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: June 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 August 12, 2008 was 1,000.







CRC
HEALTH CORPORATION




INDEX




Page No.Part I.
            Financial
      InformationItem 1.
            Financial
      Statements (Unaudited)Condensed Consolidated Balance Sheets as
      of June 30, 2008 and December 31, 2007
            
            
            3Condensed Consolidated Statements of
      Operations for the three and six months ended June 30, 2008 and
      2007
            
            
            4Condensed Consolidated Statements of
      Cash Flows for the six months ended June 30, 2008 and
      2007
            
            
            5Notes to Condensed Consolidated
      Financial Statements
            
            
            6Item
      2.
            Management’s Discussion and Analysis
      of Financial Condition and Results of Operations
            
            
            26Item
      3.
            Quantitative and Qualitative Disclosure About Market
      Risk
            
            
            31Item 4T.
            Controls and Procedures
            
            
            31Part II.
            Other
      InformationItem 1A.
            Risk Factors
            
            
            32Item
      5.
            Other Information
            
            
            32Item
      6.
            Exhibits
            
            
            32Signature
            
            
            33Exhibit
      Index
            
            
            34




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)


JUNE
30, 2008 AND DECEMBER 31, 2007


(In
thousands, except share amounts)




June
      30,
              2008
            
            
            December 31,
              2007ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            10,369
            
            
            $
            5,118Accounts
      receivable, net of allowance for doubtful accounts of $5,725 in 2008 and
      $6,901 in 2007
            
            
            31,630
            
            
            
            31,910Prepaid
      expenses
            
            
            8,113
            
            
            
            7,544Other
      current assets
            
            
            1,673
            
            
            
            2,120Income
      taxes receivable
            
            
            —
            
            
            
            193Deferred
      income taxes
            
            
            6,599
            
            
            
            6,599Total
      current assets
            
            
            58,384
            
            
            
            53,484PROPERTY
      AND EQUIPMENT—Net
            
            
            128,132
            
            
            
            122,937GOODWILL
            
            
            731,396
            
            
            
            730,684INTANGIBLE
      ASSETS—Net
            
            
            386,206
            
            
            
            390,388OTHER
      ASSETS
            
            
            22,818
            
            
            
            24,798TOTAL
      ASSETS
            
            $
            1,326,936
            
            
            $
            1,322,291LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            $
            6,702
            
            
            $
            7,014Accrued
      liabilities
            
            
            39,040
            
            
            
            37,582Current
      portion of long-term debt
            
            
            39,476
            
            
            
            35,603Other
      current liabilities
            
            
            31,550
            
            
            
            29,824Total
      current liabilities
            
            
            116,768
            
            
            
            110,023LONG-TERM
      DEBT—Less current portion
            
            
            609,829
            
            
            
            612,764OTHER
      LIABILITIES
            
            
            5,856
            
            
            
            7,514DEFERRED
      INCOME TAXES
            
            
            144,838
            
            
            
            145,867Total
      liabilities
            
            
            877,291
            
            
            
            876,168COMMITMENTS
      AND CONTINGENCIES (Note 11)MINORITY
      INTEREST
            
            
            17
            
            
            
            374STOCKHOLDER’S
      EQUITY:Common
      stock, $0.001 par value—1,000 shares authorized; 1,000 shares issued and
      outstanding at June 30, 2008 and December 31,
    2007
            
            
            —
            
            
            
            —Additional
      paid-in capital
            
            
            440,606
            
            
            
            438,608Retained
      earnings
            
            
            9,374
            
            
            
            7,141Accumulated
      other comprehensive income
            
            
            (352
            )
            
            
            —Total
      stockholder’s equity
            
            
            449,628
            
            
            
            445,749TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
            
            $
            1,326,936
            
            
            $
            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 SIX MONTHS ENDED JUNE 30, 2008 AND 2007
 (In
thousands)
  Three Months
                Ended
                June
      30,
                2008
              
              
              Three Months
                Ended
                June 30,
                2007
              
              
              Six Months
                Ended
                June 30,
                2008
              
              
              Six Months
                Ended
                June 30,
                2007NET
      REVENUE:Net
      client service revenue
              
              $
              120,284
              
              
              $
              114,384
              
              
              $
              234,368
              
              
              $
              220,866Other
      revenue
              
              
              2,008
              
              
              
              1,409
              
              
              
              3,979
              
              
              
              2,857Total
      net revenue
              
              
              122,292
              
              
              
              115,793
              
              
              
              238,347
              
              
              
              223,723OPERATING
      EXPENSES:Salaries
      and benefits
              
              
              61,288
              
              
              
              56,380
              
              
              
              122,530
              
              
              
              111,688Supplies,
      facilities and other operating costs
              
              
              36,058
              
              
              
              33,384
              
              
              
              70,654
              
              
              
              64,161Provision
      for doubtful accounts
              
              
              1,641
              
              
              
              1,525
              
              
              
              3,295
              
              
              
              3,028Depreciation
      and amortization
              
              
              5,840
              
              
              
              5,621
              
              
              
              11,414
              
              
              
              10,913Total
      operating expenses
              
              
              104,827
              
              
              
              96,910
              
              
              
              207,893
              
              
              
              189,790INCOME
      FROM OPERATIONS
              
              
              17,465
              
              
              
              18,883
              
              
              
              30,454
              
              
              
              33,933INTEREST
      EXPENSE, NET
              
              
              (12,505
              )
              
              
              (14,813
              )
              
              
              (27,022
              )
              
              
              (29,802
              )OTHER
      INCOME (EXPENSE)
              
              
              1,585
              
              
              
              766
              
              
              
              (33
              )
              
              
              458INCOME
      BEFORE INCOME TAXES
              
              
              6,545
              
              
              
              4,836
              
              
              
              3,399
              
              
              
              4,589INCOME
      TAX EXPENSE
              
              
              2,842
              
              
              
              1,974
              
              
              
              1,523
              
              
              
              1,873MINORITY
      INTEREST IN LOSS OF SUBSIDIARIES
              
              
              (54
              )
              
              
              (52
              )
              
              
              (357
              )
              
              
              (152
              )NET
      INCOME
              
              $
              3,757
              
              
              $
              2,914
              
              
              $
              2,233
              
              
              $
              2,868


See notes
to unaudited condensed consolidated financial statements.




4


CRC
HEALTH CORPORATION




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)


FOR
THE SIX MONTHS ENDED JUNE 30, 2008 AND 2007


(In
thousands)




Six Months
              Ended
              June
      30,
              2008
            
            
            Six Months
              Ended
              June
      30,
              2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
            
            $
            2,233
            
            
            $
            2,868Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            11,414
            
            
            
            10,913Amortization
      of debt discount and capitalized financing costs
            
            
            2,225
            
            
            
            2,248Loss
      (gain) on interest rate swap agreement
            
            
            33
            
            
            
            (462
            )Gain
      on disposition of property
            
            
            (1
            )
            
            
            (10
            )Provision
      for doubtful accounts
            
            
            3,295
            
            
            
            3,028Stock-based
      compensation
            
            
            2,303
            
            
            
            2,143Deferred
      income taxes
            
            
            (1,029
            )
            
            
            (870
            )Minority
      interest
            
            
            (357
            )
            
            
            (152
            )Changes
      in assets and liabilities:Accounts
      receivable
            
            
            (3,015
            )
            
            
            (2,362
            )Income
      taxes receivable
            
            
            193
            
            
            
            2,266Prepaid
      expenses
            
            
            (569
            )
            
            
            105Other
      current assets
            
            
            447
            
            
            
            (1,113
            )Accounts
      payable
            
            
            (312
            )
            
            
            67Accrued
      liabilities
            
            
            1,433
            
            
            
            (3,227
            )Other
      current liabilities
            
            
            2,616
            
            
            
            5,124Other
      assets
            
            
            42
            
            
            
            269Other
      liabilities
            
            
            (120
            )
            
            
            141Net
      cash provided by operating activities
            
            
            20,831
            
            
            
            20,976CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
            
            
            (12,523
            )
            
            
            (14,968
            )Proceeds
      from sale of property and equipment
            
            
            55
            
            
            
            29Acquisition
      of business, net of cash acquired
            
            
            —
            
            
            
            (1,085
            )Acquisition
      adjustments
            
            
            (33
            )
            
            
            1,029Payments
      made under earnout arrangements
            
            
            (2,531
            )
            
            
            —Net
      cash used in investing activities
            
            
            (15,032
            )
            
            
            (14,995
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Capital
      distributed to Parent
            
            
            (305
            )
            
            
            —Capitalized
      financing costs
            
            
            (136
            )
            
            
            (622
            )Repayment
      of capital lease obligations
            
            
            (11
            )
            
            
            (104
            )Net
      borrowings (payments) under revolving line of credit
            
            
            4,000
            
            
            
            (3,600
            )Repayments
      of long-term debt
            
            
            (4,096
            )
            
            
            (2,669
            )Net
      cash used in financing activities
            
            
            (548
            )
            
            
            (6,995
            )NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            5,251
            
            
            
            (1,014
            )CASH
      AND CASH EQUIVALENTS—Beginning of period
            
            
            5,118
            
            
            
            4,206CASH
      AND CASH EQUIVALENTS—End of period
            
            $
            10,369
            
            
            $
            3,192


SUPPLEMENTAL
      DISCLOSURE OF NONCASH INVESTING ACTIVITIES:Payable
      for contingent consideration
            
            $
            416
            
            
            $
            4,543SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for interest
            
            $
            25,798
            
            
            $
            28,062Cash
      paid for income taxes, net of refunds
            
            $
            683
            
            
            $
            478






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 June 30, 2008, the Company operated 106 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 June 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 June 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.




