associated with such earnouts related to the
Acquisition.









Item 3.
            Quantitative and Qualitative Disclosure about Market
      Risk




For
quantitative and qualitative disclosures about market risk affecting us, see
“Quantitative and Qualitative Disclosure about Market Risk” in Item 7A of
Part II of our Annual Report on Form 10-K for the year ended December 31,
2007, which is incorporated herein by reference. As of September 30, 2008, our
exposure to market risk has not changed materially since December 31,
2007.




Item 4T.
            Controls and
Procedures




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 Quarterly 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.




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
Quarterly Report that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




Inherent
Limitations on Effectiveness of Controls




Our
management, including our chief executive officer and chief financial officer,
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.




34


PART II.
OTHER INFORMATION




Item 1A.
            Risk Factors




As of
September 30, 2008, except as set forth below, there have been no material
changes to the factors disclosed in Item 1A Risk Factors in our Annual Report on
Form 10-K for the year ended December 31, 2007.




Unfavorable
student loan markets could negatively impact our revenues in our youth
division.




Some
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, certain lenders have announced that
they will apply more stringent lending standards for private student loans.
Continued tightening of the credit markets may result in financing difficulties
for those students who rely on private student loans and could adversely impact
our revenues.




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.




Item 6.                      Exhibits




The
Exhibit Index beginning on page 37 of this report sets forth a list of
exhibits.




35


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: November 14,
2008


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




36


CRC
HEALTH CORPORATION




EXHIBIT INDEX




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)4.1h
            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.
      ‡10.3i
            Release
      of Guarantee and Collateral dated as of July 25, 2008 by and among
      Citibank, NA, as Administrative Agent and Collateral Agent, CRC
      Health
              Corporation,Adirondack
      Leadership Expeditions,LLC and Lone
      Star Expeditions, Inc.  ‡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.