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 9 for additional
information including the effects of adoption on the Company’s condensed
consolidated financial statements.




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 has


similar
instruments that it elects not to measure at fair value. The Company adopted
SFAS 159 on January 1, 2008. Upon adoption and for the six months ended
June 30, 2008, the Company did not elect any fair value options under the
provisions of SFAS 159.




In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (revised 2007), Business Combinations
(“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. SFAS 141(R) also
establishes disclosure requirements to enable the evaluation of the
nature




6


and
financial effects of the business combination. SFAS 141(R) is effective for
fiscal years beginning after December 15, 2008, and will be adopted by the
Company in the first quarter of 2009. The Company is currently evaluating the
potential impact, if any, 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.




3.
            BALANCE
      SHEET COMPONENTS




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




June 30,
              2008
            
            
            December 31,
              2007Accounts
      receivable—gross
            
            $
            37,355
            
            
            $
            38,811Less
      allowance for doubtful accounts
            
            
            (5,725
            )
            
            
            (6,901
            )Accounts
      receivable—net
            
            $
            31,630
            
            
            $
            31,910Other
      assets:Capitalized
      financing costs—net
            
            $
            21,421
            
            
            $
            23,361Deposits
            
            
            858
            
            
            
            874Note
      receivable
            
            
            539
            
            
            
            563Total
      other assets
            
            $
            22,818
            
            
            $
            24,798Accrued
      liabilities:Accrued
      payroll and related expenses
            
            $
            14,792
            
            
            $
            14,923Accrued
      vacation
            
            
            6,561
            
            
            
            5,421Accrued
      interest
            
            
            9,027
            
            
            
            9,647Other
      accrued expenses
            
            
            8,660
            
            
            
            7,591Total
      accrued liabilities
            
            $
            39,040
            
            
            $
            37,582Other
      current liabilities:Deferred
      revenue
            
            $
            15,149
            
            
            $
            13,190Client
      deposits
            
            
            10,831
            
            
            
            8,628Insurance
      premium financing
            
            
            806
            
            
            
            2,653Interest
      rate swap liability
            
            
            2,047
            
            
            
            1,662Other
            
            
            2,717
            
            
            
            3,691Total
      other current liabilities
            
            $
            31,550
            
            
            $
            29,824







7




4.
            PROPERTY
      AND EQUIPMENT




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




June 30,
              2008
            
            
            December 31,
              2007Land
            
            $
            21,593
            
            
            $
            19,230Building
      and improvements
            
            
            64,409
            
            
            
            63,316Leasehold
      improvements
            
            
            21,318
            
            
            
            19,424Furniture
      and fixtures
            
            
            11,381
            
            
            
            9,571Computer
      equipment
            
            
            9,012
            
            
            
            8,146Computer
      software
            
            
            6,969
            
            
            
            4,291Motor
      vehicles
            
            
            5,267
            
            
            
            4,516Field
      equipment
            
            
            2,740
            
            
            
            2,382Construction
      in progress
            
            
            9,376
            
            
            
            8,792152,065
            
            
            
            139,668Less
      accumulated depreciation
            
            
            (23,933
            )
            
            
            (16,731
            )Property
      and equipment—net
            
            $
            128,132
            
            
            $
            122,937




Depreciation
expense was $3.8 million and $2.9 million for the three months ended
June 30, 2008 and 2007, respectively, and $7.2 million and $5.6 million for
the six months ended June 30, 2008 and 2007, respectively.




5.
            GOODWILL
      AND INTANGIBLE ASSETS




For the
quarter beginning October 1, 2007, the Company realigned its operating
segments to better fit its organizational and operating strategy around three
divisions: recovery, healthy living and youth (see Note 15). In conjunction
with this change, certain operating units within its youth and recovery division
were transferred to its healthy living division. As a result, the corresponding
goodwill of those operating units was allocated to the healthy living division.
Under the provisions of Statement of Financial Accounting Standards
No. 131, Disclosures
about Segments of an Enterprise and Related Information ("SFAS 131"), the
Company is reporting healthy living under "corporate/other."
   Changes
to goodwill by reportable segment for the six months ended June 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
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —Goodwill
      related to earnouts
              
              
              —
              
              
              
              641
              
              
              
              —
              
              
              
              641Goodwill
      adjustments
              
              
              25
              
              
              
              (1
              )
              
              
              47
              
              
              
              71Goodwill
      June 30, 2008
              
              $
              488,343
              
              
              $
              219,461
              
              
              $
              23,592
              
              
              $
              731,396
 
 Goodwill
related to 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. During the six months ended June 30, 2008, the youth
segment recorded additional goodwill of $0.6 million as a result of one of the
entities exceeding the benchmarks.
 Goodwill
Adjustments
  The
goodwill adjustments are for prior acquisitions and relate primarily to
revisions of the original estimates.
  Other
Adjustments
  Subsequent
to the issuance of the Company's 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.   There is no other effect on the Company's consolidated
financial statements related to the above disclosures.




8




Intangible
assets at June 30, 2008 and December 31, 2007 consist of the following
(in thousands):
  June 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
              
              $
              45,400
              
              
              $
              (3,689
              )
              
              $
              41,711
              
              20 years
              
              $
              45,400
              
              
              $
              (2,554
              )
              
              $
              42,846Accreditations
              20
      years
              
              
              24,400
              
              
              
              (1,983
              )
              
              
              22,417
              
              20
      years
              
              
              24,400
              
              
              
              (1,373
              )
              
              
              23,027Curriculum
              20
      years
              
              
              9,000
              
              
              
              (731
              )
              
              
              8,269
              
              20
      years
              
              
              9,000
              
              
              
              (506
              )
              
              
              8,494Government
      includingMedicaid
      contracts
              15 years
              
              
              35,600
              
              
              
              (5,735
              )
              
              
              29,865
              
              15 years
              
              
              35,600
              
              
              
              (4,548
              )
              
              
              31,052Managed
      care contracts
              10
      years
              
              
              14,400
              
              
              
              (3,480
              )
              
              
              10,920
              
              10
      years
              
              
              14,400
              
              
              
              (2,759
              )
              
              
              11,641Managed
      care contracts
              5
      years
              
              
              100
              
              
              
              (15
              )
              
              
              85
              
              5
      years
              
              
              100
              
              
              
              (5
              )
              
              
              95Core
      developed technology
              5
      years
              
              
              2,704
              
              
              
              (1,311
              )
              
              
              1,393
              
              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
              
              
              2,241
              
              
              
              (2,241
              )
              
              
              —
              
              1
      year
              
              
              2,241
              
              
              
              (2,241
              )
              
              
              —Total
      intangible assets subject to amortization:
              
              
              $
              134,197
              
              
              $
              (19,537
              )
              
              
              114,660
              
              
              
              $
              134,197
              
              
              $
              (15,355
              )
              
              
              118,842Intangible
      assets not subject to amortization:Trademarks
      and trade names
              
              
              
              
              
              
              
              
              
              
              
              183,725
              
              
              
              
              
              
              
              
              
              
              
              
              183,725Certificates
      of need
              
              
              
              
              
              
              
              
              
              
              
              44,600
              
              
              
              
              
              
              
              
              
              
              
              
              44,600Regulatory
      licenses
              
              
              
              
              
              
              
              
              
              
              
              43,221
              
              
              
              
              
              
              
              
              
              
              
              
              43,221Total
      intangible assets not subject to amortization
              
              
              
              
              
              
              
              
              
              
              
              271,546
              
              
              
              
              
              
              
              
              
              
              
              
              271,546Total
      intangible assets
              
              
              
              
              
              
              
              
              
              
              $
              386,206
              
              
              
              
              
              
              
              
              
              
              
              $
              390,388
  Amortization
expense of intangible assets subject to amortization was $2.1 million and $2.7
million for the three months ended June 30, 2008 and 2007, respectively,
and $4.2 million and $5.4 million for the six months ended June 30, 2008 and
2007, respectively.
  Estimated
future amortization expense related to the amortizable intangible assets at
June 30, 2008 is as follows (in thousands):
  Fiscal
      Year2008
      (remaining 6 months)
              
              $
              4,1562009
              
              
              8,3142011
              
              
              8,3142012
              
              
              7,8142013
              
              
              7,768Thereafter
              
              
              78,294Total
              
              $
              114,660




6.
            INCOME
      TAXES





The
Company determines income tax expense for interim periods by applying the use of
the full year’s estimated effective tax rate in financial statements for interim
periods.




The
income tax expense for the three and six months ended June 30, 2008 was
$2.8 million and $1.5 million, respectively, reflecting an effective tax rate of
43.4% and 44.8%, respectively. The income tax expense for the three and six
months ended June 30, 2007 was $2.0 million and $1.9 million, respectively,
reflecting an effective tax rate of 40.8% in both periods.




9







7.
            LONG-TERM
      DEBT




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




June 30,
              2008
            
            
            December 31,
              2007Term
      loan
            
            $
            411,938
            
            
            $
            414,034Revolving
      line of credit
            
            
            30,500
            
            
            
            26,500Senior
      subordinated notes, net of discount of $2,258 in 2008 and $2,407 in
      2007
            
            
            197,742
            
            
            
            197,593Seller
      notes
            
            
            9,102
            
            
            
            10,206Capital
      lease obligations
            
            
            23
            
            
            
            34Total
      debt
            
            
            649,305
            
            
            
            648,367Less
      current portion
            
            
            (39,476
            )
            
            
            (35,603
            )Long-term
      debt—less current portion
            
            $
            609,829
            
            
            $
            612,764




Interest
expense on total debt was $12.5 million and $15.1 million for the three months
ended June 30, 2008 and 2007, respectively, and $27.1 million and $30.2
million for the six months ended June 30, 2008 and 2007,
respectively.




8.
            FINANCIAL
      INSTRUMENTS




Derivatives
      -Interest Rate
      Swaps




As of
June 30, 2008, the Company had an interest rate swap agreement which
converted $80 million of its floating-rate debt to fixed-rate debt at
4.99%.  As of June 30, 2008, the interest rate swap has 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 hedge.  In accordance with the Company’s risk
management policy, future changes in the fair value of the interest rate swap
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. Additionally, future ineffectiveness in hedging
activity related to the interest swap, if any, will be 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 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 on OCI, if any, are
discussed in Note 9 and in Note 10.




9.
            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 indicative values based on
mid-market levels and 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 June 30, 2008, the aggregate fair
value of the Company’s interest rate swap agreements was a liability of $2.0
million. For its interest rate swap agreement executed February 28, 2006, the
Company recognized a gain of approximately $1.6




10


million
and an immaterial amount of loss for the three and six months ended June 30,
2008, respectively, and a gain of $0.8 million and $0.4 million for the three
and six months ended on June 30, 2007, respectively, and is recorded in other
income on the condensed consolidated statements of
operations.   The Company recognized a loss of approximately $0.4
million for the three and six months ended June 30, 2008, respectively, on its
interest rate swap agreement executed on June 30, 2008 and is recorded in other
comprehensive income.




10.
            OTHER
      COMPREHENSIVE INCOME




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




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





Three Months
              Ended
              June
      30,
              2008
            
            
            Three Months
              Ended
              June
      30,
              2007
            
            
            Six Months
              Ended
              June 30,
              2008
            
            
            Six Months
              Ended
              June
      30,
              2007Net
      income
            
            $
            3,757
            
            
            $
            2,914
            
            
            $
            2,233
            
            
            $
            2,868Other
      comprehensive incomeNet
      change in unrealized losses on cash flow hedges
            
            
            (352
            )
            
            —
            
            
            
            (352
            )
            
            —Total
      other comprehensive income
            
            $
            3,405
            
            
            $
            2,914
            
            
            $
            1,881
            
            
            $
            2,868




11.
            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.




12.
            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.




11


As
of June 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 certain
performance conditions and a market condition, as defined in the Executive and
Incentive plans; tranche 3 options vest and become exercisable over a five-year
period upon achievement of performance conditions or alternatively upon
achievement of 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.





During
the six months ended June 30, 2008, the Group’s board of directors increased the
number of share units available under the Plans by 20,000 units. Consequently,
at June 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
June 30, 2008 and 2007 were $55.45 and $54.55 per unit,
respectively.




12


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
              June
      30,
              2008
            
            
            Three Months
              Ended
              June
      30,
              2007Black
      ScholesExpected
      term (in years)
            
            
            6.22
            
            
            
            6.35Expected
      volatility
            
            
            39.50
            %
            
            
            45.90
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.38
            %
            
            
            5.06
            %Binomial
      (Monte Carlo simulation)Expected
      volatility
            
            
            51.78
            %
            
            
            54.50
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.92
            %
            
            
            5.06
            %





Six Months
              Ended
              June
      30,
              2008
            
            
            Six Months
              Ended
              June
      30,
              2007Black
      ScholesExpected
      term (in years)
            
            
            6.31
            
            
            
            6.33Expected
      volatility
            
            
            39.10
            %
            
            
            47.40
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.13
            %
            
            
            4.88
            %Binomial
      (Monte Carlo simulation)Expected
      volatility
            
            
            51.29
            %
            
            
            54.80
            %Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk-free
      interest rate
            
            
            3.73
            %
            
            
            4.88
            %










•
            
            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.







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 $1.1
million and $1.0 million for the three months ended June 30, 2008 and 2007,
respectively, and $2.3 million and $2.1 million for the six months ended June
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 June 30, 2008
and 2007, respectively, and $1.0 million and $0.8 million for the six
months ended June 30, 2008 and 2007, respectively.





As of
June 30, 2008, $15.4 million of total unrecognized compensation, net of
estimated forfeitures of $0.8 million, is expected to be recognized over a
weighted-average period of 2.98 years if all performance conditions are met
under the provisions of the




13


plans.
During the three and six months ended June 30, 2008, 51,802 and 309,651 shares
vested with an aggregate grant date fair value of $0.3 million and $1.7 million,
respectively.





Stock
Option Activity under the Plans





During
the six months ended June 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 six months ended June 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
            
            
            243,175
            
            
            
            11.23
            
            
            
            9.75Exercised
            
            
            (38,793
            )
            
            
            2.98Forfeited/cancelled/expired
            
            
            (204,282
            )
            
            
            9.67Outstanding—June
      30, 2008
            
            
            7,251,236
            
            
            $
            7.84
            
            
            
            7.88Exercisable—June
      30, 2008
            
            
            2,556,122
            
            
            $
            5.06
            
            
            
            7.71Exercisable
      and expected to be exercisable
            
            
            6,888,674
            
            
            $
            7.84





As of
June 30, 2008, the aggregate intrinsic value of share options outstanding,
exercisable, and outstanding and expected to be exercisable was $24.6 million,
$15.8 million and $23.4 million, respectively. The aggregate intrinsic value is
calculated as the difference between the exercise price of the underlying awards
and the fair value of the Group’s shares as of June 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
June 30, 2008 was immaterial. For the six months ended June 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 June 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
            
            
            
            7.69
            
            
            $
            0.10
            
            
            
            1,129,132
            
            
            $
            0.10$1.00 - $ 3.30
            
            
            
            5,407,818
            
            
            
            7.93
            
            
            
            1.13
            
            
            
            1,182,190
            
            
            
            1.07$7.89 - $17.62
            
            
            
            114,616
            
            
            
            7.62
            
            
            
            8.07
            
            
            
            114,616
            
            
            
            8.07$81.00 - $98.16
            
            
            
            599,670
            
            
            
            7.93
            
            
            
            82.92
            
            
            
            130,184
            
            
            
            81.71Total
            
            
            
            7,251,236
            
            
            
            7.88
            
            
            $
            7.84
            
            
            
            2,556,122
            
            
            $
            5.06





13.
            RELATED
      PARTY TRANSACTIONS




In
connection with the 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 June 30, 2008 and 2007 and approximately
$1.1 million for the each of the six months ended June 30, 2008 and 2007, which
is included in supplies, facilities and other operating costs.




14


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.




14.
            CONDENSED
      CONSOLIDATING FINANCIAL INFORMATION




As of
June 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 June 30, 2008 and
December 31, 2007, the condensed consolidating statements of operations for
the three and six months ended June 30, 2008 and 2007, and the condensed
consolidating statements of cash flows for the six months ended June 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 six months ended June 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.




15


Condensed
Consolidating Balance Sheet as of June 30, 2008


(In
thousands) (Unaudited)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
            
            $
            —
            
            
            $
            9,515
            
            
            $
            854
            
            
            $
            —
            
            
            $
            10,369Accounts
      receivable—net of allowance
            
            
            1
            
            
            
            31,031
            
            
            
            598
            
            
            
            
            
            
            
            31,630Prepaid
      expenses
            
            
            4,517
            
            
            
            3,117
            
            
            
            479
            
            
            
            
            
            
            
            8,113Other
      current assets
            
            
            19
            
            
            
            1,611
            
            
            
            43
            
            
            
            
            
            
            
            1,673Deferred
      income taxes
            
            
            6,599
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            6,599Total
      current assets
            
            
            11,136
            
            
            
            45,274
            
            
            
            1,974
            
            
            
            —
            
            
            
            58,384PROPERTY
      AND EQUIPMENT—Net
            
            
            7,508
            
            
            
            117,916
            
            
            
            2,708
            
            
            
            
            
            
            
            128,132GOODWILL
            
            
            —
            
            
            
            719,598
            
            
            
            11,798
            
            
            
            
            
            
            
            731,396INTANGIBLE
      ASSETS—Net
            
            
            —
            
            
            
            386,206
            
            
            
            —
            
            
            
            
            
            
            
            386,206OTHER
      ASSETS
            
            
            21,511
            
            
            
            1,285
            
            
            
            22
            
            
            
            
            
            
            
            22,818INVESTMENT
      IN SUBSIDIARIES
            
            
            1,219,459
            
            
            
            —
            
            
            
            —
            
            
            
            (1,219,459
            )
            
            
            —TOTAL
      ASSETS
            
            $
            1,259,614
            
            
            $
            1,270,279
            
            
            $
            16,502
            
            
            $
            (1,219,459
            )
            
            $
            1,326,936LIABILITIES
      AND STOCKHOLDER’S EQUITYCURRENT
      LIABILITIES:Accounts
      payable
            
            $
            4,505
            
            
            $
            2,065
            
            
            $
            132
            
            
            $
            —
            
            
            $
            6,702Accrued
      liabilities
            
            
            17,348
            
            
            
            19,887
            
            
            
            1,805
            
            
            
            
            
            
            
            39,040Current
      portion of long-term debt
            
            
            34,693
            
            
            
            4,783
            
            
            
            —
            
            
            
            
            
            
            
            39,476Other
      current liabilities
            
            
            2,941
            
            
            
            23,529
            
            
            
            5,080
            
            
            
            
            
            
            
            31,550Total
      current liabilities
            
            
            59,487
            
            
            
            50,264
            
            
            
            7,017
            
            
            
            —
            
            
            
            116,768LONG-TERM
      DEBT—Less current portion
            
            
            605,487
            
            
            
            4,342
            
            
            
            —
            
            
            
            
            
            
            
            609,829OTHER
      LIABILITIES
            
            
            174
            
            
            
            5,682
            
            
            
            —
            
            
            
            
            
            
            
            5,856DEFERRED
      INCOME TAXES
            
            
            144,838
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            144,838Total
      liabilities
            
            
            809,986
            
            
            
            60,288
            
            
            
            7,017
            
            
            
            —
            
            
            
            877,291MINORITY
      INTEREST
            
            
            —
            
            
            
            —
            
            
            
            17
            
            
            
            —
            
            
            
            17STOCKHOLDER’S
      EQUITY
            
            
            449,628
            
            
            
            1,209,991
            
            
            
            9,468
            
            
            
            (1,219,459
            )
            
            
            449,628TOTAL
      LIABILITIES AND STOCKHOLDER’S EQUITY
            
            $
            1,259,614
            
            
            $
            1,270,279
            
            
            $
            16,502
            
            
            $
            (1,219,459
            )
            
            $
            1,326,936




16


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




17


Condensed Consolidating Statements of
Operations


For
the Three Months Ended June 30, 2008


(In
thousands) (Unaudited)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            3
            
            
            $
            114,356
            
            
            $
            5,925
            
            
            $
            —
            
            
            $
            120,284Other
      revenue
            
            
            3
            
            
            
            2,005
            
            
            
            —
            
            
            
            
            
            
            
            2,008Management
      fee revenue
            
            
            23,355
            
            
            
            —
            
            
            
            —
            
            
            
            (23,355
            )
            
            
            —Total
      net revenue
            
            
            23,361
            
            
            
            116,361
            
            
            
            5,925
            
            
            
            (23,355
            )
            
            
            122,292OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            3,967
            
            
            
            54,412
            
            
            
            2,909
            
            
            
            
            
            
            
            61,288Supplies,
      facilities and other operating costs
            
            
            535
            
            
            
            32,292
            
            
            
            3,231
            
            
            
            
            
            
            
            36,058Provision
      for doubtful accounts
            
            
            —
            
            
            
            1,614
            
            
            
            27
            
            
            
            
            
            
            
            1,641Depreciation
      and amortization
            
            
            603
            
            
            
            5,018
            
            
            
            219
            
            
            
            
            
            
            
            5,840Management
      fee expense
            
            
            —
            
            
            
            22,381
            
            
            
            974
            
            
            
            (23,355
            )
            
            
            —Total
      operating expenses
            
            
            5,105
            
            
            
            115,717
            
            
            
            7,360
            
            
            
            (23,355
            )
            
            
            104,827INCOME
      (LOSS) FROM OPERATIONS
            
            
            18,256
            
            
            
            644
            
            
            
            (1,435
            )
            
            
            —
            
            
            
            17,465INTEREST
      EXPENSE, NET
            
            
            (12,319
            )
            
            
            (186
            )
            
            
            —
            
            
            
            
            
            
            
            (12,505
            )OTHER
      INCOME
            
            
            1,585
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            1,585INCOME
      (LOSS)  BEFORE INCOME TAXES
            
            
            7,522
            
            
            
            458
            
            
            
            (1,435
            )
            
            
            —
            
            
            
            6,545INCOME
      TAX  EXPENSE (BENEFIT)
            
            
            3,118
            
            
            
            412
            
            
            
            (688
            )
            
            
            
            
            
            
            2,842MINORITY
      INTEREST IN LOSS OF  SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            (54
            )
            
            
            
            
            
            
            (54
            )EQUITY
      IN (LOSS) INCOME OF SUBSIDIARIES, NET OF TAX
            
            
            (647
            )
            
            
            —
            
            
            
            —
            
            
            
            647
            
            
            
            —NET
      INCOME (LOSS)
            
            $
            3,757
            
            
            $
            46
            
            
            $
            (693
            )
            
            $
            647
            
            
            $
            3,757




18


Condensed Consolidating Statements of
Operations


For
the Three Months Ended June 30, 2007


(In
thousands) (Unaudited) (Restated)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            10
            
            
            $
            110,772
            
            
            $
            3,602
            
            
            $
            —
            
            
            $
            114,384Other
      revenue
            
            
            2
            
            
            
            1,398
            
            
            
            9
            
            
            
            
            
            
            
            1,409Management
      fee revenue
            
            
            19,688
            
            
            
            —
            
            
            
            —
            
            
            
            (19,688
            )
            
            
            —Total
      net revenue
            
            
            19,700
            
            
            
            112,170
            
            
            
            3,611
            
            
            
            (19,688
            )
            
            
            115,793OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            3,385
            
            
            
            51,486
            
            
            
            1,509
            
            
            
            
            
            
            
            56,380Supplies,
      facilities and other operating costs
            
            
            2,251
            
            
            
            28,886
            
            
            
            2,247
            
            
            
            
            
            
            
            33,384Provision
      for doubtful accounts
            
            
            —
            
            
            
            1,513
            
            
            
            12
            
            
            
            
            
            
            
            1,525Depreciation
      and amortization
            
            
            508
            
            
            
            5,049
            
            
            
            64
            
            
            
            
            
            
            
            5,621Management
      fee expense
            
            
            —
            
            
            
            18,846
            
            
            
            842
            
            
            
            (19,688
            )
            
            
            —Total
      operating expenses
            
            
            6,144
            
            
            
            105,780
            
            
            
            4,674
            
            
            
            (19,688
            )
            
            
            96,910INCOME
      (LOSS) FROM OPERATIONS
            
            
            13,556
            
            
            
            6,390
            
            
            
            (1,063
            )
            
            
            —
            
            
            
            18,883INTEREST
      EXPENSE, NET
            
            
            (14,595
            )
            
            
            (218
            )
            
            
            —
            
            
            
            
            
            
            
            (14,813
            )OTHER
      INCOME (EXPENSE)
            
            
            767
            
            
            
            (1
            )
            
            
            —
            
            
            
            
            
            
            
            766(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (272
            )
            
            
            6,171
            
            
            
            (1,063
            )
            
            
            —
            
            
            
            4,836INCOME
      TAX (BENEFIT) EXPENSE
            
            
            (111
            )
            
            
            2,519
            
            
            
            (434
            )
            
            
            
            
            
            
            1,974MINORITY
      INTEREST IN LOSS OF  SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            (52
            )
            
            
            
            
            
            
            (52
            )EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
            
            
            3,075
            
            
            
            —
            
            
            
            —
            
            
            
            (3,075
            )
            
            
            —NET
      INCOME (LOSS)
            
            $
            2,914
            
            
            $
            3,652
            
            
            $
            (577
            )
            
            $
            (3,075
            )
            
            $
            2,914




19


Condensed Consolidating Statements of
Operations


For
the Six Months Ended June 30, 2008


(In
thousands) (Unaudited)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            12
            
            
            $
            225,802
            
            
            $
            8,554
            
            
            $
            —
            
            
            $
            234,368Other
      revenue
            
            
            6
            
            
            
            3,973
            
            
            
            —
            
            
            
            
            
            
            
            3,979Management
      fee revenue
            
            
            38,681
            
            
            
            —
            
            
            
            —
            
            
            
            (38,681
            )
            
            
            —Total
      net revenue
            
            
            38,699
            
            
            
            229,775
            
            
            
            8,554
            
            
            
            (38,681
            )
            
            
            238,347OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            8,176
            
            
            
            109,860
            
            
            
            4,494
            
            
            
            
            
            
            
            122,530Supplies,
      facilities and other operating costs
            
            
            3,984
            
            
            
            61,393
            
            
            
            5,277
            
            
            
            
            
            
            
            70,654Provision
      for doubtful accounts
            
            
            8
            
            
            
            3,205
            
            
            
            82
            
            
            
            
            
            
            
            3,295Depreciation
      and amortization
            
            
            1,124
            
            
            
            9,962
            
            
            
            328
            
            
            
            
            
            
            
            11,414Management
      fee expense
            
            
            —
            
            
            
            37,307
            
            
            
            1,374
            
            
            
            (38,681
            )
            
            
            —Total
      operating expenses
            
            
            13,292
            
            
            
            221,727
            
            
            
            11,555
            
            
            
            (38,681
            )
            
            
            207,893INCOME
      (LOSS) FROM OPERATIONS
            
            
            25,407
            
            
            
            8,048
            
            
            
            (3,001
            )
            
            
            —
            
            
            
            30,454INTEREST
      EXPENSE, NET
            
            
            (26,647
            )
            
            
            (375
            )
            
            
            —
            
            
            
            
            
            
            
            (27,022
            )OTHER
      EXPENSE
            
            
            (33
            )
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            (33
            )(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (1,273
            )
            
            
            7,673
            
            
            
            (3,001
            )
            
            
            —
            
            
            
            3,399INCOME
      TAX (BENEFIT) EXPENSE
            
            
            (571
            )
            
            
            3,439
            
            
            
            (1,345
            )
            
            
            
            
            
            
            1,523MINORITY
      INTEREST IN LOSS OF  SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            (357
            )
            
            
            
            
            
            
            (357
            )EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
            
            
            2,935
            
            
            
            —
            
            
            
            —
            
            
            
            (2,935
            )
            
            
            —NET
      INCOME (LOSS)
            
            $
            2,233
            
            
            $
            4,234
            
            
            $
            (1,299
            )
            
            $
            (2,935
            )
            
            $
            2,233




20


Condensed Consolidating Statements of
Operations


For
the Six Months Ended June 30, 2007


(In
thousands) (Unaudited) (Restated)




CRC
      Health
              Corporation
            
            
            Subsidiary
              Guarantors
            
            
            Subsidiary
              Non-Guarantors
            
            
            Eliminations
            
            
            ConsolidatedNET
      REVENUE:Net
      client service revenue
            
            $
            14
            
            
            $
            214,882
            
            
            $
            5,970
            
            
            $
            —
            
            
            $
            220,866Other
      revenue
            
            
            4
            
            
            
            2,836
            
            
            
            17
            
            
            
            
            
            
            
            2,857Management
      fee revenue
            
            
            39,138
            
            
            
            —
            
            
            
            —
            
            
            
            (39,138
            )
            
            
            —Total
      net revenue
            
            
            39,156
            
            
            
            217,718
            
            
            
            5,987
            
            
            
            (39,138
            )
            
            
            223,723OPERATING
      EXPENSES:Salaries
      and benefits
            
            
            6,822
            
            
            
            102,184
            
            
            
            2,682
            
            
            
            
            
            
            
            111,688Supplies,
      facilities and other operating costs
            
            
            4,245
            
            
            
            56,107
            
            
            
            3,809
            
            
            
            
            
            
            
            64,161Provision
      for doubtful accounts
            
            
            (1
            )
            
            
            3,017
            
            
            
            12
            
            
            
            
            
            
            
            3,028Depreciation
      and amortization
            
            
            1,087
            
            
            
            9,712
            
            
            
            114
            
            
            
            
            
            
            
            10,913Management
      fee expense
            
            
            —
            
            
            
            37,742
            
            
            
            1,396
            
            
            
            (39,138
            )
            
            
            —Total
      operating expenses
            
            
            12,153
            
            
            
            208,762
            
            
            
            8,013
            
            
            
            (39,138
            )
            
            
            189,790INCOME
      (LOSS) FROM OPERATIONS
            
            
            27,003
            
            
            
            8,956
            
            
            
            (2,026
            )
            
            
            —
            
            
            
            33,933INTEREST
      EXPENSE, NET
            
            
            (29,397
            )
            
            
            (404
            )
            
            
            (1
            )
            
            
            
            
            
            
            (29,802
            )OTHER
      INCOME (EXPENSE)
            
            
            430
            
            
            
            29
            
            
            
            (1
            )
            
            
            
            
            
            
            458(LOSS)
      INCOME BEFORE INCOME TAXES
            
            
            (1,964
            )
            
            
            8,581
            
            
            
            (2,028
            )
            
            
            —
            
            
            
            4,589INCOME
      TAX (BENEFIT) EXPENSE
            
            
            (802
            )
            
            
            3,503
            
            
            
            (828
            )
            
            
            
            
            
            
            1,873MINORITY
      INTEREST IN LOSS OF  SUBSIDIARIES
            
            
            —
            
            
            
            —
            
            
            
            (152
            )
            
            
            
            
            
            
            (152
            )EQUITY
      IN INCOME OF SUBSIDIARIES, NET OF TAX
            
            
            4,030
            
            
            
            —
            
            
            
            —
            
            
            
            (4,030
            )
            
            
            —NET
      INCOME (LOSS)
            
            $
            2,868
            
            
            $
            5,078
            
            
            $
            (1,048
            )
            
            $
            (4,030
            )
            
            $
            2,868




21




Condensed Consolidating Statements of Cash
Flows
 For
the Six Months Ended June 30, 2008
 (In
thousands) (Unaudited)
  CRC
      Health
                Corporation
              
              
              Subsidiary
                Guarantors
              
              
              Subsidiary
                Non-Guarantors
              
              
              Eliminations
              
              
              ConsolidatedCASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      cash provided by operating activities
              
              $
              2,777
              
              
              $
              14,354
              
              
              $
              3,700
              
              
              $
              —
              
              
              $
              20,831CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (2,987
              )
              
              
              (9,213
              )
              
              
              (323
              )
              
              
              
              
              
              
              (12,523
              )Proceeds
      from sale of property and equipment
              
              
              
              
              
              
              55
              
              
              
              
              
              
              
              
              
              
              
              55Prior
      period acquisition adjustments
              
              
              
              
              
              
              (33
              )
              
              
              
              
              
              
              
              
              
              
              (33
              )Payments
      made under earnout arrangements
              
              
              (2,531
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (2,531
              )Net
      cash used in investing activities
              
              
              (5,518
              )
              
              
              (9,191
              )
              
              
              (323
              )
              
              
              —
              
              
              
              (15,032
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              3,278
              
              
              
              (566
              )
              
              
              (2,712
              )
              
              
              
              
              
              
              —Capital
      distributed to Parent
              
              
              (305
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (305
              )Capitalizedfinancing
      costs
              
              
              (136
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (136
              )Repayments
      of capital lease obligations
              
              
              
              
              
              
              (11
              )
              
              
              
              
              
              
              
              
              
              
              (11
              )Net
      borrowings under revolving line of credit
              
              
              4,000
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,000Repayments
      of long-term debt
              
              
              (4,096
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (4,096
              )Net
      cash provided by (used in) financing activities
              
              
              2,741
              
              
              
              (577
              )
              
              
              (2,712
              )
              
              
              —
              
              
              
              (548
              )INCREASE
      IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              4,586
              
              
              
              665
              
              
              
              —
              
              
              
              5,251CASH
      AND CASH EQUIVALENTS Beginning of period
              
              
              —
              
              
              
              4,929
              
              
              
              189
              
              
              
              —
              
              
              
              5,118CASH
      AND CASH EQUIVALENTS End of period
              
              $
              —
              
              
              $
              9,515
              
              
              $
              854
              
              
              $
              —
              
              
              $
              10,369


22




Condensed Consolidating Statements of Cash
Flows
 For
the Six Months Ended June 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
              
              $
              6,634
              
              
              $
              11,848
              
              
              $
              2,494
              
              
              $
              —
              
              
              $
              20,976CASH
      FLOWS FROM INVESTING ACTIVITIES:Additions
      of property and equipment
              
              
              (1,667
              )
              
              
              (12,854
              )
              
              
              (447
              )
              
              
              
              
              
              
              (14,968
              )Proceeds
      from sale of property and equipment
              
              
              
              
              
              
              29
              
              
              
              
              
              
              
              
              
              
              
              29Acquisition
      of businesses, net of cash acquired
              
              
              (1,085
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,085
              )Prior
      period acquisition adjustments
              
              
              
              
              
              
              1,029
              
              
              
              
              
              
              
              
              
              
              
              1,029Net
      cash used in investing activities
              
              
              (2,752
              )
              
              
              (11,796
              )
              
              
              (447
              )
              
              
              —
              
              
              
              (14,995
              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Intercompany
      transfers
              
              
              3,009
              
              
              
              (908
              )
              
              
              (2,101
              )
              
              
              
              
              
              
              —Capitalizedfinancing
      costs
              
              
              (622
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (622
              )Repayments
      of capital lease obligations
              
              
              
              
              
              
              (104
              )
              
              
              
              
              
              
              
              
              
              
              (104
              )Net
      repaymentsunder
      revolving line of credit
              
              
              (3,600
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (3,600
              )Repayments
      of long-term debt
              
              
              (2,669
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (2,669
              )Net
      cash used in financing activities
              
              
              (3,882
              )
              
              
              (1,012
              )
              
              
              (2,101
              )
              
              
              
              
              
              
              (6,995
              )DECREASE
      IN CASH AND CASH EQUIVALENTS
              
              
              —
              
              
              
              (960
              )
              
              
              (54
              )
              
              
              —
              
              
              
              (1,014
              )CASH
      AND CASH EQUIVALENTS Beginning of period
              
              
              —
              
              
              
              4,167
              
              
              
              39
              
              
              
              —
              
              
              
              4,206CASH
      AND CASH EQUIVALENTS End of period
              
              $
              —
              
              
              $
              3,207
              
              
              $
              (15
              )
              
              $
              —
              
              
              $
              3,192




23


15.
            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 June 30, 2008, the recovery segment provided
substance abuse and behavioral health services to patients at 106 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 June 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 June 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 5, 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.







24




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




Three
              Months Ended
              June 30,
              2008
            
            
            Three
              Months Ended
              June 30,
              2007
            
            
            Six
              Months Ended
              June
      30,
              2008
            
            
            Six
              Months Ended
              June
      30,
              2007Net
      revenue:Recovery
      division
            
            $
            78,778
            
            
            $
            72,057
            
            
            $
            156,014
            
            
            $
            142,464Youth
      division
            
            
            36,167
            
            
            
            38,489
            
            
            
            69,081
            
            
            
            72,468Corporate/other
            
            
            7,347
            
            
            
            5,247
            
            
            
            13,252
            
            
            
            8,791Total
      consolidated net revenue
            
            $
            122,292
            
            
            $
            115,793
            
            
            $
            238,347
            
            
            $
            223,723Operating
      expenses:Recovery
      division
            
            $
            56,329
            
            
            $
            51,244
            
            
            $
            112,789
            
            
            $
            101,861Youth
      division
            
            
            34,203
            
            
            
            34,820
            
            
            
            67,338
            
            
            
            67,511Corporate/other
            
            
            14,295
            
            
            
            10,846
            
            
            
            27,766
            
            
            
            20,418Total
      consolidated operating expenses
            
            $
            104,827
            
            
            $
            96,910
            
            
            $
            207,893
            
            
            $
            189,790Income
      from operations:Recovery
      division
            
            $
            22,449
            
            
            $
            20,813
            
            
            $
            43,225
            
            
            $
            40,603Youth
      division
            
            
            1,964
            
            
            
            3,669
            
            
            
            1,743
            
            
            
            4,957Corporate/other
            
            
            (6,948
            )
            
            
            (5,599
            )
            
            
            (14,514
            )
            
            
            (11,627
            )Total
      consolidated income from operations
            
            $
            17,465
            
            
            $
            18,883
            
            
            $
            30,454
            
            
            $
            33,933Income
      (loss) from operations before income taxes:Total
      consolidated income from operations
            
            $
            17,465
            
            
            $
            18,883
            
            
            $
            30,454
            
            
            $
            33,933Interest
      expense, net
            
            
            (12,505
            )
            
            
            (14,813
            )
            
            
            (27,022
            )
            
            
            (29,802
            )Other
      income (expense)
            
            
            1,585
            
            
            
            766
            
            
            
            (33
            )
            
            
            458Total
      consolidated income before income taxes
            
            $
            6,545
            
            
            $
            4,836
            
            
            $
            3,399
            
            
            $
            4,589Capital
      expenditures:Recovery
      division
            
            $
            3,274
            
            
            $
            5,668
            
            
            $
            5,715
            
            
            $
            9,270Youth
      division
            
            
            1,412
            
            
            
            1,611
            
            
            
            2,745
            
            
            
            2,920Corporate/other
            
            
            2,054
            
            
            
            1,714
            
            
            
            4,063
            
            
            
            2,778Total
      consolidated capital expenditures
            
            $
            6,740
            
            
            $
            8,993
            
            
            $
            12,523
            
            
            $
            14,968June
      30,
              2008
            
            
            December 31,
              2007(Restated)Total
      assets:Recovery
      division
            
            
            
            
            
            
            
            
            
            $
            891,313
            
            
            $
            891,556Youth
      division
            
            
            
            
            
            
            
            
            
            
            349,756
            
            
            
            348,224Corporate/other
            
            
            
            
            
            
            
            
            
            
            85,867
            
            
            
            82,511Total
      consolidated assets
            
            
            
            
            
            
            
            
            
            $
            1,326,936
            
            
            $
            1,322,291




25


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




The
following discussion should be read in conjunction with the 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 15 to the condensed consolidated
financial statements). As of June 30, 2008, our recovery division, which
operates the 28 inpatient and 78 outpatient facilities in 22 states, provides
treatment services to patients suffering from chronic addiction related diseases
and related behavioral disorders. As of June 30, 2008, our recovery division
treated approximately 28,000 patients per day. As of June 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 second fiscal quarter ended on June
30. Unless otherwise stated, all year and quarterly dates refer to our fiscal
year or our second fiscal quarter, respectively.




Management
is responsible for the fair presentation of the accompanying 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
June 30, 2008 and 2007,we generated 84.5% and 86.4% of our net revenue from
non-governmental sources, including 68.8% and 71.4% from self payors,
respectively, and 15.7% and 15.0% from commercial payors, respectively. During
the six months ended June 30, 2008 and 2007, we generated 84.3% and
86.4%




26


of our
net revenue from non-governmental sources, including 68.7% and 71.4% from self
payors, respectively, and 15.6% and 15.0% 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 June 30, 2008, our consolidated same-facility net
revenue increased by $1.1 million or 1.0% when compared to the comparable period
in 2007.  For the six months ended June 30, 2008, our consolidated,
same-facility revenue increased $2.2 million or 1.0% 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 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 six months ended June 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.




27


RESULTS
OF OPERATIONS




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




Three
      Months Ended June 30,
            
            
            Six
      Months Ended June 30,Statement
      of Income Data:
            
            2008
            
            
            %
            
            
            2007
            
            
            %
            
            
            2008
            
            
            %
            
            
            2007
            
            
            %Net
      revenue:Recovery
      division
            
            $
            78,778
            
            
            
            64.4
            %
            
            $
            72,057
            
            
            
            62.3
            %
            
            $
            156,014
            
            
            
            65.5
            %
            
            $
            142,464
            
            
            
            63.7
            %Youth
      division
            
            
            36,167
            
            
            
            29.6
            %
            
            
            38,489
            
            
            
            33.2
            %
            
            
            69,081
            
            
            
            29.0
            %
            
            
            72,468
            
            
            
            32.4
            %Corporate
      / other(1)
            
            
            7,347
            
            
            
            6.0
            %
            
            
            5,247
            
            
            
            4.5
            %
            
            
            13,252
            
            
            
            5.5
            %
            
            
            8,791
            
            
            
            3.9
            %Total
      revenue
            
            
            122,292
            
            
            
            100.0
            %
            
            
            115,793
            
            
            
            100
            %
            
            
            238,347
            
            
            
            100.0
            %
            
            
            223,723
            
            
            
            100
            %Operating
      expenses:Recovery
      division
            
            
            56,329
            
            
            
            46.0
            %
            
            
            51,244
            
            
            
            44.2
            %
            
            
            112,789
            
            
            
            47.3
            %
            
            
            101,861
            
            
            
            45.5
            %Youth
      division
            
            
            34,203
            
            
            
            28.0
            %
            
            
            34,820
            
            
            
            30.1
            %
            
            
            67,338
            
            
            
            28.3
            %
            
            
            67,511
            
            
            
            30.2
            %Corporate
      / other(1)
            
            
            14,295
            
            
            
            11.7
            %
            
            
            10,846
            
            
            
            9.4
            %
            
            
            27,766
            
            
            
            11.6
            %
            
            
            20,418
            
            
            
            9.1
            %Total
      operating expenses
            
            
            104,827
            
            
            
            85.7
            %
            
            
            96,910
            
            
            
            83.7
            %
            
            
            207,893
            
            
            
            87.2
            %
            
            
            189,790
            
            
            
            84.8
            %Income
      from operations:Recovery
      division
            
            
            22,449
            
            
            
            18.4
            %
            
            
            20,813
            
            
            
            18.0
            %
            
            
            43,225
            
            
            
            18.1
            %
            
            
            40,603
            
            
            
            18.1
            %Youth
      division
            
            
            1,964
            
            
            
            1.6
            %
            
            
            3,669
            
            
            
            3.2
            %
            
            
            1,743
            
            
            
            0.7
            %
            
            
            4,957
            
            
            
            2.2
            %Corporate
      / other(1)
            
            
            (6,948
            )
            
            
            (5.7
            )%
            
            
            (5,599
            )
            
            
            (4.8
            )%
            
            
            (14,514
            )
            
            
            (6.0
            )%
            
            
            (11,627
            )
            
            
            (5.2
            )%Income
      from operations
            
            
            17,465
            
            
            
            14.3
            %
            
            
            18,883
            
            
            
            16.4
            %
            
            
            30,454
            
            
            
            12.8
            %
            
            
            33,933
            
            
            
            15.1
            %Interest
      expense, net
            
            
            (12,505
            )
            
            
            
            
            
            
            (14,813
            )
            
            
            
            
            
            
            (27,022
            )
            
            
            
            
            
            
            (29,802
            )Other
      income (expense)
            
            
            1,585
            
            
            
            
            
            
            
            766
            
            
            
            
            
            
            
            (33
            )
            
            
            
            
            
            
            458Income
      before income taxes
            
            
            6,545
            
            
            
            
            
            
            
            4,836
            
            
            
            
            
            
            
            3,399
            
            
            
            
            
            
            
            4,589Income
      tax expense
            
            
            2,842
            
            
            
            
            
            
            
            1,974
            
            
            
            
            
            
            
            1,523
            
            
            
            
            
            
            
            1,873Minority
      interest in loss of a subsidiary
            
            
            (54
            )
            
            
            
            
            
            
            (52
            )
            
            
            
            
            
            
            (357
            )
            
            
            
            
            
            
            (152
            )Net
      income
            
            $
            3,757
            
            
            
            
            
            
            $
            2,914
            
            
            
            
            
            
            $
            2,233
            
            
            
            
            
            
            $
            2,868






(1)
            Includes
      our healthy living division.




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




Consolidated
net revenue increased $6.5 million, or 5.6%, to $122.3 million in 2008 from
$115.8 million in 2007. Of the total net revenue increase, the recovery division
contributed $6.7 million, representing 9.3% growth for the division, with
the remaining net revenue growth driven by an increase of $2.1 million, or 40.0%
in corporate/other.  Total net revenue growth was partially offset by
a net revenue decrease in the youth division of $2.3 million, or 6.0%. Excluding
the one-time effect of a $0.5 million unearned revenue adjustment related
to the Aspen acquisition during the three months ended June 30, 2007, our youth
division revenue decreased $2.8 million, or 7.2%, during the three months ended
June 30, 2008. Of the $2.8 million decrease in youth division revenue, $1.9
million is attributed to a single therapeutic boarding school that experienced a
significant increase in student graduations and other student departures
beginning the quarter ended September 30, 2007 without a commensurate increase
in new enrollments. We believe, in addition to the impact of this boarding
school, that there has been a slight lessening in demand as a result 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 $3.9 million, or 10.3%, 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 growth of $4.6 million, or 6.5%. The
remaining $2.1 million increase resulted from an acquisition, completed in the
quarter ended September 30, 2007 and startups.  Of the $2.1
million net revenue increase in corporate/other, $0.5 million, or 9.4%, was due
to same facility growth and $1.6 million was contributed by start-ups and
by  acquisitions completed in the three months ended September 30,
2007.




Consolidated
operating expenses increased $7.9 million, or 8.2%, to $104.8 million for
the three months ended June 30, 2008 from $96.9 million in the same period of
2007. Of the $7.9 million increase in operating expenses, the recovery
division incurred an increase of $5.1 million, or 10.0%, corporate/other
incurred an increase of $3.4 million, or 31.9%, and our youth division
incurred a decrease of $0.6 million, or 1.8%. For our recovery division,
same-facility increase in operating expenses was $3.5 million, or 7.5%,
acquisition-related increase was $1.0 million, and startup related increase was
$0.6 million. For corporate/other, same-facility




28


increases
in operating expenses were $0.6 million, or 15.0%. Of the remaining growth,
$1.2 million was related to acquisitions,$0.6 million
ofstart-up
related growth and a remaining increase of $1.0 million due to corporate and
divisional administrative costs.




Our
consolidated operating margin was 14.3% in the quarter ended June 30, 2008
compared to 16.3% in the quarter ended June 30, 2007. On a same-facility basis,
our consolidated operating margin decreased to 29.4% in the quarter ended June
30, 2008 compared to 32.9% in the quarter ended June 30, 2007. Recovery division
same-facility operating margin decreased to 36.6% in the quarter ended June 30,
2008 compared to 37.5% in the quarter ended June 30, 2007. Youth division
same-facility operating margin decreased to 15.8% in the quarter ended June 30,
2008 compared to 26.1% in the quarter ended June 30, 2007. The significant
decrease in our youth division operating margin is in part due to a decrease of
$2.0 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 13.8% in the quarter ended June 30, 2008 compared to 18.0%
in the quarter ended June 30, 2007.




For the
three months ended June 30, 2008, consolidated net income increased by $0.8
million compared to the same period in 2007. The increase in net income in 2008
was primarily attributable to a $6.5 million increase in revenue, a reduction of
interest expense of $2.3 million, and interest swap gains of $0.8 million,
partially offset by increased operating expenses of $7.9 million and an increase
in income tax expense of $0.9 million when compared to the same period in 2007.
The effective tax rate for the three months ended June 30, 2008 was 43.4%
compared to 40.8% in the same period of 2007.




Six
Months Ended June 30, 2008 Compared to Six Months Ended June 30,
2007




Consolidated
net revenue increased $14.6 million, or 6.5%, to $238.3 million in 2008 from
$223.7 million in 2007. Of the $14.6 million increase, the recovery division
contributed $13.6 million, representing 9.5% growth for the division, and the
remaining net revenue growth was driven by a net revenue increase of $4.5
million, or 50.7% in corporate/other. Our youth division had a net revenue
decrease of $3.4 million, or 4.8%. Excluding the one-time effect of a
$2.6 million unearned revenue adjustment related to the Aspen acquisition
during the six months ended June 30, 2007, the our youth division revenue
decreased $6.0 million, or 8.0% during the six months ended June 30, 2008.
Of the $6.0 million decrease in youth division revenue, $4.1 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 $8.2
million, or 11.1% due in part 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 $9.3 million, or 6.6%. The remaining $4.2 million
increase resulted from an acquisition, completed in the quarter ended
September 30, 2007 and startups.  Of the $4.5 million net revenue
increase in corporate/other, $1.1 million or 13.3% was due to same facility
growth and $3.4 million was contributed by start-ups and by an acquisition
completed in the three months ended September 30, 2007.





Consolidated
operating expenses increased $18.1 million, or 9.5%, to $207.9 million
in 2008 from $189.8 million in 2007. Of the $18.1 million increase in
operating expenses, the recovery division incurred an increase of
$10.9 million, or 10.7%, corporate/other incurred an increase of
$7.3 million, or 36.1%, and our youth division incurred a decrease of $0.2
million, or 0.3%. For our recovery division, same-facility increase in operating
expenses was $8.0 million, or 9.1%, and acquisition-related increase was
$2.1 million while startups and divisional administrative costs contributed
$0.8 million in operating expenses. For corporate/other, same-facility increase
in operating expenses was $1.2 million, or 17.2%. Of the remaining increase,
$2.4 million was related to an acquisition completed in the quarter ended
September 30, 2007 and a $3.7 million increase due to start-up related growth
and increases in corporate and divisional administrative costs.




Our
consolidated operating margin was 12.8% for the six months ended June 30, 2008
compared to 15.2% for the six months ended June 30, 2007. On a same-facility
basis, our consolidated operating margin decreased to 28.4% for the six months
ended June 30, 2008 as compared to 32.4% for the six months ended June 30, 2007.
Recovery division same-facility operating margin decreased to 35.7% for the six
months ended June 30, 2008 as compared to 37.2% for the six months ended June
30, 2007. Youth division same-facility operating margin decreased to 14.3% for
the six months ended June 30, 2008 as compared to 25.5% for the six months ended
June 30, 2007. The significant decrease in our youth division operating margin
is in part due to a decrease of $4.1 million in revenue from one single
therapeutic boarding school, and the remaining decline is generally attributable
to lower census in the remaining youth division programs. Corporate/other
same-facility operating margin decreased to 10.8% for the six months ended June
30, 2008 as compared to 13.8% for the six months ended June 30,
2007.




For the
six months ended June 30, 2008, consolidated net income decreased by $0.6
million compared to the same period in 2007. The decrease in net income in 2008
was driven by an increase in operating expense of $18.1 million, partially
offset by revenue growth of $14.6 million and a reduction in interest expense of
$2.8 million when compared to the same period in 2007. The effective tax rate
for the six months ended June 30, 2008 was 44.8% compared to 40.8% for the same
period of 2007.




29


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 $58.4 million at June 30, 2008, compared to negative
working capital of $56.5 million at December 31, 2007. The decrease in
working capital from June 30, 2008 compared to December 31, 2007 was
primarily attributable to an increase of $4.0 million in current debt related to
the revolving portion of our senior secured credit facilities and an increase of
$1.1 million in income tax liabilities. The increase in current debt was
partially offset by a slight decrease in accounts payables as well as by a
decrease in the current portion of long term debt.




Sources
and Uses of Cash
  Six
      Months Ended
                June
      30,2008
              
              
              2007(In
      thousands)Net
      cash provided by operating activities
              
              $
              20,831
              
              
              $
              20,976Net
      cash used in investing activities
              
              
              (15,032
              )
              
              
              (14,995
              )Net
      cash used in financing activities
              
              
              (548
              )
              
              
              (6,995
              )Net
      increase (decrease) in cash
              
              $
              5,251
              
              
              $
              (1,014
              )
   Cash used
provided by operating activities was $20.8 million
for the six months ended June 30, 2008 compared to cash provided in operating
activities of $21.0 million during the same period in 2007.
  Cash used
in investing activities was $15.0 million
in for the six months ended June 30, 2008 compared to $15.0 million in the same
period of 2007.
  Cash used
in financing activities was $0.5 million for the six months ended June 30, 2008
compared to $7.0 million for the same period in 2007. The decrease in cash used
in financing activities is due to net increases of $7.6 million in borrowing
under the revolving line of credit.  Such increases were partially
offset by increases of $1.4 million in repayments of long term
debt.




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 June 30, 2008, our senior secured
credit facility was comprised of a $411.9 million senior secured term loan
facility and a $100.0 million revolving credit facility. At June 30, 2008, the
revolving credit facility had $62.3 million available for borrowing, $30.5
million outstanding and classified on our balance sheet as current portion of
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 June 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 and
currently intend to make payments to reduce borrowing under the revolving line
of credit from operating cash flow. In addition, we expect that future
financings will serve not only to partially fund acquisitions but also to repay
all or part of any outstanding revolving line of credit balances then
outstanding. In negotiating such financing, there can be no assurance that we
will be able to raise additional capital on terms satisfactory to us. Failure to
obtain additional financing on reasonable terms could have a negative effect on
our plans to acquire additional treatment facilities. We expect to spend
approximately $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 June 30,
2008, we were in compliance with all such covenants.




30


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 $80 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 contain
contingent earnout provisions that provide for additional payments if the
acquisitions meet performance milestones as specified in the agreements. For the
six months ended June 30, 2008, we incurred liabilities of $0.6 million
associated with earnout obligations and made payments of $2.5 million. We have
no future obligations for additional liabilities associated with such
earnouts.









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 June 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.




31


PART II.
OTHER INFORMATION




Item 1A.
            Risk Factors




As of
June 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 5.                      Other Information




On July 15, 2008, Mr. James Hudak
joined the Company as Chief Administrative Officer. Mr. Hudak previously
held executive positions at United Health Care. A graduate of Yale University,
Mr. Hudak previously spent nearly 20 years with Accenture (formerly Anderson
Consulting) as Global Managing Partner to their Health Services division.
Mr. Hudak's role will include responsibility for Information
Technology, Human Resources, Risk Management and Finance.




Item 6.                      Exhibits




The
Exhibit Index beginning on page 34 of this report sets forth a list of
exhibits.




32


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:
August 12, 2008


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




33


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)4.1g
            Form
      of Seventh Supplemental Indenture dated as of May 23, 2008, by and among
      CRC Health Corporation, the Guarantors named therein, the New Guarantor
      named therein and U.S. Bank National Association, as Trustee, with respect
      to the 10 3 / 4 % Senior Subordinated Notes due 2016 ‡10.2h
            Form
      of SUPPLEMENT NO. 8 dated as of May 23, 2008, to the Security Agreement
      dated as of February 6, 2006 among CRC Health Corporation (f/k/a CRC
      Health Group, Inc.), CRC Health Group, Inc. (f/k/a/ CRCA Holdings, Inc.),
      and the Subsidiary of the Borrower identified therein and Citibank, N.A.,
      as collateral Agent for the Secured Parties, as defined therein.
      ‡10.3h
            Form
      of SUPPLEMENT NO. 8 dated as of May 23, 2008, to the Guarantee Agreement
      dated as of February 6, 2006, among CRC Health Group, Inc., CRC Health
      Corporation, the Subsidiary of the Borrower identified therein and
      Citibank, N.A., as Administrative Agent. ‡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.